Delaware Provides Predictability of Outcome

Steven D. Goldberg, Esq.
Wilmington, DE
sgoldberg@stevendgoldberg.com
http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law.
On April 6, 2010, the Delaware Supreme Court entered its decision in the consolidated cases of Nemec v. Shrader and Wittkemper v. Sharder. Nemech and Wittkemper were former stockholders of the consulting firm Booz Allen. The defendants were the directors of the company. When the pettioners retired they had a 3 year window to put un-executed options to the company at “book value”, after that 3 year period the company had the right to redeem the options at “book value” at any time.

The petitioners having failed to exercise their put right, the Company exercised its right to redeem the options. The issue sub judice arose over the timing of the redemption. It appears that at the time of the redemption the Board was aware that the company was about to enter into a transaction to sell a portion of the company for $2.54 billion. The result of the timing was to shift $60 million from the proceed that the petitioners would have received from the transaction to the active stockholders including the Directors.

The petitioners alleged that the company violated the implied contratual covenant of good faith and fair dealing.  According to the petitioners the company’s decision to redeem the shares when it did was made in bad faith.

The Court of Chancery had dismissed the petitioners claims and they appealed. The Supreme Court stated that “[w]e cannot reform a contract because enforcement of the contract as written would raise ‘moral questions’.” In its decision it stated that it would only imply contract terms if a party had acted “arbitrarily or unreasonably” and had denied the other party the benefit of their bargain. “Parties have a right to enter into good and bad contracts, the law enforces both.”

At a visceral level one could argue that the shift of $60 million must logically violate the implied contractual covenant of good faith and fair dealing. After getting past the visceral level you can see that the court was absolutely correct. This is not the case of widows or orphans being taken advantage. The two petitioners were stockholders of one of the nation’s most sophisticated consulting firms. In hind sight they made a bad bargain by allowing the company unfettered timing of the redemption, but that was their deal, like it or not. The Court stated that it will enforce “bad contracts”.

As lawyers we look to the courts for predictability of outcome. We want the courts to enforce the contracts that people negotiate and sign. We do not want courts re-writing parties agreements because the court concluded that they had entered into a bad deal or another parens patrea reason. This predictability of outcome is one of several reasons that practitioners choose Delaware business entities as that choice makes Delaware courts available to their clients. See my recent post http://www.delawarellcblog.com/wp-admin/post.php?action=edit&post=482 Institute for Legal Reform Ranks Delaware’s Legal Climate Number 1 In the Nation.

2010 Amendments to the Delaware LLC Act Are Signed Into Law

Steven D. Goldberg, Esq.
Wilmington, DE
sgoldberg@delcorp.com 
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law.
 

The 2010 amendments to the Delaware LLC Act have been signed into law by the Governor. The amendments have an effective date of August 2, 2010. HB 372. This legislation was the product of a years’ work by the Delaware Bar Association’s Alternative Entity Sub Committee of the Corporation Council. I am a member of the Committee, though the comments expressed herein are mine and not necessarily those of the Committee. The Committee’s work is reviewed by the Corporation Council and the Bar Association’s Executive Committee, it is then recommended to the General Assembly.

I previously made a post on a Chancery Court decision on the application of the statute of frauds to an oral Delaware LLC Agreement. Section 1 of the Bill confirms that notwithstanding the decision of the Court of Chancery, the statute of frauds does not apply to an oral LLC Agreement.

Sections 2, 26 & 27 of the Bill were included at the request of the Secretary of State and permit service of process upon the Secretary of State by means of “electronic transmission” in accordance with rules to be adopted by the Secretary.

Section 3 is a confirmation that unless otherwise provided in a LLC Agreement, the LLC has the power and authority to grant, hold or exercise a power of attorney, including an irrevocable power of attorney.  Section 5 provides that powers of attorney granted regarding to the organization, internal affairs or termination of a LLC granted by a member, a person seeking to become a member or an assignee of a member shall be irrevocable if it states that it it is irrevocable and is coupled with an interest sufficient in law to support an irrevocable power. The section states that a power is coupled with an interest if it  is granted regarding to the organization, internal affairs or termination of a LLC granted by a member, a person seeking to become a member or an assignee of a member of the LLC and the power is granted to the company, a manager, member or certain other designated persons.  Much of the discussion regarding powers of attorney resulted from unfortunate legislation adopted in New York which brought into question may powers routinely granted in commercial transactions.

In tender offers, the offeror will generally structure the tender using a Delaware LLC as the offeror and following the close of the transaction will enter into a merger with the target. Delaware does not have a short form merger provision which would permit a parent LLC to merge with a 90% owned subsidiary corporation. (In a short form merger the parent owning not less than 90% of the subsidiary may cause a merger between the parent and subsidiary without the approval of the remaining 10% stockholders or members.) On the corporate side a new Section 267 of the DGCL provides the mechanism for short form mergers. Sections 6, 7, 8, 9, 10, 11, 13, 14, 15, 16, 17, 20 and 30 facilitate the short form merger.

Sections 12, 18 & 19 permit service upon the Secretary of State under 18-209(c)(8), 213(b)(7) and 216(e)(7) by electronic transmission in accordance with rules adopted by the Secretary.

