Chancery Applies Corporate Advancement Case Law to LLC Context

A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context.  In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.

The highlights of this decision are based on the assumption that the reader is familiar with the principles of advancement for officers and directors pursuant to DGCL Section 145, and the leading Delaware court decisions on the topic–even if they are not aware that I have written several book chapters on advancement and published multiple articles on advancement and handled many advancement cases.   

Brief Background:

This case involved a request for advancement by a member (not a manager) of an LLC seeking advancement for the cost of defending a suit in New Jersey brought by the managing member of the LLC relating to the call right of the member under the LLC Agreement.  (The plaintiff-member of the LLC involved in this case was itself an LLC.)

Issues Addressed:

The two issues that the court addressed in this case are:  (1) Does corporate case law apply to the provisions for advancement in an LLC Agreement which contains language that mirrors the corporate statute, DCGL Section 145; and (2)  Whether the underlying action for which advancement is sought, arises “by reason of the fact” that the party seeking advancement acted in its “official” capacity?  The court answered both questions in the affirmative.

Highlights of this Decision–Assuming Familiarity with Delaware Corporate Advancement Case Law:

·     The court referenced the well-known truism that advancement cases are particularly appropriate for resolution on a paper record, such as via dispositive motions.  See footnote 22 and accompanying text.

·     The court cited other Delaware cases that have applied corporate case law to analyze the contractual terms of advancement in an LLC Agreement.  See, e.g., Hyatt v. Al Jazeera American Holdings, II, LLC, 2016 WL 1301743 (Del. Ch. Mar. 31, 2016) (highlighted on these pages previously)See also other cases cited at footnotes 36, 37 and 38.

·     The court explained that LLCs and corporations differ most pertinently in regard to indemnification: “mandating it in the case of corporate directors and officers who successfully defend themselves, but leaving the indemnification of managers or officers of LLCs to private contract.”  See footnote 46 and accompanying text.

·     The court recited the guidelines that the Delaware courts used to determine if someone was acting “by reason of the fact”–for purposes of being entitled to either indemnification or advancement, and restated the familiar standard that the operative phrase will be satisfied “if there is a nexus or a causal connection between any of the underlying proceedings and one’s official corporate capacity . . . without regard to one’s motivation for engaging in that conduct.”  See footnotes 50 and 51 and accompanying text.

·     By contrast, the court cited examples of cases where the “by reason of the fact” requirement was not satisfied, which is best exemplified by disputes involving personal contractual obligations that do not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation.  See footnote 53 and accompanying text.  Because the party seeking advancement in this case was a member and not an officer or a director, the context was unusual, but the LLC Agreement clearly defined the responsibilities of the member.

·     The court reasoned that the causal relationship between the official capacity of the member and the underlying lawsuit was met for several reasons: (i) The underlying case in New Jersey was about the failure of the member to carry out its responsibilities specified in the LLC Agreement: (ii) The underlying lawsuit in New Jersey is based on whether the member discharged its official duties such that the call rights could be exercised; and (iii) The underlying dispute fully implicates whether or not the member seeking advancement carried out its official duties.  Thus, the court held that the “by reason of the fact” requirement and the “official capacity requirement” were met.

·     The court distinguished five cases in which advancement or indemnification claims were denied because the underlying litigation involved a personal interest that lacked a sufficient connection to official duties.  Those five cases that were distinguished are cited in footnote 56–most of which have been highlighted on these pages:  Bernstein v. TractManager, Inc., 953 A.2d 1003 (Del. Ch. 2007); Cochran v. Stifel Fin. Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000) (rev’d in part on other grounds, 809 A.2d 555 (Del. 2002)); Lieberman v. Electrolytic Ozone, Inc., 2015 WL 5035460 (Del. Ch. Aug. 31, 2015); Dore v. Sweports, Ltd., 2017 WL 45469 (Del. Ch. Jan. 31, 2015); Charney v. Am. Apparel Inc., 2015 WL 5313769 (Del. Ch. Sept. 11, 2015).

·     Regarding whether the “undertaking” provided by the party seeking advancement satisfied the statutory undertaking requirement, the court ruled that the sufficiency of an undertaking is determined by looking at the substance–and not the form alone–of the document containing the undertaking. 

