Edmond Costantini, et. al. v. Swiss Farm Stores Acquisition LLC, C.A. No. 8613-VCG (Del. Ch. Sept. 5, 2013, Glasscock, V.C.)
In this letter opinion, the Court determined that a manager of Swiss Farms Stores Acquisition LLC (“Swiss Farms” or the “Company”) who prevailed in breach of fiduciary duty litigation brought by the Company against him was entitled to indemnification in accordance with the terms of Swiss Farms’ Operating Agreement (the “Operating Agreement”), while a second defendant who prevailed in the same action was not entitled to indemnification since he was not a member, officer, employee or agent of the Company, as required by the terms of the Operating Agreement.
Plaintiffs Edmond D. Costantini (“Costantini”) and James Kahn (“Kahn”) sought indemnification from Swiss Farms for fees and costs incurred in connection with a breach of fiduciary duty claim brought by Swiss Farms against plaintiffs, which the Court of Chancery dismissed based on the equitable defense of laches. The Delaware Supreme Court subsequently affirmed the Court of Chancery’s decision. After reiterating that the policy reasons underlying indemnification in the corporate context as provided in DGCL Section 145 apply to other Delaware entities, the Court noted that “LLCs are creatures of contract,” and plaintiffs’ indemnification claims were therefore governed by the contractual terms reflected in the Operating Agreement.
With respect to Costantini’s request for indemnification, the Court first dismissed defendant’s argument that plaintiff was not entitled to indemnification since Costantini’s defense prevailed on the “technical defense” of laches, noting that the relevant provision of the Operating Agreement required indemnification where a manager “prevails ‘on the merits or otherwise.’” The Court then analyzed defendant’s second argument that permissive indemnification language contained in the Operating Agreement mirroring DGCL Section 145(a) and (b) required plaintiff to act in “good faith” in order to be entitled to indemnification. Finding defendant’s reading of the permissive paragraphs “unavailing,” the Court stated that the third paragraph of the same provision of the Operating Agreement, which tracked mandatory indemnification language contained in DGCL Section 145(c), merely required Costantini to prevail on the merits of the action, and did not mandate a separate showing of good faith. In further support of its holding, the Court emphasized that defendant’s reading of the Operating Agreement appeared inconsistent with the drafter’s intent to provide mandatory indemnification under certain circumstances, “[inviting] precisely what Swiss Farm has proposed here: a trial within a trial on the now-dismissed underlying fiduciary duty claims under the guise of demonstrating Costantini’s good faith or lack thereof.” In addition to granting Costantini’s indemnification claim for the prior breach of fiduciary duty action, the Court awarded indemnification for reasonable fees and costs incurred in enforcing Costantini’s indemnification rights in the instant case.
Turning to Kahn’s indemnification claim, the Court observed that, unlike Costantini, Kahn was not a manager, officer, employee or agent of Swiss Farms, but was merely a partner in a partnership that was a member of Swiss Farms and designated a manager of Swiss Farms. Citing case law holding that fiduciary duties to Delaware LLCs “are owed only by controllers, managing members and persons assuming such duties contractually,” Kahn argued that Swiss Farm did not sue him as a controller or a person who assumed contractual fiduciary duties; therefore, by default, Kahn must have been sued in his capacity as a managing member of the LLC. The Court disagreed, noting that neither plaintiff nor defendant articulated a theory under which the Court could find that Kahn owed fiduciary duties to Swiss Farm, and reiterating that Kahn did not fall into any of the categories of persons entitled under the Operating Agreement as a contractual matter to receive indemnification. Acknowledging Kahn’s argument that a third party should not be denied indemnification upon successfully defending a fiduciary duty claim “where the predicate for such liability appears not even to exist,” the Court nonetheless held that its ruling was consistent with the American Rule on legal fees and costs. Summarizing its holding with respect to Kahn, the Court stated “Kahn was sued under a theory that, despite not being a manager, he nonetheless owed and breached fiduciary duties to Swiss Farm. Kahn prevailed, and if he were in the class of indemnitees listed in the Operating Agreement, he would be entitled to indemnification. Since he is not within that class, however, he cannot prevail.”