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Exculpation Provisions in LLC Agreements: A Comparison of Delaware and Texas

Exculpation Provisions in LLC Agreements: A Comparison of Delaware and Texas

By Andrew S. Hicks, Bryan Zubay, and James A. Keefe

Case law involving limited liability companies (LLCs) is rapidly evolving. Some states, most notably Delaware, permit LLCs to limit or eliminate liability for breaches of fiduciary duty by an LLC’s members or managers. Other states cabin that ability to varying degrees. Disputes regarding breaches of fiduciary duty can often hinge on the scope of any relevant exculpation provisions in the LLC agreement, and the body of law governing the LLC agreement can materially alter outcomes. Individuals seeking to do business in Texas are likely to encounter LLCs that were organized in Delaware (popular for, among other things, this very reason) and in Texas. In this article, we compare key differences between Delaware and Texas law on LLC exculpation provisions.

I. Delaware

Delaware law provides LLCs the broad latitude to limit, or even completely eliminate, fiduciary duties.[1] When effectively drafted, an LLC agreement can prevent any claim against a manager or member for breach of fiduciary duty—at least as to that LLC entity.

But to eliminate fiduciary duties, drafters of an LLC agreement must make their intent “plain and unambiguous.”[2] While that seems simple, those relying on exculpation provisions sometimes learn that, however clear the intent to eliminate may have been in their minds, the provision is not plain and unambiguous to the courts.

Some exculpation provisions, in an attempt to appear more reasonable or to account for potential inconsistencies with other terms of the LLC agreement, will include limiting language—for example, making the elimination “subject to” or “notwithstanding” other provisions of the agreement. Depending on what other provisions of the agreement state, a court may find that this limiting language leaves ample room for fiduciary duties to survive.[3]

Similarly, some LLC operating agreements refer to, incorporate, or allude to specific fiduciary duties, such as the duties of care, loyalty, and good faith. Breaches of those duties are measured against certain well-established standards—for example, a breach of the duty of care may be shown by “gross negligence.”[4] When an LLC agreement contains provisions incorporating such standards as “gross negligence” or “good faith”—even if not using those exact words—it may be harder to persuade the courts that any alleged exculpation is “plain and unambiguous.”[5]

If the LLC agreement has effectively eliminated fiduciary duties owed to the LLC itself, that may not yet be the end of the analysis. In In re USACafes, L.P. Litigation[6] and its progeny, the Delaware Court of Chancery has held that if an LLC is the manager of another entity, the individual managers of the LLC may owe fiduciary duties to the managed entity. These duties may or may not be addressed by the managing LLC’s agreement. Whether they are addressed or not, they may not be affected by the terms of the LLC agreement.

In USACafes, the Court of Chancery held that the limited partners of a limited partnership could sue the directors of that limited partnership’s general partner, a corporation, for breach of fiduciary duty. The defendant directors of the general partner argued that they, as the general partner’s directors, only owed fiduciary duties to the general partner’s stockholders, and not to the limited partners.[7] The court held that, notwithstanding the directors’ lack of direct relationship to the limited partnership, “one who controls property of another may not, without express or implied agreement, intentionally use that property in a way that benefits the holder of the control to the detriment of the property or its beneficial owner.”  Therefore, the directors could be held liable for breaching a fiduciary duty owed to the limited partnership.[8]

In Bay Center, the Delaware courts extended the doctrine of USACafes to LLCs.[9] Under this doctrine, an LLC agreement’s complete elimination of fiduciary duties may not protect that LLC’s members and managers from claims based on their duties to other entities that the LLC owns or controls.

Delaware law offers LLCs much broader ability to limit or eliminate fiduciary duties than that of most states. Still, Delaware LLCs exercising that ability may be frustrated by some of the limitations and pitfalls above.

II. Texas

Previously, we considered how Delaware law treats exculpation provisions in LLC agreements. In short, Delaware law offers LLCs much broader ability to limit or eliminate fiduciary duties than that of most states, but that ability may be frustrated by a variety of limitations and pitfalls. Here, we examine how Texas law compares.

