GIVING-THANKS

 

Last year, in my first Thanksgiving week post, I gave public thanks for my students. I could just as easily have done that again this year.  My students continue to impress and inspire me.  And that is certainly something to be grateful for–year in, and year out.

This year, however, I also want to acknowledge my thanks for all of the special colleagues I have in the academy (and yes, fellow BLPB editors, that includes you!) and the bar that make my job complete.  When I have needed assistance, support, or just a good laugh, it is my fellow law peeps–and especially my business law peeps–to whom I most often turn and on whom I almost always rely.

You, my law teacher and lawyer friends, have:

  • read and edited my early syllabi, exams, and assignments, preventing me from making mistakes that new law professors often make;
  • taught my Business Associations class when my mother was dying so I could be by her side;
  • helped my son learn about e-discovery and various types of law practice so that he could launch his career;
  • provided assistance to my Corporate Finance students when they needed specialized guidance or advice on their planning and drafting projects;
  • reviewed innumerable drafts of law review articles and provided honest, insightful criticism and comments;
  • supplied (whether knowingly or unknowingly) material that I can and do use to help educate my students about real-world legal problems that impact businesses and the people who engage with them;
  • forgiven me when I have done stupid sh*t in conducting my professional activities that doesn’t warrant mercy or amnesty;
  • stayed up with me late at night to draft portions of self-study reports, legislation, and other important documents; 
  • invited or elected me to serve in professional leadership positions, on academic panels, on professional association and bar committees, and in other capacities that have enabled me to both serve and continue to learn;
  • collaborated with me on materials and presentations for important continuing legal education programs; 
  • extended publication or submission deadlines to give me time and space to handle emergent personal or professional obligations that I determined were important; and
  • built solid foundations in theory, policy, and doctrine from which I can build my teaching and scholarship.

I am sure I am forgetting important things, large and small, in this list.  But you get the picture and the point.  And I am sure that each of you reading this could come up with your own similar list of things about which you are thankful relative to our colleagues–truly remarkable, extraordinary people.

In any event, I am grateful for you all.  Have a blessed Thanksgiving.

Like many people, I am traveling for the holiday this week.  Because of that, I’ll keep this short. Since November 15, 2015, several more courts have listed an LLC as a “limited liability corporation,” instead of the correct, “”limited liability company.”  The culprits:

Editorial Note: A case was removed from this listing on September 3, 2017 at the request of a reader after consultation with the author.

1) Ironridge Glob. IV, Ltd. v. Securities and Exch. Commn., 1:15-CV-2512-LMM, 2015 WL 7273262, at *11 (N.D. Ga. Nov. 17, 2015) (“Notwithstanding the plain text of § 1391(c), the SEC argues that (1) § 1391(c) was intended to apply to corporations, partnerships, limited liability corporations, and labor unions—not federal agencies—according to “a natural reading of the full text of the statute” and its legislative history; and (2) to read § 1391(c) otherwise would facilitate forum shopping.”).

2) In the caption: Perez v. Sophia’s Kalamazoo, LLC, d/b/a SOPHIA’S HOUSE OF PANCAKES, a limited liability corporation, et al., Defendants., No. 1:14-CV-772, 2015 WL 7272234 (W.D. Mich. Nov. 17, 2015).

3) In the caption: Oracle America, Inc., a Delaware Corporation, Plaintiff, v. The Oregon Health Insurance Exchange Corporation, dba Cover Oregon, an Oregon Limited Liability Corporation, and The State of Oregon, by and through The Oregon Health Authority and The Oregon Department of Human Services, Defendants, No. 3:14-CV-01279-BR, 2015 WL 7296233 (D. Or. Nov. 18, 2015). 

4) In re Jeffries, No. 14-50656, 2015 WL 7348214, at *3 (Bankr. M.D.N.C. Nov. 19, 2015) (“The Debtor did not disclose her affiliation with GQM, a limited liability corporation organized in North Carolina in May, 2005. The Debtor was listed as the registered agent and signed the Articles of Organization as the President [member organizer]. This LLC was dissolved in August 2010.”).

