Delaware Court of Chancery Recognizes “Equitable Dissolution” of LLCs

Courtesy of Kurt Heyman of Proctor Heyman Enerio LLP, who represented the party seeking the dissolution of an LLC in a decision issued today by the Court of Chancery, we have the following highlights of the important opinion:

The Court of Chancery, per Vice Chancellor Laster, just issued an Opinion denying a motion to dismiss the petition for dissolution in In re Carlisle Etcetera LLC, C.A. No. 10280-VCL (Del. Ch. Apr. 30, 2015).  This decision appears to be the first in Delaware to provide strong support for the concept of “equitable dissolution” of LLCs.

The respondent, Tom James Company, moved to dismiss on the grounds that the petitioners lacked standing to seek judicial dissolution under Section 18-802 of the LLC Act, because neither was a member of the LLC as a result of (a) the LLC agreement’s silence on the issue of assignments and (b) the original member’s (WU Parent) assignment of its interest to its wholly owned subsidiary (WU Sub).  (See Section 18-702 of the LLC Act regarding the effect of assignments where the LLC agreement is silent on the issue.)

The Vice Chancellor agreed with Tom James’ argument, notwithstanding the fact that Tom James was aware of the assignment when it occurred and treated the assignee as a member, and therefore held that the petitioners lacked standing to seek judicial dissolution under Section 18-802.

However, in a lengthy analysis of the Court’s equitable jurisdiction, the Vice Chancellor found that the assignee nevertheless had standing to seek “dissolution in equity,” and consequently denied the motion to dismiss.  The critical holding of the case is as follows:

“James argues that because neither WU Parent nor WU Sub can seek statutory dissolution under Section 18-802, this case must be dismissed. In my view, James errs in contending that Section 18-802 is the exclusive extra-contractual means of obtaining dissolution of an LLC.  Under the facts of this case, WU Sub has standing to seek dissolution in equity.”

Because the Court took pains to note that its finding was based on “the facts of this case,” a careful analysis of those facts is necessary before concluding that the decision applies to other cases.

Supplement: On May 4, 2015, the Court granted a motion for summary judgment in this case. The Order provides a helpful description, with citations to authority, of those circumstances in which a deadlock will warrant dissolution–because not all deadlocks will justify a dissolution by the court. The same day the Court also entered an Order appointing a Receiver to oversee the dissolution. This Order provides helpful details that address the powers of a Receiver and scope of a Receiver’s role in connection with a dissolution.

By coincidence, a day before the initial decision in the above case, another member of the Court of Chancery issued a separate decision in an unrelated case that also involved an issue of standing to pursue an claim for dissolution of an LLC pursuant to Section 18-802. See Hampton v. Turner, C.A. No. 8963-VCN (Del. Ch. Apr. 29, 2015). Proctor Heyman Enerio LLP also represented a party in this Hampton case.

Section 220 Demand Granted for Investigation of Subsidiary

thOklahoma Firefighters’ Pension & Retirement System v. Citigroup, Inc., C.A. No. 9587-ML (VCN) (Del. Ch. Apr. 24, 2015).

This Delaware Court of Chancery opinion allowed an inspection of books and records pursuant to DGCL Section 220 in order to investigate mismanagement and possible breaches of fiduciary duty by the directors and officers of Citigroup in connection with allegations of fraud by its Mexican subsidiary.  The plaintiff also sought to investigate, in contemplation of derivative litigation, the disinterest of the board to determine whether pre-suit demand would be excused.  It is not surprising that such a demand would be granted in light of the many exhortations by the Delaware courts that Section 220 should be used prior to filing a plenary complaint asserting Caremark claims.

More noteworthy is a practical commentary on procedural points.  The initial demand pursuant to DGCL Section 220 was made on March 17, 2014.  A trial on the paper record was held in June 2014 before a Master in Chancery.  Exceptions to the prompt decision of the Master were submitted by Citigroup after which the parties briefed those exceptions and the Master promptly issued a Final Report and recommendation.  In October 2014, Citigroup filed its Notice of Exception to the Master’s Final Report.  The final arguments were submitted to the Court of Chancery in December and this decision followed.

The point is, that it took more than a year, through no fault of the court, to reach a final decision — and after all that effort, including the work of no less than seven attorneys (listed on the first page of the opinion) from three offices of an AmLaw 100 Law Firm opposing the demand, the winning plaintiff now enjoys the prize of having the right to receive documents that it hopes will support a claim in a plenary lawsuit.  So much for a statute that appears on its face to be simple to use and which provides for summary proceedings. The many cases highlighted on these pages on this topic suggest that Section 220 litigation is not always simple corporate litigation.

