Last fall the Delaware Supreme Court surprised many corporate lawyers when it declared that whether the Delaware LLC Act imposes fiduciary duties on LLC managers is an open question. Gatz Props., LLC v. Auriga Capital Corp., 59 A.3d 1206, 1218 n.62 (Del. 2012).
Prior to Gatz, most Delaware lawyers believed that Delaware LLC managers were subject to fiduciary duties, absent contrary provisions in the LLC agreement. The Delaware LLC Act does not explicitly say that, but it’s implied in Section 18-1101(c):
To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member's or manager's or other person's duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement ….
(Emphasis added.) There was also case law from the Court of Chancery, most notably the Chancery opinion in the Gatz case: Auriga Capital Corp. v. Gatz Properties, LLC, 40 A.3d 839 (Del. Ch. 2012). The Chancery opinion comprehensively explained how and why the Delaware LLC Act applies fiduciary duties to LLC managers. I discussed that decision here.
The Supreme Court affirmed the judgment of the Court of Chancery, but it did so by relying only on the LLC agreement’s contractual provisions for fiduciary duties. The court rebuked the Court of Chancery for unnecessarily expounding on the statute’s interpretation, since deciding whether the LLC Act imposed fiduciary duties was not necessary to resolve the dispute. The Supreme Court declared that Chancery’s “statutory pronouncements must be regarded as dictum without any precedential value.” Gatz, 59 A.3d at 1218.
The Supreme Court’s opinion in Gatz was startling and generated a lot of commentary. I discussed it here. Not only did it reveal a gaping hole in Delaware’s LLC law, it also reflected some tension in the relationship between the Supreme Court and the Court of Chancery.
The Fix. Recognizing that the LLC Act may be ambiguous on whether fiduciary duties apply to LLC managers, the Supreme Court suggested that the Delaware State Bar Association “may be well advised to consider urging the General Assembly to resolve any statutory ambiguity on this issue.” Id. at 1219.
And lo, it is happening. The Corporation Law Section of the Delaware State Bar Association has approved proposed legislation which is now awaiting the Bar Association’s final approval. Approval is expected by the end of this month, after which the proposal presumably will be introduced as a bill in the Delaware General Assembly. It would then proceed through the legislative process, and if all goes well will be passed by the legislature and signed into law by Governor Markell. Given the importance of predictable rules to Delaware’s prominence in the world of corporate law, I think it likely that this proposal will be adopted relatively soon.
The proposed amendment would add 11 words to the LLC Act. Section 18-1104 would be modified to read as follows (the new language is underscored):
In any case not provided for in the chapter, the rules of law and equity, including the rules of law and equity relating to fiduciary duties and the law merchant, shall govern.
The Synopsis to the proposed bill elaborates on the amendment:
Section 8. The amendment to Section 18-1104 confirms that in some circumstances fiduciary duties not explicitly provided for in the limited liability company agreement apply. For example, a manager of a manager-managed limited liability company would ordinarily have fiduciary duties even in the absence of a provision in the limited liability company agreement establishing such duties. Section 18-1101(c) continues to provide that such duties may be expanded, restricted or eliminated by the limited liability company agreement.
Comment. This is an intriguingly short insert to the statute. In one sense it says nothing, because the current language – “the rules of law and equity” – would normally be read to mean all the rules of law and equity. If the rules of law and equity include the rules relating to fiduciary duties, then why the insertion?
Sometimes lawyers will use a phrase in contracts – “including, for the avoidance of doubt” – as a way of clarifying the purpose of an “including” clause. That thinking may be behind the proposed revision, i.e., it may be intended to eliminate any doubt whether fiduciary duties are included in the statute’s reference to “the rules of law and equity.”
Chancery’s opinion in Auriga Capital characterized fiduciary duties as originating in equity, and the proposed amendment’s emphasis on equitable rules can be viewed as a nod to the Chancery Court analysis.
New Hampshire Governor John Lynch signed into law a comprehensive revision to New Hampshire’s limited liability company statute on June 18, 2012. The new act, the New Hampshire Revised Limited Liability Company Act, will be effective January 1, 2013 for LLCs formed thereafter. It will not be effective until January 1, 2014 for LLCs formed under the current statute, although they can elect to be covered by the new act beginning January 1, 2013. The current statute is here.
One of the new act’s major changes is the shift away from requiring an LLC agreement to be in writing, and to now allow LLC agreements to be oral or implied as well as written. The significance of this is that the current LLC act provides a framework of LLC default provisions that can only be modified by a written LLC agreement.
