Hughes v. Kelly, C.A. No. 414-VCN (Del. Ch. Aug. 3, 2010), read opinion here.
Although this case was decided on June 30, 2010, it was filed under seal and the redacted public version was released on August 3, 2010. Procedurally this decision comes in response to a Motion to Dismiss Counterclaims by the managing member of an LLC who seeks to enforce indemnification, non-disparagement and release provisions of the Operating Agreement.
The Court explained that at the motion to dismiss stage, when questions of contract interpretation involve ambiguous provisions that are fairly susceptible of different interpretations, the Court cannot choose between two or more reasonable interpretations. See footnote 17. The Court concluded in this case that the narrow interpretation supported by the moving party was not the only reasonable one.
The specific issue before the Court was whether an indemnification clause that facially limits itself to coverage for one role of many held by an executive, can be expanded to include actions taken by the executive in other roles that have some relation to the role subject to indemnification. See footnote 23. Although the Court was skeptical of an expansive reading of the provision, because the applicable indemnity provisions are susceptible to two opposing, yet reasonable, interpretations as to the proper scope, dismissal on a motion to dismiss would be improper.
Can Determinations of Bad Faith be made through a Motion to Dismiss?
The Court reasoned that allegations of bad faith are generally factual issues not appropriate for resolution at a motion to dismiss stage. See footnotes 25 and 26. The Court concluded that many material related questions of fact require discovery, such as the intent in relying on the agreement’s indemnification provisions.
The motion to dismiss the non-disparagement claims was based, in part, on a provision in the agreement that only prevented criticism of Kelly as a managing member but did not prohibit criticism of Kelly as a CEO. In addition the fact that criticism was made in the course of “legal process”, as defined in the agreement, exempts any such claim. The Court determined that due to ambiguities about the proper scope of the non-disparagement provision, it was required to look to extrinsic evidence to ascertain the intent of the parties regarding the non-disparagement provision, and on that basis, due to factual issues, the motion to dismiss failed.
Whether the Non-Disparagement Claims were Exempt Due to Disclosure Requirements Pursuant to the Agreement’s definition of Legal Process?
The moving parties argued that the non-disparagement claims should fail for three main reasons: (1) Principles of agency law required disclosure of known facts to their employer; (2) The mere filing of a civil complaint constitutes “legal process;” and (3) Regardless of the non-disparagement clause, they should be afforded an absolute privilege as witnesses to a “proceeding as a matter of public policy and under Delaware law.” See footnote 28.
The Court determined that there were factual issues regarding the scope of the phrase “legal process” as defined in the agreement, to the extent that the provision in the agreement prohibited “disparagement except to the extent required by law and legal process.” In addition, the absolute privilege afforded to witnesses in judicial proceedings which typically operates to bar a cause of action against the witness for defamation or disparagement for statements made in a judicial proceeding requires a showing that: “(1) The statements issued were part of the judicial proceedings; and (2) The statements were relevant to a matter at issue in the case.” It is not clear that the statements involved here in connection with preparing the litigation will necessarily fall within the privilege and thus factual questions would need to be determined before the absolute privilege could be applied.
The Court considered the provision to be written for the purpose of providing a means whereby funds from a sale would be evenly distributed to members and the Court could not accept the argument that the parties intended to employ a multi-staged litigation process in order to induce a member to carry out his obligations under the agreement.