Texas LLC statutes do not define or expressly impose fiduciary duties on managers or members of an LLC.[10] The statutes do, however, implicitly recognize fiduciary duties by permitting fiduciary duties to be expanded or restricted and allowing liability for breach of those duties to be limited or eliminated. Agency law also appears to impose fiduciary duties on governing persons of an LLC. The agent status of a manager in a manager-managed LLC, and a member in a member-managed LLC, provides a basis under agency principles to impose duties of loyalty and care.[11] Some cases have construed agency law as imposing fiduciary duties on a managing member of a Texas LLC.[12]

Under Texas Business Organizations Code § 101.401, an LLC’s company agreement “may expand or restrict any duties, including fiduciary duties, and related liabilities that a member, manager, officer, or other person has to the company or to a member or manager of the company.” In 2013, the Legislature amended Section 7.001 to clarify that LLCs are permitted to impose a contractual limitation or elimination of liabilities for money-damages for breach of fiduciary duties, but they are not permitted to allow the elimination of liabilities for breach of the duty of loyalty.[13] Only a limited number of Texas courts have addressed exculpatory provisions in the context of LLCs. However, the issue of whether an LLC can contractually eliminate all liability for a governing member or manager in the articles of organization was addressed in Cardwell v. Gurley, which concluded that liability for a breach of the fiduciary duty of loyalty could not be eliminated by the members’ agreement.[14]

Thus, while Texas law allows an LLC company agreement to “expand or restrict” fiduciary duties and eliminate liability, they do not allow the wholesale elimination of fiduciary duties. Also, even if the liability of a governing person is contractually eliminated for an existing duty, a party who breaches such a duty could be subject to equitable relief even though they could not be held liable for damages. This means that a manager could be exposed to equitable consequences involving monetary recoveries that are not technically labeled as damages, such as disgorgement.[15]

In conclusion, Delaware law allows LLC operating agreements to eliminate fiduciary duties altogether, but such provisions must be carefully drafted so that the intent to eliminate fiduciary duties is plain and unambiguous. In contrast, Texas LLCs cannot eliminate fiduciary duties. Texas LLC statutes do, however, allow LLCs to eliminate liability for breaches of fiduciary duties, except for breaches of the duty of loyalty.

Andy Hicks is the managing partner and Bryan Zubay and James Keefe are associates at Schiffer Hicks Johnson PLLC, a Houston-based trial law firm.

[1] 6 Del. C. § 18-1101(c) (a “member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement”); MKE Holdings Ltd. v. Schwartz, No. CV 2018-0729-SG, 2019 WL 4723816, at *9 (Del. Ch. Sept. 26, 2019) (“[The LLC] was formed as a Delaware limited liability company and, therefore, pursuant to Delaware law its operating or governing agreement may eliminate the fiduciary duties its managers would otherwise owe.”).

[2] Feeley v. NHAOCG, LLC, 62 A.3d 649, 664 (Del. Ch. 2012); Ross Holding & Mgmt. Co. v. Advance Realty Grp., LLC, CIV.A. 4113-VCN, 2014 WL 4374261, at *13.

[3] See, e.g., In re Cadira Grp. Holdings, LLC Litig., CV 2018-0616-JRS, 2021 WL 2912479, at *12 & n.111 (Del. Ch. July 12, 2021); Supermex Trading Co., Ltd. v. Strategic Sols. Grp., Inc., Civ. Action 16183, 1998 WL 229530, at *6 (Del. Ch. May 1, 1998) (“[W]here the words ‘subject to all provisions of this policy’ preface a term of a contract it means that inconsistent terms to which reference is made will trump the provision so prefaced.”).

[4] Feeley, 62 A.3d at 664 (“Gross negligence is the standard for evaluating a breach of the duty of care.”) (“Willful misconduct is one standard for evaluating whether a fiduciary breached the duty of loyalty by acting in bad faith.”); Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006) (“[T]he fiduciary duty of loyalty . . . encompasses cases where the fiduciary fails to act in good faith . . . . A director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation’s best interest.”) (internal brackets, quotations, and citations omitted).

