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Obeid v. Hogan, C.A. No. 11900-VCL (Del. Ch. June 10, 2016) (Laster,VC)

June 10, 2016

In this memorandum opinion, the Court of Chancery held that it was an improper abdication of authority for the board of directors of a Delaware limited liability company that had adopted the governance structure of a corporation, and a related limited liability company that had adopted a manager-managed governance structure, to appoint a non-director and a non-manager to serve as the sole member of a special litigation committee.

Obeid involved several disputes between the members and managers of Gemini Equity Partners, LLC, which had adopted a corporate-style governance structure (the “Corporate LLC”) and Gemini Real Estate Advisors, LLC, which had adopted a manager-managed governance structure (the “Manager LLC”).  William T. Obeid, Christopher S. La Mack and Dante A. Massaro each initially served on the board of directors of the Corporate LLC and as managers of the Manager LLC.  After La Mack and Massaro took action to remove Obeid from the board of the Corporate LLC and as “Operating Manager” (but not as a manager) of the Manager LLC, Obeid filed direct and derivative actions against La Mack and Massaro in the Southern District of New York (the “New York Federal Action”) asserting the usurpation of corporate opportunities and related breach of fiduciary duty claims.  Obeid argued that demand was futile for purposes of the derivative claim because La Mack and Massaro were conflicted, and the Court determined that the New York Federal Action had progressed beyond the point where La Mack and Massaro could contest Obeid’s authority to pursue derivative claims based on a demand futility theory.

In August 2015, La Mack and Massaro, in their capacity as “member-managers” of the Corporate LLC and the Manager LLC, executed an engagement letter with Michael Hogan, a retired federal judge, who was not a director of the Corporate LLC or a manager of the Manager LLC.  Neither entity adopted formal resolutions establishing parallel special litigation committees, or appointing Judge Hogan to a special litigation committee.  After learning of La Mack’s and Massaro’s actions, Obeid filed suit in the Court of Chancery seeking (i) a declaratory judgment that Judge Hogan could not serve as a special litigation committee for the Corporate LLC or the Member-Managed LLC and had no authority over any derivative claim, (ii) injunctive relief preventing Judge Hogan from taking any action on behalf of either entity related to any derivative claim, and (iii) a declaratory judgment that Obeid remained a director of the Corporate LLC and that all actions taken by the Corporate LLC since Obeid’s removal were void.

In evaluating Obeid’s claim that Judge Hogan was not authorized to serve as the sole member of either entity’s special litigation committee, the Court first determined that the Corporate LLC had adopted a governance structure similar to a Delaware corporation by including language in its LLC Agreement providing that the business and affairs of the Corporate LLC would be managed by or under the direction of its board of directors, tracking Section 141(a) of the General Corporation Law of the State of Delaware (the “DGCL”), and permitting the board to delegate its authority to a committee comprised solely of board members, tracking Section 141(c) of the DGCL.  Citing these provisions as well as related language contained in the Corporate LLC Agreement, the Court held that it was appropriate to draw analogies to Delaware corporate law in determining whether the board of the Corporate LLC could empower a special litigation committee comprised of a single non-director member.

In evaluating the appropriate grant of authority by the Corporate LLC, the Court analyzed the Delaware Supreme Court’s opinion in Zapata v. Maldonado, 430 A.2d 779 (Del. 1981), which held that a board of directors possessed the necessary authority under Section 141(a) to assert control over a derivative action.  Noting that a board may delegate to a committee all of the authority it possesses over a litigation asset pursuant to Section 141(a), the Court nonetheless determined that delegating such authority to an officer or non-director of the corporation would “risk an improper abdication of authority” under Section 141(c).  Although defendants argued that Section 18-407 of the Delaware Limited Liability Company Act permits a member or manager of an LLC to “delegate to 1 or more other persons the member’s or manager’s … rights and powers to manage and control the business and affairs” of the LLC, the Court rejected this argument, noting that the “general default provision” regarding delegation contained in Section 18-407 “does not trump the specific provisions of the [Delaware Limited Liability Company] Act that address derivative actions,” and vests the authority to bring derivative suits in an LLC’s “managers and members.”  The Court also reiterated that, by embracing a governance structure modeled after Section 141, the drafters of the Corporate LLC Agreement “evidenced their intent to have corporate principles govern the Corporate Board.  These principles include Zapata, under which only a duly empowered committee of directors can serve as a special litigation committee.”  Because Judge Hogan was not a director of the Corporate LLC and was not authorized to function as a special litigation committee on behalf of the board, the Court granted summary judgment in Obeid’s favor.

With respect to the appropriate grant of authority by the Manager LLC, the Court observed that the Manager LLC Agreement established a “corporate-style division between members and managers in which members are passive and managers operate the business of the entity.”  The Court declined to reach the issue, however, after concluding that other provisions of the Manager LLC Agreement, taken as a whole, distinguished between matters relating to the ordinary course of business of the Manager LLC and more significant matters that must be handled by the managers, demonstrating that the drafters of the Manager LLC Agreement intended to limit the ability of managers to delegate their core governance functions.  Because Judge Hogan was not a manager and was not authorized to serve as the sole member of a special litigation committee of the Manager LLC, the Court also granted summary judgment in Obeid’s favor.

Noting that the plain language of the Corporate LLC Agreement stated that members of the Corporate LLC holding a majority of the interests in the profits of the Corporate LLC could remove Obeid as a director, Obeid’s motion for summary judgment on his third count was denied.

The full opinion is available here