5) HUA LIN, HENG CHEN, FEI HU, WEI LIN, ZHEN ZU, and JIU TAO WANG, Plaintiffs, v. W & D ASSOCIATES LLC doing business as KUDETA, CHRISTINA TAN, DOUG MCSHANE, ALBERT WONG, ELAINE PI YUN CHAO, EMILY PI SHIA CHAO, HERRY DARBI, TERRENCE KUM, and TOM HO, Defendants, and W & D ASSOCIATES LLC doing business as KUDETA, CHRISTINA TAN, DOUG MCSHANE, ALBERT WONG, ELAINE PI YUN CHAO, and EMILY PI SHIA CHAO, Third-Party Plaintiffs, v. HERRY DARBI, Third-Party Def.., 3:14-CV-164 (VAB), 2015 WL 7428528, at *2 (D. Conn. Nov. 20, 2015) (“W&D was founded as a Connecticut limited liability corporation in 2005 for the purpose of funding and managing Kudeta Restaurant in New Haven, Connecticut.”).
 

This post concludes the Contract Is King, But Can It Govern Its Realm? Micro-symposium.  The symposium was hosted as part of the AALS section on Agency, Partnership, LLCs and Unincorporated Associations in advance of the section meeting on January 7th at 1:30 where the conversation will be continued.

I summarized the conversation and provided links to all of the individual posts.  Bookmark this page– there is great commentary at your finger tips on a range of topics.  Please keep reading (and commenting) on these great contributions by our insightful participants to whom we are very grateful.

Jeffrey Lipshaw kicked off the symposium conversation with his post (available here) questioning, in practice, how different LLCs are from traditional corporations.  He used a great map analogy to talk about the role of formation documents and default rules as gap fillers. 

“The contractual, corporate, and uncorporate models are always reductions in the bits and bytes of information from the complex reality, and that’s what makes them useful, just as a map of Cambridge, Massachusetts that was as complex as the real Cambridge would be useless.” 

After asserting that LLCs differ from corporations only in matters of degrees, Jeff went on to to them illustrate how degrees of difference may still matter.  He provided a good example of a situation where the ability to eliminate fiduciary duties may produce the right result—an option only available in alternative entities not corporations.  

Mohsen Manesh contributed two posts (available here and here).

Mohsen argued that if contract is king, business revenue rules the reign in Delaware.  Franchise taxes and revenues generated from being the business domicile of so many businesses, in all forms, is a source of riches, one that Mohsen argued will be protected by preserving a commitment to freedom of contract.

“Delaware’s annual tax charged to alternative entities is flat. All LLCs and LPs, no matter how large or small, whether publicly traded or closely held, pay the state only $300 annually for the privilege of being a Delaware entity. Thus, unlike the corporate context, where Delaware’s business is dependent on attracting large, publicly traded corporations, in the alternative entity context, Delaware’s business depends on volume alone.”

In his first post, Mohsen also addressed Delaware Chief Justice Strine and Vice Chancellor Laster’s provocative “Siren Song” book chapter, where the pair advocate for mandatory fiduciary duties in publicly traded LLCs and LPs.  Mohsen questioned the limitation arguing that

“[M]any of critiques that Strine and Laster levy at publicly traded alternative entities– unsophisticated investors, the absence of true bargaining, and confusing contract terms that often unduly favor the managers—could be levied at many private entities as well. If so, then why should Strine & Laster’s proposal be limited to public entities?”

Sandra Miller blogged here about investor sophistication and its relationship to fiduciary duty waivers.  She highlighted her scholarship in the area and provided helpful links to her papers discussing her points in greater detail.

“[T]here are asymmetries in the marketplace that make it unlikely that the marketplace will efficiently discount the effects of waivers.  Given the investor profile, at a very minimum, the duty of loyalty should be non-waivable for publicly-traded entities.” 

Joan Heminway questioned whether LLC operating agreements are contracts, and if not the implication for fiduciary duties, statue of frauds, capacity and public policy challenges and enforceability against third parties.

“[W]ith judicial and legislative attention on freedom of contract in the LLC, the status of the LLC as a matter of contract law may shed light on the extent to which contract law can or should be important or imported to legal issues involving LLC operating agreements…So, while contract may be king in LLC law, we may question whether a contract even exists under LLC law.”

Joan also highlighted her recent appearance at the ABA LLC Institute in a related post available here and shared the many functions of an operating agreement (whether contract or not!).

Daniel Kleinberger contributed to the conversation in four parts (appearing in three separate posts here (1), here (2) and here(3)).  Daniel focused on Delaware’s implied contractual covenant of good faith and fair dealing and the covenant’s role in Delaware entity law.  He carefully distinguished the covenant from the UCC implied covenant of good faith and fair dealing and from the corporate standards of good faith as articulated in Stone v. Ritter and Smith v. Van Gorkum.  Thirdly he addressed waivers of good faith and fair dealing both in the governing agreement and arising from contract in Delaware and under the Uniform Limited Partnership Act. 

