2019 First State Update

Case Law Developments and Updates to Delaware’s LLC Act

From a global perspective, the Delaware LLC continues to be one of the most popular business entities, in no small part due to the contractual freedom and flexibility afforded under the Delaware Limited Liability Company Act. Join us as we take a detailed look at the 2019 amendments to the Delaware Limited Liability Company Act and review recent case law developments in this complimentary CSC webinar. Inform and advise your clients looking to make the most of Delaware’s limited liability company statute with the most up-to-date information in your repertoire.

Join Christopher N. Kelly, and Michael P. Maxwell of Potter Anderson & Corroon LLP as they share their insights, review associated case law, and discuss this year’s amendments to the Act.

Webinar Transcript:

Disclaimer: Please be advised that this recorded webinar has been edited from its original format, which may have included a product demo. To set up a live demo or to request more information, please complete the form to the right, or if you are currently not on CSC Global, there is a link to the website in the description of this video. Thank you.

Annie: Hello, everyone, and welcome to today's webinar, "First State Update: 2019 Case Law Developments and Updates to Delaware's LLC Act." My name is Annie Triboletti, and I will be your moderator. Joining us today are guest speakers Christopher Kelly and Michael Maxwell of Potter Anderson & Corroon. And with that, let's welcome Chris and Mike.

Chris: Good morning, everyone, and thank you for attending this First State Update webinar on Delaware LLCs, thrown by our great host, CSC, in conjunction with LexisNexis.

My name is Christopher Kelly, and I'm a partner in the Corporate Group at Potter Anderson & Corroon, practicing primarily corporate and alternative entity litigation in the Delaware Court of Chancery. I'm joined by my partner, Mike Maxwell, who's in the Business Group at Potter Anderson and who, among other things, advises clients on Delaware corporate and alternative entity law and transactions involving Delaware entities. Regrettably, our partner, Matt O'Toole, coauthor of the treatise "Symonds & O'Toole on Delaware Limited Liability Companies" published by CSC/LexisNexis, couldn't be here today, so it'll just be Mike and me.

As we've done in the past, I'll lead off with an overview of recent case law developments involving Delaware LLCs, and then Mike will jump in and discuss the latest updates to Delaware's LLC Act.

The three cases we'll look at today are appellate decisions by the Delaware Supreme Court addressing implied covenant of good faith and fair dealing, alleged breaches of LLC agreements, and related issues with contract interpretation as well as contractual fiduciary duties.

Let's turn to our first case today, the Oxbow Carbon case. Note that lawyers in our firm were involved in the case, but not us. The statements today solely are based on a review of the court opinions and are my views alone and not the views of the firm, any of the other firm lawyers, or any firm client. The same goes for the rest of the webinar.

This dispute centered on Oxbow Carbon LLC, who I'll refer to as Oxbow or the company, and the desire of certain minority members to force an exit sale of the company under Oxbow's LLC agreement. The minorities members' claim to compel an exit sale followed their exercise of a put right and the company's rejection thereof.

The LLC agreement contained a number of requirements for an exit sale to occur, including that it must exceed the fair market value of the company, may not require any other member to engage in an exit sale unless the resulting proceeds to every member, when combined with all prior distributions, equaled at least 1.5 times the member's aggregate capital contributions, and must apply the same terms and conditions to Oxbow's members. So those are the fair market value requirement, the 1.5 times capital contribution requirement, and then an equal treatment requirement.

After commencing a sale process, Oxbow received a letter of intent from a third party that valued the company at $177 per unit, an amount that exceeded the company's fair market value as defined in the LLC agreement. The parties, however, disagreed whether the terms of the third party's offer satisfied the other exit sale requirements under the LLC agreement, ultimately leading to litigation.

In the litigation, the central question was whether an exit sale could proceed notwithstanding the fact that the third party's bid did not satisfy the 1.5 times requirement as to two small investors who were affiliated with the majority member and who invested in Oxbow 4 years after it was organized at a price of $300 per unit. The small holders held approximately 1.4% of the company's equity.

The majority member argued that an exit sale could not proceed unless all exit sale requirements were met, i.e., that all members participated, that the consideration paid exceeded fair market value, that each member received at least 1.5 times its capital contributions, and that all members were offered the same terms and conditions, which would require consideration of $414 per unit. The highest amount interpretation was the coined term in the opinion. Given then market conditions, that price appeared unlikely.

The minority members, in contrast, argued that the third-party bid satisfied the exit sale requirements because, one, the small holders could be left behind — that was what was referred to as the leave behind theory — or a top off payment could be paid to the small holders in addition to the exit sale consideration, such that the small holders received 1.5 times their capital contributions. That's what was referred to as the top off option or the seller top off.

The Court of Chancery ultimately rejected the leave behind theory, finding that the plain language of the LLC agreement foreclosed that interpretation. Trial court next determined that, when read together with the equal treatment requirement, the 1.5 times clause called for reading the LLC agreement to implement the highest amount interpretation, and, therefore, the highest amount interpretation was the only reading that gave effect to the LLC agreement as a whole.

