Delaware Corporate Law Update

Updates on Delaware Corporate Law by Evan O. Williford, Esq., Delaware Corporate Litigation Attorney.

Goggin: LLC Fudges Fiduciary Duties

In MHS Capital LLC v. Goggin, the Court of Chancery had to interpret an oddly-drafted LLC agreement provision regarding fiduciary duties.  Goggin shows why it is in the interests of both LLC management and investors to have knowledgeable lawyers carefully review such documents.  It also shows a Delaware court dealing with the difficult task of interpreting such a provision and coming to a result that is equitable but also consistent with its plain language.

The lawsuit arose from a transaction in which the LLC’s manager allegedly diverted assets in a bankruptcy proceeding from the LLC to a group of entities of which the LLC was only one.  Plaintiff filed suit; the individual defendants moved to dismiss the complaint.

The LLC’s operating agreement contained two interesting provisions relating to fiduciary duties.  First, the agreement required the manager to act “with the care an ordinarily prudent person in a like position would exercise under similar circumstances” (as well as “in good faith” and “in a manner [he] reasonably believes to be in the best interests of the Company”).  As Delaware corporate litigation practitioners know, the default Delaware entity duty of care typically only requires behavior that is not grossly negligent, it does not impose the much higher standard of ordinary care.

Second, the agreement provided that the manager was not “liable . . . for monetary damages” for breach of his or her “duty as a Manager, except as otherwise required under the [Delaware LLC] Act.”  It is not uncommon to see waivers of damages for violating the duty of care (“Section 102(b)(7) provisions”), but those typically exclude other duties (such as good faith).

Defendants did not argue that the alleged conduct was not a breach of the fiduciary duties set forth in the agreement.  Rather, defendants argued that plaintiff’s case should be dismissed because the waiver of damages precluded a remedy.  The Court, however, emphasized that plaintiff was seeking to “disgorge the monetary proceeds received” from the alleged misconduct and “impose a constructive trust”.  The Court ruled that if a claim is stated, “the nature of [] relief [for that claim] is not relevant and need not be addressed.”  As such, the Court “need not decide whether [plaintiff’s] request for some forms of equitable relief is so close to a request for monetary damages that it runs afoul of the exculpatory provision.”  In so ruling, the Court stated that “the way the operating agreement’s ‘Manager’ standard of care—good faith and ordinary care—is meant to work with the exculpatory clause, which purports to eliminate all damages, is unclear to me.”

Faced with a non-standard fiduciary duty provision, the Court ruled that – in this case and at this stage of the litigation – the provision did not preclude plaintiff’s claims.  Thus, in a way the provision ended up costing both sides: defendants by not eliminating costly discovery and further proceedings on plaintiff’s claims; plaintiffs by preserving a chance that after such costly further proceedings the Court might hold that the appropriate remedy is unavailable after all.

The Goggin case shows the importance of having knowledgeable lawyers draft or review fiduciary duty provisions in LLC agreements before they are finalized.  Delaware fiduciary duties have many wrinkles that even an intelligent layperson, or a lawyer not familiar with the subject matter, might miss.  Costly litigation or uncertainty may be the price for not reviewing such provisions carefully.

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Filed under: Court of Chancery, Fiduciary Duties

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Disclaimer

Delaware Corporate Law Update solely reflect the views of Evan Williford of The Williford Firm, LLP. Its purpose is to provide general information concerning Delaware law; no representation is made about the accuracy of any information contained herein, and it may or may not be updated to reflect subsequent relevant events. This website is not intended to provide legal advice. It does not form any attorney-client relationship and it is not a substitute for one.