Delaware Court of Chancery Allows Claims for Breach of Both Fiduciary Duty and Contract Against LLC Manager

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.

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Author:

Francis Pileggi, Managing Partner