Section 21 amends 18-305(f) which grants the Court of Chancery the power to enforce a demand for information under Section 19-305. As currently drafted the Section only permitted the Court to order  the disclosure of a current list of members and their last know address.  The Amendment grants authority to the Court to order disclosure of all of the information set out in subsection (a). The amendment allows the parties to shorten or extend the 5 day response period in the Company Agreement, but not beyond 30 days.

Section 22 is a technical amendment to 18-305(g) to clarify that the right to obtain information may be restricted in an amendment to a Company agreement and that the restriction are not intended to limit any other restrictions provided under the Chapter.

Sections 23 and 24 confirm the circumstances under which an assignee may be admitted as a member. Section 18-702 is amended by providing that in addition to an assignee being admitted “except a provided in a limited liability company agreement” that an assignee may be admitted upon the affirmative vote or written consent of all of the members, deleting the phrase “other than the member assigning the limited liability company interest; or (2) Compliance with any procedure provided for in the limited liability company agreement”. Section 18-704(a) is also amended to make it clear that the assignee is admitted as a member “as provided in the limited liability company agreement” and “Unless otherwise provided in the limited liability company agreement, upon the affirmative vote or written consent of all of the members of the limited liability company” and deleting, inter alia, the phrase “other than the member assigning…”.

Section 25 requires that in order for a foreign LLC to register in Delaware under 18-902 it must supply a good standing certificate and if the certificate is in a foreign language, a translation.

Section 29 adds to 18-1101 a new subsection (i) that reads “A limited liability company agreement that provides for the application of Delaware Law shall be governed by and construed under the laws of the State of Delaware in accordance with its terms.” This may seem obvious that if the parties form a LLC under the Delaware Act that it should be construed under the laws of Delaware and in most cases it is, in particular regarding its organization, dissolution and internal affairs. It is not entirely clear what constitutes “internal affairs” however the term is often found in decisions and law review articles dealing with LLC’s as well as corporations. One area where the issue arises is when the agreement address issues that are not within those categories such as employment, redemption and other similar business deal issues. Delaware Courts have upheld that a LLC agreement may be governed by the laws of other states and in one case permitted it to be governed by the DGCL.

The issues addressed in these amandments should not create substantial debate. The only issue which may cause some discussion is Section1 and its relationship to the Olson case.

Please feel free to contact me if you have any questions.

Institute for Legal Reform Ranks Delaware’s Legal Climate Number 1 in the Country for Fairness

Steven D. Goldberg, Esq.
Wilmington, DE
sgoldberg@stevendgoldberg.com
http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law.

The Institute for Legal Reform, an arm of the U.S Chamber of Commerce, has again ranked the legal environment in Delaware number 1 in the nation.  The survey has been conducted by the Institute since 2002 and in each year Delaware has been ranked number 1. In the ten categories Delaware ranked number 1 in 8 of the categories.

The report is based upon interview with 1,482 general counsel and senior management of companies with revenue of at least $100 million. The report states that two-thirds, or 67%, of the 1,482 corporate lawyers contacted for the survey say a state’s lawsuit environment is likely to impact important business decisions at their company, such as where to locate or expand their business—up 10% from just three years ago.

Other states ranking near the top were #2 North Dakota, #3 Nebraska, #4 Indiana, and #5 Iowa. States often selected by large companies for business formations Colorado was #8, New York was #23, Nevada was #28, New Jersey was #32, Florida was #42, California was #46 and bringing up the bottom was West Virginia at #50.

The decision as to where to form a LLC or a corporation will be based upon many factors. In a recent article titled Jurisdictional Competition for Limited Liability Companies written by Professors Bruce H. Kobayashi and Larry E. Ribstein In the Illinois Law and Economic Research Papers Series, research Paper No. LE09-017, they state on page 1, “…we find evidence that large LLC’s, like large corporations, tend to form in Delaware, and that they do so for many of the same reasons–that is, for the quality of Delaware’s legal system.”

Companies do not intend to be sued when they are considering a state in which to form, however as pointed out in the Illinois article, companies consider the legal environment in a state as an important factor in case they are sued. It is interesting to note that when a company is formed by a large law firm, the firms will generally select Delaware while small firms select their own jurisdiction.

If a company is to be formed in a state other than the local jurisdiction, it makes no sense to form in a state which ranks 23 or below for fairness in its legal climate.

I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or have a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.

Delaware LLC Agreement is Subject to the Statute of Frauds

Steven D. Goldberg, Esq. Wilmington, DE
sgoldberg@stevendgoldberg.com http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

[The 2010 Amendments to the Delaware LLC Act removes oral LLC agreements from the Statute of Frauds]
Section 18-101(7) of the Delaware LLC Act provides that the LLC agreement means “any agreement (whether referred to as a limited liability company agreement, operating agreement or otherwise) written, oral or implied, of the member or members as to the affairs of a limited liability company and the conduct of its business.” If an agreement may be “oral or implied” one could reasonably assume that such an agreement has been taken out of the Statute of Frauds.

Delaware’s Statute of Frauds, 6 Del. C. §2714(a) bars the enforcement of an agreement “that is not to be performed within the space of one year from the making thereof,” unless it is (1) written and (2) signed by the party against whom the agreement is to be enforced.  Only if the parties cannot possibly perform the agreement within one year does the statute of frauds apply and require a writing, signed by the charged party.

