I have frequently discussed the ongoing jurisprudential drama in Delaware on how firms can avoid fiduciary duties.
The basic setup here is that Delaware allows LLCs and other unincorporated firms to completely eliminate fiduciary duties. But they have to do it carefully.
Here’s my most recent discussion of the state of play on what that means:
As I discussed recently, Delaware law * * * imposes an obligation of clear drafting of fiduciary waivers in order to take advantage of the statutory license to contract freely. See Ribstein & Keatinge §9:4, The Uncorporation and Corporate Indeterminacy, DirecTV Latin America, LLC v. Park 610, LLC, 2010 WL 305201 at *27 (S.D.N.Y., January 26, 2010) (Del. law), Kelly v. Blum, 2010 WL 629850 at *10, n. 70 (Del.Ch., February 24, 2010), and Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC, 2009 WL 1124451 (Del.Ch., April 20, 2009).
One big question is whether the parties have to explicitly negate fiduciary duties, or whether it is enough to include language that clearly defines a non-fiduciary duty, without negating the default fiduciary duty.
A recent opinion by VC Strine is illuminating on that subject. Francis Pileggi gives his usual good analysis of Related Westpac LLC v. JER Snowmass LLC, C.A. No. 5001-VCS (Del. Ch. July 23, 2010). The case involved the frequent situation of active operating and passive financing members who disagree about the future of the business – the operator wants to push ahead, the investor wants to stop funding the venture. The court held that the investor did not breach contractual, good faith or fiduciary duties by declining to continue to contribute capital and by exercising his voting power. Mr. Pileggi cites the relevant language in the opinion, which I’ll repeat here (footnotes omitted):
The Operating Agreements represent an example of the contractual freedom parties can use under our law to craft an approach to operating an entity that fits their own needs. When, as the parties here did, they cover a particular subject in an express manner, their contractual choice governs and cannot be supplanted by the application of inconsistent fiduciary duty principles that might otherwise apply as a default.
Now some factual background on the agreements, from the opinion, again footnotes omitted:
The Operating Agreements make plain that JER Snowmass’s right to refuse to consent to a Major Decision that constitutes a Material Action was unqualified by any reasonableness condition. They do so by plainly stating that the approval of plans submitted by the Operations Manager was not to be “unreasonably withheld or delayed, except with respect to JER Snowmass, to the extent the modification constitutes a Material Action.” Material Actions are defined as anything that would “require additional Capital Contributions” or “involve any material change in the budget … or any line item therein.” Thus, as to Material Actions, JER Snowmass was clearly free to give or withhold its consent in its commercial interest. By contrast, the Operating Agreements make clear that JER Snowmass could not “unreasonably with[o]ld” consent on a range of other matters including taxes, terms of a “co-list” arrangement, and the removal of Westpac Investments LLC as the “Operations Manager” of Related.
The Operating Agreements also provide that the Operations Manager may issue capital calls to members. Under the Operating Agreements, “if any Member is required … to provide Additional Funds to the LLC[s] and shall fail to do so, such Failing Member’s sole liability, and the Contributing Member’s sole remedy, shall be expressly set forth in [the Operating Agreements] … [and][n]o Member … shall have any personal liability to provide such Additional Funds.” That remedy provides that the issuing member can choose to “either notify the other members that such Contributing Member is withdrawing such contribution from the LLC[s] … or … agree to contribute an amount equal to the Failing Member’s Default Amount.”
The relevant issue involved a material action as to which the agreement made clear that the member was free to withhold consent even in its own commercial interests.
All of this sounds unremarkable, except for the fact that there was no explicit fiduciary waiver. To see why that matters, let’s go back to my Indeterminacy article, linked above (footnotes omitted):
In Miller v. American Real Estate Partners, Vice Chancellor Strine refused to hold that the agreement authorized the general partner to invest partnership funds to protect his own venture instead of pursuing investments that would be less risky and more profitable for the partnership. No. Civ. A. 16788, 2001 WL 1045643, at *10–11 (Del. Ch. Sept. 6, 2001). The agreement gave the general partner full, exclusive and complete discretion to manage and control the business and affairs of the Partnership, to make all decisions affecting the business and affairs of the Partnership, and to take all such actions as it deems necessary or appropriate to accomplish the purposes of the Partnership as set forth herein. The agreement also provided:
Whenever in this Agreement the General Partner is permitted or required to make a decision (i) in its “sole discretion” or “discretion”, with “absolute discretion” or under a grant of similar authority or latitude, the General Partner shall be entitled to consider only such interests and factors as it desires and shall have no duty or obligation to give any consideration to any interest of or factors affecting the Partnership, the Operating Partnership or the Record Holders, or (ii) in its “good faith” or under another express standard, the General Partner shall act under such express standard and shall not be subject to any other or different standards imposed by this Agreement or any other agreement contemplated herein.
Vice Chancellor Strine held that the agreement not only failed explicitly to preclude the application of default fiduciary duties, but affirmatively revealed an intention to include such duties because the parties used a popular form but deleted language explicitly preempting default duties. The court also noted references to default fiduciary duties in the registration statement used to sell the partnership interests. Preemption of fiduciary duties therefore was not “plain” enough under Sonet, and so default substantive fairness and the duty of loyalty applied.
So VC Strine may have at least slightly shifted his position in the last decade to no longer require an explicit negation of fiduciary duties. Language inconsistent with the parties’ intent to impose fiduciary duties will be enough.
The cases, however, differ in a few respects. The most important difference is that Miller involved a general partner of a limited partnership – that is, a party that clearly had default fiduciary duties. Related Westpac involved a mere non-managing member. In my theory of fiduciary duties, fiduciary duties necessarily accompany open-ended management power. Therefore, while there were fiduciary duties that needed clearly to be negated in Miller, there was arguably no such duty to negate in Related Westpac. Could this explain VC Strine’s willingness in the later case to hold the duty negated without an explicit disclaimer?
The bottom line is that there’s still confusion in the Delaware cases not only about how to negate duties, but what must be negated. I’m awaiting further developments.
Meanwhile, I wonder when the drafting technology in Delaware will rise to the level of taking care of these problems. Why can’t the parties to sophisticated LLCs take the seemingly small extra step of explicitly defining and negating their duties?