This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Court of Chancery recently found Delaware’s Limited Liability Company Act requires American Rail Partners LLC to reimburse the legal bills a managing member and its directors and CEO incur in defense of ARP’s unjust enrichment and mismanagement charges — even if such “first party claims” are not specifically covered, in International Rail Partners LLC et al. v. American Rail Partners LLC, No. 2020-0177-PAF, memorandum opinion issued, (Del. Ch. Nov. 24, 2020).

Vice Chancellor Paul Fioravanti, Jr.’s Nov. 24, 2020 memorandum opinion on a novel advancement issue rejected ARP’s contention that two-member limited liability company agreements, like two-party commercial contracts, provide fee-shifting in some situations but not advancement and indemnification for the company’s suit against a member.

Ruling on dueling summary judgment motions, he sided with the plaintiffs seeking advancement, finding that unlike commercial contracts, the Delaware Limited Liability Company Act Section 18-108 was designed to encourage LLC officers, directors and members to serve without worry about suits over their actions on behalf of the company.

The underlying action

ARP filed an underlying action in February in the Delaware Superior Court, spurred by non-party member Newco SBS Holdings, LLC’s complaint that the management of the other member, International Rail Partners LLC, and ARP CEO and Chairman-of-the-Board Gary Marino unjustly profited at ARP’s expense. American Rail Partners, LLC et al. v. International Rail Partners LLC et al., C.A. No. N20C-02-283 EMD complaint filed (Del. Super. Feb. 28, 2020).

When IRP, Marino and their corporate allies sought advancement, ARP claimed the type of claims in the Superior Court suit could never be indemnified despite the broad scope of Section 10.02(c)(i) of the LLC Agreement, contending that an indemnification or advancement provision may only cover first-party claims if it expressly says so.

The court said that argument is grounded in a line of decisions which established a presumption that a standard indemnification provision in a bilateral commercial contract would not automatically be presumed to provide for fee-shifting in the indemnity section of a contract. TranSched Sys. Ltd. v. Versyss Transit Solutions, LLC, 2012 WL 1415466 (Del. Super. Mar. 29, 2012).

Not like a commercial contract

That decision spawned others that barred fee shifting in a commercial contract unless specifically spelled out, and the only Chancery Court ruling on the issue, Senior Housing Capital, LLC v. SHP Senior Housing Fund, LLC, 2013 WL 1955012 (Del. Ch. May 13, 2013), followed TranSched in holding that the indemnity provision in a management agreement was not a valid fee-shifting provision between the parties because it did not contain language indicating an intent to cover first-party claims.

But Vice Chancellor Fioravanti said the parties here were unable to locate any case applying the first-party/third party distinction to an indemnification or advancement provision in a certificate of incorporation, corporate bylaws, limited partnership agreement, or limited liability company agreement.

Defendant ARP argued that there was no significant difference between those agreements and a commercial contract, but the court said, “Unlike typical commercial contracts, indemnification and advancement provisions in LLC agreements are derived from clear statutory authority and apply much more broadly.”

The LLC Act statute, 6 Del. C. § 18-108, prescribes that an LLC contract “may indemnify any person to the fullest extent possible by contract. The only restrictions are those expressly set forth in the contract,” the opinion says. Therefore, “the clarity of the provision regarding power to indemnify, located in Section 18-108, underscores an effort to avoid any uncertainty or negative implication that might exist if the statute were silent on this important point.”

Not like TranSched

Even though “alternative entity agreements are a type of contract” the broad language of the LLC Agreement’s indemnification provision, and the strong public policy in favor of indemnification and advancement,” caused the vice chancellor to conclude that the first-party/third-party claim distinction applied in the TranSched line of cases is inapplicable here.

Even if there is a fee-shifting provision in the parties’ LLC agreement, it expressly applies only to members so it does not eviscerate the indemnification and advancement rights found elsewhere in the pact, the court ruled.

Defendant argued that ARP’s management agreement is the only possible source of indemnification because the claims in the Superior Court Action arise from IRP providing services to the company, but the vice chancellor held that, “because the company has asserted non-contract claims in the Superior Court Action, the court cannot determine at this stage whether the company’s claims asserted against the defendants in that action (i.e., Plaintiffs here) are exclusively governed by the management agreement.”

In granting summary judgment for plaintiffs and denying judgment to defendants, the court ruled that because the plaintiffs are entitled to advancement, they are also entitled to reasonable attorney fees and expenses to pursue advancement, commonly referred to as “fees-on-fees.”