Court of Chancery Applies Corporate Rules to Special Litigation Committee of LLC

In Obied v. Hogan,[1] the Court of Chancery granted a motion for summary judgment holding that members of a manager-managed Delaware LLC (the “Manager LLC”) and a board-managed Delaware LLC (the “Corporate LLC”) did not have the authority to appoint a retired Federal Judge as the sole member of a special litigation committee for the LLCs.  The plaintiff, William Obied, along with non-parties Christopher La Mack and Dante A. Massaro, served as members of the LLCs, each holding one-third interest in each LLC.  In 2015, Obied derivatively filed a lawsuit in the Southern District of New York against the other two members. 

In response to these claims, La Mack and Massaro hired an outside law firm to represent the LLCs.  The outside law firm recommended that a retired federal judge, defendant Michael Hogan, serve as a sole member of a special litigation committee for the LLCs.  Both La Mack and Massaro voted in favor of this proposition, while Obied voted against it.  In September 2015, La Mack and Massaro voted Obied off the board of the Corporate LLC, and in November 2015, hired Judge Hogan to serve on the special litigation committee. 

In January 2016, Obied filed a lawsuit seeking: 1) a declaratory judgment that Judge Hogan cannot serve on the special litigation committee for either LLC, 2) an injunction against Judge Hogan from taking any action or control over the derivative claim, and 3) a declaratory judgment that Obied is still a director.  Vice Chancellor Lastor granted Obied’s summary judgment on the first two claims, but denied his third claim.

The Court began its analysis of whether Judge Hogan had the authority to be the sole member of the special litigation committee by describing the contractual nature of an LLC.  It went on to state that the Corporate LLC’s operating agreement was similarly structured to a corporation and, therefore, the LLC should be analyzed under the Delaware General Corporate Law (DGCL) and corporate precedent.  Vice Chancellor Lastor then established that he would apply Section 18-407 of the LLC Act to the members as if they were acting in same capacity as directors of a corporation.  The Court interpreted Section 18-407 in a similar light as Sections 141(a) and (c) of the DGCL, and determined that 18-407 allows members of an LLC to delegate certain functions to non-members, in the same manner that directors delegate functions to officers and other employees within a corporation.  However, Section 18-407 does not validate every delegation, specifically “conflict-laden” delegation of authority such as the special litigation committee. 

In addition to stating that Section 18-407 on its face does not permit delegating authority in all instances, the Court also discussed the relationship between Section 18-407 and other provisions within the LLC Act.  Specifically, Section 18-407 was trumped by both Sections 18-1001 and 18-1003.  Both Sections 18-1001 and 18-1003 are aimed at clarifying who has the ability to bring a lawsuit derivatively.   Vice Chancellor Laster interpreted these sections to mean that “only the duly authorized decision-making body of the entity” can make the decision, which in this case was only Obied, La Mack, and Massaro.  Even without the Sections 18-1001 and 18-1003 analysis, the paralleled structure to DGCL 141(a) and 141(c) demonstrate the intent of the corporate principals to govern the board.  Therefore, the Court of Chancery held that Judge Hogan, through an interpretation of the LLC Agreement based on corporate principles, is not permitted to be the sole member of the special litigation committee.

Key Points of Law:

  • “Using the contractual freedom that the LLC Act bestows, the drafters of an LLC agreement can create an LLC with bespoke governance features or design an LLC that mimics the governance features of another familiar type of entity.”
  • “If the drafters have opted for a manager-managed entity, created a board of directors, and adopted other corporate features, then the parties to the agreement should expect a court to draw on analogies to corporate law.”
  • “A full delegation is required because … the decision over the litigation must be final and not reviewable by the conflicted directors.  A committee of directors is the only vessel that is capable of receiving and exercising the full authority of the board in this context.”
  • “Section 18-407 validates the vast array of ordinary-course-of-business delegations that are part of the operation of an entity.  Just as a corporate board of directors can rely on and delegate tasks and responsibilities to officers, employees, advisors, and other persons, so too can the members in a member-managed LLC or the managers in a manager-managed LLC.”
  • “Section 18-407 does not validate every theoretically possible delegation, and it does not extend to the conflict-laden delegation of authority involved in the creation of a special litigation committee.”
  • “Together [Sections 18-1001 and 18-1003] indicate that only the duly authorized decision-making body of the entity, be it the members or the managers, can make the necessary decision.”
  • “By embracing the governance structure of a corporation and including provisions paralleling Sections 141(a) and (c), the drafters of the Corporate LLC Agreement evidenced their intent to have corporate principals govern the Corporate Board.”

Special thanks to Matthew Arnold for preparing this summary.



[1] C.A. 11900-VCL (June 10, 2016).

Category: 

Tag: 

By: