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Delaware Amends Management Delegation Section of its Limited Liability Company Act

Broadening the Rights of Managers and Members to Delegate – Does the Chancery Court’s Decision in Obeid vs. Hogan Remain Good Law?

This author has reported on the recent amendments to Delaware’s Limited Liability Company Act, 6 Del. C. § 18-101 et seq. (the “DE LLC Act”) which become effective August 1, 2017. Possibly the most consequential changes were made to Section 18-407, dealing with the delegation of management duties by members and managers to “other persons.” To understand the possible significance of these amendments, the Delaware Chancery Court’s June 2016 decision in Obeid v. Hogan1 must be re-visited for necessary context.

A Delaware limited liability company (an “LLC”) is a creature of contract. The DE LLC Act allows interested parties to establish most if not all of their relationship through the LLC’s limited liability company agreement (an “operating agreement”). Many provisions of the DE LLC Act, including Section 18-407, are, in effect, “default provisions” – they apply unless the LLC’s operating agreement provides otherwise.2 Commentators have noted that an LLC may implement “virtually any” management structure desired.3 Management structures akin to those used by corporations (with the LLC managed by, or at the direction of, a board of directors) or limited partnerships (with a manager-member and other, essentially silent or passive, investor members) are commonplace. However, as the decision in Obeid v. Hogan pointed out, mimicking a corporate or other recognized entity’s management form may result in the adoption by courts of legal concepts relating to those non-LLC entities in determining disputes, including with respect to management issues and the ability of members and managers to delegate their duties.

In Obeid v. Hogan, the Delaware Chancery Court considered the propriety of a delegation of the management duty to determine whether the LLC should continue a derivative action that a member already had acquired the right to pursue to an “other person” as contemplated by Section 18-407 but who neither was a director nor a manager. Two LLCs were involved, one a corporate-style managed LLC with a board of directors (the “Corporate LLC”) and another that was manager-managed (the “Manager-Managed LLC”). The Chancery Court held the purported delegations to a non-director of Corporate LLC management duties and to a non-member with respect to the Manager-Managed LLC were not appropriate under the circumstances.

The Corporate LLC and the Manager-Managed LLC jointly managed over $1 billion in real estate assets; each was owned by the same three members in the same proportions; and the members each constituted the full complement of the directors and managers, respectively, of the LLCs. Prior to the Chancery Court action one of the members (who later purportedly was ousted from his capacity as a director of the Corporate LLC and as a manager of the Manager-Managed LLC) asserted derivative claims on behalf of both LLCs alleging the other two members wrongfully had competed with the LLCs. The non-Plaintiff members later purported to hire a retired federal judge to act as a special litigation committee (an “SLC”) for each of the LLCs to determine whether the LLCs should continue the derivative litigations. The Plaintiff-member sought a declaration from the Chancery Court that the judge, neither a director of the Corporate LLC nor a manager of the Manager-Managed LLC, was not authorized to act as an SLC for either LLC as such constituted an improper delegation of managerial authority.

As an initial matter, the Chancery Court acknowledged freedom of contract principles including the DE LLC Act’s deferral to the contracting parties in ordering their relationship, but determined that a consequence of the Corporate LLC mimicking a corporate management form (including incorporation of language similar to Section 141 of the Delaware General Corporation Law (the “DGCL”) in the LLCs’ operating agreements) was adoption of corporate law concepts in determining the appropriateness of the delegations by the non-Plaintiff members. Accordingly, the Chancery Court analyzed the delegation by the Corporate LLC’s directors within the framework of delegations by corporate boards of directors as outlined in the Delaware Supreme Court decision Zapata v. Maldonado, 430 A.2d 779 (Del. 1981).4

Turning to the situation in Obeid v. Hogan, the Chancery Court, in accordance with the principles outlined in Zapata, accordingly held that the delegation of the Corporate LLC’s decision whether to pursue the derivative litigation, which resided with management (in such case the directors of the Corporate LLC), could not be delegated to someone that was not a director of the company. The Corporate LLC argued that Section 18-407 authorized delegation to an “other person” and did not require delegation to a director but the Chancery Court held that Section 18-407 did not represent a clear authority to delegate every management duty and that other provisions of the DE LLC Act rendered management’s authority with respect to derivative litigation non-delegable.5

