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FIRST STATE UPDATE: 2023 CASE LAW DEVELOPMENTS AND UPDATES TO DELAWARE’S LLC ACT

The Delaware limited liability company (LLC) continues to be one of the most popular business entities globally, in no small part due to the contractual freedom and flexibility afforded under the Delaware Limited Liability Company Act.

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Join us as we take a detailed look at the 2023 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 LLC statute with the most up-to-date information in your repertoire.

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: 2023 Case Law Developments and Updates to Delaware LLC Act." My name is Annie Triboletti, and I will be your moderator.

So joining us today are guest speakers Matthew O'Toole, Michael Maxwell, and Alyssa Frank from Potter Anderson & Corroon. So with that, I'd like to welcome Matt, Mike, and Alyssa.

Matt: Thank you, Annie. Good morning, everyone. We're happy to be here presenting this Delaware LLC update program once again.

The last few years we've done this program we've included a brief overview of caseload statistics from the Delaware Court of Chancery at the outset, and we think this is helpful to provide some context, especially for the portion of the program that provides a summary of case law developments. An understanding of the volume of work done by the Chancery Court really highlights the fact that our discussion here is entirely summary in nature. There are so many case decisions coming out of the Court we can't possibly cover all of them in an hour. So what you'll hear from Mike Maxwell shortly is truly a summary of case law developments.

Also, for me personally, the statistics put a point on the workload that's borne by the members of the Court, their clerks, and other court personnel. And it's nice to have an opportunity such as this to express appreciation and gratitude for the continuing high caliber of the Court's performance.

The caseload statistics also underline one central aspect of the so-called Delaware advantage, and that is a confluence of factors that makes Delaware a preferred jurisdiction for business organization formation. It's been called a three-legged stool supported roughly speaking by the three branches of government. The legislative branch and the legislative process, which is sort of unique, the legislature is attuned and dedicated to keeping all the business organization statutes, including the LLC Act, up to date, current, flexible. And the underlying legislative process, which involves the cooperation of the local bar, really is sort of a unique feature of the Delaware legislative process.

There's also the executive branch, and, of course, the governor heads that up, and he is on the same page with the legislature in terms of putting a priority on maintaining our business entity statutes and keeping them current. And in terms of the so-called Delaware advantage, the Court of Chancery and its customer orientation, service orientation really is a central component of the Delaware advantage.

And of course, finally, you've got the Judiciary and the Chancery Court with judges who are not elected, they're selected on the merits, the court has a special, circumscribed subject matter jurisdiction. And so when you have expert judges comprising a court of relatively narrow subject matter jurisdiction, addressing myriad issues in a high volume of cases, they collectively contribute to the case law that has accumulated over many years, and that provides certainty and predictability in the law. So this overview, very brief overview of Chancery Court caseload sort of informs that understanding of the Delaware advantage.

And finally, I'll note, although we don't get into it here, that the Superior Court, especially the Complex Commercial Litigation Division of the Superior Court also enhances that body of law, dealing as they do with many important and sophisticated contract disputes.

So you see the graph chart here, and basically the statistics show more filings in Chancery Court cases last year than at any time in the last 10 years, and it also shows a substantial number of case dispositions.

This chart basically sort of picks up for this year and shows that during the first half of 2023 there's a high volume of new case filings and a continuing high percentage of cases for which expedited treatment is requested.

So with that as background, I'll hand the discussion over to Mike Maxwell, who will discuss, as I said, just a handful of the many decisions coming out of the Delaware courts over the last year or so. Mike.

Mike: Yeah. Thanks, Matt. Yeah, as Matt mentioned, we are really just picking and choosing a few interesting cases that we can discuss that bear on some of the more recent developments in the case law as well as touch on some of the interesting aspects of the LLC Act that is amended from time to time, and Alyssa will talk about some of those amendments coming up.

So the first case we're going to talk about today is the In re Reinz Wisconsin Gasket case. So in this case, this deals with a petitioner whose husband was exposed to asbestos and alleged that he worked with asbestos gaskets manufactured by a distant ancestor of the LLC, in this case Reinz Wisconsin Gasket, LLC. The petitioner sought damages for her husband's illness and death in a Massachusetts district court filing. And while that case was ongoing, alleging the asbestos exposure and wrongful death, while that case was pending, the Gasket LLC dissolved and filed a certificate of cancellation.

So the process for that dissolution, the company's sole member at the time called a special meeting for the purpose of discussing the dissolution of the LLC. At the meeting, it presented a windup plan for the company, and the presentation included background information about the company and three possible options that it could take regarding its windup. This background information included claims that the company was not capitalized at the time of the bankruptcy, that it lacked insurance and assets, and currently had six cases pending against it and one of those cases was this Massachusetts action by the petitioner in the Delaware action. The members and the board voted to dissolve the company. The next day the company filed a notice of dissolution and cancellation, and notably it did not take any steps to set aside assets for creditors or claimants.

So the petitioner turned to this court, the Chancery Court to appoint a receiver to determine if the LLC held any insurance policies or other assets that could potentially satisfy damages award in the Massachusetts action and as well as to find that the LLC's dissolution was improper and to void the certificate of cancellation. And this was filed pursuant to Section 18-805 of the LLC Act, which provides that when the certificate of formation of any LLC has been canceled by the filing of a certificate of cancellation, the Court of Chancery on application of any creditor, member, or manager of the LLC, or any other person who shows good cause therefor at any time may appoint one or more of the managers of the LLC to be trustees or appoint one or more persons to be receivers of and for the LLC to take charge of the LLC's property and to collect the debts and property due and belonging to the LLC, with the power to prosecute and defend, in the name of the LLC or otherwise, all such suits as may be necessary and proper for the purposes aforesaid.

