Delaware Chancery Court confirms that fiduciary duties apply to LLC managers in absence of contrary LLC agreement provisions and distinguishes the implied covenant of good faith and fair dealing
A Delaware LLC leased from and developed into a golf course
property owned by the LLC's manager and his family, which
subsequently gained voting control over the LLC. The golf course
was subleased to a golf management company, which mismanaged the
property. Recognizing the property's greater value unencumbered
by the lease, the manager sought to wrest from the minority LLC
members their interest in the property, as the sublease's term
approached. Rather than pursuing strategic alternatives as the
sublease expired, the manager discouraged and misled the minority
regarding an unsolicited third-party proposal to buy the lease and,
ultimately, pursuant to a buyout provision in the LLC agreement,
conducted a sham auction at which the manager was the only bidder.
The minority's claim for damages for breach of contract and
fiduciary duty afforded the Chancery Court, in Auriga Capital Corp. v. Gatz Properties,
LLC, C.A. 4390-CS, a forum to discuss how equitable and
legal principles govern conduct of LLC fiduciaries, as well as
specific contract provisions.
As is generally recognized, the Delaware LLC Act authorizes the
parties to an LLC agreement to modify or eliminate fiduciary duties
of an LLC's members and managers. However, the Act also
expressly provides that legal and equitable principles govern cases
not otherwise provided for by the statute. Therefore, Delaware
courts hold managers to traditional corporate fiduciary standards,
in absence of contrary language in an LLC agreement.
With respect to the manager's buyout of the minority at the
auction, the court interpreted an LLC agreement provision
authorizing arms-length transactions between the manager and the
LLC as substituting a fair-price requirement for an entire-fairness
analysis, but not as eliminating the fair-dealing element
altogether, because evidence of fair dealing is necessary to
establish fair price. In the case at hand, the manager's
conduct designed to discourage bids that would maximize value for
the minority substantially undermined his claim that the buyout
price was fair. Because not supplanted by express contract
language, traditional duties of loyalty and care applied to other
manager conduct. As described below, the court distinguished these
fiduciary duties from the implied covenant of good faith and fair
dealing, which cannot be eliminated by agreement.
That the manager and his family, as members, could have voted down
any third-party transaction did not relieve the manager of his
affirmative duty, as fiduciary, to maximize value for the minority.
Conduct characterized by the manager in relation to the minority as
"hardball" is inequitable and breaches the manager's
fiduciary duty.
An individual controlling an LLC's manager may have fiduciary
duties directly to the LLC.
From the perspective of measurement of damages, the manager may
not assert as a defense the uncertainty or decline in value of the
LLC's assets resulting from the manager's inequitable
conduct.
The court explained that the implied covenant of good faith and
fair dealing applies only when the express terms of a contract
indicate how the parties would have agreed on a disputed matter,
had they thought to negotiate the point. The terms "good
faith" and "fair dealing" do not have the same
meaning as the terms are used in the fiduciary duties context, and
the covenant, which arises under contract law, does not substitute
for general equitable principles. Courts are to apply the covenant
cautiously, to avoid re-writing the parties' agreements.
In addition to modest damages amounting to a return of investment
plus one percent per year, the chancellor took the unusual step of
awarding the minority a portion of the legal fees they incurred in
the litigation, because of defendant's bad faith conduct in the
litigation, evidenced by legally and factually implausible
assertions and an apparent aim to defend by attrition.
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