In Case of First Impression, Court of Chancery Awards Expenditures Incurred in Third-Party Litigation as Breach of Contract Damages

On remand from the Delaware Supreme Court, the Court of Chancery has awarded XRI more than $6 million in litigation expenses and recoupment of fees advanced to a former LLC member who breached the governing LLC Agreement.  XRI Inv. Holdings LLC v. Holifield, C.A. No. 2021-0619-JTL (July 24, 2024).  The former LLC member, Gregory Holifield, breached contractual transfer provisions in connection with loans he obtained from a third-party mezzanine lender, Assurance.  After Holifield defaulted on the Assurance loans, Assurance sued XRI in Texas, claiming that XRI had violated rights to Holifield’s XRI equity that Assurance had obtained as part of the loan transaction.  XRI spent $4.1 million defending against and ultimately settling Assurance’s claims.  The Court of Chancery awarded XRI damages reflecting those expenditures in full.  The decision marks the first time a Delaware court has awarded expenses incurred in third-party litigation as breach of contract damages.  The Court of Chancery also held that XRI is entitled to recoup all attorneys’ fees previously advanced to Holifield—approximately $2 million and counting—under the indemnification provisions of the LLC Agreement.  The latter holding marks the rare occasion on which a Delaware court has allowed a company to claw back previously advanced fees.

Background and Previous Decisions

After Assurance sued XRI in Texas, XRI sued Holifield in Delaware based on  his violation of the transfer restrictions.  In the Delaware action, XRI sought both to void the violative transfer of Holifield’s XRI equity and to recover its Texas litigation expenditures.  In a 2022 decision, the Court of Chancery held that the transfer was void under a provision in the LLC Agreement specifying voidness as a remedy for certain breaches.  XRI Inv. Holdings LLC v. Holifield, 283 A.3d 581 (Del. Ch. 2022).  But the Court of Chancery also asked the Delaware Supreme Court to revisit its 2018 decision in CompoSecure, which holds that parties to an LLC agreement may contract out of equitable defenses by specifying voidness as a remedy.  CompoSecure, L.L.C. v. CardUx, LLC, 206 A.3d 307 (Del. 2018).  The Court of Chancery also declined, in its 2022 decision, to award XRI damages for Holifield’s breach of the transfer restriction.

Holifield appealed, and the Supreme Court held that CompoSecure remains controlling law:  Under that decision, parties in an LLC may specify voidness as a remedy for particular breaches, thereby contracting out of equitable defenses such as acquiescence and ratification.  Holifield v. XRI Inv. Holdings Inc., 304 A.3d 896 (Del. 2023).  Under the terms of XRI’s LLC Agreement, the contractual voidness remedy is absolute, and equitable defenses accordingly cannot rescue a void transfer.  The Supreme Court further held that this reasoning “applies equally to an award of damages,” and directed the Court of Chancery on remand to “consider the amount of damages to which XRI is entitled.”  The Supreme Court also remanded on a second issue:  XRI’s entitlement to claw back fees advanced to Holifield for his defense in the Delaware action (as opposed to the Assurance action in Texas).

Recovery of Third-Party Litigation Expenses as Breach of Contract Damages

Taking XRI’s Texas expenditures first, the Court of Chancery turned to the Restatement (Second) of Contracts, as no Delaware court had previously considered third-party litigation expenses as breach of contract damages.  The Restatement recognizes the right to recover such expenses, provided they are foreseeable.  Under the Restatement, the “loss that actually occurred” must be foreseeable; it is not enough that “some loss was foreseeable.”

The Court of Chancery concluded that XRI had proven that Holifield could foresee that Assurance would sue XRI to preserve its interest in Holifield’s XRI equity.  A complication arose because the court credited Holifield’s contention that he had intended to convey to Assurance only an interest in the proceeds of the sale of the equity, and not an interest in the equity itself.  Assurance, however, asserted a right to the equity itself in the Texas action.  But Assurance’s litigation position did not render damages unforeseeable.  Holifield ultimately adopted Assurance’s position as his own when he sought to intervene in the Texas action.  That undermined any contention that damages were not foreseeable.  The Court of Chancery awarded damages reflecting XRI’s Texas expenditures in full:  $1.6 million in attorneys’ fees and a $2.5 million settlement.

Recoupment of Previously Advanced Attorneys’ Fees

That left the issue of recoupment, to which XRI was entitled on a judicial finding of “Disabling Conduct,” defined under the LLC Agreement as “gross negligence or willful breach of this Agreement.”  The Court of Chancery broadly surveyed case law adopting various definitions of both gross negligence and willfulness, noting that willfulness in particular can mean anything from a deliberate act with no knowledge of breach to an act specifically intended to cause harm to a counterparty.  In the context of the LLC Agreement, the court concluded that willfulness meant an intentional act that a party knows will cause a breach.

The Court of Chancery found that Holifield’s conduct met that willfulness standard.  Although Holifield believed in good faith that XRI had acquiesced in his breach, that did not change the fact that he knew it was a breach:  Holifield was “charged with knowing the terms of the LLC Agreement.”  Under that contract, any transfer made for consideration is prohibited, and Holifield could not have been unaware that he was receiving consideration—more than $4 million in loans from Assurance—in connection with the transfer.  In addition, Holifield told XRI he was making the transfer for estate planning purposes when this was not the case.  His untruthfulness about the transfer was further evidence of willfulness.  Thus, notwithstanding its earlier findings that Holifield had acted in good faith, the court concluded that “[t]here was . . . no dispute [in its 2022 decision] that Holifield acted badly and was not blameless.”

Intra-company litigation can be uncomfortable, inconvenient, and expensive to an entity while the case is ongoing.  The Court of Chancery’s decision suggests that a company with a meritorious position may nevertheless go at least some way toward being made whole if it stays the course.

Sidley represented XRI in both the Court of Chancery and the Delaware Supreme Court.  Yolanda Garcia, Angela Zambrano, Margaret Allen, Robin Wechkin, and Annabeth Reeb made up Sidley’s team.  Abrams & Bayliss partners A. Thompson Bayliss and Eric Veres were co-counsel.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.