Thursday, September 10, 2020

Using Contractual Flexibility to Avoid Otherwise (Inappropriate) Fiduciary Obligations

Using Contractual Flexibility to Avoid Otherwise
(Inappropriate) Fiduciary Obligations

              A recent decision from the Delaware Court of Chancery highlights the ability of persons drafting unincorporated business entity contracts (partnerships, limited partnerships and LLCs) so as to avoid the application of Delaware's (highly questionable) decision USACafés, L.P. Litigation, 600 A.2d 43 (Del. Ch.), appeal refused sub nom. Wyly v. Mazzafo, 602 A.2d 1082 (Del. 1991). This most recent guidance was delivered in Fannin v. YMTH Land Development, L.P. (In re: United Development Funding III, L.P.), C.A. No. 12541-VCF, 2020 WL 4384230 (Del. Ch. Jul. 31, 2020).

Both this decision and USACafés involved limited partnerships. In USACafés, then-Chancellor Allen of the Delaware Chancery Court held that “directors and controllers of a corporate general partner owed fiduciary duties to the limited partnership and the limited partners.” In that case, when an opportunity was presented that could conceivably have been utilized by the limited partnership, certain principles of the corporate general partner utilized it for themselves. In this instance, the defendants argued that USACafés was incorrectly decided and should be abandoned. The court, however, found that there was no indication that USACafés was clearly wrong and noted its continued citation in both court decisions and the legal scholarship. Note, however, that the parent satisfaction with USACafés is incomplete. For example, Mohsen Manesh has cogently argued that it was incorrectly decided, and is catalog the decisions of numerous other state courts that have not followed. See Mohsen Manesh, The Case Against Fiduciary Entity Veil Piercing, 72 Bus. Law. 61 (Winter 2016-17).

        But all is not lost. Under Delaware law as well as the law of many other jurisdictions, it is possible to disclaim, modify and entirely eliminate fiduciary duties. The Fannin decision points out that this opportunity to use contract reduces the impact of USACafés. Specifically, if it is desired that those in control of the general partner of the limited partnership not owe fiduciary obligations to either the limited partnership as a whole lot to the limited partners either individually or as a class, that can be specified in the controlling agreements. “Controllers may avoid or at least minimize the duty that USACafes recognized by structuring their limited partnership agreements to eliminate fiduciary duties. Delaware limited partnership jurisprudence has long recognized broad license to limit fiduciary duty protections in limited partnership agreements.” Fannin, 2020 WL 4384230, * 18.  In that way the otherwise default application of the principles set forth in USACafés is avoided.
Of course, this means that the application of USACafés continues to exist where the drafters of the controlling agreements are unaware of this option. In those circumstances, those organizing the venture should have done a better job of hiring legal counsel who were up to date with developments in the law. More pernicious is, however, the situation of small ventures that are not in the position to draft bespoke organizational documents; they are not inexpensive. Those smaller, less sophisticated ventures will continue to bear the brunt of USACafés and its arguably invalid core holding.

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