First State Update: 2017 Case Law Developments and Updates to Delaware's LLC Act
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The Delaware LLC continues to be one of the most flexible type of business entities globally. Join us as we take a detailed look at the 2017 amendments and updates to the Delaware Limited Liability Act in this free recorded webinar. Inform and advise your clients looking to make the most of Delaware's limited liability company statues with the most up-to-date information in your repertoire.
Join Matthew J. O'Toole, Christopher N. Kelly, and Michael P. Maxwell of Potter Anderson & Corroon LLP as they share their insights, outline associated case law, and discuss amendments to the act. O'Toole is also senior legal advisor to CSC® and LexisNexis for their joint publications, as well as a co-author of the detailed guide on the subject, Symonds & O'Toole on Delaware Limited Liability Companies, Third Edition. Attendees will have the opportunity to ask these experts about specific LLC-related case law and amendments.
Presented by: LexisNexis, CSC, and Potter Anderson & Corroon LLP.
Anu: Hello everyone and welcome to today's webinar, "First State Update: 2017 Case Law Developments and Updates to Delaware LLC Act." Joining us today, our guest speakers Matthew O'Toole, Christopher Kelly, and Michael Maxwell of Potter Anderson and Corroon, LLP and with that, let's welcome Matt, Chris, and Mike. Matt, would you like to kick things off for today's session?
Matt: Sure, thank you Anu. Good afternoon everyone, apologies for the delay, thank you for joining us. I assume we've now been successful in building a little bit of suspense before we got started, so I hope the wait proves worthwhile. As Anu mentioned, our bios are available on your website, so we'll get started just by saying that we've got a diversity of perspectives here today.
Mike Maxwell and I bring to the table a transactional lawyer's perspective, focusing most of our time on so-called office work transactions and advisory counseling, whereas Chris Kelly focuses his time on litigation matters with a very active practice in the Delaware Court of Chancery. Our program today will have two parts, a case law review component and then an overview of this year's amendments to the Delaware LLC Act.
So, Chris will start us off by surveying just a few of the cases involving Delaware LLC that have been decided in the Delaware Court of Chancery this past year. And the first one really centers around what the Vice Chancellor Slights called one of the most popular and beloved food preparations in all of history. So Chris, turn it over to you.
Christopher: Thanks, Matt. So the first case we're going to discuss today is in re GR Burgr, LLC. In this case, the Delaware Court of Chancery dissolved a Delaware limited liability company owned by British celebrity chef, Gordon Ramsay, and his business partner, Rowen Seibel because they were deadlocked and it was not reasonably practicable for them to continue operating a gourmet burger restaurant in the Planet Hollywood Casino in Las Vegas in conformity with the LLC's operating agreement.
So by way of background, GR Burgr, LLC, which I'll refer to as GRB or simply B, LLC, was formed by a Ramsay-owned entity and by Seibel for the purpose of developing and operating gourmet burger restaurants. The Ramsay-owned entity, GRUS Licensing, and Seibel each owned a 50% member interest in GRB. Under GRB's operating agreement, each member was entitled to designate one manager for the LLC. GRUS, the Ramsay entity, appointed a third party while Seibel appointed himself. The LLC agreement gave the two managers full and exclusive right, power, and authority to manage all of the business and affairs of the company.
All decisions made by LLC managers had to be by majority, this meant that in practice, the managers had to be unanimous to make decisions or act on behalf of the LLC. The LLC agreements did not offer a contractual mechanism by which to break a deadlock. GRB's only revenue-producing asset was a licensing agreement with Caesars Entertainment, pursuant to which GRB license trademarks and other intellectual property owned by Gordon Ramsay for Caesars' use in a burger-themed restaurant in the Planet Hollywood Casino. Caesars operates in a highly-regulated industry that depends on licenses issued by the Nevada Gaming Commission.
As such, Caesars conditioned the licensing agreement on GRB and its members, managers, and affiliates not being "Unsuitable Persons" with such determination to be made at Caesars' sole discretion. If Caesars were to find the party unsuitable, the parties were obligated to terminate the relationship or Caesars would terminate the licensee. In 2016, Seibel was convicted of a felony tax-related offense, thereafter Caesars notified GRB that Seibel was an Unsuitable Person and demanded the GRB terminated its relationship with Seibel.
When GRUS requested that Seibel terminate its relationship, Seibel refused. In September of 2016, Caesars terminated the Licensee Agreement. Thereafter, GRUS filed a petition in the Court of Chancery for the State ofDelawareseeking judicial dissolution of GRB. Seibel opposed the dissolution as a matter of equity, arguing that GRUS was seeking dissolution to usurp business opportunities by ousting Seibel from GRB. GRUS moved for judgment on the pleadings and the Court granted the motion.
