Manager self-dealing, corporate opportunity theft, duty of loyalty and care violations, and the implied covenant of good faith and fair dealing under Delaware law
Delaware law imposes default fiduciary duties on LLC managers, but grants extraordinary contractual freedom to modify or eliminate these duties. Understanding which duties apply in your LLC requires careful analysis of the operating agreement.
"To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member's or manager's or other person's duties may be expanded, 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."
Before asserting a fiduciary duty claim, answer these questions:
Do Not Assume Default Duties Apply: Many Delaware LLC operating agreements contain provisions like "the Manager shall have no fiduciary duties to the LLC or Members except as expressly set forth herein" or "the Manager may engage in competing businesses." Read your operating agreement carefully before drafting a demand letter.
I personally review your operating agreement, analyze Delaware fiduciary duty law, and draft customized demand letters addressing manager misconduct.
Email owner@terms.lawThe duty of loyalty requires managers to act in the LLC's best interests rather than their own. It prohibits self-dealing and conflicts of interest unless properly disclosed and approved.
A manager cannot place themselves in a position where their personal interests conflict with the LLC's interests without full disclosure and obtaining approval from disinterested members.
Manager enters transaction where they're on both sides:
Court held that manager who sold LLC's primary asset to himself violated duty of loyalty. Manager had duty to obtain highest price for LLC, not to advantage himself. Transaction rescinded and manager ordered to pay damages.
Manager learns of business opportunity through LLC position and takes it for themselves rather than presenting it to the LLC.
Four-Part Test:
"While serving as manager of ABC Holdings LLC (a real estate investment LLC), you learned that a commercial property at 123 Main Street was for sale. The seller contacted you specifically because of your role as manager of ABC Holdings. The property is exactly the type of asset ABC Holdings invests in, and the LLC had $2.5 million in available capital to acquire it. Rather than presenting this opportunity to the LLC, you purchased the property personally through a separate entity you control. This is a textbook usurpation of a corporate opportunity in violation of your duty of loyalty."
Manager operates a competing business while managing the LLC, diverting opportunities, customers, or resources away from the LLC.
Check Operating Agreement: Many Delaware LLC operating agreements explicitly permit managers to engage in competing businesses. If your operating agreement contains such a provision, competing business alone may not constitute a breach (though diverting specific LLC opportunities still might).
Manager receives undisclosed kickbacks, referral fees, or other compensation from third parties dealing with the LLC.
Example: Manager negotiates contract with vendor who pays manager $50,000 "consulting fee" without disclosing this to LLC members. Even if the contract terms are fair, the undisclosed payment violates duty of loyalty.
When a manager engages in a self-dealing transaction, Delaware courts apply the "entire fairness" standard - the most stringent review. The manager bears the burden of proving:
Managers who acted to preserve their own control in violation of LLC agreement breached duty of loyalty. Court noted that duty of loyalty is "the most fundamental fiduciary duty" requiring managers to "subordinate their personal interests to the interests of the [entity] and its [members]."
| Defense | Requirements |
|---|---|
| Full Disclosure + Approval | Manager disclosed all material facts and obtained approval from disinterested members before engaging in transaction |
| Operating Agreement Authorization | Operating agreement explicitly permits the challenged conduct (e.g., "Manager may engage in competing businesses") |
| Entire Fairness | Even without disclosure/approval, manager proves transaction was entirely fair to LLC (both fair dealing and fair price) |
| Ratification | After learning of the conduct, members ratified it with full knowledge of the facts |
The duty of care requires managers to manage the LLC with reasonable diligence, prudence, and attention. It's about competence and informed decision-making, not outcomes.
Unlike the duty of loyalty (which examines conflicts), the duty of care focuses on manager competence. In Delaware, the standard is gross negligence, not ordinary negligence:
Managers are protected by the business judgment rule: courts will not second-guess business decisions made in good faith, with reasonable information, and in the honest belief the decision serves the LLC's best interests. This protection is lost if manager acted with gross negligence.
Manager makes significant decisions without obtaining reasonably available information:
Manager completely abdicates oversight responsibilities:
While this case involved a corporation, Delaware courts apply similar principles to LLCs. Court held that complete failure to implement oversight systems can constitute bad faith breach of duty of care, especially when legal compliance is at issue.
