A short survey of Delaware and Georgia law regarding standards of care for judging decisions of members or managers when fiduciary duties have been eliminated.
Delaware has successfully become a bellwether for its law regarding fiduciary duties in the corporate context given the quality of the judiciary and the bar and the volume of judicial opinions that have been issued over the years, cultivating a deep body of law to guide the decisions of boards of corporations as fiduciaries of shareholders. Consequently, Delaware’s reputation, preceded by its corporate law development, means its law relating to unincorporated entities, e.g., limited liability companies, cannot be ignored.
This article will briefly compare and contrast the standards of care used to judge decisions and actions of members and managers under Georgia and Delaware law when the traditional fiduciary duties are eliminated. 6 Del C. § 18-1101(c) states:
To the extent that…a member or manager…has duties (including fiduciary duties) to a limited liability company or to another member or manager…, the member’s or manager’s…duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.
Georgia’s statute found at O.C.G.A. § 14-11-305(4)(A)(i) and (ii) states:
To the extent that…a member or manager has duties (including fiduciary duties) and liabilities relating thereto to a limited liability company or to another member or manager: (A) The member’s or manager’s duties and liabilities may be expanded, restricted, or eliminated by provisions in the articles of organization or a written operating agreement; provided, however, that no such provision shall eliminate or limit the liability of a member or manager: (i) For intentional misconduct or a knowing violation of law; or (ii) For any transaction for which the person received a personal benefit in violation or breach of any provision of a written operating agreement….
These two statutes are similar and, at the same time, dissimilar. The similarity lay in that in both Georgia and Delaware, the members can agree to expand, contract or even eliminate traditional fiduciary duties that govern the members or managers. The Delaware statute says the duties can be eliminated in the “limited liability agreement.” As defined in 6 Del C. § 18-101, a limited liability agreement does not expressly include articles of organization. The Georgia statute is explicit. The duties can be eliminated in either the operating agreement or the articles of organization.
To successfully eliminate fiduciary duties, the applicable agreement needs to clearly, expressly and unambiguously express the duties that are waived. See Paul M. Altman & Srinivas M. Raju, Delaware Alternative Entities and the Implied Contractual Covenant of Good Faith and Fair Dealing Under Delaware Law, 1469-1485 (The Business Lawyer Vol. 60, August 2005). The fiduciary duties that can be eliminated are: the duties of loyalty, care and good faith. Id. at 1470. The duty of care invokes the obligation of the decision making process to be reasonable and to take into consideration all that should be considered by those imbued with the obligation to do so, e.g., members. Id. Good faith considers situations that could endanger the existence of the company and for the fiduciary to not expose the company to such risks. Id. Loyalty requires the fiduciary to not allow a conflict of interest to pervert his decisions at the company’s expense, whereby the company loses out and the fiduciary benefits. Id. Put another way, loyalty requires the company’s interests to be put in front of the fiduciary’s personal interests. Id.
Nevertheless, the distinction between the two statutes lay in what the standard of care for evaluating the legal efficacy of decisions or behavior of members or managers when the fiduciary duties are eliminated. In Delaware, the governing standard of care is the implied contractual covenant of good faith and fair dealing. See 6 Del C. § 18-1101(c). The covenant is an independent, statutorily-created cause of action. See 6 Del C. § 1-304. Delaware courts have affirmed, as a general principal of contract law, that there is a contractual duty to perform in good faith that protects the reasonable expectations of the parties. See Paul M. Altman & Srinivas M. Raju, Delaware Alternative Entities and the Implied Contractual Covenant of Good Faith and Fair Dealing Under Delaware Law, 1469-1485, at 1475 (The Business Lawyer Vol. 60, August 2005).
The fact the obligation is contractual limits a court’s review to only fulfilling the intent and purpose of the contract the parties agreed to in the first place as opposed to substantively reviewing the “entire fairness” of the agreement that would have applied had the fiduciary duties not been eliminated in the operating agreement. Id. at 1474. Instead, the covenant is a tool for contract interpretation, not substantive review of the deal negotiated. Id.
Whether a breach of the covenant exists is a subjective determination made in a myriad of contexts by courts. Id. at 1475. Despite the consistency or inconsistency of application of the covenant to certain factual settings, the purpose of the covenant is to effectuate the intent or reasonable expectations of the parties by filling in “gaps” in the contract that exist due to silence on the matter at issue. Id. at 1478. Notwithstanding the subjectivity of the consideration, the test requires a court to determine what the parties intended to accomplish by the express terms of the contract and figure out what the parties would have agreed to had they foreseen the particular circumstances at issue, given the express terms therein. Id. at 1477.
Nevertheless, in Delaware, members of a limited liability company can agree to go so far as to eliminate the fiduciary duties of members and managers that would otherwise govern, leaving the standard of review of the behavior and decisions of the members and managers to be governed by the implied contractual covenant of good faith and fair dealing, as subjectively determined by courts.