Under Section 18-802 of the Delaware LLC Act, an LLC may be judicially dissolved when it is "not reasonably practicable to carry on the business in conformity with a limited liability company agreement." To determine whether it is not reasonably practicable to carry on the business in conformity with the LLC agreement, the Court will consider a number of factors including whether the members' vote is deadlocked at the board level, whether the operating agreement gives the means by which to break the deadlock, and whether, due to the financial condition of the company, there is any effective business to operate.
None of these factors alone is dispositive, not unless they all exist for a Court to order a dissolution. Judicial dissolution is a remedy of last resort, it typically is reserved for situations where the management of the LLC is so dysfunctional that it is no longer practical to operate the business such as a voting deadlock or where the defined purpose of the entity has become impossible to fulfill.
Here, the Court by Vice Chancellor Slights found that the deadlock at GRB was insurmountable, observing that the dysfunction in voting deadlock has left the company in a petrified state with no means in the LLC agreement to break it free. The Court observed that Ramsay and Seibel were no longer on speaking terms and Ramsay wanted to disassociate from Seibel due to his felony tax conviction and the reputational damage that result from continued connection with it. Because all decisions of GRB required unanimity of its managers and GRB's LLC agreement provided no mechanism by which to break the deadlock, GRB was hopelessly deadlocked.
The Court found that the deadlock could be the basis for dissolution even though GRB still engaged in marginal operations because Seibel's qualification as an unsuitable person and the subsequent refusal to disassociate from GRB left GRB stripped of its only revenue-producing asset and essentially a lifeless joint venture. The Court accordingly held that it was not reasonably practicable for GRUS and Seibel to carry on GRB in conformity with its operating agreement and the Court ordered a judicial dissolution. The Court also found that equitable principles did not override the fact that judicial dissolution was warranted under Section 18-802 of the Delaware LLC Act.
Rejecting the Seibel's argument that Ramsey was inequitably using the dissolution to take the burger-themed restaurant business for himself and disenfranchising Seibel, reasoning that Seibel cannot point to any specific future business opportunity that GRUS or Ramsay were seeking to exploit beyond Seibel's conclusory allegation that Ramsay may, at some point in the future, engage in other burger ventures using his name and likeness to capitalize on his celebrity status. The Court explained that indefinitely locking Ramsay into a failed joint venture, thereby precluding him from ever engaging in a business that resembles GRB would "be the antithesis of equitable."
So what are some of the takeaways from the GR Burgr case? Well, one would be just because an LLC is technically functioning or has marginal operations, that won't prevent the Court from finding that the LLC is not operating in accordance with its operating agreement. That is, the Court won't elevate form over substance and will ask whether that LLC could, if necessary, take any important action that requires the vote of the members. Here, the Court found that that was not the case.
Another takeaway would be where an LLC has two 50/50 owners, the Court may turn by analogy to Section 273 of the Delaware General Corporation Law and the Court did so here. DGCL Section 273 sets forth three prerequisites for judicial dissolution. First, the corporation must have two 50% stockholders. Second, those stockholders must be engaged in a joint venture. And third, they must be unable to agree whether to discontinue the business or on how to dispose of it.
The Courts faced with a petition to dissolve an LLC with two 50% owners draw this analogy because when an LLC agreement requires that there be agreement between two managers for business decisions to be made, those two managers are deadlocked over serious matters and the operating agreement provides no way to break the deadlock, it's not reasonably practicable to continue to carry on the business in conformity with the operating agreement.
Finally, even if Section 18-802 of the LLC Act, the "not reasonably practicable standard" is met, the Court still retain its discretion to decline to grant judicial dissolution. The statute expressly states that the Court "may" decree dissolution when they're not reasonably practicable showing Heasman. So, turning to the next slide, we're going to discuss the CelestialRX Investments, LLC versus Krivulka case.
Matthew: And Chris, this is a case from Vice Chancellor Glasscock and sort of keying this up as an interesting discussion, the Vice Chancellor described it as a procedurally awkward and factually prolix memorandum opinion, so have at it.
Christopher: Thanks, Matt. So, in this case, the Delaware Court of Chancery rolled on a motion for partial summary judgment concerning simply the construction of a limited liability company agreement to determine whether it as authorized and contemplated by the LLC Act, whether the agreement eliminated common-law fiduciary duties and provided a contractual standard governing conflict of interest transactions.
So by way of background, a member of Akrimax Pharmaceuticals, LLC, a three-member Delaware LLC, stated that its two other members who are participating in the management of the LLC, alleging that the other members engage in improper self-dealing and conspired to divert pharmaceutical interests away from the company. In moving for partial summary judgment, the defendants sought a judicial determination that Akrimax's LLC Agreement eliminated common-law fiduciary duties and provided contractual standards governing the challenged transactions. At issue is whether the following provision contained an amendment to the LLC agreement eliminated the common-law fiduciary duties.
