Delaware Court of Chancery Addresses Issue of First Impression in Connection with an LLC Dissolution

This article by Kevin F. Brady and Francis G.X. Pileggi first appeared in the March 14, 2012 issue of The Delaware Business Court Insider, and reviews the recent Delaware Court of Chancery decision in  Matthew v. Laudamiel, C.A. No. 5957-VCN (Feb. 21, 2012).

The Delaware Court of Chancery recently issued an opinion on an issue of first impression in Delaware.  Apparently no Delaware statutory or case law directly addressed the issue of whether the dissolution and cancellation of an LLC transformed derivative claims into direct claims held proportionately by the members of the LLC.  The Court concluded that, after the filing of the certificate of cancellation, such claims must be brought in the name of the LLC by a trustee or a receiver appointed under 6 Del. C. Section 18-805, or directly by the LLC, or derivatively by its members after reviving the LLC by obtaining a revocation of its certificate of cancellation.

Background

The Court’s 61-page decision in Matthew v. Laudamiel (C.A. No. 5957-VCN,  Del. Ch. Feb. 21, 2012), provides a detailed description of the extensive background facts.  In brief, the case involved Stewart Matthew asserting various claims against his former business associates, including his former fellow members and board of managers of Aeosphere LLC, as well as two companies with which Aeosphere purportedly had business dealings.  All of Matthew’s claims related to the dissolution of Aeosphere which he argued was wrongfully undertaken by the other managers in order to remove him from a potentially lucrative fragrance business.

Two defendant companies with which Aeosphere purportedly had business dealings, Flakt Woods Group and Semco LLC, moved for dismissal based on the lack of subject matter jurisdiction in Delaware.  Semco also moved for dismissal under Court of Chancery Rule 12(b)(6).  The former members and/or managers of Aeosphere, besides Matthew, were Christophe Laudamiel, Roberto Capua and Action 1, srl, an Italian company.  These defendants also asserted counterclaims against Matthew relating to actions he took or did not take in his capacity as a manager of Aeosphere.  Matthew moved for dismissal of many of those claims under Rule 12(b)(6), as well.

Laudamiel was a member, manager and co-CEO of Aeosphere.  Action 1 was a member of Aeosphere.  Capua was a manager of Aeosphere and the majority owner of Action 1.

Preliminarily, the Court noted that motions to dismiss under Court of Chancery Rule 12(b)(6) are usually limited to the facts alleged in the complaint, but the Court may consider documents both integral to and incorporated into the complaint, as well as documents not relied on for the truth of their contents.  In a somewhat noteworthy approach, the Court considered many e-mails referred to in the complaint, as well as the LLC agreement.

The LLC agreement provided that Aeosphere was to be managed by a board of managers, which included Matthew, Laudamiel and Capua.  The LLC agreement also provided that board meetings could be called on 24 hours’ notice, and the managers could waive notice.  The LLC agreement also provided that Matthew and Laudamiel had to approve all actions that required the consent of the board, but that in the event that Matthew and Laudamiel would deadlock, Capua was to cast the tie-breaking vote.  However, certain actions such as the winding up of Aeosphere, required “unanimous approval of the board.”

Matthew alleged that Laudamiel and Capua excluded him from the business and misappropriated assets.  On May 3, 2010, Laudamiel and Capua purported to deliver a notice of emergency meeting of the board to be held the next day.  According to the agenda for the meeting, the board would consider and vote on:  (1) dissolution and winding up of Aeosphere; (2) the termination of all employees of Aeosphere; (3) distribution of Aeosphere’s remaining intellectual property.  Matthew did not waive notice of the meeting and notified Laudamiel and Capua that he would not be participating in the meeting and did not consent to the dissolution of Aeosphere.  Nonetheless, Laudamiel and Capua, the only managers present at the emergency meeting, voted to wind-up the affairs of Aeosphere and dissolve it.  They also voted to terminate Matthew as co-CEO and to terminate all other employees of Aeosphere, and to close its offices.  Laudamiel was designated to oversee the winding up and liquidation of Aeosphere, and on May 12, 2010, a certificate of cancellation was filed with the Delaware Secretary of State.

Matthew also alleged that Laudamiel and Capua took several actions to enrich themselves at his expense, both prior to and in connection with the liquidation of Aeosphere.  According to the plaintiff, Laudamiel and Capua misappropriated the most valuable asset of Aeosphere which was a business venture with Flakt Woods.  After the dissolution, they allegedly continued to work with Flakt Woods to develop technology that was intended to be developed by Aeosphere.

Claims

Matthew claimed that Laudamiel and Capua breached the LLC agreement and their fiduciary duties, converted assets of Aeosphere and transferred them after dissolution to entities that the defendants controlled.  The allegation against Action 1, a member of Aeosphere, was that Action 1 breached the LLC agreement.  The allegations against Flakt Woods and Semco were that they aided and abetted the breach of fiduciary duties, and tortiously interfered with the plaintiff’s rights under the LLC agreement and his employment agreement.  Allegations against all the defendants included unjust enrichment and civil conspiracy.