Despite finding that the highest amount interpretation reflected a plain reading of the LLC agreement, the trial court found that it produced an extreme and unforeseen result because of the failure to address the small holders' rights when the company admitted them. According to the Court of Chancery, issues of compelling fairness called for deploying the implied covenant to fill the gap created when the company admitted the small holders because, without it, the fortuitous admission of the small holders gutted the exit sale right.

In applying the implied covenant, the trial court determined that the parties intentionally left a gap in the provision in the LLC agreement governing admission of new members, which left it to the board to determine the terms and conditions for admission of new members. The Court of Chancery found that the majority member created a gap regarding the terms on which the small holders became members because the board never established the terms of their admission in 2011.

Having determined that a gap existed, the trial court held that the top off option should be implied to fill that gap. The trial court reasoned that if the parties addressed the issue and the small holders were issued units in the company, the minority members never would have consented to admitting the small holders if they had understood that the admission would reset the 1.5 times clause and that the majority member would not have insisted on the highest amount interpretation. Rather, the trial court found that the most likely outcome is that the parties would have agreed to a seller top off.

Because the trial court found that the top off option was viable and because the third-party letter of intent otherwise satisfied the requirements for an exit sale, the trial court ruled that the transaction that the minority members had secured met the requirements for an exit sale. Following supplemental briefing on the appropriate remedy, the trial court awarded a decree of specific performance that the parties complete the exit sale process initiated by the minority members.

On appeal, the Supreme Court affirmed in part, reversed in part, and vacated in part in the unanimous en banc decision. Pertinently, the Supreme Court held that the trial court correctly interpreted the operating agreement but erred in finding a contractual gap concerning the admission of the small holders and in applying a seller top off through the implied covenant.

The Supreme Court agreed with the trial court that the highest amount interpretation was the only reading of the LLC agreement that gave meaning to all of the exit sale requirements. But the Supreme Court parted ways with the Court of Chancery and its application of the implied covenant, holding that the trial court erred in finding that a gap existed in the LLC agreement relating to the terms on which the small holders became members.

The Supreme Court found that the record showed that the board admitted the small holders without imposing a different set of rights. The Supreme Court found that the LLC agreement delegated responsibility to the board to set the terms of admission and permitted but did not require the board to issue units with different rights and classes. Thus, absent the imposition of different rights, the newly admitted members would have the same rights as all members.

In addition, the Supreme Court noted that it's declined in other cases to imply new contact terms merely because the contract grants discretion to a board of directors and that such a granted discretion is more appropriately viewed as a contractual choice and not a gap.

Further, the Supreme Court found that there was no argument that the board had exercised its discretion in bad faith in admitting the new members, and, at the time of contracting, the parties expressly contemplated that new members could be admitted later on. Thus, no gap existed for the implied covenant to fulfill, and the court concluded by reiterating that the implied covenant should not be used as an equitable remedy for rebalancing economic interests, particularly where, as here, the parties were sophisticated businesspersons and entities.

Our next case today is the Leaf Invenergy case, which primarily involved the issue of a company's breach of a requirement in its LLC agreement that it first obtain the plaintiff member's consent to a substantial asset sale or else redeem the member's interest in the company for a specified target multiple of its capital investment.

By way of background, in 2008, Invenergy was raising money in a Series B investment round, and Leaf invested $30 million in Series B notes. The note agreement gave Leaf and other noteholders the right to convert the equity, and the note agreement incorporated an LLC agreement that the noteholders and Invenergy would execute on conversion. Both the note agreement and the Incorporated LLC agreement contained provisions prohibiting Invenergy from conducting what was defined as a material partial sale, which referred to, for our purposes, the sale of a significant portion of Invenergy's assets without obtaining Leaf's consent or else Invenergy was required to pay Leaf a target multiple of its capital investment.

In late 2014, Invenergy began to explore an asset sale but did not want to have to obtain Leaf's consent or pay it the target multiple. Invenergy tried to keep Leaf in the dark, but Leaf soon discovered that Invenergy was considering an asset sale, and, in June 2015, Leaf exercised its right to convert its notes into equity. Invenergy, however, did not complete the conversion and instead sought regulatory approval for it.

Then, in early July, Invenergy and TerraForm, the buyer, executed a purchase agreement pursuant to which TerraForm would buy a material portion of Invenergy's assets. Although Invenergy rushed to finalize the TerraForm deal, according to the Supreme Court, it dragged its feet when it came to completing Leaf's conversion from the notes to equity. Leaf was not admitted as a member of the LLC until late September. Then, in December 2015, Invenergy and TerraForm entered into an amended and restated purchase agreement, and they closed the deal the next day. Invenergy did not receive Leaf's consent to the transaction, nor did Invenergy pay Leaf the target multiple.

In an initial ruling, the Court of Chancery found that Invenergy breached the LLC agreement by not obtaining Leaf's consent or paying Leaf the target multiple. The trial court held that the operative time for determining Leaf's status as a member was at closing, and, in the alternative, Leaf was still a member prior to the signing of the amended and restated purchase agreement.