"Notwithstanding anything to the contrary in this agreement, neither the manager nor any of the members of the Board of Directors nor any member shall have any fiduciary duties to the company or the members or shall be personally liable to the company or its members for breach of any duty that does not involve, one, an act or omission not in good faith for which involves intentional misconduct or knowing violation of law, or two, the transaction from which such manager or member of the Board of Directors or member derived an improper personal benefit."
So interpreting the LLC Agreement, the Court observed that the common-law fiduciary duties generally apply to a manager of a limited liability company under Delaware law. That's what we oftentimes refer to a default fiduciary duty. The Court noted however that the Delaware LLC Act affords parties the contractual freedom to eliminate common-law fiduciary duties if done in clear and unambiguous terms in the LLC Agreement. The Court explained, "In other words, the intention of the parties to the agreement that fiduciary duties apply is implied where that agreement does not provide otherwise."
Matthew: So there are default fiduciary duties?
Christopher: There are default fiduciary duties unless the LLC Agreement explicitly eliminates them. The Court found that despite the parties' various arguments, the plain language of the provision I have read generally eliminated common-law fiduciary duty. According to the Court, the LLC Agreement imposed liability for intentional or illegal misconduct, bad faith actions, and improper self-dealing which the Court found to be contractual-based liability standards under the agreement rather than the standards premised on common-law fiduciary duties.
The Court noted, however, the common-law fiduciary concepts would be instructive in construing the meaning of undefined contractual terms such as "bad faith." The Court additionally found that whether a conflicted transaction involves improper self-dealing, it must be assessed in light of other provisions of the LLC Agreement which provided a safe harbor for self-dealing transactions. The Court discussed one of those safe harbors, interpreting it as providing that the defendant will be found not to have engaged in improper self-dealing if it entered into a conflicted transaction in good faith and determine if the transaction was fair and reasonable to the company and its members after a good-faith balancing of interests.
Michael: This case is interesting in providing those sort of safe harbor provisions that you more commonly see in the case law, at least in mass limited partnership agreements. This is a case where it came up in an LLC content.
Christopher: So, what are some of the takeaways of the Krivulka case? Well, this is among the many cases illustrating the Delaware LLC Act affords business planners and their counsel substantial flexibility to privately order the affairs of an LLC. This latitude includes the ability to eliminate the fiduciary duties of LLC members, managers, and other persons with clear and unambiguous provisions in the LLC Agreement.
Now, as Matt noted in the DMLP context, in the LLC context as well parties may utilize the contractual freedom provided by the Act to replace common-law fiduciary duties with contractual duties, as well as safe harbors that immunize conflict of interest transactions from judicial review if certain conflict resolution procedures are followed, such as the use of a special committee or the determination on some, you know, fair and reasonable or other standards set forth in the agreement.
To the extent, any such contractual duties employed undefined terms as the Court noted in the Akrimax case. The Court may refer to other provisions in the LLC agreement or the common-law fiduciary duty case law for how to interpret those terms.For example, the bad faith standard that the Court noted where it was undefined in the agreement, it would refer to a fiduciary duty case law to determine what that meant, what the parties meant by that. Lastly, the last takeaway is it's important to keep in mind that the contractual freedom provided by the Act does not permit the elimination of the implied covenant of good faith and fair dealing, the implied covenant is non-waivable.
Matthew: So I just add one comment on the case and that is that it repeats a fairly common refrain from the Court of Chancery about the LLC agreements, that it has to interpret and the cases before are poorly drafted, that's not anything new coming from the Court. That's a common criticism that's been repeated more than once. Now, I would say, and Vice Chancellor Glasscock, in this case, acknowledge that the agreements that are subject to litigation or self-selecting group, so the Court really does not see the well-drafted agreements that don't leave any room for ambiguity or argument.
And so I think the reading of the, or reading just of the Chancery Court decisions can create a misimpression that LLC agreements generally are sloppily prepared. That's not necessarily true because you've got a selective cross-section of the universe of LLC agreements that are reflected in these cases. But no doubt, the Courts' criticisms does have a basis, in fact, there are many agreements that are not well done and it just goes to highlight that, you know, with the upside of contractual freedom, there's also a burden and that's the obligation to draft carefully and clearly.
Christopher: That's right, Matt. Oftentimes, the Court will interpret things as implying, where there's ambiguous or incomplete drafting, the Court oftentimes will interpret things in a way, "Well, the parties could have contracted for that but they didn't." So, dissolution of Arctic Ease. In this case, Vice Chancellor Montgomery-Reeves found that she lacked personal jurisdiction over a member of a Delaware LLC as well as the members, owners, and affiliates against the third-party complaints for breach of fiduciary duty fraud and other claims have been filed in a proceeding to dissolve the LLC.