So effectively, pursuant to this statutory provision, upon application of a creditor or any other person for good cause, the Court of Chancery has the power to appoint a liquidator or a receiver, a trustee or a receiver for purposes of winding up properly the affairs of the LLC. So that's what this petitioner did. They filed a petition under 18-805 individually and as the executor of the estate of her husband Roland Cook.

So Count I sought nullification of the certificate of cancellation because they failed to comply with 18-804 in failing to provide for known claims pending against the LLC. And Count II sought appointment of a receiver to continue or complete the winding-up process in accordance with applicable law.

So counsel entered their appearance, and we'll talk about this a little bit later, but for the respondent of the defunct LLC, Reinz Wisconsin Gasket. So the petitioner alleged that they failed to comply with the dissolution statutes because it still had assets when it dissolved, that it should have set aside to compensate the plaintiffs in the pending asbestos lawsuits.

Now notably, there was some corporate restructurings that happened in the interim between when the alleged injury occurred to the petitioner's husband and where we ended up during this case and, in fact, I think in the Massachusetts case itself. So in the intern though, and the court cases too, there was potentially insurance policies that would have continued to be in existence notwithstanding that the presentation of the sole member was that there were no insurance policies.

So the court then had to determine whether . . . well, and then the other point I'll make here is that Gasket LLC, the defunct LLC appeared as a respondent asserting that it did not have any assets, so essentially contesting the petition, and that its dissolution and cancellation were proper. And it also argued that the petitioner did not have standing to seek appointment of a receiver.

So a couple things here. First, the court found that the petitioner had standing to seek appointment of a receiver for the dissolved and terminated Gasket LLC and then appointed a receiver. So and on the first question, it found that the petitioner was not a creditor because the claims had not been subject to the judgment. The judgment was not final in the Massachusetts action. But they did find that they show good cause to suspect a statutory violation in the dissolution sufficient to establish standing to request a receiver under 18-805. And in discussing that standard of showing good cause, the court relied on a case, the Texas Eastern case, and concluded that it was using that standard to provide sufficient grounds for the court to conclude that it was reasonably likely to continue to hold undistributed assets. And so that the petitioner only had to show a specter of assets. And so the court then adopted this reasonably likely standard for 18-805's good cause standard here.

So that was the first kind of aspect is that the court found that while not a creditor, she was, as the statute says, any person, other person who shows good cause. And that good cause here was established by the reasonably likely standard showing a specter of assts that existed in the form of these potential insurance policies.

So the court then went on to provide that the or to find that the LLC did not properly wind up its affairs because it knew about the Massachusetts action, but no provision was made for the winding up of the LLC and making reasonable provision for these pending and known claims. Now the company itself came in and was trying to argue or argued that there were no assets. So the court appointed receiver to determine whether the LLC held these insurance assets. Again, pursuant to these corporate restructurings, it wasn't clear whether the insurance policies continued to flow down into the defunct LLC, but there was a reasonable likelihood that it did. And there's this, like I said, this "specter" of assets, and so the court decided to appoint a receiver to determine whether it held insurance assets at the time of dissolution sufficient to justify a nullification of the LLC's certificate of cancellation, and holding that if no assets are discovered, then the petitioner would bear the receiver's costs.

Matt: Mike, that last point is interesting insofar as it puts really any party that is contemplating a petition for the appointment of receiver on notice that the request for the appointment may not be cost free to the petitioner. And so I think it indicates the advisability of an upfront cost benefit assessment for anyone who is in the same shoes as the petitioner in this case.

I'll just ask you. There have been I think a number of decisions in this case beyond this one on the appointment of a receiver. Would you mind briefly addressing any other interesting issues that have emanated from this litigation?

Mike: Yeah. Interestingly enough, in a footnote in the initial case, the court questioned whether the LLC could actually appear for itself as a defunct and no longer existing LLC and asked the parties to brief her on that. In a later decision, she determined that the terminated LLC was not in existence. It had no longer a legal existence, so it could not hire counsel and could not have privilege with counsel.

And so I'll just quote a few things here that says, yeah, they diverge on whether the entity can retain counsel and speak on its own behalf in that action. So the court found that the cancellation precluded a defunct entity from retaining counsel and litigating before a receiver is appointed, even in a proceeding in which it must be named as a respondent. So the court, she noted that by statute an LLC's existence as a separate legal entity shall continue until cancellation of the LLC's certificate of formation. When a certificate of cancellation is filed, its existence as a jural entity ceases and its legal existence ends. The defunct entity ceases to be a body corporate because the entity is no longer viable, it no longer has a registered agent or active senior officers. The entity only exists insofar as it can hold assets and be guided by an appointed receiver. And the officers serving at the time of cancellation only retain their positions to the extent that they may be called upon to answer for the entity after it has been dissolved and they have been discharged from their positions.

After a certificate of cancellation has been filed, a defunct entity may speak only through a receiver to manage litigation or any other outstanding business. The receiver is appointed because there are no other fiduciaries to make decisions for the entity. So this goes on to say that the defunct entity cannot make decisions or take any action, and it follows that a defunct entity cannot retain counsel or speak through counsel unless and until a receiver or other fiduciary is appointed.

Matt: Yeah. It's an interesting sort of playing out of the scenario that has been, I think, sort of avoided in prior cases that presented similarly, where there's been a request for nullification of the cancellation. The issue, it's been there obviously. It's existed, but it's been just sort of disregarded. And this is the first case that I can recall where the court really got into it. And it's hard to argue with the reasoning that if a company doesn't exist, it doesn't have power to do anything until someone is appointed to act on its behalf.

