Eye Doctor With Blind Spot Loses LLC Manager Position

Last month, the Delaware Court of Chancery upheld an amendment of a Limited Liability Company agreement through a merger even when it had recently struck down a similar amendment in the same LLC agreement. In Campus Eye Management Holdings, LLC v. E. Bruce DiDonato, OD, Vice Chancellor Will concluded that because the LLC agreement contained no provision explicitly forbidding amendment through merger, the amendment was valid and enforceable. The ruling might not be eye-catching, but it is an important reminder that parties to an LLC agreement, and particularly those with minority power, must have a clear vision into not only the express provisions of the contract but also the implications of any gaps that will be filled by the Delaware Limited Liability Company Act, 6 Del.C. § 18-101, et seq. (the “LLC Act”).

Background

In 2021, an optometrist, Dr. Bruce DiDonato, OD, sold a majority stake in his optometry practice to private equity firm The Beekman Group (“Beekman”). As part of the transaction, the practice was restructured into a parent company, Campus Eye Management Holdings (“Parent”), and a subsidiary, Campus Eye Management, LLC (“Subsidiary”). When the transaction closed, DiDonato retained 35% control of the Parent, along with one of three board seats, while Beekman held 65% of the Parent and the two remaining board seats.

The Subsidiary was governed by an LLC agreement (“Subsidiary LLC Agreement”), and the Parent was governed by its own LLC agreement (“Parent LLC Agreement”).

As part of the transaction, DiDonato was appointed as the “initial manager” of the Subsidiary. After closing, however, the two Beekman-affiliated board members attempted to amend the Subsidiary LLC Agreement to oust him. In response, DiDonato sued in the Delaware Court of Chancery and won (“First Legal Action”), in part because he had not been consulted about the amendment as required by the terms of the Subsidiary LLC Agreement. Because the amendment was found to be invalid, DiDonato retained his position as manager.

The Beekman-affiliated directors were undeterred, however, and took an alternative approach to oust the good doctor. On the very same day they received the unfavorable decision in the First Legal Action, they executed two written consents: one that created a new entity fully owned by the Parent (“NewCo”) and another that caused the Subsidiary to be merged into NewCo (the “Merger”). In connection with the Merger, the Beekman directors amended the Subsidiary LLC Agreement (“Amended Subsidiary LLC Agreement”) to shift NewCo from a manager-managed entity to a member-managed entity, resulting in DiDonato losing his manager position.

The Parent then filed a new action in the Delaware Court of Chancery against DiDonato, seeking a declaratory judgment validating the Merger and the Amended LLC Agreement and a finding that DiDonato was no longer the manager. (The Parent also alleged breaches of fiduciary duty and reformation, which the Court did not address in the decision discussed here.) The Parent moved for partial judgment on the pleadings regarding its declaratory judgment claims, claiming that it complied with all relevant agreements and the default rules of the LLC Act, which provide statutory provisions to fill gaps where an LLC agreement lacks an applicable provision. DiDonato argued, among other things, that the Merger and the resulting Amended LLC Agreement violated the operative limited liability company agreements, the implied covenant of good faith and fair dealing, and fiduciary duty law.

The Court of Chancery Decision

The Parent Company’s Arguments for Declaratory Judgment

The crux of the issue addressed by the Court was whether the three actions taken by the Beekman-affiliated directors were valid. These three actions were: (1) the written consents, (2) the Merger, and (3) the amendment of the LLC Agreement through the Merger. For each step, the Court examined the contracts at issue and the relevant provisions of the LLC Act.

Action by Written Consent. First, the Court found that the actions taken by the Beekman-affiliated board members by written consent were valid. The Court examined two relevant provisions: Section 18-404(d) of the LLC Act and Section 6.4 of the Subsidiary LLC Agreement. Under Section 18-404(d), “[u]nless otherwise provided in a limited liability company agreement,” written consent by managers may be done by majority, “without a meeting,” and “without prior notice.” Section 6.4 of the Parent LLC Agreement authorizes the Parent board to act by majority written consent. The Court determined that the Beekman managers, as the majority of the board, validly executed the two written consents because the Subsidiary LLC Agreement had no notice provision, and the LLC Act has no default requirement of notice.

