The Race to the Bottom, Delaware, and LLCs: Waiver of Fiduciary Duties
J Robert Brown Jr. | Wednesday, September 29, 2010 at 06:00AM In the realm of limited liability companies, Delaware allows the parties to waive all fiduciary duties by those managing the LLC (members if it is member managed; managers if it is manager managed) except the duty of good faith and fair dealing. See 6 Del. C. § 18-1101(c).
It is an extreme position. Operating agreements can entirely eliminate the duty of care and the duty of loyalty. While most states allow for some reduction in these duties, only a few states have followed Delaware's lead and permitted complete waiver. See Nev. Rev. State. Ann. 86.286; C.R.S. 7-80-108(2)(d).
In other words, operating agreements can almost entirely eliminate recourse for mismanagement and self dealing. That the agreement is a matter of contract does not prevent the uniformed or the inattentive from investing in an LLC that eliminates most protections for investors. Whatever the policy reasons behind the authority, it certainly has the collateral benefit of making Delaware a favorable jurisdiction for LLC formation.
The authority has generated a growing body of case law. Courts have had to decide whether waiver has in fact occurred and the extent of any waiver. One of those cases is discussed in the next post.
Reader Comments (2)
What makes you think that managers of an LLC have a duty of care or duty of loyalty as set forth in your post? Those are corporate law concepts that do not necessarily translate to the LLC world. A manager of an LLC under Delaware law (18-402) has the "responsibilities accorded to the manager by or in the manner provided in a limited liability company agreement". Admittedly the Chancery Court found a duty of loyalty in VSG, Inc. v. Castiel (2000), that that was a duty owed by the two managers to the third - not to the LLC itself. Unlike Colorado law, Delaware law requires that there be a limited liability company agreement (LLC Agr) (18-201). As Colorado law and that of most other states, the purpose of the LLC Act is to defer to freedom of contract (18-1101(b)). The LLC Agr can be made to sing and dance any way the parties want, but the point is that it must be written carefully since it does not have the default rules that a corporation does - and Delaware even fewer than Colorado. Effectively the only "duty" under Delaware law is the "implied contractual covenant of good faith and fair dealing" (18-1101(c)), and the statute goes on to state "[u]nless otherwise provided in the [LLC Agr], a member or manager or other person shall not be liable . . . for breach of fiduciary duty for . . . reliance on the provisions of the [LLC Agr]."
LLCs are risky entities where the LLC Agr is not carefully drafted to meet the goals of the parties. I have negotiated specifically the waiver of fiduciary duty language, and those negotiations can be quite heated. Where there are "investors" involved as you mention in your post, consider the disclosure issues if the promoter wants to eliminate fiduciary duties of any sort.
And where the investors don't care or place their trust in a trustless promoter, they need to revert to the implied contractual covenant of good faith and fair dealing - frequently a difficult battle.
If they want fiduciary duties, look at a limited partnership (or LLLP) or the corporate form. There are choices other than the LLC. Or negotiate their inclusion in the LLC Agr.
What makes you think that managers of an LLC have a duty of care or duty of loyalty as set forth in your post? Those are corporate law concepts that do not necessarily translate to the LLC world. A manager of an LLC under Delaware law (18-402) has the "responsibilities accorded to the manager by or in the manner provided in a limited liability company agreement". Admittedly the Chancery Court found a duty of loyalty in VSG, Inc. v. Castiel (2000), that that was a duty owed by the two managers to the third - not to the LLC itself. Unlike Colorado law, Delaware law requires that there be a limited liability company agreement (LLC Agr) (18-201). As Colorado law and that of most other states, the purpose of the LLC Act is to defer to freedom of contract (18-1101(b)). The LLC Agr can be made to sing and dance any way the parties want, but the point is that it must be written carefully since it does not have the default rules that a corporation does - and Delaware even fewer than Colorado. Effectively the only "duty" under Delaware law is the "implied contractual covenant of good faith and fair dealing" (18-1101(c)), and the statute goes on to state "[u]nless otherwise provided in the [LLC Agr], a member or manager or other person shall not be liable . . . for breach of fiduciary duty for . . . reliance on the provisions of the [LLC Agr]."
LLCs are risky entities where the LLC Agr is not carefully drafted to meet the goals of the parties. I have negotiated specifically the waiver of fiduciary duty language, and those negotiations can be quite heated. Where there are "investors" involved as you mention in your post, consider the disclosure issues if the promoter wants to eliminate fiduciary duties of any sort.
And where the investors don't care or place their trust in a trustless promoter, they need to revert to the implied contractual covenant of good faith and fair dealing - frequently a difficult battle.
If they want fiduciary duties, look at a limited partnership (or LLLP) or the corporate form. There are choices other than the LLC. Or negotiate their inclusion in the LLC Agr.