Court Of Chancery Holds That Member Of Limited Liability Company Is Entitled To Advancement While Defending A Lawsuit In Its “Official Capacity”
In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. April 30, 2019), the Delaware Court of Chancery (the “Court”) held that a member of a limited liability company, in defending a lawsuit in its “official capacity” brought by the company’s managing member, was entitled to advancement of litigation expenses under the company’s operating agreement.
In mid-2008, Freeman Family LLC (“Freeman Family” or “Member”) entered into the First Amended Limited Liability Company Agreement (the “Operating Agreement”) of Park Avenue Landing LLC (the “Company”). Hugo Neu Corporation, the Company’s managing member (the “Managing Member”), was also party to the Operating Agreement. In exchange for equity in the Company, Freeman Family agreed to cause its owner to “use his best efforts on behalf of the Company” to effect an exchange of real property on the Company’s behalf and to support the Company in other ways. In connection with this arrangement, the Operating Agreement provided for two call rights (the “Call Rights”) enabling the Managing Member to buy back Freeman Family’s equity under certain circumstances. In late 2016, the Managing Member sought to exercise its Call Rights and, having encountered resistance from Freeman Family, filed a federal lawsuit several months later in New Jersey in an effort to enforce such Call Rights (the “New Jersey Action”).
In mid-2018, Freeman Family filed a complaint (the “Complaint”) with the Court, seeking advancement of litigation expenses arising from the New Jersey Action under the terms of the Operating Agreement. In relevant part, the Operating Agreement stated that the Company would indemnify and advance expenses to a person in connection with “any action by or in the right of the Company to procure a judgment in its favor, by reason of the fact that such Indemnitee is or was a Managing Member, Member or an officer of the Company.”
The Court considered two primary issues. First, the Court examined the applicability of corporate advancement decisions. The Court noted that, as a general matter, Delaware limited liability companies are “creatures of contract” under the Delaware Limited Liability Company Act (the “LLC Act”) and thus the Court would typically apply principles of contract interpretation to construe the terms of the Operating Agreement. However, the Court observed that drafters of operating agreements may elect to adopt and incorporate concepts from the laws of other entities and, in the case of the Operating Agreement, the indemnification and advancement provisions mirrored language from Sections 145(a) and (b) of the Delaware General Corporation Law (the “DGCL”). As a result, because “parties are free to contract into corporate case law (or not) when they create LLCs, and courts will respect that choice,” the Court held that it was proper to apply the DGCL and related corporate case law to the interpretation of the Operating Agreement.
Next, the Court determined that, under the terms of the Operating Agreement, Freeman Family was entitled to advancement of legal expenses from the Company in connection with the New Jersey Action. Under the “official capacity” standard, a director, officer, or other member of an entity is generally entitled to indemnification and advancement if the underlying proceedings have a nexus or causal connection to such director’s, officer’s, or member’s official capacity (i.e., as opposed to litigating a purely personal contractual obligation). In the Court’s view, the Operating Agreement made clear that Freeman Family, as a member of the Company, was responsible for negotiating on the Company’s behalf and finding real estate developers in connection with the proposed exchange of real property. According to the Court, the “Company’s desire that these tasks be completed forms the purpose of Freeman Family’s membership, and thus actions taken in support of discharging these duties comprise Freeman Family’s official capacity.” The Court further found the requisite nexus between Freeman Family’s alleged failure to carry out its responsibilities under the Operating Agreement and the underlying litigation for which advancement was sought (i.e., the New Jersey Action and exercise of the Call Rights). As a result, the Court held that Freeman Family was, in defending the New Jersey Action in its official capacity, entitled to advancement of litigation expenses under the Company’s Operating Agreement.