The Delaware Court of Chancery last month issued a lengthy and thorough analysis in a dispute over an LLC manager?s claimed breaches of fiduciary duties. Auriga Capital Corp. v. Gatz Props., LLC, No. C.A. 4390-CS, 2012 WL 294892 (Del. Ch. Jan. 27, 2012).
The dispute arose because the LLC?s manager and majority owner (along with his family) took steps to squeeze out the minority investors in order to obtain ownership of the LLC?s valuable golf course. The court?s lengthy catalog of the manager?s activities shows a manager bent on ridding the LLC of the disfavored minority. Professor Ann Conaway in her blog described the manager as ?a devilish manager of an LLC who acted every bit the part of Lord Voldemort determined to ?do in? his members,? here. The court?s unremarkable holding, given the facts, was that the manager breached his fiduciary duties of loyalty and care. Auriga, 2012 WL 294892 at *25.
The court?s discussion and analysis, on the other hand, were remarkable. Not for the court?s legal conclusion, but for its comprehensive and detailed review of the Delaware LLC Act and the Delaware case law on LLC fiduciary duties. The court?s conclusion was consistent with prior Delaware case law: ?[O]ur Supreme Court, and this court, have consistently held that default fiduciary duties apply to those managers of alternative entities who would qualify as fiduciaries under traditional equitable principles, including managers of LLCs,? unless those duties are clearly waived or modified in the LLC?s operating agreement. Id. at *2.
In explaining its decision, the court reviewed (i) the Delaware LLC Act; (ii) the lack of any language in the Act establishing fiduciary duties for LLC managers; (iii) the Act?s authorization in Section 18-1101 that, to the extent a member or manager has duties including fiduciary duties, those duties may be expanded, restricted, or eliminated by the LLC agreement; and (iv) the history of revisions to Section 18-1101. The court analogized the LLC Act to Delaware?s General Corporation Law and noted the Delaware Supreme Court?s application of fiduciary duties to Delaware corporations notwithstanding the absence of any definition or creation of fiduciary duties in the DGCL.
The court also examined Section 1104 of the LLC Act, which provides that ?[i]n any case not provided for in this chapter, the rules of law and equity ? shall govern.? Del. Code Ann. tit. 6, ? 18-1104 (emphasis added). The court found fiduciary duties to be grounded in equity and therefore to be mandated by Section 1104. Auriga, 2012 WL 294892 at *8.
The facts are complex, and the court?s lengthy analysis is multi-part, thorough, and detailed. The brief description above is only a high-level overview. For a more detailed review of the Auriga opinion, I recommend Francis Pileggi?s post on his Delaware Corporate & Commercial Litigation Blog, here, and Peter Mahler?s post on his New York Business Divorce blog, here.
A part of the opinion that I found particularly interesting is the court?s discussion of the difference between the implied covenant of good faith and fair dealing, and the fiduciary duties of loyalty and care. Both are equitable gap-fillers, but they operate in different ways. The implied covenant of good faith and fair dealing applies only ?when the express terms of the contract indicate that the parties would have agreed to the obligation had they negotiated the issue.? Auriga, 2012 WL 294892 at *10. In other words, the implied covenant operates only in cases where the language of the contract as a whole suggests an obligation and points to a result, but does not provide an explicit answer. Id. at *10 n.57. Fiduciary duties, in contrast, provide a framework to govern the discretionary actions of business managers acting under the enabling framework of the LLC agreement. Id. *10.
One part of the opinion will likely be of more interest to litigators than to business lawyers ? the court?s award of attorneys? fees to the plaintiffs. In civil litigation such as the Auriga case, each party normally bears its own legal fees. (This is sometimes referred to as the American Rule, and is in contrast to the English Rule, under which the loser pays the winner?s attorneys? fees.)
Delaware recognizes an exception to the American Rule when a litigant has acted in bad faith. Id. at *29. The Auriga court awarded the plaintiffs one half of their reasonable attorneys? fees and costs ? the award because of the defendants? bad faith, and the one-half limit because the plaintiffs? efforts in the litigation were ?less than ideal in terms of timeliness or prudent focus.? Id.
The court said the bad-faith exception should not be lightly invoked and requires clear evidence of the wrongdoer?s subjective bad faith. The court found plenty of evidence, though: ?The record is regrettably replete with behavior by Gatz and his counsel that made this case unduly expensive for the Minority Members to pursue. Rather than focus on only bona fide arguments, Gatz and his counsel simply splattered the record with a series of legally and factually implausible assertions.? Id. The court also considered the defendants? pre-litigation conduct, as well as violations of the discovery rules.
The procedure mandated by the court for determining the attorneys? fees appears designed to streamline the process. The plaintiffs must simply submit an affidavit with the amount of their ?reasonable attorneys? fees and costs.? Id. The court will then consider that amount to be reasonable unless the defendants? legal counsel produces their own billing records in support of an argument that the plaintiffs? attorneys? fees are too high. And in case there was any doubt about the court?s attitude, the court remarked that ?[i]n objecting to the amount of the fee, Gatz and his counsel should remember that it is more time-consuming to clean up the pizza thrown at a wall than it is to throw it.? Id. at *29 n.184.
The Auriga case is fascinating for a host of reasons: (a) the court?s detailed and lengthy review of Delaware?s LLC fiduciary duty law, (b) the emphasis on the origins of fiduciary duty principles in equity (the Delaware Court of Chancery, like the original English version, is a court of equity), (c) the discussion of the implied covenant of good faith and fair dealing, (d) invocation of the principle that uncertainties in damages are resolved against the breaching fiduciary, (e) the award of attorneys? fees, and (f) the court?s colorful language. The opinion has already generated significant commentary in the blogosphere, and in the future it will undoubtedly be the subject of law review articles and continuing legal education seminars.
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