By way of background, Summetria, LLC was a Delaware limited liability company that owned 100% of Arctic Ease, LLC, also a Delaware LLC. Arctic Ease is in the business of developing and marketing reusable cryotherapy wraps. Entities associated with Carol Forden own 60% of the equity of Summetria, Bruce Heck and his affiliates own 20% of Summetria, and Costar Partners, LLC which was owned by William Cohen owned the remaining 20% of Summetria. Carol Forden was listed as the sole managing member of Summetria in its LLC agreement. So, in mid-2012, Arctic Ease and Summetria were in need of capital and Cohen provided a $1 million loan to Summetria.
The Arctic Ease business, however, continued to flounder and the term of Cohen's loan was extended twice and he also provided another quarter million dollars of additional capital. Arctic Ease continued to need further financing and in early 2013, Cohen arranged for bridge financing through an entity that he had used for personal business before. Throughout this time, Cohen was a member of Summetria's Board of Directors and allegedly participated in Arctic Ease's business.
In the spring of 2013, Cohen told Forden that the entity would . . . the CSG entity that had arranged the bridge financing would require that Cohen guarantee the financing, which was not acceptable to Cohen. Cohen later resigned from the Summetria board and shortly thereafter notified Summetria that it was in default on his loan. In the summer of 2013, Summetria and Arctic Ease defaulted on loans owed to certain non-party banks that were secured by all of the assets of Arctic Ease and all of the assets of Summetria accepted interests in Arctic Ease.
Summetria's and Arctic Ease's assets were foreclosed on and an entity controlled by Cohen purchased those assets at a foreclosure sale. Thereafter, the Forden entities filed a petition in the Court of Chancery to dissolve Arctic Ease and Summetria and then Forden and Heck filed third-party complaints against Cohen and his related parties for breach of fiduciary duty fraud and other claims.
Cohen and his affiliates moved to dismiss the third-party complaints, arguing among other things that the Court lacked personal jurisdiction over him under Rule 12-B2. The Forden and Heck parties opposed the motions, arguing that the Court had personal jurisdiction among other things, section 18-109 of the Delaware LLC Act and over the remaining Cohen parties under the conspiracy theory of jurisdiction.
The Court granted Cohen's motion to dismiss. The Court explained that the Delaware LLC Act contains an implied consent provision, 6 Delaware C Section 18-109, which allows Delaware Courts to exercise personal jurisdiction over parties who manage Delaware LLCs in actions "involving or relating to the business" of the company.
The Court observed that Section 18-109 describes two types of managers for personal jurisdiction purposes. One, managers as defined in the Limited Liability Company Agreement, and two, parties who "participate materially in the management" of a Delaware limited liability company. The Court found that Cohen was not a manager of Summetria under either statutory definition.
In holding that Cohen was not a manager as defined in the LLC Agreement, the Court reasoned that the agreement made clear that Forden was the sole manager of the LLC and that the other members shall not take any part in the management or affairs of the company and have no authority to do so.
While the Summetria LLC Agreement established a board of directors, the agreement did not give the board any management authority other than to set Director of Compensation. As such, the Court found that the board was only advisory in nature and lacked management authority.
Second, the Court likewise found that Cohen did not participate materially in the management of Summetria including the evidence that Cohen negotiated a distribution agreement for Arctic Ease, conveyed information to Summetria members about its finances, and arranged for bridge financing, among other things, did not demonstrate that he had "necessary control or decision-making role" over Summetria because his involvement was subject to Forden's exclusive management authority under the LLC Agreement.Because Cohen was not a subject to personal jurisdiction under 18-109, the other third-party defendants associated with him were not subject to personal jurisdiction under the conspiracy theory of jurisdiction. Accordingly, the Court granted the motion to dismiss.
So the takeaway from this case is that it illustrates that someone acting in a corporate officer-like capacity generally will not be subject to personal jurisdiction under the "material participation in management" prong of section 18-109. That is, someone who's subject to oversight and control by another person will not be considered a manager under that subsection of 18-109, rather to fall within this subsection of the implied consent provision, a person typically must have a corporate director-like role, managing and overseeing the business and affairs of the LLC.
Matthew: So Chris, two of the cases that you just discussed, this Arctic Ease case and the earlier Burgr case, where cases that involve petitions for judicial dissolution under 18-802 of the LLC Act and each of those cases involved other claims, they were not limited to the petition for judicial dissolution. Can you just comment a little bit on the prevalence of that sort of multifaceted litigation where a petition for dissolution is involved?
Christopher: Sure, when you get to the point of judicial dissolution of an entity, oftentimes the parties involved have not pleasant relations with each other and believe that one or the other has engaged in misconduct and often times that fills in to parallel litigation in the Court of Chancery or in other Courts around the country. For example, in the GR Burgr case, there was litigation in Nevada. In the Arctic Ease case, there was litigation elsewhere, it's a pretty common scenario.
