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Originally Published in ALM's Delaware Business Court Insider
Delaware upholds parties' freedom of contract. This is also a guiding principle in Delaware's alternative entity statutes, including Delaware's Limited Liability Company Act. However, the "primacy" of freedom of contract will yield, in certain circumstances, to other countervailing public policy concerns. One area where this tension is playing out before Delaware courts is in the context of restrictive covenants written into alternative entity governing agreements, pitting contract law against other bodies of law.
In this recent decision from the Delaware Court of Chancery, Seva Holdings v. Octo Platform Equity Holdings, C.A. No. 2022-0437-PRW (Del. Ch. Aug. 29, 2024), the court considered whether a membership interest repurchase right under an LLC agreement triggered by breach of a nondisparagement restriction was enforceable, or whether the repurchase scheme violated the absolute litigation privilege. Specifically, the repurchase right triggered after one of the member's filed lawsuits containing allegedly defamatory content. Reasoning that the repurchase right did not prevent or "chill" litigation, the Court of Chancery held that, in this instance, the freedom of contract prevailed over the competing absolute litigation privilege policy.
Following a business acquisition, plaintiff, Seva Holdings, Inc. (Seva), held membership interests in Defendant Octo Platform Equity Holdings, LLC (Octo). Seva's principal, Arvinder Kakar (Kakar), held an executive position at Octo and, in that role, was a party to an Employment Agreement and a noncompetition agreement which included several restrictive covenants, including a nondisparagement provision. Octo's limited liability company agreement, further, permitted Octo to repurchase Seva's membership interest, in the event Kakar breached the restrictive covenants in his employment agreement and noncompetition agreement.
Relations between the parties soured. Kakar filed two lawsuits against Octo, one in Virginia and one in the Superior Court of Delaware. In response, and claiming that Kakar's complaints contained defamatory statements against the company in violation of Kakar's nondisparagement restrictions, Octo exercised its membership interest repurchase right against Seva. Seva then filed an action in the Court of Chancery seeking, among other things, a declaration that the repurchase rights provision in Octo's limited liability company agreement was unenforceable because it infringed on the absolute litigation privilege.
In reviewing the parties' cross-motions for summary judgment on the enforceability of the repurchase rights provision, the Court of Chancery noted that, through the absolute litigation privilege, Delaware encourages parties to resolve their differences through legal proceedings without fear of facing liability for "what they say" in those proceedings and "without the prospect of having their good faith legal claims" lead to more litigation. The key question, according to the Court, was whether and when parties' contractual choices, like the limited liability company agreement's repurchase rights scheme—which Delaware strongly respects— may trump the absolute litigation privilege.
The Court of Chancery noted that three prior Delaware decisions have addressed this question —two from the Court of Chancery (Ritchie CT Opps v. Huizenga Managers Funds; Sheehan v. AssuredPartners), and one from the Superior Court (Feenix Payment Systems v. Blum). The former two decisions found a contractual nondisparagement provision was unenforceable and in violation of the absolute litigation privilege, where a party sought to specifically enforce the provision through an injunction. By contrast, the Court of Chancery noted that in the Feenix decision, where the party seeking to enforce the provision sought only money damages, the Superior Court found the provision to be enforceable because, in that context, the original and allegedly defamatory litigation could still proceed, irrespective of the outcome of the Superior Court case.
For the Court of Chancery here, the Feenix distinction proved dispositive of the issue. Looking to a decision from the Delaware Supreme Court earlier this year (January 2024) in Ainslie v. Cantor Fitzgerald, the Court of Chancery determined that Delaware has a strong interest in promoting the freedom of contract in connection with the internal governance of Delaware alternative entities. According to the Court of Chancery, that interest may yield to other public policy considerations, but not when those considerations are "weak," under the circumstances. The Court of Chancery reasoned that the policy behind the absolute litigation privilege was not compelling in the context of Octo's repurchase rights, because it did not "chill" Kakar's litigations. Kakar was still entitled to pursue his lawsuits, subject only to Seva forgoing its economic rights in Octo's membership interests. Accordingly, the Court of Chancery found that the freedom of contract "prevailed," and the repurchase rights provision tied to the non-disparagement restriction was, thus, valid and enforceable.
As the Court of Chancery's opinion in Seva demonstrates, the inclusion of restrictive covenants in Delaware alternative entity agreements is resulting in Delaware courts having to make decisions pitting the freedom of contract against other public policy considerations like, in this case, the absolute litigation privilege. While every case is fact specific and, ultimately, which policy wins out will turn on those facts, the "primacy" of freedom of contract is not lightly set aside by Delaware courts.
In this recent decision from the Delaware Court of Chancery, Seva Holdings v. Octo Platform Equity Holdings, C.A. No. 2022-0437-PRW (Del. Ch. Aug. 29, 2024), the court considered whether a membership interest repurchase right under an LLC agreement triggered by breach of a nondisparagement restriction was enforceable, or whether the repurchase scheme violated the absolute litigation privilege. Specifically, the repurchase right triggered after one of the member's filed lawsuits containing allegedly defamatory content. Reasoning that the repurchase right did not prevent or "chill" litigation, the Court of Chancery held that, in this instance, the freedom of contract prevailed over the competing absolute litigation privilege policy.