Effective August 1, 2017, however, Section 18-407 has been amended. Related commentary has suggested the amendments thereto are in response to Obeid v. Hogan, and designed to clarify the authority of managers and members to delegate their duties “to anyone” notwithstanding the holding of Obeid v. Hogan. Amended Section 18-407 now reads, in relevant part (with additions in bold italics and deletions stricken):

Unless otherwise provided in the limited liability company agreement, a member or manager of a limited liability company has the power and authority to delegate to 1 or more other persons any or all of the member’s or manager’s, as the case may be, rights, and powers and duties to manage and control the business and affairs of the limited liability company. , including to delegate Any such delegation may be to agents, officers and employees of a member or manager or the limited liability company, and to delegate by a management agreement or another agreement with, or otherwise to, other persons. … No other provision of this chapter shall be construed to restrict a member’s or manager’s power and authority to delegate any or all of its rights, powers and duties to manage and control the business and affairs of the limited liability company.

Although the change from “delegate … the member’s or manager’s … rights and powers” to “delegate … any or all of the member’s or manager’s … rights, and powers and duties” may be considered non-substantive and merely clarifying in nature, the additional sentence added at the end of the statute certainly seems to go to the heart of one of the reasons the Chancery Court rejected the Corporate LLC’s argument based on Section 18-407. The Chancery Court stated in part in this regard “[m]oreover, as a general default provision, addressing the delegation of managerial authority, Section 18-407 does not trump the specific provisions of the LLC Act that address derivative actions. Section 18-1001, entitled “Right to Bring Action,” provides that any member or assignee may bring a derivative suit “if managers or members with authority to do so have refused … or if an effort to cause … [them] … to bring the action is not likely to succeed.”6 The amendments to 18-407 may now mean that the statute indeed does now “trump” Sections 18-1001 and 18-1003.

In any event, practitioners drafting LLC operating agreements must consider in light of Obeid v. Hogan and new Section 18-407: (i) whether the provisions of the agreement including those relating to management issues, and delegation, may cause a court to adopt bodies of law separate and apart from the law represented by the DE LLC Act or matters of contract incident to the operating agreement itself, (ii) whether by contract parties can draft around such other bodies of law by, perhaps, expressly disclaiming such other bodies of law, and (iii) whether amended Section 18-407 now, in effect, excludes non-LLC specific delegation standards such as those applied by the Chancery Court in Obeid v. Hogan.

For More Information

If you have any questions regarding this News Alert, please contact John D. Demmy at 302.425.3308 or the Stevens & Lee attorney with whom you normally consult.

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John D. Demmy

This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.

1 C.A. No. 11900-VCL (Del. Ch. June 10, 2016).

 2 Section 18-407 starts with, and includes two other, “[u]nless otherwise provided in the limited liability company agreement,…” clauses.

 3 See, most notably, Robert L. Symonds, Jr. & Matthew J. O’Toole, Delaware Limited Liability Companies § 9.01[B], at 9-9 (2015).

 4 In Zapata the Delaware Supreme Court held that (i) even after a shareholder (or, as applied in Obeid v. Hogan, a member) obtains the right to pursue a derivative action an otherwise conflicted board may appoint a committee of independent directors (as required by Section 141 of the DGCL) to determine whether to pursue or dismiss the action, and (iii) that an independent committee’s decision to dismiss would be subject to “enhanced scrutiny.”

 5 With respect to the Manager-Managed LLC, the Chancery Court found that its operating agreement “provided otherwise” as contemplated by Section 18-407, by distinguishing between ordinary course matters (which could be delegated) and non-ordinary course matters which the operating agreement suggested were vested solely with managers and, thus, could not be delegated to a non-manager (including the decision whether to not pursue derivative litigation).

 6 The Chancery Court also referenced Section 18-1003 of the DE LLC Act to the same effect.