“Perhaps ironically (or some might even say “counter-intuitively”), the Uniform Limited Liability Company Act (2006) (Last Amended 2013) permits an ULLCA operating agreement to go where a Delaware operating agreement cannot.” 

In his final post, available here, Kleinberger addressed interpretation questions with implied covenants analogizing the analysis to that used with impracticability. 

“For impracticability or a breach of the implied covenant to exist, the situation at issue must have been fundamentally important to the deal and yet unaddressed by the deal documents.  Put another way:  the notion of a “cautious enterprise” means that only a condition that is egregious or at least extreme is capable of revealing a gap to be remedied by the implied covenant.”

BLPB editor, Joshua Fershee, was inspired by the topic and contributed his own post to the micro-symposium.  In his post, he declared himself a Larry Ribstein devotee and highlighted how the structural differences in the LLC form, as opposed to the corporate form, provide business benefits for LLC members.

“The flexibility of the LLC form creates opportunity for highly focused, nimble, and more specific entities that can be vehicles that facilitate creativity in investment in a way that corporations and partnerships, in my estimation, do not.”

Greg Day, another BLPB-generated contribution to the conversation, blogged about sophisticated parties’ utilization of freedom of contract in LLC, and sophisticated investors demand for the conformity of traditional corporate formation over LLCs.

“[W] hen Delaware LLCs become big, and attract big funds, a condition of investment almost always requires an LLC to convert into a Delaware corporation. It seems that the lack of predictability associated with the freedom of contract scares potential investors who prefer the comforts of fiduciary duties, among other corporate staples. …So the parties who ostensibly are best served by contractual freedoms—i.e., sophisticated parties—appear to be the ones most likely to demand the traditional corporate form. And on a related note, this helps to explain why such a paltry number of LLCs and LPs have become public companies.”

Finally, Peter Molk & Verity Winship also contributed a last-minute addition to the symposium highlighting their empirical work on LLC operating agreement dispute resolution provisions as it relates to the question of contracting rights in unincorporated entities.  They reported some of their early findings and linked it to the discussion about contractual freedom and the implications of mandatory fiduciary duties. 

“More than a third of the agreements in our sample selected the forum for resolving disputes, primarily through exclusive forum provisions or mandatory arbitration provisions.  The agreements also modified litigation processes through terms that imposed fee-shifting, waived jury trials, and, less commonly, through other means like books and records limitations.”

Participants in the Micro-Symposium were asked to respond to a series of questions (available here) that will be further discussed at the AALS section meeting.  Joan MacLeod Heminway (BLPB editor), Dan Kleinberger, Jeff Lipshaw, Mohsen Manesh, and Sandra Miller.will be panelists at the AALS meeting and joined by Lyman Johnson and Mark Loewenstein. 

Guest Post by Daniel Kleinberger

Part IV– Delaware’s Implied Contractual Covenant of Good Faith and Fair Dealing

Delaware case law applying the implied contractual covenant of good faith and fair dealing to a limited partnership dates back to at least 1993,[i] and Delaware’s limited partnership and limited liability company acts have expressly recognized the covenant since 2004.[ii] However, the contents of the implied covenant have not always been crystal clear.[iii]

     A passage from a 2000 Chancery Court decision is illustrative:

The implied covenant of good faith requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the contract.  This doctrine emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party.  The parties’ reasonable expectations at the time of contract formation determine the reasonableness of the challenged conduct.  [C]ases invoking the implied covenant of good faith and fair dealing should be rare and fact-intensive.  Only where issues of compelling fairness arise will this Court embrace good faith and fair dealing and imply terms in an agreement.[iv]

     This formulation was correct as far as it went, but it omitted the all-important frame of reference.  In the “fact-intensive” inquiry, what types of facts matter?  Where does the court look to determine “the agreed common purpose” and “the justified expectations of the [complaining] party”?  What evidence is admissible to prove the expected “fruits of the bargain”?

