Grove v. Brown, C.A. No. 6793-VCG (Del. Ch. Aug. 8, 2013) (Glasscock, V.C.)

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In this memorandum opinion, the Court of Chancery, relying on the unambiguous terms of a limited liability company operating agreement, found that a member’s failure to make an initial capital contribution to a limited liability company did not affect that member’s ownership interest in the limited liability company.  Further, the Court of Chancery, applying default fiduciary duties to the managing members of a limited liability company, found that two managing members breached their fiduciary duty of loyalty under the corporate opportunity doctrine.

In December 2009, the plaintiffs, Mary Marlene Grove (“Marlene”) and Larry Grove (“Larry,” and together with Marlene, the “Groves”), and the defendants, Melba Brown (“Melba”) and Hubert Brown (“Hubert,” and together with Melba, the “Browns”), started a home health care agency, Heartfelt Home Health, LLC (“Heartfelt”).  The Groves and the Browns entered into a limited liability company operating agreement (the “LLC Agreement”), which named the four individuals as the four members of Heartfelt and indicated that each member owned 25% of Heartfelt.  Further, the LLC Agreement provided that each member was to make an initial capital contribution of $10,000. 

During its first year of operation, Heartfelt was successful.  This success led Marlene and the Browns to discuss the possibility of expanding Heartfelt’s operations into Maryland and southern Delaware.  However, the Groves, without informing the Browns, formed and operated two new home health care agencies, serving Maryland and southern Delaware (the “Competing Entities”). 

In April 2011, the parties began disputing their respective ownership interests in Heartfelt.  As of April 5, 2011, both Larry and Melba had not contributed the full amount of their required initial capital contributions.  Though Melba subsequently increased her cash contributions to the required amount, the Groves and the Browns disagreed about whether Larry’s donations of furniture and equipment to Heartfelt satisfied his remaining contribution obligations.  The Groves contended that each of Marlene, Larry, Hubert, and Melba owned 25% of Heartfelt.  The Browns, however, contended that they owned 63% of Heartfelt because of their greater collective cash contributions to Heartfelt. 

Following unsuccessful attempts to resolve the ownership dispute, the Groves threatened to file a certificate of dissolution to liquidate Heartfelt and notify Heartfelt’s sole client of the dissolution.  In response, the Browns, relying on their alleged 63% ownership of Heartfelt, purported to merge Heartfelt into a new entity (“Heartfelt II”), which was solely owned by the Browns.  Following the purported merger, the Groves sued the Browns for breach of fiduciary duty and the Browns counterclaimed for breach of fiduciary duty against the Groves. 

The Court of Chancery first addressed the issue of the parties’ ownership interests in Heartfelt.  Though acknowledging that the LLC Agreement required each of the four members to make an initial capital contribution of $10,000, the Court of Chancery found that the allocation of the members’ ownership interests was not contingent on the members’ actions post-signing.  In particular, the Court of Chancery noted that the LLC Agreement did not provide that a member’s failure to make his or her initial capital contribution would divest that member of his or her interest in Heartfelt.  In addition, at the time the Browns initially sought to have Larry make up his shortfall in his initial capital contribution, the Browns did not contend that he had already forfeited a portion of his interest in Heartfelt.  Therefore, the Court of Chancery held that Marlene, Larry, Hubert, and Melba each remained an equal 25% member of Heartfelt.  Because the Browns were 50%—not 63%—owners of Heartfelt, the Court of Chancery held that the purported merger of Heartfelt into Heartfelt II was a nullity. 

The Court of Chancery then addressed the Browns’ claim that the Groves breached the fiduciary duty of loyalty by wrongfully taking the corporate opportunities of Heartfelt via the Competing Entities.  The Court of Chancery held that the Groves owed default fiduciary duties to the Browns and that the opportunities on which the Groves capitalized via the Competing Entities were within Heartfelt’s line of business.  Therefore, under the corporate opportunity doctrine, the Groves had the burden to demonstrate that there was no breach of the duty of loyalty because Heartfelt was either (1) presented the opportunity and rejected it, or (2) not in a position to take the opportunity. 

In light of Heartfelt’s success in its first year of operation, the Court of Chancery reasoned that Heartfelt would have been financially able to capitalize on the opportunities to expand operations into Maryland and southern Delaware.  The only evidence that the Groves offered to support a finding that Heartfelt waived those opportunities was self-serving testimony.  In addition, though the Groves claimed that they invited the Browns, in their personal capacities, to join the Groves in creating new, competing entities, the Groves did not testify that those opportunities were presented to Heartfelt.  Further, the Court of Chancery found that the Groves’ failure to tell the Browns about the Competing Entities when they were formed contradicted Marlene’s testimony that the Browns gave her permission to create the Competing Entities.  Thus, the Court of Chancery found that the Groves failed to meet their burden to show that Heartfelt disclaimed its interest in expanding operations into Maryland and southern Delaware and held that the Groves breached the fiduciary duty of loyalty by establishing and operating the Competing Entities. 

To remedy the parties’ breaches of fiduciary duties, the Court of Chancery, relying on its equitable powers, ordered the Browns to account to Heartfelt for the profits Heartfelt II earned following the purported merger and ordered the Groves to account to Heartfelt for the profits earned by the Competing Entities.  Further, noting that the there was no pending application for dissolution of Heartfelt under 6 Del. C. § 18-802, and declining to effectuate judicial dissolution of Heartfelt sua sponte, the Court of Chancery encouraged the parties to submit a petition for dissolution to be considered concurrently with the accounting. 

The full opinion is available here.

Topics:  Breach of Duty, Business Ownership, Fiduciary Duty, LLC, Operating Agreements

Published In: Business Organization Updates, Business Torts Updates, General Business Updates, Finance & Banking Updates, Mergers & Acquisitions Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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