Postscript: It was recently reported by The Chancery Daily that the Vice Chancellor who wrote this opinion published it the day after giving birth to a baby boy. Wow. That’s a dedicated jurist. Congratulations to Her Honor and her family on their new addition.

Chancery Interprets Contractual Indemnification Clause

A recent Delaware Court of Chancery decision interpreted an indemnification clause and rejected the applicability of equitable defenses to a strictly legal claim.  I highlighted the recent decision in NASDI Holdings v. North American Leasing, Inc., C.A. No. 2017-0399-KSJM (Del. Ch. Apr. 8, 2019), in an article published in the current issue of the Delaware Business Court Insider, that I co-authored with Jessica Reno of Eckert Seamans.  The article is copied below:

Chancery Interprets Contractual Indemnification Clause

By: Francis G.X. Pileggi and Jessica L. Reno

The Delaware Court of Chancery recently analyzed an indemnification clause and performed other contract interpretation in NASDI Holdings, LLC, et al. v. North American Leasing, Inc., et al., C.A. No. 2017-0399-KSJM (Del. Ch. Apr. 8, 2019). The Court also rejected the applicability of equitable defenses to strictly legal claims.

The dispute involved the sale of a demolition and site-redevelopment company pursuant to an Ownership Interest Purchase Agreement (“Purchase Agreement” or “Agreement”).  Under the Agreement, the seller Plaintiffs were obligated to maintain payment bonds secured by a letter of credit for ongoing construction projects.  The purchaser eventually withdrew from one of the projects, and the surety drew more than $20 million on the letter of credit that the seller maintained.  The seller demanded indemnification for their losses pursuant to the Agreement, and the purchaser refused.

It appears the purchaser did not dispute whether the seller incurred losses, as defined in the Purchase Agreement.  Rather, the purchaser argued the seller’s claims for indemnification were barred by the “Notice of Claim” requirements in the Purchase Agreement.

In an attempt to avoid indemnifying the seller for their losses under the Agreement, the purchaser argued that the language in the Notice of Claim provision included a qualification, thereby limiting the amount of time during which seller could make a claim for indemnification.  Specifically, the purchaser argued that the first clause of the Notice of Claim provision that required notice of indemnification within a reasonable time, and which applied to letters of credit, was limited by the second clause.  The second clause of the provision provided a deadline of the termination date or the survival period for claims pertaining to representations or warranties.  The purchaser attempted to argue that the second clause did not deal only with representations or warranties, but to all claims, including those for letters of credit.

In determining that the purchaser was required to indemnify the seller, the Court interpreted the Notice of Claim provision to include an exception to the reasonable time standard, rather than a qualification.  Applying longstanding principles of contract interpretation, the Court held that the clear language of the first clause applied to all claims of indemnification, including letters of credit, while the second clause, an exception to the general provision, applied only to representations or warranties.  This opinion features many useful footnotes with citations to sources that support the court’s reasoning, including the court’s analysis of sentence structure and syntax.

The Court noted that the purchaser’s reading of the Notice of Claim provision would have undermined the entire purpose in the Purchase Agreement of indemnification.  See generally, Glidepath, Ltd. v. Beumer Corp., C.A. No. 12220-VCL (Del. Ch. Nov. 26, 2018) (Transcript at 4-6) (In a bench ruling, the Court rejected an argument that the indemnification clause could be used as a broad liability cap, such as for a claim that the payment provision of an agreement of sale was breached—as opposed to a breach of the representations and warranties clause).

The Court also agreed with the seller’s additional arguments in their motion for summary judgment related to the purchaser’s third and fourth affirmative defenses of unclean hands and failure to mitigate damages, respectively.  The Court granted the motion with respect to unclean hands, holding that equitable defenses, including that of unclean hands, do not apply to purely legal claims.

Had the present dispute been brought in a court of law, the purchaser would not be entitled to that equitable defense, and it should not have an advantage simply because the claims were pending in a court of equity.  With respect to purchaser’s affirmative defense related to mitigation of damages, the Court held that the purchaser’s argument relied on events that occurred before the breach relevant to the litigation, whereas the duty to mitigate arises only after a breach has occurred.

