Non-Signatory LLC Members Bound By Operating Agreement

Seaport Village Ltd. v. Seaport Village Operating Company, LLC, et al., C.A. No. 8841-VCL (Del. Ch. Sept. 24, 2014). This decision by the Delaware Court of Chancery highlights a counterintuitive statutory rule. The Delaware LLC Act provides that each LLC member, and the LLC itself, are considered parties to an LLC operating agreement, even if they did not sign the agreement.

As the court explained, Section 18-101(7) of the Delaware LLC Act:

added the following language to the LLC Act: “A limited liability company is not required to execute its limited liability company agreement. A limited liability company is bound by its limited liability company agreement whether or not the limited liability company executes the limited liability company agreement.” Del. SB 363, 141st General Assembly, 2002 Delaware Laws Ch. 295 (June 20, 2002). The amendment became effective on August 1, 2002. In 2005, the General Assembly added nearly identical language to the LLC Act to clarify that members also are bound by the LLC’s operating agreement, regardless of whether they execute the agreement. Del. SB 86, 143rd General Assembly, 2005 Delaware Laws Ch. 51 (June 14, 2005) (adding the words “[a] member … is bound by the limited liability company agreement whether or not the member … executes the limited liability company agreement”). These amendments make clear that the LLC and its members are parties to and bound by the LLC agreement, regardless of whether they sign it.

Another noteworthy aspect of this short ruling is one that the parties did not argue. The dispute related to a contractual provision that awarded attorneys’ fees to the prevailing party. There was no issue raised by the parties or the court that such a contractual provision was generally enforceable in Delaware, and enforceable in this case.

 

Update on Fee-Shifting Bylaw Issue in Pending Chancery Case

Recent activity in the Delaware Court of Chancery has followed the Delaware Supreme Court’s May 2014 decision in ATP Tour, Inc v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), highlighted on these pages, which upheld a fee-shifting bylaw, at least in principle.   The plaintiff in the pending Delaware Court of Chancery case in Kastis v. Carter, C.A. No. 8657-CB, recently moved to challenge the validity of a bylaw adopted expressly by the defendant corporation to invoke the fee-shifting provided for in ATP. This is a cutting-edge issue in Delaware corporate litigation.    

The defendant corporation, Hemispherx, adopted the fee-shifting bylaw on July 3, 2014, after it became clear that the Delaware General Assembly was not going to act to disallow such provisions in response to the Court’s decision in ATP.  On July 18, 2014, Hemispherx notified the plaintiff in Kastis that it had adopted the bylaw and intended to apply it retroactively, invoking it in the pending Chancery case.  Kastis quickly filed a motion to invalidate the bylaw.[1]  Both parties briefed the issue.[2]  After an August 12 teleconference with the Court, in which the Court indicated that the plaintiff needed to amend its complaint to challenge the validity of the bylaw, Plaintiff moved, on August 22, for leave to amend its complaint.[3]  Again, both parties submitted briefing.[4]

Surprisingly, after briefing, the parties agreed just this week not to apply the fee-shifting bylaw to any aspect of the litigation.  They informed the Court that they had agreed “that the bylaw will have no application to this litigation, and [Hemispherx] will not assert the bylaw as a basis for fee-shifting in this case.”[5]  Accordingly, since the fee-shifting bylaw was no longer at issue, plaintiffs’ Motion for Leave to Amend its complaint was denied.[6]  Although the case will continue its progress in the Court of Chancery on other issues, the issue of whether Hemispherx’s bylaw is valid or enforceable will no longer be addressed.

Aimee Czachorowski, an associate in our Wilmington office, prepared most of this post.

—————————————–

The following referenced court filings in the Kastis case are hyperlinked together as one pdf.

[1] July 21, 2004 Motion to Invalidate Retroactive Fee-Shifting and Surety Bylaw or, in the Alternative, to Dismiss and Withdraw Counsel.

[2] Hemispherix Response and Plaintiffs’ Reply Brief.

[3] Plaintiffs’ Motion for Leave to File an Amended Complaint.

[4] Defendants’ Response to Plaintiffs’ Motion For Leave to File an Amended Complaint and Motion for Partial Stay.

[5] September 16, 2014 letter to Chancellor Bouchard.

[6] September 16, 2014 Order.

Dismissal Denied for Disinterested Directors When Entire Fairness Applies to Transaction

In re Cornerstone Therapeutics Inc. Stockholders Litigation, Cons. C.A. No. 8922-VCG (Del. Ch. Sept. 10, 2014). This Chancery decision is noteworthy for its analysis of the applicable standard for a motion to dismiss members of a special committee when the challenged transaction would otherwise be subject to the entire fairness standard. This opinion provides a helpful review of the history of the standard and a discussion of when the burden of proof shifts to the plaintiff even when that standard applies, though initially the burden rests with the defendant.

The opinion also features one of the first applications of the recent Supreme Court opinion in M&F Worldwide, highlighted here, which provides that a deal with a controlling shareholder, in order to enjoy the business judgment rule standard of review, be conditioned ab initio on a majority of the minority approval, and approval by an independent special committee.

