Don’t Write a Delaware LLC Agreement Unless You Know All Phases of Delaware Law.

What experienced attorney would write an agreement to be controlled by the laws of a state where she or he is not admitted to practice or give a legal opinion on the laws of a state where she or he is not admitted? You, as a responsible and experienced attorney are undoubtedly thinking to yourself that you would never do that, you would seek out local counsel. But, when a client tells you that it wants to form a Delaware LLC and wants you to write the Limited Liability Company Agreement, or Operating Agreement (LLC Agreement), many of you would not think twice about accepting the engagement.

Our practice focuses on delivering legal opinions on single member Delaware LLC Agreement to meet the lender requirements for multi-family Fannie Mae, Freddie Mac and CMBS loans. We also organize Delaware LLC’s and draft for clients both single member and multi member LLC Agreements. In many instances we are asked to review LLC Agreement drafted by the client’s or borrower’s non-Delaware counsel. (Though lenders prefer the LLC to be single member, in some instances where the LLC is existing and there are real estate transfer taxes involve in the drop down of the property, the lender will accept the multi-member LLC as the borrower.) These agreement, particularly the multi-member agreements, run the gamut from embarrassingly terrible to well-organized and well drafted, however the former are the largest group of agreement we see. Where do these poorly drafted agreements come from? The internet is likely the largest source of these documents, the other significant source is “other people’s agreements”. These are the LLC Agreements which an attorney received from another attorney in another deal, which the attorney saved to her or his computer and then reused in the deal submitted to us. Each of these bad agreements have one thing in common, the attorney submitting the agreement did not have a good, working knowledge of the Delaware Limited Liability Company Act and likely did not actually understand the agreement itself. Sometimes we wonder whether the attorney actually read the agreement prior to submitting it to us.

Delaware did not invent the LLC, but its Limited Liability Company Act has become the preeminent LLC act in the US. In sophisticated deals and in multi-state deal, attorneys default to selecting Delaware as the forum, notwithstanding the fact that their knowledge of the Delaware LLC Act may be limited. The Delaware Act, in Section 18-1101(b) provides that it is the policy of the Delaware Act “to give maximum effect to the principle of freedom of contract and to the enforcement of  limited liability company agreements…”. The Delaware Act contains some limited default provisions, all, with the exception of the implied contractual covenant of good faith and fair dealing, may be expanded, revised or eliminated in a LLC Agreement. The LLC Agreement is itself a contract under Delaware law. A Delaware corporation is governed by the Delaware General Corporation Law, Title 8, Delaware Code, Section 101, et seq. (the DGCL) The DGCL provides a statutory framework for the organization and operation of a Delaware corporation. While the DGCL provides a statutory framework, the LLC Act is enabling in nature and permits the parties to substitute contractual provisions for statutory provisions in their LLC Agreement. That is all well and good if the drafter is schooled and has kept current on Delaware LLC law, Delaware limited partnership law, Delaware corporate law and Delaware contract law. The Delaware LLC Act and its amendments can be found in the many available statutory treatises  and through such services as Westlaw® and Lexis®. The treatises and services will show  the current law and cases decided under the LLC Act. What the treatises and services will not show are Delaware court decisions involving Delaware contract law generally. To draft a Delaware LLC Agreement the drafter must not only remain current on Delaware LLC law, but also must have a good working and current knowledge of Delaware limited partnership  law, Delaware contract law and Delaware corporate law. Delaware courts, when faced with a novel issue, will often look to the DGCL and the cases determined there under, to reach its conclusion. The attorney must also understand the Delaware Revised Uniform Limited Partnership Act (LP Act) and the cases decided under that Act as the provision of the LLC and LP Acts are reciprocal. Provisions found in the LLC Act are found in the LP Act under the same sub-section numbers in the other Act. A LP decision will have equal weight in determining a LLC issue.

Professor Daniel Kleinberger,  who is the principle drafter of the Uniform Limited Liability Company Act, is a frequent commentator and sometime critic of the Delaware Act, wrote in the July, 2017, edition of the American Bar Association’s publication, Business Law Today, an article titled “Don’t Dabble in Delaware.” He posits that keeping up with Delaware case-law is “almost a full-time job”. He points to another article which stated that “… when an attorney is asked for a formal legal opinion pertaining to a Delaware limited liability company ‘[i]t is …he responsibility of the opinion-giver to navigate Delaware common law [especially contract law] prior to rendering a Delaware LLC opinion, and to keep abreast of its shifting landscape’.”

Professor Kleinberger points out in his article may of the strengths and weaknesses of the Delaware LLC Act. In examining why practitioners gravitate to Delaware he states “The answer lies in the reputation of the Delaware Judiciary. The Delaware Court of Chancery has jurisdiction over claims relating to the internal affairs of a Delaware LLC, and that court is the preeminent business court in the United States. It is comfortable with business disputes and is capable of handling esoteric and even arcane issues of law. The Delaware Supreme Court is likewise capable; many of its judges have served previously in the Court of Chancery.”

He continues by stating ‘[b]oth the Court of Chancery and the Delaware Supreme Court accept and adhere to the policy of the Delaware Act ‘to give maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements’ under Section 18-1101(b). Indeed, Delaware courts are conservative about contracts in general. They lean away from modernist notions that all agreement are necessarily indeterminate and toward the old-fashioned approach that a contract is a contract and that a court is not a proper forum for salving the pain of ‘buyer’s remorse’.”

One aspect of Delaware’s courts which Professor Kleinberger did not address is that Delaware judges are appointed from a slate submitted to the Governor by a non-partisan Judicial Nominating Commission, and are not elected. Delaware’s court of Chancery’s jurisdiction is limited to matters of Equity which generally break down to business disputes, real property disputes and matters involving trusts. The Chancellor and Vice Chancellors do not hear any criminal cases nor do they hear accident cases as is the case with elected judges in most states which do not have separate business courts with full-time, dedicated business judges.

Before a non-Delaware attorney accepts an engagement to draft a Delaware LLC Agreement the attorney needs to understand the issues involved in drafting that contract. Certainly there are small deals where the client will not be willing to spend the money to engage Delaware Counsel to assist her or his local attorney. When faced with that issue the attorney should consider with the client whether Delaware is the proper venue for the small deal or whether the LLC should be formed in the jurisdiction where the attorney practices. When faced with a larger deal the non-Delaware attorney should seek assistance from a Delaware LLC attorney to assist with the Delaware contract drafting. Under no circumstances should a non-Delaware attorney ever consider issuing an opinion under Delaware law, it is an invitation to malpractice.

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