In a recent decision by the Delaware Court of Chancery, Auriga Capital Corp. v. Gatz Properties, LLC, C.A. 4390-CS (Del. Ch. Jan. 27, 2012), the court strongly reaffirmed that managers of a limited liability company owe traditional fiduciary duties to the limited liability company and its minority members unless such duties are explicitly reduced or eliminated by the terms of the limited liability company's operating agreement.
This Update summarizes the key issues in the Auriga v. Gatz case.
Background on the Auriga v. Gatz Case
Peconic Bay, LLC (Peconic) owned a long-term leasehold interest in a Robert Trent Jones, Jr. designed golf course on Long Island. Peconic was beneficially owned primarily by the Gatz family, but it also had a handful of minority interest holders. Voting control of Peconic resided with the Gatz family. In addition, the manager of Peconic was Gatz Properties, LLC, which itself was managed and controlled by William Gatz (Mr. Gatz).
Peconic entered into a long-term sublease with a large golf course operator to operate and manage the property. After a few years of operations, the operator was acquired and the new owners let the condition of the golf course deteriorate and did not renew the sublease. Despite this anticipated non-renewal, Mr. Gatz made no legitimate attempt to (i) seek out a replacement operator, (ii) sell the property or (iii) have Peconic operate the golf course on its own. Even when a credible buyer approached Peconic, Mr. Gatz refused to provide due diligence materials and took other actions that dampened any hopes for a sale.
Mr. Gatz was motivated by his belief that the highest and best use of the property was not a golf course but rather a residential development. Mr. Gatz sought to exploit the perceived opportunity entirely for his own benefit by ridding himself of the minority members of Peconic, whom he viewed largely as a nuisance. Through a variety of misleading and bad faith tactics, Mr. Gatz attempted to purchase the minority members' interests in Peconic with a below-market value offer based on materially misleading information. After being rebuffed, Mr. Gatz eventually forced Peconic into a distressed, sham auction in which he was the only bidder and pursuant to which he purchased the minority members' interests for a nominal amount. The minority members subsequently brought suit alleging that Mr. Gatz had breached his contractual and fiduciary duties.
Key Court Findings in the Auriga v. Gatz Case
In its analysis of this case, the court articulated the following key principles:
- While the Delaware Limited Liability Company Act (LLC Act) does not explicitly state that the traditional duties of loyalty and care apply to managers and members of a limited liability company, it does mandate that in any case not provided for in the LLC Act, the rules of law and equity shall govern.
- A manager of a limited liability company qualifies as a fiduciary of the limited liability company and its members.
- The LLC Act is properly read to provide that the default position is that the manager of a limited liability company owes enforceable fiduciary duties of loyalty and care to the limited liability company and its members.
- The LLC Act does permit contractual modification or elimination of fiduciary duties except for the implied contractual covenant of good faith and fair dealing.
- Where the parties have clearly contracted around the default position that fiduciary duties are owed, the court will give effect to the parties' contract.
- When the core default fiduciary duties have not been clearly eliminated by contract, the rules of law and equity mandate that such duties exist and will be applied by the Delaware courts.
In applying these principles to the facts at hand, the court concluded that the parties had not contracted around the default fiduciary duties as nothing in Peconic's limited liability company agreement clearly modified or eliminated them. As such, Mr. Gatz owed the fiduciary duties of loyalty and care to Peconic and its members. The court found Mr. Gatz's conduct to be in blatant breach of such duties as he deliberately took steps to obtain the minority members' interest in Peconic for his personal benefit on unfair terms. The minority members were awarded damages by the court plus 50 percent of their reasonable legal costs in light of the frivolous nature of the defendant's actions.
Practical Implications of the Auriga v. Gatz Case
The court's decision serves as a strong reminder that the traditional fiduciary duties of loyalty and care, so very familiar in a corporate setting, also exist in the context of a Delaware limited liability company unless there is a clear contractual modification or elimination of such duties in the limited liability company's operating agreement. As most states look to Delaware court cases as persuasive authority, this reaffirmation that the law imputes fiduciary duties in the LLC context may have broad applicability. Managers and controlling members of limited liability companies should remain mindful of this as they direct and carry out the activities of their companies. Sponsors forming Delaware limited liability companies should carefully consider the exculpation provisions of their agreements.
This Update is intended only as a summary of the court's decision in Auriga v. Gatz. You can find the full text of the decision at http://www.delawarelitigation.com/files/2012/01/Auriga-Final-Opinion.pdf. You can also find discussions of other recent cases, laws, regulations and rule proposals of interest on our website.
© 2012 Perkins Coie LLP