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Chancery Refuses to Impose Fiduciary Duties on Parties to LLC Agreement

By Francis G.X. Pileggi

Related Westpac LLC v. JER Snowmass LLC, C.A. No. 5001-VCS (Del. Ch. July 23, 2010), read opinion here.

Brief Overview

This case involves a suit between members of two LLCs formed to pursue a land development project in Snowmass, Colorado. When the funding needs of the project exceeded the agreed upon budget, and one member refused to meet a capital call, the argument was made that the refusal was unreasonable. The Court dismissed the complaint because the operating agreements allowed the defendant member to withhold its consent for any reason, including a self serving reason. Thus the Court refused to imply or impose a reasonableness requirement, especially when such requirements were present elsewhere in the agreement but not in the provision at issue. The Court also refused to impose fiduciary duties that were at odds with express provisions of the LLC agreement.

Legal Analysis

The Court cited to many Delaware cases that emphasize the freedom of contract, especially in the context of LLCs which are creatures of contract. See footnote 30. In addition the Court observed that the contracts involved were plainly written with no lack of clarity.

In rejecting an argument to imply a reasonableness condition, the Court cited to several recent decisions in which such claims were rejected. See footnote 34. This is true especially in this case where express provisions were provided that did not impose a reasonableness requirement. See footnote 35.

The Court also rejected claims for fiduciary duty and unjust enrichment, explaining based on cited authorities the reason why those claims fail when the factual basis of the claim is one for breach of contract. See cases cited in footnotes 39, 41, 43, 45 and 46.

Default Fiduciary Duties Rejected

The Court addressed an area of Delaware LLC law that is--uncharacteristically for Delaware, not well-settled. Namely, whether fiduciary duties can be used as 'default gap fillers' in LLC agreements when the agreement does not expressly disclaim them is an issue not fully matured yet although it has certainly been addressed . See, e.g., an article by Delaware Supreme Court Chief Justice Myron Steele here (note that this article is not ex cathedra as an opinion of the Court would be). See also recent Chancery opinion in Kelly v. Blum addressing the issue here and imposing fiduciary duties in LLC context as default gap fillers. Cf. Fisk Ventures, here, where the Chancellor reached a different result on different facts. See generally commentary here at a recent seminar (Noting two schools of thought on this topic. One would use as a default principle only the implied duty of good faith and fair dealing. The other school of thought would rely of a default default fiduciary duty if the agreement was silent on the topic.)

The Court in this opinion addresses a nuanced but important distinction between an LLC agreement that does not expressly disclaim fiduciary duties (which the LLC statute allows), and the facts of this case in which certain express provisions that permit the exercise of certain rights would be at odds with "default fiduciary duties".

The relatively pithy treatment by the Court of the interplay between the contractual provisions and the argument that 'default fiduciary duties should fill in any gaps' focused on the reasoning that fiduciary duty principles should not contradict specific bargained-for terms expressing the parties' intent by means of a contractual provision. See footnotes 45 through 49 and accompanying text. Due to both its importance and its brevity, the discussion by the Court on this important topic deserves to be quoted verbatim:

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. Here, JER Snowmass clearly bargained for the freedom to decide whether to give its consent to Major Decisions involving Material Actions without being restricted by any reasonableness requirement. Related seeks to deprive JER Snowmass of the freedom it preserved by contending that JER Snowmass, as a member of the LLCs, was a fiduciary of the LLCs and was required to act in the reasonable best interests of the LLCs at all times. Related then seeks to have a trial about whether JER Snowmass complied with this supposed fiduciary duty and to hold JER Snowmass liable if its refusal to give consent was adverse to the best interests of the LLCs.

The problem with this theory is as follows. Under the Operating Agreements, JER Snowmass was left free to give consents to Major Decisions involving Major Actions as it chose, in its own commercial interest. That freedom was not qualified by any fiduciary duty of so-called 'reasonableness' and to imply such a duty in these circumstances would nullify the parties' express bargain. Under our law dealing with alternative entities such as the LLCs here, this court may not do that. When a fiduciary duty claim is plainly inconsistent with the contractual bargain struck by parties to an LLC or other alternative entity agreement, the fiduciary duty claim must fall, otherwise 'the primacy of contract law over fiduciary law in matters involving . . . contractual rights and obligations [would be undermined].' Thus, Related has failed to state a claim for breach of fiduciary duty. (footnotes omitted).
 

Full post as published by Delaware Corporate and Commercial Litigation Blog on August 09, 2010 (boomark / email).