Chancery Applies Comity to Stay Litigation

In Scott v. Dandero, C.A. No. 9041-VCG (Del. Ch. Sept. 8, 2014), the Court of Chancery applied general principles of comity and judicial efficiency to deny a request to lift a stay of a case before it involving parties and issues that were common to separate pending litigation in Texas. This amorphous power of the court is a useful and practical tool to employ when  common parties are involved in multi-jurisdictional litigation involving related issues.

Chancery Upholds Forum Selection Clause Outside Delaware

City of Providence v. First Citizens BancShares Inc., et al., No. 9795, 2014 WL 4409816 (Del. Ch. Sept. 8, 2014).

The Delaware Court of Chancery upheld the forum selection clause of the bylaws of a Delaware corporation that requires most shareholder suits against the company to be filed in North Carolina, where the company’s main office is located. This is a natural evolution of the prior Chancery decision in the Chevron decision, highlighted on these pages.

Frank Reynolds of Thomson Reuters provides an insightful overview of the case that includes a quote from yours truly and others.

Chancery Rejects Reargument of Prior Decision on Advancement Claims

Pontone v. Milso Indus. Corp., et al., C.A. No. 7615-VCP, letter op. (Del. Ch. Sept. 3, 2014).  This decision denied a motion for reargument of an opinion regarding advancement of fees pursuant to DGCL section 145 available to officers and directors. The nuance addressed in this case involves the types of counterclaims that are available for advancement and indemnification. This decision reiterates that such a counterclaim must be considered a compulsory counterclaim, and “necessarily part of the same dispute” as the affirmative claims asserted against the advancee, and be advanced to “defeat or offset those claims.” See Citadel Holding Corp. v. Roven, 603 A.2d 818 (Del. 1992).

Rule 59(f) motions for reargument are rarely granted, and this case was no exception to that statistical probability. In essence, the court regarded the motion as a reprise of previously rejected arguments, though perhaps providing additional details or nuances.

The prior decision in this case was recently highlighted on these pages.

 

First Filed Rule Applied to Arbitration Claim

LG Electronics, Inc. v. Interdigital Communications, Inc., C.A. No. 9747-VCL (Del. Ch. Aug. 20, 2014).

This decision applied the familiar first-filed rule, also known as the McWane Doctrine, to a first filed arbitration claim. The court dismissed a complaint that sought injunctive relief notwithstanding that the same issue had been presented in a previously-filed arbitration between the parties.  This appears to be the first time that the first-filed rule was applied (in Delaware) to bar a suit as a result of that doctrine, when a previously-filed arbitration proceeding between the same parties involving the same dispute was already pending, as compared to a prior suit filed in court.

Notice Required Prior to Payment by Corp for Mooted Claims

In Re Astex Pharmaceuticals, Inc. Stockholders Litigation Cons., C.A. No. 8917-VCL (Del. Ch. Aug. 25, 2014).

This short letter ruling required the parties to comply with the notice provisions explained in a prior Chancery decision in connection with their request that fees be paid by the corporation for mooted claims.  The prior decision cited was In Re Advanced Mammography Sys., Inc. S’holders Litig., 1996 WL 633409 (Del. Ch. Oct. 30, 1996) (Allen, C.).

Supreme Court Recognizes Exception to Attorney/Client Privilege

The National Association of Corporate Directors publishes a magazine called Directorship. They published my article on the recent decision of the Delaware Supreme Court in the Wal-Mart case, highlighted on these pages, which recognized an exception to the attorney client privilege when a stockholder sues a member of the board of directors of a company and there is no other method to obtain the requested information.

Chancery Addresses Advancement and Indemnification of Corporate Officer

In Pontone v. Milso Industries Corp., C.A. No. 8842-VCP (Del. Ch. Aug. 22, 2014), the Delaware Court of Chancery addressed the rights to advancement and indemnification of attorneys’ fees for a corporate officer pursuant to both DGCL Section 145 and applicable agreements among the parties. The most notable aspect of this 65-page scholarly treatment of this recurring issue in corporate litigation is how indemnification claims will be treated when two parties have arguably overlapping obligations to indemnify, and what percentage of “fees on fees” will be awarded if a party is not 100% successful. This opinion deserves careful reading, not only by those who want to know the latest iteration of Delaware law on this topic, but also by those who want a primer on the prerequisites and nuances of Delaware law on the perennial issues presented that are of important to directors, officers and the companies they serve. 

It remains remarkable how, despite hundreds of Delaware decisions on these issues, new cases seem to present nuances that have not been addressed before. I co-author a chapter of an annually updated multi-volume treatise on corporate litigation developments that surveys court decisions around the country on indemnification and advancement, and even though the majority of cases nationwide, by far, are decided in Delaware, subtle differences in the facts of new cases often present new complexities not previously addressed by the myriad of decisions already published.

A prior related Delaware decision in this matter was highlighted on these pages.