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July 26, 2014

Subjective vs. Objective: Beliefs Matter for Fiduciaries of Delaware Limited Liability Partnerships and Limited Liability Companies

The Delaware Supreme Court recently clarified when a contractual fiduciary duty imposes a subjective, rather than an objective, standard for determining the appropriateness of a fiduciary’s actions. Under Delaware law, limited liability companies and limited partnerships are allowed—subject to the strictures of Delaware’s Limited Liability Company Act (LLC Act) and its Revised Uniform Limited Partnership Act (RULPA)—to contractually modify or eliminate traditional fiduciary duties of loyalty, care, and candor. Within this context, one commonly used contractual fiduciary duty provision appears to obligate the fiduciary to act in a manner that he or she believes is in the best interests of the entity (whether limited liability company (LLC) or limited partnership (LP)). This type of provision has wildly different impact depending on whether or not it is interpreted as requiring a fiduciary to act on a reasonably-held belief or simply a subjectively-held belief that an action is in fact in the entity’s best interests.

Last week, in William Allen v. Encore Energy Partners, L.P., the Delaware Supreme Court affirmed an earlier decision by Vice Chancellor Parsons, explaining that a fiduciary’s belief that she was acting in the best interests of the LP, if unqualified by a reasonableness requirement, is held to a subjective standard. Del. Supr., C.A. No. 6379 (July 22, 2013). In other words, unless the LP or LLC agreement specifically requires the fiduciary’s belief to be “reasonable,” the fiduciary need only subjectively believe that she acted in the best interests of the entity in order to satisfy her fiduciary obligations. This is, of course, something to keep in mind when drafting an LLC or LP agreement; the lack of a “reasonableness requirement” could afford an executive protection for a decision that harms the entity and flies in the face of commonsense—as long as the executive is empty of head and pure of heart.

This objective vs. subjective distinction also has important implications for a litigator pleading a breach of a contractual fiduciary duty. To plead a breach of a subjective belief, a plaintiff must plead facts from which a court could reasonably infer that the fiduciary did not actually believe he or she was acting in the LLC’s or LP’s best interests. A plaintiff can satisfy this pleading requirement in one of two ways. First, a plaintiff can plead that the fiduciary believed he or she was acting against the LLC’s or LP’s best interests. Second, a plaintiff can plead that the fiduciary consciously disregarded his or her duty to form a subjective belief that he or she was acting in the LLC’s or LP’s best interests. Each option is difficult to satisfy. As a result, courts frequently dismiss cases in which the fiduciary’s subjective belief is at issue.

In sum, both corporate lawyers and litigators need to pay close attention to the distinction between a subjective and an objective belief when analyzing fiduciary duties in connection with an LLC or LP agreement. In most situations, the rights, obligations, and interpretations so familiar from Delaware corporate law are not automatically applicable to the parties to an LLC or LP. If a party wants to import some aspect of Delaware corporate law, it certainly can. But these desired aspects of Delaware corporate law must be specifically provided in the relevant LLC or LP agreements. A party representing a fiduciary in a transaction will want to incorporate a subjective standard; a party concerned about keeping some control over the actions of corporate fiduciaries will prefer the objective standard that comes with a “reasonableness requirement.” Likewise, a litigator faced with the subjective standard may want to advise his or her client that, absent very compelling evidence, it will be extremely difficult to successfully plead a breach of fiduciary duty claim.

© 2014 BARNES & THORNBURG LLP

About the Author

Vincent Schmeltz, Finance, Corporate, Attorney, Barnes Thornburg, Law Firm
Partner

Trace Schmeltz is a partner in the Chicago office of Barnes & Thornburg LLP, where he is the co-chair of the firm’s Financial, Corporate Governance, and M&A Litigation Group and a member of the White Collar Crime Defense Practice Group. A trial attorney with experience in numerous forums including the Delaware Court of Chancery, he concentrates his practice on securities, commodities, mergers and acquisitions and white collar criminal litigation. In addition, he has pursued and defended claims on behalf of auditors, investment banks, corporate boards and corporations.

312-214-4830

About the Author

Anne DePrez, Securities Litigation Attorney, Barnes Thornburg law firm
Partner

Anne N. DePrez is a member of Barnes & Thornburg LLP's Litigation and Corporate Departments. Co-chair of the firm's Financial, Corporate Governance and M&A Litigation Practice Group, she is also a member of the White Collar Crime Defense and Government Litigation Practice Groups. She concentrates her practice in the areas of securities and business litigation. Her securities litigation practice includes representing issuers, directors, underwriters, broker-dealers and others clients in securities fraud class actions, securities regulatory matters, and...

317-231-7264
Brian Casey, Litigation Attorney, Barnes Thornburg, Law firm
Partner

Brian Casey is a partner in the Litigation Department of Barnes & Thornburg LLP'sSouth Bend, Indiana office. He concentrates his practice in business litigation, particularly securities and ERISA litigation, as well as appellate practice. Mr. Casey has represented issuers, and their directors and officers in private securities fraud class actions, SEC and Department of Labor investigations and enforcement actions, as well as investigations by the Department of Justice and the Internal Revenue Service.  He has represented ERISA plan sponsors...

574-237-1285

About the Author

David L. Young, Of Counsel, Barnes Thornburg
Of Counsel

David L. Young is of counsel in the Minneapolis office of Barnes & Thornburg where he is a member of the firm’s Litigation Department. Mr. Young focuses his practice on complex commercial matters with an emphasis on securities litigation and ERISA fiduciary services. He has a wide range of experience that includes director and officer liability, corporate governance matters, antitrust litigation, class action defense and banking litigation.

612-367-8766

About the Author

Solomon L. Wisenberg, Barnes Thornburg Law Firm, White Collar Criminal Attorney
Partner

Solomon L. Wisenberg is a partner in the Washington, D.C. office and co-chair of the White Collar Crime Defense Practice Group. He has more than two decades of experience as lead counsel in complex white collar crime investigations and jury trials.

202-371-6378

About the Author

Kevin David Rising, Barnes Thornburg, Partner
Partner

Kevin D. Rising is a partner in the Los Angeles office of Barnes & Thornburg, where he serves as administrator of the Litigation Department, and is a member of the firm's Labor and Employment Department. Mr. Rising represents clients across several industries in a broad range of complex commercial disputes including contractual disputes, partnership and fiduciary litigation, consumer and wage and hour class action defense, product liability, toxic torts and securities enforcement investigations and securities fraud litigation. He has an active trial...

310-284-3888

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