The Delaware Supreme decided the case of Olson v. Viking Global on December 15, 2009. Olson v Viking Global The case in part involved the enforcement of an unsigned LLC Company Agreement which was drafted for a hedge fund. Olson sought to enforce an earn out provision of the unsigned agreement on the basis that it represented an “oral” Company Agreement as permitted under the Act. The Company and the remaining members defended on the basis that an agreement had not been formed and even if there was an agreement a provided in the unsigned agreement, the provision in question was unenforceable under the Delaware Statute of Frauds as the earn out could not possibly be performed within one year of the date the agreement was allegedly made.

The Court preferenced it Statute of Frauds analysis at page 20 that:

“We have often declined to decide an issue that does not affect a case’s disposition, but this issue is one that could considerably impact the drafting and enforcement of LLC agreements. For this reason and because this issue involves a question of law and statutory construction, we proceed to review it de novo.”

“The Delaware LLC Act seeks “to give maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.” To that end, the Delaware LLC Act allows “written, oral or implied” LLC agreements. The Delaware LLC Act also provides that “[a] limited liability company is not required to execute its limited liability company agreement” and that “[a] limited liability company is bound by its limited liability company agreement whether or not the limited liability company executes the limited liability company agreement.” Thus, the Delaware LLC Act generally allows parties to enforce unwritten, unsigned LLC agreements.”

“In this case, we must determine whether parties to a Delaware LLC agreement may enforce an unsigned or unwritten LLC agreement that would require more than a year to complete. We must adhere to the rules of statutory construction and, whenever possible, presume consistency between recent legislation and pre-existing law. “Laws are assumed to be cumulative, not destructive of other laws.” We “assume[] that when the General Assembly enacts a later statute in an area covered by a prior statute, it has in mind the prior statute,” and thus, “statutes on the same subject must be construed together so that effect is given to every provision unless there is an irreconcilable conflict between the statutes . . . .” ”

“… We have long recognized that “unless it is expressly so provided, one act does not ordinarily repeal another, if both, in whole or in part, can be construed together.” We are “reluctant to find repeal by implication even when the later statute is not entirely harmonious with the earlier one,” and “[i]f two statutes conflict somewhat, [we] must, if possible, read them so as to give effect to both, unless the text or legislative history of the later statute shows that [the legislature] intended to repeal the earlier one and simply failed to do so expressly.””

“The legislative history of the LLC Act does not demonstrate the General Assembly’s intent to place LLC agreements outside of the statute of frauds. When the General Assembly originally enacted the LLC Act in 1992, it only permitted written LLC greements. In 1995, the General Assembly amended the LLC Act to permit “any agreement, written or oral.” In 2007, the General Assembly further expanded the LLC Act to allow “implied” LLC agreements. In its current form, Section 18-101(7) of the LLC Act provides that LLC agreements may be “written, oral or implied.” ”

“Because we can construe the statute of frauds and the LLC Act together and the General Assembly did not clearly intend the LLC Act to render the statute of frauds inapplicable, there is no implied repeal of the statute of frauds. As the Vice Chancellor stated, the statue of frauds should “protect defendants against unfounded or fraudulent claims that would require performance over an extended period of time.” The legislature enacted the statute of frauds over a century ago, and its purpose remains valid. If the General Assembly intends to limit the application of the statute of frauds by removing LLC agreements from its scope, the General Assembly must say so explicitly. “[We] will not do by judicial implication what the General Assembly itself has declined to do by express legislation.” Accordingly, we hold that the Delaware LLC Act does not preclude application of the statute of frauds to LLC agreements. Therefore, the statute of frauds applies to LLC agreements, and the Vice Chancellor correctly so held.”

[Citations and foot notes omitted]

The Court’s holding in this case may come as a suprise to many practitioners who reasonably  interpreted 18-101(7) as an implied repeal of the Statute of Frauds. While most agreements do not contain complicated earn out provision that last over a series of years, some agreements do contain provisions that implicate the Statute of Frauds. The use of oral or implied Company Agreements has always been a difficult practice issue. While permitted by the Act, the use of oral agreements has always been frowned upon by practitioners. This decision gives one more reason why the practioner will press his or her clients to reduce their agreements to writing and to follow through with clients to assure that agreements sent out for signature are actually signed.

I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or has a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.

Motions to Transfer Litigation from Delaware, Forum Non Conveniens

Steven D. Goldberg, Esq. Wilmington, DE
sgoldberg@stevendgoldberg.com
http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

The Delaware General Corporation Law and the Delaware Limited Liability Company Act have become the de-facto national corporation and LLC laws. As such the State of Delaware is and has been the favored jurisdiction to form business entities. As the favored jurisdiction it also the jurisdiction where many companies choose to litigate as a company’s jurisdiction of formation or incorporation is one of the jurisdictions where personal service may be had against a company without having to rely on a “long arm” statute.

The Judges of the United States District Court for the District of Delaware, the Delaware Superior Court and the Delaware Court of Chancery have an enviable national reputation for fairness and thoughtful jurisprudence which has caused an arm of the US Chamber of Commerce to rank Delaware number 1 in the nation as the best jurisdiction to litigate business disputes. Sometimes, however, one of the parties to such litigation seeks to transfer the litigation to another jurisdiction, often referred to as a montion Forum Non Conveniens. They seek transfer for a variety of reasons, the convenience of the parties, a witness may not be available in Delaware, a similar case is pending in the other jurisdiction or the interests of justice. Recently the USDC handed down a decision in the case of Ethicon Endo-Surgery, Inc., v. Hologic, Inc., and Suros Surgical Systems, Inc., CA 09-580-JJF. Ethicon v Hologic Both corporations are incorporated in Delaware.

