A recent Delaware Court of Chancery decision clarified Delaware law in connection with determining that an alleged violation of a non-disparagement clause could be the basis to trigger the repurchase of LLC interests post-closing, in connection with the sale of a company—notwithstanding the general rule that the absolute litigation privilege generally bars claims of defamation based on pleadings filed with the court. Seva Holdings Inc. v. Octo Platform Equity Holdings, LLC, C.A. No. 2022-0437-PRW (Del. Ch. August 29, 2024).

Brief Factual Overview

The court examined the issues in the factual context of an LLC agreement that gave the seller of a company, as part of the deal, LLC interests in the holding company of the buyer. The seller’s founder also signed a related employment agreement that included confidentiality, non-compete, non-solicit, non-interference and non-disparagement clauses. (Superior Court Judge Paul Wallace was siting by designation of the Chief Justice pursuant to an order assigning selected Superior Court judges to hear Chancery decisions that arise under 8 Del. C. § 111.) 

The founder of the selling company, Sonny Kakar, remained involved in the business after the sale but the relationship with the buyer did not go smoothly. Not long after the closing he was purportedly terminated for cause. Both Kakar and the purchaser believed that they were disparaged in connection with Kakar’s departure post-closing. Several lawsuits and counterclaims were filed by the parties, most of which were consolidated into the Chancery matter.

Shortly after the lawsuits were filed, the purchaser purported to exercise an option to repurchase the LLC interests of Kakar based on a triggering provision which included claims of a violation of non-disparagement obligations. The employment agreement, which includes the non-disparagement clause that was a triggering event in the LLC agreement, defined “disparaging statements” but includes an exception for truthful information. The notice of repurchase cites to “publicly filed complaints” against the purchaser of a defamatory nature as the basis for the trigger.

There were other issues in the case about whether the procedural prerequisites in the LLC agreement for the repurchase were satisfied, such as whether a promissory note sufficed instead of cash, but the court determined there were too many factual issues to make a ruling on summary judgment on those other issues.

Noteworthy Highlights

I am providing selected highlights of the opinion that provide useful insights into how Delaware law treats alleged violations of a non-disparagement clause as a trigger to the right to repurchase LLC membership interests—and whether statements made in connection with court filings in a lawsuit can serve as a defense to the non-disparagement claims based on the absolute litigation privilege.

  • The court rejected the argument that the repurchase was void based on the unsuccessful position that statements made in a complaint filed with the court could not be the basis of a violation of the non-disparagement clause due to the absolute litigation privilege.
  • In order to understand the court’s ruling, we must understand what the absolute litigation privilege (“ALP”) is. The court explained that the ALP “protects from actions for defamation statements of judges, parties, witnesses and attorneys offered in the course of judicial proceedings so long as the party claiming the privilege shows that the statements issued as part of a judicial proceeding and were relevant to a matter at issue in the case.” Slip op. at 12.
  • The court provides citations to cases that explain the public policy behind the ALP. The court referred to two other decisions that it distinguished and a third decision dealing with this issue that formed the foundation for its reasoning. The court distinguished the following two cases: Ritchie CT Opps, LLC v. Huizenga Managers Funds, LLC, a 2019 Chancery decision, as well as Sheehan v. AssuredPartners, a 2020 Chancery decision. 
  • The court also discussed the 2022 Superior Court decision in Feenix Payment Systems LLC v. Blum, and found the facts and reasoning in that case to be applicable. The Feenix decision also distinguished the Ritchie and Sheehan decisions.
  • The competing public policy interests in the three cited cases, and the instant matter, are: (1) the freedom of a person to pursue one’s claims in court; and (2) upholding the freedom of contract. The court described the Feenix case as falling on the “latter end of the spectrum” and Sheehan and Ritchie cases falling on the other.
  • The court rejected what it referred to as the attempt by the seller to expand the scope of the ALP to nullify the repurchase of a member’s interest in a Delaware LLC in part because the court explained that: “[the seller] identifies no Delaware caselaw permitting this.”  Slip op. at 16.
  • The court reasoned that the balancing of the two policy interests at play, based on the circumstances of this case, require freedom of contract to prevail—regardless of the collateral effect that the repurchase of Kakar’s LLC interests will have on Kakar’s decision to litigate claims against the buyer, and defending claims that the non-disparagement clause was violated.  Slip op. at 16.
  • The court emphasized that Delaware law upholds the primacy of contract, especially in the context of agreements governing the internal affairs of an LLC. Id.
  • The court also found support for its reasoning in the Delaware Supreme Court decision of Cantor Fitzgerald, L.P. v. Ainslie, 312 A.3d 674 (Del. 2024). Although that case involved a limited partnership, the reasoning in cases involving the LP Act and the LLC Act are nearly interchangeable. The court focused on the reasoning of the high court in that case which resolved the divergent policy interests of respecting parties’ private agreements and the public interests against restraints of trade—in favor of the former.
  • The Ainslie case involved a forfeiture-for-competition in the non-compete context. The Delaware Supreme Court found that that provision did not prohibit the limited partners from engaging in competitive behavior, and held that the policy interests of disfavoring restraints on trade “significantly weakened.” Id. at 691. Therefore, the high court enforced the contract provisions in that case.
  • The court in this case found that Delaware precedent, including the Ainslie case, supported a similar limitation on the scope of the absolute litigation privilege.
  • The court underscored the important fact that the ALP was not being used as a defense to the non-disparagement claims under the employment agreement—but rather was being used as a means of opposing the right to repurchase under the LLC agreement. Slip op. at 18.
  • The court highlighted the determining factor of the contractual provisions involved controlling the governance of the internal affairs of the LLC, which the court was “strongly inclined” to respect unless, unlike the facts of this case: “dishonoring the contract was required to vindicate a public policy interest even stronger than freedom of contract.” Slip op. at 18 (footnote omitted).
  • The court’s summary of its key holding on this issue deserves to be quoted verbatim:
  • “In sum, Delaware law provides for maximum freedom in allowing parties to order their governance arrangements.  It doesn’t offend the public policy of this state for a Delaware limited liability company’s operating agreement to condition a member’s ownership in the business on whether a member makes disparaging remarks about the business.” Slip op. at 19.

The court also addressed issues relating to whether procedural prerequisites under the LLC agreement for the repurchase were complied with, but the court determined that there were too many factual issues to decide those matters before trial, such as whether a promissory note was sufficient in lieu of cash.