In Georgia, if the fiduciary duties have been eliminated, the standard of review of members’ or managers’ conduct and decisions is limited to whether they engaged in intentional misconduct or committed a known violation of law, or received a personal benefit in violation of an express provision of the operating agreement. See O.C.G.A. § 14-11-305(4)(A)(i) and (ii). Georgia does not have an independent cause of action of the implied contractual covenant of good faith and fair dealing. See, e.g., Stuart Enterprises intern., Inc. v. Peykan, Inc., 252 Ga. App. 231 (2001). Ironically, the Georgia Court of Appeals adopted the rule for the first time in Stuart by following the Eleventh Circuit Court of Appeals’s interpretation of Georgia law in Alan’s of Atlanta, Inc. v. Minolta Corp., 903 F.2d 1414, 1429(IV) (1990), a case decided eleven years earlier and concluded no such independent cause of action existed for breach of the implied contractual covenant of good faith and fair dealing.
The Stuart Court said the covenant “modifies, and becomes part of…the contract itself.” As such, the covenant is not independent of the contract. Quoting the Eleventh Circuit, the Stuart Court said, “‘[t]he ‘covenant’ [to perform in good faith] is not an independent contract term. It is a doctrine that modifies the meaning of all explicit terms in a contract, preventing a breach of those explicit terms de facto when performance is maintained de jure.’” This analytical framework of the covenant is very different than Delaware’s. In Delaware, the covenant is viewed as a separate, unstated term of the contract that must be supplied by the court so as to effectuate the spirit and intent of the parties.
In Georgia, however, the covenant is considered a modification of the explicit terms of a contract that prevents one party from breaching the contract, de facto, i.e, in fact, when the other party is rightfully entitled to performance, i.e., de jure. This begs the question, can a court “modify” explicit terms without rewriting the contract? If a contract is rewritten a/k/a “modified,” is not the proclamation of the court a result the parties did not agree and intend? Nevertheless, Georgia does not have an independent cause of action for breach of the implied contractual covenant of good faith and fair dealing.
When fiduciary duties are contractually eliminated in Georgia, members or managers are only prohibited from engaging in “intentional misconduct or a knowing violation of law” or from obtaining a personal benefit “in violation of any provision of a written operating agreement…..” See O.C.G.A. § 14-11-305(4)(A)(i) and (ii). There is no analytical legal framework to contest the validity or invalidity of objectionable conduct of members or managers. The analysis is limited to determining not what the parties intended, etc., but whether the decisions or actions taken arise to the level of “intentional misconduct,” a knowing violation of law, or grant a personal benefit in violation of an express term of the operating agreement. Id. To make it more difficult to contest the conduct of members or managers, they are entitled to good faith reliance on the terms and provisions of the operating agreement. See O.C.G.A § 14-11-305(4)(B). The significance of this provision relates to providing members or managers an argument that they relied upon the operating agreement and did not, as a result, engage in misconduct, making it hard to successfully argue the members or managers are liable for “intentional misconduct.”
If the operating agreement is silent about prohibiting personal benefits on members or managers, that prohibition is moot, leaving only the first two prohibitions. Furthermore, the conduct in question has to be “misconduct.” One has to wonder what makes conduct “mis” conduct. Is conduct that is prejudicial to one party and not another “misconduct” just because of the prejudicial imposition of burdens attendant to the conduct? Furthermore, is not every decision intentional, but what if the affect of the decision, the prejudice, is unintentional? Obviously, there is no objective answer, a case-by-case analysis is required, as it always is required.
There have only been five (5) court opinions in Georgia dealing with O.C.G.A. § 14-11-305(4)(A)(i) or (ii), and only the Stoker case deals with limitations of fiduciary duties, but it still does not involve the elimination of fiduciary duties. See Stoker v. Bellemeade, 272 Ga.App. 817 (2005) (a case involving restrictions of fiduciary duties); see also, Internal Medicine Alliance, LLC v. Budell, 290 Ga. App. 231 (2008) (a case involving no restrictions on fiduciary duties); Argentum Intern., LLC v. Woods, 280 Ga.App. 440 (2006) (a case that only cites the statute for the proposition for which it stands); Myers v. Myers, S15A0403 (GA., 2015) (a case dealing with restrictions on authority, not fiduciary duties); Niloy & Rohan, LLC v. Sechler, A15A1987 (GA. App., 2016) (a case regarding an alleged breach of fiduciary duties).
The “knowing violation of law” implies illegal conduct such as fraud, embezzlement, misappropriation, theft, etc., crimes that in and of themselves require an intentional mens rea that make the actions not an accident, but purposeful illegal acts. So, if the actions of members or managers are not “known” violations of law or are not intentional conduct that constitutes “misconduct,” and if the operating agreement does not proscribe personal benefits on members or managers, everything else is fair game and legal under Georgia law. However, in Delaware, the complaining party has a tool to question the contractual intent of the acts complained of, the implied contractual covenant of good faith and fair dealing.
Georgia and Delaware are similar in that they both allow fiduciary duties to be eliminated. However, the two states’ law diverges greatly when there is a problem with the decisions or actions taken by members or managers whose decisions or actions are not governed by fiduciary duties. In Delaware, issues are resolved by courts applying the implied contractual covenant of good faith and fair dealing. In Georgia, the decisions or actions pass legal muster so long as they are not “intentional misconduct,” known violations of the law, or so long as the members or managers do not obtain a personal benefit in contravention of an express term of the operating agreement forbidding such a benefit. This leaves Delaware with the ability to review the deal and see if the conduct of the parties is anything other than good faith and fair dealing, but in Georgia, the courts can only judge whether there was intentional misconduct, a known violation of law or receipt of a personal benefit in contravention of a provision of the operating agreement. Thus, courts in Georgia have narrower and fewer opportunities to review a transaction than Delaware courts.