Chancery Court Interprets Contractual Provisions, the Elimination of Fiduciary Duties and Standard to be Applied for Self-Dealing Transactions under LLC Agreement

By Nicholas I. Froio and Rachel Cheasty Sanders

In CelestialRX Investments, LLC and Krittika Life Sciences, LLC v. Krivulka, et al., C.A. No. 11733-VCG (Del. Ch. Jan. 31, 2017), the Delaware Court of Chancery addressed two preliminary issues before it on motions for partial summary judgment filed by the various defendants.  The plaintiffs include CelestialRX Investments, LLC (“CelestialRX”), one of three members of the Delaware limited liability company Akrimax Pharmaceuticals, LLC (“Akrimax”).  The defendants include Leonard Mazur and Joseph J. Krivulka (“Krivulka”), the two other members of Akrimax, along with various entities Krivulka controls or in which he has invested.  These entities entered into a number of transactions with Akrimax, these transactions being at the heart of this dispute.  The Court first considered whether a release agreement dated July 1, 2013 (“Release Agreement”) barred CelestialRX from bringing causes of actions against the defendants which occurred prior to the release.  After applying rules of contract interpretation, the Court, in dismissing the motion for partial summary judgment, held that the plaintiff was not a “Releasing Party” as defined in the Release Agreement and thus had not released any claims existing as of July 1, 2013.  The Court next considered the extent to which the LLC Agreement of Akrimax and its July 1, 2013 amendment (“Amendment No. 7”) limited or modified fiduciary duties of the members, directors or managers of Akrimax, and what standard of care applied under the LLC Agreement in the context of conflicted transactions.

The defendants argued that Amendment No. 7 eliminated fiduciary duties from the LLC Agreement. Further, the defendants asserted that two provisions of the LLC Agreement provided “express contractual standards” governing self-dealing transactions and that these provisions displaced any lingering fiduciary duties which may not have been eliminated under Amendment No. 7.  The Court stated that under Delaware law, which governs the LLC Agreement, certain fiduciary duties can be eliminated, but only if articulated clearly and unambiguously by the contract drafters. However, the implied contractual covenant of good faith and fair dealing cannot be eliminated.  Here, Amendment No. 7 added section 4.01(h) to the LLC Agreement, which states:

[n]otwithstanding anything to the contrary in this agreement, neither the Manager nor any of the members of the Board of Directors nor any Member shall have any fiduciary duties to the Company or the Members or shall be personally liable to the Company or its Members for a breach of any duty that does not involve (i) an act or omission not in good faith or which involves intentional misconduct or a knowing violation of law; or (ii) a transaction from which such Manager, a member of the Board of Directors, or Member derived an improper personal benefit.

The Court in granting the motion for partial summary judgment found that the LLC Agreement as amended by Amendment No. 7 (i) effectively eliminated default common law fiduciary duties of the members, directors and managers of Akrimax, and (ii) provided for contractual duties that imposed liability for intentional misconduct or illegal conduct, improper self-dealing, and other bad faith actions, noting, however, that to the extent that such contractual duties use undefined terms such as “bad faith” that common law fiduciary duties would be instructive to provide the definition.

In addition to Section 4.01(h), the Court examined Sections 8.01 and 8.02 of the LLC Agreement. The Court found that (i) Section 8.02 abandoned the corporate opportunity doctrine, allowing conflicted interests to be held by directors and members of Akrimax unless otherwise prohibited by separate contracts, and (ii) Section 8.01(b) created a safe harbor wherein a conflicted party would be insulated from liability if he acted in good faith, and made a resolution of the conflict by a good-faith balancing of “the relative interest of each party (including his own interest) to [the conflicted] transaction . . . and the benefits and burdens relating to such interests, any customary or acceptable industry practices, and GAAP.”  By falling into this safe harbor, the Court noted that the defendants would not be considered in breach of the LLC Agreement or any duty as long as they entered into the transactions with Akrimax in good faith and Krivulka determined that the transaction was fair and reasonable to the Akrimax, CelestialRX, and Mazur after he balanced the requisite interests in good faith.  Thus, the Court held that this standard against which the challenged transactions occurring on or after July 1, 2013 should be evaluated.  The Court further urged the parties to mediate the dispute.

CelestialRX Invstements v. Krivulka, C.A. No. 11733-VCG (Del. Ch. Jan. 31, 2017)