Matthew: Yeah, and interestingly and importantly as in the Burgr case where the petition was granted, that doesn't mean that the litigation of those other claims ends. I think towards the end of the Burgr decision, the Court noted that a liquidating trustee would be appointed for the company and among the charges of the litigating trustee would be the evaluation of those pending claims. So, thank you, Chris. So with that, we'll move from the case law portion of the program to the statutory portion. There were various amendments to the Delaware Limited Liability Company Act enacted this past year, 2017, and Mike Maxwell will walk us through those updates. Mike?
Michael: Great, thanks Matt. So the first amendment that we're going to discuss today is an amendment to Section 18-201 of the Delaware Limited Liability Company Act, dealing with formation of a Delaware LLC, and in particular, the requirements of the Act regarding the content of a certificate of formation. So in that regard, I thought it would be helpful to start with some basics about formation of an LLC and what the requirements are for that. Formation of an LLC requires the filing of an executed certificate of formation with the office of the Secretary of State of the State of Delaware and such certificate must contain the information required under the Act.
The Act provides that an LLC is formed at the time the filing of the certificate of formation is effective, so long as there has been substantial compliance with the requirements of Section 18-201. So Section 18-201 requires the filing of a certificate of formation and requires that a Limited Liability Company Agreement be entered into or otherwise existing either before or after or at the time of the filing of a certificate of formation and such agreement may be oral or written.
Now, with respect to the content of the certificate of formation, the Act requires only that the certificate set forth the name of the LLC and the address of the company's registered office and the name and address of its registered agent for service of process in Delaware.
With respect to the first requirement of a certificate of formation regarding the name, the name of an LLC must contain the words "Limited Liability Company" or the abbreviation, "LLC" or the designation LLC and the company's name may contain the name of a member or manager. It can also include any number of words such as Company, Association, Club, Foundation, or abbreviations of similar import.The Act, however, does restrict the use of the word "Bank" or any variation thereof in the name of an LLC.
Now, with respect to the second and third requirements to be included in a certificate of formation, an LLC must have and maintain in the State of Delaware a registered office and a registered agent for service of process on the LLC. Now, the address of the registered office and the name and address of the registered agent must be stated in the certificate of formation and often, the address of the registered agent and the address of the registered office of the company are the same.
Matthew: In fact, that's an essential provision of the statute. There's a provision of the statute Section 18-104(a)(2) that provides that the registered agent must have a business office that's located at the registered office of the LLC, so although a registered agent can have other offices for a particular company, the registered agent has to have a place of business at that registered office for that company.
Michael: For that company, that's exactly right. And in particular, the address of the registered office and address of the registered agent with respect to the requirements that are necessary to be incorporated into the certificate, that address must include the street, the number, the city, and the postal code. The designation of a post-office box alone is not sufficient for purposes of these address requirements.
So an LLC is required also to maintain not simply a registered mailing address but also a registered office and an LLC's registered office in Delaware may be a place of business but it does not have to be. And I think that goes to the point that you were making, Matt, you know, if you're the company and you have a place of business in Delaware, maybe you can act as your own registered office.
Matthew: Right, and a company can be its own registered agent but as is widely known there is a substantial commercial registered agent business in Delaware including companies like our host, CSC, and so, the registered office does not have to be a place of business of the LLC itself.
Michael: Exactly right. And in fact, often times it's not.
Michael: So with respect to the registered agent requirements, the LLC Act provides flexibility as to who may serve as the registered agent of an LLC. The registered agent may be an individual Delaware resident or corporation, partnership, LLC, or statutory trust. If the registered agent is an entity, the person acting as the registered agent must maintain a business office in the state of Delaware. It's generally open at sufficiently frequent times to accept service of process and otherwise, perform the functions of a registered agent.
If an individual is the registered agent of an LLC, that person must with sufficient frequency be generally present at a designated location in Delaware so that he or she can accept service of process and perform the other functions that are required of the registered agent. An LLC must provide to its registered agent the name, business address, and business telephone number of a natural person who is a member, manager, officer, employee, or designated agent of the company who is then authorized to receive communication from the registered agent.
We typically refer to this person as a communications contact for the LLC. Now, the registered agent must retain the information concerning the current communications contact for an LLC and if an LLC fails to provide the registered agent with current communications contact, that registered agent may resign.
Now, so with that background in mind, even though the statutory requirements for forming a Delaware LLC are pretty minimal and pretty easily satisfied, sometimes mistakes happen. In those circumstances, it's useful to bear in mind that in the case of formation of an LLC, the Act does not demand perfection, rather the statute requires substantial compliance with the requirements of Section 18-201.
So what does substantial compliance mean? Well, the application of substantial compliance standard would likely render harmless certain defects on the certificate of formation, such as perhaps minor misspellings on the name of the registered agent or perhaps the address of the registered office that is not misleading. So this brings us to our amendment in this year.
