A recent Chancery decision addressed many important issues related to a squeeze-out merger involving an LLC in which the minority member claimed that it did not receive a fair price for its minority interest. See Cygnus Opportunity Fund, LLC v. Washington Prime Group, LLC, C.A. No. 2022-0718-JTL (Del. Ch. Aug. 9, 2023). There are many issues in the 48-page decision that could be the subject of an extensive review, but for purposes of this relatively short blog post I will limit my discussion to the fiduciary duties of officers, which the court described as: having “long been an undertheorized area of Delaware law.” Slip op at 13.
Whether the defendant-officers breached their fiduciary duties because the company provided no or few disclosures in connection with a squeeze-out merger. The court refused to grant a motion to dismiss on that issue. Although there was a waiver of fiduciary duties for some, there was only an exculpation clause that applied to officers. The LLC was structured in a manner similar to corporations with a board of directors and officers.
The Fiduciary Duty of Disclosure
This decision engages in a rather deep-dive into the public policy and historical underpinnings of the fiduciary duty of officers to make disclosures. Slip op. at 12 through 25.
The court explained that the duty of disclosure is not a separate duty but rather a contextual manifestation of the duties of care and loyalty. Slip op. at 13. The court instructed that the duty of disclosure arises situationally, its scope and requirements depend on context. The court cited to cases that refer to the recurring scenarios in which the governing principles of disclosure have been developed.
Duty to Inform
The court reasoned that the duty of disclosure is a context-specific duty, and
“no Delaware decision holds that fiduciaries do not owe any duty in the context of a transaction in which the fiduciaries unilaterally eliminate their investors from an enterprise. I personally am not prepared to rule as a matter of law that a fiduciary can take the property of its beneficiary without some level of disclosure, even in the absence of any request for action. To the contrary, basic fiduciary principles suggest that a fiduciary cannot do that”.
Slip op. at 18-19.
The court traces the anglicized Latin word fiduciary to its meaning as trustee-like, and also traces the origin of fiduciary duties to obligations similar to those of a trustee—and the fiduciary relationship as analogous to one between an express-trustee and a beneficiary.
The court cited to treatises and case law for the principle that a fiduciary should keep beneficiaries informed as a central aspect of a trustee’s duties at common law and: “Even in the absence of a request for information, a trustee must communicate essential facts to beneficiaries.” Slip op. at 19. The court emphasized that: “The duty to inform is not limited to trustees. It runs through the whole law of fiduciary and confidential relations.” Slip op. at 21.
Duty to Disclose in Context of Squeeze-Out Merger
In the context of a squeeze-out merger, the court reasoned that:
“If the duty to inform could apply anywhere, it would apply to a transaction in which a fiduciary unilaterally effectuates a taking of a beneficiary’s interest. In that setting, the duty of loyalty could manifest as an obligation to inform the beneficiary of the material facts surrounding the transaction, regardless of whether or not the beneficiary’s approval is required.” Slip op. at 21.
The court further explained that even if the LLC Agreement would allow the defendants to argue that they could convert a minority interest into a right to receive the amount offered—without any explanation: “that result would be contrary to equity.” Slip op. at 21.
The court discusses the exculpation provision, as contrasted with the waiver of fiduciary duties, and describes the willful conduct that is not covered by the exculpation provision. The court described those situations at the pleadings stage where the allegations of willful conduct which require insight into the state of mind, such as the intent of a person, “may be averred generally”. Slip op at 46. The court also observed that the degree to which a party must plead facts of this nature takes into account whether the facts lie more in the knowledge of the opposing party than of the pleading party. Id.
The court found that the complaint alleged facts supporting a reasonable inference that the defendants intentionally pursued a scheme to eliminate the minority at a grossly unfair price. The court held that the difference between the transaction price and the actual value supported an inference of subjective bad faith that inferably violated the provisions of the LLC Agreement and the fiduciary duties of the officers. The exculpation provision at this early phase of the case could not be relied upon to support a motion to dismiss.