VC Strine on LLC fiduciary duties

A recent decision by Delaware VC Strine in Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC, decides a number of issues involving the implied covenant of good faith and fair dealing, fiduciary duties of LLC managers, fraud and aiding and abetting breach. Francis Pileggi does his usual excellent job of analyzing the case, so I will simply refer to that for the longer analysis and highlight a couple of specific points.

First, the court interprets an agreement that did not clearly opt out of fiduciary duties as providing for the full range of corporate-type fiduciary duties of the LLC’s manager. VC Strine reasoned (footnote omitted):

the interpretive scales also tip in favor of preserving fiduciary duties under the rule that the drafters of chartering documents must make their intent to eliminate fiduciary duties plain and unambiguous.

I’ve discussed this Strine approach in my Uncorporations and Corporate Indeterminacy (2009 Illinois L. Review 131, 165), noting that

Vice Chancellor Strine’s admonition to lawyers not to address fiduciary duties “coyly” could require such careful and costly drafting that it makes fiduciary duties in effect mandatory. Even a moderate insistence on careful drafting could put fiduciary duty waivers out of the reach of smaller firms. In other words, by making very skilled drafting the price of avoiding indeterminacy, Delaware’s uncorporate law may be trading lower litigation costs for higher fees to transactional lawyers. This may reserve the benefits of the uncorporate approach only for the largest and most sophisticated uncorporations.

While I still think this drafting burden issue is a potential concern, I’m not worried about it in the seemingly significant number of cases, like this one, in which the agreement seemingly is at war with itself.  Here the agreement provided:

Section 6.1 Relationship of Members. Each Member agrees that, to the fullest extent permitted by the Delaware Act and except as otherwise expressly provided in this Agreement or any other agreement to which the Member is a party: . . . (b) The Members shall have the same duties and obligations to each other that members of a limited liability company formed under the Delaware Act have to each other.

Section 6.2 Liability of Members. . . . Except for any duties imposed by this Agreement . . . each Member shall owe no duty of any kind towards the Company or the other Members in performing its duties and exercising its rights hereunder or otherwise.

Maybe the lawyers carelessly used boilerplate, or maybe the parties just hadn’t made up their minds how much they wanted to opt out of fiduciary duties. In either case it is sensible for the courts not to give the parties an agreement they were unable or unwilling to give themselves.

A second issue is whether affiliates of a managing member can be liable for breach of fiduciary duties. This liability has often been recognized in partnership cases. See Bromberg & Ribstein Section 6.07(a)(8). I note in Ribstein & Keatinge (§9.9, n. 6) that it may also be recognized in LLC cases, citing Federalpha Steel LLC Creditors' Trust v. Federal Pipe & Steel Corp., 368 B.R. 679 (N.D. Ill. 2006) (where the LLC to which duties were owed owned the manager). VC Strine says it’s a case of first impression in Delaware LLCs, and that may be true.

Finally, and perhaps most importantly, the court held that liability for fraud may lie against the individual owner and manager (Nevis) of the managing LLC. The court reasoned that under settled Delaware law [footnotes omitted],

[a] corporate officer can be held personally liable for the torts he commits and cannot shield himself behind a corporation when he is a participant.” This includes situations where a corporate agent participates in corporate fraud. Nevis does not argue that he cannot be held individually liable for his participation in fraud committed by PKI, or that he did not participate in the activities that Bay Center alleges were fraudulent. Instead, Nevis argues that PKI’s actions were not fraudulent because PKI had no duty to speak, so there was no fraud for Nevis to participate in. But, as discussed above, I find that Bay Center has stated a claim that PKI’s conduct constituted fraud. Bay Center may therefore also move forward on its claim against Nevis individually for his participation in the alleged fraud.

This reasoning, taken too far in this context, could eviscerate the liability shield. I’ve noted in Ribstein & Keatinge, Section 12:4, n. 1, that

some cases amount to findings that the act of managing an LLC may result in personal culpability. This may be justified where there is a strong need for such culpability * * * In other cases, the liability may be an unjustified abrogation of the limited liability shield.

I cited as a particular example Estate of Countryman v. Farmers Co-op. Ass'n, 679 N.W.2d 598 (Iowa 2004), which reversed summary judgment in favor of manager and 95% that provided managerial services, including ‘‘safety management,’’ in a suit arising out of explosion of propane gas provided by LLC.

The problem here is that a business entity has to be managed by someone. If when the LLC commits the tort the manager is the tortfeasor, what’s left of limited liability for torts?

I can understand that you wouldn’t want to let an LLC manager lie with impunity. But in Bay Center the fraud claim was based on a breach of the managing member's duty to disclose. That member was the LLC, not Nevis.  Without some basis for veil-piercing, this theory gets pretty close to, if not crosses, the line I’m drawing.

Comments

[Fat Man]

"If when the LLC commits the tort the manager is the tortfeasor, what’s left of limited liability for torts?"

Responsibility for torts of employees and other third parties.

[Business Attorney]

Larry, I have read the case and the commentary and I don't see how you can say "Without some basis for veil-piercing, this theory gets pretty close to, if not crosses, the line I’m drawing."

Nevis was the sole equity owner of PKI, the managing member. Every action that PKI took was an action of Nevis. An individual cannot lie, steal or cheat someone and say "It wasn't me, it was my entity" There is no reason to think that breaching a duty of good faith or fair dealing would be any different.

When I have spoken on the topic of "How Limited is Limited Liability?" I try alert people to the fact that in a single member LLC with no employees, the concept of limited liability may be vastly overstated. See my article at http://www.limitedliabilitycompanycenter.com/how_limited_is_limited_liability.html

I am not only NOT surprised by the holding in this case, I think it is absolutely correct. There should be no need to resort to veil-piercing. If the allegations are true, Nevis personally participated in the activities giving rise to the liabilities and it is his personal action, not some theory of veil-piercing, that makes him liable.

[Larry Ribstein]

Clearly a manager or other employee can be liable for his own tort, including fraud. That might include the nondisclosure here. My point was that it also might not, and that Strine's reasoning supporting liability was too broad. The cases on this are mixed, and not clear. See, e.g., NC and LA cases cited in Ribstein & Keatinge, Sec. 12.4, n. 1.

[Kal Malik]

Would the result be different if PKI actually disclosed all the activities plaintiff is complaining of? Since PKI was charged with all the duties to manage the affairs of the LLC, all it had to do was to provide reasonably disclosures to the plaintiff-member of its activities to avoid/successfully defend most of the claims. Our economic system rests upon entities being respected as such; hence, the reluctance/heartburn over entities' actions being attributed to individual members/managers. However, society is not served well when respect for entities allows individuals to perpetrate fraud (especially on other equity-holders). Disclosure and transparency between members/equity-holders are essential to balancing the need for respecting the entity's existence apart from the individual managers and providing meaningful protection to investors. The VC opinion should have emphasized disclosure principles in reaching its conclusions.