Fiduciary Duties of Limited Liability Principals Undecided

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Court Rejects as UnneceSsary Statutory Interpretation Finding Fiduciary Duties in LLC Act

One of the burning issues in limited liability company law is the existence and scope of company-stock-in-retirement-plans-cartoon
the fiduciary duties that are the core of the business relationship between the owners and managers of the business.  Our discussion of a recent decision from Delaware is intended to emphasize the unsettled nature of the question in much of the country and to provide a good starting point for an ongoing discussion of just how deep are the changes in the recently enacted changes to New Jersey’s limited liability company statute.

The decision, Gatz Properties, LLC v. Auriga Capital Corp., C.A. No. 4390 (Nov. 7, 2012), is significant to the members and managers of New Jersey LLCs not just because of the influence of the Delaware courts, but because the New Jersey statute – for a short while longer – contains an identical provision.  We don’t discuss the case at length here because our point is somewhat different – the the different way fiduciary duties are addressed by the Revised Uniform Limited Liability Company Act adopted in September.  There are some excellent discussions of the case and its impact can be found on the blogs of Francis Pileggi’s blog (post here), Stoel Rives LLP (post here) and Peter Mahler (post here.)

There are those that argue that an LLC is at its core is a creature of contract, and that the relationship between the members or managers carries with it no inherent fiduciary obligations.  Thus, the argument goes, the members and managers owe each other no greater obligations that they do in any other contractual relationship and the only fiduciary duties that exist are those that are created by the LLC’s operating agreement.

Others, meanwhile, argue that a limited liability is a business enterprise and that the fiduciary relationships that one finds in other forms of business organization, such as corporations or partnerships, should apply.  In many states, including New Jersey, it is an open issue.  So when a Delaware Chancery Court judge went out of its way to find that the Delaware limited liability company statute itself creates fiduciary duties akin to those widely accepted in the context of corporate governance, people paid attention.  Delaware is still considered the fatherland of corporate governance and its decisions, even those of trial judges, carry a great deal of influence.

Any certainty, however, disappeared with the holding of the Delaware Supreme Court that the finding of the trial court concerning any fiduciary duties under the statute was dicta not necessary to the final outcome of the case, and expressly stating that the question of the fiduciary duties of limited liability company managers is still an open issue under Delaware law.

Breach of Fiduciary Duty Alleged in Property Sale

Gatz involved a limited liability company that owned the land where the Long Island National Golf Club is located, and leased the property to the golf course’s operators.  The plaintiffs alleged that the manager of the LLC had breached its fiduciary duty in not seeking the highest price in a sale of the property and purchasing the tract for himself.  Among the allegations were that the property was purchased by the manager at auction, even though third parties had already expressed their willingness to pay a significantly higher price.

The Supreme Court held the Operating Agreement, which prohibited deals with affiliated parties that were less favorable than those available from other third parties, unless approved by a 2/3 disinterested majority, covered all of the issues in dispute.  The interpretation of the statute, the Supreme Court held, was unnecessary and should be “regarded as dictum without any precedential value.”

The court then explicitly stated that it declined to express any views regarding default fiduciary liabilities existing as a matter of statutory construction.  Whether any such duties are created by the statute is “one about which reasonable minds could differ” and that the statute seemed “consciously ambiguous.”

The trial court relied on Sections 1101 and 1104 of Delaware LLC, 6 Del. C. §§ 18-1101 and 18-104(c), which provide first that the members may expand, restrict or eliminate any duty, including fiduciary duties and that in the absence of any statutory provision the rules of law and equity “shall govern.”  These provisions, from which the trial court found the existence of fiduciary duties as a matter of statutory interpretation, are substantially identical to provisions found in N.J.S.A. § 42:2B-66 and § 42:2B-67.

Uncertainty for LLC Members

What does this mean to the owners or managers of a New Jersey LLC? If you follow the reasoning of the Delaware Supreme Court — and many judges will – then it is risky to assume that there are any fiduciary duties governing the relationships of the members and managers that are not specified in the operating agreement.

There is no controlling authority about the nature and scope of fiduciary duties among members and mangers in New Jersey and my own experience is that there is rarely a willingness to specify the duties of members or managers when drafting an operating agreement.  Provisions that restrict common fiduciary duties are relatively commonplace, but it remains to be seen how the courts will construe the ambiguous language.

One can certainly argue that a court asked to consider whether a duty exists should reason by analogy from the corporations statute.  Courts are often reluctant, however, to reach into another statute to create new rights, as was seen in decisions declining to find an implied caused of action for oppression from the fact that the corporations code contains such a right.

New Jersey’s new LLC statute will take an entirely different approach.  N.J.S.A. § 42:2C-1 et seq.  The statute sets out specific duties of loyalty and care, but gives members the ability to adopt an operating agreement that either eliminates those rights (with certain limits) or identify others.  The statute also expressly provides for an obligation of good faith and fair dealing and, subject to the business judgment rule, what appears to subject members and managers to liability under an ordinary negligence standard subject to the business judgment rule and a right to rely on expert opinions (both of which are sizable safe harbors.)

Thus the new statutory framework in New Jersey contains a clear enumeration of rights that the organizers must affirmatively, if they can, disavow.  The new statute’s creation of fiduciary duties is comprehensive and will be the subject of an upcoming post.

The new statute does not take effect for existing limited liability companies until March 2014 and it could be a costly error to assume too much from an operating agreement that is silent about fiduciary duties.  A close look at existing operating agreements and consideration of the changes brought about by statutory revisions may be in order.

And of course the time to look at these corporate governance issues is always now, before there is a dispute between the members.  Once that happens, it is invariably too late to make these decisions in a business-like fashion.

As always, we welcome your questions and comments.

 

 

 

 

 

 

 

 

 

N.J.S.A. § 42:2B-66. Liberal construction [Repealed effective March 1, 2014]

a. This act is to be liberally construed to give the maximum effect to the principle of freedom of contract and to the enforceability of operating agreements.
b. To the extent that, at law or in equity, a member or manager has duties (including fiduciary duties) and liabilities relating to a limited liability company or to another member or manager: (1) any member or manager acting under an operating agreement shall not be liable to the limited liability company or to any other member or manager of the limited liability company for the member’s or manager’s good faith reliance on the provisions of the operating agreement; and (2) the member’s or manager’s duties and liabilities may be expanded or restricted by provisions in an operating agreement.

N.J.S.A. § 42:2B-67. Rules of law and equity govern [Repealed effective March 1, 2014]

In any case not provided for in this act, the rules of law and equity, including the law merchant, shall govern.

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