After that ruling on liability, Leaf sought final judgment in its favor in the amount of the target multiple, which Leaf calculated as $126 million. In response, Invenergy claimed that Leaf was not entitled to any damages because the asset sale hadn't harmed Leaf.

In a post-trial decision, the Court of Chancery agreed with Invenergy and held that Leaf had failed to prove actual damages. This was despite the contemporaneous record evidence showing that all the parties to the LLC agreement understood that Leaf would receive its target multiple if Invenergy conducted a material partial sale, such as the sale to TerraForm, without Leaf's consent. The trial court awarded Leaf $1 as nominal damages.

On appeal, the en banc Supreme Court reversed and awarded Leaf the target multiple. The Supreme Court rejected the trial court's interpretation of the LLC agreement that payment of the target multiple in the absence of Leaf's consent was not a contractual obligation but simply an exception to Invenergy's need to obtain Leaf's consent. The Supreme Court observed that the way the trial court had interpreted the LLC agreement would mean that Leaf's consent rights would simply vanish upon Invenergy's election to ignore it without any consequence.

Instead, the Supreme Court held that the LLC agreement unambiguously required Invenergy to pay Leaf the target multiple if it conducted a material partial sale without obtaining Leaf's consent. Because Invenergy conducted a non-consensual material partial sale, the Supreme Court ruled that the calculation of Leaf's damages was simple. It was entitled to the target multiple.

The Supreme Court also stated that the trial court ignored the contractual expectations of the parties in determining damages, erring in deciding that a hypothetical negotiation was the framework for analyzing Leaf's damages. The Supreme Court explained that the trial court's analysis failed to consider the entirety of Invenergy's breach, because Invenergy's breach was only complete when it failed to obtain Leaf's consent and when it failed to pay the target multiple. The trial court's damages analysis, however, only focused on the former and not both.

Considering the breach as a whole, the Supreme Court concluded that what would most aptly repair that breach is Invenergy's payment, now in satisfaction of the damages award, of the amount it agreed to pay for the right to engage in a material partial sale without Leaf's consent. Accordingly, the Supreme Court awarded Leaf the target multiple as contractual damages on condition that it surrender its membership interests in the company.

Turning to our third case of the day, the Shorenstein Hays-Nederlander Theatres Appeals, this case has a lengthy procedural background, but the principal issue in the trial court and in this appellate decision was whether one of the two members of a 50-50-owned theater partnership, Shorenstein Hays-Nederlander Theatres, which was organized as an LLC, could stage competitive theater productions.

SHN began in the 1970s in San Francisco to stage productions in theaters in the city, including the Curran Theatre, which SHN had leased since the beginning of the partnership. In 2000, SHN was converted to a Delaware LLC. At the times relevant to the case, SHN was owned 50-50 by 2 members — Nederlander and CSH. In 2010, the CSH affiliate purchased the Curran and, in 2014, did not extend the lease with SHN when it expired. Thereafter, CSH's owners, the Hayses, began staging productions at the Curran.

In early 2014, CSH sued Nederlander in the Court of Chancery for a declaratory judgment that it had no legal obligation to renew the Curran lease. Nederlander asserted counterclaims against CSH and third-party claims against the Hayses for breaches of fiduciary and contractual obligations among other things.

The litigation implicated several provisions of the governing LLC agreement, including a provision by which the member entities agreed to devote their efforts to maximize the economic success of the company and avoid conflicts of interest, a provision that generally prohibited member entities from staging any production they controlled within 100 miles of San Francisco and a provision that authorized the parties' general ability to engage in non-SHN business.

In July 2018, the Court of Chancery issued an opinion that there was no enforceable promise to renew the lease, that CSH did not breach the LLC agreement, and that the Hayses breached their common-law fiduciary duties of loyalty.

Then, in September of 2018, Nederlander sought a preliminary injunction in the Court of Chancery against CSH and the Hayses to prevent them from staging productions at the Curran based on breach of contractual fiduciary duties owed to SHN and its members under the LLC agreement. The trial court denied the injunction, and an appeal followed.

The Supreme Court affirmed in part and reversed in part. Pertinently, the Supreme Court held that the trial court misinterpreted the LLC agreement and ruled that the Hayses cannot stage competitive productions at the Curran that violate their contractual duty to maximize SHN's economic success. Accordingly, the court reversed that aspect of the Court of Chancery's decision.

The Supreme Court first held that the LLC agreement provision that restricted members from competing with SHN also covered affiliates of members. Thus, CSH affiliates were bound by the contractual restriction in the LLC agreement. The court explained that permitted transferees was defined as "an affiliate of any member" and not an affiliate of any member who has received or will receive transferred membership interests. And thus, the restriction was not contingent on a transfer of interests. The court further reasoned that limiting the restriction to only members would do nothing to limit competition because either member could simply set up a shell entity down the street to the other theaters and then compete with SHN.

