Key Takeaways

  • The Delaware Limited Liability Company Act (DLLCA) provides flexibility, allowing LLC agreements to expand, restrict, or eliminate fiduciary duties.
  • By default, managers and managing members owe duties of loyalty and care unless expressly modified in the LLC agreement.
  • Delaware courts rely on both statutory law and equitable principles, including the implied covenant of good faith and fair dealing.
  • The 2018 amendment to the DLLCA clarified fiduciary duty rules and affirmed that LLC agreements can define or waive these obligations.
  • Understanding “what does the Delaware Limited Liability Company Act mean” is critical for drafting operating agreements that protect both managers and investors.

Delaware LLC Act fiduciary duties were originally not specifically stated in the text of the law, so Delaware limited liability company managers were not bound to the same fiduciary care and loyalty as Delaware corporate officers and directors. However, an August 2018 amendment to the LLC Act confirmed that managers, including managing members, must uphold fiduciary duty by default unless the LLC operating agreement clear establishes otherwise by eliminating these duties.

Original Waiver Language

The relevant text of the state LLC Act reads: "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 . . . ." 6 Del. C. § 18-1101(c)."

The act also indicates that managers may not be held liable for breaches of fiduciary and other duties provided that this is stated in the LLC agreement. Some attorneys and legal scholars note that fiduciary duties must legally exist if this language eliminates the duty. Others feel that fiduciary duties exist only if explicitly stated in the agreement.

Purpose and Flexibility of the Delaware LLC Act

The Delaware Limited Liability Company Act is designed to provide maximum contractual freedom to members and managers. Unlike traditional corporate law, which imposes a standardized set of fiduciary duties, the DLLCA allows the parties to an LLC agreement to customize their rights and responsibilities. This flexibility is one of the reasons Delaware is considered the most popular jurisdiction for forming LLCs.

The Act emphasizes the principle of “freedom of contract.” Members can agree to waive fiduciary duties, impose heightened standards of care, or adopt a framework tailored to their unique business goals. However, the statute preserves the implied covenant of good faith and fair dealing, which cannot be eliminated. This ensures that even where fiduciary duties are waived, parties must still honor a baseline of fair and honest conduct.

Relevant Case Law

In general, the Delaware court system has favored business interests over investor interests, particularly when it comes to those who are particularly sophisticated and invest in alternative entities. They are thus exchanging limited fiduciary care for the prospect of high financial returns.

However, an investor who feels that he or she was not treated with fiduciary care can sue for breach of contract if the LLC's operating agreement did not expressly limit or eliminate fiduciary duty on behalf of the managers. In this case, the investor must prove that the company acted against the implied covenant of good faith and fair dealing by avoiding these duties, which are considered default by the court.

The Delaware Court of Chancery extensively addressed this issue in the 2012 case of Capital Corporation v. Gatz Properties LLC. The court found that LLC managers are bound by fiduciary duties unless these are restricted or eliminated explicitly in the agreement. However, this decision was overturned on appeal.

The Supreme Court reviewed the decision of Chancellor Leo E. Strine Jr. and found that if a manager is prohibited from entering agreements with affiliates on less favorable terms than could be obtained from third parties, this constitutes contractual fiduciary duties. Moreover, the court said that no "magic words" are needed to establish fiduciary duties in the LLC agreement and that it should be considered part of the standard for ethical conduct.

Implied Covenant of Good Faith and Fair Dealing

Delaware courts often enforce the implied covenant of good faith and fair dealing as a safeguard when fiduciary duties are restricted or eliminated. This covenant requires that parties to an LLC agreement act consistently with the spirit of their bargain and not undermine the agreed-upon expectations.

For example, if an operating agreement grants broad discretion to managers, they cannot exercise that discretion in bad faith or in a manner that defeats the purpose of the agreement. The covenant operates as a “gap-filler,” addressing issues not explicitly covered in the contract. However, it is not a substitute for fiduciary duties—it only applies in narrow circumstances where the agreement is silent or ambiguous.

Amendments to the LLC Act

The Delaware LLC Act was amended to reflect this Supreme Court decision. Although the court failed to weigh in on whether fiduciary duties apply by default in the case of Auriga Capital Corporation v. Gatz Properties, it encouraged the state bar attorneys and general assembly to work together to resolve the statutory ambiguity.

The amendment to Section 18-1104 of the act added the following text:

  • “In any case not provided for in this chapter, the rules of law and equity, including the rules of law and equity relating to fiduciary duties and the law merchant, shall govern.”
  • Commentary with the amendments clarified that the LLC agreement can waive fiduciary duties of members with an express statement to that effect.

This means that an LLC can manage fiduciary duty with provisions in the operating agreement that restrict, limit, or expand these duties within the boundaries of fair dealing and good faith. This allows each LLC to define its own fiduciary relationships.

Sample language that can be used to eliminate fiduciary duties in the operating agreement is provided by Bloomberg:

"Any standard of care and duty imposed by this Agreement or under the Delaware Act or any applicable law… shall be modified waived or limited, to the extent permitted by law, as required to permit [GP] to act under this Agreement … so long as such action is reasonably believed by [GP] to be in, or not inconsistent with, the best interests of [LP]."

Practical Implications for Business Owners

For entrepreneurs and investors, understanding what does the Delaware Limited Liability Company Act mean in practice is essential for managing risk. Key takeaways include:

  • Customization of Duties: LLC members should carefully negotiate and draft operating agreements to clearly define or waive fiduciary obligations.
  • Investor Protections: Investors should review agreements to confirm whether managers owe fiduciary duties or whether protections are contractual only.
  • Dispute Resolution: Courts will enforce the terms of the agreement first and apply fiduciary or equitable principles only when the agreement is silent.
  • Choice of Delaware: Many businesses choose Delaware because of its predictable legal framework, well-developed case law, and specialized Court of Chancery.

This flexibility makes Delaware LLCs attractive to both small businesses and large investment funds, but it also places significant importance on the operating agreement as the governing document.

Frequently Asked Questions

  1. What does the Delaware Limited Liability Company Act mean for LLC members?
    It means members can define their own rights and responsibilities in an operating agreement, including whether fiduciary duties apply.
  2. Are fiduciary duties automatic under the Delaware LLC Act?
    Yes, managers owe fiduciary duties by default, but these can be limited or waived in the operating agreement.
  3. Can the implied covenant of good faith be waived?
    No. The implied covenant of good faith and fair dealing always applies, even if fiduciary duties are eliminated.
  4. Why is Delaware the preferred state for LLCs?
    Delaware offers strong contractual flexibility, a respected Court of Chancery, and extensive business-friendly case law.
  5. How can LLC members protect themselves?
    By carefully reviewing and negotiating the operating agreement to ensure fiduciary duties or contractual protections align with their expectations.

If you need help with Delaware LLC Act fiduciary duties, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.