Most indemnification cases involve successfully defending claims, but a recent Delaware Court of Chancery decision granted indemnification for the successful pursuit of a books and records action, in Gentile v. GPB Capital Holdings, LLC, C.A. No. 2024-0165-PAF (Del. Ch., Nov. 27, 2024).

This decision is noteworthy because it explains the broader scope of indemnification that is possible based on the terms of an operating agreement for an alternative entity. This should be compared with the more typical fact pattern for an indemnification claim, such as that involved in a recent Chancery decision addressing another post-closing dispute, highlighted on these pages on the same day as this blog post was published.

Brief Overview of Background

This case involved the sole member, Gentile, and during the relevant period the sole manager, of an LLC who successfully pursued a books and records action in connection with obtaining information necessary to prepare and file the tax returns of the LLC.

Although the facts in this case are somewhat sui generis, the court’s interpretation of the indemnification provision in the LLC agreement is still noteworthy for the broader application of its reasoning. In this case, the sole member and manager was displaced by a receiver appointed by a federal court in connection with civil and criminal proceedings against the sole member brought by the U.S. Securities and Exchange Commission as well as the U.S. attorney for the Eastern District of New York.

Gentile successfully pursued a books and records complaint under Section 18-305 of the Delaware LLC Act to obtain records necessary to prepare his tax returns and those of the LLC, in his role as the “Tax Matters Partner” of the LLC. [The implementing order in the post-trial decision for the books and records case was signed on November 29, 2023, but the parties did not enter into a stipulated confidentiality order to implement the post-trial decision until May of 2024.] In February of 2024, Gentile filed the instant indemnification action.

Highlights

The indemnification provision in the LLC agreement had five key parts. It provided that, to the “fullest extent permitted by applicable law”: (i) a covered person is entitled to indemnification from; (ii) any loss; (iii) by reason of any act by such covered persons; (iv) in good faith on behalf of the company; and (v) in a manner reasonably believed to be within the scope of authority conferred on such covered person.

  • The court applied that provision to the facts of the case and found that the plaintiff was a covered person. The court then analyzed whether the loss was “ by reason of” an act by the covered person.
  • The court applied by analogy the cases in the corporate context holding that an action meets the “by reason of” standard “if there is a nexus or causal connection” between any of the underlying proceedings in one’s official capacity, regardless of one’s motivation for engaging in that conduct. Slip op. at 9. The court found that Gentile established a causal connection between the books and records action and the obligation to prepare the tax returns of the LLC.
  • As the Tax Matters Partner of the LLC, and the sole member, the court determined that Gentile was the only individual permitted to certify and file the tax returns of the LLC, citing a federal statute that provides the general rule that an entity is disregarded for tax purposes as an entity separate from its single owner. Slip op. at 11. The LLC agreement also provided that the Tax Matters Partner has the power to file tax returns. Id.
  • Importantly, the court emphasized that as long as Gentile acted in a “manner reasonably believed to be within the scope of authority conferred on him by the LLC agreement” it was reasonable for him to believe he had the authority to file the tax returns. Slip op. at 12.
  • A key issue was whether or not Gentile was required to show that he acted in good faith. The court reasoned that an indemnification agreement in an alternative entity that grants mandatory indemnification “to the fullest extent permitted by law,” as the agreement here does, means that mandatory indemnification is required when the party “has been successful . . . on the merits or otherwise, without having to show good faith.” Slip op. at 13.
  • Notably, notwithstanding the provision that included a good faith requirement in the agreement, the court determined that because the claimant was successful on the merits in the books and records action, he is not required to make a showing of good faith to be entitled to indemnification. Id.
  • In determining “success on the merits,” the court explained that it “looks strictly at the outcome of the underlying action” and that despite imposing some restrictions as part of the books and records decision, the court ruled in favor of Gentile. Id.
  • The court’s analysis of what is meant by “success on the merits” is useful when someone does not win 100% of the relief requested.
  • It’s also noteworthy for purposes of the conclusion that good faith need not be shown when there is success on the merits–in light of the provision involved in this case. Slip op. at 13-14.
  • Lastly, the court applied the truism that when one is found entitled to indemnification, it follows that “fees on fees” for pursuing indemnification are also granted. Slip op. at 17-18.