The Delaware Supreme Court recently upheld, in Gatz Properties v. Auriga Capital, C.A. No. 4390 (Del. Nov. 7, 2012), the Delaware Court of Chancery's opinion that a limited liability company agreement imposed fiduciary duties upon a manager and that the manager of that limited liability company had violated those duties. However, in doing so, the Supreme Court explicitly stated that the Chancery Court should not have held that Delaware limited liability law imposes fiduciary duties by default.
Peconic Bay LLC was a Delaware limited liability company formed by Gatz Properties LLC, Auriga Capital Corp. and other minority investors for the purpose of holding a long-term lease and to develop a golf course on certain property. Under Peconic's limited liability company agreement, Gatz Properties was designated as Peconic's manager. The golf course was never profitable. William Gatz, who managed and controlled Gatz Properties, received offers from a third party to purchase Peconic's interest in the lease. Gatz rejected these offers and, ultimately, engineered an auction process for Peconic's assets that the court found was poorly publicized and was based upon incomplete information. Ultimately, Gatz himself was the only bidder at the auction and purchased Peconic's assets for what the minority members claimed was far less than fair value. The minority members commenced an action claiming, among other things, that Gatz Properties had breached its fiduciary duties under the LLC agreement.
CONTRACTUAL FIDUCIARY DUTIES
Section 15 of the LLC agreement provided:
"Neither the manager nor any other member shall be entitled to cause the company to ... enter into any additional agreements with affiliates on terms and conditions which are less favorable to the company than the terms and conditions of similar agreements which could then be entered into with arms-length third parties, without the consent of a majority of the non-affiliated members (such majority to be deemed to be the holders of 66-2/3 percent of all interests which are not held by affiliates of the person or entity that would be a party to the proposed agreement)."
The court agreed with the Delaware Court of Chancery that this language contractually imposed fiduciary duties upon Gatz Properties, as Peconic's manager, with respect to transactions between Peconic and its affiliates, and that Gatz Properties had breached those fiduciary duties by holding an unfair auction process.
As stated by the court, the language in Section 15 "is the contractual equivalent of the entire fairness equitable standard of conduct and judicial review," which required that any affiliate transaction be subject to a "fair price" obligation, unless approved by a majority of the minority members. The court noted that this holding is consistent with its ruling in Gotham Partners v. Hallwood Realty Partners, 817 A.2d 160 (Del. 2002), in which the court affirmed the Delaware Court of Chancery's holding that a partnership agreement imposed entire fairness obligations with respect to affiliate transactions.
Moreover, the court stated that, had the sale of Peconic's assets to an affiliate been approved by an informed majority of the minority members, then the sale would not be subject to the entire fairness standard of review. As the court noted, this is different than what would have resulted under Delaware corporate law, in which a majority-of-the-minority vote would have shifted the burden of proof regarding the issue of fairness.
The court went on to conclude that Gatz Properties had not demonstrated that the sale of Peconic involved a fair price or fair dealing.
'DEFAULT' FIDUCIARY DUTIES
Although the Supreme Court upheld the Delaware Court of Chancery's holding upon contractual grounds, it also held that the Court of Chancery should not have held that the Delaware Limited Liability Company Act imposes "default" fiduciary duties on managers. The Court of Chancery's opinion in this regard must be "regarded as dictum without any precedential value" for several reasons.
First, the LLC agreement explicitly addressed the issue of whether Gatz Properties owed fiduciary duties to Peconic in the context of affiliate transactions.
Second, no party had asked either court to determine whether default fiduciary duties existed at law.
Third, the Court of Chancery should not have implied that the Delaware Supreme Court would be bound by the Court of Chancery's prior interpretations of the LLC Act that appear to provide for default fiduciary duties.
Fourth, there could be reasonable disagreement on the issue of whether the LLC Act does or does not impose default fiduciary duties. In fact, Section 1101(c) of the LLC Act, which allows a limited liability company agreement to eliminate or mitigate fiduciary duties, begins with: "to the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties)." This language is ambiguous (and perhaps intentionally so) because it implies, but does not expressly state, that fiduciary duties might exist under Delaware limited liability company law.
Finally, the Supreme Court reminded the Court of Chancery that a judicial opinion is not the proper forum for judges to "ruminate on what the proper direction of Delaware law should be." Rather, "a judge's duty is to resolve the issues that the parties present in a clear and concise manner."
Importantly, the court did not expressly state that default fiduciary duties do not apply in the context of Delaware limited liability companies. It merely "decline[d] to express any view regarding whether default fiduciary duties apply as a matter of statutory construction."
ADVICE FOR PRACTITIONERS
Delaware is still a jurisdiction in which freedom of contract reigns supreme, particularly in the context of limited liability companies, which are very much creatures of contract. Given the Delaware Supreme Court's holding in Gatz,however, practitioners should take care to expressly provide in a Delaware limited liability company's LLC agreement not only the extent to which fiduciary duties do not apply, but also the extent to which they do apply. For example, if the parties to a limited liability company agreement wish to provide for default fiduciary duties that are akin to those under the Delaware General Corporation Law, they might consider including language similar to the following:
"The manager [and the controlling member] hereby have fiduciary duties analogous to those imposed upon a Delaware corporation's directors [and controlling stockholders, respectively,] under the Delaware General Corporation Law and Delaware case law, except to the extent that those fiduciary duties are otherwise increased, reduced, eliminated or otherwise modified by this agreement."
This type of language arguably provides, in a contractual manner, the "default" fiduciary duties that the Delaware Court of Chancery was lobbying for, while still allowing parties to a limited liability company agreement to modify those duties to the extent permitted by the LLC Act.
Reprinted with permission from the December 5, 2012, issue of Delaware Business Court Insider. © 2012 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.