In October, 2007, Hologic had commenced a patent infringement action against Ethicon in the USDC ED Ohio. That matter was scheduled for trial on November 16, 2009. On April 30, 2009, Ethicon commenced the Delaware Action which is scheduled for trial in September 2010.  The Delaware Action involved additional patents and an affiliated party. Hologic filed a motion to transfer the action to Ohio where it contends that related patents are being litigated, that the parties to the actions are the same and that the “public interest factors” weigh in favor of transfer.

The Court began its analysis under 28 U.S.C. § 1404(a) “for the convenience of the parties and witnesses, in the interest of justice, a district court may transfer a civil action to any other district of division where it might have been brought.” The leading case in the 3rd Circuit is Jumara v. State Farm Ins. Co., 55 F.3d 873 (3d Cir. 1995) where in the court set out 6 tests to consider the private interests of the litigants: “(1) the plaintiff’s choice of forum; (2) the defendant’s preferred forum; (3) where the claim arose; (4) the convenience of the parties; (5) the convenience of the witnesses, but only to the extent that the witnesses may be unavailable for trial in one of the fora; and (6) the location of books and records, again, only to the extent that they may not be available in one of the fora.” Id. at 879. In addition the Jumara court laid out 6 additional test when considering the “public” interests of the litigants; “(1) the enforcability  of the judgment; (2) practical considerations that could make the trial easier, quicker or less expensive; (3) court congestion; (4) local interest in the controversy; (5) public policies of the fora; and (6) the trial judge’s familiarity with the applicable state law.” Id. at 879-80.

“Generally, a plaintiff’s choice of forum is entitled ‘paramount consideration,’ and should not lightly be disturbed. Shutte v. Armco Steel Corp., 431 F.2d 22, 25 (3d Cir. 1970). The weight assigned to this factor is somewhat attenuated here because the movant’s burden is lessened when a plaintiff does not bring suit in its ‘home turf.’ Waste Distillation Tech., Inc., v. Pan Am. Res., Inc.,775 F.Supp. 759, 764 (D. Del. 1991). Even given this lesser burden, the Court concludes this Motion should be denied because the private and public interest do not strongly enough favor transfer, and because Ethicon’s choice of forum does relate to its legitimate, rational concerns. See Dish Network Corp. v. TiVo, Inc., C.A. No. 08-327-JJF, 2009 WL 1529836, at 2 (noting that a defendant’s incorporation in Delaware provides a plaintiff with a rational, legitimate reason to bring suit in Delaware.)”

The Court acknowledged that “[t]he public interest factor only slightly weighs in favor of transfer,” stating that the Ohio Court is more familiar with 2 of the patents than this Court. However the Court stated that “due to the Delaware Action, this Court must also become familiar with the technology”. “Because this action involves a different accused product and two patents not asserted in the Ohio Action, the Ohio Court would likely have to conduct further discovery and perform additional claim construction at the same time this Court would be conducting discovery with similar technologies in the Delaware Action.”

“Although the Court recognizes that the deference given to Ethicon’s choice of forum is somewhat lessened by virtue of the fact that Ethicon has not filed in its home turf, the public and private interest factors do not weigh strongly enough in favor of transfer”.

This is a well reasoned opinion by a well respected jurist. Transfer decisions never are black and white, they often turn on the facts and circumstances of the case and often how interested the judge himself or herself is in the subject matter of the case.

I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or has a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.

Must a Delaware LLC have a manager?

Steven D. Goldberg, Esq. Wilmington, DE
sgoldberg@stevendgoldberg.com
http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

Recently I have noticed a number of searches reaching this site asking whether a Delaware LLC must have a manager. In previous posts I have written about the duties of the manager of a Delaware LLC and that  the LLC must have a company agreement, however I have not explored the question of whether it must have a manager.

The short and direct answer is NO.

Section 18-101(10) defines the manager as : (10) “Manager” means a person who is named as a manager of a limited liability company in, or designated as a manager of a limited liability company pursuant to, a limited liability company agreement or similar instrument under which the limited liability company is formed. The definition is somewhat of a tautology, it does not explain either the necessity or function of the manager.

Somewhat more instructive is 18-402:
§ 18-402. Management of limited liability company.
Unless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members in proportion to the then current percentage or other interest of members in the profits of the limited liability company owned by all of the members, the decision of members owning more than 50 percent of the said percentage or other interest in the profits controlling; provided however, that if a limited liability company agreement provides for the management, in whole or in part, of a limited liability company by a manager, the management of the limited liability company, to the extent so provided, shall be vested in the manager who shall be chosen in the manner provided in the limited liability company agreement. The manager shall also hold the offices and have the responsibilities accorded to the manager by or in the manner provided in a limited liability company agreement. Subject to § 18-602 of this title, a manager shall cease to be a manager as provided in a limited liability company agreement. A limited liability company may have more than 1 manager. Unless otherwise provided in a limited liability company agreement, each member and manager has the authority to bind the limited liability company.