In furtherance of clarifying this concept of substantial compliance, with respect to the requirements of identifying the certificate of formation and a registered agent and a registered office, the Delaware LLC Act was amended by adding a new subsection 18-201(e) to confirm and clarify that a certificate of formation of an LLC is in substantial compliance with the requirements set forth in the Act if it contains the name of the registered agent and the address of the registered office, even if the applicable certificate does not expressly designate such person as the registered agent or such address as the registered office or the address of the registered agent.
So what does that mean in practical terms? Well, one of the examples that come to my mind is many times in my practice, I encountered a certificate of formation that would include a line identifying the name of the company and then the name of the registered agent and possibly the address of the registered office of the LLC, but not specifically identifying the address of the registered agent. Technically, that would not have met the requirements of the Act but because of substantial compliance, you were able to look at that and come to some determination but not without some uncertainty.
But with the current amendment, it was designed to clarify that practitioners can look at the certificate of formation and determine if the address of the registered office is the same as the address of the registered agent and they're going to make a determination that the certificate of formation substantially complies with the requirements of the LLC Act and just provide some certainty.
Now, of course, all of this could be avoided by careful drafting of the certificate of formation and as well the other organizational documents for formation of an LLC. This would minimize the need to resort to substantial compliance analysis to determine whether formation has occurred and as we see in some of the cases and in other contexts, careful drafting would avoid a lot of issues in formation as well as governance of the LLC.
Matthew: Right, and you know that if you are drafting a certificate of formation and you need to rely on the substantial compliance standard to make sure that it works, keep in mind that substantial requirements is essentially the same standards that applies to de-facto companies, de-facto LLCs, and you really don't want to be in the same breath as the discussion of de-facto when you're talking about a company that you're trying to form correctly.
So the substantial compliance standard in this year's amendments, in particular, are really designed to avoid foot faults defects that really, as a practical matter, don't really carry any real-world consequence, particularly because as I mentioned earlier, registered agent has to have an office that's identical to the registered office that's identified in a particular certificate of formation. So, if you have a certificate that says the name and address of the registered agent are, CSC at XYZ Road, you know that you've got the registered office of the company and also the address of the registered office stated in that certificate but it's easily enough to avoid it and frankly, it should be.
One thing I will say is that if you read the amendment on its face, it would suggest that any reference anywhere in the certificate to the name of the registered agent, for example, will suffice to mean it's substantial compliance. But I do think that there's got to be some common sense brought to bear when you interpret that and the way I always think of it is if it's reasonably inferable from the face of the document that the address that's mentioned there is the address of the registered office or of the registered agent or the person or entity name who's intended to be the name of the registered agent, then you've got a substantial compliance situation.
On the other hand, if you've got, let's say there was a fax, God knows there are not many faxes sent nowadays but it used to be, you get some sort of a header or a footer that might reference CSC or Corporation Service Company. If you have a situation like that and that was the only reference to the name of the registered agent, you could rely on the specific language of this year's substantial compliance amendment but in my way of thinking, I don't know that that satisfy as my own, admittedly, non-statutory reasonable inference sort of standards. So, with that, Mike, why don't we move on to the next amendment.
Michael: Great, thanks, Matt. So the next amendment to the Act that we'll discuss relates to the power of members and managers to delegate management rights to others. In that regard, it's helpful to discuss Section 18-407 of the LLC Act which explicitly permits delegation of management by members and managers of a Delaware LLC and also to discuss some of the background leading to the proposed amendments related to this section. Under the Act's default framework, members and managers may delegate their rights and powers to manage and control the company's business and affairs. Such a delegation may be made to one or more persons which may include agents, officers, employees of a member or of a manager, or the company itself.
So, unless otherwise provided in the LLC Agreement, a delegation of management authority does not cause a person to whom rights and powers have been delegated to be a member or manager, nor does a member or manager's delegation of management rights and powers cause that delegator to cease to be a member or manager. Until last year, Section 18-407 of the Act was generally interpreted to not limit the extent to which a member or manager could delegate management authority as a default matter.
The Delaware Court of Chancery's decision in Obeid v. Hogan, however, interpreted Section 18-407 in a more limited manner, so not regarding, I think it's helpful to review the Obeid case in a little more detail in order to understand the background of why this amendment on Section 18-407 was adopted.
In Obeid, the Court of Chancery held that the board of directors of an LLC that had adopted a corporate-style governance structure referred to as the "Corporate LLC" and the managers of a related LLC that had adopted a manager-managed governance structure referred to as "manager-managed LLC" had improperly abdicated their authority by appointing a non-director or a non-manager to serve as the sole member of a special litigation committee.