Delaware Supreme Court Clarifies Appraisal Law

Mitchell Mengden, a second-year law student at the Georgetown University Law Center, who will be clerking at the Delaware Court of Chancery for the 2020 term, prepared the following synopsis:

The Delaware Supreme Court, in a per curiam decision, recently determined that “deal price less synergies” was the appropriate determination of fair value in the appraisal action before it.  In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (Del. Apr. 16, 2019), the Court reversed the Court of Chancery’s holding that “unaffected market price” was the fair value on the date of the merger. This case is the third in a recent trilogy of precedent-setting Delaware appraisal cases, preceded by DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd, 177 A.3d 1 (Del. 2017).  This case has been the subject of extensive commentary by scholars and practitioners in the short time since its publication.  Thus, we will only highlight key aspects of this important decision.

Background:

Hewlett-Packard Company approached Aruba Networks about a potential combination. Both were publicly traded companies. Aruba shopped the deal, approaching five other strategic bidders in the process. After several months of negotiations with HP, the Aruba board accepted HP’s offer of $24.67 per share.

Once the transaction was consummated, Verition Partners Master Ltd. and Verition Multi-Strategy Master Fund Ltd. sought appraisal in the Court of Chancery under Section 262 of the DGCL. Verition argued that Aruba’s fair value was $32.57, but Aruba maintained that its fair value was “deal price less synergies”—$19.10 per share.

After the Supreme Court issued its opinion in Dell, the Vice Chancellor requested supplemental briefing on “the market attributes of Aruba’s stock.” In its brief, Aruba abandoned its “deal price less synergies” approach and instead argued that its preannouncement stock price was its fair value at the time of the merger. The Court of Chancery subsequently considered three approaches to fair value in its post-trial opinion: the “unaffected market price” of Aruba’s stock before the merger announcement (i.e., thirty-day unaffected market price); deal price less synergies; and two expert witnesses’ valuations, which were based primarily on DCF models.

The Court of Chancery ultimately gave no weight to the parties’ DCF models. In calculating deal price less synergies, the Vice Chancellor found that the appropriate value was $18.20. But the Court of Chancery nonetheless neglected to adopt this value because the “deal-price-less-synergies figure continues to incorporate an element of value resulting from the merger” in the form of “reduced agency costs that result from unitary (or controlling) ownership.” The Court of Chancery therefore concluded that the unaffected market price of Aruba’s stock before the merger announcement—$17.13—was the fair value at the time of the merger.

The Court of Chancery denied Verition’s Motion for Reargument. This appeal followed.

Analysis of the Court:

The Court emphasized that in an appraisal action under DGCL Section 262, the Court of Chancery must evaluate the value of the company as a “going concern” less any synergy or other value the buyer expects from changes it plans to make to the company.

The Supreme Court, in particular, took issue with the Court of Chancery’s determination that deal price less synergies must be further reduced to account for “reduced agency costs.” The Vice Chancellor’s theory appeared to be that consolidation of ownership aligns the interest of a company’s managers and its public stockholders in such a way that reduces agency costs. As the Court alludes to, this theory is more applicable to a private equity deal that results in a concentrated group of owners, whereas this transaction was merely “swap[ping] out one set of public stockholders for another: HP’s.” Slip op. at 10. Even if reduced agency costs were applicable to this transaction, it is likely that they were priced into HP’s estimate of its expected synergies. See id. at 9–11.

The Court also discussed Delaware’s long history of applying corporate finance principals in appraisal proceedings in ways that depend on market efficiency. See id. at 15–18. In addition the court noted that:

Dell and DFC did not imply that the market price of a stock was necessarily the best estimate of the stock’s so-called fundamental value at any particular time. Rather, they did recognize that when a market was informationally efficient in the sense that ‘the market’s digestion and assessment of all publicly available information concerning [the Company] [is] quickly impounded into the Company’s stock price,’ the market price is likely to be more informative of fundamental value. See footnotes 51–52 and accompanying text.

Yet, this does not necessarily imply that an informationally efficient market price reflects the company’s fair value on appraisal. The Court explained that, as in DFC and Dell, deal price is a better indicator of fundamental value than preannouncement market price because it is further informed by the due-diligence of arm’s length buyers that prices in confidential non-public information. See footnote 56 and accompanying text. For example, HP was privy to Aruba’s strong quarterly results. When the results were made public (after the period the Court of Chancery used to measure “unaffected market price”), Aruba’s stock price jumped 9.7%.

