In the case of a sale-of-control transaction of an LLC, absent waiver or elimination of fiduciary duties in the operating agreement, the same fiduciary duties could apply to the managers or managing members of an LLC, as would apply to directors of a corporation. Traditional fiduciary duties, including Revlon duties, can be eliminated or waived through specific language in the LLC‘s operating agreement.
By Alon Harnoy, Esq. and Robert Rosenberg, Esq.
There is a common misconception that managers or managing members of a Delaware limited liability company do not owe the same fiduciary duties owed by directors of Delaware corporations. An extension of this misconception is that in the context of an LLC that has several members and a manger, the manager is able to freely conduct a sale process and find a willing buyer for the LLC at a price that such manager believes is attractive. The problem with this misconception is that absent the operating agreement of the LLC specifically eliminating fiduciary duties of the manager, the manager will be subject to such fiduciary duties, including so-called Revlon duties, requiring the manager to take steps in order to obtain the highest value reasonably available to the members of the company. In this article we will address this issue by taking a look at the Delaware LLC, the scope of fiduciary duties owed by a manager of a Delaware LLC and certain specific duties that arise in the context of a sale of a Delaware LLC.
An LLC represents a hybrid of the corporation and partnership business models, providing its members (i.e., the owners) with the limited liability protection of a corporation along with the optional pass through income tax benefits and flexibility of management available in a partnership.
The Delaware Limited Liability Company Act (the “Delaware Act”) provides the statutory framework for LLCs formed in Delaware. The Delaware Act does not explicitly address the imposition of fiduciary duty or any standards of conduct for managers. Instead, the Delaware Act provides that whatever fiduciary duties other laws or common law principles impose on LLC managers may be “expanded or restricted or eliminated” by the LLC’s operating agreement. In Bay Ctr. Apartments Owner, LLC v. Emery Bay PKI, LLC, on the other hand, the court held that managers of LLCs and general partners of partnerships owe fiduciary duties parallel to those of a corporation’s directors. Therefore, absent any specific waiver or exclusion of fiduciary duties in an LLC operating agreement, or where the limiting language is unclear, LLC managers or managing members owe fiduciary duties to other LLC members, and could be sued by the members for breaching such duties.
Fiduciary duties are basically comprised of the duty of care and the duty of loyalty. The duty of care requires a fiduciary to act with the care that a person in a like position would reasonably exercise under similar circumstances and in a manner reasonably believed to be in the best interests of the company. The duty of loyalty essentially requires that the best interest of the company and its members takes precedence over any interest possessed by a manager and not shared by the members generally.
While fiduciary duties of managers of an LLC can be eliminated or waived in the operating agreement, the one exception to this rule is with respect to the implied covenant of good faith and fair dealing which cannot be waived in any way. The implied covenant of good faith and fair dealing requires parties to a contract to deal with each other honestly, fairly, and in good faith, so as to not destroy the right of the other party or parties to receive the benefits of the contract.
In the context of a sale-of-control of a corporation transaction, Delaware courts have imposed increased fiduciary standards on directors, known as Revlon duties based on Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., the first leading case to address the issue. In such a situation, directors are responsible for obtaining the highest value reasonably available to the corporation’s stockholders. In Arnold v. Soc’y for Sav. Bancorp, Inc., the Delaware Supreme Court has held that this standard will be applied: (1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear breakup of the company; (2) where in response to a bidder’s offer, a target abandons its long term strategy and seeks an alternative transaction involving the break-up, of the company; or (3) when approval of a transaction results in a ‘sale or change of control.
Managers of newly or yet to be formed LLCs must therefore be careful when drafting their operating agreements to specifically delineate the desired fiduciary duties, and to explicitly disclaim (if so desired) all other fiduciary duties. Minority members of LLCs, on the other hand, might wish to benefit from the protection of having their managers subject to fiduciary duties and therefore not wish to allow managers to eliminate fiduciary duties in the operating agreement. Accordingly, members of LLCs considering provisions in their operating agreement with respect to expanding, restricting or eliminating fiduciary duties, should consult with legal counsel to make sure the desired fiduciary duties apply.