CHANCERY COURT NULLIFIES DISSOLUTION OF LIMITED LIABILITY COMPANIES FOR FAILURE TO SET ASIDE A RESERVE TO SATISFY KNOWN CLAIMS

By: Scott E. Waxman and Calvin D. Kennedy

In Kevin Capone and Steven Scheinman v. LDH Management Holdings LLC, et al., C.A. No. 11687-VCG (Del. Ch. April 25, 2018), the plaintiffs, Kevin Capone (“Capone”) and Steven Scheinman (“Scheinman”), and the defendants, LDH Management Holdings LLC (“Management Holdings”), LDHMH MM, LLC (together with Management Holdings, the “LLCs”), Castleton Commodities International LLC (f/k/a Louis Dreyfus Highbridge Energy LLC (“LDH”)) and certain members of the Board of Directors of LDH, each moved for summary judgment regarding the plaintiffs’ claim that the defendants violated Delaware law by cancelling the LLCs without setting aside a reserve for the plaintiffs’ breach of contract claims.  The court granted the plaintiffs’ motion for summary judgment and held that the defendants were aware of the plaintiffs’ non-frivolous claims for breach of contract against the LLCs and, therefore, the defendants acted in violation of Delaware law when they failed to create a reserve to cover the plaintiffs’ claims when the LLCs were dissolved.

The plaintiffs were former employees of LDH and each held indirect profits interest in LDH (the “Units”), in Management Holdings, a subsidiary of LDH, under LDH’s equity incentive plan. The plaintiffs were separately fired by LDH in January 2011 and Management Holdings redeemed the plaintiffs’ Units in April of the same year.  Per the terms of Management Holdings’ LLC Agreement, the call right on the Units was required to be exercised at “the Fair Market Value for such Unit as of the last day of the last Fiscal Year preceding the Fiscal Year in which the Call Notice is given.”  In December 2010, LDH, which was in the midst of holding an auction to sell off certain assets, prepared a valuation of $1.744 billion for all of the assets of LDH and its subsidiaries and later used this valuation in its calculation of the Units’ Fair Market Value.  The plaintiffs disagreed with this valuation for a number of reasons, including the fact that certain assets, which LDH valued at $1.43 billion in its December 2010 valuation, were sold off for $1.925 billion in March of the following year and there was no proof of any appreciation over that time.  Both Capone and Scheinman separately raised doubts and questions regarding the valuation with members of the Board of Directors of LDH over the months following their firings and the subsequent redemption of their Units.  Then, in December 2012, LDH was acquired by third party investors and the LLCs were cancelled.

The plaintiffs initially brought a lawsuit against the defendants in New York in May 2015 and the New York court subsequently dismissed all of the plaintiffs’ claims except for their breach of contract claims against the LLCs relating to the redemption of the plaintiffs’ Units. The plaintiffs separately commenced action in Delaware later that same year to, among other things, nullify the cancellations of the LLCs on the grounds that the defendants’ violated Section 18-804(b) of the Delaware Limited Liability Company Act (the “Act”) by not setting aside a reserve for the plaintiffs’ claims.

The Delaware court analyzed Section 18-804(b) of the Act and determined that a dissolved LLC must reasonably provide for all claims that are actually known to the LLC. The court then turned to the relevant facts of the case and stated that the plaintiffs’ breach of contract claims constituted a proper “claim” in light of Section 18-804(b) of the Act (though the actual merits of such claim remained before the New York court). The court next determined that both Capone and Scheinman, through their various emails and phone calls with members of the Board of Directors of LDH, had provided actual knowledge of the plaintiffs’ breach of contract claims to the LLCs.  Lastly, the court noted that the defendants did not set aside any funds for the plaintiffs’ claims.  The defendants stated that they believed the claims to be meritless and therefore their decision to not set aside any money for the claims was reasonable.  The court found, however, that the plaintiffs’ breach of contract claims had an “arguable basis in law” and raised “the prospect of a large damages award.” Thus, the court held that the LLCs were dissolved in violation of Section 18-804(b) of the Act because the defendants were aware of the plaintiffs’ claims against the LLCs at the time of their dissolution and the defendants failed to create a reserve to cover the plaintiffs’ claims.  Therefore, the court granted the plaintiffs’ motion for summary judgment and ruled that the certificates of cancellation for the LLCs should be nullified.

Capone and Scheinman v. LDH Management Holdings LLC, et al., memorandum opinion 180425