Back to Basics: Delaware Court of Chancery Uses Contract Principles To Determine Dispute Involving Several Provisions of a LLC Agreement

By: Scott E. Waxman and former Associate Rashida Stevens

The Delaware Court of Chancery (“Court”) applied contract principles in interpreting a limited liability company (“LLC”) agreement to determine the impact of a written consent attempting to terminate the founder’s position as President and CEO in Matthew Godden and Tobias Bachteler (collectively, “Plaintiffs”) v. Harley V. Franco (“Franco”) C.A. No. 2018-0504-VCL (Del. Ch. August 21, 2018). The Court declined to grant fully the Plaintiffs’ motion for summary judgment because it was not clear whether or not the provisions of the LLC agreement governing the termination were satisfied.

After an internal investigation into allegations of Franco’s misappropriation of company funds, Franco was asked to step down from his position as President and CEO of Harley Marine Services, Inc. (“HMS”), a Washington corporation held by a three-tiered holding company comprising three Delaware LLCs. In response to the request, Franco filed suit in Washington State Superior Court alleging the request for his resignation and sale of his interest in HMS, LLC constituted a breach of fiduciary duty by the party making the request. Plaintiffs then filed a derivative action with the Court seeking compensatory damages and the removal of Franco from his positions at HMS, and each of the Delaware holding companies. After conducting an emergency meeting to remove Franco, Plaintiffs filed a notice of voluntary dismissal without prejudice, which was granted during a subsequent status conference. In reaction to objections Franco raised as to the validity of the action taken at the emergency meeting, Plaintiffs acted by written consent following the status meeting to terminate Franco’s positions from HMS, Inc., and each of the holding companies. Franco then amended his Washington State Superior Court complaint to seek a temporary retraining order—subsequently granted—to maintain his position until the disposition of a full hearing to show cause for the preliminary injunction. Plaintiffs then responded with this action seeking a declaratory judgment regarding the actions taken to remove Franco from his positions.

Summary judgment is granted when there is no genuine issue as to a material fact and thus the moving party is entitled to judgment as a matter of law. Generally, disputes governed by unambiguous contracts do not pose issues of material fact and can be resolved on a motion for summary judgment. LLCs are “creatures of contract,” and when questions arise about the internal affairs of an LLC, the court looks first to the LLC agreement, which will govern unless the applicable provision is contrary to a mandatory provision of the LLC Act. In the event an LLC Agreement is silent on a matter, courts will then look to resolve a dispute based on a default provision the LLC Act, should one exist. Additionally, if neither the LLC Agreement nor the LLC Act addresses the question before the court, the rules of law and equity will govern the dispute. When an ambiguity, based on the reasonable-person standard, exists in the interpretation of a contract provision, the court uses the four corners of the document, keeping in mind the contracting party’s intent, to assign meaning to the ambiguous provision. The courts also work hard to give meaning to every word contained in a contract to avoid instances of surplusage, with the thought that drafters would not include meaningless statements in agreements.

The Court limited its analysis to the one holding-company LLC Agreement signed by Franco, inasmuch as his being a party to the agreement created a personal obligation on his behalf. The Court granted summary judgment on several issues based on the language of the LLC Agreement but denied to give the actions at the emergency meeting and the written consent the validity needed completely to remove Franco from the organization. The Court determined that Franco should have the opportunity to use discovery tools to determine if one of the Plaintiffs met the independence requirements, as set forth in the LLC Agreement, to be a party to the decision to terminate his positions within the organization. Additionally, because the LLC Agreement specifically stated that Franco could remain chairman of the board of directors until terminated by HMS, the Court determined that action taken at the holding company level would not automatically be implemented at the subsidiary level citing ideals about separatism between various organizations. Furthermore, the Court determined that a question about action taken by HMS would be best decided by a Washington State court, because the entity included in the clause had been formed under Washington State law.

Godden and Bachteler v. Franco memorandum opinion 180821

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