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Auriga Capital Corporation v. Gatz Properties, LLC: Court of Chancery Confirms that a Manager of a Delaware LLC is Subject to Traditional Fiduciary Duties Unless Contractually Modified

February 9, 2012

In Auriga Capital Corporation v. Gatz Properties, LLC, C.A. 4390-CS (Del. Ch. Jan. 27, 2012), the Court of Chancery stated that, unless a limited liability company agreement expands, restricts or eliminates the fiduciary duties owed by a manager, a manager is subject to the fiduciary duties of loyalty and care. After holding a trial, the court concluded that the manager of Peconic Bay, LLC breached both his fiduciary duties and contractual duties under Peconic Bay's limited liability company agreement.

Peconic Bay was formed for the purpose of acquiring a leasehold interest in a piece of land owned by Peconic Bay's manager, Gatz Properties, LLC, developing the land into a golf course and subleasing the course to American Golf Corporation, a professional golf course operator. Gatz Properties and its affiliates owned a sufficient percentage of interests in Peconic Bay to veto or approve any transaction proposed for the company. Gatz Properties was in turn managed by William Gatz, and it is Gatz's actions that were the court's focus.

The plaintiffs accused Gatz of being a disloyal and negligent fiduciary and having breached Peconic Bay's limited liability company agreement. The plaintiffs alleged that Gatz and his affiliates were able to obtain fee simple ownership of a piece of property improved by millions of dollars of investment for a price well below market value. As a defense Gatz argued, first, that his actions were not subject to any fiduciary duty analysis because Peconic Bay's limited liability company agreement displaced fiduciary duties, and, second, that his actions were taken in good faith and with due care and that he was able to obtain the improved property at a low price because Peconic Bay was insolvent at the time of the acquisition. After a trial, the court agreed with the plaintiffs.

On Gatz's first defense, the court concluded that a manager of a Delaware limited liability company owes the traditional duties of loyalty and care unless the duties are expanded, restricted or eliminated by a limited liability company agreement. While the Delaware Limited Liability Company Act does not plainly state that traditional fiduciary duties of loyalty and care apply to a manager, the Act provides for the application of principles of equity in any case not provided for in the Act. In addition, a manager is a fiduciary because a manager is vested with discretionary power to manage the business of the company and there is an expectation that it will act in the interests of the members of the company. Thus, because Peconic Bay's limited liability company agreement did not contain any general provision modifying the fiduciary duties of a manager, but rather contained a provision that contemplated that a manager would pay a fair price in any transaction between it and Peconic Bay, the traditional duties of loyalty and care were applicable.

On Gatz's second defense, the court found that Gatz pursued "a bad faith course of conduct to enrich himself and his family without any regard for the interests of Peconic Bay or its Minority Members." In summary, the conduct that gave rise to this finding included (i) a bad faith and grossly negligent refusal to explore strategic alternatives for Peconic Bay when it became clear that American Golf would terminate its sublease, (ii) a bad faith refusal to consider a third party's interest in purchasing Peconic Bay or leasing the golf course, (iii) a bad faith presentation of misleading information about the third party's interest in purchasing Peconic Bay in connection with Gatz's attempt to buy out minority members, and (iv) bad faith and grossly negligent conduct in running a sham auction of Peconic Bay.