International Rail Partners LLC v. American Rail Partners, LLC, C.A. No. 2020-0177-PAF (Del. Ch., Nov. 24, 2020) (Fioravanti, V.C.)

In this memorandum opinion, Vice Chancellor Fioravanti determined that an advancement provision in a limited liability company agreement required defendant American Rail Partners, LLC (“American Rail” or the “Company”) to advance attorneys’ fees and expenses to Plaintiffs for first-party claims that the Company asserted against them.  In reaching that conclusion, the Court refused to apply the interpretative presumption that fees and expenses for first-party claims are not advanced unless provided for expressly in the contract, instead finding that the statutory provisions concerning advancement in the LLC Act and Delaware public policy favored a broader reading of indemnification and advancement rights.

Plaintiff International Rail Partners LLC (“IRP”) was one of two members of American Rail, and it was responsible for the day-to-day management of the Company pursuant to a management agreement (the “Management Agreement”).  A dispute over the management of the Company arose, resulting in the termination of the Management Agreement. Subsequently, the Company asserted claims against Plaintiffs in the Delaware Superior Court, including claims that IRP and its controller mismanaged the Company and used their control to unjustly enrich themselves and other entities affiliated with the controller.  Plaintiffs sought advancement for their fees and expenses in connection with that action, and the Company refused to advance fees, leading to the Plaintiffs filing suit in the Delaware Court of Chancery for advancement of expenses. The Court denied a motion to dismiss, and both parties subsequently moved for judgment on the pleadings.

The Company’s limited liability company agreement (the “LLC Agreement”) contained a broad indemnification and advancement clause which provided in relevant part as follows:

The Company shall indemnify, defend and hold harmless each Covered Person against any losses, claims, damages, liabilities, expenses (including all reasonable fees and expenses of counsel), judgments, fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, in which such Covered Person may be involved or become subject to, in connection with any matter arising out of or in connection with the Company’s business or affairs, or this Agreement or any related document, unless such loss, claim. … If any Covered Person becomes involved in any capacity in any action, suit, proceeding or investigation in connection with any matter arising out of or in connection with the Company’s business or affairs, or this Agreement or any related document, other than (x) by reason of any act or omission performed or omitted by such Covered Person that was in bad faith, knowing violation of Law or willful misconduct on behalf of the Company and materially injurious to the Company, or (y) as a result of a material breach of the contractual obligations under the Management Agreement or any material breach by such Covered Person of a Specified Covenant, the Company shall reimburse such Covered Person for its reasonable legal and other reasonable out-of-pocket expenses . . . as they are incurred in connection therewith.

The Company did not dispute that Plaintiffs qualified as Covered Persons under the LLC Agreement.  However, the Company argued that it did not have to provide advancement for the first-party claims it asserted against Plaintiffs because such claims could never be indemnifiable.  In support of that argument, the Company cited a line of commercial contract cases in which courts applied the interpretative presumption that first-party claims could not be indemnified pursuant to contractual indemnification provisions where the contract did not explicitly say that first-party claims could be indemnified. 

The Court rejected the Company’s argument.  While the Court recognized that LLC agreements are contracts and are typically subject to the same interpretative presumptions as commercial contracts, the Court found that indemnification and advancement rights in LLC agreements were different from those in commercial contracts because they arise from statutory authority.  The Court cited the broad indemnification rights in 6 Del. C. § 18-108, which provides that a limited liability company may indemnify “any and all claims and demands whatsoever,” “[s]ubject to such standards and restrictions, if any, as are set forth in [the] limited liability company agreement.” Moreover, the Court found that Delaware’s public policy in favor of broad indemnification and advancement rights, which encourage individuals to take management and directorial roles, supported finding that the first-party claims could be indemnified, and the Court declined to elevate the interpretative presumption for commercial contracts above that public policy. 

The Court then rejected the Company’s argument that the existence of a fee-shifting provision in the LLC Agreement and an indemnification provision in the Management Agreement that was limited to third-party claims implied that there was no advancement right for first-party claims.  Finally, the Court awarded Plaintiffs their fees on fees because they were successful on their advancement claim.

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