Delaware Court Of Chancery Allows Claims For Breach Of Both Fiduciary Duty And Contract Against LLC Manager – Corporate/Commercial Law

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Delaware Court Of Chancery Allows Claims For Breach Of Both Fiduciary Duty And Contract Against LLC Manager


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Wilmington, Del. (August 3, 2021) – The
Delaware Court of Chancery recently explained under what
circumstances dual claims will be allowed to proceed for both
breach of fiduciary duty and breach of contract in the context of
the manager of an LLC allegedly using LLC assets for his personal
benefit in a manner not shared by all the other LLC members.
In Largo Legacy Group, LLC v. Charles, C.A. No.
2021-MTZ (Del. Ch., June 30, 2021), the court addressed many
noteworthy bedrock principles of Delaware commercial
litigation.

Practitioners would be well-served to keep this decision handy
in their virtual toolbox because it includes many statements of
Delaware law that have widespread applicability to commonly
encountered business disputes, especially among LLC members.

Background of the Case

The detailed facts provided in the court’s opinion are
essential to fully understanding this case, but for the limited
purpose of highlighting the most consequential statements of law,
I’ll only provide a modest amount of color to give context to
the rulings. Although arguably involving usurpation of corporate
opportunity, the parties and the court referred to the claims as a
more generic and simple breach of fiduciary duty.

The LLC in this case owned a hotel as well as adjacent land that
was undeveloped. According to the complaint, which was viewed in
the context of a motion to dismiss under Rule 12(b)(6)
(see Slip op. at 18-19), the LLC manager transferred
the adjacent land to a separate entity that the manager personally
owned and controlled. He assigned zero value to the land of the LLC
that was transferred to his own entity. Among other things, the
manager allegedly also paid himself for redevelopment costs from
LLC funds, instead of retaining the value of the adjacent property
for the LLC and its members. Slip op. at 36-37.

Key Takeaways

  • The most momentous part of this opinion is the explanation
    about why the fiduciary duty claims were not preempted by the
    breach of contract claims–notwithstanding the primacy of
    contract under Delaware law. See Slip op. at
    37-38; compare footnotes 124 and 125. In sum, the fiduciary duty
    claims only survived to the extent that they did not duplicate the
    breach of contract claims.

  • Importantly, the court buttressed its reasoning with the
    venerable Schnell v. Chris-Craft Indus., Inc., 285
    A.2d 437, 439 (Del. 1971), which announced one of the most famous
    equitable principles: “inequitable action does not
    become permissible simply because it is legally
    possible.
    ” Slip op. at 39 and fn. 106. Another
    variation on this bedrock principle of Delaware law is that
    corporate actions must be twice-tested: once by the law and again
    by equity. Fn. 106.

  • As applied to this case, the court explained that simply
    because the LLC agreement may have been technically complied with,
    default fiduciary duties do not disappear as a check on managerial
    conduct. Id. (The LLC agreement expressly allowed the
    members to compete against the LLC, which might explain why the
    malfeasance was not described as a usurpation of corporate
    opportunity.)

A few other well-settled principles that are well-known to
corporate and commercial litigators are still worth reiterating as
a refresher:

  • Traditional common law fiduciary duties of loyalty and due care
    apply to LLC managers, unless unambiguously limited. Slip op. at 30
    and fn. 84.

  • In order for traditional fiduciary duties to be eliminated or
    limited in an LLC agreement, the language must plainly and
    unambiguously disavow common law fiduciary duties. Slip op. at
    30-31 and fn. 87-91.

  • Primacy of contract only preempts fiduciary duty claims when
    the LLC agreement expressly and unambiguously disavows fiduciary
    duties. Id.

  • Any ambiguity in the language of the LLC agreement about
    whether fiduciary duties were waived is resolved in favor of the
    full panoply of duties. Fn. 117.

  • The court relied on the well-worn USA Cafes case to
    explain why the individual manager of the entity that served as the
    manager of the LLC was exposed to personal liability for breach of
    the fiduciary duty of loyalty. Fn. 96.

  • A classic description of the elements of fiduciary duty and
    what that obligation entails, is always
    useful. See Slip op. at 32-33 and fn. 92-95.
    E.g., a fiduciary “cannot play ‘hardball’ with those
    to whom a fiduciary duty is owed.”

  • Tolling of the statute of limitations is available in three
    situations. Slip op. at 21-23. One of them is equitable tolling
    during a plaintiff’s reasonable reliance upon the competence
    and good faith of a fiduciary. No evidence of actual concealment is
    necessary for tolling under this category. Slip op. at 26.

  • Inquiry notice is explained in terms of when someone should
    have been aware of activity that would trigger the beginning of the
    statute of limitations period, which Chancery usually follows but
    is not required to do so. Id.

  • Chancery follows a three-part test to determine if a claim is
    time-barred. Although the defense of laches is not well-suited for
    a Rule 12(b)(6) motion (see fn. 66), Chancery often
    follows the three-year statute of limitations for breach of
    contract, fraud, and fiduciary duty claims. Slip op. at 21-23.

  • A prior action for books and records based on the LLC agreement
    was withdrawn after this plenary action was filed, but the court
    allowed a claim to proceed for breach of the LLC agreement due to
    failure to provide the requested books and records required under
    the LLC agreement.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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