     The answers to these questions determine whether “implying obligations based on the covenant of good faith and fair dealing [remains] a cautious enterprise.”[v]  The broader the frame of reference, the more likely is the covenant to become “a judge’s roving commission for determining fairness.”[vi] 

     Fortunately, over the past five years the Court of Chancery and the Delaware Supreme Court have provided both clarity and context.  The frame of reference is confined to the actual words of the agreement; the reasonable expectations must be gleaned from those words.[vii]

     Thus, the actual words of the agreement control the application of the implied covenant, both as to “fair dealing” and “good faith”:

“Fair dealing” is not akin to the fair process component of entire fairness, i.e., whether the fiduciary acted fairly when engaging in the challenged transaction as measured by duties of loyalty and care …. It is rather a commitment to deal “fairly” in the sense of consistently with the terms of the parties’ agreement and its purpose.  Likewise, “good faith” does not envision loyalty to the contractual counterparty, but rather faithfulness to the scope, purpose, and terms of the parties’ contract.  Both necessarily turn on the contract itself and what the parties would have agreed upon had the issue arisen when they were bargaining originally.[viii]

     When a court considers a fiduciary claim, the “court examines the parties as situated at the time of the [alleged] wrong….  [and] determines whether the defendant owed the plaintiff a duty, considers the defendant’s obligations (if any) in light of that duty, and then evaluates whether the duty was breached.”[ix]  In contrast, because the actual words of the agreement control the application of the implied covenant:

An implied covenant claim … looks to the past.  It is not a free-floating duty unattached to the underlying legal documents.  It does not ask what duty the law should impose on the parties given their relationship at the time of the wrong, but rather what the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting.[x]

     A successful implied covenant claim depends on finding a gap in the contractual language; therefore, an implied covenant claim cannot override an express contractual provision.[xi]  For example, if a limited partnership agreement creates options for limited partners under specified circumstances and not otherwise, the implied covenant will not extend the option right to circumstances not specified.[xii]  Expressio unius est exclusio alterius.[xiii]  There is no gap.

     But inevitably gaps will exist:[xiv]

No contract, regardless of how tightly or precisely drafted it may be, can wholly account for every possible contingency. Even the most skilled and sophisticated parties will necessarily fail to address a future state of the world … because contracting is costly and human knowledge imperfect. In only a moderately complex or extend[ed] contractual relationship, the cost of attempting to catalog and negotiate with respect to all possible future states of the world would be prohibitive, if it were cognitively possible. And parties occasionally have understandings or expectations that were so fundamental that they did not need to negotiate about those expectations.[xv]

     For example, suppose that: (i) a limited partnership agreement authorizes the general partner to restructure the organization as the general partner sees fit provided a competent expert provides a “fairness opinion” stating that the restructuring is fair to the limited partners; (ii) a competent expert furnishes the opinion; but (iii) the expert omits to consider the value of certain contingent assets of the limited partnership, namely the value of pending derivative litigation.[xvi]  Because the limited partnership agreement “[does] not specify whether the fairness opinion [has] to consider the value of derivative litigation,” the expert’s omission reveals “a gap for the implied covenant to fill.”[xvii]  The gap is filled with what the court concludes “the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting.”[xviii]

     In this respect, the implied covenant analysis resembles the analysis for determining whether a party’s contractual duties are discharged by supervening impracticably.  “In order for a supervening event to discharge a duty …, the non-occurrence of that event must have been a ‘basic assumption’ on which both parties made the contract.”[xix]  For impracticability or a breach of the implied covenant to exist, the situation at issue must have been fundamentally important to the deal and yet unaddressed by the deal documents.  Put another way:  the notion of a “cautious enterprise”[xx] means that only a condition that is egregious or at least extreme is capable of revealing a gap to be remedied by the implied covenant.[xxi]

Endnotes:

[i] Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1207 (Del. 1993) (“Desert Equities alleges that the defendants breached their implied covenant of good faith and fair dealing when they, in bad faith, breached the Partnership Agreement.”).

[ii] 74 Del. Laws, c. 265, §15 (revising Del. Code tit. 6, § 17-1101(d) to provide inter alia that “the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing”).  The same change was made to the limited liability company act by 74 Del. Laws, c. 275, § 13 (revising Del. Code tit. 6, § 18-1101(c) to provide inter alia that “the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing”).

