DELAWARE COURT OF CHANCERY REFUSES TO DISMISS CLAIM OF AIDING AND ABETTING AN LLC MANAGER’S BREACH OF FIDUCIARY DUTY

Date: February 4th, 2010

In Julian v. Julian, No. 4137-VCP (Del. Ch. Sept. 9, 2009), the Delaware Court of Chancery identifies the standard for asserting that a defendant aided and abetted a breach of fiduciary duty by a limited liability company’s manager.

The LLC in question paid management fees to a management company controlled by two brothers, one of whom was the LLC’s manager, and these management fees had been increased by 400% without the management company providing any additional services. The plaintiff, a third brother, asserted a breach of fiduciary duty claim against his brothers on behalf of the LLC, contending that the manager had increased the fees with the consent of the other defendant brother. The plaintiff claimed that his non-manager brother had aided and abetted the manger’s breach of fiduciary duty.

Analyzing the claim and the motion to dismiss in the light most favorable to the plaintiff rather than on the merits, the court identified the applicable legal standard and the plaintiff-favorable interpretation of the pleaded facts that could support it:

The court wrote:

“Aiding and abetting a breach of fiduciary duty requires both knowledge of the breach of a duty and participation in the wrongful conduct. The Complaint alleges that [plaintiff] was engaged in litigation against [defendants] and that, some time after the litigation began, the management fees charged to [the LLC] . . . suddenly skyrocketed by 400%. A management company allegedly controlled by [defendants] received the increased fees. Further, the Complaint alleges the fees were increased by ‘[the manager defendant] with the consent of [the non-manager defendant].’

“Under the plaintiff-friendly motion to dismiss standard, the allegations that [the non-manager defendant] consented to the increase in fees, which benefited a company controlled by [defendants], are sufficient to support a reasonable inference that [the non-manager defendant] participated in the alleged wrongdoing. The fact that [the manager defendant] could have taken that action on his own as a manager does not negate a reasonable inference that [the non-manager defendant] may have been involved in the decision.”

Note that the Delaware Limited Liability Company Act does not state whether, under what circumstances and to what extent LLC managers owe fiduciary duties to LLCs they manage or their members, and an LLC’s limited liability company agreement can define the fiduciary duties the members wish to apply. Therefore, one of the favorable assumptions the court made was that the LLC manager owed a fiduciary duty to the plaintiff in the first instance.

The aiding-and-abetting standard the court identifies, “knowledge of the breach of a duty and participation in the wrongful conduct” was articulated in the corporate context by the Delaware Supreme Court in Malpiede v. Townson, 780 A.2d 1075, 1097 (Del. 2001):

“A third party may be liable for aiding and abetting a breach of a corporate fiduciary’s duty to the stockholders if the third party “knowingly participates” in the breach. To survive a motion to dismiss, the complaint must allege facts that satisfy the four elements of an aiding and abetting claim: “(1) the existence of a fiduciary relationship, (2) a breach of the fiduciary’s duty, . . . (3) knowing participation in that breach by the defendants,” and (4) damages proximately caused by the breach.”

An alternative formulation, stated by the Delaware Court of Chancery in Nebenzahl v. Miller (Del. Ch. Aug. 26, 1999, corrected, Aug. 26, 1999) states four requirements for a claim of aiding and abetting a breach of fiduciary duty:

“(1) the existence of a fiduciary relationship, (2) the fiduciary breached its duty, (3) a defendant, who is not a fiduciary, knowingly participated in a breach, and (4) damages to the plaintiff resulted from the concerted action of the fiduciary and the non-fiduciary.”

The latter formulation presents a higher bar for plaintiffs, explicitly stating that damages to the plaintiff must have resulted from “concerted action” between the defendant and the fiduciary. The Nebenzahl court added “A court can infer a non-fiduciary’s knowing participation only if a fiduciary breaches its duty in an inherently wrongful manner, and the plaintiff alleges specific facts from which that court could reasonably infer knowledge of the breach.”

Claims against LLC members and third parties for aiding and abetting LLC managers’ breaches of fiduciary duties have not been tested in Washington courts, but we would expect courts here to apply standards similar to those applied in Delaware.

These standards create broad possibilities for assertions of aiding and abetting an LLC manager’s breach of fiduciary duty. There is no requirement that the aider-and-abettor have an ownership interest or other relationship to the LLC prior to the alleged aiding and abetting. For example, if there is a claim that a manager breached a fiduciary duty by misappropriating a business opportunity that was rightfully the LLC’s, a plaintiff could seemingly assert an aiding-and-abetting claim against the other party to the offending transaction, or a broker of that transaction. In addition, an LLC member could possibly be targeted as an aider-and-abettor on the basis of conduct–such as voting for or against a transaction– that is aligned with its own economic interests as an owner of the business.

At the same time, as one of the Delaware courts suggests, an aiding-and-abetting claim is not likely to be sustained unless the fiduciary’s breach is obviously wrongful enough to give rise to knowledge on the part of a supposed aider-and-abettor. LLC members and others should be sensitive to situations where a manager seeks their participation in conduct or transactions that seem like they may not benefit the LLC as whole, or seem to improperly benefit the manager or its affiliates.