Lessons In LLC Governance: Delaware’s Contractual Freedom…And Its Limits

Our recent eAlerts discussed the Delaware legislature’s corporate law reforms to try to stanch the flow of corporations relocating to Texas and Nevada and Delaware courts’ refusal to enforce overly-broad noncompete covenants in buy-sell transactions. In that light, the Delaware Court of Chancery’s April 2025 decision in Khan v. Warburg Pincus, LLC (affirmed by the Delaware Supreme Court in November 2025) reminds us that Delaware courts will enforce a carefully-drafted agreement – here, an LLC operating agreement – as written and not impose a plaintiff’s contrary notions of fairness. Khan provides a sort of “owner’s manual” to private equity and other fund sponsors and LLC management of what it takes to waive fiduciary duties in a Delaware LLC, and how to do it right.

Background

In Khan, Warburg Pincus held a majority stake in WP CityMD Topco LLC, a Delaware limited liability company (CityMD). CityMD’s LLC agreement expressly disclaimed fiduciary duties entirely, authorized Warburg Pincus to act “exclusively in its own interest” and allowed amendments to minority protections with majority-of-the-affected-class consent.

In 2022, CityMD merged with Village Practice Management Company, LLC (VillageMD). Warburg Pincus received $3.3 billion cash in the merger while CityMD’s minority members received $1.6 billion cash plus $2.05 billion in VillageMD equity. The merger was conditional upon a majority of the minority members of CityMD approving certain amendments to the CityMD LLC agreement, which approvals were obtained. Two minority members subsequently sued Warburg Pincus, alleging breach of the implied covenant of good faith and fair dealing, tortious interference, and unjust enrichment.

The Court of Chancery dismissed all claims, holding that the LLC agreement’s express terms, including its waiver of fiduciary duties and the amendment provisions, governed the parties’ relationship.

The Court’s Reasoning

• The implied covenant of good faith and fair dealing cannot override an express bargain. The Court rejected the plaintiffs’ argument that the implied covenant of good faith and fair dealing is an implicit term in the LLC agreement, holding that this covenant only applies when a “contract is truly silent concerning the matter at hand”. Here the covenant did not apply because the CityMD LLC agreement expressly addressed amendment mechanics, minority protections, and the absence of fiduciary duties.
• No coercion claim survives the absence of fiduciary duties. The plaintiffs characterized the conditioned merger as “coercion,” but conditioning the minority members’ receipt of consideration on waiving their protections was precisely what the LLC agreement permitted. The Court made clear that Delaware law will not bend the implied covenant of good faith and fair dealing into a fiduciary substitute.
• Disclosure standards derive from the contract, not corporate law. The Court declined to import corporate-law disclosure requirements. The CityMD LLC agreement required only “reasonable and sufficient notice”, not “full material disclosure.” That said, material inaccuracies in disclosures could have changed the outcome.
• LLCs aren’t corporations. The Court distinguished LLC contractual principles from corporate fiduciary duties. Corporations cannot eliminate fiduciary duties like LLCs can. Section 122(18) of the Delaware General Corporation Law permits stockholder agreements allocating governance rights, but fiduciary duties remain.

California: Different rules

While Khan demonstrates Delaware’s approaches of flexible LLC governance and “staying within the four corners” of a carefully-drafted LLC agreement, California (home to many venture-backed and closely held LLCs) is more restrictive regarding LLC management’s ability to craft an operating agreement to suit its needs at the members’ expense. When forming a California LLC, management should:

• understand that an oral operating agreement cannot modify any of the statutory member protections under Section 17701.10 of the California Revised Uniform Limited Liability Company Act (RULLCA);
• understand that under Section 17701.10 even a written operating agreement cannot entirely eliminate the duties of loyalty and care or any other fiduciary duty (though the agreement can modify them within reason);
• obtain “informed consent” from members for any modification of Section 17701.10’s statutory member protections (it is not enough merely to have members assent to the operating agreement by signing it);
• if limiting the duty of loyalty and even with consent, identify specific activities that do not violate that duty of loyalty (if not “manifestly unreasonable”) and specify authorization procedures; and
• recognize that parties cannot eliminate the implied covenant of good faith and fair dealing (though agreements can prescribe reasonable compliance standards).