The Merger. Next, the Court looked at the validity of the Merger. It determined that neither the Subsidiary LLC Agreement that was operative at the time nor the Amended LLC Agreement spoke to whether a merger could be brought by a majority of the members. Given this silence, the Court turned to Section 18-209(b) of the LLC Act, which states that a majority of an entity’s members can approve a merger unless “otherwise provided” in a limited liability company agreement. Because the Parent was the only member and the Beekman directors comprised the majority of the Parent’s board, it had statutory authority to approve the Merger.

Amendment to the Subsidiary LLC Agreement. Finally, the Court turned to the Amended LLC Agreement that was adopted when NewCo and the Subsidiary were validly merged under the LLC Act. The amendment changed the Subsidiary from being manager-managed to member-managed, which removed the manager position that DiDonato had held. Under Section 18-209(f) of the LLC Act, members of an LLC can amend an LLC agreement in connection with a merger even if there is an amendment provision in the agreement, unless that provision expressly applies to an amendment in connection with the merger. Here, the Subsidiary LLC Agreement contained no provision regarding amendments in connection with a merger. Accordingly, using the LLC Act gap filler, the Court found that the amendment was valid.

DiDonato’s Arguments, Affirmative Defenses, and Counterclaim

The Court found neither DiDonato’s arguments or affirmative defenses nor his counterclaim were sufficient to create doubt that the Parent was entitled to partial judgment on the pleadings, as the Merger was “not invalid based on contract, quasi-contract, or equity.”

For example, DiDonato argued that the Amended LLC Agreement was ineffective because he had not been given advance notice of the Merger. But the Court rejected this argument because the Subsidiary LLC Agreement contained no notice provision that would require the Beekman-affiliated directors to provide such notice.

DiDonato also argued that the LLC Act should be read as requiring “an actual transaction of some kind” rather than one with the “sole purpose” of affecting “an otherwise impossible amendment.” The Court held that this reading would be inconsistent with the plain text of the LLC Act, which does not include any required purpose to affect a merger. Such an interpretation also would be inconsistent with the doctrine of independent legal significance as codified in the LLC Act.

Likewise, DiDonato argued that the approval of the Merger was inconsistent with the Parent LLC Agreement because the provisions require the Parent to be managed by the board; DiDonato had a seat on the board, and therefore the Parent LLC Agreement should have been read to require that he receive notice about Board-level topics, like the Merger. Here again, the Court noted that the plain text of the Parent LLC Agreement has no such provision.

Finally, the Court rejected DiDonato’s implied covenant of good faith and fair dealing claims. The Court noted that the implied covenant applies where it is clear from the contract that the parties would have agreed to such a term had they foreseen it. The Court found that the LLC Act is not blurry on this point. It contemplates this exact situation, and DiDonato had failed to cite any law permitting the Court to imply a contractual provision to overcome the default terms of the LLC Act. The Court also found that the Merger and amendment did not frustrate the purpose of the agreements, as DiDonato had not bargained for the right to unilaterally stop a merger or to manage the Subsidiary indefinitely, and the Court refused to read in such rights.

Takeaways

Campus Eye is a reminder of the importance of careful contract construction in the LLC context, particularly for minority members who have less protection in numbers. Although DiDonato was ostensibly protected by the provision in the Subsidiary LLC Agreement regarding amendments, because the provision did not explicitly refer to amendment through merger, he was left at the mercy of the LLC Act. This is true even though he had already won against the original attempt to change the amendment in the Initial Legal Action. As the decision demonstrates, in these circumstances, it comes down to the plain language of the contract, whether there are any legitimately unforeseen gaps, and the applicable provisions of the LLC Act. These default principles cannot merely be waived away by perceived feelings of unfairness. To not expressly contract about something is to place one’s fate in the hands of the LLC Act. When contracting, parties should not focus myopically on the explicit terms of the contract but should also consider where the LLC Act may be employed and, if it is, what exactly it will mean for them.

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.