Analysis of Personal Jurisdiction over Flakt Woods

The Court concluded that there was neither general nor specific long-arm jurisdiction over Flakt Woods, and regardless, any assertion of personal jurisdiction would violate the Due Process Clause of the Fourteenth Amendment.  Additionally, although it was not necessary to reach the Rule 12(b)(6) motion to dismiss, the Court also explained that even if there were jurisdiction, the plaintiff failed to state a claim upon which the relief could be granted.

The Court recited the procedural burden pursuant to a motion to dismiss for lack of personal jurisdiction under Court of Chancery Rule 12(b)(2).  The Court explained that once a defendant moves to dismiss under Rule 12(b)(2), the burden rests on the plaintiff to demonstrate the two bedrock requirements for personal jurisdiction:  (1) a statutory basis for service of process; and (2) the requisite “minimum contact” with the forum to satisfy constitutional due process.

The Court also recited the prerequisites for the well-established conspiracy theory of jurisdiction which posits that “where a conspiracy exists, the acts of each co-conspirator with respect to the aim of the conspiracy are attributable to the acts of the other co-conspirators under a theory of agency.”  That five-part test was announced by the Delaware Supreme Court in the case styled Istituto Bancario Italiano SpA v. Hunter Eng’g Co., Inc., 449 A.2d 210, 225 (Del. 1982).  The Court explained that the conspiracy theory of jurisdiction need not be specifically framed as such in the complaint, and although the test speaks in terms of a conspiracy to defraud, the principle is not limited to that particular tort.  Rather, the factors outlined in Istituto Bancario may be satisfied by sufficiently pleading a claim for aiding and abetting a breach of fiduciary duty.  The Court also explained that the filing of a certificate of cancellation satisfies one element of the Istituto Bancario factor because the filing of a corporate instrument such as a certificate of cancellation is considered an act occurring in Delaware.

However, the Court found that the Istituto Bancario test was not met because “a defendant does not purposefully avail himself of a forum without knowledge that an act or effect will occur there.”  The record reflected that Flakt Woods did not know that the conspiracy would have a Delaware nexus until after the goal of the conspiracy had been attained and was completed.  That is, the conspiracy had come to an end by the time Flakt Woods learned of its Delaware connection.  There was no other basis to impose personal jurisdiction on Flakt Woods.

Personal Jurisdiction Analysis for Semco

The Court conducted a thorough analysis of whether or not Semco was subject to general jurisdiction under Section 3104(c)(4) of Title 10 of the Delaware Code.  The Court concluded that there was neither a statutory basis for service of process on Semco, nor a basis for exercising personal jurisdiction over Semco that would comport with constitutional due process.

In order to determine whether there were sufficient contacts with Delaware to impose general personal jurisdiction over Semco, the Court reviewed several key facts.  For example, Semco: (i) had no offices nor employees nor bank accounts nor real estate in Delaware; (ii) its sales in Delaware for each of the four years before filing this suit were less than 1% of the total sales.  Although it did have an independent sales agent that worked in Delaware, the Count found the facts insufficient to establish general personal jurisdiction.

Under Section 3104(c)(4), personal jurisdiction may be exercised over a nonresident when tortious injury inside or outside of Delaware is caused “by an act or omission outside of Delaware if the person regularly does or solicits business, engages in any other persistent course of conduct in Delaware, or derives substantial revenue from services, or things used or consumed in Delaware.”  The Court found that this standard could not be met regarding the facts presented against Semco.  That is, the facts did not support an inference that Semco “regularly does or solicits business, engages in any other persistent course of conduct in Delaware or derives substantial revenue from Delaware.”

The Court added that even if jurisdiction would be proper against Semco under the Delaware long-arm statute, the exercise of jurisdiction would be improper under the Due Process Clause.  In order to satisfy constitutional due process, a defendant must engage in sufficient minimum contacts with a forum state to require it to defend itself in that state consistent with “traditional notions of fair play and justice.”  That is, in order to maintain general jurisdiction over a foreign defendant, the facts must establish “continuous and systematic general business contacts with the foreign state.”  After reviewing the contacts that Semco had with Delaware and finding that the limited contacts were unrelated to the causes of action in this case, the Court concluded that they did not meet the “high standard for an assertion of general jurisdiction.”

The Court went on to explain why the motion to dismiss for failure to state a claim under Court of Chancery Rule 12(b)(6) would have been granted – - even if there were personal jurisdiction over Semco.  The Court then discussed each of the claims and defenses in the motion to dismiss under Rule 12(b)(6).

Counterclaims

The Aeosphere defendants brought counterclaims against Matthew, claiming breach of the LLC agreement, the implied covenant of good faith and fair dealing, breach of fiduciary duty, and unjust enrichment.