The Supreme Court next found that the trial court misinterpreted the LLC agreement provision that required members to devote their efforts to maximizing SHN's economic success. The Supreme Court interpreted that provision as imposing a contractual duty on SHN's members and their affiliates to refrain from competitive activities that would undermine SHN's economic success or give rise to conflicts of interest between the members. The Supreme Court viewed the LLC agreement provision permitting outside business activities as saying nothing about the right to compete against SHN, and, therefore, CSH could not itself or through affiliates use the Curran to compete with SHN as such competition would not maximize SHN's economic success.

Lastly, the Supreme Court agreed with the Court of Chancery that Nederlander failed to show a likelihood of success that CSH or the Hayses breached the LLC agreement provision prohibiting staging of controlled productions because CSH and the Hayses did not have the right or the authority to cause productions to play at the Curran Theatre or to set the terms thereof, which were negotiated with the producers of the plays in question, who negotiated with multiple other venues. Rather, the CSH affiliate and the Hayses were mere lessors of the Curran Theatre as to those particular plays and lacked control of the productions.

With that, I'll turn it over to Mike to talk about the legislative updates to the Delaware LLC Act.

Mike: Thanks, Chris. Good morning. So as Chris mentioned, we'll now discuss recent amendments to the LLC Act. So we're now going to turn our attention to the recent amendments to the Delaware LLC Act.

Now the amendments enacted this year were not nearly as extensive as those that were enacted last year, and many of the amendments this year focus on the additional revisions to some of those amendments that were adopted last year, including updates to the newly effective series provisions as well as to the concept of division. This year, additionally, a new section was added to the Act to address electronic signatures and delivery of documents. The amendments adopted this year by the legislature became effective August 1, 2019.

Let's turn first to registered agent resignations. So Sections 18-104(c) and (d) of the LLC Act provide circumstances in which a registered agent may resign. Specifically, Section 18-104(d) provides circumstances in which a registered agent may resign when there's not another registered agent appointed in its place.

Whenever a Delaware LLC's registered agent resigns and does not appoint a successor, the Act provides that the effectiveness of the resignation is delayed until 30 days after the certificate of resignation is final. Now these delay periods are intended to afford a reasonable amount of time to remedy the resignation through the appointment of a successor registered agent and to avoid the negative consequences that could result from a failure to do so.

This year, Section 18-104(d) of the Act has been amended to provide that the registered agent of the LLC, including one whose certificate of formation has been canceled pursuant to Section 18-1108 of the Act, which is a failure to pay annual tax, may resign without appointing a successor registered agent by filing a certificate of resignation. So it's just some clarification around the circumstances when a registered agent may resign in that context, specifically if the certificate of formation has been canceled pursuant to 18-1108.

The amendment also adds requirements regarding the content and form of such a certificate, that is a certificate of resignation. Typically, a resignation requires the filing of a certificate of resignation with the Delaware Secretary of State. As I discussed before, it's effective 30 days after the certificate is filed, and it contains a statement that a written notice of resignation was given to the LLC at least 30 days prior to the filing of the certificate by mailing or delivering such notice to the LLC at its address last known to the registered agent, and it must set forth the date of such notice. Now the Act was amended this year to provide that the requirements of such certificate must also include information that was last provided to the registered agent regarding an LLC's communications contact, and the amendments provide that such information will not be deemed public.

Just by way of reminding everyone what a communications contact is or the information that's required for that, it's information required under Section 18-104(g), which includes the name, email address, business address — which means no P.O. boxes — and business telephone number of someone at the company, a member or manager that can act for the company and provide the information that a registered agent provides to the company.

Finally, a certificate filed pursuant to Section 18-104(d) must be on the form prescribed by the Delaware Secretary of State.

Moving on to electronic signatures and delivery of documents, the amendments to the Act this year include the addition of provisions relating to the execution of documents by electronic signature and the delivery of documents by electronic transmission.

A new Section 18-113 has been added to the Act establishing non-exclusive safe harbor methods to reduce certain acts or transactions to a written or electronic document and to sign and deliver a document manually or electronically. Specifically, any act or transaction contemplated or governed by the LLC Act or an LLC agreement may be provided for in a document, and an electronic transmission will be deemed the equivalent of a written document.

New Section 18-113(a) permits LLC transactions, such as entering into an agreement of merger that's not filed with the Delaware Secretary of State, to be documented, signed, and delivered through DocuSign and similar electronic means. These safe harbor provisions apply solely for the purposes of determining whether an act or transaction has been documented and whether a document has been signed and delivered in accordance with the LLC Act and the LLC agreement.

Now along with this new provision, new terms "document" and "electronic transmission" were added to the Act as well. The term "document" is defined to mean any tangible medium on which information is inscribed and includes handwritten, typed, printed, or similar instruments and copies of such instruments, and, two, an electronic transmission.

The term "electronic transmission" is defined as any form of communication not directly involving the physical transmission of paper, including the use of or participation in one or more electronic networks or databases, including one or more distributed electronic networks or databases, i.e. blockchain, that creates a record that may be retained, retrieved, and reviewed by a recipient thereof and that may be directly reproduced in paper form by such a recipient through an automated process.