[5] See, e.g., Gatz Props., LLC v. Auriga Cap. Corp., 59 A.3d 1206, 1213 (Del. 2012) (holding LLC agreement that prohibited managers or members from causing LLC to enter into a transaction with an affiliate, unless the terms are at least as favorable to the company as they would be in an arms-length transaction with third parties, “adopts the fiduciary duty standard of entire fairness”); CMS Inv. Holdings, LLC v. Castle, No. CV 9468-VCP, 2015 WL 3894021, at *18 (Del. Ch. June 23, 2015) (“Because the limitation of liability contained in Section 5.7 of the RPH LLC Agreement does “not apply to the extent the act or omission was attributable to such Person’s gross negligence, willful misconduct or knowing violation of law, I conclude that the Agreement does not diminish the default standards of care and loyalty under Delaware law.”); In re Cadira Grp. Holdings, LLC Litig., No. CV 2018-0616-JRS, 2021 WL 2912479, at *12 (Del. Ch. July 12, 2021) (“Section 13.02 then green-lights claims against the Manager arising from the “Manager’s bad faith, gross negligence, willful misconduct or actual fraud. Given this language, it cannot be said the drafters of the Operating Agreement evinced a ‘plain and unambiguous’ intent fully to displace traditional fiduciary duties. Accordingly, as pled, Gertz owes the default traditional fiduciary duties of care and loyalty to KGH.”); Brinckerhoff v. Enbridge Energy Co., Inc., 159 A.3d 242, 262 (Del. 2017), as revised (Mar. 28, 2017) (holding that a provision stating, “[n]either the General Partner nor any of its Affiliates shall sell, transfer or convey any property to, or purchase any property from, the Partnership, directly or indirectly, except pursuant to transactions that are fair and reasonable to the Partnership,” gave rise to “a contractual fiduciary standard similar if not identical to entire fairness”); In re Energy Transfer Equity, L.P. Unitholder Litig., CV 12197-VCG, 2018 WL 2254706, at *18–19 (Del. Ch. May 17, 2018), judgment entered sub nom. In re Energy Transfer Equity (Del. Ch. 2019) and aff’d without opinion sub nom. Levine v. Energy Transfer L.P., 223 A.3d 97 (Del. 2019) (applying an entire fairness-like standard and corresponding burden of proof where “[l]ike the LLC agreement in [Gatz], the LPA here prohibits ‘sell[ing], transfer[ring] or convey[ing] any property to, or purchas[ing] any property from, the Partnership,’ subject to (i) an exception for transactions that are ‘fair and reasonable to’ ETE, and (ii) a set of safe harbors. Thus, once the plaintiff shows that a transaction was conflicted in the manner contemplated by Section 7.6(f), the burden falls to the defendant to prove that the transaction was fair and reasonable to the partnership. Because there is no dispute that the issuance was a conflicted transaction per Section 7.6(f), the Defendants bear the burden of proving that it was fair and reasonable to ETE.”) (brackets in single quotations original).

[6] 600 A.2d 43 (Del. Ch. 1991).

[7] Id. at 47–48.

[8] Id. at 48.

[9] Bay Ctr. Apartments Owner, LLC v. Emery Bay PKI, LLC, 2009 WL 1124451, at *8 (Del.Ch. Apr. 20, 2009); see also Feeley, 62 A.3d at 670–71 (citing Bay Center for proposition that USACafes liability applied to LLCs); see also Altenberg, 2020 WL 2529806, at *43.

[10] Straehla v. AL Glob. Servs., LLC, 619 S.W.3d 795, 804 (Tex. App.—San Antonio 2020, pet. denied).