Supreme Court Opines on Earn-Out Provision

Lazard Technology Partners, LLC v. Qinetiq North America Operations LLC, No. 464, 2014 (Del. Supr., Apr. 23, 2015). The Delaware Supreme Court interpreted a post-closing earn-out provision and determined that the Court of Chancery was correct when it held that there was no breach of the implied covenant of good faith and fair dealing; plus, there was no evidence that the requirement in the applicable provision had been met, to demonstrate that the buyer intentionally evaded the trigger for an earn-out to be paid. This decision may be unprecedented in its brevity for an en banc  Supreme Court opinion, but nevertheless should be required reading for anyone with an issue involving an earn-out provision under Delaware law.

Practice point: drafters should make sure the standard by which an earn-out provision will be reviewed is capable of easy, objective measurement.

Chancery Allows Claim for Breach of Oral Agreement to Proceed

CSH Theaters, LLC v. Nederlander of San Francisco Associates, C.A. No. 9380-VCP (Del. Ch. Apr. 21, 2015). The Delaware Court of Chancery opinion applied an exception to the statute of frauds based on partial performance, and denied a motion to dismiss a claim for breach of an oral agreement to renew a lease, based on the reasonably conceivable standard.

The court also dismissed a fraudulent inducement claim based on the well-established Delaware case law that a simple breach of contract cannot be bootstraped into a fraudulent inducement claim simply by adding the term “fraudulently induced” to a complaint or mere conclusory allegation that the defendant never intended to comply with the agreement at issue at the time the parties entered into it.  See footnote 112 and accompanying text.  There is much else to commend this 56-page decision, but the most noteworthy aspects with the most widespread applicability or  greatest interest are contained in the foregoing paragraph.

Postscript: This decision should be compared with a recent order by the Supreme Court in Grunstein v. Silva, which affirmed a Chancery decision, see Grunstein v. Silva, 2014 WL 4473641 (Del. Ch., Sept. 5, 2014), refusing to uphold an oral agreement involving an interest in nursing homes, as well as a separate recent Chancery opinion in the Pulieri case, that rejected an effort to enforce an oral agreement regarding real estate transfers.

Johnston on Advancement and Indemnification of Directors and Officers

William Johnston, one of Delaware’s premier practitioners of corporate litigation, is the lead author of a treatise recently published by Bloomberg BNA on the law of advancement and indemnification of directors and officers as well as insurance and exculpation as a means of providing protection for those who serve in such positions. The scholarship of Bill and his co-authors may be cited, according to its publisher, as William Johnston, et al., Indemnification and Insurance for Directors and Officers, 54-3rd Corporate Practice Portfolio Series (BNA). Although this important work has a national focus, as one would expect, the several hundred footnotes are heavily weighted with citations from Delaware’s Court of Chancery and Supreme Court. The book also features sample provisions for advancement and indemnification.

[By comparison, the much more modest work for the chapter of a recent ABA publication that I co-authored on key cases from 2014 on advancement and indemnification, was an assignment I took on at Bill’s request when I succeeded him as the Chair of the Subcommittee on Advancement and Indemnification of the ABA Business and Corporate Litigation Committee.]

Chancery to Decide Advancement Issue for CEO of Coal Mining Company

The Delaware Court of Chancery is scheduled to hear post-trial oral argument in connection with its expected ruling on a claim for advancement by the ex-CEO of Massey Energy, a coal mining company, who is scheduled to go on trial for criminal charges in connection with the death of 29 minors. One of the issues is whether an agreement can modify rights otherwise mandated (once triggered) by Section 145 of the Delaware General Corporation Law.

Recent Chancery decisions on advancement have shown both judicial impatience and disquietude with companies that do not pay advancement when the court determines that those payments had been required–notwithstanding arguments the company may have for not paying. Past decisions have found some provisions in agreements that purport to limit advancement to be in conflict with the provisions of Section 145. Those same decisions have described this type of corporate litigation to be both contentious and expensive.

Frank Reynolds of Thomson Reuters has written a helpful overview with background details on the case. A few days ago I provided a link to a chapter I wrote on recent key decisions about advancement cases around the country (including Delaware).