In addition to arguing that the Court of Chancery double counted agency costs, the Supreme Court raised due process and fairness concerns. See id. at 21–23. The Court reasoned:

As Verition argued, the Vice Chancellor’s desire not to award deal price minus synergies could be seen—in light of his letter to the parties and the overall tone of his opinion and reargument decision—as a results-oriented move to generate an odd result compelled by his personal frustration at being reversed in Dell. . . Because the Vice Chancellor introduced this issue late in the proceedings, the extent to which the market price approximated fair value was never subjected to the crucible of pretrial discovery, expert depositions, cross-expert rebuttal, expert testimony at trial, and cross examination at trial. Id. at 21–22.

The Court concluded that Aruba’s deal price less synergies value was supported by the record and, therefore, a final judgment in the amount of $19.10 plus any interest to which the petitioners are entitled should be entered.

Key Takeaways:

  1. Agency costs are priced into synergy and therefore, in appraisal actions, the Court of Chancery need not further reduce deal price less synergies to account for such costs. Although the Court distinguished between strategic and private equity buyers, noting that agency costs are more likely to be relevant in a private equity transaction, it suggested that such costs would be priced into synergies in either situation.
  2. Despite not explicitly creating a presumption in favor of deal price, the Court continues to hint that such a presumption exists. The Court held:

    DFC and Dell recognized that when a public company with a deep trading market is sold at a substantial premium to the preannouncement price, after a process in which interested buyers all had a fair and viable opportunity to bid, the deal price is a strong indicator of fair value, as a matter of economic reality and theory. The apparent novelty the trial judge perceived is surprising, given the long history of giving important weight to market-tested deal prices in the Court of Chancery and this Court, a history that long predated the trial judge’s contrary determination in Dell. See footnote 41 and accompanying text.

    The Court’s discussion of the value of access to non-public information further supports this contention. See id. at 17–22.

  3. It is unclear whether the Court would accept “unaffected market price” in a future appraisal action. This case suggests that such a valuation is inapplicable in an arms-length-transaction, such as HP’s acquisition of Aruba. But the Court did not indicate whether unaffected market price may be used with respect to a transaction that was not arms length, particularly in a case in which such an argument was raised in a timely manner.

Chancery Considers Exception to Production of Attorney-Client Privileged Communications

A recent short ruling from the Delaware Court of Chancery examined one of the exceptions to the general rule that attorney-client privileged information is not subject to production. In Tigani v. Tigani, C.A. No. 2017-0786-KSJM (Del. Ch. April 10, 2019), the court addressed a motion to compel documents from various law firms that were withheld as privileged or which were produced in redacted form.  The issue in the case is whether the fiduciary exception or the crime-fraud exception to the general rule applicable to attorney-client privileged information would require the production of documents.

Short Overview:

The parties relied on the decision in Riggs National Bank v. Zimmer, 355 A.2d 709, 710 (Del. Ch. 1976), in which the court granted a motion to compel filed by beneficiaries of a trust regarding privileged information prepared for their benefit.  By contrast, a Special Discovery Master in the instant matter recommended that the motion to compel in this case be denied based on a prior decision of the Court of Chancery in separate litigation involving the parties, issued in 2010, which held that the ultimate client of the law firm whose documents were sought to be produced was akin to an adverse party—based on the facts in 2010–and on that basis the motion in the 2010 decision was denied. The Special Discovery Master applied that same conclusion to the instant case. That 2010 decision referred to above, as well as related Chancery decisions involving the internecine Tigani litigation, have been highlighted on these pages here.

Court’s Reasoning:

Taking a different view than the Special Discovery Master, the court in the instant ruling determined that the situation between the parties currently was substantially different than it was in 2010–and now the party seeking the production was not clearly adverse as it was in prior litigation in 2010. The court observed that there was no pending litigation between the parties from August 2011 through September 2017, and that the documents requested were created during this “period of peace.” See footnote 58.

The court reasoned further that whether or not disclosure of the documents in question should be allowed “must be determined in light of the purpose for which it was prepared.” (citing Riggs).  In order to determine in this case the purpose for which the documents requested were prepared, the court determined that inspection in camera was appropriate.

The court ordered the production in camera within in five days so that the court could make its own determination. See generally, by comparison, the Garner exception to attorney/client privilege, that allows in some instances the production of otherwise privileged attorney-client communication, for example, in the context of a  stockholder who seeks copies of the legal advice given to fiduciaries who are the subject of claims that they breached fiduciary duties. Cases applying Garner have been highlighted on these pages.

