Related Westpac LLC v. JER Snowmass LLC: Implicit Waiver of Fiduciary Duties (Discouraging Investment into Delaware LLCs)

On the one hand, Westpac stands for the proposition that freedom of contract will ultimately prevail.  Parties can waive fiduciary duties if they so decide.

This case, however, does not really stand for that proposition.  It is in fact a provision that makes investments into LLCs more uncertain and difficult and, as a result, discourages capital formation.  By allowing waiver of fiduciary duties (save the duty of good faith and fair dealing), investors are subject to a rule of "let the buyer beware."  Nonetheless, to the extent that investors were inattentive and agreed to invest notwithstanding, as well as an absence of meaningful fiduciary duties, the argument exists that they bear some of the fault. 

In this case, however, the court did not deal with an explicit waiver of fiduciary duties but found an implicit one.  The specifics of the operating agreement (concerning capital calls) implicitly eliminated fiduciary obligations relative to those actions.  Investors, therefore, must take into account the possibility that courts in Delaware will imply a waiver of fiduciary duty implicitly whenever behavior is explicitly addressed in the operating agreement.

In other jurisdicitions where complete waiver of fiduciary duties is not permitted, investors will not incur the same risk.  The moral of this case is that investors should not only bargain for favorable provisions but also should bargain for formation in other jurisdictions to escape a court system that renders fiduciary obligations uncertain. 

Comments

[Tom Bell]

With respect, I think your view of the effect of this case is 180 degrees mistaken. The court's decision in this case makes investments into LLCs by investors more certain and predictable and, as a result, encourages capital formation through Delaware LLCs. The issue before the court in this case was whether certain required consents by an investor to capital calls could be withheld by the investor for its own selfish reasons (i.e, it didn't think it was in its financial interest to invest further into the LLC) or whether there was some implicit duty to make that decision as a fiduciary (i.e., to act in the interests of the LLC or other members). The court construed the LLC agreement (quite correctly in my view based upon my own experience in these transactions) as letting the investor make these decisions for its own selfish reasons and not as a fiduciary. Any other result by the court would have introduced a troubling degree of uncertainty for investors into the nature and extent of their funding obligations and the conditions they can establish for being required to make further investments in a project. For example, if an investor has some kind of vague implicit fiduciary duty to consent to make further investment into a troubled project, that will discourage investors making commitments to projects. In my experience, Delaware courts are quite good at understanding the business deal that the parties have struck and enforcing that deal, even if one party later regrets the deal and tries to argue that the other party was "breaching its fiduciary duty" in taking advantage of the deal that was negotiated.