[iii] Cincinnati SMSA Ltd. P’ship v. Cincinnati Bell Cellular Sys. Co., 708 A.2d 989, 992 (Del. 1998) (stating that “[t]he articulation of the standard for implying terms through application of the covenant of good faith and fair dealing represents an evolution from previous Delaware case law” and that “Delaware Supreme Court jurisprudence is developing along the general approach that implying obligations based on the covenant of good faith and fair dealing is a cautious enterprise”).  See also, e.g., Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1207 (Del. 1993) (reversing the Chancery Court’s dismissal on the pleadings of plaintiff’s implied covenant claim; accepting the seemingly redundant notion that bad faith breach of the partnership agreement could breach the implied covenant; and suggesting the general partner may have acted in bad faith by “act[ing] unreasonably”).  For a decision that addresses the redundancy issue, see Painewebber R & D Partners, L.P. v. Centocor, Inc., No. C.A. 96C-04-194, 1998 WL 109818, at *4 (Del. Super. Feb. 13, 1998) (“The Court is satisfied that the payment obligations of Centocor are encompassed by the express terms of the PPA and, as a matter of law, cannot be the subject of any implied covenant.”)

[iv] Cont’l Ins. Co. v. Rutledge & Co., 750 A.2d 1219, 1234 (Del. Ch. 2000) (internal quotations and footnotes omitted).

[v] Cincinnati SMSA Ltd. P’ship v. Cincinnati Bell Cellular Sys. Co., 708 A.2d 989, 992 (Del. 1998).

[vi] Daniel S. Kleinberger, Two Decades of “Alternative Entities”: From Tax Rationalization Through Alphabet Soup to Contract as Deity, 14 Fordham J. Corp. & Fin. L. 445, 469 (2009) (first presented as the keynote address at the 2lst Century Commercial Law Forum – Seventh International Symposium 2007 – sponsored by School of Law, Tsinghua University, Beijing, People’s Republic of China).  See also Nemec v. Shrader, 991 A.2d 1120, 1128 (Del. 2010) (“Crafting, what is, in effect, a post contracting equitable amendment that shifts economic benefits from [one set of shareholders to another] would vitiate the limited reach of the concept of the implied duty of good faith and fair dealing…. The policy underpinning the implied duty of good faith and fair dealing does not extend to post contractual rebalancing of the economic benefits flowing to the contracting parties.”); Lonergan v. EPE Holdings, LLC, 5 A.3d 1008, 1019 (Del. Ch. 2010) (criticizing and rejecting attempts to “re-introduce fiduciary review through the backdoor of the implied covenant” of good faith and fair dealing).  This point is precisely what divided the majority and dissent in Nemec. The core of the dissent is this statement: “[U]nder Delaware case law, a contracting party, even where expressly empowered to act, can breach the implied covenant if it exercises that contractual power arbitrarily or unreasonably.”  Nemec, at 1131 (Jacobs, J. dissenting).  The statement does not recognize that the frame of reference must be the words of the contract.  Cf. ULLCA (2013) § 409(d), cmt. (stating that “the purpose of the contractual obligation of good faith and fair dealing is to protect the arrangement the members have chosen for themselves, not to restructure that arrangement under the guise of safeguarding it”).  But cf. HB Korenvaes Inv., L.P. v. Marriot Corp., Del. Ch., C.A. No. 12922, Mem. Op. at 11, Allen, C., (June 9, 1993) (“Indeed the contract doctrine of an implied covenant of good faith and fair dealing may be thought in some ways to function analogously to the fiduciary concept.”) (quoted in Gale v. Bershad, No. CIV. A. 15714, 1998 WL 118022, at *5 n. 24(Del. Ch. Mar. 4, 1998); Gale v. Bershad, No. CIV. A. 15714, 1998 WL 118022, at *5 (“The function of the implied covenant of good faith and fair dealing in defining the duties of parties to a contract, is analogous to the role of fiduciary law in defining the duties owed by fiduciaries.”); Blue Chip Capital Fund II Ltd. P’ship v. Tubergen, 906 A.2d 827, 832 (Del. Ch. 2006) (stating that “[t]he court [in Gale v. Bershad] explained that the implied covenant of good faith and fair dealing defines the duties of parties to a contract and is analogous to the role of fiduciary law in defining the duties owed by fiduciaries”) (citing Gale v. Bershad, No. CIV. A. 15714,.1998 WL 118022 at *5, (Del.Ch. Mar. 3, 1998)).