So whenever the LLC Act or an LLC agreement requires or permits a signature, an electronic signature will be a permissible mode of executing a document. An electronic signature is defined as an electronic symbol or process that is attached to or logically associated with a document and executed or adopted by a person with an intent to authenticate or adopt the document.

These provisions further provide that, unless otherwise provided in an LLC agreement or agreed to between the sender and recipient, an electronic transmission is delivered to a person at the time it enters an information processing system that the person has designated for the purpose of receiving electronic transmissions of the type delivered as long as the electronic transmission is in a form capable of being processed by that system and the person is able to retrieve it.

Furthermore, Section 18-113(a) does not prohibit the conduct of a transaction in accordance with the Delaware Uniform Electronic Transactions Act so long as the parties to the transaction that are governed by the LLC Act or parts of the transaction are documented, signed, and delivered in accordance with Section 113(a) or otherwise in accordance with the LLC Act. Section 113(a) also does not preempt any statute of frauds or other law that might require actions to be documented or documents to be signed or delivered in a specified manner. In particular, they're thinking of real estate transactions in that context.

Moving on through the new sections, Section 18-113(b) enumerates specifically certain documents and actions that are not governed by section 18-113(a). These include a document filed with or submitted to the Delaware Secretary of State, the Register in Chancery, or a court or other judicial or governmental body of the State of Delaware, a certificate of limited liability company interests or partnership interests — when I speak of a certificate of LLC interest or partnership interest, those are certificates that represent such LLC interests or partnership interests — nor will it govern acts or transactions effected pursuant to respective provisions of the LLC Act relating to the requirements to maintain a registered office or registered agent in the State of Delaware, service of process, foreign entities, or derivative actions.

113(b) also provides that it does not create any presumption that such excluded items are prohibited from being effected by electronic or other means. Even though they're excluded, it's not intended to create a presumption that these are prohibited from being effected by electronic or other means pursuant to other statutes or other law. If an exclusion applies, however, 18-113 may not be relied on as a basis for documenting an act or transaction or signing or delivering a document.

Now a limited liability company agreement may limit the application of Section 113(a) by expressly restricting one or more of the statutorily permitted means of documenting an act or transaction or signing or delivering a document. That said, a provision of the LLC agreement providing only that an act or transaction will be documented in writing or that a document will be signed or delivered manually will not preclude the application of Section 113(a). A prohibition, to the extent that you want it to be effective to prohibit application of 113(a), should be expressed and must expressly limit the means of documenting an act or transaction expressly set forth in 113(a).

Moving on to Section 113(c), 113(c) addresses the interaction between the Act — the LLC Act, that is — and the federal Electronic Signatures in Global and National Commerce Act, commonly known as the eSign Act, evidencing an intent the LLC Act govern the documentation of actions and the signature and delivery of documents to the fullest extent permitted by Sections 7002(a)(2) of the eSign Act.

In general, the eSign Act provides that with respect to a transaction in or affecting interstate or foreign commerce and subject to specified exceptions and limitations, signature, contract, or other records relating to the transaction may not be denied legal effect, validity, or enforceability solely because it's in electronic form, and a contract relating to such transaction may not be denied legal effect, validity, or enforceability solely because an electronic signature or an electronic record was used in its formation.

Specifically, section 7002(a)(2) of the eSign Act provides that a state statute, regulation, or other rule of law may modify, limit, or supersede the provisions of Section 7001 of the eSign Act with respect to state law only if such statute, regulation, or rule of law, (A) specifies the alternative procedures or requirements for the use or acceptance or both of electronic records or electronic signatures to establish the legal effect, validity, or enforceability of contracts or other records if, (i), such alternative procedures or requirements are consistent with Subchapters 1 and 2 of the eSign Act and, (ii), such alternative procedures or requirements do not require or accord greater legal status or effect to the implementation or application of a specific technology or technical specification for performing the functions of creating, storing, generating, receiving, communicating, or authenticating electronic records or electronic signatures, and (B), if enacted or adopted after June 30, 2000, makes specific reference to the eSign Act.

That's a mouthful [inaudible 00:34:07] the statute there. Essentially, the provisions of Section 113 expressly confirm an intent to allow the LLC Act to govern the documentation of actions and the signature and delivery of documents to the fullest extent that the LLC Act is not preempted by the eSign Act.

With that, we'll move on to contractual appraisal rights. The LLC Act currently contemplates that contractual appraisal rights may be provided with respect to an LLC interest or another interest in a Delaware LLC in connection with any amendment of an LLC agreement, any merger or consolidation in which an LLC is a constituent party, any conversion of an LLC to another business form, any transfer to or domestication or continuance in any jurisdiction by an LLC, or a sale of all or substantially all of an LLC's assets. Now notably, these are rights that must be contractually provided in an LLC agreement or an agreement or plan of merger or consolidation. These are not default appraisal rights that you might find in the DGCL. So for appraisal rights to apply in the context of an LLC, they have to be contractually provided.

