Source: http://mbelr.org/llc_fiduciary_duties_in_delaware_private_equity_and_venture_capital/
Timestamp: 2019-04-19 17:00:11+00:00

Document:
In its January 27th decision of Auriga Capital Corp. v. Gatz Properties, LLC, the Delaware Chancery Court put to rest any ambiguity in its reading of the Delaware LLC Act as it applies to establishing default fiduciary duties in the LLC context.1 Although the topic had been addressed in a number of recent cases, none approached the depth and breadth of analysis exhibited by the Court in Auriga.2 In his opinion, Chancellor Strine definitively establishes that a manager or member of an LLC owes the default duties of care and loyalty to all other members, unless an LLC agreement effectively expands, limits, or eliminates these duties.
The dispute in Auriga centered on Gatz Properties, LLC’s management of property held by Peconic Bay, LLC. William Gatz, as the sole actor for Gatz Properties, formed Peconic Bay with Auriga Capital Corporation in order to develop land held by the Gatz family into a golf course. Peconic Bay then leased the golf course land from Gatz Properties. While the LLC Agreement required dual class majority approval for any “major decision affecting the company,” Gatz was effectively able to approve his own decisions as Manager without interference from minority members due to majority control of both the A and B Peconic share classes by Gatz Properties and the Gatz family.
Gatz made and approved such a “major decision” when he chose to perform a sale of Peconic, which ultimately led to a dispute with Auriga and other minority owners of Peconic Bay. In 2010, after the underperforming golf course operator with a sublease on the property chose to exercise its early termination option, Gatz turned away a serious bidder for Peconic Bay and orchestrated a sham auction. Gatz was the only bidder for the company, and purchased Peconic Bay at an unfairly low price. The minority members, whose invested capital amounted to $725,000, received a paltry $20,985 distribution from the sale. This led them to file suit and claim Gatz breached his fiduciary duties.
At trial, Gatz raised various defenses. However, of particular interest was his assertion that the LLC Agreement of Peconic Bay “displaced any role for the use of equitable principles in constraining the LLC’s manager,” and thus removed his actions from any fiduciary duty analysis. The Court rejected this argument, however, and affirmatively determined the existence of default restrictions on the actions of a managing member of an LLC beyond the requirements of good faith and fair dealing.
Like the Delaware General Corporation Law (“DGCL”), the LLC Act (the “Act”) does not plainly state the fiduciary duties of care and loyalty apply by default to managers and members of an LLC. However, unlike the DGCL, 6 Del. C. § 18-1104 of the Act provides an explicit default application of the “rules of law and equity.” Do those rules of law and equity include the duties of care and loyalty? Footnote 34 of Auriga explains they do.
That § 18-1101(c) provides for the contracting out or modification of fiduciary duties implies these duties exist by default. The Court goes on to explain that when §§ 1101(c) and 1104 are read together, these sections establish that when a manager or member would traditionally owe fiduciary duties, they are a fiduciary and are subject to the express right of the parties to contract out of those duties. So far as a manager or member would not owe fiduciary duties under traditional equitable principles, they do not owe any in the LLC context. This is not by operation of the Act, but by those same traditional equitable principles. The Act does not create a broader range of duties.
The Court also pointed to the 2004 amendment of the Act (in addition to the amendment of Delaware Revised Uniform Limited Partnership Act (“DRULPA”)) by the Delaware Legislature. The amendments were instigated by a Delaware Supreme Court holding in Gotham Partners L.P. v. Hallwood Realty Partners L.P, which questioned the extent to which default duties could be completely eliminated in the partnership context.3 Both the Act and DRULPA were reworded to permit the complete elimination of fiduciary duties, as well as full contractual exculpation for breaches (through the introduction of §18-1101(e) for LLCs).
The Court in Auriga reasoned if the “equity backdrop” did not apply to LLCs then: 1) the amendment would have provided that members and managers owed no duties to the LLC other than those set forth by agreement or in the statute; 2) the General Assembly would have eliminated or modified the default application of the rules of law and equity in §18-1104; and 3) the General Assembly would not have provided for the elimination and exculpation of something if that something did not exist. These factors combined with the case law establishing the existence of default duties in the LLC setting and the policy concerns surrounding displacement of a widespread investor belief in the same, firmly established, in the Court’s mind, the alignment of those holdings and the legislature’s intent.
Chancellor Strine awarded the minority members what they should have received in a fair auction: their initial investment of $725,000 and a 10% return. He deemed this “a modest remedy and the record could support a higher one.” Additionally, because the “record is regrettably replete with behavior by Gatz and his counsel that made this case unduly expensive for the Minority Members to pursue,” Strine required Gatz to pay one half of the minority’s attorneys’ fees and costs. If the manager or a member of an LLC wants a lesson on what not to do, this case is a very instructive read.
• The traditional duties of loyalty and care apply by default to Delaware LLCs.
• A manager of a Delaware LLC is a fiduciary and subject to those default duties.
• Such duties may be altered or eliminated and liability exculpated by clear and explicit agreement under the LLC Agreement.
• The duties of good faith and fair dealing, as they exist independently from the duty of loyalty, apply to all LLCs and cannot be contracted around.
• LLC agreements in existing Private Equity and Venture Capital investments should be evaluated for clarity in any desired modification of fiduciary duties, with necessary amendments made to bring them in line with the intentions of the parties to the agreement in light of the Court’s clarifications.

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