Court of Chancery Harmonizes Operating Agreement Governance Provisions To Resolve LLC Control Dispute

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Pearl City Elevator, Inc. v. Gieseke, C.A. No. 2020-0419-JRS (Del. Ch. Mar. 23, 2021)

Under Delaware law, limited liability company agreements are interpreted like other contracts; they are read as a whole in light of the commercial context, in a manner that gives effect to and harmonizes all of their terms. In this expedited control dispute, the Court of Chancery applied those canons to consider whether certain of the plaintiff’s purchases of units from other members complied with transfer restrictions.

Specifically, under the LLC operating agreement for an ethanol and biodiesel production facility owned by local Illinois farmers, the plaintiff Pearl City Elevator held fifty percent of the LLC’s membership units, and had the right to appoint three members to the six-member board of governors. The general members of the LLC held the remaining fifty percent of the units, and also had the right to appoint three governors to the board. Either Pearl City or the general members had the right to appoint an additional governor to the board—and obtain attendant control of the LLC—if they acquired at least fifty-six percent of the LLC’s units. In 2020, Pearl City acquired from other members sufficient units to reach the fifty-six percent member ownership threshold, and sought to appoint a seventh governor to the board. The three governors appointed by the general members refused, however, to recognize the seventh governor on the grounds that Pearl City allegedly acquired its majority units improperly under the operating agreement.

The Court of Chancery held that Pearl City had complied with the operating agreement, and therefore, had the right to appoint a seventh governor to the board. The Court found that the prior notice and approval provisions in the transfer restrictions at issue did not create veto authority for the general members or the board to prevent Pearl City’s acquisition of additional units. The Court reasoned that if members or the board could withhold such approval, they could block the acquisition of additional units, which would negate the ability of members to ever meet the fifty-six percent member ownership threshold, and render meaningless the provision allowing appointment of a seventh governor. The Court explained that, under its plain language, the agreement only required prior board approval of unit transfers to non-members as a means of vetting new members in a local community. This was to ensure the transfer did not violate a narrow set of legal and tax compliance requirements. The Court also reasoned that, under the specific language of this operating agreement, the transfer was effective prior to delivery of certain opinions of counsel affirming such compliance; the fact such opinions were not delivered until the early stages of this litigation was of no moment. The Court accordingly concluded that Pearl City had complied with the transfer restrictions, and that the general members did not have veto authority over its acquisition of additional units to meet the threshold necessary to appoint a seventh governor.

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