Section 18-210 has been amended this year to provide that contractual appraisal rights may also be available in connection with any division of a limited liability company as well as any merger or consolidation in which a registered series is a constituent party, any conversion of a protected series to a registered series of such LLC, and any conversion of a registered series to a protected series of such LLC.

Now we'll talk a little bit more about series later in this presentation, but suffice it to say for now, it's worth recalling that conversion and mergers of registered and protected series must be accomplished within the same LLC. So this concept of appraisal rights would apply with respect to those limited transactions as well as expanding it to this concept of division that was enacted last year.

Speaking of division, we're next going to talk about some amendments adopted this year related to divisions. In that regard, I think it makes sense to review generally the concept of division that was adopted last year as it is still a fairly new concept that practitioners are adapting to and getting used to.

As you may recall, Section 18-217 was added to the Act last year to permit a Delaware LLC to divide into two or more separate and distinct LLCs. Now this enables LLCs with various assets to separate the assets apart, similar to what you'd call maybe a reverse merger. Unlike a classic asset transfer to another entity, it allows an LLC to be split apart into smaller, freestanding LLCs according to a plan of division adopted by the original LLC. Now the law does not require identical ownership or management. By design, pools of assets can be reduced into smaller pools without needing to transfer assets out of the LLC.

Now a division is effected pursuant to the adoption of a plan of division and a filing with the Secretary of State of a certificate of division and a certificate of formation for each new LLC formed pursuant to the division.

Now whether or not an LLC can be divided is subject to its LLC operating agreement. If the LLC agreement of a dividing company specifies the manner of adopting a plan of division, a plan of division shall be adopted as specified in the LLC agreement. If the LLC agreement is silent, then the manner of adopting a plan of division is the same vote for authorizing a merger, assuming that a division is not expressly prohibited in the LLC agreement. Now if the LLC agreement is silent on what it takes to adopt or authorize a merger, then a division is authorized by holders of over 50% of the LLC interests, essentially 50% of the majority of the profits interest.

When an LLC decides to divide, the amendments adopted effective this year make clear that the dividing LLC must file a certificate of division and a certificate of formation with the Secretary of State. Previously, there were some general references to a dividing LLC or a division company generally, and the statutes as part of the amendments this year make clear that the dividing LLC is the one that will file the certificate of division.

The original LLC has the option to either continue its existence or terminate as a result of the division. Now following a division, each division LLC will be liable for the debts, liabilities, and duties of the original dividing LLC as are allocated to it pursuant to the plan of division, and no other division LLC will be liable for such obligations unless the plan of division constitutes a fraudulent transfer under applicable law. And if any allocation of assets or liabilities is determined by a court of competent jurisdiction to constitute a fraudulent transfer, each division LLC will be jointly and severally liable on account of such fraudulent transfer. The debts and liabilities of the original dividing LLC that are not allocated by the plan of division will be the joint and several debts and liabilities of all division LLCs.

With that general background in mind about the concept of division and how it works again at a high level, amendments to Section 18-217, the division provision of the LLC Act, address various matters related to division. These include clarification in amended Section 18-217(b) that obligations and liabilities of a dividing company will be allocated to and enforceable against the division company or companies to which such obligations and liabilities have been allocated pursuant to the plan of division. Again, I believe this was the intent all along, but this has just been clarified in 18-217(b).

Also, as discussed previously, the addition of a provision in Section 18-217(h) that the certificate of division shall be executed on behalf of and filed by the dividing company, a revision to that provision.

Additionally, there was clarification and confirmation in Section 18-217(l)(9) providing that Section 18-217(l)(4) is operative even though a pending action or proceeding may be continued against the surviving company as if the division did not occur. But recall that 18-217(l)(4) provides that each of the debts, liabilities, and duties of the dividing company shall, without further action, be allocated to and be the debts, liabilities, and duties of such division company as is specified in the plan of division as having such debts, liabilities, and duties allocated to it in such a manner and basis and with such effect as is specified in the plan of division, and no other division company shall be liable therefore so long as the plan of division does not constitute a fraudulent transfer under applicable law, and all liens upon any properties of the dividing company shall be preserved unimpaired, and all debts, liabilities, and duties of the dividing company shall remain attached to the division company to which such debts, liabilities, and duties have been allocated in the plan of division and may be enforced against such division company to the same extent that if said debts, liabilities, and duties had originally been incurred or contracted by it in its capacity as a domestic limited liability company.

So really this amendment is just clarifying that any action or proceeding pending against the dividing company may be continued against the surviving company as if the division did not occur, but it will be subject to the allocation of debts, liabilities, and duties to a division company provided in Section (l)(4) that we just discussed.

In connection with the revisions just discussed regarding division, an additional amendment was adopted this year to Section 18-301. While not amending Section 18-217, which expressly deals with division, 18-301 was amended, which deals with admission of members in connection with a division, so some clarifying changes to this section.

