http://blogs.law.widener.edu/delcorp

Professor Conaway on Auriga

3

Auriga Capital Corporation v. Gatz Properties, LLC

It is with regret that I find myself compelled to respond to Chancellor Strine’s unfortunate opinion in Auriga v. Gatz. I do so as a result of serving as a legislative drafter for partnerships, limited liability companies and other alternative entities both in Delaware and as a Life Member with the Uniform Law Conference for over two decades.

It is a well-known legal axiom that bad facts make bad law. Following this axiom, in Auriga Chancellor Strine was faced with bad facts – a devilish manager of an LLC who acted every bit the part of Lord Voldemort determined to “do in” his members. Regrettably, the Court defined the legal issue in Auriga as whether default fiduciary duties existed in a Delaware manager-managed LLC, which is not the default form for a Delaware LLC. As provided at 6 Del. Code § 18-101(6), a Delaware limited liability company is defined as “a limited liability company formed under the laws of the State of Delaware and having 1 or more members.” Thus, in the first instance, for the Court to attempt to resolve the important question of the existence of default fiduciary duties for members or managers of Delaware LLCs upon the facts of this case must necessarily muddy the waters of any judicial analysis.

In the second instance, Chancellor Strine relied upon a well-known “catch-all” phrase originally found in UPA (1914) as crafted by the drafters of the Uniform Law Conference as the basis for his finding of a default fiduciary duty in Delaware’s LLC Act. However, in the Comment to § 104 of the Revised Uniform Partnership Act (1997) (“RUPA”) from which all the ULC alternative entity Acts derive the same “law and equity” clause upon which Chancellor Strine places his emphasis, the following is noted:

”The principles of law and equity supplement RUPA unless displaced by a particular provision of the Act . . . Those supplementary principles encompass not only the law of agency and estoppel and the law merchant mentioned in the UPA, but all of the other principles listed in UCC Section 1-103: the law relative to capacity to contract, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, and other common law validating or invalidating causes, such as unconscionability. No substantive change from either the UPA or the UCC is intended.” (Emphasis is added)

From the Comment to § 104 of RUPA, it is clear that the phrase, “Unless displaced by particular provisions of this [Act], the principles of law and equity supplement this Act,” was never intended to address, much less impose, fiduciary duties on owners or managers in partnerships or limited liability companies.

The third, and most compelling, error in the Auriga opinion is its failure to address the preamble to § 18-1104 that states: “In any case not provided for in this chapter, the rules of law and equity, including the law merchant, shall govern.” According to the prefatory language of § 18-1104, if any provision in the Delaware LLC Act speaks to fill the void of “law and equity,” then § 18-1104 is rendered moot as to that issue. The Delaware LLC Act uniquely, clearly and concisely – since its adoption in 1992 – has specifically expressed the position of the Delaware General Assembly on the policy to be followed for all Delaware LLCs. That policy is found at § 18-1101(b) that unambiguously provides: “It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.”

[(Emphasis added) This same language of usurpation over the “catch all” provisions referencing equity appears in each Delaware partnership act as well as the Delaware LLC Act.]

Thus, if the Court of Chancery were to find that a contractual legal issue could not be answered within the tenets of contract law, only then would the language of § 18-1104 have meaning.

It is also noteworthy that apparently Chancellor Strine believes that the failure to include “a general provision stating that the only duties owed by the manager to the LLC and its investors are set forth in the Agreement itself,” leaves the manager with default fiduciary duties, even where the Agreement in Auriga included express provisions for approval of conflicting interest transactions. Upon the Chancellor’s interpretation then, in the absence of a general fiduciary duty provision in an LLC Agreement, all Delaware LLC Agreements will, in essence, be construed as more of a trust document than a contract.

Finally, the most regrettable portion of the Chancellor’s opinion is the dicta stating that the Delaware LLC is, in essence, the same as a Delaware corporation. Delaware’s own law school devotes two independent advanced seminars to the topics of corporations and LLCs respectively in order to examine the rich diversity of these two entities. Having learned LLCs from the ground up instead of the top down, these distinctions are more readily apparent to this author.

It is with due deference to our Chancellor that I respectfully disagree with the necessity for, as well as the legal basis of, his opinion in Auriga.

Respectfully submitted,

Professor Ann E. Conaway

Comments (3)

[…] not without its critics (read here Widener Law Professor Ann Conaway’s commentary), the core of […]

[…] Professor Ann Conaway, in her withering critique of Chancellor Strine’s decision (read here), presents the argument against reading into Section 18-1104 the incorporation of traditional […]

[…] This case establishes a high-water mark in terms of providing the most comprehensive explanation, based on legislative history and a review of Delaware cases, to explain why the default standard in the LLC context is that fiduciary duty principles will apply to managers of an LLC unless those duties are expressly and clearly limited or eliminated in an LLC agreement.  Prof. Larry Hamermesh, Director of the Institute of Delaware Corporate and Business Law, comments on the decision here. Professor Ann Conaway provides her insights on this opinion here. […]

Write a comment

You must be logged in to post a comment.