Delaware’s strong laws regarding corporate issues such as minority member rights attract venture-backed companies.
Skye Mineral Partners was decided by a court and concluded that minority members who use contract rights to block financing of their LLC subsidiary owe fiduciary duties to both themselves and to their LLC. Furthermore, it found that any waiver of such duties regarding corporate opportunities wasn’t clear and unambiguous enough in its provisions.
Rights to Inspection
The Delaware General Corporation Law gives stockholders rights to inspect a corporation’s books and records. This includes its ledger, list of stockholders and any other books or records related to that corporation. In a landmark court decision involving Yahoo, the Court of Chancery held that these rights extend even to electronic documents or records that exist electronically.
Additionally, the Delaware Act permits various important arrangements not allowed under any other 50 state LLC acts – including transfers, domestications and series LLCs – that may give promoters and managers of high-stakes private equity deals pause.
However, it should be borne in mind that the Delaware Act and its case law only comprise part of the picture; many other factors must also be taken into account and it’s impossible to predict their effects in individual high-stakes scenarios. Yet its permissive provisions regarding potentially significant LLC arrangements may make Delaware Act an advantage in these instances.
Rights to Termination
Financial rights acquired through an LLC membership are usually detailed in an operating agreement, while state laws provide default provisions that will govern how its assets will be divided upon dissolution and liquidation.
Fiduciary obligations can be challenging to establish and administer. As the Delaware Supreme Court recently demonstrated in Largo Legacy Grp. LLC, actions by controlling member-managers may violate these duties even when their activities are authorized or sanctioned in the company operating agreement or whether such obligations explicitly disclaimer exist.
This case illustrates how Delaware LLC Act provisions that confer nonexclusive subject matter jurisdiction on the Court of Chancery for derivative lawsuits regarding LLCs formed under that act could provide members a mandatory right to seek resolution–an additional factor promoters should consider when selecting it as opposed to LLC acts of other jurisdictions.
Rights to Withdrawal
The Delaware Act prohibits LLC agreements from restricting members’ right to third-party review of matters concerning an LLC’s organization and internal affairs in both Court of Chancery proceedings and arbitration, and Section 18-109(d) renders such provisions null if they restrict review to occur outside Delaware.
Minority members should make sure that, under their operating agreement, distributions to them cover income tax liabilities at maximum marginal tax rates on their share of LLC taxable income. Furthermore, they should negotiate an arrangement whereby mandatory tax distributions occur on an annual basis.
The Delaware Bar Association Corporate Section closely tracks LLC statutory and case law developments nationwide, using this knowledge as well as its highly competent members’ creative approach, to make proposals each year to preserve the Delaware Act as the go-to statute for implementing high stakes private equity deals.
Rights to Distributions
Many sophisticated investors and investment promoters prefer the Delaware LLC Act for high-stakes private equity deals, often out of reflexively pro-Delaware biases or three key considerations:
Default legal provisions tend to favor minority shareholders. For instance, most LLC statutes provide members the right to inspect the books and records of the company including member lists, profit interests and tax returns as well as operating agreements and financial statements.
These statutory provisions give members of an LLC the ability to bring legal actions against its management if they believe that its management has breached their fiduciary duties. For instance, if an LLC unlawfully distributed property without fully valuating all its assets before handing over ownership to outsiders without first fully appraising all assets as required under its assets valuation model without taking proper account of tax consequences (an example being unlawful property distribution without properly appraising assets), the court can hold each manager personally liable. This type of suit is called derivative suit; after reviewing evidence presented against claimant, the court can hold one manager personally liable.
