It’s been interesting to watch uncorporations (particularly LLCs and limited partnerships) evolve over the last twenty years or so. Perhaps the most interesting aspect of this evolution is what’s been happening in Delaware regarding contracting over fiduciary duties. This is particularly intriguing because it concerns a key area of difference between corporations and uncorporations — that is, the role of private ordering. See generally my Rise of the Uncorporation, particularly Chapters 7 and 8.
The story begins with Delaware’s adoption of Section 1101 of its LP and LLC acts, which gave firms the power to opt out of fiduciary duties.
Firms initially used this provision somewhat gingerly, and the courts responded with ginger applications, as discussed in my Uncorporation and Corporate Indeterminacy and Fiduciary Duties and Limited Partnership Agreements, 37 SUFFOLK U. L. REV . 927 (2004) (SSRN) .
For example, in Miller v. American Real Estate Partners, 2001 WL 1045643, at *10–11 (Del. Ch. Sept. 6, 2001), VC Strine held that an agreement giving a general partner complete discretion to manage and control the business didn’t authorize him to invest partnership funds in aid of his own venture. The court emphasized the importance of the agreement, noting that Delaware limited partnership law “reflects the doctrine of caveat emptor, as is fitting given that investors in limited partnerships have countless other investment opportunities available to them that involve less risk and/or more legal protection.” However, the court added:
[J]ust as investors must use due care, so must the drafter of a partnership agreement who wishes to supplant the operation of traditional fiduciary duties. In view of the great freedom afforded to such drafters and the reality that most publicly traded limited partnerships are governed by agreements drafted exclusively by the original general partner, it is fair to expect that restrictions on fiduciary duties be set forth clearly and unambiguously. A topic as important as this should not be addressed coyly. * * *
The Delaware Supreme Court in Gotham Partners, L.P. v. Hallwood Realty Partners, L.P. , 817 A.2d 160, 167–68 (Del. 2002) sounded a caveat on freedom of contract by stating in dictum that Delaware law didn’t allow elimination of fiduciary duties. The court echoed VC Strine in noting “the historic cautionary approach of the courts of Delaware that efforts by a fiduciary to escape a fiduciary duty, whether by a corporate director or officer or other type of trustee, should be scrutinized searchingly.”
Interestingly for present purposes, the court was unwilling to leave a gap-filling role to the implied contractual covenant of good faith and fair dealing.
However, the Delaware legislature responded to Gotham by amending the above statute to explicitly provide that fiduciary duties may be “eliminated” by the partnership agreement. Then Delaware Chief Justice Steele followed up with an article urging his fellow Delaware judges to enforce agreements in Delaware noncorporate cases. See Myron T. Steele, Judicial Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability Companies , 32 DEL. J. C. L . 1 (2007).
In general, as Rise of the Uncorporation notes in Chapter 8, limited partnerships (and LLCs) get more contractual freedom than corporations (which can only opt out of the duty of care) because they “almost always are the product of detailed bargaining. * * * [T]he limited partnership substitutes other constraints on managers for fiduciary duties, particularly high-powered owner-like incentives of managers and the owners’ greater access to the firm’s cash.”
Wood v. Baum, 953 A.2d 136 (Del. 2008) explicitly extended this contractual freedom to a publicly traded LLC, dismissing a complaint containing a strong allegation of a breach of monitoring that might have gotten attention in a corporate case under Stone v. Ritter, 911 A. 2d 362 (Del. 2006).
This leaves open what the Delaware courts might do post-financial crisis/Dodd-Frank in a case involving the near elimination of all fiduciary duties in a Blackstone-type entity fraught with conflicts of interest (here’s an earlier post on this situation).
We have a response, if not definitive answer, in VC Laster’s decision in Lonergan v. EPE Holdings, LLC, 5 A.3d 1008 Del.Ch.,2010. This was a publicly traded LP in which a general partner’s board sought a merger of two related entities. Here are the important provisions of the agreement (footnotes omitted):
Except as expressly set forth in this Agreement, neither [Holdings GP] nor any other Indemnitee shall have any duties or liabilities, including fiduciary duties, to the Partnership or any Limited Partner and the provisions of this Agreement, to the extent that they restrict or otherwise modify the duties and liabilities, including fiduciary duties, of [Holdings GP] or any other Indemnitee otherwise existing at law or in equity, are agreed by the Partners to replace such other duties and liabilities of [Holdings GP] or such other Indemnitee.
* * *
Any standard of care and duty imposed by this Agreement or under the Delaware Act or any applicable law, rule or regulation shall be modified, waived or limited, to the extent permitted by law, as required to permit [Holdings GP] to act under this Agreement and to make any decision pursuant to the authority prescribed in this Agreement, so long as such action is reasonably believed by [Holdings GP] to be in, or not inconsistent with, the best interests of [Holdings].
The court summarized:
In light of these provisions, the only duties owed by Holdings GP flow from (i) contractual standards set forth in the Holdings LP Agreement and (ii) the implied covenant of good faith and fair dealing. The complaint does not identify any provision of the Holdings LP Agreement that the Proposed Transaction might violate. It relies solely on the implied covenant.
The court might have filled in in protection for the limited partners via narrow interpretation of the agreement and the implied contractual covenant of good faith and fair dealing. This would be consistent with the approach used in earlier cases like Miller, discussed above. Indeed, the plaintiff argued in Lonergan for application of a Revlon analysis and for broad disclosure duties. The court theoretically could hold that the agreement could preclude these duties only by explicit provisions and not by a blanket waiver of duties. However, the court declined the invitation (footnotes omitted):
When parties exercise the authority provided by the LP Act to eliminate fiduciary duties, they take away the most powerful of a court’s remedial and gap-filling powers. As a result, parties must draft an LP agreement as completely as possible, and they bear the risk of incompleteness. If the parties have agreed how to proceed under a future state of the world, then their bargain naturally controls. But when parties fail to address a future state of the world-and they necessarily will because contracting is costly and human knowledge imperfect-then the elimination of fiduciary duties implies an agreement that losses should remain where they fall. After all, if the parties wanted courts to be in the business of shifting losses after the fact, then they would not have eliminated the most powerful tool for doing so.
Respecting the elimination of fiduciary duties requires that courts not bend an alternative and less powerful tool into a fiduciary substitute. * * *To the extent the complaint seeks to re-introduce fiduciary review through the backdoor of the implied covenant, it fails to state a colorable claim.
The bottom line is that, as Congress and the SEC seek increase regulation of corporate governance through Dodd-Frank, Delaware is going in the opposite direction through uncorporations. There was a recent glimmer that Delaware might be up for a direct fight: in Parkcentral Global, L.P. v. Brown Inv. Management, L.P., 1 A.3d 291 (Del., 2010) the Delaware Supreme Court held that limited partners’ right of access to partnership books under Delaware law was not preempted by federal financial privacy regulations.
These cases potentially make the uncorporation an escape hatch for firms seeking a way out of Dodd-Frank. If they choose to use it, we might see a rather interesting confrontation between Delaware and the federal government.