Delaware Court of Chancery Finds That “Blocking Rights” Exercised by Minority Investors May Amount to an “Actual Control” Position
In Skye Mineral Investors, LLC and Clarity Copper, LLC v. DXS Capital (U.S.) Limited et al., C.A. No. 2018-0059-JRS (Del. Ch. Feb. 24, 2020), the Delaware Court of Chancery allowed claims to survive a motion to dismiss when such claims sufficiently pled that, by exercising certain “blocking rights,” minority members of an LLC achieved an actual control position over the LLC and, in bankrupting the LLC’s subsidiary in order to purchase its assets at a reduced price, breached their related fiduciary duties.
Skye Mineral Partners, LLC (the “Company” or “SMP”) is a Delaware LLC. Skye Mineral Investors, LLC and Clarity Copper, LLC (collectively, the “Plaintiffs”) were majority members of the Company. DXS Capital (U.S.) Limited and PacNet Capital (U.S.) Limited were minority members of the Company. The minority members were owned and controlled by a number of non-member affiliates, and such entities, along with the Company’s lender, are referred to collectively as the “Defendants.” Virtually all of the Company’s assets consisted of a wholly-owned operating subsidiary, CS Mining, LLC (“CSM”).
The Company’s operating agreement provided for certain “blocking rights,” such that specific corporate transactions (e.g., entering into a merger or sale) could be approved only with the approval of at least 75% of the Company’s outstanding unitholders. The Company also could not approve an annual budget or take on material debt without such approval. According to the Plaintiffs, in exercising such blocking rights to prevent the Company from financing a capital project and taking other related actions that deprived the Company and CSM of financing, the minority members and their affiliates intentionally caused CSM to default on a loan, drove CSM into bankruptcy, and then bought CSM’s assets at a steep discount in an auction sale.
In their complaint, the Plaintiffs brought claims for breach of contract, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, tortious interference with contract, civil conspiracy, and fraud. In response to the complaint, the Defendants filed a motion to dismiss.
With respect to the Plaintiffs’ contractual and fiduciary duty claims, the Court declined to grant the Defendants’ motion to dismiss and allowed such claims to proceed. With regard to breach of contract, the Court concluded that the Plaintiffs sufficiently pled a claim regarding the minority members’ breach of confidentiality obligations under the Company’s operating agreement. Regarding the fiduciary duty claims, the Court found that the Plaintiffs had pled facts sufficient to show that the minority members “exercise[d] such formidable voting and managerial power that, as a practical matter, [they were] no differently situated than if [they] had majority voting control.” Although blocking rights, by themselves, are not sufficient to establish an inference of “actual control,” the Court found that, as in this instance, when blocking rights empower a minority investor to channel the corporation into a particular outcome, they contribute to an inference of control. Accordingly, because, in the Court’s view, the Company’s operating agreement unambiguously holds SMP’s managers to contractual fiduciary duties that are the same as common law fiduciary duties in all regards, except with respect to corporate opportunities, the claims for breach of fiduciary duty were allowed to proceed. In other words: “When a fiduciary, in his own words, intentionally ‘sits back’ while his company ‘collapses’ so that another to whom he is beholden can buy the company’s assets ‘out of bankruptcy very cheap,’ it is reasonably conceivable that he has breached the duty of loyalty.” However, the Court granted the Defendants’ motion to dismiss with respect to claims (i) against the Company’s lender for aiding and abetting breaches of fiduciary duty, and (ii) for fraud.