Manager approves transaction so one-sided that no person of ordinary sound business judgment could conclude it serves any legitimate business purpose:
Poor Results Don't Equal Breach: The duty of care is about process, not outcomes. If manager makes informed, good-faith decision that turns out badly, that's not a breach. Members cannot use hindsight to challenge business decisions that seemed reasonable at the time.
Examples of decisions protected by business judgment rule:
Most Delaware LLC operating agreements contain exculpation provisions eliminating or limiting manager liability for duty of care violations:
"No Manager shall be liable to the LLC or any Member for any loss or damage sustained by the LLC or any Member, unless the loss or damage shall have been the result of fraud, willful misconduct, or gross negligence."
Such provisions are generally enforceable in Delaware. However, they cannot eliminate liability for:
Delaware grants LLCs extraordinary freedom to modify, restrict, or eliminate fiduciary duties through the operating agreement. This is a fundamental distinction from corporate law.
"To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member's or manager's or other person's duties may be expanded, 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."
"To the fullest extent permitted by law, the Manager shall have no fiduciary duties (including without limitation any duty of loyalty or duty of care) to the LLC or the Members, except for the implied contractual covenant of good faith and fair dealing."
Effect: Manager has virtually no fiduciary obligations beyond the irreducible minimum of good faith.
"Manager shall not be liable to the LLC or Members for any act or omission except for acts or omissions constituting fraud, willful misconduct, or bad faith."
Effect: Even gross negligence doesn't create liability - only intentional wrongdoing.
"The Manager and its Affiliates may engage in business activities competitive with the LLC without liability to the LLC or Members, provided that Manager may not divert to such competing businesses any opportunity specifically presented to Manager in its capacity as Manager of the LLC."
Effect: Manager can operate competing business but cannot usurp specific LLC opportunities.
"Manager may enter into transactions with the LLC in which Manager has a conflict of interest, provided that Manager discloses the conflict to Members and the transaction is on terms no less favorable to the LLC than those available from unaffiliated third parties."
Effect: Self-dealing permitted if disclosed and commercially reasonable.
"In exercising discretion under this Agreement, Manager's sole obligation is to act in good faith, and any determination made by Manager in good faith shall be binding on all Members."
Effect: Loyalty and care duties eliminated; only good faith covenant remains.
| Can Be Eliminated/Modified | Cannot Be Eliminated |
|---|---|
| Duty of loyalty | Implied covenant of good faith and fair dealing |
| Duty of care | Claims for fraud or willful misconduct |
| Liability for negligence or gross negligence | Liability for bad faith conduct |
| Prohibition on self-dealing | Requirement to honor explicit contractual obligations |
| Prohibition on competing businesses | Members' statutory rights under DLLCA (e.g., Section 18-305 inspection rights) |
When drafting a fiduciary duty demand letter, follow this analysis:
Do Not Waste Time on Eliminated Duties: If the operating agreement clearly states "Manager owes no duty of loyalty to Members," do not draft a 10-page demand letter about duty of loyalty violations. The court will reject the claim. Instead, focus on the implied covenant of good faith and fair dealing, which cannot be eliminated.
Even when the operating agreement eliminates all fiduciary duties, Delaware law imposes an irreducible minimum: the implied covenant of good faith and fair dealing. This is the ultimate backstop against manager misconduct.
The implied covenant requires that parties to a contract (including LLC operating agreements) deal with each other in good faith and not act arbitrarily, unreasonably, or in a manner that deprives the other party of the benefits of the agreement.
"...the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing."
The implied covenant fills gaps where the operating agreement grants discretion but doesn't specify standards for exercising that discretion.
Delaware Supreme Court clarified that implied covenant claims are "rare" and apply only when: (1) operating agreement grants discretion, (2) such discretion is exercised in a manner that is arbitrary or unreasonable, and (3) no other express contractual provision addresses the conduct.
Delaware courts are reluctant to use the implied covenant to rewrite agreements or import fiduciary duties that parties deliberately excluded. Successful claims typically involve:
Scenario: Operating agreement requires "Manager's consent" for member transfers. Member finds qualified buyer. Manager refuses consent for no reason other than personal animosity toward member.
Analysis: Even though agreement gives manager discretion, exercising it arbitrarily (no business justification) violates implied covenant.
Scenario: Operating agreement gives manager "sole discretion" over distributions. Manager distributes $1 million to themselves (who is also a member) but $0 to other members despite LLC profitability and their pro-rata entitlement being similar.
Analysis: Using discretion to discriminate among members without rational basis violates implied covenant.