The bottom line is that there are exceptions to the general rule that attorney-client privileged communications cannot be compelled, and this decision provides an example of one of those potentially applicable exceptions.

 

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review

The Delaware Supreme Court recently clarified the “ab initio” requirement announced in the Kahn v. M&F Worldwide Corp. case as part of the set of standards that would allow for the BJR standard to apply to a challenged merger. See Olenik v. Lodzinski, No. 392, 2018 (Del. Supr., rev. April 11, 2019).  The High Court determined that the requirement was not satisfied based on the facts of the instant case because the “economic bargaining took place prior to the date” when the protections announced in the Kahn v. M&F Worldwide Corp. case needed to be in place.

Much commentary has already been written about this case, so it will not be covered thoroughly on these pages, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.

Third Circuit Strikes Delaware Constitutional Requirement of Political Balance in Judicial Appointments to State Courts

A recent decision by the U.S. Court of Appeals for the Third Circuit in Adams v. Governor of Delaware, upheld a prior ruling which found unconstitutional a provision in the Delaware State Constitution that mandates a balance between Republicans and Democrats on the state bench in connection with the appointment of judges by the Governor.  The most recent ruling by the federal appeals court upheld a prior panel decision from February 2019, which found unconstitutional the provisions in the state constitution requiring that appointments to the bench by the Governor cannot result in a majority of more than one Republican or one Democrat on the court.  Nor was the provision saved as a narrow exception to the First Amendment applicable to “policy-makers”, which would allow party affiliation to be taken into account when considering applicants for certain governmental positions.

It was not clear as of this writing whether the Governor would attempt to appeal the Third Circuit decision to the United States Supreme Court. The successful plaintiff in this case was registered as an Independent and argued that the constitutional provision unjustly prevent third-party applicants from serving as judges on Delaware’s constitutional courts.

The bottom-line is that it remains to be seen how this will impact the quality of the Delaware judiciary which is generally regarded in most circles as among the better state judiciaries in the country.

The Intersection of Corporate Law and the Political Activity of CEOs

Professor Stephen Bainbridge, the nationally-recognized, prolific corporate law expert, known to readers of this blog (among other reasons) for citations in Delaware court opinions to his scholarship, provides scholarly commentary and citation to multiple sources regarding the corporate law implications for the political activity of CEOs–including some who think of themselves as social justice warriors. The good professor also cites to a 2016 post on these pages by yours truly on the topic generally.

Recent Decision Clarifies Safe Harbors in DGCL § 144 for Board Action

The following article appeared in the current issue of the Delaware Business Court Insider:

Recent Decision Clarifies Safe Harbors in DGCL § 144 for Board Action

By: Francis G.X. Pileggi* and Chauna A. Abner**

The recent Superior Court decision in Toedtman v. Turnpoint Medical Devices, Inc., C.A. No. N17C-08-210 RRC (Del. Super. Ct., Jan 23, 2019), adds clarity to the case law interpreting Section 144 of the Delaware General Corporation Law (“DGCL”), 8 Del C. § 144. This case is important for the clear guidance it provides for anyone who seeks to understand Section 144(a)’s safe harbors when one or more board members are conflicted in connection with a board vote.

In Toedtman, the court discussed Section 144(a)’s three safe harbors and considered the application of two of the safe harbors to a former director’s employment agreement as a CEO.  Ultimately, the court decided that even though a self-interested director entered into the agreement, the agreement was nonetheless valid because it fell within at least one of Section 144(a)’s safe harbors.

The plaintiff in Toedtman filed suit alleging, among other things, that the defendant company breached his employment agreement by terminating his employment without cause. Slip op. at 2. The company argued that the employment agreement was invalid because it was a self-interested transaction as a result of the plaintiff entering into the agreement on behalf of himself and the company. Id. at 12.

The court explained that the purpose of § 144 is “to provide ‘safe harbors’ for interested director transactions, to prevent the transaction from being void or voidable solely because an interested director was involved.” Id. at 14. Relying on a 1976 Delaware Supreme Court decision, the court explained that § 144(a)’s safe harbors prevent an agreement from being invalid solely because an interested director was involved. Id. (quoting Fliegler v. Lawrence, 361 A.2d 218, 222 (Del. 1976)).