Mike: Yeah. And to the Court's credit, it did on numerous occasions say that the sole member could potentially file a motion to intervene and invited them to do so, in particular in connection with because at the end of the initial case, she asked the petitioner to come up with, I think, three receivers or a list of receivers, potential receivers and since the other side had no representation at that point. So there was an interlocutory appeal and some other developments. And at the end of the day, because they delayed in filing a motion to intervene initially. I think the case was in March, and there was the appeal. And then so the motion to intervene didn't come until later in the summer, at which point the court then denied the motion to intervene. So it it'll be interesting to see how this progresses.

But so I guess one takeaway there is obviously the good cause standard and making sure that you're winding up your assets in your LLC properly before filing a certificate cancellation. And if you do find yourself in this situation as an interested party, whether a sole member or an officer or somebody that has an interest or in a fiduciary capacity for the LLC, it may be worth intervening earlier than later, especially if you feel like the winding up was done properly. And in this case, it is possible that there are no insurance assets, and that goes to that point of the petitioner is taking a risk because if there are no insurance assets, the LLC has nothing to pay with and therefore the petitioner is going to have to foot the bill for that.

Matt: Yeah. It's interesting that insurance assets were at the heart of the dispute here because I've run into that situation myself in practice where you've got a dissolved entity. There's allegation or the possibility of some sort of existing insurance, and it gets pretty complicated because the viability of the coverage depends on premium payments over time, and sometimes those policies are allowed to lapse or sometimes policies are misplaced. So it's a potentially daunting factual undertaking that's required.

Well, it's an interesting case to start with because it offers some guideposts for litigants certainly who find themselves involved in these types of cases. And with a little bit of thought, it may offer some suggested tweaks for practitioners who are guiding companies on the front end of the dissolution and winding-up process.

Mike: Yeah, certainly. All right. So moving on to our next case, so the next case we're going to talk about is Cygnus Opportunity Fund. This is an interesting case because it involves a squeeze-out merger by a company's controller and its board of managers. And notably, the minority unitholders did not receive a vote on the squeeze-out merger, because in the LLC context, as you may recall a few years ago . . . Well, this has primarily been the case that there are no statutory appraisal rights. And a few years ago, the LLC Act was amended to clarify that unless you provide for those rights in an agreement of merger or an LLC agreement or the transactional document, you're not entitled to those appraisal rights as a matter of default. So there are no default appraisal rights under the LLC Act.

So here, squeeze-out merger, no right to vote, no right to obtain an appraisal. So just by way of background, before its reorganization bankruptcy, this company existed as a publicly traded . . . So Washington Prime Group existed as a publicly traded Indiana Corporation. And notably the plaintiffs here had purchased their interest, common and preferred stock issued by that publicly traded corporation.

So in the fall of 2020, the company announced that it was negotiating with the holders of its unsecured senior notes. And during those negotiations, Strategic Value Partners, LLC or SVP acquired a majority of the senior notes. And SVP is an investment firm that specializes in distressed debt.

So the senior notes would not mature until 2024, and the company's next regular payment was due in February of '21. So the company had more than enough cash on hand to make the payment. Nevertheless, shortly before the due date, the company announced that it had elected to withhold the payment. On June 11th of that year, 2021, the company entered into a restructuring agreement with SVP and other creditors, and the agreement contemplated a Chapter 11 filing with a plan of reorganization sponsored by SVP. Three days later, the company filed for bankruptcy. Now a group of the preferred stockholders, that includes some of the plaintiffs here, formed an ad hoc committee to challenge the plan, and they did obtain some improvements, the court notes, as well as an official committee of equity holders.

So on September 3rd of 2021, the company emerged from bankruptcy as a privately held Delaware LLC. So out of that bankruptcy, the Strategic Value Partners, SVP controlled the company with 87% of its equity. Now the former holders of the company's preferred and common equity received 9% of the equity in the form of stapled units. And I think the stapled units were a combination of three classes of interest in the LLC that were bundled together to call what they refer to as the stapled units. Other former creditors received the rest.

So the company's LLC agreement provided for a governance structure similar to that of a corporation and provided for fiduciary duties of officers, but eliminated fiduciary duties of members and board members. So the LLC agreement also prohibited SVP from increasing its ownership stake without certain specified approvals and placed additional restrictions on SVP's ability to engage in a squeeze-out transaction.

So notably it provided that neither SVP nor its affiliate shall engage in any transfer or other transaction to acquire or otherwise squeeze out all of the outstanding shares without approval as a specified approval. And so the LLC agreement defined "transfer broadly" as a transfer of any person of any LLC interest in any form. And the specified approval required a couple of things. One was approval of a majority of the independent managers, whether or not acting as a board committee of independent managers. That was deemed as the manager approval. The other was approval from a majority of the votes cast on the matter by members other than SVP, so the minority investor approval. So this no acquisition provision, is what the court calls it, prohibited SVP from increasing its ownership stake without this specified approval.

Further restrictions in the LLC agreement, there's a challenge right that placed additional restrictions on SVP's ability to engage in a squeeze-out for 18 months after the company emerged from bankruptcy. Now during that period, the company first must give notice to the owners of the stapled units, and at that point holders of at least 5% of the stapled units would have the option to challenge the fairness of the terms of any squeeze-out.

Now the lawsuit was required to be filed within 21 days after notice was provided. And in connection with any exercise of the challenge right, the company will pay or reimburse reasonable, documented professional fees and expenses up to a cap of $500,000.

Now notably, the challenge right did not apply if the minority unitholder stake had fallen below 2.5% or the squeeze-out received either minority approval or approval from the minority approved independent manager. And so that minority approval again was a majority of the votes cast on the matter by members other than SVP. And the approval from the minority approved independent manager, that was defined a little bit differently than the special approval as the manager designated as such on a schedule together with any replacement or successor manager approved by a majority of the minority vote.

