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CORPORATIONS: A Manager's Fiduciary Duty Under the Delaware LLC Act

1/23/2013

On January 27, 2012, the Delaware Chancery Court issued a 75-page slip opinion in Auriga Capital Corp. v. Gatz Properties, LLC, No. C.A. 4390-CS, 2012 WL 361677 (Del. Ch. Jan. 27, 2012) (slip op.), which holds that managers of Delaware limited liability companies ("LLCs") owe fiduciary duties of loyalty and care to their investors unless an express contractual provision exists that waives or modifies those duties.  The opinion is notable for the broad and comprehensive scope of the court's analysis of the Delaware LLC Act and its application to common-law principles of fiduciary duty.

The facts of Auriga Capital Corp. involved various egregious acts committed by Gatz, the majority owner and manager of a Delaware LLC, against the minority members of the company.  Gatz had entered into a long-term lease with a management company to manage the golf course owned by the LLC.  The management company managed the golf course poorly, and Gatz soon saw that an opportunity would present itself for him to both buy back the property at a bargain price and simultaneously squeeze out the minority investors.  Gatz then exercised his management powers within the LLC in a manner that ultimately resulted in an auction in which he was the only bidder and in which the same counsel represented him in his dual capacities as both manager of the LLC and auction bidder.

In its analysis, the court first noted that the Delaware LLC Act, like the Delaware General Corporations Law ("DGCL"), does not plainly state that traditional fiduciary duties of loyalty and care apply by default to LLC managers or members.  Id. at *8.  However, section 18-1104 of the LLC Act does state that "[i]n any case not provided for in this chapter, the rules of law and equity . . . shall govern."  Del. Code Ann. tit. 6, ' 18-1104.  Under traditional principles of equity, an LLC manager "would qualify as a fiduciary of that LLC and its members."  2012 WL 361677, at *8.  As a result, the court ruled that "the LLC Act starts with the default that managers of the LLCs owe enforceable fiduciary duties."  Id.  The court then conducted an extensive review of the history and statutory construction of the LLC Act and determined that the interpretation of the Act as imposing fiduciary duties on LLC managers by default "is confirmed by the Act's own history."  Id. at *9.

Although the LLC Act incorporates by default equitable principles, including fiduciary duty, the court emphasized that the statute also permits the parties to an LLC agreement "to entirely supplant those default principles or to modify them in part."  Id. at *9 & n.50.  If the LLC Agreement "clearly supplant[s] default principles in full," Delaware courts will give effect to the express contractual language.  Id. at *9 & n.52.

The court then cautioned that the implied covenant of good faith and fair dealing should not be confused with, or used as a replacement for, the principle of fiduciary duty.  "If, rather than well thought out fiduciary duty principles, the implied covenant is to be used as the sole default principle of equity, then the risk is that the certainty of contract law will itself be undermined."  Id. at *10.  This, in turn, would provide "room for subjective judicial oversight" and would therefore "inject unpredictability into both equity and contract law."  Id.  Moreover, "a judicial eradication of the explicit equity overlay in the LLC Act could tend to erode [Delaware's] credibility with investors in Delaware entities."  Id.

Under the LLC Agreement at issue in the case, Gatz had a fiduciary duty to manage the business loyally for the benefit of the company's members.  An affirmative aspect of the fiduciary duty of loyalty requires the fiduciary to take affirmative steps to protect the interests of the company committed to his charge.  A reasonable fiduciary in Gatz's position would have immediately searched for a replacement management company, assessed whether the LLC could operate the golf course profitably itself, or looked for a buyer to acquire the golf course or its assets.  Under the circumstances, Gatz's inaction amounted to a breach of fiduciary duty.

Further, by failing to take any steps to preserve the golf course's value, Gatz breached his fiduciary duty to deal fairly with the minority members of the LLC.  Toward this end, the court emphasized that a "fiduciary may not play 'hardball' with those to whom he owes fiduciary duties, and [Delaware] law provides recourse against disloyal fiduciaries or controllers who use their power to coerce the minority into submission."  Id. at *22.

Finally, in regard to damages, the court noted that any uncertainty in the determination of damages was to be resolved against Gatz as the wrongdoer.  In addition, the court awarded attorney's fees as part of the damages for Gatz's breach of fiduciary duty.  Interestingly, the court suggested that one reason it decided to impose attorney's fees against Gatz was because of Gatz's deletion of electronically stored information.

Because Delaware is the seminal authority for corporate and LLC law, Auriga Capital Corp. is an important decision.  The case provides useful guidelines for counsel involved not only in breach-of-fiduciary-duty claims but in any aspect of LLC formation and management.

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