The default rule is that unless you otherwise provide in your LLC company agreement, the management of the company is vested in its members, like the case of a general partnership, and the members vote upon management decisions “in proportion to the then current percentage or other interest of members in the profits of the limited liability company owned by all of the members.” Those members holding more than 50% of the interest have the absolute right to control the LLC, subject the the “implied contractual covenant of good faith and fair dealing”, the terms of the LLC agreement and any fiduciary duties applicable to the members. Delaware does not provide any so called “minority rights.”

A company managed it members is referred to as a member managed company. In a member managed company it is often the case that the company agreement will provide that less than all of the members will have the day to day authority to manage and bind the company. Some agreements will provide for a board of directors or board of managers who will set policy.  Some agreements will designate one of the members to serve as the “managing member”. The term managing member is not found in the Act. It is often the case that the managing member is not designated as a manager as such person does not, under the agreement, have the full power and authority of a manager under 18-402 and 404.

If the agrement provides for the managment of the company by one or more managers, the agreement may give the manager or managers absolute authority to manage the company without any participation of the members, similar to a limited partnership. In other situations the authority of the manager may limitd such that he may not take specified actions without the prior consent of a stated percentage of the interests approving such actions. These specified actions are often referred to a “major decisions.” If the agreement call for more than one manager, it must also provide for rules to govern their actions and to provide a remedy if the managers deadlock.

A manager (as well as a member) need not be a natural person, but may be another LLC, corporation or other business entity. A single member LLC may also have a manager. The manager of any LLC, single member or multi-member need not be a member. Under Section 18-403, a manager may make a capital contribution to the company and share in the profits and distributions as a member. A person who serves both as a manager and member is subject to the rights and restrictions of both.

I continue to emphasize that proper drafting is essential. The company agreement is a contract governed by Delaware law and it is necessary for a Delaware attorney to review the agreement for compliance with Delaware law before execution. I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or has a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.

Fiduciary duties of a director of a Delaware corporation, the current standard.

Steven D. Goldberg, Esq. Wilmington, DE
sgoldberg@stevendgoldberg.com
http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

Generally I write about limited liability companies, however some corporate decision will directly impact upon LLC law. The case I discuss today is one of those decisions.

In 2007 the Delaware Supreme court decided the case of North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, et al., (Del. Supr. 2007) 930 A2d 92. Prior to the release of this decision the Chancery cases and commentators had hinted at the concept that a director had a distinct and cognizable fiduciary duty to the corporation’s creditors while operating in the “zone of insolvency” and when “insolvent”. Ghewalla holds that creditors of an Delaware corporation have no direct right to sue the directors for a breach of fiduciary duties while operating in the “zone of insolvency”. Additionally the creditors of an “insolvent” Delaware corporation do not have a direct right to sue the Directors for breach of fiduciary duties to the creditor, though in insolvency the creditors do have the right to sue derivatively. Many practitioers initially thought that this decision did not change the landscape as the creditors could accomplish derivately what they could not accomplish directly. These derivative claims, in my view, are based upon the same fiduciary duties which the directors have irrespectively of insolvency and the Court did not create or recognize a new or enhanced set of duties owed to creditors in their capacity as creditors. New or enhanced duties would create an impossible delemma for directors of a troubled corporation.

The director defendants served as directors of Clearwire Holdings, Inc., at the behest of their employer Goldman Sachs & Co. The complaint alleges that the defendants, though less than a majority of the directors, were able to dominate the company as Goldman was its only source of funding. The plaintiff is a creditor of Clearwire and asserted a direct (not derivative) claim for breach of fiduciary duties against the defendants while Clearwire was either insolvent or operated in the zone of insolvency.

The Court spointed out that this is a matter of first impression.  Justice Holland, writing for the Court at 94 stated:
In this opinion, we hold that the creditors of a Delaware corporation that is either insolvent or in the zone of insolvency have no right, as a matter of law, to assert direct claims for breach of fiduciary duty against the corporation’s directors.

Note that the Court used the word “direct” and not “derivative”. As this case involved a direct action, the court could have stopped there, however the Court then went on to examine whether a creditor had any derivative rights. The Court concluded, based upon earlier Chancery decisions, that creditors have the right to bring derivative claims  when the company is insolvent.

At 101 Justice Holland stated:

Delaware Corporate law provides for a separation of control from ownership. The directors of Delaware corporations have “the legal responsibility to manage the business of a corporation for the benefit of its shareholders owners. Accordingly, fiduciary duties are imposed upon the directors to regulate their conduct when performing that function. Although the fiduciary duties of directors are unremitting:
the exact cause of conduct that must be charted to properly discharge that responsibility will change in the specific context of the action the director is taking with regard to either the corporation or its shareholders. This Court has endeavored to provide the directors with clear signal beacons and brightly lined channel markers as they navigate with due care, good faith, a loyalty on behalf of a Delaware corporation and its shareholders. This Court has also endeavored to mark the safe harbors clearly. [citations omitted]

Justice Holland then attempted to provide that guidance:

In this case, the need for providing directors with definitive guidance compels us to hold that no direct claim for breach of fiduciary duties may be asserted by the creditors of a solvent corporation that is operating in the zone of insolvency. When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change: directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners.  … (101)

In discussing the insolvent corporation the Court stated at 101, “[w]hen a corporation is insolvent, however, its creditors take the place of the shareholders as the residual beneficiaries of any increase in value.” The Court held “[c]onsequently, the creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties. The corporation’s insolvency ‘makes the creditors the principle constituency injured by any fiduciary breaches that diminish the firm’s value’. Therefore, equitable considerations give creditors standing to pursue derivative claims against the directors of an insolvent corporation. Individual creditors of an insolvent corporation have the same incentive to pursue valid derivative claims on its behalf that shareholders have when the corporation is solvent.”