[vii] These points are analogous to Professor Williston’s four corners approach to determining ambiguity for the purposes of the parol evidence rule.  See, e.g., Wallace v. 600 Partners Co., 86 N.Y.2d 543, 548, 658 N.E.2d 715, 717 (1995) (stating that “[t]he question whether a writing is ambiguous is one of law to be resolved by the courts” and that “excursion beyond the four corners of the document” is warranted only when the wording is not “clear and complete”) (citing Williston, 4 Williston, Contracts, § 610A, at 513 [3d ed.]).  The “roving commission” notion resembles Professor Corbin’s approach to the ambiguity question.  “According to Corbin, the court cannot apply the parol evidence rule without first understanding the meaning the parties intended to give the agreement. To understand the agreement, the judge cannot be restricted to the four corners of the document.”  Taylor v. State Farm Mut. Auto. Ins. Co., 175 Ariz. 148, 153, 854 P.2d 1134, 1139 (1993) (citation omitted).  Delaware takes the Williston approach.  GMG Capital Investments, LLC v. Athenian Venture Partners I, L.P., 36 A.3d 776, 781-84 (Del. 2012) Schwartz v. Centennial Ins. Co., No. CIV. A. 5350 (1977), 1980 WL 77940, at *5 (Del. Ch. Jan. 16, 1980) (stating that “parol evidence may not be used to show an ambiguity in the first place”).

[viii] Gerber v. Enter. Products Holdings, LLC, 67 A.3d 400, 418-19 (Del. 2013) (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440–42 (Del. Ch. 2012), aff’d in part, rev’d in part on other grounds, 68 A.3d 665 (Del. 2013)) (footnotes omitted) (citations omitted) (internal quotations omitted without ellipsis by Gerber). 

[ix] Gerber v. Enter. Products Holdings, LLC, 67 A.3d 400, 418 (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440–42 (Del. Ch. 2012), aff’d in part, rev’d in part on other grounds, 68 A.3d 665 (Del. 2013)) Del. 2013).  Gerber was overruled on other grounds by Winshall v. Viacom Int’l, Inc., 76 A.3d 808 (Del. 2013).  See also Gilbert v. El Paso Co., 575 A.2d 1131, 1142-43 (Del. 1990) (enforcing express conditions pertaining to a tender offer; stating that “[a]lthough an implied covenant of good faith and honest conduct exists in every contract … such subjective standards cannot override the literal terms of an agreement”).

[x] Gerber v. Enter. Prods. Holdings, LLC, 67 A.3d 400, 418 (Del. 2013) (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440–42 (Del. Ch. 2012), aff’d in part, rev’d in part on other grounds, 68 A.3d 665 (Del. 2013)) (emphasis added) (footnotes omitted) (citations omitted) (internal quotations omitted without ellipsis by Gerber).  In this respect, the implied covenant parallels the contract law doctrine of unconscionability.  See Restatement (Second) of Contracts § 208 (1981) (stating that the unconscionability analysis addresses whether “a contract or term thereof is unconscionable at the time the contract is made”) (emphasis added); UCC § 2-302 (stating that the doctrine applies only if “the court finds the contract or any clause of the contract to have been unconscionable at the time it was made”) (emphasis added).

[xi] Nemec v. Shrader, 991 A.2d 1120, 1127 (Del.2010) (“The implied covenant will not infer language that contradicts a clear exercise of an express contractual right.”).

[xii] See Aspen Advisors LLC v. United Artists Theatre Co., 843 A.2d 697, 707 (Del. Ch.) aff’d, 861 A.2d 1251 (Del. 2004) (“By specific words, the parties to the Stockholders Agreement and the Warrants identified particular transactions that would provide the Warrantholders with the right to receive the same consideration paid to common stockholders (e.g., in mergers involving United Artists) and the right (if they had exercised their Warrants) to tag along (i.e., in certain change of control transactions). Similarly, the parties also (by omission) defined the freedom of action other parties to those contracts (such as United Artists, the UA Holders, and Anschutz) had to engage in transactions without triggering rights of that nature.”).

[xiii] “[T]o express or include one thing implies the exclusion of the other.” EXPRESSIO UNIUS EST EXCLUSIO ALTERIUS, Black’s Law Dictionary (10th ed. 2014).

[xiv] However, whether a gap matters depends on whether a party’s conduct makes the gap apparent – i.e., whether one party’s conduct exposes an issue on which the parties would have agreed had the issue arisen when the deal was being made.

[xv] Allen v. El Paso Pipeline GP Co., L.L.C., No. CIV.A. 7520-VCL, 2014 WL 2819005, at *11 (Del. Ch. June 20, 2014) (internal quotations and citations omitted).

[xvi] In simplified form, this example reflects one of the transactions – the 2010 merger – addressed in Gerber v. Enter. Products Holdings, LLC, 67 A.3d 400 (Del. 2013), overruled on other grounds by Winshall v. Viacom Int’l, Inc., 76 A.3d 808 (Del. 2013).