The Court reviewed the familiar standard and nuances of the implied covenant that attaches to every contract in Delaware by operation of law, as well as the high bar that needs to be met in order to prevail on such a claim.  The Court reasoned that there was “no gap for the implied covenant to fill,” and that there was no breach of the implied covenant because the actions alleged were addressed by the specific terms of the LLC agreement which covered those actions.  The Court explained that it would be inappropriate for it to “supplant or supplement the contractually agreed upon standard” by implying additional terms.  If the allegations violated a standard set forth in the LLC agreement, the appropriate counterclaim is for breach of contract, which was also alleged.

The counterclaim also alleged that Matthew’s refusal to cooperate and the “general assertions of mismanagement” were not sufficient to state a cause of action for breach of the implied covenant.  The Court’s reasoning also is indicative of why generalized and amorphous claims of “mismanagement” are often challenging claims to prevail on, without measurable evidence.

Issue of First Impression: Whether the dissolution and cancellation of an LLC transforms derivative claims into direct claims held proportionately by the LLC’s members.  Answer:  No.

The Court provided a more detailed answer to this unsettled issue by concluding that:  After the filing of the certificate of cancellation, such claims must be brought in the name of the LLC by a trustee or receiver appointed under 6 Del. C. Section 18-805, or directly by the LLC, or derivatively by its members after reviving the LLC (in a related proceeding), by obtain revocation of its certificate of cancellation.

Practice Pointer

The Court explained in footnote 140 that the LLC agreement in this case did not provide a method for how the claims of Aeosphere should be pursued after the filing of its certificate of cancellation.  Therefore, the Court emphasized that it was not addressing the validity of a provision in an LLC agreement that purported to establish an alternative process for pursuing the claims of a cancelled entity.  Rather, the Court explained that this opinion was only addressing the rule that would govern the disposition of such claims in the absence of some other contractually provided process that might displace what the Court referred to as the “background rule.”  Thus, drafters of LLC agreements would be well advised to heed the instruction provided in this opinion at footnote 140.

Dissolution Process

The Court outlined the dissolution process for an LLC provided in Sections 18-801 through 18-806 of Title 6 of the Delaware CodeAfter an act of dissolution occurs, an LLC is to be wound up and its assets distributed as provided in Section 18-804.  The persons winding up the LLC’s affairs may prosecute and defend suits on the LLC’s behalf until the filing of the certificate of cancellation.  After the certificate of cancellation has been filed, suits generally may not be brought by or against an LLC.  However, Section 18-805 provides that “at any time” after the filing of a certificate of cancellation, the Court of Chancery may, on application, appoint one or more managers or other persons to act as trustees or receivers “to take charge of the LLC’s property, and to collect the debts and property due and belonging to the LLC, with the power to prosecute and defend in the name of the LLC, suits as may be necessary or proper for the purposes aforesaid.”  The trustee or receiver may also be given the broad power to do other acts which might be done by the LLC and may be necessary for the final settlement of unfinished business of the LLC.

The Court observed that the foregoing provision of the LLC Act is almost identical to Section 279 of the Delaware General Corporation Law, which allows the Court of Chancery to appoint a receiver or trustee with the same powers described in Section 18-805 to conclude the unfinished business of the dissolved corporation.  The Court noted that it often looks to corporate law authorities when interpreting similar statutory provisions.

By comparison to DGCL Sections 278 and 279, the Court observed the intention of the corporate statue: “that a dissolved corporation maintains the authority and ability to sue and be sued incident to the winding up of its affairs.”

Section 18-805 also provides members a method to pursue claims of the LLC in the name of the LLC after the filing of a certificate of cancellation so that one who harmed an LLC would not be “absolved” of any related liability by the filing of a certificate of cancellation even if the members of the LLC could not pursue the claims directly.

The case law regarding the dissolution of LLCs is not as well-developed as it is for corporations, and the procedures are different.  For a helpful discussion on this topic, see Robert Symonds & Matthew O’Toole, Symonds & O’Toole on Delaware Limited Liability Companies, at §16.02.

The statutory analysis of the Court indicated that the undistributed claims of a cancelled LLC may not, on the authority of the statute alone, be asserted directly by the former members of the LLC.  Such claims may be brought in the name of the LLC using the process set forth in Section 18-805, or – - in conjunction with a related action seeking the nullification of the certificate of cancellation of the LLC.  At that point the members might pursue direct or derivative claims.  Footnote 150 referred to another decision which found that a litigant need not bring a separate action seeking nullification of a certificate of cancellation before filing a derivative suit on behalf of the LLC.  The Court dismissed those counterclaims that could only been brought derivatively on behalf of Aeosphere before the certificate of cancellation was filed.  The Court concluded by noting that the former members of the LLC presented virtually no authority to support a contrary conclusion.

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Kevin F. Brady and Francis G.X. Pileggi are both members in the Wilmington, Delaware, office of Eckert Seamans Cherin & Mellott, LLC.  Mr. Brady is a member of the Court of Chancery Rules Committee.