Delaware Business Litigation Report

District Court Applies Exception to Tooley Test and Rejects Argument That Exculpatory Provisions Create Contractual Obligations

Shamrock Holdings v. Arenson, C.A. 06-62-SLR, 2006 WL 2802913 (D. Del. Sept. 29, 2006). This case involved a dispute between the Class A and Class B members of a Delaware LLC called ALH Holdings. The dispute arose after ALH faced financial trouble and the Class A members voted to sell the company over the objections of the Class B members, who eventually threatened to sue. To preempt such a suit, the Class A members brought an action for a declaratory judgment that, among others, they did not breach their fiduciary duties or the LLC's operating agreement. In response, the Class B members counterclaimed, alleging breaches of the same. Plaintiffs subsequently moved for summary judgment as to four of the counts in their complaint, and they moved to dismiss the defendants' counterclaim. The Court denied the motion to dismiss and denied the motion for judgment on the pleadings in part (and granted it in part). While the opinion addressed a number of issues, two stood out as particularly interesting. First, the Court rejected the defendants' argument that the exculpation provisions in the LLC's operating agreement and a related consulting agreement could provide independent grounds for contractual liability. Both of the contracts in question contained provisions stating that ALH's fiduciaries and its consultant, SCA, would not be protected from liability for acts or omissions done in bad faith or with gross negligence. Defendants argued that these provisions were not merely exculpatory, but were also contractual obligations in and of themselves--that could be violated by acting in bad faith or in a grossly negligent manner. The Court disagreed, finding that the provisions only stated the circumstances under which the fiduciaries and SCA would be protected from liability. Second, the Court held that the defendants could bring their fiduciary breach claims as a direct action, despite plaintiffs' characterization of the claims as derivative. Plaintiffs argued that the claims could only be brought derivatively, under the Tooley test, as the defendants could not show that their injuries arose independently from injuries to ALH. Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1039 (Del. 2004). The defendants, however, urged the Court not to apply Tooley since such a derivative-action recovery would unjustly benefit the majority member of ALH (a plaintiff and counterclaim defendant). In finding for the defendants, the Court noted that ALH was effectively dissolved and followed the reasoning of Gentile v. Rossette, in which the Delaware Supreme Court held that shareholders could bring their fiduciary duty claims against a majority shareholder directly, particularly when the corporate entity was liquidated and thus unable to receive a recovery. Gentile v. Rossette, 2006 WL 2388934, at *1 (Del. Aug. 17, 2006). Share