Delaware Chancery Court Allows Disclosure of Privileged Information to LLC Members Under Garner Fiduciary Exception
By Scott Waxman and Claire White
In De Vries v. Del Mar, L.L.C., two minority limited liability company members of Del Mar, L.L.C. (the “Company”) sought to compel disclosure of privileged information relating to the settlement of a $3.0 million loan to the Company, the transfer of the Company’s primary asset to the lender in post-settlement negotiations, and potential mismanagement and self-dealing by the managing member of the Company, Baja Management, LLC (“Baja”), and its president and sole managing member, Kenneth Jowdy (“Jowdy”). The Court held that the plaintiffs demonstrated sufficient “good cause” to compel inspection of privileged books and records of the Company related to the post-settlement events under the Garner doctrine of the Fifth Circuit Court of Appeals, adopted by the Delaware Supreme Court in Wal-Mart Stores v. Indiana Electrical Workers Pension Trust Fund IBEW, No. 614, 2013 (Del. July 23, 20
The Company was formed for the principal purpose of owning and developing a hotel, golf course and residential properties in Baja California, Mexico, and its main asset consisted of 9,238 acres of undeveloped land, valued at $68.9 million (the “Property”). Baja, the Company’s majority and managing member, owned 93% of the Company’s membership interests, and the remaining interests were held by various minority members who invested $500,000 each in exchange for a 0.5% interest in a private placement round in 2005. The Company obtained a secured loan of $3.0 million from a “hard money” lender in 2006, but failed to raise substantial investment funds for full development of the Property. Jowdy, the sole managing member of Baja, personally guaranteed the loan. In 2010, the Company defaulted on the loan, and the Company and Jowdy executed confessions of judgment for the full amount of the loan (and interest). Following settlement negotiations, and the Company’s inability to satisfy the judgments with further financing, the Company agreed to transfer the Property to the lender in lieu of the lender recording the judgments against the Company and Jowdy.
The plaintiffs were unaware of these agreements or the transfer of the Property until they made a demand in 2014 to inspect the Company’s books and records to conduct a current valuation of their ownership interests and potential mismanagement of the Company. The Company disclosed various non-privileged books and records, which alerted the plaintiffs to the transfer of the Property, and the plaintiffs instituted this action to compel disclosure of additional privileged documents under the fiduciary exception to the attorney-client privilege, arguing that the specter of mismanagement and self-dealing colored the transaction given Jowdy’s personal guarantee of the loan and the transfer of the Property in satisfaction of a loan representing less than 5% of the appraised value of the asset.
After argument, the Court found that the plaintiff’s adequately demonstrated that the privileged information was essential to their stated purpose, and good cause to support application of the fiduciary duty exception. The Court emphasized that documents relating to the post-settlement negotiations were essential to determining whether the Company, Baja or Jowdy undertook other efforts to save the members’ investment, or whether Jowdy’s interest in securing the release of his personal guarantee may have factored into the asset transfer. In evaluating the “good cause” factors under the Garner doctrine, the Court concluded that the plaintiffs had presented a colorable claim of mismanagement (from which the Court could infer a credible basis of wrongdoing), a significant necessity of access and availability to the privileged information, and a narrow basis of inquiry. The Court also found compelling the fact that the Company had failed to provide annual financial reports to its members over the years, as required by the Company’s operating agreement, which could have alerted the minority members to the status of their investment and the Property. As a result, the Court concluded plaintiffs’ had met the burden of showing sufficient “good cause” under Garner to invoke the fiduciary duty exception and compel inspection of the post-settlement privileged documents.