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 as a default on the more plenary 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 big news in this decision is that there was no express waiver of fiduciary duties but the Court nonetheless refused to impose fiduciary duties to the extent that such duties would be in conflict with certain express provisions and rights of a party to the agreement–in this case a non-managing member.

The relatively pithy treatment by the Court of the interplay between the contractual provisions and the (rejected) 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).

SUPPLEMENT:  Professor Larry Ribstein, a leading authority on LLCs, provides his scholarly insights here. His analysis is akin to "manna from heaven" for those interested in the cutting edge thought among the experts regarding the issues addressed in the case. The good professor concludes his thorough discussion thusly:

"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?"
 

Moreover, after discussing the nuances of this case, he adds that:

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?