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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
Morris James Blogs
Under the famous Zapata decision, a board of directors may take control of a derivative case, provided it meets the test set out in that opinion. But may such a board, or the managers in an LLC, delegate that authority to a non-member? This decision says that delegation is not appropriate for an LLC with a management structure similar to a corporation or in an LLC that limits the delegation authority of it member-managers.
This is an interesting decision because it explains what direct claims are available to investors in an LLC. More ›
This decision may answer the question of whether an LLC Agreement’s bar of dissolution without a member’s consent trumps the statutory remedy of court-ordered dissolution when the entity’s purpose cannot be achieved any longer. It concludes that dissolution is proper under the facts presented where the objecting member really had no good reason to object.
This is a great decision on how to get rid of a minority owner in an LLC when she is disruptive. More ›
The language of an LLC agreement is all important in determining what it permits. This decision illustrates that point by holding that, under the LLC agreement involved, a 90% owner cannot remove the LLC manager. This seems counterintuitive. But that is the lesson of LLC law - you get what you agree to even if it is odd.
In this case, the defendant quit his employment, lied to his co-owners about why and then set up a competing business. However, the LLC agreement did not have any limitation on competing with it. As a result, while the court was quick to condemn the lie, it held that competing was permitted. This is an example of how people in business together often feel there are some unwritten ethical rules that a court will enforce even if they are not part of the parties' agreement. At least in the area of competition, that is just not so. You need to get it in writing to enforce an obligation to not compete after some one leaves your employment. Of course, this does not mean that there are no fiduciary or other duties that may require a course of conduct not spelled out in writing. Hence, this decision should not be read too broadly
As this decision affirms, it is possible to waive the right to a judicial dissolution in an LLC agreement. However, the decision also notes that the Court may use its equitable powers to remedy an abuse of power. This possible "escape valve" may be hard to invoke given the respect the Delaware Courts have for the right to contract away one's rights in an LLC agreement.
This decision holds that language in an LLC agreement that mirrors the indemnification language of the Delaware Corporation law will be interpreted the same way to mandate indemnification to a prevailing manager.
The interplay between fiduciary duties and contractual obligations is often hard to understand. Add to that the task of explaining the duty to act in good faith and deal fairly and the law is even more confusing. This decision does a good job of cutting through that problem to explain: (1) when a complaint alleges enough facts to state a claim for acting in bad faith, (2) when contractual obligations take the place of fiduciary duties, and (3) when the obligation to act fairly is not superseded by contract.
This is an interesting decision because it explains what is the effect when a member fails to pay the consideration contemplated by the LLC operating agreement to obtain his membership interest. The answer is determined by what the operating agreement says is the consequence, loss of interest or just a debt owed to the LLC.
This is also an example of what a mess may be created when parties try to do their own legal work in setting up an entity and working their way through disputes.
This decision has big implications. In a line of past decisions, the Court of Chancery has upheld arguments that an LLC agreement may define what constitutes "good faith" in such a way as to severely limit claims based on the implied duty of good faith and fair dealing. Of course, that duty under the Delaware LLC Act cannot be eliminated in an LLC agreement. But, by permitting drafters to define what constituted good faith, the trial courts came close to eliminating that duty. No more.
Exactly what will constitute a violation of the duty of good faith and fair dealing is also implicated by this decision. Conduct that may seem permitted by the LLC agreement may now be prohibited if done to take an action that the investors never would have agreed to had they thought of it when the LLC agreement was drafted. Time will have to tell what all this means.
The Delaware Supreme Court has made it clear that investors in LLCs get what they bargained for in their LLC agreement, but not much more. That seems attractive to those who manage LLCs because they feel they can limit their liabilities to investors by the terms of the LLC agreement. Yet, management may be overstating the benefits of the LLC form, as this decision points out.
In this case, very sophisticated counsel advised on how to issue additional interests in the LLC to raise more capital. Unfortunately, and despite being the drafter of the LLC agreement, he got it wrong and failed to follow the terms of the agreement. This points out that LLC agreements are often so complicated that compliance with their terms is tricky. Each agreement is individually crafted, unlike in a corporation where the statute generally spells out in well understood terms what are the rights and obligations of the investors and managers. These errors have happened time after time. Hence, use of the LLC or LLP form needs to be with great caution.
It is now common for LLC and LLP agreements to have provisions permitting a "special committee" to approve transactions with a controller. What the limits are of that form of protection is the subject of this interesting opinion. As the Court points out, surely not every committee approval, no matter how onerous, can immunize the transaction from judicial review. Here, even when the transaction did not get an independent adviser's review and was at a price reflecting a startling run up in value for the underlying assets, the complaint failed to allege facts sufficient to state a claim that the approval was in bad faith. More was required.
For years the Court of Chancery has repeatedly held that the controllers of an LLC owe fiduciary duties to the members - at least absent an express disclaimer of those duties in the LLC Operating Agreement. Then on November 7, 2012 in the Gatz Properties decision, the Delaware Supreme Court said "not so fast" and indicated in no uncertain terms that the fiduciary duties of an LLC controller were not yet decided under Delaware law. Well in this decision, the Court of Chancery decided that so long as the Supreme Court continued to not rule on the question, the Court of Chancery would continue to hold those duties exist. Maybe this will force the Supreme Court to decide that issue.
This decision is also interesting for its ruling on when a claim must go to arbitration. If the claim might have been brought even without the contract having the arbitration clause in existence, then it need not be arbitrated.
In the absence of a provision that excludes fiduciary duties, do the managers of a Delaware LLC have those duties? The Court of Chancery has long said "yes" but this decision of the Delaware Supreme Court says "not so fast." Instead, the Supreme Court held that the terms of the LLC agreement in this case imposed fiduciary duties on the manager in a self-dealing transaction. Thus, the Court held, it was premature to also hold, as the Court of Chancery did, that under the LLC statute such fiduciary duties existed absent a renunciation of those duties in the agreement.
Will the Supreme Court ever decide that issue and if it does, how will it come out? Is it time for the Delaware General Assembly to resolve this issue? If LLCs are ever to be used for more publicly traded entities, their managers will need to have a fiduciary duty. Trusting to the LLC agreement to protect investors is to ask too much of drafters of such agreements who cannot anticipate every circumstance that may occur. That calls for the legislature to act.