For a Delaware or other non-California corporation, California General Corporation Law section 2115 purports to impose shareholder protections applicable to California corporations if the non-California corporation does more than half its business in California and has majority California share ownership. The RULLCA does not have a similar “long arm” provision and, in fact, provides in Section 17708.01 that the laws of a non-California LLC’s state of formation govern. There are, however, two exceptions:

• Under RULLCA Section 17708.08, if 25% or more (by voting interest) of members of a non-California LLC are California residents, then those members have the same information and inspection rights as a member in a California LLC would under RULLCA Section 17704.10. These inspection rights may be broader than those otherwise required by the non-California LLC’s state of formation (such as Delaware).
• Under RULLCA Section 17711.13, if a non-California LLC registers to transact business in California and more than 50% (by voting interest) of members are California residents, then the same dissenter and appraisal rights for a California LLC under RULLCA Article 11 will also apply to the non-California LLC even if the laws of the non-California LLC’s state of formation (such as Delaware) do not require (as opposed to permitting) dissenter rights. (A California or non-California LLC can crawl out from under Article 11 if the operating agreement specifically describes the consideration to be received by the members in a reorganization, or if the LLC has 35 or fewer members and each member has waived dissenter rights in the operating agreement or other writing. However, if the LLC ever exceeds 35 members then the waivers automatically “vaporize”.)

RULLCA has no comparable exception if a non-California LLC wants to waive fiduciary or other duties, but as Khancautions us the waiver still must be carefully drafted under the laws of Delaware (or other jurisdiction of formation).

Key Takeaways

1. Precisely draft the waiver. Section 18-1101(c) of the Delaware Limited Liability Company Act permits parties to “expand, restrict, or eliminate” fiduciary duties by express provision. Use unambiguous language and repeat the waiver in provisions addressing managerial discretion, affiliate transactions, and conflicts.
2. Specify the scope of permitted self-dealing. A blanket waiver removes default duties, but Delaware courts look to whether the agreement also addresses how much self-interested conduct is permitted. Expressly authorizing controlling members to act “exclusively in their own interest” forecloses claims of an implicit duty to balance competing interests.
3. Expressly address amendment mechanics. Khan turned on the LLC agreement permitting amendments adverse to a class with majority-of-that-class consent. To preserve minority protections, require unanimous or supermajority consent; to retain flexibility, draft amendment provisions accordingly.
4. Recognize the limits of the implied covenant of good faith and fair dealing. The implied covenant remains the floor. Parties cannot contract around the duty not to act in bad faith under section 18-1101(c) of the Delaware LLC Act . But the covenant fills gaps: It does not override express terms. Draft with the understanding that you are defining the full set of obligations.
5. Know your jurisdiction. Notwithstanding the RULLCA’s express provisions, California courts may refuse to enforce an LLC agreement that validly eliminates fiduciary duties under Delaware law especially if fraud or oppression is involved. The adage “pigs get fat but hogs get slaughtered” applies here. Sponsors or management structuring transactions involving Delaware LLCs with California connections, should carefully evaluate choice-of-law provisions and beware of the RULLCA’s “long-arm” provisions for inspection and dissenter rights.
6. Choice of entity matters. In Delaware, corporations cannot eliminate fiduciary duties the same way that LLCs can: While the Delaware General Corporation Law permits stockholder agreements to allocate governance rights, fiduciary duties remain intact. In California, the General Corporation Law section 2115 “long arm” statute for Delaware and other non-California corporations is far broader than the RULLCA’s imposition of inspection and dissenter rights on Delaware and other non-California LLCs with substantial California connections.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.