Chancery Gives Victory to “Freedom of Contract” Regarding Fiduciary Duties in LLC Agreement

Fisk Ventures, LLC v. Segal, 2008 WL 1961156 (Del. Ch., May 7, 2008), read opinion here. This Chancery Court opinion, I predict, will be cited often by scholars and practitioners alike as part of the ongoing discussion about the difference between applying fiduciary duty concepts to LLCs–or not–as compared with the conventional application of those duties in the corporate context.

This case began as an action to dissolve an LLC pursuant to 6 Del. C. Sections 18-801 and 802 but this decision does not address those issues. Rather, the court grants motions to dismiss filed by the Third-party Respondents based on a personal jurisdiction argument and failure to state a claim. (Thus, the court was not called upon yet to address the dissolution issues.)

The third-party claims that the court addressed alleged that  the third-party defendants: (i) breached the LLC Agreement; (ii) breached the implied covenant of good faith and fair dealing; and (iii) breached fiduciary duties, among other allegations. 

[Although the court granted a motion to dismiss based on lack of personal jurisdiction pursuant to 10 Del. C. Section 3104 and 6 Del C. Section 18-109, because the other issues decided have much more far-reaching importance, I won't spend any time on the personal jurisdiction discussion, which otherwise is noteworthy in its own right.]

Though clearly separated in the structure of the opinion, the court’s discussion of the breach of contract claim and the breach of fiduciary duty and implied duty claims was somewhat, of necessity, interwoven. The court began its analysis with basic contract principles and the truism that LLCs are creatures of contract, and that a prerequisite to any breach of contract analysis, is to determine if there is a duty  in the document that has been breached.

In this regard, the court cites in footnote 34 to Delaware Supreme Court Chief Justice Myron Steele’s article entitled: Judicial Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability Companies, 32 Del. J. Corp. L. 1, 4 (2007)("Courts should recognize the parties’ freedom of choice exercised by contract and should not superimpose an overlay of common law fiduciary duties…")  See here  for overview of  that article on this blog and a link to it.

Prof. Larry Ribstein, one of the country’s leading experts on LLCs, was cited twice in footnote 35 of the court’s opinion, on the topics addressed in this case that he has written about extensively, such as the "freedom of contract" principles underlying LLC Agreements.

Importantly, the court found no provision in the LLC Agreement at issue that:  "create[d] a code of conduct for all members; on the contrary, most of those sections expressly claim to limit or waive liability."

Here is the money quote:

"There is no basis in the language of the LLC Agreement for Segal’s contention that all members were bound by a code of conduct, but, even if there were, this Court could not enforce such a code because there is no limit whatsoever to its applicability".

The "implied covenant of good faith and fair dealing" claim was carefully examined and dispatched with one of the more lucid and cogent treatments I can recall of this amorphous cause of action.

Finally, the breach of fiduciary duty claim was confronted by first reciting the provisions of the Delaware LLC Act  at Section 18-1101(c) that allow for complete elimination of all fiduciary duties as part of an LLC Agreement. The court read the parties’ LLC Agreement in this case to eliminate fiduciary duties because it flatly stated that:

"…members have no duties other than those expressly articulated in the Agreement. Because the Agreement does not expressly articulate fiduciary obligations, they are eliminated."

Query: If the parties’ LLC Agreement was completely silent on the issue of whether any fiduciary duties were eliminated, would the court have reached the same result? Comments are welcome.

UPDATE: Here is the analysis of the case by Prof. Ribstein, who answers my above query thusly:

So what result here without an express elimination of duties?

As discussed in my article linked above [The Uncorporation and Corporate Indeterminacy] and in other writings, the Delaware cases have made it clear that the parties must contract carefully to waive fiduciary duties, as the parties did in Fisk. In other words, courts will add fiduciary duties to the express contract if the parties don’t negate them. This can be reconciled with CJ Steele’s admonition in this way: in the absence of contrary agreement, the fiduciary duties are part of the Delaware standard form contract, consisting of statutory and common law default rules. This seems sensibly consistent with the parties’ usual expectations.

UPDATE II: Here is my post about the case on The Harvard Law School Corporate Governance Blog.

FURTHER UPDATE: Here is the Court’s decision of July 3, 2008 denying a motion for reargument and emphatically explaining its interpretation of the Operating Agreement, finding no fiduciary duty.

  • Anon

    The Chancellor has answered your “query”, and in a somewhat surprising way. The plaintiff in this case moved for reargument, in part because some of the defendants were managers but not members, and were therefore not covered by the language in the LLC Agreement restricting members’ duties to those set forth therein.
    In a July 3 opinion, the Chancellor wrote that that had nothing to do with it. He explicitly said, “[b]ecause the Agreement does not expressly articulate fiduciary obligations,
    they are eliminated.” This was despite language preserving liability for gross negligence or intentional misconduct.
    Will this stand?

  • http://community.martindale.com/blogs/delawarelitigation/archive/2009/11/14/court-of-chancery-decides-fiduciary-duty-claims-against-llc-manager-and-allows-dissolution-claim-to-proceed.aspx Delaware Corporate and Commercial Litigation Blog

    Court of Chancery Decides Fiduciary Duty Claims Against LLC Manager and Allows Dissolution Claim to Proceed

    Lola Cars Int'l Limited v. Krohn Racing, LLC, No. 3379-VCN (Del. Ch. Nov. 12, 2009). This 31-page