A recent Delaware Court of Chancery decision is notable for featuring the resolution of a dispute regarding the valid managers of an LLC, and rejecting the “bump-out theory” of replacing LLC managers–that is, incumbent managers need to be removed before their replacements can validly “take their seats”. The ruling in Llamas v. Titus, C.A. No. 2018-0516-JTL (Del. Ch. June 18, 2019), is the product of the summary proceedings available pursuant to Section 18-110 (a) of the Delaware LLC Act, which is the counterpart to DGCL Section 225, which allows for an expedited procedure to determine the proper composition of a corporate board.
Originally, one member of the LLC in this case had a 90% interest and the other member had a 10% interest. The person owning 90% died, leaving the surviving member as the sole member and manager. An advisor of the deceased member cajoled the surviving member to appoint two others as managers.
After regretting his decision, the surviving member tried to appoint two different managers whom he thought would be more reliable allies. There were purported amendments to the operating agreement and various written consents whose impact was disputed. The applicable LLC documents provided for only three managers.
Among the key facts are that the surviving member’s attorney failed to prepare the requisite paperwork to remove the other two managers before attempting to install their replacements via the written consent of the sole member. That critical fact played a determinative role in the court’s decision.
Noteworthy Legal Principles in Court’s Analysis
- Delaware rejects the bump-out theory, which means that an individual cannot be appointed to a board with no vacancies. Slip op. at 43. Namely: “Without a vacancy, there is no room for an individual to be appointed.” Id.
- The summary proceeding available via Section 18-110(a) is “limited to determining those issues that pertain to the validity of actions to elect or remove” an LLC manager. Slip op. at 32.
- Case law addressing corporate board membership applies by analogy to manager-managed LLCs. Id. at 38.
- When one attempts to reduce the size of a board below the number of sitting directors, for example via a bylaw amendment, and the attempt takes place between annual meetings, that act does not remove the sitting directors. Id. (citing Crown EMAK Partners, LLC v. Kurz (Del. 2010))[That Delaware Supreme Court decision was highlighted on these pages.]
- The Court emphasized that it did not use the corporate law analogy to override the LLC agreement–which had a provision for removing managers but that provision was not followed in this case. Slip op. at 39-40. Compare: case cited at footnote 55 for the position that before a director is removed for cause he is entitled to notice and an opportunity to address the accusations.
- The introductory clause of an LLC agreement, such as the “whereas clause” in other documents, typically does not have “substantive effect” and does not establish agreed upon facts. Slip op. at 35. The introductory clauses in this case wrongly stated that there was only one manager at the time of the attempt to replace two other managers.