Zimmerman
v. Crothall, C.A. No. 6001-VCP (Del. Ch. Jan. 31, 2013)
Issue Presented
This 74-page opinion addresses the allegations of a
minority unitholder in an LLC who asserts claims that the directors breached
their fiduciary duties in connection with several financing transactions.
Brief Overview
Zimmerman claimed that the challenged transactions should
be analyzed under the entire fairness standard of review based on the actual
control by a majority of the directors interested in the challenged
transactions and who received an exclusive benefit, but in any event, Zimmerman
argued unsuccessfully that the directors could not demonstrate the fairness of
the transactions which were alleged to be a violation of their duty of
loyalty. Zimmerman also claimed that the transactions did not receive the
necessary approval from all of the members. See prior Chancery decision in this matter summarized on
these pages here.
The Court concluded after a three-day trial and
post-trial briefs that even though a declaratory judgment would be entered that
the directors exceeded their authority in engaging in the financing
transactions, the Court found that the directors' breach did not cause any
damages. The Court also ruled that the directors were entitled to both
advancement and indemnification, notwithstanding the breach by the directors of
the LLC operating agreement.
The Court provided an extensive description of the
applicable law for interpreting an ambiguous contract such as the one involved
here. The Court also observed that the applicable statute, the Delaware
LLC Act, allows parties wide latitude in crafting an agreement customized to
their needs. See pages 21 and 22. For example in this case,
the LLC Agreement involved the issuance of ownership interests in units as
opposed to admitting members, and it also incorporated certain corporate law
terms, such as a board of directors.
The Court discusses in extensive detail under what
circumstances additional units can be issued under the LLC Agreement. The
Court noted that the LLC Act establishes "no formalities that must be observed
for the creation and issuance of limited liability company interests," as
opposed to the analogous situation in a corporate context. See
footnote 100 and accompanying text.
The Court concluded that the board breached the operating
agreement in undertaking each of the challenged transactions regarding the
issuance of additional units.
The Court explained that in determining the contractual
intent of the parties, the "true test is not what the parties to the contract
intended it to mean, but what a reasonable person in the position of the
parties would have thought it meant." See footnote 117. The
Court also applied the rule that construing and ambiguous contract against the
drafter is appropriate based on the rule of contra proferentum.
The Court considered the breach of duty of loyalty claims
that were based at least in part on the argument that certain unitholders owed
fiduciary duties in light of their controlling interest. The Court
described the case law that determines when an interest in an entity will be
considered controlling, even if it is less than 50% or when actual control over
a board takes place in the course of a particular transaction. See
footnote 129 and accompanying text.
However, the Court found that the parties involved
"neither acted together nor were connected in some legally significant way" so
that they were not acting in concert in a manner that was sufficient to
establish control. Because the Court concluded that the two unitholders
were not acting in concert or otherwise exerting "actual control" over the
board, there was no basis for the breach of fiduciary duty claim that rested on
the finding of a control group of shareholders.
The Court next considered the fiduciary duties under the
terms of the operating agreement and found that the operating agreement did
provide that the directors of the LLC were fiduciaries.
Importantly, at footnote 145, the Court of
Chancery noted that the Delaware Supreme Court has not yet "definitively
determined whether the LLC statute imposes default fiduciary duties," but
also cited a more recent decision of the Court of Chancery that held that
"subject to clarification from the Supreme Court, managers and managing members
of an LLC do owe fiduciary duties as a default matter." [citation
omitted]
Moreover, the Court found that the fiduciary duties were
restricted pursuant to 6 Del. C. Section 18-1101(c) to the extent that
the agreement gave the directors the right to engage in transactions with the
company.
The Court interpreted the provision of Section 6.13 of
the LLC Agreement requiring the transactions with the company be "fair" as
"effectively calling for review under an entire fairness standard." See
footnote 159 (noting that magic words such as "entire fairness" or "fiduciary
duties" are not necessary in order to impose fiduciary standards of conduct as
a contractual matter). However, the Court also found that the entire
fairness standard was not shown to have been breached.
The Court also observed that the concepts of Section 144
of the Delaware General Corporation Law were incorporated into the LLC
Agreement by reference. Section 144 allows for self interested
transactions with the director's corporation to survive the common law concept
that they are voidable. Although this concept has no analogue in the LLC
context; because it was incorporated into the agreement, the Court had to
address it. See footnotes 153 and 154 and accompanying text.
The Court found in this case that the defendants did comply with at least one
of the safe harbors in Section 144 that was incorporated into the LLC Agreement
by reference. Thus, because the Court found that the challenged
transactions were approved in good faith by informed disinterested directors, and
should receive the benefit of the business judgment rule, the Court found that
the burden of proof of entire fairness shifted to Zimmerman. The Court
also found the challenged transactions to be fair.
Remedy
The Court concluded that Zimmerman was entitled to
judgment in his favor on the breach of contract claim but not on the breach of
fiduciary duty claim. The appropriate remedy would be to recover damages
resulting from the breach of the agreement but the Court determined that the
transactions were fair and therefore there were no such damages.
Zimmerman also asked the Court to order defendants to
reimburse the company for over $1 million in legal fees that it advanced to the
law firm representing the defendants. The Court reasoned held that:
"Whether a party has the ultimate right to an
advancement depends on whether his underlying conduct is indemnifiable." [citation
omitted]. The Court found that the agreement required indemnification for
the defendants based on the circumstances of this case. See
footnote 210.
In this post-trial opinion, the right to advancement was
largely moot, but the Court explained that even though the operating agreement
"does not explicitly address advancement rights," the board had the authority
to approve the advancement of legal fees based on broad authority to make
decisions for the company not otherwise provided for in the LLC Agreement.
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