The new Subsection (4) was added to section 18-301(b) of the LLC Act to clarify the mechanics for the admission of a member to a division company or to an LLC that is not a division company in a division. If a person is being admitted as a member of a division company pursuant to a division, that admission would occur as provided in the LLC agreement of such division company or in the plan of division, and, in the event of any inconsistency, the terms that the plan of division shall control. Now note that this is similar to the approach taken in 18-301 with respect to mergers as well, where the merger agreement can control the LLC agreement with respect to admission of a member. Now in the case of a person being admitted as a member of an LLC pursuant to a division in which such LLC is not a division company in the division, then the admission will occur as provided in the LLC agreement of such LLC.

Now we're next going to turn to amendments to the series provisions of the LLC Act. Again, as we did with division, I think it may be helpful for a short review regarding series LLCs generally.

You might recall that Section 18-215 was added to the LLC Act I think roughly around 1996 and provided that an LLC may establish or provide for one or more series of members, managers, LLC interests, or assets.

Now a series is essentially an internal cell within an LLC that may have a separate business purpose or an investment objective and separate rights, powers, and duties with respect to specified assets and liabilities of the LLC. A goal of setting up a series LLC is generally to have interseries liability protections. This means that the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to a series shall be enforceable against the assets of that series only and not against the assets of the LLC generally or any other series thereof. Additionally, none of the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to the LLC generally or any other series shall be enforceable against the assets of such series.

This provides for concepts similar to as if there were a number of separate LLCs under one LLC, but they are not separate legal entities. Although a series of members, interests, or assets that complies with 18-215(b) is not a separate legal entity, that series will be treated in many important respects as if it were a separate LLC. If properly structured and implemented, a series of members, LLC interests, or assets under the LLC Act may possess further attributes that under the statute pertain uniquely to series and that offer to business organizers and planners benefits that are relatively novel.

With that general background in mind, recall that last year, in 2018, the LLC Act was amended to provide for the concept of protected and registered series. Now these provisions, while adopted last year by the legislature, took effect and became effective just this year on August 1, 2019. Again, I think it's helpful to review these concepts.

As part of these amendments, a new definition of series was added to the LLC Act so that the term "series" refers to a designated series of members, managers, LLC interests, or assets which may but need not be a protected series or a registered series.

What do we mean by protected series or registered series? A protected series is a designated series of members, managers, LLC interests, or assets established in accordance with 18-215(b). So in effect, this provision in conjunction with the revisions to Section 18-215 essentially changes the nomenclature used to refer to series established in accordance with 18-215(b) as we discussed previously. Thus, a protected series is a series established in accordance with 18-215 with a few significant updates.

First, 18-215(b) expressly provides that a member or manager of a protected series shall not have personal liability for debts, obligations, or liabilities of a protected series solely by reason of being a member thereof or acting as a manager thereof. Additionally, section 18-215(b)(12) was added to provide that, irrespective of the number of members or managers of a protected series, a protected series is an association for all purposes of Delaware law, including the Delaware UCC. This helps with some of the financing UCC issues that series previously encountered.

Now a new concept of registered series was added to the LLC Act with the addition of section 18-218. A registered series has the same rights and powers and the same interseries limitation on liability as a protected series established in accordance with section 18-215(b). It is also an association under Delaware law.

However, the registered series is distinct in other ways, including in how it's formed. A registered series is formed by the filing of a certificate of registered series with the Delaware Secretary of State, and, accordingly, a registered series qualifies not only as an association but also as a registered organization under the Delaware UCC, again addressing some of the financing and UCC-related issues as to whether a series can be a debtor, in debt, and take on debt in lending transactions.

Now just quickly to recap, Section 18-219 was added last year and became effective this year to address conversion of a protected series to a registered series of the same LLC, as we previously discussed.

Section 18-220 was added and addresses conversion of a registered series to a protected series of the same LLC, and Section 18-221 was added and addresses the merger and consolidation of one or more registered series with or into one or more registered series again of the same LLC. Just a reminder, these provisions were adopted last year and became effective August 1st of this year.

Now this year, the 2019 amendments to the Act were adopted and became effective August 1st as well. These further address certain matters relating to protected series and registered series, building on these 2018 amendments that substantially revise the LLC Act's treatment of series.

Now ion 18-101(12) and (13) of the LLC Act were amended this year to confirm that the definition of a manager includes a manager of the LLC generally and a manager associated with a series of the LLC and the definition of "member" includes a member of the LLC generally and a member associated with a series of the LLC.

Further, Section 18-215(b) has been amended to provide that, with respect to protected series, neither the limited liability company agreement nor the certificate of formation, with respect to its notice of limitation on liabilities of a protected series — again, a formality required in the certificate of formation with respect to protected series — the Act was amended this year to provide that neither of those — the LLC agreement or the certificate of formation — must refer to Section 18-215 of the Act or use the term "protected" when referencing series. So long as you comply with the formalities of 18-215 in creating a protected series, you don't have to expressly reference 215 or protected to create a protected series. Again, a clarification, I believe.