So with some background, William Obeid, Christopher La Mack, and Dante Massaro where each individual serving as members of the Board of Directors of the Corporate LLC and as managers of the manager-manage LLC. Each owned a third interest in each of the two LLCs and La Mack and Massaro removed Obeid from the Board of Directors of the Corporate LLC and as the Operating Manager of the manager-managed LLC. Obeid filed suit against these other managers and directors in Federal Court in New York, asserting a variety of direct and derivative claims.
After the New York litigation had progressed beyond the stage when La Mack and Massaro could argue that Obeid should have made demand on the Board or the managers of the LLCs, La Mack and Massaro, each as a member manager of the LLCs, signed an engagement letter with a retired federal judge named Michael Hogan, purporting to hire Judge Hogan to function as a special litigation committee for each entity to investigate and make a recommendation with respect to Obeid's claims.
After learning of Judge Hogan's engagement, Obeid filed suit in the Court of Chancery, seeking among other things, a declaratory judgment and Judge Hogan could not serve as a special litigation committee and that he had no authority over the derivative claims and seeking an injunction preventing Judge Hogan from taking any action on behalf of either entity or relating to the derivative claims. On Obeid's motion for summary judgment, the Court largely found in Obeid's favor, ruling in pertinent part that Judge Hogan could not serve as a one-man special committee for either LLC. The Court first found that Judge Hogan was not authorized to serve as the Corporate LLC special litigation committee.
The Court explained that the Corporate LLC had adopted a governance structure similar to a corporation by including language in its LLC Agreement providing, among other things, that its business and affairs would be managed by or under the direction of its Board of Directors such in Section 141(a) of the Delaware General Corporation Law and permitting the Board to delegate its authority to a committee of its members, such in Section 141(c) of the DGCL.
Now, based on the Delaware Supreme Court's opinion in Zapata v. Maldonado which held that a board of directors possessed authority under Section 141(a) of the DGCL to assert control over derivative action and to delegate that authority to a committee, Vice Chancellor Laster held that delegating such authority to a non-director would risk an improper abdication of authority under Section 141(c) of the DGCL. The Court also rejected the defendant's arguments at Section 18-407 of the LLC Act, permits a member or manager of an LLC to delegate to one or more other persons the member's or manager's rights and powers to manage and control the business and affairs of the LLC.
The Court's reasoning was that the general default provision regarding delegation contained in section 18-407 does not trump the specific provisions of the Act that addressed derivative actions, in which the authority to bring such derivative suits in an LLC is manager's and member's only. The Court also emphasized that by embracing a governance structure modeled after Section 141 of the DGCL that the drafters of the Corporate LLC agreement evidenced an intent to have the corporate principles govern the corporate board, including the Supreme Court's decision in Zapata. Because Judge Hogan was not a director of the Corporate LLC, the Court held that he was not authorized to function as a special litigation committee.
Now, with respect to the manager-managed LLC, the Court observed that the LLC Agreement established a corporate-style division between members and managers, in which members are passive and managers operate the business of the entity and indicated that its reasoning with respect to the Corporate LLC would apply equally to the manager-managed LLC.
The Court, however, declined to rule on that basis, instead holding that other provisions of the manager-managed LLC agreement taken as a whole, distinguished between matters relating to the ordinary course of business of the LLC and more significant matters that must be handled by the managers. According to the Court, this demonstrated that the drafters of the manager-managed LLC agreement intended to limit the ability of managers to delegate their core governance functions. Because Judge Hogen was not a manager of the LLC, Vice Chancellor concluded that Judge Hogan was not authorized to serve as a special litigation committee of the manager-managed LLC.
But as a result, Obeid made clear that the LLC Act does not, as a default matter, allow for delegation of control over derivative litigation to a special litigation committee consisting of non-members in the context of a member-managed LLC or non-managers in the context of a manager-managed LLC. Now, this was significant because, at the time, many practitioners believed until that point, that Section 18-407, a fairly broad authority to delegate rights, powers, and duties of a member or manager of an LLC.
So, in light of Obeid, the Act was amended this year to confirm and clarify the broad default power and authority of a member or manager of an LLC to delegate any or all of such member's or manager's rights, powers, and duties to manage and control the business and affairs of an LLC including any core governance functions which would have permitted the special litigation committee. The amendments further made clear that no other provision of the Act shall be construed to restrict such power and authority to delegate.
Matthew: Mike, I would say that this amendment that you just discussed is really the most substantive and the most consequential of the amendments that were enacted this year. It might have been possible to read Obeid is limited to its facts and interpret that decision as a contract-driven case, that is to say it was a decision that turned on the particular language and structure of the relevant LLC agreements.
But given the widespread reliance on a broad interpretation of the default rule in the statute regarding delegation, the clarity that's afforded by this amendment is both important and very helpful and it's also worth noting that the default rule in Obeid for that matter have no bearing on situations where you've got an express grant of authority in the operative agreement with respect to delegation of management rights and powers. So, we're talking about the default rule that was amended and it simply confirms that if the agreement does not provide, otherwise there is expansive ability to delegate then.
