The battle for the heart of Delaware uncorporations continues

In my Uncorporation and Corporate Indeterminacy, I contrast the indeterminacy of corporate law with the Delaware uncorporate cases, in which “Delaware lawmakers provide substantial coherence by focusing on the parties' contracts.” I backed this up with a detailed analysis of recent Delaware limited partnership and LLC cases.

This is consistent with Delaware Chief Justice Steele’s admonition, in Judicial Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability Companies, 32 Del. J. Corp. L. 1,4 (2007) that “[c]ourts should recognize the parties' freedom of choice exercised by contract and should not superimpose an overlay of common law fiduciary duties, or the judicial scrutiny associated with them, where the parties have not contracted for those governance mechanisms in the documents forming their business entity.”

This emphasis on the contract is an important part of what I view as the heart of the uncorporation. 

Nevertheless, I worried in my article that "the judicial tendency to apply corporate rules is always lurking and that courts have not yet completely severed the uncorporate cases from corporate indeterminacy."

Recently Chancellor Chandler had an opportunity to come down on the side of applying the contract, in a case I described here. However, in a more recent limited partnership case, discussed here, Vice Chancellor Parsons went out of his way to read a proper purpose requirement for inspecting books and records into a limited partnership agreement that plainly did not have one.

Another shoe dropped Wednesday when Chancellor Chandler, in Fisk Ventures, LLC v. Segal, 2008 WL 1961156 (no link yet) refused to limit LLC members' clear veto power under an LLC agreement. Here’s some of what the Chancellor had to say about the plaintiff’s various attempts to read contractual, good faith and fiduciary duties into a contract that didn’t have any (some footnotes omitted):

The sine qua non of pleading an actionable breach is demonstrating that there was something to be breached in the first place. In other words, before the Court can start worrying about whether or not there was a breach, the Court needs to determine that there was a duty.In the context of limited liability companies, which are creatures not of the state but of contract, those duties or obligations must be found in the LLC Agreement or some other contract.FN34

FN34.See, e.g., Myron T. Steele, Judicial Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability Companies, 32 DEL. J. CORP. L. 1, 4 (2007) (“I conclude that parties to contractual entities such as limited liability partnerships and limited liability companies should be free-given a full, clear disclosure paradigm-to adopt or reject any fiduciary duty obligation by contract. Courts should recognize the parties' freedom of choice exercised by contract and should not superimpose an overlay of common law fiduciary duties....”).

* * * [T]he LLC Agreement endows both the Class A and Class B members with certain rights and protections. In no way does it obligate one class to acquiesce to the wishes of the other simply because the other believes its approach is superior or in the best interests of the Company. To find otherwise-that is, to find that the Court must decide whose business judgment was more in keeping with the LLC's best interests-would cripple the policy underlying the LLC Act promoting freedom of contract.FN35

FN35.See Larry E. Ribstein, The Rise of the Uncorporation 3 (Illinois Law and Economics Research Papers Series, Research Paper No. LE07-026, 2007) (“[U]ncorporate firms have flexible control rules and permit contractual modification or even elimination of fiduciary duties.”), available at http://ssrn.com/abstract=1003790; Sandra K. Miller, The Role of the Court in Balancing Contractual Freedom with the Need for Mandatory Constraints on Opportunistic and Abusive Conduct in the LLC, 152 U. PA. L.REV. 1609, 1616-17 (2004) (“The Delaware LLC statute stands out, however, for its lack of mandatory rules and its express policy to ‘give maximum effect to the principle of freedom of contract.’”); Larry E. Ribstein, Fiduciary Duty Contracts in Unincorporated Firms, 54 WASH. & LEE L.REV. 537, 594 (1997) (recognizing that the Delaware LLC act allows parties “to alter default duties in their agreements as long as they are held to good faith compliance with their contracts”). *

Although occasionally described in broad terms,the implied covenant is not a panacea for the disgruntled litigant. In fact, it is clear that “a court cannot and should not use the implied covenant of good faith and fair dealing to fill a gap in a contract with an implied term unless it is clear from the contract that the parties would have agreed to that term had they thought to negotiate the matter.”Only rarely invoked successfully, the implied covenant of good faith and fair dealing protects the spirit of what was actually bargained and negotiated for in the contract.

* * * [T]he Genitrix LLC Agreement eliminates fiduciary duties to the maximum extent permitted by law by flatly stating that members have no duties other than those expressly articulated in the Agreement. Because the Agreement does not expressly articulate fiduciary obligations, they are eliminated. * * *

Bottom line: Chief Justice Steele and Chancellor Chandler have made it clear that the contract controls uncorporations in Delaware. Hopefully the rest of the Delaware judiciary will get on board.

There is, however, one possible caveat to this analysis.  Chief Justice Steele suggests that the courts should not add duties to the contract.  Chancellor Chandler, saying that fiduciary duties not stated are eliminated, was also at pains to note that the agreement had eliminated them.  So what result here without an express elimination of duties? 

As discussed in my article linked above and in other writings, the Delaware cases have made it clear that the parties must contract carefully to waive fiduciary duties, as the parties did in Fisk. In other words, courts will add fiduciary duties to the express contract if the parties don't negate them. This can be reconciled with CJ Steele's admonition in this way: in the absence of contrary agreement, the fiduciary duties are part of the Delaware standard form contract, consisting of statutory and common law default rules. This seems sensibly consistent with the parties' usual expectations.

Update:  Here's Francis Pileggi's thorough analysis.