The current act defines a limited liability company agreement as “a written agreement of the members or a document adopted by the sole member as to the affairs of a limited liability company and the conduct of its business.” N.H. Rev. Stat. § 304-C:1(VI).The new act uses the term “operating agreement” and provides that it may be “written, oral, or implied by course of dealing or otherwise.” § 304-C:40. The new act thus allows the members’ oral agreement to override the statute’s default rules in almost all cases.
Allowing oral operating agreements provides more flexibility for the many organizers of LLCs that desire to avoid the expense of hiring a lawyer to prepare a written agreement. The downside is that if there is a dispute it may be more difficult to prove the terms of an oral agreement, which is why lawyers usually recommend putting the agreement in writing.
Another major change is that the new act comprehensively defines the members’ and managers’ fiduciary duties of loyalty and care. § 304-C:106. The current act, in contrast, has no fiduciary duty provisions. The new act’s description of members’ and managers’ fiduciary duties brings clarity to this important issue and is a big improvement.
The new act was drafted by an ad hoc committee of the New Hampshire Business and Industry Association that was chaired by John Cunningham. John is the co-author, with Vernon Proctor, of Drafting Delaware LLC Agreements, a treatise I have used frequently in creating Delaware LLCs. I note that the third edition is now available. John M. Cunningham, Drafting Limited Liability Company Operating Agreements (3d ed. 2012).
John has authored a June 30, 2012 article in the Union Leader on the practical significance of the new LLC act, here, and indicates that it is the first in a series. Stay tuned to the Union Leader for his subsequent articles. He has also written a more detailed article on the new act for the New Hampshire Business Review, here.
Ohio has amended the charging order provisions of its Limited Liability Company Act to clarify that a charging order is the exclusive remedy of a judgment creditor against an LLC member. Governor Kasich signed Substitute House Bill 48 on February 2, 2012, and the bill becomes law on May 4, 2012.
The Ohio statute gives a judgment creditor of an LLC member the right to obtain a charging order against the member’s LLC interest. A charging order means that any LLC distributions that would otherwise go to the member must instead be paid to the judgment creditor. The creditor is treated like an assignee until the debt is satisfied, has no management rights, and cannot force the LLC to make any distributions. Most states have a charging order provision in their LLC Acts.
Ohio’s current statute is unclear whether a judgment creditor of an LLC member can also use other creditors’ remedies, such as foreclosing on the member’s interest. This lack of clarity is not uncommon. A number of states use language in their Acts such as “the court may charge the limited liability company interest of the member with payment of the unsatisfied amount of the judgment.” E.g., Wash. Rev. Code § 25.15.255; N.Y. Ltd. Liab. Co. Law § 607. This sort of language clearly authorizes the charging-order remedy, but does not address the potential applicability of other remedies.
Ohio’s amendment makes clear that a judgment creditor’s charging order remedy is its exclusive remedy against the member-judgment debtor. The new language is italicized and bolded:
1705.19 [Effective 5/4/2012] Rights of judgment creditor
(A) If any judgment creditor of a member of a limited liability company applies to a court of common pleas to charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest, the court may so charge the membership interest. To the extent the membership interest is so charged, the judgment creditor has only the rights of an assignee of the membership interest as set forth in section 1705.18 of the Revised Code. Nothing in this chapter deprives a member of the member’s statutory exemption.
(B) An order charging the membership interest of a member of a limited liability company is the sole and exclusive remedy that a judgment creditor may seek to satisfy a judgment against the membership interest of a member or a member’s assignee.
(C) No creditor of a member of a limited liability company or a member’s assignee shall have any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.
(D) A limited liability company or one or more members of a limited liability company who are not subject to a charging order entered in favor of a judgment creditor may at any time pay to the judgment creditor the full amount then still due under the judgment and by that payment succeed to the rights of that judgment creditor.
The amendment also clarifies that judgment creditors of an LLC member have no right to reach the assets of the LLC itself, although that should already have been clear from the entity nature of an Ohio LLC. See Ohio Rev. Code § 1705.03.
Presumably the amendment will be interpreted to apply to single-member LLCs, although some state court decisions have reflected a negative view of the asset-protection feature of single-member LLCs. E.g., Meyer v. Christie, No. 07-2230-CM, 2011 WL 4857905 (D. Kan. 2011); Olmstead v. FTC, 44 So. 3d 76 (Fla. 2010). I have discussed those cases, here (Meyer) and here (Olmstead). The amendment’s language appears to be applicable to all Ohio LLCs, however, regardless of the number of members.
Substitute House Bill 48 also makes several other changes to Ohio’s LLC Act. The most significant are that it (a) clarifies which default provisions of the LLC Act may be overridden by the operating agreement, and (b) adds fiduciary duties of loyalty and care for LLC members, apparently even if the LLC is manager-managed.