Having acknowledged that there exists a derivative right for creditors of an insolvent corporation, the Court emphasizedthat there is no direct right of creditors to sue directors under a fiduciary duty theory. What the Court did not address was whether the fiduciary duties owed by the directors when the corporation is insolvent are manifestly different from the fiduciary duties that are owed to the corporation and its shareholder owners when the corporation is solvent or in the zone of insolvency. Some commentators opined that there are distinct duties owed to creditors in their position as creditors drawing from bankruptcy law.  However the Court did hold at 103 “Directors of insolvent corporations must retain the freedom to engage in vigorous, good faith negotiations with individual creditors for the benefit of the corporation.”

If as the Court said, creditors are the principal constituency injured by any fiduciary breaches that diminish the firm’s value, then the creditors when asserting derivative claims have no greater rights than would a shareholder in the same position within a solvent corporation. “…[C]laims of this kind belong to the corporation itself because even if the improper acts occur when the corporation is insolvent, they operate to injure the firm in the first instance by reducing its value, injuring creditors only indirectly by diminishing the value of the firm and therefore the assets from which the creditors may satisfy their claims.” (102)

It is my conclusion that the fiduciary duties which the directors of a Delaware corporation owe to to the corporation and its stockholder owners do not change in insolvency, however the creditors have the right in insolvency to step into the rights of the shareholder owners and sue derivatively on behalf of the corporation. To hold otherwise would place the directors in a dilemma when the corporation is in the zone of insolvency, always having to determine whether the corporation was insolvent and thereby triggering a different set of fiduciary duties. Such a holding would be contrary to the “brightly lined chanel markers” referred to by Justice Holland.

In a thoughtful article published in the August 2009 issue of The Business Lawyer, Volume 64, Number 4 at pae 1087, Sabin Willett wrote “Gheewalla and the Director’s Dilema. In this article he thoroughly reviews the case law and commentators opinions on Ghewalla. I recomend this article to you.

Whether your company is a Delaware corporation or a LLC where fiduciary duties have not either been eliminated or limited, careful drafting is required. I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or has a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.

Arbitration of an agreement subject to Delaware law

Steven D. Goldberg, Esq. Wilmington, DE
sgoldberg@stevendgoldberg.com
http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

This post will address arbitration under an agreement that is subject to Delaware law. The legal concepts are uniquely applicable to a Limited Liability Company Agreement, however the concepts are also applicable to all “Delaware Agreements” generally.

Arbitration, as a mechanism for dispute resolution, has become increasingly important. There are several business risk of arbitration. Paramount is that an unskilled arbitrator will be selected or appointed depending upon the mechanism provided in the agreement and that arbitrator will “split the baby”. Agreements to arbitrate disputes must be carefully written; they must clearly define what disputes are to be subject to arbitration and which, if any, are not; the agreement needs to address whether or not the determination of whether a dispute is subject to arbitration or not is itself subject to arbitration; how the arbitrator is to be selected or whether the parties will defer to a third party such as the American Arbitration Association, the National Arbitration Forum or the International Council for Commercial Arbitration to select the arbitrator; what rules will govern the arbitration itself including whether the local rules of evidence will apply; the authority of the arbitrator, will the judgment be limited to actual damages, will consequential damages be permitted and will exemplary or punitive damages be permitted; who will pay the costs assesed by the arbitration sponsoring organization as well as the arbitrator’s fee and associated costs of the arbitration itself; and finally will attorney fees and costs of the prevailing party be included in the award.

I personally do not like the traditional 3 arbitrator panel model. My experience with that model has been that the award tends to come in somewhere between the two competing demands rather than one party clearly prevailing. I prefer the model adopted by professional baseball where there is a single arbitrator selected by the parties where the arbitrator has only the power to pick one of the positions submitted by the parties plus award attorneys fees and costs to the prevailing party plus award the costs of the arbitration. The arbitrator may make corrections to computational errors of a party, however, aside from making such corrections the arbitrator is limited to picking a winning position and cannot modify the position of any party and therefore cannot split the baby.

If an arbitration agreement is to provide for the award of counsel fees to the prevailing party the notion of “prevailing” must be defined carefully and the concept of costs must be included with “reasonable counsel fees” as counsel fees does not by definition include the attorney’s costs. Costs of arbitration (arbitrator’s fee, AAA fees, room charges, etc.,) are not “costs” in the general sense and must be addressed specifically.

The decision to arbitrate disputes is a decision to forgo the right to a hearing before a court applying traditional court rules and rules of evidence and forego the right to judicial review of the substantive merits of the arbitrator’s decision. In Delaware the Court of Chancery may review an arbitration order under 5 limited circumstances set out in the statute (10 Del C. § 5714). The Court does not sit  as an appellate court reviewing the arbitrator’s legal findings and procedural actions.