[xvii] Allen v. El Paso Pipeline GP Co., L.L.C., No. CIV.A. 7520-VCL, 2014 WL 2819005, at *14 (Del. Ch. June 20, 2014).  The opinion refers to the omission “creating a gap,” id. but the author respectfully disagrees.  The gap existed ab initio.  It remained hidden until revealed by the expert’s omission.

[xviii] Gerber v. Enter. Prods. Holdings, LLC, 67 A.3d 400, 418 (Del. 2013) (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440–42 (Del. Ch. 2012), aff’d in part, rev’d in part on other grounds, 68 A.3d 665 (Del. 2013)) (emphasis added) (footnotes omitted) (citations omitted) (internal quotations omitted without ellipsis by Gerber).  It might be more consistent with actual practice to revise the quoted language so that the sentence read: “The gap is filled with what the court concludes the now complaining party would have insisted on as a condition to going forward with the deal, if the party had then considered the issue in the party’s original bargaining position at the time of contracting.”

[xix] Restatement (Second) of Contracts § 261, cmt. b (1981)

[xx] See n. 66.

[xxi] In this respect, the implied covenant is similar to the unconscionability doctrine of contract law.  See Restatement (Second) of Contracts § 208. cmt. b (1981) (“Traditionally, a bargain was said to be unconscionable in an action at law if it was ‘such as no man in his senses and not under delusion would make on the one hand, and as no honest and fair man would accept on the other….”) (quoting Hume v. United States, 132 U.S. 406 (1889), which in turn was quoting Earl of Chesterfield v. Janssen, 2 Ves.Sen. 125, 155, 28 Eng.Rep. 82, 100 (Ch.1750)).

Last week was the 30th anniversary of the Delaware Supreme Court’s decision in Moran v. Household International, Inc., 500 A.2d 1346 (Del. 1985). In Moran, decided on Nov. 19, 1985, the Delaware Supreme Court upheld what has become the leading hostile takeover defensive tactic, the poison pill.

Martin Lipton, the primary developer of the pill, even makes an appearance in the case—and obviously a carefully scripted one: “The minutes reflect that Mr. Lipton explained to the Board that his recommendation of the Plan was based on his understanding that the Board was concerned about the increasing frequency of ‘bust-up’ takeovers, the increasing takeover activity in the financial sector industry, . . . , and the possible adverse effect this type of activity could have on employees and others concerned with and vital to the continuing successful operation of Household even in the absence of any actual bust-up takeover attempt.”

I’m not sure the takeover world would be that different today if Moran had rejected poison pills. I’m reasonably confident the Delaware legislature would have amended the Delaware statute to overturn the ruling, as they effectively did with another ruling decided earlier that same year, Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). Shortly after Van Gorkom made it clear that directors might actually be liable for violating the duty of care, the legislature added section 102(b)(7) to the Delaware law, allowing corporations to eliminate any possibility of damages for duty-of-care violations.

As my colleague Joan Heminway has pointed out, 1985 was an incredibly important year for M & A practitioners. In addition to Moran and Van Gorkom, a third major case was also decided that year: Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).

Van Gorkom was decided in late January of 1985, Unocal in June, and Moran in November. Corporations casebooks and treatises are filled with Delaware Supreme Court decisions, but that has to be one of the most important ten-month periods in Delaware corporate law jurisprudence—especially in the mergers and acquisitions area.

… but going back to corporations for a moment – a while ago, I speculated that corporate forum-selection bylaws could unfairly work to favor management, because management can choose to invoke them at will – they can deploy them to dismiss cases when it will benefit them, but also can refuse to invoke them when it would work to their advantage to have plaintiffs’ firms compete with each other in different jurisdictions.

Alison Frankel now reports that the FX company is doing just that.  According to her report, FX enacted a forum-selection bylaw choosing Utah as the forum; but now, faced with shareholder lawsuits in Nevada and Utah, it is choosing not to enforce the bylaw – precisely because, according to the Utah plaintiffs, it benefits management to have the plaintiffs compete for the opportunity to settle the case on sweetheart terms.

The basic problem is that these bylaws do not resemble contractual forum selection clauses, in that they can only be invoked by management – not plaintiffs.  And at least according to Delaware, they are only valid because they allow management the freedom to choose whether to invoke them (i.e., they contain a fiduciary out).  As a result, it’s critical that courts police their use, and, in particular, make sure they do not bring about the forum-shopping evil they were intended to prevent.  Better than that – and I realize it’s heresy to suggest  – multiforum litigation perhaps is not a problem that should be addressed privately, but instead should be addressed through coordinated action by the states.

