Sean Brennecke, a partner in the Delaware office of Lewis Brisbois Bisgaard & Smith, prepared this post.
In a limited post-trial opinion, Vice Chancellor Glasscock relied on the doctrine of promissory estoppel to hold that a person had an ownership in a Delaware LLC despite not being identified as an owner in an LLC’s formation documents nor admitted in accordance with the company’s LLC agreement.
Rostowsky v. Hirsch, 2024 WL 4491902 (Del. Ch. Oct. 15, 2024), involved a dispute regarding the ownership of Aither Health LLC, which the individual defendants, Laura Hirsch and Lisa True, formed in July 2019. According to Rostowsky, his ownership interest did not appear in the company’s formation documents because he was subject to a non-compete agreement with his previous employer, however, Hirsh and True promised him that he still would have a 15% ownership interest in the company. Id. at *9-10.
Background
For two years following Aither’s formation, Rostowsky provided behind the scenes services to Aither, and Hirsch and True treated Rostowsky as an owner. Id. at *4-5. When Rostowsky resigned from the Company, Hirsch and True claimed that he was not an owner and that his 15% interest was inchoate, and would only vest after Rostowsky worked for the company for 5 years. Id. at *6. Rostowsky filed a multi-count complaint seeking, among other things, a declaration that he was an owner of the company either by its terms or pursuant to the doctrine of equitable estoppel. Id. Considering it a threshold issue, the Vice Chancellor held an evidentiary hearing on the sole issue of whether Rostowsky had an ownership interest in the Company.
The Court held that although Rostowsky was not technically a member of Aither because he was not listed in the formation documents, and he was never admitted in accordance with the operating agreement (id. at *9), based on the parties’ conduct the Court found that they agreed Rostowsky had a 15% ownership interest in the company and, pursuant to the doctrine of promissory estoppel the defendants could not deny Rostowsky’s interest.
Promissory Estoppel
Promissory estoppel requires proof that “(i) a promise was made, (ii) it was the reasonable expectation of the promisor to induce action or forbearance on the part of the promisee, (iii) the promisee reasonably relied on the promise and took action to his detriment, and (iv) such promise is binding because injustice can be avoided only be enforcement of the promise.” Id. at *9.
Court’s Reasoning
The Vice Chancellor relied on numerous emails between True, Hirsch and Rostowsky which suggested, and in one case expressly stated, that Rostowsky held a 15% ownership interest, the lack of communications disabusing Rostowsky of his belief, and Rostowsky’s inclusion in the definition of “Founder” in the company’s business plans and projections, as evidence of the existence of a promise and the reasonableness of Rostowsky’s reliance on that promise. The defendants raised several arguments regarding the communications and definition of “Founders” which the Court rejected as not persuasive and contrary to reasonable interpretation. Id. at *10-11.
Defendants also argued that Rostowsky’s reliance was not reasonable because he disseminated certain marketing materials, minutes and other documents which stated there were only two owners. Id. at *11. Consistent with the Court’s stated approach of reviewing the record “as a whole,” the Court rejected this argument and accepted Rostowsky’s explanation that those materials were initially circulated when he was subject to a non-compete restriction and he continued to circulate them to avoid confusion in the marketplace. Id. at *14.
Turning to the defendants’ intention to induce reliance, the Court focused on the significant roles Rostowsky played in the company. Specifically, Rostowsky (i) worked 80-90 hours per week for eighteen months without compensation, (ii) was responsible for securing the company’s first client, and (iii) participated in high-level strategy, employment, and financial decisions. Id. at *11-14.
The Vice Chancellor also found that the defendants relied on Rostowsky to use his influence to obtain a critical collateral-free loan for the company from his father (id. at *12) and the company would not have gotten the loan but for Rostowsky’s father’s understanding that Rostowsky was an owner. Id. at *12. Pivoting the defendants argued that any agreement between the parties was oral and conditional on Rostowsky being employed for five years, however, the Court rejected that argument, holding that only an “unreasonable person” would expect a non-equity holder to perform the services Rostowsky did, without compensation, when they could be terminated before any interest vested. Id. at *11.
Finally, the Court held that given the defendants conduct and the benefits Rostowsky’s efforts provided the company injustice could only be avoided by enforcing defendants’ promise.
While this decision resolved the issue of Rostowsky’s ownership, there are other issues that remain to be addressed, including how “equity should act to vindicate this interest remains for further consideration.” Id.at *14.