Chancery Applies Non-Exclusive Forum Selection Clause; Denies Motion to Dismiss

Utilipath, LLC v. Baxter McLindon Hayes, Jr., C.A. No. 9922-VCP (Del. Ch., Apr. 14, 2105), is a short Chancery opinion notable for a few short reasons:5409380582_0b993a45d0_m

  • In light of a non-exclusive forum selection clause pursuant to which the parties agreed to litigate their dispute in Delaware, the court declined to apply the first-filed rule, known as the McWane doctrine, and denied a motion to dismiss. But the greater import of this case lies in its potential application on a larger stage.
  • One reasonable application of this Court of Chancery opinion is that: when parties have irrevocably consented to Delaware courts as a non-exclusive forum, even if a first-filed suit has been filed elsewhere involving similar parties and similar claims, the McWane doctrine may not require that the Delaware action be stayed in deference to the pending action in another forum.
  • This decision may have relevance to the pending legislation in Delaware described on these pages, that would require forum selection clauses that are included in bylaws to provide for the selection of Delaware courts in addition to any other state. In other words, when a forum selection clause is included in a bylaw to cover intra-corporate disputes, any state in the country can be selected as the forum–as long as Delaware is also included as one of those two fora. Stated another way, if the legislation is passed, when forum selection clauses are included in bylaws for stockholder disputes, Delaware must be either (i) the exclusive forum; or (ii) if another forum is selected, Delaware must be included as an additional forum.
  • Also notable is footnote 29 of the opinion which described a conversation that the author of this Chancery opinion had with the federal judge overseeing the related first-filed case in the U.S. District Court for the Eastern District of Pennsylvania, in which both jurists invited cooperation to the extent that there may be some overlap between the two cases.

Roman forum (an ancient forum selection) image above provided by Flikr’s Creative Commons by Benson Kua.

Director Advancement and Indemnification Rights

The Delaware law of advancement and indemnification for directors and officers is not for the fainthearted. Much of the statutory interpretation in the case law is counterintuitive. Each year the ABA Business and Corporate Litigation Committee publishes recent developments in the eponymous areas of the law in a two volume publication.American Bar Association.svg

The chapter on the key cases around the country (most of which are in Delaware) regarding advancement and indemnification involving directors and officers was co-written by yours truly along with my colleagues Gary Lipkin and Aimee Czachorowski. Included are the most noteworthy cases from 2014 involving DGCL Section 145. Information about the publication is available at this link.

Divided Supreme Court Upholds First-Filed Rule

SupremCourtThe Delaware Supreme Court provided this week the latest iteration of Delaware law on the first-filed rule and whether a particular issue is covered by an arbitration clause. Over a vigorous dissent, Delaware’s high court affirmed a decision of the Delaware Court of Chancery that applied the first-filed rule to an arbitration proceeding that preceded the filing of a subsequent lawsuit. LG Electronics, Inc. v. InterDigital Communications, Inc., No. 475, 2014 (Del. Supr., April 14, 2015), also features a robust disagreement among the justices regarding whether the provisions of the parties’ agreements included a clear intent of the parties to submit the issues involved to arbitration.

The Chancery decision was highlighted on these pages here. Also notable is that the dissent, at 21 pages, was nearly as long as the majority opinion, which weighed in at 23 pages.

Also interesting as an aside, is the increasing percentage of Supreme Court opinions over the last year or so that feature dissents. A majority of the current members of the 5-person court were not on the court a year ago. The prior composition of the court, which previously had remained the same for about a decade or so, rarely included dissenting opinions. According to The Chancery Daily, the chronicle of record for Delaware corporate and commercial litigation, of the 21 opinions issued in 2015 so far by the Delaware Supreme Court, dissents were featured in six of them. Previously only about 1% of Delaware Supreme Court decisions included dissenting opinions. Draw your own conclusions.

Injunctive Relief Denied for Alleged Misuse of Customer Lists

The Delaware Court of Chancery recently addressed an issue that commonly appears in corporate and commercial litigation:  the alleged misuse of customer lists by someone other than the company who created the list.  In American Messaging Services LLC v. DocHalo, LLC, C.A. No. 10761-VCN (Del. Ch. Apr. 9, 2015), the court recited the well-worn prerequisites for obtaining a temporary restraining order (TRO).

In contrast to a request for a preliminary injunction, the focus in the court’s review of a motion seeking a TRO is more on the irreparable harm factor based on a mere colorable claim, but in this case the court found that even if the requirement for establishing a colorable claim was barely met, the balancing of the equities did not favor grant of the TRO.  In part, this was due to the agreement between the two parties that they were, under certain circumstances, entitled to cross-sell to their customers as part of a joint venture that quickly soured.  That is a factual component that is not commonly present in most cases alleging a misappropriation of customer lists, even though customer lists are often within the definition of the state statute for trade secrets.