Costantini v. Swiss Farm Stores Acquisition LLC, C.A. No. 8613-VCG (Del. Ch. Sept. 5, 2013). A subsequent decision in this case was highlighted on these pages here.
Issue Presented: Whether a non-manager of an LLC was entitled to indemnification based on the terms of the LLC agreement.
Short Answer: Not based on the applicable terms.
In the underlying action, Swiss Farms sought damages against Costantini and Kahn for breach of fiduciary duties. That case was dismissed based on a successful defense of laches. Kahn and Costantini now seek indemnification for their fees and costs incurred in defending that fiduciary duty action. Costantini was a member of the board of managers of Swiss Farms, but Kahn was not a manager. The Court reiterated the public policy behind indemnification, which encourages able people to serve in managerial positions.
Permissive indemnification under Section 145(a) and (b) of Title 8 of the Delaware Code is allowable as long as the individual acted in good faith.
In addition to those permissive indemnifications, Section 145(c) provides for mandatory indemnification to the extent that any present or former director or officer has been successful “on the merits or otherwise in defense of any action,” suit or proceeding referred to in subsections (a) and (b) of Section 145.
The Court of Chancery explained that the same policy reasons supporting indemnification for corporate actors also applies to actors for other entities, including LLCs such as Swiss Farms. However, because LLCs are creatures of contract, those terms are controlling. In this case, the LLC chose to import verbatim both the permissive and mandatory indemnification rights for its managing members, officers, employees or agents as provided to corporate actors in Section 145.
The Court did not address whether the corporate statute was binding in light of it being imported verbatim. Nonetheless the Court found that the indemnification provision did apply to Mr. Costantini.
Swiss Farms’ argument, which the Court described as “surprising,” was that because Costantini only prevailed on the technical defense of laches, he did not prevail “on the merits.” However, the language imported from Section 145 allows for indemnification where one prevails on the merits “or otherwise.” The language “or otherwise” allows indemnification where, as in this case, a managing member prevails in any manner.
The LLC provisions mirrored subsections (a) and (b) of Section 145 regarding permissive indemnification, and another provision in the LLC agreement mirrored subsection (c) of Section 145 regarding mandatory indemnification. The permissive indemnification is conditioned on the good faith actions of the indemnitee but the mandatory indemnification provisions are not conditioned on good faith, and require indemnification where the actor has merely prevailed in defense of an action. The latter situation is the one in which Costantini finds himself.
The Court found that it was not reasonable to construe the LLC provisions that mirrored Section 145, to require a good faith condition for the mandatory indemnification coverage.
The Court also viewed as “unfortunate” that corporations and other entities often find broad advancement and indemnification clauses useful for enticing talented people to associate themselves with the entity, only to spurn them once the time for payment arrives. In this case, the Court also found that Constantini was entitled to reasonable fees incurred in pursuing his indemnification rights.
A separate analysis was performed for a separate defendant, Kahn, who was neither a manager of the LLC, nor was he an officer, employee or agent of Swiss Farms, or even a member. Rather, he was a partner in a partnership that was a member. The Court found that Kahn was not within the class of indemniteees covered by the provision. Although the LLC agreement could have been drafted to provide coverage for a broader class of persons who are neither managers, officers, employees not agents, that was not done.
The Court understood the argument that it may appear unfair for one of the successful defendants to be covered by the indemnification provision but not to provide indemnification for another, but that is the result of the language in the LLC agreement which did not include Kahn among those for whom indemnification was provided.
The Court also distinguished the case of Imbert v. LCM Interest Holding LLC, 2013 Del. Ch. LEXIS 126, 2013 WL 1934563 (Del. Ch. May 7, 2013). That case involved a dispute as to whether allegations against the potential indemnitee had been brought in his capacity as a manager, for whom advancement rights applied, or as a member, for whom advancement was not provided in the LLC agreement. It was undisputed in that case that the potential indemnitee was a manager, so the issue was in what capacity the allegations against him were brought. Therefore, the holding in Imbert was found not to be persuasive.
In sum, Costantini was a manager of Swiss Farms and within the class of indemnitiees entitled to indemnification for prevailing on the applicable claim. Even though Kahn also prevailed, he was not entitled to indemnification because he was not within the class of indemnitees covered by the LLC agreement’s indemnification provision.