Court found implied covenant violation where manager used broad discretion under operating agreement to freeze out minority member by denying consent to transfer and refusing to purchase member's interest at fair value. Manager's conduct "went beyond the limits of reasonableness."
Scenario: Operating agreement establishes LLC to develop specific real estate project. Manager has broad authority over LLC operations. Manager abandons the project and uses LLC funds to pursue unrelated business.
Analysis: Even with broad authority, completely abandoning LLC's fundamental purpose violates implied covenant.
Scenario: Operating agreement silent on manager compensation. Manager pays themselves $1 million annually for LLC generating $500,000 revenue, leaving nothing for members.
Analysis: Exploiting silence in agreement to extract all value violates implied covenant.
Cannot Use Implied Covenant to Add Omitted Terms: If operating agreement doesn't require something, you cannot use implied covenant to import that requirement. The implied covenant fills gaps in exercising discretion; it does not create obligations parties deliberately omitted.
Examples of conduct that does NOT violate implied covenant:
"Section 5.4 of the Operating Agreement provides that 'distributions shall be made in the Manager's sole discretion.' While this provision grants you discretion, it does not grant you unlimited authority to act arbitrarily or unreasonably. The implied covenant of good faith and fair dealing - which cannot be eliminated under 6 Del. C. § 18-1101(c) - requires that discretion be exercised reasonably and in a manner consistent with the parties' reasonable expectations. For the past three years, you have distributed 100% of LLC profits to yourself (as the majority member) while distributing $0 to minority members, despite our pro-rata entitlements being 60% (you) and 40% (minority members). You have provided no business justification for this discriminatory treatment. The LLC has no debt, no pending capital needs, and strong cash reserves. Your exercise of 'sole discretion' to systematically deprive minority members of all distributions while enriching yourself violates the implied covenant of good faith and fair dealing. See Nemec v. Shrader, 991 A.2d 1120 (Del. 2010) (manager's use of discretion to freeze out minority violated implied covenant)."
When demand letters fail to resolve fiduciary duty violations, Delaware Court of Chancery provides powerful remedies.
Compensatory damages equal to financial harm caused by breach:
Manager must return all profits obtained through breach of fiduciary duty:
Disgorgement focuses on manager's gain, not LLC's loss. Even if LLC suffered no provable harm, manager must return ill-gotten profits.
Court unwinds the improper transaction and restores parties to original positions:
Court imposes trust on property wrongfully obtained by manager, requiring transfer to LLC:
Court-supervised review of all LLC finances to identify scope of misconduct:
Court orders manager to stop ongoing violations:
In egregious cases involving fraud, malice, or willful misconduct, Delaware courts may award punitive damages exceeding actual harm.
| Factor | Considerations |
|---|---|
| Forum | Delaware Court of Chancery (check operating agreement for forum selection clause - nearly all require Delaware) |
| Standing | Direct action (member suing for individual harm) vs. derivative action (member suing on behalf of LLC for harm to LLC) |
| Demand Requirement | In derivative suits, must demand manager take action OR show demand would be futile (manager is the wrongdoer) |
| Discovery | Books and records demand under Section 18-305 before filing to gather evidence |
| Attorney's Fees | Check operating agreement fee-shifting provisions; derivative suits may recover fees if successful |
| Timeline | 12-24 months from filing to trial; expedited proceedings available in some cases |
Use when breach caused individualized harm to you as a member:
Recovery: Damages paid directly to you.
Use when breach harmed the LLC as a whole:
Recovery: Damages paid to LLC; you benefit indirectly through increased LLC value.
Demand Futility: In derivative suits, Delaware requires you to demand that the manager take corrective action before filing suit, unless making such a demand would be futile (which it usually is when the manager is the wrongdoer). Your pre-litigation demand letter serves this purpose.
Delaware fiduciary duty claims:
Accrual: Claim accrues when you knew or should have known of the breach. This is why timely books and records demands are critical - they help establish when you discovered the misconduct.
[Your Name]
[Address]
[City, State ZIP]
[Email]
[Phone]
[Date]
[Manager Name]
[LLC Name]
[Address]
[City, State ZIP]
Re: Demand to Cease Breaches of Fiduciary Duty and Provide Accounting
I am a member of [LLC Name], a Delaware limited liability company, holding a [X]% membership interest. I have been a member since [date]. This letter constitutes a formal demand that you immediately cease breaching your fiduciary duties to the LLC and its members, provide a complete accounting of your self-dealing transactions, and remedy the harm you have caused.
