DELAWARE COURT OF CHANCERY LIMITS MEMBER’S SOLE AND EXCLUSIVE RIGHT TO CAUSE COMPANY TO UNDERTAKE A QUALIFIED IPO TO MERE RIGHT OF APPROVAL
By: Scott Waxman & Ernest Simons
In Williams Field Services Group, LLC v. Caiman Energy II, LLC, et al., C.A. No. 2019-0350-JTL (Del. Ch. Sep. 25, 2019), the Delaware Court of Chancery considered the parties’ competing requests for declaratory judgments. The dispute reduced to disagreements over the parties’ respective rights under an LLC agreement with respect to a proposed initial public offering. In this post-trial decision, the Court ruled that the defendants had the authority to implement certain steps in the proposed IPO, but not others, and ordered the parties to prepare a form of final order consistent with its rulings.
Defendants Jack M. Lafield and Richard Moncrief formed Caiman Energy LLC (“Caiman I”) in 2009 and sold its assets to The Williams Companies, Inc. (“Plaintiff”) in March 2012. Shortly thereafter, Lafield and Moncrief formed Caiman Energy II, LLC (“Caiman II”) through funding from investors, including EnCap fund managers (“EnCap”) and Plaintiff, who became the largest investor. Caiman II was a manager-managed LLC with a nine-member board of managers. Plaintiff received the right to designated three of the Board members (“Williams Managers”); EnCap received the right to designate two of the Board members (“EnCap Managers”). The remaining four spots were filled by another investor and Caiman I management.
The Caiman II LLC Agreement, as amended (the “LLC Agreement”), provided for three different tiers of Board approval, each applicable to particular Board actions. As a general matter, valid Board action required a number of votes equal to or exceeding a majority of the managers then entitled to be designated to the Board, i.e., five managers. Other items, including amendments to the LLC Agreement regarding the geographic scope of permissible activity, required an underlying majority of Board and approval of at least one Williams Manager and one EnCap Manager (“Special Voting Items”). The LLC Agreement provided for “Major Special Voting Items” which a single EnCap Manager had the sole and exclusive authority to authorize. The parties revised the former agreement such that the list of Major Special Voting Items in Section 6.8 of the LLC Agreement consisted of only: “(i) to approve a Qualified IPO, or (ii) to take any action, authorize or approve, or enter into any binding agreement with respect to or otherwise commit to do any of the foregoing.”
In May 2019, Plaintiff filed suit naming EnCap, Caiman II and others as defendants (collectively, the “Defendants”). Count I asserted a claim for anticipatory breach of the LLC Agreement based on the Defendants’ plan to amend certain provisions of the LLC Agreement regarding the geographic scope of Caiman II’s (and one of its subsidiaries) business operations. Count II sought a declaratory judgment that the Defendants could not amend the geographic scope restrictions without Plaintiff’s consent. The Defendants filed counterclaims and asserted affirmative defenses. The sole count in the counterclaims sought declaratory judgments designed to allow the Defendants to proceed with a proposed IPO. Among other things, the proposed IPO would invert the Caiman II entity structure, transforming Caiman II from its current status as the top-tier entity into a post-IPO role as the lowest-tier subsidiary (the “Up-C IPO”).
The parties agreed that the LLC Agreement gave the EnCap Manager(s) the sole and exclusive right to cause Caiman to approve of an IPO that meets the definition of a “Qualified IPO”. However, the Defendants read the relevant language the LLC Agreement to grant power to modify the definition of a Qualified IPO and to alter the steps that the LLC Agreement otherwise would require in connection with the Qualified IPO. Plaintiff forwarded a more narrow reading which granted to the Defendant only the limited authority to approve of a Qualified IPO, as defined in the LLC Agreement, and then to take actions that are necessary to achieve a Qualifed IPO that meets the contractual definition. Plaintiff argued that the Defendants’ reading of the relevant language ) would render the twelve-single spaced paragraphs regarding the mechanics of a Qualified IPO (the “Qualified IPO Section”) as surplusage. The Court ultimately agreed with Plaintiff and added that the Defendants’ position was also unreasonable because it had no natural limiting principle. “Read in conjunction with other sections in the Caiman LLC Agreement, [the relevant provision] does not give EnCap expansive authority to take any conceivable action with respect to a Qualified IPO”.
The Court then analyzed EnCap’s authority under the Qualified IPO Section, which the Court determined included an “IPO Exchange Clause,” an “IPO Facilitation Clause,” and an “Entity Formation Clause.” IPO Facilitation Clause provided that at any time after the approval of a Qualified IPO in accordance with this Agreement, EnCap was entitled to take all such other actions as are required and necessary to facilitate the Qualified IPO without the consent or approval of any other person. As such, the Court concluded that EnCap is entitled to take actions that are necessary or required to facilitate an IPO having the characteristics of a Qualified IPO as defined in the LLC Agreement. However, the Court ruled that because EnCap is acting on behalf of the Board, EnCap cannot take actions that the LLC Agreement does not empower the Board to take. Accordingly, because that Board could not amend the LLC Agreement, among other things, when approving the Qualified IPO, EnCap could not amend the LLC Agreement to alter the geographic scope when effectuating the Qualified IPO.
Finally, the Court applied its plain meaning interpretation of various LLC Agreement provisions to the disputed steps in the proposed Up-C IPO. Because of the Court’s negative determinations with regards to the majority of the disputed steps, Defendants could not proceed with the Up-C IPO as structured. Rather, the Court directed the parties to prepare a final order that implements the rulings from this decision.