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Chancery Sustains Breach of Fiduciary Duty Claim Against Long-Time Friend and Financial Advisor, and Addresses Double-Derivative Standing for Alternative Entities

Bamford v. Penfold, L.P., C.A. No. 2019-0005-JTL (Del. Ch. Feb. 28, 2019).

After realizing that a 2016 reorganization stripped them of their voting and other governance rights in a highly profitable limited liability company, the plaintiffs brought direct and derivative claims against their former business partner and the entities he controlled. The defendant and his entities moved to dismiss, which the Court largely denied. Of particular note were the Court’s rulings about one of the breach of fiduciary duty claims and the plaintiffs’ standing to bring double-derivative claims challenging pre-organization conduct.    

Vice Chancellor J. Travis Laster declined to dismiss what he described as “a relatively uncommon claim”, a breach of fiduciary duty claim against a close friend and financial advisor to one of the plaintiffs. The Vice Chancellor examined the former advisor’s position as an agent, his unrestricted access to his friend’s personal confidential information, his superior knowledge and experience regarding complex business structures, financing and tax matters, and the long friendship that “reached a level of familial intimacy[.]” The Court concluded that such facts, if proven, could show that the advisor owed fiduciary duties in the circumstances. 

In examining the plaintiffs’ standing to bring derivative claims, the Court noted that pursuant to the 2016 reorganization, the plaintiffs assigned their LLC membership interests to a limited partnership that in turn became the LLC’s member. The plaintiffs became limited partners in the newly formed limited partnership. The Court ruled that both the plaintiffs and the limited partnership satisfied the contemporaneous ownership requirements necessary to establish derivative standing despite the fact that the limited partnership did not exist and, therefore, the plaintiffs were not limited partners in the limited partnership, at the time of the allegedly unlawful pre-reorganization behavior.

The Vice Chancellor reasoned that the plaintiffs had double-derivative standing because the limited partnership had standing to bring a claim on behalf of the LLC as its member and the plaintiffs had standing to bring a claim on behalf of the limited partnership as its limited partners. Because the limited partnership existed at the time the action was filed and was an assignee of the plaintiffs’ membership interest in the LLC, which they held at the time of the challenged pre-reorganization conduct, the Court found that the limited partnership fulfilled the contemporaneous ownership requirement imposed by Section 18-1002 of the LLC Act. 

The Court also concluded that the plaintiffs satisfied the derivative standing requirements imposed by Section 17-1002 of the LP Act, because they were limited partners in the limited partnership at the time the action was filed and they maintained contemporaneous ownership of their interests, which sufficed under the Delaware Supreme Court’s reasoning in Lambrecht v. O’Neal, 3 A.3d 277 (Del. 2010).

In Lambrecht, the Supreme Court held that when an intervening transaction and strict adherence to the contemporaneous ownership requirement would prevent parent-level investors from invoking double-derivative standing to challenge conduct on behalf of the subsidiary, “the wrong for purposes of analyzing the contemporaneous ownership requirement at the parent-entity level is the failure of the parent to cause the subsidiary to assert is claims” because otherwise there would be no procedural vehicle to remedy the harm. Because the other partners were the alleged wrongdoers, and in the specific circumstances only the plaintiffs could file suit to right the defendants’ alleged pre-reorganization wrongs, the plaintiffs had standing to sue under the statutory provisions of the LP Act and Lambrecht.

The defendants also contended that the plaintiffs’ exchange of their LLC membership interests for limited partnership interests meant that they could not satisfy the continuous ownership requirement. The Court reasoned that the equitable exceptions to the continuous ownership requirement recognized in the corporate context applied in the limited liability context. Those exceptions are where the transaction was either (i) a “mere reorganization” in which the plaintiffs maintained their relative equity interests, or (ii) motivated at least in part by a desire to eliminate the plaintiffs’ derivative standing. Based on the facts alleged, the Court reasoned that both exceptions applied.

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