In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, the Delaware Supreme Court reviewed the Court of Chancery’s 2018 opinion allowing the Minority Members to force a sale based on a contractual gap in the LLC Agreement. The Court of Chancery used the implied covenant of good faith and fair dealing to fill the gap. Delaware’s highest state court reviewed whether the Chancery Court properly found a contractual gap and properly applied the implied covenant to fill that gap.
Oxbow LLC (“Oxbow”), a limited liability company in Delaware, is controlled by William Koch through Oxbow Carbon and Minerals Holdings, Inc. (“Oxbow Holdings”). William Koch serves as Oxbow’s CEO and chairman of the board. In 2007, two minority investors, Crestview Partners LP and Load Line Capital LLC, bought one-third of Oxbow’s membership’s interests for $265 million. Under the terms of the LLC Agreement, the minority investors could seek an exit after seven years from the date of their investment. Upon exercising this Exit Right, Oxbow’s Majority Members refused to buy out the two members pursuant to an LLC Agreement provision that requires that members be barred from forcing an all-company exit sale unless all members received 1.5 times their investment directly from sale proceeds. Two other minority investors affiliated with Koch (the “Small Holders”) invested in 2011 at $300 per unit. Oxbow argued that the LLC would need a $450 per unit offer to settle all accounts, despite a $269 per unit fair market valuation in early 2016 and a $176 per unit offer by Crestview and Load Line. Therefore, under this provision, Oxbow argued the Small Holders could block the sale due to a failure to comply with the payment conditions.
In June 2016, the Oxbow’s Majority Members, under William Koch, filed suit against the Minority Members seeking a declaratory judgment of its interpretation of the LLC agreement that the Small Holders could block the exit sale. The Court of Chancery held that the LLC Agreement required paying investors the highest amount, meaning to initiate an exit sale each Oxbow member must participate and receive 1.5 times their initial investment by pro rata distribution. However, Vice Chancellor Laster held that a contractual gap existed between the LLC Agreement relating to the admission of the Small Holders as Members in the LLC. The Court of Chancery stated that “[b]y deferring until a later point the question of what rights subsequent members would have, the LLC Amendment created a gap.” The Court of Chancery used an implied covenant to fill the gap and allowed the Minority Members to satisfy the Small Holders 1.5 times requirement by using a Seller-Top Off, allowing for an Exit Sale. Oxbow’s Majority Members appealed to the Delaware Supreme Court.
The Delaware Supreme Court agreed with the Court of Chancery that under the LLC Agreement Members were required to be paid the highest amount. However, the Delaware Supreme Court held the trial court erred in finding a contractual gap and applying a Seller-Top off. Therefore, holding no contractual gap exists, the Delaware Supreme Court held the plain language of the LLC agreement gives the Smaller Holders the right to block the Exit Sale unless paid the highest amount required under the LLC Agreement.
The Court concluded that a plain reading of the LLC Agreement showed the parties contracted to leave the terms of new Members’ admission to the discretion of the Board. The Board chose not to specify different rights to the new members, the Smaller Holders, and therefore the terms of the LLC Agreement “apply with equal force”. The Delaware Supreme Court noted that at the time of the LLC Agreement, the parties contemplated the addition of new members and placed certain restrictions on the board’s discretionary authority in admitting new members. However, the parties chose not to amend or place restrictions on the Exit Sale 1.5 times threshold requirement, and the plain language states it applies to “any other Member.” The Delaware Supreme Court held that the Minority Parties could have bargained for protections regarding Exit Sale Rights and the admission of new Members.
The Delaware Supreme Court showed little sympathy for the Minority Members, noting: “[t]he parties’ sloppiness and failure to consider the implications of the Small Holder’s investment in 2011 did not equate to a contractual gap … [t]he Minority Members were highly sophisticated entities with three Board members who were capable of reading the LLC agreement and bargaining for the rights they now seek through litigation.” The Delaware Supreme Court held that the parties agreed and expected the Small Holders to become members, and a mistake as to this effect on the Exit Sale Rights does not create a contractual gap.
The Delaware Supreme Court opinion reiterates Delaware’s strong policy of strictly interpreting LLC Agreement contracts and adhering to the arm’s length transactions of parties, and in particular, sophisticated parties. The opinion stresses that the implied covenant of good faith is a “limited and extraordinary legal remedy” and is not to be used to re-write an agreement between the parties. Those operating under Delaware law must be cautious relying on the implied covenant of good faith. As this opinion demonstrates, Delaware courts are reluctant to disrupt bargaining between private parties. In sum, where two sophisticated parties bargain under an LLC Agreement, Delaware courts are disinclined to grab the mop and clean up the mess.