A Report on Oral Argument in Gatz Properties v. Auriga Capital Corp.

Ben Chapple (Widener Law ’13) attended the oral argument on September 19, 2012, before the Delaware Supreme Court in Gatz Properties v. Auriga Capital Corp.  (No. 148, 2012).  This is the case in which Chancellor Strine’s opinion concluded, following a lengthy analysis, that members and managers of a Delaware LLC owe fiduciary duties to the LLC by default, and that such duties exist unless excluded by the LLC agreement.

Ben files the following dispatch, and makes two predictions about the outcome:  (1) the Court may avoid deciding what standard of judicial review applies in the case, by holding that the result would be unaffected even if the entire fairness standard does not apply; and (2) the Court will likely determine that the defendant contractually owed fiduciary duties under the LLC agreement, and therefore it is unnecessary to decide whether such duties exist by default.

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In the opinion below, the Court of Chancery held that a majority owner and manager of a LLC (“Gatz”) breached his fiduciary duties when he attempted to obtain ownership interests of the minority members in bad faith.  In deciding the case, Chancellor Strine found that traditional fiduciary duties of care and loyalty apply to LLCs unless the parties contract them away; thus, it was held that there are “default” fiduciary duties. As a result of this holding, many academics and practitioners have closely followed this appeal, anticipating that the Supreme Court will finally weigh in on this interesting issue, which was the subject of an online symposium here late last year. What follows is a brief overview of the oral argument and a couple predictions about the Court’s holding.

Defendant’s Arguments

On appeal, Gatz argued that LLCs are creatures of contract, not common law, and the LLC agreement at issue was unambiguous in its terms that certain conflict transactions were appropriate. Gatz further argued that the Court of Chancery implicitly applied the entire fairness standard, and that decision was contrary to terms of the LLC agreement. Justice Ridgely responded by asking Gatz’s counsel, “Wouldn’t the case be the same even without the entire fairness standard?” Counsel replied that the “prism” through which one views the facts makes a considerable difference, and the burden shift associated with the entire fairness standard was devastating to Gatz’s case.  To this end, Gatz argued that because Chancellor Strine turned a “safe harbor” provision—section 15 of the LLC agreement[1]—into an entire fairness provision, the legal prism should be corrected. Gatz asserted that reading entire fairness into section 15 is inappropriate because if the parties intended to limit transactions they would have done so contractually, which, Gatz contends, they did not. Gatz explained that although the LCC agreement imposed fiduciary duties—for example, as a result of section 15—section 16[2], as written, should have prevented the application of those duties in present case. Gatz argued that although the LLC agreement does not explicitly state that no fiduciary duties apply to certain conflict transactions, under Delaware law the applicable standard that is contractually identified should be enforced and respected by the courts. At the end of Gatz argument, Justice Jacobs stated, “Since [Gatz] conceded that some fiduciary duties apply, to that extent it was unnecessary for the trial court to interpret the LLC statute about default fiduciary duties.” Gatz responded, briefly, by reiterating his previous point that although the LLC agreement imposed fiduciary duties, section 16 of the agreement prevented the application of the duties in the case sub judice.

Plaintiffs’ Arguments

The appellee, Auriga Capital Corp. (“Auriga”), focused its portion of the argument on the contention that Gatz waived the claim that fiduciary duties did not apply—by default or otherwise. Auriga asserted that Gatz repeatedly admitted, throughout pre-trial stages, that fiduciary duties applied and it, like Chancellor Strine, relied on these representations. Auriga asserted that fiduciary duties, whether based on contract or common law, are the same—(1) the duty of loyalty, and (2) the duty of care—and based on the facts of the case, the Court does not need to address whether duties exist by default because they existed by contract, namely as a result of section 15. Additionally, Auriga stated that the “law review” portion of the trial court’s opinion—relating to whether fiduciary duties exist by default—was not addressed by the parties below, and therefore the Court should not decide this issue because it was not “vigorously debated” at trial.

Two Predictions

(1) Based on Justice Ridgely’s question—”Wouldn’t the case be the same even without the entire fairness standard?”—the Court may avoid deciding this issue by holding that the result of the case is unaffected regardless of whether the entire fairness standard applies; and (2) the Court, consistent with avoiding this issue, will likely limits its analysis by determining that Gatz contractually owed Auriga fiduciary duties as a result of section 15 of the LLC agreement, and therefore it is unnecessary to decide whether they exist by default.


[1] Section 15 of the agreement provides, in pertinent part,

Neither the Manager nor any other Member shall be entitled to cause the Company to enter . . . into any additional agreements with affiliates on terms and conditions which are less favorable to the Company than the terms and conditions of similar agreements which could be entered into with arms-length third parties, without the consent of a majority of the non-affiliated Members (such majority to be deemed to be the holders of 66-2/3% of all Interests which are not held by affiliates of the person or entity that would be a party to the proposed agreement

[2] Section 16 of the agreement provides,

No Covered Person [defined to include, “the Members, Manager, and the officers, equity holders, partners, and employees of such of the foregoing”] shall be liable to the Company, [or] any other Covered Person or any other person or entity who has an interest in the Company for any loss, damage or claim incurred by reason of any act or omission performed or omitted by such Covered Person in good faith in connection with the formation of the Company or on behalf of the Company and in a manner reasonably believed to be within the scope of the authority conferred on such Covered Person by this Agreement, except that a Covered Person shall be liable for any such loss, damage, or claim incurred by reason of such Covered Person’s gross negligence, willful misconduct, or willful misrepresentation.

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