[co-author: Kyle Benson]
In In re Cadira Group Holdings, LLC (2021 WL 2912479 (Del. Ch. July 12, 2021)), the Delaware Court of Chancery has again shown its inclination to treat an agreement that purports to replace traditional fiduciary duties with duties not to engage in bad faith, willful misconduct, or gross negligence as instead having imposed the traditional fiduciary duties of loyalty and care.
While this decision was on a motion to dismiss and not a holding on the merits, this is the third time that the court has shown its inclination to equate certain contractual duties with traditional fiduciary duties.
Cadira Group Holdings, LLC (“Cadira”), a Delaware limited liability company, was initially formed to formalize a joint venture arrangement between Knights Genesis Healthcare, LLC (“KGH”) and Perseverance Med, LLC (“Perseverance”). After Beau Gertz (“Gertz”), controller of Perseverance, had approached representatives of KGH in 2017 with a business opportunity, the parties formally established Cadira in early 2018 with the intention of making investments and acquiring companies in the healthcare field. The arrangement specified that Perseverance would own 51% of Cadira and KGH would own 49% after all necessary capital contributions had been paid.
However, shortly after an operating agreement between the two entities was signed (the “Operating Agreement”), relations quickly deteriorated as KGH alleged that Gertz, acting as manager, had violated his express contractual commitments and manager standards of conduct set forth within the Operating Agreement by taking certain actions without the requisite unanimous approval of all members of Cadira. Moreover, in April of 2018 Cadira sent notice of default to KGH, alleging that it had not fulfilled its capital contribution requirements as outlined in the Operating Agreement, and had therefore concluded that KGH’s membership rights in Cadira had not vested. Then in July of 2018, Gertz unilaterally seized operations of Cadira and fired all of its employees. In that same month, KGH received news that Gertz and one of Cadira’s subsidiaries, Serodynamics, were subject to a Missouri lawsuit by 25 insurance companies alleging insurance fraud.
By the end of 2018 KGH and Cadira/Gertz had both filed complaints against each other. KGH’s complaint includes counts of common law and equitable fraud, breach of the Operating Agreement by Gertz, breach of fiduciary duties by Gertz, and unjust enrichment. Cadira’s complaint includes a prayer for declaratory judgment that KGH breached its funding obligations and an injunction to require KGH to comply with its funding requirements and to prevent KGH from asserting any ownership rights in Cadira. The Delaware Court of Chancery, in the recently released opinion, addressed each party’s motion to dismiss.
Although the court addressed a wide variety of claims in its opinion, the main area of interest is the court’s stance on the breach of fiduciary duty claims by KGH. At the core of those claims KGH asserts that Gertz violated his fiduciary duties by knowingly taking certain actions without KGH’s consent. In their motion to dismiss, Cadira and Gertz opposed KGH’s assertion and instead argued that the language in the Operating Agreement replaced traditional fiduciary duties with contractual duties and that KGH failed to state a claim for such contractual duties. The specific language of the Operating Agreement read as follows:
It is the intent of this Section [13.02] to restrict the liability and fiduciary duties of the Members and the Managers to the maximum extent permitted by applicable law. Neither the Company nor any Member or Manager shall have any claim against any Member or Manager, provided that such act or omission was performed by the Member or Manager within the scope of its authority under this Agreement and that such act or omission did not involve the Member’s or Manager’s bad faith, gross negligence, willful misconduct or actual fraud, REGARDLESS OF WHETHER SUCH ACT OR OMISSION CONSTITUTED THE SOLE, PARTIAL OR CONCURRENT NEGLIGENCE (WHETHER ACTIVE OR PASSIVE) OF THE MEMBER OR MANAGER.
The Delaware Court of Chancery did not agree with Cadira and Gertz. First, the court noted the ability of parties to freely expand or limit fiduciary duties under the Delaware Limited Liability Company Act. The court also recognized that any intent to eliminate fiduciary duties must be plain and unambiguous. Next, the court found that contractual duties not to engage in bad faith, gross negligence, or willful misconduct essentially replace traditional fiduciary duties with identical contractual duties and that the language of the Operating Agreement was not plain and unambiguous so as to evidence an intent to fully eliminate fiduciary duties. Moreover, the court specifically stated that a contractual duty to refrain from “bad faith” or “willful misconduct” directly corresponds with the traditional fiduciary duty of loyalty and that a contractual duty to refrain from “gross negligence” directly corresponds with the traditional fiduciary duty of care. Ultimately, after equating the contractual duties to traditional fiduciary duties, the court determined that KGH satisfied its low pleading burden for the breach of fiduciary duty claims and denied Cadira’s motion to dismiss.
The Court previously made similar findings in rulings on motions to dismiss in CMS Inv. Hldgs., LLC v. Castle (2015 WL 3894021, at *18 (Del. Ch. June 23, 2015)) and in Smith v. Scott (2021 WL 1592463, at *10 (Del. Ch. Apr. 23, 2021)).
While these rulings by the Delaware Court of Chancery have come in cases involving motions to dismiss, practitioners and drafters should take note of the Court’s apparent willingness to equate certain contractual duties with traditional fiduciary duties in situations in which the parties have sought to contractually limit traditional fiduciary duties.
Drafters should exercise caution when seeking to limit or eliminate traditional fiduciary duties while including contractual language prohibiting bad faith, willful misconduct, or gross negligence. The Delaware courts may view such contractual duties as being equivalent to the traditional fiduciary duties of loyalty and care.