Michael: Right, and I also think that goes back to the point of careful drafting in your agreement to accomplish the business terms that the parties want for your particular agreement or governance style.
Michael: So, moving on to the next slide, we'll address a few additional revisions that have been made to the Act related to what entities can participate in fundamental transactions. The Act contains provisions that enable LLCs to enter into a number of fundamental transactions such as mergers, consolidations, domestication, and conversions. The Act was amended this year to confirm the broad scope of such provisions with respect to the type of entity or business that may be involved in these types of transactions.
So let's start with the first type of fundamental transaction that discusses mergers and consolidations. As many of you know, a merger involves an existing entity assimilating one or more other existing entities and a consolidation involves two or more existing entities combining to create a new resulting entity. Each entity that merges or consolidates is a constituent entity. A consolidation likewise involves a minimum of two constituent entities as does a merger.
All such constituent entities, however, cease to exist separately in a consolidation once the consolidation has become effective. They are integrated into the resulting entity which is formed by and commences to exist upon the consolidation. The section 18-209 of the Act addresses comprehensively in a single section, matters related to merger and consolidation of an LLC. By comparison, Delaware's General Corporation Law contains multiple sections regarding these topics and uses comparatively more exact language.
For example, there are separate sections of the DGCL dealing with merger of a Delaware corporation, merger of a Delaware corporation with a Limited Liability Company with another Delaware corporation or even with a partnership. Section 18-209, however, provides that one or more Delaware LLCs may merge or consolidate with or into one or more other Delaware LLCs or other business entities, so the Act offers tremendous flexibility in terms of the non-natural persons with or into which a Delaware LLC make merger or consolidate. And the statute allows the company to merge or consolidate, not only with or into another Delaware LLC, but also with or into another business entity and the term is defined as "another business entity."
So the Act was amended this year to confirm the broad scope of such provisions with respect to the type of business or entity that may be involved in these fundamental transactions. The amendment to section 18-209(a) of the Act related to mergers or consolidations confirms that the term "other business entity" as used in that section includes any incorporated or unincorporated business or entity, whereas before it just referenced a number of different entities but also which only included unincorporated entities. The amendment specifically now has been amended to or . . . sorry, the amendment to this section has been put forth to essentially expand an already expansive list and include incorporated businesses or entities.
Matthew: Right, and that's to eliminate any sort of negative inference from the prior language where the catch-all description of entities or associations with which a Delaware LLC could merge refer to any other unincorporated business or entity, and so, the thought is that by creating that sort of comprehensive catch-all, whether unincorporated or incorporated, we really captured every possibility in the pursuit of the objective of avoiding limitations and enabling and facilitating these sorts of fundamental transactions. I will say that there is a risk notwithstanding everything we just said of reading that sort of language too expansively.
For example, if there were a desire to try to merge a Delaware LLC with a series, and I realize we don't want to get into a discussion of series, that would take a whole other webinar, but if there were an effort to merge a company into a series of another company or another partnership, that simply wouldn't be feasible within the confines of the filing mechanics and provisions of the various acts, including the LLC Acts. So, notwithstanding that, the catch-all for other entities with which Delaware LLC can merge would include any other incorporated or unincorporated business or entity, it is not so broad as to encompass a series of another entity.
Michael: Right, and I think it just confirms the breadth of the intention of the statute for these types of transactions and I would note that similar amendments have been adopted this year for the term "other business entity" with respect to conversions and to the term "non-United States entity" with respect to domestications. Again, adding the term "incorporated" to clarify the broad scope of other business entities that include not only unincorporated businesses or entities but also incorporated.
Matthew: Right, and the whole idea here is that we want there to be maximum, maybe not quite maximum, but very robust transactional flexibility here. We want Delaware LLCs and other business entities to be able to engage in these fundamental transactions, merger, conversion, transfer, consolidation, etc., with and into a wide array of other types of business forms and organizations and jurisdictions for that matter.
Michael: Right, thanks. Moving to our last slide today and really, it's just a notation for the audience today. The Act distinguishes between domestic LLCs and foreign LLCs and a variety of sections of the Act were amended to essentially further clarify and confirm the distinctions between a domestic LLC and a foreign LLC to make a few other conforming changes to just clarify that.
Matthew: Yeah, and those provisions really are just housekeeping changes that were included in the Bill amending the LLC Act this year for purposes of fostering internal consistency within the LLC Act and also to promote clarity.
Anu: And thank you for your patience during the technical difficulties. It's always a pleasure to have you join us and a big thank you to our presenters for your time.
Matthew: Hope it was worth waiting for.
Anu: We hope to see you all again next time.