Diane E. Ghrist
In Gatz Properties, LLC v. Auriga Capital Corp., the Delaware Supreme Court held that the Delaware LLC Act does not explicitly impose default fiduciary duties when those duties have not been provided for in the LLC agreement. This per curium decision vociferously knocked Chancellor Strine’s assertion that managers of Delaware LLCs owe fiduciary duties to shareholders, and reflects the strength of Delaware’s freedom of contract principle for corporate practices.
In 1998, Gatz formed a Delaware LLC to act as a passive operator of a Long Island’s Peconic Bay golf course that was to be run by and subleased to American Golf Corporation beginning in 2000. The long-term sublease provided American Golf Corp. with an early termination option after the first ten years. Gatz and his family owned the majority of the LLC’s shares and held veto power over any strategic decisions. Events soured during the latter half of the first ten years when American Golf Corp. went under new management and began to neglect the property. The golf course deteriorated and lost revenue, and by 2005 it became clear to Gatz that American Golf Corp. would elect to terminate the sublease. At this point, Gatz determined that the now improved property would be more valuable if converted to a residential neighborhood, which would only be possible without the minority investors. So instead of taking steps to keep Peconic Bay viable, Gatz did not “search for a replacement management corporation, explore whether the LLC itself could manage the golf course profitably, or undertake to search for a buyer of the LLC.” He turned away a credible buyer and did not provide the due diligence expected of an ordinary seller similarly situated. Gatz additionally mislead and frustrated an interested buyer to discourage a good bid, and then threatened minority shareholders with litigation if they did not sell him their membership interest in the property. As the sublease term was about to expire, Gatz held a sham auction to sell the LLC in the form of a distressed sale and purchased the LLC for nominal value above the amount of debt. This led a group of minority investors to sue Gatz for breach of contractual and fiduciary duties.
The Delaware Supreme Court looked to the language of the LLC agreement and held that Gatz owed fiduciary duties to the members of the LLC. The court found that the section of the LLC agreement requiring that any agreements with third parties be made on the most favorable terms to the LLC or otherwise require a majority vote by the members to be controlling. The court affirmed the Chancery Court’s determination that this language imposed fiduciary duties on Gatz. Gatz’s admission to having fiduciary duties in his Answer to the Amended Complaint and trial testimony added conclusive support to the court’s holding. It also affirmed the lower Chancery Court’s holding that Gatz’s bad faith actions and willful misrepresentations precluded him from exculpation for breach of contractual and fiduciary duties.
However, a bulk of the supreme court’s analysis is devoted to addressing the issue it claims the Chancery Court “should never have reached nor decided.” Namely what fiduciary duties, if any, do managers of Delaware LLCs owe their members absent any explicit language in the respective LLC agreement.
The crux of the issue lies in the statutory interpretation of the Delaware LLC Act (DLLCA), which does not outline the specific duties owed by managers beyond good faith and fair dealing and permits the elimination of fiduciary duties through the LLC agreement. With specific respect to contractual exculpation, § 18-1101(e) states “[a] limited liability company agreement may provide for the elimination of any and all liabilities for breach of contract and breach of duties (including fiduciary duties) of a . . . manager[.]” However, the DLLCA § 18-1104 also blankets LLCs with the general rules of law and equity for “any case not provided for in this chapter.”
When Gatz first appeared before the Delaware Chancery Court in February 2012, Chancellor Strine found that default fiduciary duties apply to managers of Delaware LLCs. He noted that fiduciary duties are deeply grounded in the laws of equity between managers and members of LLCs, and absent specific language eliminating those duties, default fiduciary duties apply. He continued to support his position by looking at the legislative history of the DLLCA. He argued that by adding provisions to optionally eliminate fiduciary duties, those duties must already exist by default. He then added policy reasoning to his analysis. First he argued that those LLCs made by members relying on traditional default fiduciary provisions would have their expectations disrupted, making the terms of their agreements “shapeless and more uncertain.” And second that “judicial eradication of the explicit equity overlay in the LLC Act could tend to erode [Delaware]’s credibility with investors in Delaware entities.”
The supreme court responded to Chancellor Strine with severe language, excising his statutory interpretation, and proclaiming it dictum without precedential value. The supreme court listed at length the reasons why Judge Strine improperly ruled on the issue of fiduciary duties. First, it held that because the fiduciary standards could be determined by reviewing the LLC agreement, it was absolutely unnecessary for Judge Strine to decide the issue of statutory construction sua sponte. Second, neither litigating party asked the court to decide the default fiduciary issue. Third, that the supreme court is not bound by the pattern of decisions that the Chancery Court cited to support its case, therefore Judge Strine’s policy justification of reliance on default fiduciary duties is irrelevant. Fourth, that the DLLCA is left consciously ambiguous and it is for the Delaware General Assembly to resolve the ambiguity. Fifth, and lastly, the supreme court found that the Chancery Court acted outside its proper purview by deciding on an issue absent a justiciable controversy “remind[ing] Delaware judges that the obligation to write judicial opinions on the issues presented is not a license to use those opinions as a platform from which to propagate their individual world views on issues not presented.”
The supreme court’s harsh admonition to Chancellor Leo E. Strine Jr. was considered an unusual but perhaps inevitable move by Delaware’s high court. The decision may be rooted in the long debate between Chancellor Strine and supreme court chief justice Myron Steele over whether the DLLCA provides for default fiduciary duties. In his previous writings, chief justice Steele repeatedly appealed to the principle of freedom of contract, which according to him permits the default elimination of fiduciary duties. However, the decision adds another chapter to the centuries old debate about how far state jurisdictions should reduce corporate regulations, famously described by Justice Brandeis as a “race to laxity.” Chancellor Strine is well known for his brilliance, unusual courtroom ramblings, and use colorful language in his opinions. But for now, chief justice Steele has the last word.