Damning dictum: the default duty debate in Delaware.

• Author: Manesh, Mohsen
• Position: Author abstract

1. INTRODUCTION II. GATZ IN CONTEXT A. The Antecedent Debate over Fiduciary Waivers B. The Subsequent Debate over Default Duties C. Gatz Properties v. Auriga Capital Corp 1. Chancery Court Confirms Default Fiduciary Duties 2. Supreme Court Repudiates the Chancery's Dictum III. Gatz's Compromise on Precedent and Dictum A. The Supreme Court's Novel Contractual Approach 1. Gaps in the LLC Agreement 2. The Supreme Court's "Functional" Interpretation B. The Supreme Court's Newfound Disdain for Dicta 1. A Venerable Delaware Tradition a. Chancery Court Dicta b. Supreme Court Dicta 2. Dictum's Many Valuable Functions a. Guidance b. Regulation c. Responsiveness d. The Recognized Value of Dictum C. Compromise over Precedent and Dictum IV. Implications of Gatz A. Problematic Consequences of Gatz for LLC Agreements B. The 2013 Amendment to the LLC Statute C. Lingering Harm to Reputation and Law-Making Process V. Conclusion I. INTRODUCTION

   Bizarrely, just earlier this year, even the most sophisticated business lawyer could not answer a seemingly simple question: whether, in the absence of an express agreement to the contrary, the manager of a Delaware limited liability company (LLC) owes traditional fiduciary duties to its members as a default matter? Despite the LLC form's ever-growing importance, (1) and Delaware's success in attracting LLCs to organize within its jurisdiction, (2) the answer to this question was until very recently unknown--which is, to put it mildly, a bit surprising. Whether LLC managers owe fiduciary duties as a default matter is the type of question that goes to the very heart of LLC governance--to the very heart of how lawyers are to draft LLC agreements.

   This was not always the case. For years, this question of what duties are owed as a default was a settled one--settled at least in the Delaware Court of Chancery. In a string of decisions, the chancery court had repeatedly and unequivocally ruled that, in the absence of an agreement to the contrary, an LLC manager owes members traditional fiduciary duties. (3) But in November 2012, the Delaware Supreme Court cast doubt on this precedent in Gatz Properties v. Auriga Capital Corp. (4)

   Sharp disagreements between Delaware's supreme court and its inferior court of chancery are not new, (5) even in the unincorporated alternative entity context. (6) Indeed, this Article is not about the underlying legal dispute reflected in Gatz. Others have already addressed that question. (7) Whether the managers of an LLC should owe fiduciary duties as a default is ultimately a normative question, sometimes couched in economic (8) or technical statutory arguments. (9)

   Rather, this Article is about the problematic compromise reflected in Gatz. Seemingly unable to muster a consensus on the default duties question, the Delaware Supreme Court avoided internal divisions by instead attacking the chancery court's consideration of the matter as "improvident and unnecessary" dictum. (10) The problem with this compromise is that it undermines both the certainty of Delaware law as well as a judicial tool long used by Delaware courts to address uncertainty. By attacking the use of dictum, the supreme court attacked an important facet of Delaware's lawmaking process--an established judicial practice vital to the state's success in attracting corporate, and now LLC, charters. (11)

   Given the broad freedom of contract available under Delaware LLC law, it may be that default duties do not much matter. (12) And, in any case, recent legislation has now resolved the specific uncertainty created by Gatz. Effective August 1, 2013, Delaware's LLC statute was amended to confirm the existence of default fiduciary obligations (the "2013 Amendment"). (13) Consequently, the lasting impact of Gatz is not on the substantive legal question. Rather, the lasting impact of Gatz is on Delaware law's vaunted reputation for certainty and the judicial practice key to fostering that reputation.

   The remainder of this Article proceeds in four parts. Part II sets the default duties debate in a broader context, describing the judicial precedent and legislative history leading up to the Gatz decision. Given this context, Part III then highlights the compromise made in Gatz with respect to doctrine and dictum. In particular, Part III shows that in Gatz, the Delaware Supreme Court departed from the express contractual language at issue, the court's own precedent, as well as a rich Delaware judicial tradition of using dictum to serve important guidance, regulatory, and responsiveness functions. Part IV then considers Gatz's implications. The immediate aftermath of Gatz has been the amendment of Delaware's LLC statute to undo the Delaware Supreme Court's decision. Longer term, however, Gatz will have consequences that cannot be fixed by a simple legislative amendment. Part V briefly concludes.

