Private Equity Fund Considerations In Light Of Delaware's LLC Debate

This article was previously published in the Expert Analysis section of Private Equity and Contract Law360 on February 20, 2013, and in the corresponding Law360 newsletters on February 21, 2013. Reprinted here with permission.

Partners of private equity funds and other investment partnerships should take notice of recent Delaware court decisions that have created some uncertainty over whether Delaware limited liability company (LLC) managers owe "default" fiduciary duties. This uncertainty highlights the often ignored need for private equity funds to specify the scope of fiduciary duties for holding companies of the portfolio investments to make clear the extent, if any, of the fiduciary duties of the directors of that holding company.

To avoid any uncertainty, in drafting or amending an LLC agreement used by a fund, draftspersons should explicitly specify any fiduciary duties for both managers and controlling members, including whether they wish to adopt, restrict or eliminate fiduciary duties. By clearly specifying the fiduciary duties of the members and/or managers in the LLC agreement, private equity fund managers can increase certainty regarding governance of the entity by ensuring any fiduciary duties are limited to only those enumerated in the LLC agreement.

The Delaware Debate

The Delaware Limited Liability Company Act, 6 Del. C. §§ 18-101, et. seq. (DLLCA) does not expressly provide for default fiduciary duties for LLC managers. Moreover, the Delaware Supreme Court has not ruled whether LLC managers owe fiduciary duties, absent an express imposition in the LLC agreement.

Although the Supreme Court has never formally ruled on the issue, Chief Justice Myron T. Steele, in his article "Judicial Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability Companies," 32 Del. J. Corp. L. 1 (2007), argues that LLC managers do not owe traditional fiduciary duties, unless the LLC agreement so specifies. The other justices on the court have neither adopted nor rejected Chief Justice Steele's position. The Court of Chancery, on the other hand, has held that such duties do exist, unless eliminated.

Chief Justice Steele takes the position that the DLLCA does not impose default fiduciary duties upon LLC managers. He bases his conclusion on three main justifications: (1) freedom of contract; (2) the fact that LLCs did not exist at common law; and (3) the DLLCA's silence on the issue. First, Chief Justice Steele points to...