Chancellor Chandler on August 18, 2009 decided the case of World-Win Marketing, Inc. v Granley Management Co. (CA 3905-CC) Decision: world-win v ganley In this case the arbitrator in an AAA arbitration decided that both parties were equally at fault and awarded plaintiff one half of the amount it demanded. The arbitration agreement stated that “the prevailing party shall be entitled to recover all reasonable costs incurred in connection therewith, including attorneys’ fees.” The arbitrator decided that the plaintiff was not entitled to attorneys’ fees as part of the award and the plaintiff sought an order vacating the portion of the award denying attornys’ fees contending that the arbitrator exceeded his authority in not including attorneys’ fees in the award.

The plaintiff contended that “prevailing party” under Delaware practice means the party which receives the award. The Court stated that under Delaware law the “prvailing party” is determined by reference to substantive issues, not damages. In the case under review the arbitrator found that both parties “where equally negligent in the performance of the Agreement, and in the breach of numerour provisions of said Agreement” and therfore denied an award of attorneys’ fees.

The Chancellor addressed several issues of general interest to my readers.

  • He noted that “If the Arbitrator decides an issue outside of those contained in the submission, or if his actions are in direct contradiction to the express terms of the agreement of the parties he has exceeded his authority.” [citation omitted]
  • Even if the arbitrator did not state the grounds for a grant or denial of relief, the grant or denial of relief will be deemed to be within the scope of the arbitrator’s authority “[i]f grounds for the award can be inferred from the facts of the case.” [citations omitted]
  • “…plaintiff is not entitled to vacate an arbitrator’s award merely because the arbitrator interpreted Delaware case law differently than a Delaware Court may have. Plaintiff’s challenge to the arbitrator’s allegedly incorrect interpretation of the term “prevailing party” invites this Court to review the substantive merit of the arbitrator’s decision. As I explained above, this Court does not sit as a Court of appeals to review arbitrator’s decision. “By agreeing to arbitrate, the parties voluntarily relinquish their right to a formal proceeding with strict adherence to court rules complete with precise finding of law and fact.” This Court cannot vacate an arbitrator’s award on the grounds that the arbitrator exceeded its authority merely because this Court disagrees with the arbitrator’s decision on the merits of the claim. This is true even where the issue is a contractual term that has an established meaning under Delaware case law.” [citations omitted]

This case is illustrative of the pitfalls of arbitration and the need to address the meaning of even well understood contractual terms in drafting the agreement to arbitrate disputes within the LLC agrement. As with any agreement to be interpreted under Delaware law, the input and review by a Delaware attorney is required. I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or has a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.

Delaware LLC derivative action; demand futility

StSteven D. Goldberg, Esq. Wilmington, DE
sgoldberg@stevendgoldberg.com
http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

TravelCenters of America, LLC is a publicly traded Delaware LLC, Alan R. Kahn is a “shareholder” in the LLC. Kahn filed a derivative action  against the LLC and its “directors” alleging that the directors breached their fiduciary duties to the LLC in connection with a transaction in which the dominant director had a direct and adverse financial interest to that of the LLC. The directors moved for summary judgment based upon exculpatory language in the LLC agreement and based upon a lack of a prior demand upon the directors as required under 18-1003. The decision by Chancellor Chandler of the Delaware Court of Chancery is on the motion for summary judgment, therefore at this stage of the proceedings the well plead factual allegations of the plaintiff are taken as true, the Court will make all reasonable inferences in favor of the plaintiff and only dismiss the complaint if the Court can determine with “reasonable certainty” that there is no set of facts that can be reasonably inferred from the well pleaded allegations in the complaint upon which the plaintiff could prevail. The Court will not on summary judgment choose between competing reasonable interpretations of ambiguous contract provisions. As I have pointed out in previous posts, the LLC agreement is a contract.

Copy of the decision in Kahn v. Portnory, et al., CA 3515-CC Kahn_v_Portnoy

The LLC agreement of TravelCenters is an example of the dangers of a poorly drafted agreement and the need for competent Delaware Counsel.

The LLC agreement provided that the “authority, powers, functions and duties (including fiduciary duties)’ of the board of directors will be identical to those of a board of directors of a business corporation organized under the Delaware General Corporation Law, unless otherwise specifically provided in the LLC agreement. The directors asserted that the LLC agreement (§ 7.5(a)) contained language which created a presumption in its favor when dealing with fiduciary duties and which created an enhanced presumption which the plaintiff must overcome. The Court found that there were two reasonable and conflicting interpretations of the paragraph in question and declined to choose which one was a more reasonable interpretation.

The Court noted that the LLC agreement explicitly imposed on the LLC corporate fiduciary duties which are the dual duties of due care and loyalty. The complaint implicates the duty of loyalty which requires that directors act in the best interest of the company and prohibits them from using their positions to further their own self-interest. The court found that the plaintiff properly plead a violation of the duty of loyalty and that the exception found in § 7.5(a) did not resolve the question as it is ambiguous.

Likewise the exculpatory provisions in the LLC agreement were found to be ambiguous and again as the exculpatory language relies on the exception found to be ambiguous, the Court declined to apply the exculpatory language.

The Court next focused on the question of demand futility. “In order to maintain a derivative suit on behalf of a LLC, a member must either (1) make a demand on the managers of the company to bring suit or (2) show that ‘an effort to cause those managers or members to bring the action is not likely to succeed'”. The complaint must allege with particularity the reasons why such demand would be futile. In evaluating futility the Court looked at corporate law. Under Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984) there are two tests which must be met. The complaint must allege particularised fact that establish a reasonable doubt that “(1) the directors are disinterested and independent [or] (2) that challenged transaction was otherwise the product of a valid exercise of business judgment.” The test is stated in the disjunctive.

