Background
Plaintiff DTI-DSIC, LLC, a Missouri LLC, invested $1.85 million in defendant 930-DSIC Company (Company), a Delaware LLC, in exchange for an 11.22% membership interest. 930-DSIC Partner, LLC (Managing Member) is the Company’s sole managing member. The relationship was governed by the Company’s Amended and Restated Operating Agreement, which is governed by Delaware law.
In 2014, Managing Member declared plaintiff a “Defaulting Member” for failure to pay management fees and administrative expenses of approximately $42,000. In 2021 and 2024, Managing Member exercised its contractual rights under the operating agreement to force the sale of plaintiff’s membership interest in two tranches, determining the purchase price in each instance. Plaintiff alleged that defendants took improper deductions from the sale proceeds and wrongfully withheld amounts owed. Plaintiff sued for breach of contract against both the Company and Managing Member, breach of fiduciary duty against Managing Member, and an accounting. Supreme Court denied defendants’ motion to dismiss all claims. The First Department partially reversed.
The Court’s Holding
The court dismissed the breach of contract claim against the Managing Member, holding that plaintiff failed to allege any conduct by the Managing Member that violated the operating agreement. The agreement expressly gave Managing Member discretion to force the sale of defaulting members’ interests, to determine the purchase price, and to control the timing of any disbursements. Critically, the operating agreement provided that the Managing Member could not be held liable for actions within its discretion unless exercised “in bad faith” — and plaintiff’s allegations of bad faith were conclusory, failing to allege that Managing Member knew its conduct contravened the agreement’s terms. Under Delaware law, “intent” is an element of bad faith, which plaintiff had not sufficiently pleaded.
The breach of fiduciary duty claim against Managing Member was also dismissed. The court applied Delaware’s principle that the exercise of a contractual right — even by a fiduciary — cannot by itself constitute a breach of fiduciary duty. While Managing Member retained fiduciary obligations (since the operating agreement’s modification of fiduciary duties was not express and unambiguous enough to eliminate them entirely), the forced sale and price determination were contractual rights the Managing Member was entitled to exercise. The court cited Nemec v. Shrader (991 A2d 1120 [Del 2010]) for the proposition that exercising a contractual right cannot form the basis of a fiduciary duty claim.
However, the breach of contract claim against the Company survived. Unlike Managing Member, the Company’s operating agreement gave it a right to set off only amounts “owed by a Defaulting Member” from sale proceeds — not the broad discretion afforded to Managing Member. Plaintiff’s allegations that the Company made improper deductions beyond what plaintiff owed were sufficient to state a breach of contract claim. The accounting claim also survived: Managing Member remained a fiduciary and plaintiff had demanded an accounting that was refused, which is sufficient to plead the cause of action; and the accounting claim was not duplicative of the breach of contract claim because it seeks different remedies.
Key Takeaways
- Under Delaware LLC law, a managing member that exercises broad discretionary powers expressly granted by the operating agreement — including determining the price in a forced sale — is insulated from breach of contract and fiduciary duty claims absent sufficiently pleaded bad faith; conclusory fraud allegations will not suffice.
- A distinction must be drawn between the managing member’s discretion-based rights and the company’s enumerated setoff rights: the latter are narrowly defined, and improper deductions beyond what a defaulting member actually owes can support a breach of contract claim against the company itself.
- Elimination of fiduciary duties under Delaware law must be express and unambiguous in the operating agreement; ambiguous or partial modifications preserve the duty and allow accounting claims to proceed.
- Defaulting members who face forced sales should closely scrutinize deductions from proceeds, as that line of attack survived here even when the forced sale itself was upheld.
Why It Matters
This decision is a practical guide for commercial lawyers structuring Delaware LLC operating agreements and litigating disputes over forced sales. The result reinforces that broad discretionary authority clauses for managing members are highly protective — a managing member that follows the agreement’s framework and keeps records of its good-faith price determination process is largely litigation-proof on breach of fiduciary duty and contract claims. But the survival of the claim against the Company signals that practitioners should audit their operating agreements to ensure the setoff and deduction provisions are no broader than intended; if the Company’s right to reduce proceeds is limited to amounts the defaulting member actually owes, any broader deduction — legal fees, administrative costs beyond the agreement’s scope — may expose the Company to liability even if the forced sale itself is unassailable.