This case summary was prepared by Spencer Miller.
In 77 Charters, Inc. v. Gould, the Delaware Court of Chancery imposed fiduciary duties on a nonparty to an LLC agreement. Vice Chancellor Slights determined the nonparty exerted his power as “remote controller” of several limited liability companies to carry out a form of self-dealing transaction. The nonparty was subject to the duty of loyalty except for the corporate opportunity doctrine, so the court held that the non-party breached his fiduciary duties by self-dealing.
Stonemar Cookeville Partners, LLC (Stonemar Cookeville) and Kimco Preferred Investor LXXIII (Kimco) formed Cookeville Retail Holdings, LLC (Cookeville Retail) to purchase a retail shopping center in Tennessee. Stonemar Cookeville served as Cookeville Retail’s managing member and Kimco retained a preferred membership interest in the company. Further, Stonemar MM Cookeville, LLC (Stonemar MM) served as Stonemar Cookeville’s managing member alongside several non-managing members, including 77 Charters, Inc. (77 Charters). Defendant, Jonathan D. Gould (Gould), was the managing member of Stonemar MM, meaning Gould indirectly controlled Stonemar Cookeville and Cookeville Retail. Gould was also the managing member of Cookeville Corridor, LLC (Cookeville Corridor), which later purchased Kimco’s preferred interest in Cookeville Retail (the Kimco Interest Sale).
After the Kimco Interest Sale, Gould held (i) managerial authority over Cookeville Retail through Stonemar Cookeville and (ii) a preferred interest in Cookeville Retail through Cookeville Corridor. Gould then wielded his managerial authority to amend the Limited Liability Company Agreement of Cookeville Retail Holdings LLC (the CRA). When amending the CRA, Gould notably increased the annual returns for all preferred interest holders. Gould then sold a portion of the preferred interest to another investor but retained a portion of the preferred interest for Cookeville Corridor (i.e himself). By retaining a preferred interest at the higher annual return, Gould and Cookeville Corridor realized a greater financial gain when the shopping center was later sold. Non-managing members like 77 Charters did not receive any income from the sale due to the preferred interest holders’ augmented returns. The CRA amendment, therefore, seemed to constitute a form of self-dealing.
77 Charters subsequently filed a complaint in the Delaware Court of Chancery against Gould and the various entities he controlled. Although the complaint included a “laundry list” of claims, 77 Charters’ primary allegation was that Gould breached his fiduciary duties by amending the CRA and then selling the shopping center “in a manner where he would recover his investment (and more) while leaving 77 Charters with nothing.”
On a motion to dismiss, Vice Chancellor Slights held 77 Charters adequately pled that Stonemar MM and Gould breached their fiduciary duties by self-dealing per the amended CRA. To arrive at this conclusion, the Vice Chancellor analyzed “(i) which, if any, of the Defendants would owe fiduciary duties, (ii) whether default fiduciary duties [had] been waived or modified by contract and (iii) whether the Complaint well [pled] a breach of those duties.” The Vice Chancellor, therefore, began by identifying which parties owed fiduciary duties. First, Stonemar MM owed fiduciary duties as the managing member of Stonemar Cookeville, which was implicated as one of the original signatories to the CRA. Second, Gould owed limited fiduciary duties as a second-tier “remote controller” of Stonemar Cookeville and Cookeville Retail. The Delaware Court of Chancery recognized in USACafes, L.P. Litigation that “remote ‘controllers’ of an alternative entity may owe limited fiduciary duties” if they can “exert control over the assets of that entity.” Through his position as managing member of Stonemar MM, Gould could effectively exert control over Stonemar Cookeville and Cookeville Retail.
Next, Vice Chancellor Slights analyzed whether any fiduciary duties were waived or modified by contract. To this end, the court emphasized that “the managers of a Delaware LLC owe traditional fiduciary duties of care and loyalty” unless clearly and unambiguously exculpated by an LLC agreement. Here, the Vice Chancellor held that Stonemar Cookeville’s LLC agreement (the SCR) only shielded Stonemar MM from monetary liability when acting as a member. The distinction between member and managing member proved important because Stonemar MM breached its fiduciary duties while operating in its managing member capacity. The SCR also disclaimed the corporate opportunity doctrine but left the “other default aspects of the of the duty of loyalty intact.”
Because the SCR disclaimed the corporate opportunity doctrine, the Kimco Interest Sale did not constitute a breach of fiduciary duties. Rather, the breach occurred when Gould “selfishly amended the CRA and shifted economic value toward Cookeville Corridor and away from 77 Charters.” Under the “remote controller” liability scheme set forth by USACafes, an entity’s controller may not self-deal at the expense of non-managing entities. 77 Charters, therefore, could likely prove at trial that is suffered damage when Gould further subordinated its investment to the preferred interest. Thus, 77 Charters’ complaint well pled a breach of fiduciary duties against Stonemar MM and Gould.
Vice Chancellor Slights then addressed the remaining claims in 77 Charters’ complaint. But, as mentioned, the breach of fiduciary duty claim was 77 Charters’ primary allegation and the focus of this memorandum opinion. An important takeaway from 77 Charters, Inc. v. Gould is that the controller of a limited liability company may not use intermediary entities to insulate himself from fiduciary duties. Both USACafes and 77 Charters demonstrate that a “remote controller” may still be subject to limited fiduciary duties. Likewise, “Delaware law recognizes the primacy of contract when addressing governance issues in the alternative entity space,” so limited liability companies must clearly and unambiguously disclaim fiduciary duties when drafting operating agreements. Delaware courts will impose fiduciary duties on the managers of a Delaware LLC unless the operating agreement states otherwise.