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Court of Chancery Interprets Conflict of Interest Provision of LLC Agreement

Posted In LLC Agreements, M&A

In re Atlas Energy Resources, LLC Unitholder Litigation, C.A. No. 4589-VCN (October 28, 2010)

This case is another example of the care practitioners must take in drafting LLC agreements. In this decision, Vice Chancellor Noble applied the Kahn v. Lynch entire fairness standard of review to a merger between a publicly traded LLC and its controlling unitholder.  Plaintiffs, LLC unitholders, alleged the controlling unitholder breached its fiduciary duties to minority unitholders by negotiating an unfair merger through an unfair process.  Plaintiffs also alleged that the directors and officers of the LLC breached their fiduciary duties by agreeing to the merger.

The controlling unitholder argued that it was not liable for breach of fiduciary duty because the LLC Agreement provided that if a conflict of interest arose between the LLC and controlling unitholder, it could be resolved by certain actions that had occurred here.  Plaintiffs argued that the conflict of interest at issue was between the controlling stockholder and minority unitholders and thus the LLC Agreement conflict of interest provision was inapplicable. The Court agreed and found the merger between the LLC and its controlling unit holder subject to the entire fairness standard of review.  In the absence of anything in the LLC Agreement addressing a conflict of interest between the controlling unitholders and minority unitholders, the Court saw no reason not to apply the reasoning of Kahn v. Lynch.  As is typical in cases where the entire fairness standard of review applies, the Court denied the controlling unitholder's motion to dismiss.

The Court did, however, grant the motion to dismiss of the LLC directors and officers. The LLC Agreement provided that the directors and officers did not owe fiduciary duties to the LLC or its members. Thus, unlike the provision governing conflicts of interest, this provision of the LLC Agreement expressly eliminated fiduciary duties of directors and officers to members. Under the LLC Agreement, the officers and directors were subject to a subjective good faith standard.  This standard of good faith is narrower than the good faith standard under Delaware law.  Applying this subjective standard of good faith, the Court found that Plaintiffs had failed to state a claim that the directors and officers believed they were acting against the best interests of the LLC's unitholders in negotiating the merger.

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