Litigation

Court of Chancery Interprets LLC Exculpation Clause

By Morris James LLP

Kahn v. Portnoy, C.A. 3515-CC (Del. Ch. Dec. 12, 2008)

This important decision illustrates how hard it is to make an LLC agreement cover all future events. While there is a growing school of thought that advocates letting the parties make their own bed in the form of the LLC agreement, that approach fails to appreciate how hard it is to do that well. The failure to successfully do so leaves everyone unhappy, and they would have been better off had they not tried to begin with.

Here the parties to an LLC agreement tried to address conflict of interest situations that were sure to occur when the entity would contract with related entities owned by its directors. They did so by a clause that was supposed to limit fiduciary duties in such cases. What happened, and it happens a lot, is that the language they used did not exactly fit the circumstances they later faced. As a result, they proceeded apparently thinking that they were alright only to be followed by the Court correctly pointing out that the language they relied upon did not work as they thought. Now they face liability under fiduciary standards they cannot meet.

One answer is better drafting. But given the many times that seems not to have been done, perhaps it is time to give up the effort to speak to all future events. Instead, those transactions that are expected to occur should be addressed directly and specifically. If the directors want their personal company to rent to the LLC, then they should say that is okay at least if the rent is approved by an independent third party. If they do not know what type of transactions they want to enter into, then they should fall back on the extensive fiduciary law under the Delaware corporation law that will tell them how to do a deal safely.

Full post as published by Delaware Business Litigation Report on December 11, 2008 (boomark / email).