So the schedule to the LLC agreement identified a gentleman named Reid as the initial minority approved member, or independent manager I should say. And the plaintiffs here in this case questioned his ability to act as that minority approved independent manager and represent the interest of minority unitholders, noting that his website and court filings in another case alleged that he made his living advising private equity funds and high-net-worth individuals on real estate investments and that because of his livelihood depends on good relations with investors, like SVP, that he would be beholden to SVP.

Also notably, the LLC agreement did not contain any mechanism for the minority unitholders to remove or replace any manager, including the minority approved independent manager. And only SVP had the authority to remove and replace managers, which it could do with or without cause and for any reason or no reason at any time.

So there are a couple things that happened in this case, a couple steps. First, there's a tender offer, a third-party tender offer from SVP and then a squeeze-out merger on the on the backend.

So with respect to the tender offer on November 9th of '21, 19 days after the company had emerged from bankruptcy, SVP launched a tender offer to purchase the stapled units. Minority unitholders who had tendered on or before November 23rd would receive, I think it was, $25.75 in cash. After that date, minority unitholders who tendered would receive less, at an even $25 in cash. So SVP had really deployed a two-tiered, front-loaded structure.

The tender offer nominally sought to acquire up to enough stapled units to take SVP's ownership stake to 95%, but they did reserve the right, in its sole discretion, to purchase more than the specified amount of stapled units in the offer. And the court noted that it was reasonable to infer from this that SVP sought to own 100% of the company's equity and that SVP would have acquired all the stapled units if it could. So to that end, SVP in its offering documents for the tender offer disclosed that it may from time to time acquire stapled units, other than pursuant to the offer, through an open market purchase privately negotiated transactions or otherwise. SVP also acknowledged that the tender offer could be considered a squeeze-out as defined in the LLC agreement and disclose the risk of that in the offer to purchase.

Notably here, SVP did not obtain the specified approval before proceeding with the tender offer. SVP also did not engage in the notice process contemplated by the challenge right. So SVP and the board did not make any recommendation in connection with the tender offer. SVP disclosed that the consideration might not reflect fair value. No one provided any financial information to the minority unitholders.

And the tender offer closed in December of '21. SVP ended up purchasing less units than initially anticipated, but increased its ownership stake to about 88.2%. On June 7th, the company informed the minority unitholders that each of their stapled units had been converted into the right to receive cash without interest and with no rights to an appraisal. And this was the first time the unitholders had heard about the squeeze-out merger.

So the disclosure for that squeeze-out merger, so this is the second step of the transaction, consisted of a three-page cover letter and a skeletal five-page information statement, which the court referred to as the disclosure documents. And according to the disclosure documents, SVP had provided the company with a proposal for the squeeze-out merger on February 2nd of '22, less than two months after the tender offer closed and only three and a half months after the company had emerged from bankruptcy.

The board responded to SVP's proposal by creating a special committee of one and appointing Reid, who we discussed earlier, as the sole independent manager. The disclosure documents refer to unidentified legal and financial advisors who purportedly assisted Reid in negotiating with SVP. But the disclosure documents notable did not describe the negotiations. It also said that Reid received a fairness opinion, but the disclosure documents did not include the opinion or provide a fair summary of its contents.

Notably the complaint from the plaintiffs alleged that the board chair of the company had familial relations that worked at the financial advisor that provided the fairness opinion. So it may not have been an entirely independent fairness opinion. That was the allegation.

The consideration provided in the squeeze-out merger was 6% higher than the cash price offered in the first tier of the two-tier tender offer and 10% higher than the consideration offered in the second part of the tender offer. The disclosure documents asserted that because one of the independent managers approved the squeeze-out merger, the challenge right restriction in the LLC agreement did not apply. So recall that the challenge right doesn't apply if you had an independent manager approval.

The plaintiffs sought for information. They were stonewalled and eventually filed a complaint alleging, among other things, that the squeeze-out merger dramatically undervalued the stapled units, alleged breaches of fiduciary duties against officers and directors of the company and SVP as a controlling member, along with claims against all defendants for breach of the express terms of the LLC agreement and for breaches of the implied covenant of good faith and fair dealing.

So in responding to the motion to dismiss, the Delaware Court of Chancery as an initial matter dismissed claims for breach of fiduciary duty against SVP as controlling member and against the board of managers in connection with the tender offer and a squeeze-out merger, notably because the company's LLC agreement contained a fiduciary duty waiver providing that the controller or that the members of the LLC as well as members of the board of managers do not owe any fiduciary duties.

So I'll just stop here to note (a) fiduciary duty waivers and eliminations and modifications are still enforced by the court as long as they're clear and unambiguous. And in this case, the court found that that they were clear and unambiguous. Notably however, in the definition of "covered persons," which is a term often using these LLC agreements to define the scope of who is covered by these types of modifications or eliminations and as well as for indemnification/exculpation Provisions as well, but notably "covered persons" in this context excluded officers. In fact, the LLC agreement expressly provided that officers would have powers and duties as are typically exercised by similarly titled officers in the corporation subject to supervision and control of the board. So the court noted that with those powers comes fiduciary duties.

So then the court denied the motion to dismiss claims for breach of fiduciary duties against the company officers for breach of potential duty to disclose in connection with the tender offer and the squeeze-out merger because, again, the waiver did not apply. And by its express terms, the court agreed it was reasonably conceivable that the transactions created duties for the officers to disclose.

So in talking about the duty of disclosure, the court noted that when asking stockholders to take an action to vote or to take an investment decision, all material information necessary to make that decision has to be provided. The court cited the Gantler case in stating that a complaint states a claim against an officer for breach of disclosure in they call it the stockholder action duty context when, one, the complaint supports an inference that the officers were involved in the drafting of the disclosure documents, and two, when the officer took responsibility for disclosure documents by signing it or possibly if it fell within that officer's area of responsibility in the company.