The court summarized Section 144(a)’s three safe harbors: “First, the transaction may be approved by a majority of disinterested directors. Second, the transaction may be approved by a majority of disinterested shareholders. Third, the transaction may be shown to be entirely fair to the corporation at the time it was authorized by interested directors or shareholders.” Id.

Under the first two safe harbors, the court assesses the validity of the transaction using a two-step analysis. First, the court determines whether the transaction falls within the safe harbor, and if it does, the court will then review the transaction under the business judgment rule. Id. “The business judgment rule is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interest of the company.” Id. at 14-15.

If the transaction falls outside of the first two safe harbors, the third safe harbor applies the entire fairness standard. Id. at 15. The court explained that “the concept of fairness has two basic aspects: fair dealing and price,” id., and the burden is on the interested director to prove entire fairness. Id. The court further explained that “fair dealing” concerns the conduct of corporate fiduciaries in effectuating the transaction while “fair price” concerns the economic and financial considerations of the contract. Id. at 18. The court analyzes the fair price of the contract as of the time the transaction was approved. Id. at 21.

The court held that the employment agreement fell within the § 144(a)(1) safe harbor because it was approved by a majority of disinterested directors. Id. at 17. In reaching this decision, the court first identified who the interested versus disinterested directors were, and concluded that the plaintiff was the only interested director. Id. Next, the court noted that disinterested directors  delegated to a corporate officer the board’s power to negotiate and enter into employment agreements. Id. at 16. The court explained that the delegation was a proper exercise of business judgment. Id. at 17. The court declined to replace its judgment with that of disinterested directors and held that the employment agreement was valid because the board properly delegated its authority to negotiate and enter into employment agreements. Id.

The court also held that the employment agreement satisfied the intrinsic fairness test in the § 144(a)(3) safe harbor. Id. at 18. As for fair dealing, the court concluded that the employment agreement followed “good corporate practice.” Id. The court also concluded that the negotiation and structure of the agreement also appeared to be fair, and there was no evidence that the plaintiff acted in bad faith. Id. at 19. Regarding fair price, the court concluded that the board authorized plaintiff’s salary and the court refused to question the business judgment of disinterested directors in approving the plaintiff’s salary. Id. at 21. The court held the agreement was valid because it was a product of both fair dealing and fair price, and was therefore intrinsically fair. Id. at 18.

The key takeaway is that DGCL Section 144 prevents an otherwise valid agreement from being invalidated solely because an interested director or shareholder was involved, as long as the challenged matter fits within one of the three safe harbors in Section 144(a).

______________________________________________________________________________

*Francis G.X. Pileggi is a litigation partner and Vice-Chair of the Commercial Litigation Practice Group at Eckert Seamans Cherin & Mellott, LLC. His e-mail address is fpileggi@eckertseamans.com. He comments on key corporate and commercial decisions, and legal ethics rulings, at www.delawarelitigation.com.

**Chauna A. Abner is an associate in the Commercial Litigation Practice Group of Eckert Seamans Cherin & Mellott LLC.

 

 

Court Dismisses Suit Against Firearms Dealer Based on Immunity Statute

The Delaware Superior Court recently dismissed a claim against Cabela’s in connection with the sale at their Delaware location of a firearm based on a Delaware statute that bars civil liability for damages sought against the seller of firearms when the seller complied with all applicable statutes and regulations. In Summers v. Cabela’s Wholesale, Inc., C.A. No. N18C-07-234 VLM, (Del. Super., March 29, 2019), the court applied the provisions of 11 Del. C. § 1448A(d) which it found to provide a complete defense based on the court’s conclusion that Cabela’s complied with all applicable laws and regulations in connection with the sale of a firearm.

Brief Background:

The unfortunate facts of the case involved the sale of a firearm to a woman who was not per se prohibited, in general, from purchasing firearms, but it was later determined (unbeknownst to Cabela’s) that she unlawfully gave the firearm that she purchased to her boyfriend who was prohibited by law from purchasing it because he was a convicted felon. Such a series of subsequent transfers is known as a straw purchase.  The boyfriend then exchanged the firearm with a third-party for another firearm, and the ultimate transferee of the firearm from Cabela’s then committed a crime with it.  The plaintiffs in this case include the family of the unfortunate person who was killed by the ultimate transferee—thrice removed—who received the firearm bought at Cabela’s. (The writer represented Cabela’s in this case.)

