Delaware Court of Chancery affirms ability to amend a limited liability company agreement through merger under Section 18-209(f) of the LLC Act notwithstanding amendment provision requiring different approval for amendment.
On August 30, 2024, the Delaware Court of Chancery issued an opinion in Campus Eye Management Holdings, LLC v. DiDonato[1], dismissing a challenge to a merger effecting an amendment to the limited liability company agreement of the target company notwithstanding an amendment provision in the existing limited liability company agreement requiring different approval for amendments.
To a Delaware law practitioner, this may seem unremarkable. However, to a small business owner selling a majority stake in his professional services company to a private equity firm (a common occurrence in present times), this may come as a surprise. In either case, it serves as a useful reminder of the importance of familiarity with the default rules of the Delaware Limited Liability Company Act[2] (the “LLC Act”) and the ability to contractually modify the rules through careful drafting.
In 2021, Dr. E. Bruce DiDonato, an optometrist, sold a majority stake in his New Jersey eye care practice to an affiliate of The Beekman Group (the “Purchaser”), a private equity firm. To facilitate the transaction, DiDonato formed a management services organization, Campus Eye Management, LLC (the “MSO”), and its parent, Campus Eye Management Holdings, LLC (“MSO Parent”), both Delaware limited liability companies. The limited liability company agreement of the MSO (the “MSO LLC Agreement”) named DiDonato as the “initial Manager,” while the limited liability company agreement of MSO Parent (the “MSO Parent LLC Agreement”) provided for management of MSO Parent by a three-member board comprised of two Purchaser designees and a DiDonato designee (initially, himself).
Following the sale transaction, the Purchaser purported to amend the MSO LLC Agreement to remove DiDonato as the Manager unilaterally by action of MSO Parent, the sole member of the MSO, despite a provision in the MSO LLC Agreement requiring Manager involvement to amend. DiDonato filed suit in the Court of Chancery and was successful on a summary judgment motion in his endeavor to have the purported amendment declared invalid and himself declared the still-acting Manager of the MSO.
The Purchaser, undeterred, subsequently formed a second wholly owned subsidiary and caused it to merge into the MSO, with the MSO surviving the merger and adopting a new limited liability company agreement for the MSO (the “Amended MSO LLC Agreement”) providing for the MSO to be managed by MSO Parent rather than a Manager. MSO Parent simultaneously filed an action for declaratory judgment in the Court of Chancery to declare the merger and the Amended MSO LLC Agreement valid and to declare that DiDonato was not the MSO’s Manager.
The Court, taking under advisement MSO Parent’s motion for partial judgment on the pleadings regarding its declaratory judgment claims, found in favor of MSO Parent. As the sole member of the MSO, it was entitled to approve the merger and to adopt a new or amended limited liability company agreement in connection with a merger. Nothing in the MSO LLC Agreement provided otherwise. Further, under the MSO Parent LLC Agreement and the LLC Act, the two Purchaser designees were entitled to approve the merger on behalf of MSO Parent without prior notice to DiDonato, the third board member.[3]
The Court also declared the Amended MSO LLC Agreement valid, noting there was no provision of the MSO LLC Agreement expressly applicable to amendments in connection with a merger. In the absence of such a provision, the Court explained, Section 18-209(f) of the LLC Act permits members of a limited liability company to amend the entity’s limited liability company agreement in connection with a merger, notwithstanding any amendment provision in the agreement. Additionally, Section 302(e) of the LLC Act provides that a limited liability company agreement may be amended pursuant to the terms of the agreement “or as otherwise permitted by law, including as permitted by Section 18-209(f)” of the LLC Act. To read in a prohibition on mergers undertaken solely to effect an amendment to a limited liability company agreement, as DiDonato urged the Court to do, would both be contrary to the plain language of the LLC Act and undermine the doctrine of independent legal significance, which is codified in the LLC Act.
Finally, DiDonato advanced an argument that the implied covenant of good faith and fair dealing should “block” the merger absent his consent. The Court, however, dismissed DiDonato’s assertion, given that the application of the implied covenant of good faith and fair dealing is limited to filling contractual gaps that neither party could have anticipated. Despite DiDonato’s claim that it was unforeseeable when the parties signed the original MSO LLC Agreement that MSO Parent might use a merger to effect an amendment, the Court noted, Section 18-209(f) of the LLC Act contemplates this very situation.
Key Takeaways
- Drafters of limited liability company agreements that want a restriction to apply to mergers should add the phrase, “whether by merger, consolidation or otherwise” to the relevant restriction.
- The ability to effect an amendment to a governing agreement by merger is also baked into the Delaware Revised Uniform Limited Partnership Act, 6 Del. C. 17-101, et seq., in Section 17-211(g).
- In a sale transaction, Delaware counsel should review relevant documents to advise clients regarding the nature of their rights and obligations and limitations thereon, which may not be obvious from a plain reading of the documents and without knowledge of applicable statutes and case law.
- The implied covenant of good faith and fair dealing will not permit a court to imply a contractual provision in a limited liability company agreement to overcome the default terms of the LLC Act.
[1] C.A. No. 2024-0121-LWW.
[2] 6 Del. C. § 18-101, et seq.
[3] The Court, addressing DiDonato’s counterclaims separately in the opinion, rejected an argument that the Purchaser or the Purchaser designees to the MSO Parent board owed fiduciary duties to DiDonato. If they did, presumably an argument could be made that lack of notice constituted a breach of those duties.