Further, amendments to Sections 18-218, 18-219, and 18-220 and 221 of the Act were adopted to make, really, just technical changes regarding certain certificates filed with respect to registered series or protected series, such as certificates of amendment, certificates of merger, or certificates of conversion.

Recall that a registered series may be issued a certificate of good standing. That's again one of those unique characteristics of a registered series. When you file a certificate of registered series and follow those formalities, the possibility exists for a registered series to be issued a certificate of good standing.

This year, an amendment was adopted to Section 18-1107(n) clarifying and confirming that a protected series or a registered series of an LLC is not liable for the debts, obligations, or liabilities of the LLC or any other series thereof solely by reason of another series' neglect, refusal, or failure to pay an annual tax or ceasing to be in good standing.

With that, we are finished with the primary area of our presentation.

Chris: Right. Now we'll take a look at anyone's questions and talk about some key takeaways from today. So from the three cases that we discussed, the overarching points to be focused on is that Delaware is a contractarian in state and that LLCs are fundamentally creatures of contract. The Delaware LLC Act is intended to give maximum effect to the principle of freedom of contract, and that's exemplified in all of the decisions we looked at today.

For example, in the Oxbow case, the key takeaway is that the implied covenant will not override the express terms of the contract. The implied covenant is applied cautiously as a narrow gap filler, and it's rarely invoked successfully. It can't be used to save a party from a bad deal. So while it's ever-present in every contract under Delaware law, it's limited and narrow in application.

So how about the Leaf Invenergy case? What's the key takeaway from that one? Well, while it's an LLC case, it's to my memory one of the only or first wins for what, in essence, was a preferred stockholder in Delaware in recent years.

A line of cases in the last several years, such as Thoughtworks, TradingScreen, ODN Holdings, they suggested that contract rights of preferred investors may not be ironclad, and those cases even could be viewed by some as suggesting that boards can breach preferred investor contract rights with little consequence. The Supreme Court's decision in Leaf Invenergy, however, indicates that there can be meaningful consequences in the form of a significant damages award from a company's breach of contractual covenants, such as, in that case, a redemption obligation where consent was not obtained from the investor in favor of preferred investors.

And what about the Shorenstein Hays-Nederlander Theatres case? Well, the key takeaway from that is the fundamental proposition that goes back, was well-established in Delaware law that fiduciaries cannot compete against the entity and that doing so very likely will violate the duty of loyalty, be it a common-law duty of loyalty or a contractual duty of loyalty, like the one in SHN's LLC agreement. Of course, LLC agreements are contracts and can have bespoke features and provisions, so the language in the particular LLC agreement is key. But as a general matter, competing against the entity that you're a fiduciary of would very likely be a duty of loyalty breach.

To the extent that LLC planners wish to eliminate fiduciaries duties, Delaware law affords the parties to an LLC agreement wide latitude as to the use of clear and unambiguous language. That's Section 18-1101(c) that allows drafters to expand, restrict, or eliminate fiduciary duties. Then there's 18-1101(e), which allows drafters of LLC agreements to leave duties in place but eliminate or limit monetary liability for breaches.

So those are some of the key takeaways from the three cases we looked at. I'll turn it over to Mike for one of the key takeaways from the statutory amendments.

Mike: As we discussed, the statutory amendments were not extensive this year. You know, we did adopt the electronic signatures and documentation provisions. But I think, overall, again as Chris mentioned, the policy of the LLC Act is freedom of contract and enforceability of the parties' LLC agreements. I think the amendments, to me, even though they're not extensive this year, just are further evidence of Delaware's overarching goal of making the LLC Act as current as possible and as user friendly for businesses and members and managers and the constituent parties.

Now a couple notes on division. Division is a new concept where it still requires, I think, a better understanding of how those provisions work. But with respect to lenders and commercial transactions dealing with LLCs, I think division requires vigilance in reviewing loan documents and organizational documents of LLCs when you're dealing with financing and really just understanding to the extent that you do not want a division to be effective. There are some safe harbor provisions that we didn't get into in detail under the division statute, but you really want to make sure that your loan documents are updated or organizational restrictions to the extent you're using single-lender LLCs or other LLC lenders or making [comments 00:57:41] to LLC agreements, making sure that those address the concept of division.

Finally, with respect to the series, treatment of series still has a lot of questions outstanding, but with the amendments to the statutes, including those this year making further adjustments, I think we're getting close to the solutions that will allow these to be more widely used. It's a registered organization under the Uniform Commercial Code, which helps with LLCs being debtors in financings.

As series become more popular, then interseries liability protections will likely be respected by other jurisdictions, and bankruptcy laws may develop to permit a filing by a single series without putting the LLC or other series in bankruptcy. Again, bankruptcy is another one of those areas of the law that we don't know how a series would be treated. But many states have now adopted series provisions, and a Uniform Protected Series Act was adopted and is being considered by a number of jurisdictions.

I think in Delaware the amendments really reflect that it's modernized its provisions to allow for the proliferation of series as soon as these problems are eliminated. Again, there are issues, but I think we're moving ever closer to the resolution of those.