Delaware Business Litigation Report

Chancery Construes LLC Agreement as Imposing Only the Managerial Duty to Act in Good Faith and Dismisses Claims for Failure to Plead Bad Faith

MKE Holdings v. Schwartz, C.A. No. 2018-0729-SG (Del. Ch. Sept. 26, 2019).

Under Delaware law, the managers of a limited liability company owe the entity and its members the traditional common law fiduciary duties of care and loyalty.  But parties may eliminate or modify those duties under the LLC’s operating agreement and impose contractual duties instead.  When they do so, Delaware courts will analyze any challenged conduct of the manager against those contractual duties.  Here, the Court of Chancery found the managers’ contractual duty to be a narrow one: act with a good faith belief that their conduct was in or not opposed to the LLC’s best interests.

In MKE Holdings v. Schwartz, plaintiffs brought derivative claims against the managers of a Delaware LLC, alleging that they had violated the LLC’s operating agreement and their fiduciary duties by making acquisitions that would benefit themselves personally, as well as by compensating themselves excessively.  Defendants sought dismissal on the ground that their conduct did not violate the operating agreement.  In construing the LLC’s operating agreement, the Court of Chancery determined that the parties had eliminated the common law duties of care and loyalty, and explicitly permitted the managers to engage in self-interested transactions, as long as the transactions were done in good faith (i.e., not in bad faith).  

Bad faith, under the LLC operating agreement in this case, would be the managers entering into a transaction not reasonably believing that it was in or not opposed the LLC’s best interests.  As the Court found, plaintiffs failed to allege facts permitting an inference of bad faith because, among other reasons, the controlling entity the managers allegedly were acting to benefit owned 70% of the LLC and would suffer the most injury by the alleged misconduct in the case.

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