[11] Elizabeth S. Miller, Overview of Fiduciary Duties, Exculpation, and Indemnification in Texas Business Organizations, 49 Tex. J. Bus. L. 1, 15 (2020) (citing RESTATEMENT (THIRD) OF AGENCY § 8.08 (2006); RESTATEMENT (SECOND) OF AGENCY § 379 (1958); Tex. Bus. Orgs. Code § 101.254 (stating that each governing person of LLC is an agent of the company for purposes of carrying out the company’s business)).

[12] Miller, supra note 11, at 15 (citing ETRG Invs. LLC v. Hardee (In re Hardee), Bankruptcy No. 11–60242, Adversary No. 11-6011, 2013 WL 1084494 (Bankr. E.D. Tex. Mar. 14, 2013) (concluding that managing member owed LLC fiduciary duties based on agency law); Zayler v. Calicutt (In re TSC Sieber Servs., LC), Bankruptcy No. 09–61042, Adversary No. 10–6031, 2012 WL 5046820 (Bankr. E.D. Tex. Oct. 18, 2012) (finding that defendant owed formal fiduciary duty to LLC because he was an agent of the LLC)).

[13] Texas Business Organizations Code § 7.001 allows the limitation or elimination of liabilities for breach of fiduciary duties as follows:

Section 7.001. Limitation of Liability of Governing Person.

(a) Subsections (b) and (c) apply to:
(1) a domestic entity other than a partnership or limited liability company;
(2) another organization incorporated or organized under another law of this state; and
(3) to the extent permitted by federal law, a federally chartered bank, savings and loan association, or credit union.

(b) The certificate of formation or similar instrument of an organization to which this section applies may provide that a governing person of the organization is not liable, or is liable only to the extent provided by the certificate of formation or similar instrument, to the organization or its owners or members for monetary damages for an act or omission by the person in the person’s capacity as a governing person.

(c) Subsection (b) does not authorize the elimination or limitation of the liability of a governing person to the extent the person is found liable under applicable law for:
(1) a breach of the person’s duty of loyalty, if any, to the organization or its owners or members;
(2) an act or omission not in good faith that:
(A) constitutes a breach of duty of the person to the organization; or
(B) involves intentional misconduct or a knowing violation of law;
(3) a transaction from which the person received an improper benefit, regardless of whether the benefit resulted from an action taken within the scope of the person’s duties; or
(4) an act or omission for which the liability of a governing person is expressly provided by an applicable statute.

(d) The liability of a governing person may be limited or eliminated:
(1) in a general partnership by its partnership agreement to the same extent Subsections (b) and (c) permit the limitation or elimination of liability of a governing person of an organization to which those subsections apply and to the additional extent permitted under Chapter 152;
(2) in a limited partnership by its partnership agreement to the same extent Subsections (b) and (c) permit the limitation or elimination of liability of a governing person of an organization to which those subsections apply and to the additional extent permitted under Chapter 153 and, to the extent applicable to limited partnerships, Chapter 152; and
(3) in a limited liability company by its certificate of formation or company agreement to the same extent Subsections (b) and (c) permit the limitation or elimination of liability of a governing person of an organization to which those subsections apply and to the additional extent permitted under Section 101.401.

[14] No. 05-09-01068-CV, 2018 WL 3454800, at *9 (Tex. App.—Dallas July 18, 2018, pet. denied). Cardwell analyzed Article 1302–7.06B (the predecessor to Section 7.001) instead of Section 7.001 because the articles of organization incorporated the terms of Article 1302–7.06B and were effective at all times relevant to the litigation. Id. at *8. The court concluded that Article 1302–7.06B allowed the articles of incorporation of a corporation to eliminate a director’s liability for monetary damages to the corporation or shareholders, except for certain types of misconduct, including breach of the duty of loyalty. Id. at *9.

[15] Miller, supra note 11, at 34 (citing In re Longview Energy Co., 464 S.W.3d 353, 361 (Tex. 2015); see also Byron F. Egan, TXCLE Choice, Governance, & Acquisition of Entities, § 5.4.1 n.933 (2016) (“[I]n theory, equitable remedies may exist to address acts for which any monetary liability has been eliminated by a company agreement.”).