So the defendants argued that SVP, and this is where I think it's a little bit interesting because the defendants argued that SVP was the only party that could owe a duty of disclosure because SVP launched the tender offer. It was a third party. It was not the board of the LLC that controlled the offer. So this is a controlling member of the LLC launches this tender offer, willing to purchase directly from the other members their units.

So the court noted that no Delaware decision that held that directors of a Delaware corporation have a duty of disclosure that applies in connection with a third-party tender offer when that was not already subject to a federal regime, like security laws. But Delaware courts have also, it noted, not held that directors never have any obligation to speak in response to a tender offer, and such a position would seem extreme because directors have an affirmative obligation to respond to threats to the corporation and its stockholders.

So the court reasoned that if a controlling stockholder, a third party makes a tender offer for the corporation shares, then depending on the circumstances, the directors might well have a duty to respond. And then it notes to the extent officers owe the same duties as directors, that duty could apply to them as well.

So third-party tender offer, if the directors in that context of the offer, it's viewed as a threat to the corporation or in this case the LLC, and it would have a duty to respond and its officers have that same or similar duty. Again, for pleading purposes here and the motion to dismiss, the court found it's possible that those officers may owe the same duties.

So the court found that the officers could have owe a duty of disclosure in connection with the tender offer, and to the extent they owe a duty, they breached it because nothing was said at all about the tender offer. So recall the tender offer happened. Nobody from the company or from SVP said anything about that.

To the extent any duty existed, the court did note that it would also have to take into account the officer's duty of obedience. As an agent, an officer has an obligation to comply with directives from its principal or from other more senior agents to whom they report.

So the court noted these competing duties, including no duty to comply with the directive. But it also did note that an officer has no duty to comply with the director that the officer has reason to believe would constitute a breach of duty. So in the absence of any disclosure by the board, the court found it reasonably conceivable that the officers had a duty to act. So little bit interesting there in the context of a third-party tender offer.

With respect to the disclosures around a squeeze-out merger, the officers that argued that the board was responsible for the disclosures and the officers were not in a position to insist that the board disclose more. So the court again noted that the duty of disclosure is context specific.

And interestingly, the court also noted that there's no Delaware decision holding that fiduciaries do not owe any duty in the context of a transaction which the fiduciaries unilaterally eliminate their investors from an enterprise. The court stated that it was not prepared to rule as a matter of law that a fiduciary can take the property of its beneficiary without some level of disclosure, even in the absence of any request for action. So to the contrary, basic fiduciary principles suggest that a fiduciary cannot do that.

So then the court also discussed the duty to keep beneficiaries informed in the trust context. So it kind of walks through the fiduciary duties that potentially apply here. I noted that this duty to keep beneficiaries informed extends beyond the trust context. And while in a commercial enterprise like this it does not require regular reporting obligations, it could mandate disclosures about extraordinary events, including an event that unilaterally takes a beneficiary's interest. So the court seemed to key in on that aspect as well.

It also made it a point to say that that there's a duty not to make misleading partial disclosures. So once you travel down the road of disclosure, you have an obligation to provide an accurate, full, and fair characterization. So it talks about information is material if there's a substantial likelihood that the information would have assumed actual significance in the deliberations of a person deciding to act. So framed another way, would disclosure of admitted information have significantly altered the total mix of information available?

And the court noted that the disclosure documents here fell short of the information that Delaware law typically requires. There was no information on the negotiations or process. There's no information on company prospects or why the price was the appropriate price for the merger consideration, no information on how the company made decisions or why it was the right course of action.

So taking that background, the court then reviewed each officer defendant to see if they either took responsibility for the disclosures or if it fell within their responsibility and found that it did for each of the three officers named in this case. So some interesting points there around disclosure, especially if you're an officer that has not been exculpated. In this, they were exculpated. We'll get to that in a second. But have your fiduciary duties eliminated or modified.

On the contract claims, the plaintiffs had stated claims for breach of the provisions the LLC agreement that prohibited the controller from engaging in a squeeze-out merger without approval of either the majority of the independent managers or approval of the minority unitholders. So the court noted again that SVP, by its own admission in its offering documents for the tender offer, noted it could be a squeeze-out, and the requirements for a squeeze-out in a tender offer, under the LLC agreement, were not complied with.

The no acquisition provision required approval of the majority of independent managers, and they only received approval from one, not from a majority of the independent managers. So again, important to note I think here that when you're following provisions trying to do a transaction like this, it's important to follow those provisions in the LLC agreement expressly in order to rely on them to overcome other restrictions.

From a drafting perspective, if you're drafting these types of things on the front end, it's important to make sure that you're clear as to what the requirements are and thinking through that process because when you get into it, and I've seen this in other cases as well, where you get into trying to do whether it's preemptive rights or drags or tags or some type of provision in the LLC agreement that you want to exercise certain rights, the more clear you can be in providing how those mechanics work and what the rights are, the better it's going to be and the easier it's going to be for you to survive in a case like this where they're looking at: Did you actually comply with this? Did you get the correct approvals? Did you take the steps that were necessary, including notices and disclosures?

Just quickly on the implied covenant, the court found that the plaintiffs also stated a claim for a breach of the implied covenant of good faith and fair dealing relating to the disclosures and that the price paid to the minority unitholders in the squeeze-out merger. So there's a couple interesting things here. So recall that the implied covenant of good faith and fair dealing is typically a very rare remedy. It's a gap filler. It does require that the decision-maker exercise, if you have discretion, to exercise that reasonably and not arbitrarily capricious.

