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DE Corporate Law
Main image for Court of Chancery Confirms No Breach of Fiduciary Duty in Connection with “Contrived” but Genuine Deadlock
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Court of Chancery Confirms No Breach of Fiduciary Duty in Connection with “Contrived” but Genuine Deadlock

Delaware Law Update

3.5.2021

In a memorandum opinion issued January 29, 2021, the Court of Chancery held that a defendant LLC manager/majority unitholder of EOS Investor Holding Company, LLC (Holdco), Jonathan Teller, did not breach fiduciary duties or contractual obligations owed to plaintiff, co-member Sanjiv Mehra, by intentionally manufacturing a deadlock between the two members in order to trigger a dissolution provision in an LLC’s operating agreement. The case caption is Sanjiv Mehra, et al. v. Jonathan Teller, et al. [EOS], C.A. No. 2019-0812-KSJM.

The action involved a dispute between Jonathan Teller and Sanjiv Mehra over the dissolution of Holdco, a consumer goods company. Before the disputed dissolution, the two individuals shared control of Holdco. While Teller held a greater equity stake in the company, Mehra handled most of the company’s day-to-day management. Accordingly, the two agreed to have “an equal say” with respect to decision-making for the company. The agreement on shared control was memorialized in Holdco’s LLC agreement. In relevant part, the LLC agreement designated Teller and Mehra co-managers in the two-person board and required unanimity to effect board action. On the other hand, if Teller and Mehra deadlocked, the LLC agreement required that Holdco would be automatically dissolved.

After a period of declining performance, the parties reached a disagreement over the management of Holdco. Teller came to blame Mehra for Holdco’s problems and was determined to cut ties with Mehra. In September 2019, Teller began meeting with lawyers and devised a plan that would allow him to exit the shared-control arrangement. The LLC agreement required dissolution of the LLC and distribution of its interest in its operating subsidiary to Holdco members pro rata in the event that a vote “upon an action by the Board of Managers results in a deadlock.” Teller decided to take advantage of this provision. He scheduled a board meeting with no stated purpose, at which he proposed a resolution to cause removal of Mehra as a manager of the subsidiary, knowing that Mehra would reject this proposition. Teller voted in favor; Mehra abstained. Teller declared a deadlock and unilaterally dissolved the LLC and distributed its interest in the subsidiary.

Mehra brought suit against Teller, alleging that Teller breached Holdco’s LLC agreement and fiduciary duties by engineering grounds to dissolve the LLC and by failing to act in good faith. Mehra contended that Teller was obligated to protect Mehra’s interests but failed to do so. Mehra sought, among other things, a declaration that the dissolution was invalid on grounds that there had been no “deadlock”—an undefined term in the LLC agreement—and Teller had breached contractual and fiduciary duties. The court bifurcated the case for trial solely on the issue of invalidation.

Following trial, the court ruled in Teller’s favor, finding that, based on Delaware case law interpreting judicial dissolution provisions in the LLC Act, the Delaware Revised Limited Partnership Act, and the Delaware General Corporation Law, a deadlock simply requires a failure to achieve the voting threshold necessary for proposed board action and a genuine, good-faith disagreement. Mehra’s abstention caused a failure to meet a voting threshold, thereby satisfying the first requirement. And although Teller “contrived the circumstances giving rise to deadlock,” Teller proved that the parties had an irreconcilable disagreement concerning Mehra’s continuing management of Holdco. The deadlock, therefore, was genuine. The court further noted that in order for a deadlock to warrant dissolution, it must concern a significant managerial matter. According to the court, a dispute over who should run a company “is the quintessential serious managerial issue.” 

The court further noted that (i) Teller testified credibly as to his decision to remove Mehra and his reasons for not approaching Mehra in advance of the September board meeting; (ii) Teller acted with the honest belief that his conduct was necessary for the company and therefore did not act in bad faith; (iii) Mehra lacked any contractual or other rights that would have enabled him to avoid the outcome of the September board meeting, even if he had detailed advance notice; and (iv) there were no facts demonstrating that Teller affirmatively misled Mehra. The court therefore entered judgment in favor of Teller and his co-defendants regarding the existence of deadlock and the validity of Holdco’s dissolution. Other claims raised by Mehra were bifurcated and will proceed separately.

The opinion is notable because it confirms that Delaware courts will continue to uphold and interpret literally LLC agreements, particularly in the absence of bad faith conduct. Limited liability companies are often referred to as “creatures of contract,” as they are largely governed by the operating agreement among the members. In addition, the opinion provides helpful guidance regarding the requirements for deadlock which may warrant dissolution. A failure to achieve the voting threshold necessary for proposed board action, coupled with a genuine, good faith, and material managerial disagreement, is sufficient to constitute deadlock under Delaware law.

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