Leiden Law Blog

Courts do not always respond to (real or perceived) injustices in company law conflicts

Posted on by Cees de Groot in Public Law , 1
Courts do not always respond to (real or perceived) injustices in company law conflicts

Company law, traditionally, makes a distinction between partnerships and corporations. Partnerships are contracts; in a partnership, the partners, basically, are (besides the partnership itself) personally liable for the debts of the partnership. Corporations are legal persons; in a corporation, the shareholders are not personally liable for the debts of the corporation (only the corporation is). As always, distinctions may get blurred. Some jurisdictions recognize so-called limited liability partnerships that are contracts, but in which the partners are not personally liable for the obligations of the partnership. Some jurisdictions recognize so-called limited liability companies that have legal personality (strictly they are not ‘corporations’, but they copy from corporations the absence of personal liability), but have members rather than shareholders and have a strong contractual character.

LA Metropolis Condo I, LLC (‘LAMC’) was a limited liability company established under Delaware law. The purpose of LAMC was to raise capital from foreign investors for further investment. LAMC had succeeded in attracting 200 investors. A&J Capital, Inc. (‘A&J’) was manager of LAMC. The relationship between LAMC, A&J, and the investors was governed by two agreements: an Operating Agreement and a Management Agreement. Under the Operating Agreement, the investors could remove a manager ‘for gross negligence, intentional misconduct, fraud or deceit, all as more fully set forth in the Management Agreement’; under the Management Agreement, the investors were ‘entitled to exercise their respective powers under the Operating Agreement’ for the purpose of appointing a new manager. A majority of the investors decided to remove A&J as manager of LAMC, and appoint Law Office of Krug as the interim manager of LAMC. A&J contended that, before removal, it was entitled to a notice of the intended removal, and an opportunity to respond to the notice. To support this argument, A&J relied on its rights under corporate common law. In its decision of 18 July 2018, the Court of Chancery of the State of Delaware denied this claim.

The decision of the Court of Chancery depended on answering the question of whether a Delaware LLC, or this particular LLC, was akin first to a corporation, or was akin first to a contractual arrangement. If LAMC was to be considered a corporation, A&J’s claim could be successful; if LAMC was to be considered a contractual arrangement, A&J’s claim could not be successful. Joseph R. Slights III, Vice Chancellor, for the court, concluded ‘that LAMC is clearly not analogous to a corporation, in structure or operation, and that drawing from corporate common law to interpret the […] removal provisions in the Agreements would be tantamount to rewriting the Company’s governance agreements without the parties’ consent’.

The reasoning that the Court of Chancery relied on to reach its decision included the following points:

‘A&J […] argues that pre-removal notice is implicit in the Agreements because that is a sine qua non of for cause removal recognized in our common law. […] A&J argues that a requirement has emerged in the common law that before a director of a Delaware corporation may be removed for cause, that director must be given pre-removal notice of the purported “cause” for removal and an opportunity to respond. […] For reasons explained below, I disagree’ (footnote deleted),

‘In governance disputes among constituencies in an LLC, the starting (and end) point almost always is the parties’ bargained-for operating agreement, and the court’s role in these disputes is to “interpret (the) contract (and) effectuate the parties’ intent.”’, ‘[…] when the parties themselves embrace corporate elements within their operating agreement, this court has taken that as a signal of the parties’ intent to model their alternative entity on a traditional corporate structure’, and: ‘LAMC is a prime example of an LLC that is expressly “uncorporate” in its governance structure. The Agreements provide for management by a single managing member rather than by a board of managers, and [the] Members, unlike stockholders in a corporation, have reserved for themselves the “sole and exclusive right to approve or disapprove” several operational decisions’ (footnotes deleted).

This reasoning by the Court of Chancery resembles the reasoning in the judgment of the Supreme Court of Canada of 31 May 2018 in Highwood Congregation of Jehovah’s Witnesses (Judicial Committee) v. Wall, as reported in the Leiden Law Blog of 6 September 2018. Courts will not adjudicate all (real or perceived) injustices. This may serve either as a disappointment, or as a wake-up call.

The decision of the Court of Chancery of the State of Delaware (Joseph R. Slights III, Vice Chancellor) of 18 July 2018.

1 Comment

Maarten van Buuren
Posted by Maarten van Buuren on September 28, 2018 at 09:22

Interessante blog Cees! Kan ik ook weer gebruiken…

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