The micro-symposium has generated interest in a broad range of topics, so we are adding the following post by Peter Molk & Verity Winship discussing their recent scholarship on dispute resolution in LLC operating agreements and its intersection with the “contract is king” discussion this week.

Guest post by Peter Molk & Verity Winship:

This post highlights a particular area of private ordering within the LLC and other alternative entities: contractual provisions within the operating agreement that set the rules for resolving internal disputes.  These terms determine how disputes are resolved, such as by specifying when claims must be submitted to arbitration, where disputes can be heard, and whether parties waive the jury right or impose fee-shifting of litigation costs.  They apply to internal disputes, meaning they govern the dispute process among the LLCs’ members, managers, and the LLC itself.

How do these provisions fit with the debate over whether contract should be king?  The broadest connection is straightforward.  Dispute resolution provisions allocate rights and duties within LLCs, so the debate about the proper bounds of freedom of contract in the LLC space has implications for them as well.  But how firms set the rules for internal disputes is also relevant to the particular debate about the imposition of fiduciary duties.  Suppose that fiduciary duties were to become mandatory in publicly traded LLCs and LPs, as Delaware Chief Justice Strine and Vice Chancellor Laster have proposed and as Sandra Miller and Mohsen Manesh discuss in their posts in this micro-symposium.  Imposing fiduciary duties, by expanding the actions that disgruntled members can bring, in turn puts particular pressure on the dispute resolution clauses. 

To see the connection, look no further than the debate in the corporate context about private ordering of shareholder litigation in corporate charters and bylaws.  Contract is not king in the corporate context – a host of mandatory rules, including fiduciary duties, are imposed to protect investor rights.  Since corporations cannot respond by waiving fiduciary duties, some have instead taken the step of nevertheless effectively eliminating these protections by contracting out of enforcement mechanisms.  Recent efforts at imposing fee shifting can be characterized as indirectly weakening mandatory protections by reducing the probability of enforcing them. 

For corporations, the Delaware legislature eventually stepped in to ban fee-shifting provisions in the organizational documents of Delaware stock corporations.  The legislative response is telling.  It targets only stock corporations, using the business form as a proxy for characteristics that trigger a need for additional protections.  This takes us back to the question of whether contract should be king, and whether business form is a good rough indicator of characteristics (sophistication, consent) that we care about.

In an empirical study we are conducting, we identified dispute resolution provisions in a sample of operating agreements of privately owned Delaware LLCs.   More than a third of the agreements in our sample selected the forum for resolving disputes, primarily through exclusive forum provisions or mandatory arbitration provisions.  The agreements also modified litigation processes through terms that imposed fee-shifting, waived jury trials, and, less commonly, through other means like books and records limitations.  

We can think of these practices as altering the calculus parties engage in when deciding whether to enforce their rights that exist under the agreement.  While looking at dispute resolution provides a more accurate picture for LLCs’ governance regimes, it also complicates the contract-as-king debate.  Strengthening LLC members’ mandatory protections beyond the duty of good faith and fair dealing, as several earlier posts propose, does little good if LLCs respond by cutting back parties’ ability to enforce these protections.

The title of this post undoubtedly promises too much.  But that won’t prevent me from trying to establish a few points that approach the many topics that could be discussed under a title that includes this much great stuff.  I make that attempt here.

I start with contract law.  As I noted in my prior post for this micro-symposium, one of my appearances at last week’s ABA LLC Institute included a debate on whether an operating agreement is a common law contract.  This question arose in connection with my teaching of operating agreements (and also has arisen in my teaching of partnership agreements) in Business Associations.  Of course, lawyers understand that not all agreements are contracts.  A significant amount of energy is spent on this matter in the beginning of the standard contracts course in law school.  

Is an LLC operating agreement a contract?  I like the question not just for its face value, but because I believe that the answer does or may matter for purposes of resolving other questions arising in and outside LLC law.  I captured some thoughts about this question in a draft essay soon to be published in revised form in the SMU Law Review.  (I blogged about it here over the summer.)  Among other things, with judicial and legislative attention on freedom of contract in the LLC, the status of the LLC as a matter of contract law may shed light on the extent to which contract law can or should be important or imported to legal issues involving LLC operating agreements.

Continue Reading Contract Law, Fiduciary Duties, Good Faith, Fair Dealing, and the Legal Status of LLC Operating Agreements (Contract Is King Micro-Symposium)