Legal Analysis:

Section 1448A(d) affords a complete defense to any cause of action for damages that relates to the lawful transfer of a firearm. Many other states also provide similar statutory defenses. See footnote 18 in the decision which lists some of those states.

The plaintiffs argue that Cabela’s failed to comply with Section 1448A(a) because the plaintiffs allege that Cabela’s should have known that the purchaser provided a false address. To the contrary, the court found that there was no reasonable way for the seller to know that the address was false, in part because the buyer provided valid identification.  Thus, the court rejected the plaintiff’s argument that Cabela’s violated 28 C.F.R. § 25.11(b)(1) by knowingly providing incorrect information to the FBI in connection with obtaining the necessary background check that the purchaser successfully completed, through what is known as the NICS system, administered by the FBI.  Nor was the court convinced that the purchaser demonstrated any “red flag” behavior in connection with the purchase, which was captured on the store’s videotape system.

The court also observed that the federal law known as the Protection of Lawful Commerce in Arms Act (“PLCAA”), though not an issue in this case, was offered to give context as to how other courts have considered similar claims. The PLCAA provides that any “qualified civil liability action may not be brought in any Federal or State Court,” which includes an action brought against the manufacturer or seller of a qualified product, “for damages, punitive damages, injunctive or declaratory relief . . . resulting from the criminal or unlawful misuse of a qualified product by the person or a third-party.” See footnote 33 for cases cited. (Unlike the Delaware state statute, the PLCAA does not apply to negligent entrustment claims.)

No Reformation for Investors Who Signed Agreement Without Reading

A recent Delaware Court of Chancery opinion is notable to the extent that it provides another example of how difficult it is to prevail on a claim for reformation of a contract.  See In re 11 West Partners, LLC, C.A. No. 2017-0568-SG (Cons.) (Del. Ch. Mar. 20, 2019).

Brief Background:

This case involves a three-member LLC formed by real estate investors.  Contrary to instructions given to their attorney to follow a sample agreement that the parties had previously used for a prior investment, the attorney drafted the LLC agreement to require an unanimous vote to oust members (instead of a mere majority.)  Two of the three members seeking reformation of the agreement did not read the agreement before signing.  Their failure to read the contract, in part, hurt their reformation claims–although they were also not able to satisfy the prerequisite for a reformation claim that there was a “specific meeting of the minds regarding a term that was not accurately reflected in the final written agreement.”  (citing Glidepath Ltd. v. Beumer Corp., 2018 WL 2670724, at *10 (Del. Ch. June 4, 2018)) (The Glidepath case was one that I was involved in, and the June 2018 decision in that matter is another example of the challenges in a reformation case).

Key Takeaways:

  • A reformation claim can be based on either mutual mistake or unilateral mistake.  See footnote 48 and accompanying text for the elements of a reformation claim:  By clear and convincing evidence, a party seeking reformation must prove:

“(1) that the party was mistaken about the contents of the final, written agreement; (2) that either its counterparty was similarly mistaken or that the counterparty knew of the mistake but remained silent so as to take advantage of the error; and (3) that there was a specific meeting of the minds regarding a term that was not accurately reflected in the final written agreement.” 

  • Although not expressly stated in the prerequisites, it is necessary to establish that the counterparty knew of the mistake prior to the agreement at issue being signed, if the argument is that the counterparty knew of the mistake–and remained silent.

As an aside, it’s notable that one of the potential ethical issues that was woven into the factual background of this case was that the attorney who drafted the LLC agreements at issue was not explicit about, at least in writing, whether he was representing the LLC, as an entity, that was involved–as compared to one or more of the individual three members of the LLC.  There was some inconsistent testimony in the record about whether one or more of the three LLC members thought that the attorney drafting the LLC agreement was representing one or more of them individually–which of course would be problematic in and of itself.

Another side note of interest, not for its legal significance but for its relevance to current events, is the fact that at least one of the three LLC members wanted to expel another member from the LLC because of apparent anger over who the other member voted for in the 2016 Presidential Election (i.e., the victorious candidate.)  See footnotes 37 to 40 and accompanying text.  In light of the result of this case, that was not a legal basis to remove the member.    


 

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