So here, the court went through a reminder of what the implied covenant is, and then it found that the disclosure failures could have breached the implied covenant expectation because the expectation was that they had received truthful and accurate disclosures of material information. The court also found the board's exercise of discretion to seek manager approval and not the minority approval could have breached the implied covenant because the expectation would have been that the independent manager should have been independent and not beholden to SVP, and that such approval could not have been used under these circumstances for approving it. So they should have gone to the minority approval of those members that held units that were not SVP.

So I thought that was interesting because that's not typically what I would have thought as the implied covenant in this context. But I think the court did find that. And finally, the court also found that the low price, and there was some indication that the price was well below what it should have been, may have been sufficient for the implied covenant breach as well. Again, motion to dismiss stage pleadings, given weight to the plaintiffs, the petitioners in this case, but something to keep in mind.

They also found that officers could be considered to be bound by the LLC agreement even if they were not signatories to the LLC agreement, and therefore the breach of contract claims survived against them. The court relied on de facto manager concepts and that managers are bound under the LLC Act and the definition of LLC agreement I believe. They're bound to the LLC agreement, and so by being a de facto manager, arguably an officer is bound. They also relied on some corporate analogies to suggest that officers would be bound to the LLC agreement.

And then finally, the court also found that although precedent suggests the doctrine of caveat emptor, and it cited to the Boardwalk case that came out in the last few years, is implicated when applying the implied covenant to an alternative entity's governing agreements. It is not here because the plaintiffs obtained their equity when the company was a corporation and only held LLC units due to a bankruptcy restructuring orchestrated by the company's now-controller. So this idea that you have to be aware when you enter into an agreement with an alternative entity, like an LLC or limited partnership, didn't necessarily apply here partly because these guys, that's not what they did. They bought into a public corporation.

Matt: A lot to digest from that case.

Mike: Yeah.

Matt: Mike, next up is this P3 case.

Mike: Yeah. I just note that this is one of many cases in this drama that has played out in the court. What's interesting about this case and why we're focusing on it today, again, it gets into this officer liability aspect. So here the defendant served as a general counsel and was a chief legal officer of P3 Health Group Holdings, LLC. This company was privately held and controlled by a PE fund, Chicago Pacific Founders Fund, L.P. And the plaintiff was a member of the company. The company's LLC agreement provided for a manager-managed governance structure with a board of up to 11 managers.

Pursuant to the LLC agreement, the company's officers owe the same fiduciary duties to the company and its members as that of officers of a corporation under the laws of the state of Delaware. Again, very similar to what we just heard about in the Cygnus case. The company's governance structure and the role of officers essentially mirrored that of a corporation. Again, another fact that I think is important here.

So in August of 2020, the company began a process of exploring ways to access public markets, including a deal structure where the company, a portfolio company controlled by Chicago Pacific and a SPAC would enter a three-way merger. The original deal structure was presented to the plaintiff, who was the second largest equity owner in the company. They vetoed it pursuant to contractual rights that they had for vetoing those types of transactions.

So after that, alternative transactions were explored, pursuant to which the plaintiff's consent, again this Hudson entity would not be required to consent. To avoid this related party trigger, a portfolio company was used on the front end, but they did notably plan on using a portfolio company on a following step down the road, a second transaction.

So the defendant here, this chief legal officer was significantly involved with the events related to the new deal structure. She provided advice to the board. The court found that she assisted preparing materials for the board, documented actions that the board took by preparing and circulating minutes, assisted in preparing and commenting on disclosures that the company provided to its investors, prepared various documents throughout the negotiation, and advised the boards on next steps.

So the plaintiff here filed suit in Delaware Court of Chancery seeking a preliminary injunction. That was denied. The transaction went on to close, and the plaintiff then filed an amended complaints that included allegations that the defendant or officer here breached her fiduciary duties to the company and its members in connection with her role as an officer of the company.

So the defendant moved for dismissal for lack of personal jurisdiction. And the court denied the motion to dismiss.

So the court first starts by noting that under Delaware law there are two requirements for the exercise of personal jurisdiction. The plaintiff has to identify a valid method of serving process, and then the exercise of personal jurisdiction must rest on sufficient minimum contacts between the defendant and Delaware, such that the exercise of such jurisdiction does not offend traditional notions of fair play and substantial justice.

The court then goes on to talk about section 18-109(a) of the LLC Act, which contains an implied consent provision that establishes a mechanism for serving process on a manager of an LLC. And Section 18-109(a) defines the term "manager" to encompass both formal managers but also acting managers. And an acting manager refers to a person who participates materially in the management of the LLC." So the plaintiff asserted that the defendant was an acting manager.

And the court found that the defendant was an acting manager for purposes of service of process under 18-109(a). And the court reasoned that extending Section 18-109(a) to a senior officer was consistent with the analogous jurisdiction statute for corporations. The court found that the defendant occupied a senior role at the company, performed functions consistent with that role, including with respect to events giving rise to the subject litigation, and therefore participated materially in the management of the LLC. And it determined that they then engaged in sufficient minimum contacts with Delaware so as to not offend notions of fair play and justice.

So notably here, the court, in talking about this case, notes that the participating materially in the management, she was pretty well involved in the actions of the company with respect to this transaction. But it's interesting because when you talk about this participating and taking part in and playing a role in an activity or event, I don't think a lot of people have thought about an officer in that context. The court did rely heavily on corporate analogies. In the corporate statutes, they specify a list of officers for corporations that are deemed as C-suite or executive officers.

And while the defendants argued that there is no list in the LLC Act, the court noted that the LLC Act, because by its nature is contractual and maximum freedom of the enforceability of the LLC agreement, there's not always going to be officers. And one thing I'll note is the LLC Act does not have a concept of officer. So if you are an officer or want to have officers for your LLC, you typically want to provide for that expressly in your LLC agreement.

