Fiduciary Duties For Managers Of Delaware Limited Liability Companies

This advisory addresses certain key fiduciary duty concepts applicable to managers of limited liability companies ("LLCs"), with a particular focus on Delaware LLCs. The areas of discussion are: (1) a brief overview of fiduciary duties; (2) contracting for fiduciary duties; (3) default fiduciary duties in an otherwise silent LLC operating agreement; and (4) crafting fiduciary duty provisions for LLC operating agreements. Understanding these areas when forming or managing an LLC should minimize the likelihood that unexpected fiduciary duty issues will arise.

I. Overview of Fiduciary Duties

Generally, a fiduciary duty exists in "a situation where one person reposes special trust in and reliance on the judgment of another or where a special duty exists on the part of one person to protect the interests of another."1 LLC managers may be fiduciaries because they are "vested with discretionary power to manage the business of the LLC" and members have an expectation that managers will act in their interest.2

The primary fiduciary duties of LLC managers, where they are found to exist, are the duty of loyalty and the duty of care.3 The duty of loyalty requires managers to serve the best interests of the company and avoid conflicts of interest.4 The duty of care requires managers to act as a prudent person would in similar circumstances.5 Managers who comply with their duty of care are afforded the protection of the business judgment rule.6 This rule protects managers who are reasonably informed and act in good faith from claims of breach of the duty of care.7 Because an LLC is a unique type of business entity that offers substantial flexibility to members in establishing their own rules of governance,8 it is imperative that managers understand the potential scope of fiduciary duties to which they may be subject.

II. Contracting for Fiduciary Duties

a. Delaware LLC Act and the Freedom to Contract

While the Delaware Limited Liability Company Act9 ("LLC Act") does not impose fiduciary duties of loyalty and care on a manager, it does allow parties to contract for these fiduciary duties in an LLC operating agreement. One of the LLC Act's main policy objectives is to "give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements." 10 Accordingly, Delaware courts will turn first to the contracted-for provisions in the governing LLC operating agreement in determining the parameters of a manager's duties.11 Additionally, Section 18-1101(c) of the LLC Act specifically provides that an LLC manager's duties (including fiduciary duties) "may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing."12 This statute grants parties wide latitude when crafting the scope of fiduciary duties for managers under LLC operating agreements.

b. Interpreting Fiduciary Duty Provisions

Delaware courts take a relatively broad interpretive approach in determining the existence of expressly contracted-for fiduciary duties. For example, in Auriga Capital Corp. v. Gatz Properties, LLC,13 the Chancery Court addressed express arrangements for fiduciary duties. In that case, a manager-majority owner of a Delaware LLC sold the company, at all times controlling the process of sale, and repurchased it at a discounted price in what the court called a "bad faith sham" auction in which he was the sole bidder. The court ruled in favor of the minority members, who claimed that the manager's actions constituted both a breach of contract and a breach of fiduciary duties.

Auriga's significance is not so much that the minority members won, but more so how the Chancery Court came to the conclusion that the manager owed a fiduciary duty. The following provision in the...