Restricting Fiduciary Duty in Delaware LLC’s for a Private Placement Offering
The entity of choice for many project finance based ventures (i.e., real estate, independent film, etc.) is the LLC (limited liability company). These entities are excellent for purposes of raising capital due to the fact that state LLC statutes often permit the LLC members to craft core aspects of the LLC by contract (namely, the operating agreement). Stated another way, many states permit the members to decide the inner workings of their LLC, as opposed to forcing structures upon the members by statute (contrast that with the venerable c-corporation). Accordingly, LLC’s conducting a private placement offering commonly impose a manager based management structure, whereby a board of managers or a single manager act as a sort of joint CEO and director of the company. Hence, a related, but key feature of that LLC management structure is the scope of such managers’ “fiduciary duty.”
The fiduciary duty is a duty owed by a company’s directors, managers, and officers to the company and its stakeholders. Generally speaking, the duty is split into two sub duties: the duty of care and the duty of loyalty. In addition, some courts have held that fiduciary duty encompasses the duties of good faith and fair dealing (in some instances the duties of good faith and fair dealing are subsumed into the duty of loyalty).
For officers, directors, and managers, the duty of loyalty requires that such parties generally act in good faith and for the best interests of the company, without elevating their own personal interests over those of the company. At the very least, this means that such parties must avoid willful conduct that could hurt the company or its prospects. The included duties of good faith and fair dealing requires these parties to act at all times with an honesty of purpose and in the best interest and welfare of the company. The duty of care requires these parties to carefully and in an informed deliberate manner conduct their affairs as an officer, director, or manager and to avoid reckless decisions.
As a result, in the private offering context, the scope of the above duties is a key negotiation point. Again, that is because unlike most corporations, LLC’s can be tailored by the parties to the operating agreement to behave the way such parties intended. Accordingly, many refer to the LLC as a “creature of contract”.
Fiduciary Duty in Delaware LLC’s
As of August 1, 2013, the Delaware General Assembly amended Section 18-1104 of the Delaware Limited Liability Company Act to provide that, unless the LLC operating agreement states something to the contrary, the *default* rule is that the managers of a limited liability company owe fiduciary duties of care and loyalty to the LLC and its members.
Hence, where an operating agreement says nothing on the scope of the managers’ fiduciary duties, the law will presume that that the managers owe its members these fiduciary duties. Critically, however, Sections 18-1101(c) and Section 18-1101(e) of the Delaware LLC Act go on to say that the LLC members are permitted to augment, circumscribe, or eliminate fiduciary duties through their LLC operating agreement (note: the members cannot contractually eliminate the implied contractual covenant of good faith and fair dealing.)
Limiting Fiduciary Duty in Delaware LLC’s Raising Capital Through a Private Offering
For companies raising capital in a Regulation D offering, modifying managerial fiduciary duties must be done in an express and unambiguous fashion. Hence rather than simply disclaiming any and all fiduciary duty, the operating agreement should carefully address the various managerial powers on an item by item basis. So for example, the operating agreement can begin by outlining the metes and bounds of the standard of care. That standard can be limited so that the managers are only liable only for acts of fraud, gross negligence or willful misconduct. In addition, any good operating agreement in a private offering should have detailed provisions discussing the indemnification of managers for liability the company may incur, while performing their duties. Coupled with the above limitation on the fiduciary duty, managers (who are typically the issuers themselves) can contractually control their exposure. And any Regulation D issuer using an LLC should pay close attention to these details.