As manager of the LLC, you owe fiduciary duties of loyalty and care to the LLC and its members. [If applicable: While Section [X] of the Operating Agreement modifies certain fiduciary duties, it does not eliminate your duty of loyalty with respect to self-dealing transactions or your obligation to act in good faith under the implied covenant of good faith and fair dealing, which cannot be eliminated under 6 Del. C. § 18-1101(c).]
Self-Dealing Transaction in Violation of Duty of Loyalty:
On [date], you caused the LLC to purchase real property located at [address] from [entity you control] for $[amount]. This transaction was a classic self-dealing arrangement in which you occupied both sides of the deal. You breached your duty of loyalty in the following ways:
1. No Disclosure: You failed to disclose to members that you were the beneficial owner of the selling entity.
2. No Member Approval: You did not seek or obtain approval from disinterested members before executing this transaction.
3. Unfair Price: The purchase price of $[amount] significantly exceeded fair market value. An appraisal I obtained values the property at $[lower amount], indicating you caused the LLC to overpay by $[difference].
4. Entire Fairness Standard: Under Delaware law, self-dealing transactions are subject to the "entire fairness" standard, requiring you to prove both fair dealing and fair price. You cannot meet this burden.
Usurpation of Corporate Opportunity:
In [month/year], [describe how manager learned of opportunity through LLC position]. This opportunity was directly within the LLC's line of business, as the LLC's stated purpose is [quote operating agreement purpose]. The LLC had both the financial capacity ($[amount] in available capital) and interest in pursuing this opportunity, as evidenced by [operating agreement provisions, past similar investments, etc.].
Despite your fiduciary duty to present this opportunity to the LLC, you usurped it for your own benefit by [describe manager's actions]. You have realized approximately $[amount] in profits from this opportunity that rightfully belonged to the LLC.
Excessive and Unauthorized Compensation:
You have paid yourself $[amount] in "management fees" for [time period]. This compensation is excessive and violates your fiduciary duties for the following reasons:
The excessive portion of your compensation ($[amount]) constitutes improper self-dealing and must be returned to the LLC.
Violation of Implied Covenant of Good Faith and Fair Dealing:
[If operating agreement eliminates/modifies fiduciary duties:] Even if the Operating Agreement eliminates or modifies certain fiduciary duties, it cannot eliminate the implied covenant of good faith and fair dealing. See 6 Del. C. § 18-1101(c). Your conduct violates this implied covenant because [describe arbitrary, unreasonable, or bad faith conduct that exploits agreement gaps or defeats fundamental purpose].
Damages and Required Remedies:
Your breaches of fiduciary duty have caused the following quantifiable harm:
I demand the following within 30 days of the date of this letter:
1. Rescission: Rescind the self-dealing real estate transaction and return the property to the selling entity, with LLC receiving full refund of purchase price.
2. Disgorgement: Disgorge all profits ($[amount]) obtained from the usurped corporate opportunity by transferring the opportunity to the LLC or paying the LLC the profits realized.
3. Reimbursement: Reimburse the LLC $[amount] representing excessive management fees.
4. Accounting: Provide complete accounting of all transactions since [date] in which you had a conflict of interest, including full disclosure of related-party transactions.
5. Prospective Compliance: Commit in writing to comply with fiduciary duties going forward, including obtaining member approval before any future self-dealing transactions.
If you fail to comply with these demands, I will file a complaint in the Delaware Court of Chancery seeking:
Delaware courts treat breaches of fiduciary duty seriously and provide expansive remedies to protect members from manager misconduct. I prefer to resolve this matter without litigation, but I am fully prepared to enforce my rights through the Court of Chancery.
[If pursuing derivative claims:] This letter also serves as a demand under Delaware law that you, as manager, take corrective action on behalf of the LLC to remedy your own breaches of fiduciary duty. Given that you are the wrongdoer, I recognize that this demand will be refused or ignored, thereby establishing demand futility for purposes of a derivative lawsuit.
Please direct all communications regarding this matter to me at [email] or [phone]. I expect your written response within 30 days.
Sincerely,
[Your Signature]
[Your Printed Name]
Member, [LLC Name]
I personally review your operating agreement, analyze the fiduciary duty framework applicable to your LLC, gather evidence of manager misconduct, and draft customized demand letters. $450 flat fee includes legal research and attorney signature.
Email owner@terms.law