A recent Delaware Court of Chancery decision addressed claims against the manager of an LLC that required the interpretation of an exculpatory clause and contractually-defined fiduciary duties in the LLC Agreement. MHS Capital LLC v. Goggin, C.A. No. 2017-0449-SG (Del. Ch. May 10, 2018).
Brief Background Facts:
The detailed facts of this opinion fill about half of the 46-pages of the court’s decision, but for purposes of this short blog post, the key factual basis for the claims includes the allegation that the sole manager of the LLC diverted a portion of the assets of the LLC to himself and his friends. Claims against the manager included breach of contract, fraud, and breach of fiduciary duty.
One of the problems the court faced is that the LLC Agreement eschewed default common-law fiduciary duties (i.e., waived them as allowed under Delaware law), in favor of what the court described as “a rigorous, if less than clear, list of contractual duties, which appear to hold the manager to standards of good faith and ordinary care.” The agreement also provided that “except as otherwise required by the LLC Act,” the parties waived the right to seek damages from the manager.
Key Legal Principles Discussed by the Court:
Several key principles articulated by the court will be useful to those involved in litigation based on an LLC Agreement that appears to waive default fiduciary duties, but replaced those duties with some type of contractual version of either a fiduciary duty or similar duty.
- At the motion to dismiss stage, which was the context in which this decision was rendered, the court explained that it need not decide issues relating to the relief that might be available if the claims prevail at trial. Thus, the court did not need to decide whether the exculpatory provision barred a request for money damages, nor did the court need to decide how that exculpatory clause interfaced with the contractual duties of the manager.
- A central part of the court’s analysis was whether the breach of contract claims and breach of fiduciary duty claims were duplicative. The court explained that Delaware law is clear that “fiduciary duty claims may not proceed in tandem with breach of contract claims absent an independent basis for the fiduciary duty claims apart from the contractual claims. See footnote 102 through 106.
- The exception to the general rule allows a fiduciary duty claim to proceed in parallel with a breach of contract claim–only if the fiduciary duty claim “depends on additional facts, is broader in scope, and involves different considerations in terms of a potential remedy.” See footnote 106. The court held that in this case the remedy sought with respect to both the fiduciary duty and breach of contract claims were identical, and there was no independent basis for the fiduciary duty claim apart from the contractual claim. See footnotes 109 and 110.
- The court recited the familiar elements required for a fraud claim, but more noteworthy is the court’s discussion of the particularity requirements of Court of Chancery Rule 9(b) that requires the following specifics to be plead in order to satisfy the minimum threshold for a fraud claim: “(1) the time, place and contents of the false representation or omission; (2) the identity of the person making the representation or omission; and (3) what the person intended to gain by making the representations or omissions.” See footnote 117 through 120.
- Additional clarification about the requirements of a fraud claim in connection with a claim for breach of contract was provided by the court. The court found that the fraud claim in this case ran afoul of the well-established principle that “a plaintiff cannot ‘bootstrap’ a claim of breach of contract into a claim of fraud merely by alleging that a contracting party never intended to perform its obligations. In other words, a plaintiff cannot state a fraud claim merely by intoning the prima facie elements of the tort while telling the story of the defendant’s failure to perform under the contract.” See footnotes 130 and 131.
- The court provided a nuanced explanation and analysis of the implied covenant of good faith and fair dealing. See Slip op. at 29-33.
- An important aspect of this court decision was the observation that equitable relief might be available for the breach of contract claims, presumably to the extent that the contract provided for a contractually-defined fiduciary duty. The court did not decide that issue specifically, but by implication left open the possibility that such equitable relief was possible. See Slip op. at 40.