And so in this case, the court was not bothered by the absence of that and relied instead on this 18-109(a), and in fact said the reason for this 18-109(a) provision was really because of this flexibility and there is variation in who the officers are. So it found that this officer in this case was consistent with what's in this corporate analogies of a chief legal officer and, more importantly, for Section 18 109(a) participated materially in the management of the LLC.

Matt: It's interesting this case points to the potential for some interesting tension in board and officer dynamics, particularly where the board is freed from any fiduciary duties and it's exculpated and the officer or officers are not. And I think this case, as well as Cygnus, highlight how important it is to consider provisions with respect to duties, exculpation, indemnification, and advancement for officers as well as members and managers. And I think these cases indicate the short shrift that officers sometimes get in terms of the drafting of these agreements. But particularly in the context we are now, where we've had recent amendments on the corporate side to 102(b)(7) to allow for exculpation of officers commensurate with what has long been permitted for directors, it's interesting that the focus in these cases is on provisions that deal with officers and their potential liability.

So I guess, Mike, a couple of quick questions, and I know we're starting to run a little bit short on time. But what would you say about what these cases teach in terms of what the LLC agreement ought to provide in terms of the duties and so forth for officers?

Mike: Yeah. I think expressly providing, so I understand why they leave the officers out of the modification of fiduciary duties because a lot of times they want them to owe certain duties, but maybe it's more contractual modification or elimination of default duties and contractually providing for those duties. One thing you do is do provide in resolutions of the board the roles and responsibilities and duties of officers, again because we don't have that overlay like the DGCL has for corporations, where you have this concept of officers. You really should be providing that in the LLC agreement. I think providing defined roles, responsibilities, and duties in the LLC agreement or providing that the board can do so by resolution will eliminate some of that ambiguity and maybe provide some more clarity around that, as well as then, of course, providing robust and clear drafting for indemnification, exculpation, modification of duties in those contexts.

Matt: Yeah. I guess the cases really teach if you're an officer of an LLC, make sure you understand what the terms of the agreement are and understand what you're getting into when you accept your appointment as an officer.

Mike: Yeah. And the other thing I'll not is both cases had this kind of benign term that said you'll have the same duties similar to those of officers in a corporation. And I think we've seen that the Court of Chancery in the cases if you have a structure similar to a corporation, the courts will not hesitate. Obeid had started this, or I don't know if it started, but it certainly brought it to light, and then it's continued where if you have that kind of structure, courts are going to look to corporate analogies. So if you're doing M&A transactions, if you're doing other stuff, even though you're dealing with an alternative entity, there may be other factors at play that you should be aware of, especially from analogies from the corporate context.

Matt: Right. Thank you. Very interesting. So with that, we'll turn to Alyssa, who will run us through the latest amendments to the LLC Act. Alyssa.

Alyssa: Thanks, Matt. So in 2023, there are actually two separate bills that contain amendments to the Delaware LLC Act, and the bulk of those amendments were contained in Senate Bill No. 113. And as we'll discuss further, the amendments deal with, among other things, the ability to amend or adopt an LLC agreement in connection with a merger or consolidation, the revocation of termination of a protected series, and the revocation of dissolution of a registered series, contractual irrevocability subscriptions for LLC interests, and the circumstances under which a certificate amendment of certificate of division is permitted or required to be filed. There are a few other amendments that we'll also look at. And the second bill, Senate Bill No. 110 amended the LLC Act to increase assessed filing fees for LLCs.

Matt: So Alyssa, one question upfront. The series and division concepts that were the subject of amendments this year have been recurring subjects of amendments the last several years. Can you speak to why that is?

Alyssa: Sure. So I mean, basically, when you're crafting a statute, it's an iterative process and it includes responding to feedback that's based on attorneys' practice and experience. And also just something else to know is that a series is entity like, and these latest amendments reflect that parallelism.

Matt: Yeah. And that first point that you raised about the statute amendments in response to practice and experience, that goes back to what I was saying at the outset about the legislative process, where the legislature is keen to make sure that the statutes stay updated. And they take input. They don't take it necessarily without any sort of evaluation, but they certainly hear feedback from practitioners.

Alyssa: Yeah. So we'll go ahead and walk through the 2023 amendments in some more detail. So the way that this is organized is it just goes through the amendments in the order that they impact the LLC Act.

So we'll start with a couple of amendments to Sections 18-204(a) and 18-205(a). Each of these sections deal with execution of certificates that are required to be filed with the Delaware Secretary of State. 18-204(a) addresses execution with certificates, and basically it just requires execution by one or more authorized persons. And 18-205(a) addresses what happens if a person who is required to execute a certificate under the LLC Act fails or refuses to do so. Pretty much it just provides for a judicial process for the certificates to be executed and consider to be filed.

And so the change here is actually pretty simple. Basically, each of these in 205(a) and 204(a), they were amended to change references to Subchapter 2. Those references were change to the Delaware LLC Act as a whole. And this change pretty much just clarifies that Subchapter 2 is not the only subchapter in the Delaware LLC Act that has filing requirements. And for example, Section 18 1109(a) deals with the filing of a certificate of revival of a LLC.

Matt: So basically, the amendments just made the authorized person execution requirement and the availability of judicial process plainly applicable to all filings under the statute, not just those that are described in Subchapter 2.

Alyssa: Exactly. The next amendment is to 18-206(e). And just a little bit of background on this, when certificates are filed with the Delaware Secretary of State, there are a number of filing fees. One of those is the courthouse municipality fee. And depending on where the company that's filing or making the filing has its registered agent or I guess its registered office, then the courthouse municipality fee will be allocated to either Wilmington, Dover, or Georgetown. And so, in 2023, the courthouse municipality fee was raised from $20 to $40.