2. GATZ IN CONTEXT

   The fiduciary duty owed by those entrusted with control over the property of another has long been a bedrock of the law of business associations. It has been a bedrock in the law of both corporations (14) and partnerships (15)--the two entities of which the LLC is supposedly a hybrid. So, how did we even get to this point? How did we get into a situation in which it was an open question whether fiduciary duties, once famously described as "unbending and inveterate," (16) apply to an LLC manager at all in the absence an express agreement imposing such obligations? To answer this question, one must understand Gatz's historical antecedents.

   1. The Antecedent Debate over Fiduciary Waivers

      The legal question raised by Gatz has its roots, coincidentally, in an earlier Delaware Supreme Court decision. In 2002, the supreme court attempted to settle another then-nagging question involving unincorporated alternative entities. The question was this: to what extent could an LLC and its ancestral relative, a limited partnership (LP), contractually eliminate the fiduciary duties of its managers through the terms of its governing agreement?

      At that time, Delaware's LLC and LP statutes were unclear. The statutes simply provided that fiduciary duties "may be expanded or restricted" by the terms of an LLC or LP agreement. (17) Nowhere did the statutes mention whether such duties may be waived altogether. But in a pair of decisions, the Delaware Chancery Court had suggested that the statutory "expanded or restricted" language permitted fiduciary duties to be wholly eliminated. (18) These judicial pronouncements were mere dicta, however; no Delaware court had definitively ruled on the matter.

      By 2002, the Delaware Supreme Court felt it necessary to confront what it viewed as the chancery court's "dubious dictum." (19) And it did so in Gotham Partners v. Hallwood Realty. (20) But because the matter was not squarely presented by the Gotham Partners litigation, (21) the supreme court was forced to engage in its own dictum to reach the fiduciary waiver question:

      In our view [the chancery court's] dictum should not be ignored because it could be misinterpreted in future cases as a correct rule of law. Accordingly, in the interest of avoiding the perpetuation of a questionable statutory interpretation that could be relied upon adversely by courts, commentators and practitioners in the future, we are constrained to draw attention to the statutory language and the underlying general principle in our jurisprudence that scrupulous adherence to fiduciary duties is normally expected. (22) This judicial disagreement between the supreme court and court of chancery, waged in dicta, was ultimately resolved through legislative intervention. (23) After the Delaware Supreme Court's Gotham Partners decision, the Delaware General Assembly amended the state's LLC and LP statutes to make clear that fiduciary duties may be contractually waived altogether--"expanded, restricted or eliminated"--by the terms of an LP or LLC agreement. (24) The question was settled. The chancery court's statutory construction, originally espoused in dictum, prevailed over the supreme court's construction. Although it is still controversial policy, (25) today, no one doubts that, as a legal matter, LLCs and

      LPs can wholly eliminate the fiduciary duties of managers by contractual agreement. (26)

   2. The Subsequent Debate over Default Duties

      By settling the judicial debate over outright fiduciary waivers, the Delaware legislature inadvertently raised another question. This question is the one that has recently vexed LLC law: to what extent are managers bound by fiduciary duties in the absence of an express agreement imposing such duties? Put differently, to what extent do LLC managers owe fiduciary duties as a default matter? The debate over this question had the familiar hallmarks of yesteryear's judicial disagreement over fiduciary waivers. In the absence of clear legislative intent, it pitted the Delaware Supreme Court against the Delaware Court of Chancery.

      With respect to the Delaware LLC statute, although the statute had since the 2004 legislative amendments following Gotham Partners clearly allowed for fiduciary duties to be contractually eliminated, prior to the 2013 Amendment, it never confirmed that fiduciary duties are owed in the absence of a contractual waiver. (27) Rather, the statute simply provided that "[t]o the extent ... [one] has duties (including fiduciary duties) ... [such] duties ... may be expanded, restricted or eliminated by the terms of an LLC agreement." (28) The statute never affirmed the existence of fiduciary duties to begin with. In this respect, the Delaware legislature seemed to have explicitly deferred the important policy question to the Delaware judiciary to determine the default duties owed by LLC managers and members. (29)

      The Delaware LLC statute was modeled on the state's LP statute; in fact, much of the architecture and wording of the two statutes is identical. (30) Like its LLC statute, Delaware's LP statute provides...