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Chancery Allows Fiduciary Duty Claims to Proceed against Minority Members Who Blocked Financings in Order to Bankrupt Company and Facilitate Unfair Asset Purchase

Skye Mineral Investors, LLC v. DXS Capital (U.S.) Ltd., C.A. No. 2018-0059-JRS (Del. Ch. Feb. 24, 2020) (Slights, V.C.).

Where parties to an LLC agreement do not unambiguously disclaim fiduciary duties, then Delaware law provides by default that managers owe traditional fiduciary duties to the entity and its members. The corporate law principles relating to fiduciary duties of controlling shareholders also apply, including that a minority member who exercises actual control may owe fiduciary duties. In this decision, the Court held that plaintiffs, the majority members of an LLC, adequately alleged that minority members exercised contractual blocking rights in a manner that gave them actual control over financing decisions and then used that control to implement in bad faith a scheme to enable the minority members to acquire the LLC’s assets on the cheap. With those allegations, the Court sustained a non-exculpated claim against the minority members for direct and derivative contract- and fiduciary-based claims.

Plaintiffs here were the majority members of Skye Mineral Partners, LLC (“Skye” or “the LLC”) that owned an operating subsidiary (“CMP”), which in turn owned valuable mineral deposits. Under the Skye LLC Agreement, the LLC could obtain financing only with the approval of a supermajority, including the approval of the minority members (“Blocking Rights”), who designated one of three managers. Plaintiffs alleged that the minority members’ designee learned that the mineral deposits were worth $600 million, a fact he disclosed to the minority members but withheld from the majority. Armed with this information, plaintiffs alleged that the minority members used their Blocking Rights to prevent equity investments at SMP that were necessary to fund CMP’s operations and service its debt. Their plan was to acquire CMP’s debt and then force it into bankruptcy. When Skye could not fund CMP’s debt, the lender declared a default. CMP then was required to re-negotiate the loan to avoid acceleration on the debt, including eliminating a provision that had prohibited a member of Skye from acquiring CMP’s debt (the “Insider Sale Provision”). With the elimination of the Insider Sale Provision, an affiliate of the minority members then purchased CMP’s debt at a substantial discount. Plaintiffs alleged that the minority members’ misconduct drove CMP into bankruptcy, where affiliates of the minority members purchased CMP’s assets in a Section 363 sale for $40 million. 

The Court first rejected defendants’ claims that the bankruptcy Section 363 sale order barred plaintiffs’ claim because it did not release claims by CMP’s parent (Skye) or its owners. 

The Court then rejected the minority members’ claim that, under the LLC Agreement, they owed no fiduciary duties. The Court held that neither a provision that waived fiduciary obligations for corporate opportunities, nor one that allowed members to vote in the member’s sole discretion, sufficed expressly to disclaim fiduciary duties. The Court held that “[i]f the SMP Agreement’s drafters wished to exempt members from the fiduciary duty of loyalty, they could do so only with express disclaimer language, not ‘by implication’.” Id. at 72 (citation omitted).

The Court then analyzed whether Plaintiffs had pleaded adequately that the minority members exercised actual control so as to have the duties of a controller. While the Court recognized that the existence of Blocking Rights standing alone creates neither a finding nor an inference of control (Id. at 75), the Court held that Plaintiffs had alleged much more:

When blocking rights empower a minority investor to “channel the corporation into a particular outcome,” they contribute to an inference of control. Here, Plaintiffs make an even stronger case as the Blocking Rights did more than “channel” SMP to a particular outcome. Instead, as pled, the Blocking Rights gave [the minority members] the unilateral power to shut SMP down—full stop.

Id. at 76 (citations omitted). The Plaintiffs adequately alleged that the minority members exercised control to prevent the majority members from financing CMP’s debt and operations to force CMP into a bankruptcy, where their affiliates could purchase its assets on the cheap. Id. at 77.

The Court also held that Plaintiffs pled facts supporting a reasonable inference that the minority members’ designated manager breached his fiduciary duty. The Court held “[w]hen a fiduciary . . . intentionally ‘sit[s] back’ while his company ‘collapses’ so that another to whom he is beholden can buy the company’s assets ‘out of bankruptcy very cheap,’ it is reasonably conceivable that he has breached the fiduciary duty of loyalty.” Id. at 64. The Court found it reasonably conceivable that the manager’s alleged misconduct exceeded the scope of any behavior the corporate opportunity doctrine prohibited so that the corporate opportunity waiver did not bar the claim.

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