The Court held:

“Turning to the first prong of the Aronson test, it is helpful to start by briefly reviewing what is meant by disinterested and independent.  A director is interested in a transaction when the director receives a personal benefit (or detriment) from a transaction that is not shared by the other shareholders of the corporation and the benefit is of subjective material significance to the director. A director can also be interested in a transaction where the director stands on both sides of the transaction. Thus, the first prong of  the Aronsontest requires inquiry into whether the director was interested in the underlying transaction. While a director has an interest, in some sense, in any decision that involves approving a derivative suit that names the director as a defendant, normally the threat of personal liability against a director is not enough, standing alone, to challenge the interestedness of a director. A director may be interested in the decision, however, if the challenged transaction is so egregious on its face that it gives rise to a ‘substantial likelihood’ of personal liability for the director.” [Citations omitted]

“Independence, on the other hand, does not necessarily involve an inquiry into whether the director will derive a benefit (or detriment) from a particular transaction or whether the director stood on both sides of the transaction. Rather inquiry into a director’s independence focuses on whether the director’s decision was impartial and based on the merits of the subject to be decided. In other words, independence inquiry focuses on whether the director’s loyalties where in any way divided such that the director will be unable to exercise business judgment in deciding whether the corporation should pursue a claim. A director, for example, is not independent if the director is ‘beholden’ to another such that the director’s decision would not be based on the merits of the subject before her. Thus, plaintiff can show lack of independence by creating ‘a reasonable doubt that a director is not so ‘beholden’ to an interested director … that his or her ‘decision would be sterilized.'” [Citations omitted]

The Court found that the plaintiff made sufficient well plead factual allegations of bad faith with regard to the dominant director to survive a motion for summary judgment.

Poorly drafted LLC agreements are an invitation to litigation. A LLC agreement is a Delaware contract which requires the skill and know how of an experienced Delaware attorney. I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or has a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.

Delaware Chancery Court orders inspection and copying of general ledger but denies counsel fees

Steven D. Goldberg, Esq. Wilmington, DE
sgoldberg@stevendgoldberg.com
http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

In a decision dated July 28, 2009, VC Parsons addressed a claim by the plaintiff, a member of two Delaware LLC’s, for the right to inspect and copy  each company’s general ledger. He also addressed whether she was entitled to a award of counsel fees. Mickman v. AIP, LLC

The company agreement of each company provided:

“Upon request, the Members and their designated representatives shall have access to all books and records of the Company at all reasonable times, provided that written notice is given to the Company at least (1) one day prior to requesting such access.”

The Delaware Act, §18-305, titled “Access to and confidentiality of information; records,” sets out rules for permitting a member or manager access to company records upon a “reasonable demand for any purpose reasonably related to the member’s interest as a member of the limited liability company”. The Court commences its analysis by noting that “the basic approach of the [LLC] Act is to provide members with broad discretion in drafting the agreement and to furnish default provisions when the members’ agreement is silent”. The Court determined that the language quoted form the LLC agreement was intended by the parties to substitute for the default provisions of §18-305.

In determining whether the right to “access to all books and records” includes the right to make copies of the general register, the Vice Chancellor noted that the phrase from the agreement “commonly denotes a grant of broad inspection rights”. In his analysis he looked to the DGCL (§220) and its case law in concluding that the language in the agreement includes the general ledger and the right to make copies. ([T]he right to access and inspect books and records typically includes the right to copies of those books and records… even though the agreement did not expressly provide a right to make copies.]

The defendant resisted the application in part because the plaintiff did not include the general ledger in her demand.  The Court held:

“The demand requirement, however, exists under the relevant statute, 6 Del. C.  §18-305, not the operating agreements. The only requirement under the operating agreements is that members give at least one day written notice of a request to access documents.”

As the Court determined that the plaintiff had the right to inspect and copy the general ledger under agreement “I need not address her additional arguments for inspection rights under §18-305 or Defendants’ opposition to those arguments”.  Certainly the inspection rights under §18-305 was determined by the Court to be a “default” provision which the parties had replaces with the language in the agreement.

After affirming that Delaware follows the “American Rule” “under which a prevailing party generally is expected to pay its own attorneys’ fees and costs” the Vice Chancellor stated that there are exceptions to that rule and that the Plaintiff was relying on an exception that the court could award fees to a “prevailing claimant if the loosing party acted in bad faith in opposing relief being sought in the lawsuit.” That is “if defendant’s conduct forces the plaintiff to file suit to ‘secure a clearly defined and established right'”.

In this case the defendant initially opposed the plaintiff’s claim that she was a member, even though she was listed as a member on the K-1. For the purpose of the motion the defendant stipulated that she was a member. The Court found that there was a reasonable dispute which militated against the award. Given that the defendant listed the plaintiff as a member on the K-1 it is difficult on the record presented in the decision to understand the Court’s holding.

I have an active Delaware business practice as well as a practice in Delaware’s State and Federal courts. If you or your client have a business matter or a matter which you wish to litigate in Delaware or has a matter pending in Delaware, we would appreciate the opportunity to consult with you regarding our representation. Please remember that we do not accept representation without a written engagement letter.