2014 • Volume 37 • Number 2

Opt-In vs. Opt-Out: Settling the Debate Over Default Fiduciary Duties in Delaware LLCs

Nicole M. Sciotto

Limited liability companies have made a quick ascension to the top of the business entity pyramid. In step with the national trend as the most popular business form, Delaware’s LLC formations outpace corporations three-to-one. This feat is unsurprising when considering the many benefits offered by this business form—namely, its limited liability, eligibility for pass-through taxation, and particularly significant for the purposes of this Note – its contractual flexibility. Unlike corporate investors who lack any meaningful opportunity to negotiate for the protection of their investments, LLC members, through their LLC operating agreement, can meticulously craft an entity exclusively tailored to meet their personal business needs. As a result, the protections afforded to corporate investors in the form of non-waivable, default fiduciary duties are unnecessary in the LLC context. In fact, the 2004 amendment to the Delaware Limited Liability Company Act expressly permits LLC members to eliminate such fiduciary duty protections. While it is clear that fiduciary duties may be removed from LLC agreements, one issue garnering feverish attention throughout the Delaware bench and bar, still remains: whether traditional default fiduciary duties exist where an LLC agreement does not explicitly eliminate, or is silent regarding, the duties owed.

In an effort to resolve this ambiguity, two divergent schools of thought have emerged. Heralded by the Chief Justice Steele of the Delaware Supreme are the “opt-in” supporters, also referred to as “contractarians.” Opt-in proponents argue that courts should conduct a contractual analysis rendering fiduciary duties applicable only if the LLC members affirmatively opt-in for their application, as opposed to superimposing them where the parties have not contracted for those protections in the LLC agreement. In sharp contrast, a recent string of Delaware Court of Chancery dispositions—namely, Kelly v. Blum, Bay Center Apartments Owner, LLC v. Emery Bay PKI LLC, In re Atlas Energy Res., LLC, and most recently, Auriga Capital Corp. v. Gatz Properties—reflect the “opt-out” standard. Opt-out supporters, referred to as “traditionalists,” reject fundamental contract principles and instead inject traditional default fiduciary duties into LLC agreements unless there is an explicit and unambiguous provision in the LLC agreement opting-out of these duties. The Delaware judiciary’s divergent methodologies, compounded by the immense popularity of LLCs and the potential degree of harm that may result from a breach of fiduciary duties claim, make this debate—opt-in vs. opt-out—ripe for the Delaware Supreme Court’s review and/or amendment by the General Assembly.

First, to establish context, this Note examines the contractual underpinnings and rise to prominence of the LLC, and presents a brief primer on fiduciary duties and their applicability in the corporate governance, partnership, and LLC frameworks. Second, it analyzes the opposing rationales that underlie the opt-in vs. opt-out debate, as well as Delaware courts’ representative dispositions. Third, this Note attempts to glean the Delaware Supreme Court’s eventual disposition gathered from an examination of its recent affirming of Chancery’s Auriga decision (and its rejection of the dicta contained therein on default fiduciary duties) and comparable areas of law. Fourth, this Note argues that Delaware courts should adopt the opt-in standard, thereby adhering to the LLC’s strong “freedom of contract” foundation. Fifth, it proposes an amendment to DLLCA section 18-1101(c) that, if incorporated, this Note suggests, would end this debate. Sixth, in addition to illustrating numerous deficiencies inherent in the opt-out standard, this Note explains other negative ramifications of adoption of such a standard. Finally, this Note provides helpful recommendations for Delaware practitioners to adhere to until the debate over default fiduciary duties in the LLC context is settled.