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Court Tackles Nonmember Appointed as a Special Litigation Committee

July 13, 2016
Brett M. McCartney
Delaware Business Court Insider

It is often said that Delaware limited liability companies are creatures of contract. Drafters of LLC agreements have the freedom to craft an LLC that best suits their goals. For instance, LLCs can be drafted to allow the members to manage the affairs of the LLC. LLCs can also be created so that members appoint a manager or managers to govern the LLC. Drafters can also mold an LLC to mimic a corporation by having the LLC's affairs governed by a board of directors. What practitioners must know is that when an LLC's governance features mimic another type of entity, a court analyzing a dispute involving that LLC will likely draw from existing precedent. So, where an LLC was created to parrot a corporation's governance structure, a court will likely look to corporate law for guidance in resolving a dispute.

In the Delaware Court of Chancery's recent decision,Obeid v. Hogan, C.A. No. 11900-VCL (Del. Ch. June 10, 2016), Vice Chancellor J. Travis Laster held that a board of directors of Gemini Equity Partners, (the corporate LLC), a Delaware entity governed similar to a corporation, and the managers of Gemini Real Estate Advisors, (the manager-managed LLC), a Delaware manager-managed entity, could not delegate to a nondirector/nonmanager the authority to act as a special litigation committee. The corporate LLC and the manager-managed LLC jointly managed over $1 billion in real estate assets and were comprised of the same three members, William Obeid, Christopher La Mack and Dante Massaro. Obeid, La Mack and Massaro were the directors of the corporate LLC and the managers of the manager-managed LLC, at least until La Mack and Massaro purportedly removed Obeid from management in 2014. Following Obeid's alleged removal, a series of lawsuits were filed in various courts. Among the pending lawsuits was an action in the U.S. District Court for the Southern District of New York in which Obeid asserted derivative claims that La Mack and Massaro had wrongfully competed with the corporate LLC and manager-managed LLC.

In August 2015, La Mack and Massaro, each acting as a "member-manager" of the corporate LLC and the manager-managed LLC, executed an engagement letter with retired federal Judge Michael R. Hogan to act as a special litigation committee for both LLCs. It was undisputed that Hogan was neither a director of the corporate LLC or a manager of the manager-managed LLC. Upon learning of Hogan's engagement, Obeid sought a declaration from the Court of Chancery that Hogan was not authorized to act as a special litigation committee for either LLC. As a threshold matter, the court held that corporate law analogies would apply to the corporate LLC. Specifically, the court noted that the corporate LLC's operating agreement created a corporate governance structure while also utilizing similar language to Section 141 of the Delaware General Corporation Law, including language which allows boards to delegate its powers to committees consisting solely of directors.

The court's focus then shifted to the role of a special litigation committee in Delaware's corporate law. In Zapata v. Maldonado, 430 A.2d 779 (Del. 1981), Delaware's Supreme Court held that a committee of directors retained the power to dismiss derivative litigation. In Obeid, Laster stated that the Zapata court's holding reflected the Supreme Court's understanding that pursuant to Section 141(c) of the DGCL a committee of directors could determine what action the corporation should take with its litigation assets. The corporate LLC argued that Section 18-407 of the LLC Act supported the delegation of a manager's authority to a nonmanager in stating "unless otherwise provided in the limited liability company agreement, a member or manager of a limited liability company has the power and authority to delegate to one or more other persons the member's or manager's ... rights and powers to manage and control the business and affairs of the limited liability company." The court was not persuaded by that argument. Specifically, the court held that the specific provisions of the LLC Act vested the power to bring derivative suits in "managers and members" while also noting that by mimicking the corporate governance structure set forth in Section 141 of the DGCL, the corporate LLC embraced the DGCL's restriction on delegation of directors' governance roles to nondirectors. In turning to the manager-managed LLC, the court noted that its governance construction was also reminiscent of a Delaware corporation. However, the court found a basis within the manager-managed LLC's operating agreement where it "provided otherwise" as to the application of Section 18-407 of the LLC Act. The court noted that certain provisions of the manager-managed LLC operating agreement demonstrated distinctions between matters in the ordinary course of business and matters vested solely to the discretion of the managers. With that distinction drawn in the operating agreement, the court held that the provisions evidenced an intention to limit the delegation of core governance functions of managers and, in doing so, forbid the delegation of control of the manager-managed LLC's litigation to the nonmanager Hogan.

The court's decision in Obeid provides practitioners with further guidance regarding the implications of creating limited liability companies in the image of other entities. As Laster notes, "the choices that the drafters make have consequences." By invoking corporate language parroting the DGCL, a drafter is likely importing the analogous corporate law decisions and precedent as well. As a result, drafters should pay special attention to provisions granting or limiting authority to members, managers or directors.

Delaware Business Court Insider |  July 13, 2016