Matt: Yeah. I'll just note there, I mean going back to the court workload statistics that we reviewed at the outset, there's cost involved in running the courts, and those costs in the age of inflation that we currently occupy, those costs have risen along with other costs.

Alyssa: The next amendment is to Section 18-209(f), and this section was amended to clarify that an agreement of merger or consolidation or a plan of merger may affect any amendment to an LLC agreement or affect the adoption of a new LLC agreement for an LLC if that LLC is the surviving or resulting LLC in the consolidation or merger. So the amendment is to clarify that the plan of merger or consolidation cannot affect an amendment to an LLC agreement of a non-surviving LLC.

Matt: And that is clearly confirmatory in nature, and it really is the only sensible interpretation of the statute anyway. You wouldn't amend the agreement of an entity that's ceasing to exist.

Alyssa: So the next one is to 18-215 and 18-218. And these are parallel sets of amendments. And sort of the context for this is looking outside the series LLCs, the LLC Act has already provided that if an LLC agreement provides them entering a certificate of dissolution, it may be revoked and it may be revoked in such manner so long as the revocation occurs prior to the filing of the certificate cancellation of the certificate formation of the LLC. So the changes here to Sections 18-215 and 18-218 of the LLC Act now extend this concept to series LLCs.

Okay. So next we'll discuss some of the various amendments that deal with division. So the first one here is regarding certificates of amendment of certificates of division. A certificate of division, it may be amended to change the name or business address of the listed division contact in a certificate of division that was filed with the Secretary of State or to change certain information that the LLC Act requires to be contained in the certificate of division. And I think that has to do with the location and the address of the division contact that is statutorily required to be contained in the certificate of division.

So the 2023 amendment provides that certain amendments to a certificate of division are mandatory when there is knowledge of false information in the certificate of division, or if there have been changes to the information that the certificate of division is required to include. And the updating requirements end six years after the effective date of the division.

Matt: Alyssa, can you just briefly describe what is a "division contact"?

Alyssa: Sure. So under the statute, this is actually a defined term, and a "division contact" can be either an natural person who is a Delaware resident, or it can be a division company that results from a division, or it can be any other Delaware entity. And the division contact is tasked with maintaining a copy of the plan of division for six years from the effective date of the division.

Matt: And in the context of these amendments that are required or permitted, who does the filing? Who files the amendment?

Alyssa: So it depends on whether the dividing company survives the division. If yes, if the dividing company is the surviving company, then the person responsible for amending a certificate of division will typically be the manager of the dividing company, or in the absence of a manager, then it can be any member of the company. And then, in the event that there was a division but the dividing company is not a surviving company, or if it just doesn't exist anymore as an LLC, then a manager of any resulting company from the division, or if not, any member of a resulting company is responsible for amending the certificate of division.

And then there's also other provisions about who needs to execute the certificate. And it's sort of in line with the same like whether the dividing company is a surviving company or not.

Matt: Got it. Thank you.

Alyssa: So there are some more division-related amendments. Section 18-1105 was amended to set a filing fee of $180 for filing a certificate of amendment of certificate of division. And Section 18-1107(k) was also amended to clarify that a certificate of amendment of a certificate of division should be accepted for filing by the Delaware Secretary of State as long as at least one division company is in good standing at the time of the filing.

Matt: Would you just explain the need for this last change? It reads somewhat odd.

Alyssa: Sure. Yeah. So a division may result in multiple resulting companies, and if a certificate of division needs to be amended and if there are also multiple resulting companies, then there must be a certificate of amendment that is filed for each division company that has resulted from the same certificate of division. And prior to these amendments, Section 18-1107(k) provided that the Secretary of State shall not accept for filing any certificate in respect of a Delaware LLC if the LLC is not in good standing. So this 2023 amendment to subsection (k) now overrides this general rule, such that all certificates of amendment for all division companies resulting from the same certificate of division that are filed, as required by Section 18-217(h)(6) will be accepted for filing if at least one of the division companies is in good standing.

Matt: Got it. Okay. So the amendment pertains to all of the division companies, and if they are no longer in good standing, the filing can still be made as long as one of them still is in good standing. Okay. Thank you.

Alyssa: Exactly. Sure. All right. So then there's a couple of more division-related 2023 amendments. Section 18-217(l)(1) and 217(l)(9) were both amended to clarify that a dividing company divides into division companies, which is a term that is already used in the LLC Act, and also to clarify that a dividing company does not need to be a surviving company.

All right. So then the last amendment to the LLC Act is to add Section 18-506, and this is a new provision that specifies that a subscription for a limited liability company interest, whether submitted in writing, by means of electronic transmission, or is otherwise permitted by law, is irrevocable to the extent such subscription states that is irrevocable. And something to note is that the same change was actually made to the Delaware Revised Uniform Partnership Act. And the genesis of these legislative amendments to the LLC Act and the Limited Partnership Act is likely to provide an alternative entity analog to Section 155 of the DGCL.

So Section 155 of the DGCL states that unless the terms of the subscription provide otherwise, a subscription for stock of a corporation to be formed shall be irrevocable, except with the consent of all other subscribers or the corporation for a period of six months from its date. And on the LLC side, consistent with the Delaware LLC Act's freedom contract principles, the 2023 amendment to add Section 18-506 doesn't specify a time period for the subscription to remain irrevocable, unlike Section 155 on the corporate side. So this is useful particularly in the context of fund formations, where sponsors are seeking commitments from various investors to raise capital. And in the LLC context, the new 18-506 provision can provide some certainty about those commitments for LLC interest without having to resort to contractual mechanisms, like offering or requiring some form of payment in exchange for the subscription offer to remain open.

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