Delaware Court of Chancery Dismisses Derivative Claims in Reliance on Exculpatory Language in Limited Liability Company Agreement

By Scott E. Waxman and Frank J. Mazzucco

In MKE Holdings, Ltd. and David Bergevin v. Kevin Schwartz, et al. and Verdesian Life Sciences, LLC, C.A. No. 2018-0729-SG (Del. Ch. Sept. 26, 2019), the Delaware Court of Chancery relied on exculpatory language in a Limited Liability Company  Agreement to grant a defendant’s motion to dismiss a derivative claim alleging breach of duty by the company’s managers.

MKE Holdings, Ltd. and David Bergevin (collectively, the “Plaintiffs”) were members of Verdesian Life Sciences, LLC (“Verdesian”).  Verdesian was managed and controlled by an eight-member Board of Managers (the “Managers”), which consisted exclusively of officers and employees of Paine Schwartz Partners, LLC (“Paine”).  At the time, Paine was Verdesian’s majority member and Paine affiliates were empowered to appoint each Manager.  The Plaintiffs filed a derivative suit against Verdesian, Paine, and individual Managers, alleging breach of contract under Verdesian’s Limited Liability Company Agreement (the “Operating Agreement”), breach of fiduciary duty, fraud, and aiding and abetting. 

According to the Plaintiffs, in connection with soliciting new equity financing from Verdesian’s members (including the Plaintiffs) to finance an acquisition, the Managers allegedly failed to disclose all material financial information.  The Plaintiffs alleged that, due to this and subsequent acquisitions, other purportedly deficient management practices, and an arrangement in which Paine received a management service fee based on Verdesian’s financial performance and transaction fees on certain Verdesian acquisitions, Verdesian’s operating performance declined and its credit rating was downgraded.

In dismissing the Plaintiffs’ derivative claims, the Court found that, under the applicable standard of care set forth in the Operating Agreement, the actions of the Managers did not violate the Operating Agreement.  As an initial matter, the Operating Agreement obligated a Manager to act “in good faith, in a manner he reasonably believes to be in or not opposed to the best interests of the Company, and with the care that an ordinarily prudent person in a similar position would use under similar circumstances.”  However, the Operating Agreement also contained exculpatory language that effectively reduced the standard of care applicable to the Managers.  In particular, the Operating Agreement provided that Managers were explicitly expected and permitted to make conflicted decisions and that Members thus “waive any such conflicts of interest directly or indirectly associated with decisions, and agree that each such Manager shall be entitled to make decisions and determinations as Member or Manager in his, her or its self-interest.”  Further, the Operating Agreement stated that Members “hereby waive any fiduciary duty of the Managers, so long as such Person acts in a manner consistent with [the Operating Agreement].”  In short, the Court found that the Operating Agreement imposed contractual duties on the Managers, in the place of common law fiduciary duties.

According to the Court, the Operating Agreement effectively exculpated the Mangers for conflicted, negligent, and other detrimental decisions, so long as such decisions were made in good faith.  In reviewing and analyzing actions taken by the Managers under this standard, the Court concluded that the Plaintiffs had failed to plead sufficient facts to allege “bad faith” on part of the Managers and, therefore, dismissed their derivative claims.

MKE Holdings v. Schwartz et al.

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