In Skye Mineral Investors, LLC and Clarity Copper, LLC v. DXS Capital (U.S.) Limited et al., C.A. No. 2018-0059-JRS (Del. Ch. Feb. 24, 2020), the Delaware Court of Chancery rejected a motion to dismiss breach of fiduciary duty claims brought against two minority members of Sky Mineral Partners, LLC (“SMP”), a Delaware limited liability company, stemming from their exercise of certain veto or “blocking” rights they had under SMP’s limited liability company agreement (the “LLC Agreement”).

The plaintiffs in this case were the two majority members of SMP. The defendants included DXS Capital (U.S.) Limited (“DXS”) and PacNet Capital (U.S.) Limited (“PacNet”), the two minority members of SMP (the “Minority Member”) who collectively owned 28% of the outstanding units of ownership in SMP. SMP was established as a manager-managed limited liability company and was managed by a Board of Managers consisting of three individuals, two of whom were appointed by the plaintiffs and one who was appointed by the Minority Members. DXS also had the right to appoint an observer who could attend all board meetings in a nonvoting capacity.

As for the duties of managers, the LLC Agreement did not eliminate the manager’s fiduciary duty, but rather confirmed that managers owed the same duties as are owed by directors of a corporation, providing, in relevant part, “[except] as otherwise set forth in this Agreement, a Manager has the fiduciary duty to the company and the Members that is the same as the duty that a director of a Delaware corporation owes to a corporation and its stockholders.”

Under the terms of the LLC Agreement, certain actions required the approval of at least 75% of the members. These actions included (i) granting or pledging any security interest, lien or encumbrance; (ii) issuing any units of any class to an existing member or a new member; and (iii) entering into a merger or a sale of substantially all the company’s assets (the “Blocking Rights”). In addition, SMP could not approve an annual budget or take on material debt without the consent of DXS. The LLC Agreement gave the Members the right to “give or withhold, condition or delay their votes, approvals, or consents in their sole and absolute discretion.” With respect to the fiduciary duties of members, the LLC Agreement stated that “no Member or any of its affiliates shall have any fiduciary obligations with respect to the Company or to the other Members insofar as making other investment opportunities available to the Company or to the other Members.” The LLC Agreement was silent as to the waiver of any other fiduciary duties imposed on members of limited liability companies under applicable law.

SMP’s primary asset was a 99% membership interest in a separate subsidiary limited liability company, CS Mining, LLC (“CSM”). SMP was the managing member of CSM. CSM held certain mineral deposits and was undertaking efforts to develop and monetize a portion of the deposits with the balance remaining in the ground for future development at such time as CSM could expand its processing facility. To accomplish the expansion of the facility, SMP and CSM initiated a “Phase II” capital project. In connection with those efforts, CSM obtained a $30,000,000 secured loan from Noble Americas Corp (“Noble”), which to complicate things did not extend credit as a traditional lender to CSM but as the exclusive purchaser of CSM’s copper. Due to the leverage this provided Noble, SMP’s members negotiated an agreement with Noble (the “Insider Sale Prohibition”) that prohibited Noble from selling its loan to one or more of the Minority Members and their many affiliated entities and controlling individuals (collectively the “Lippo Group”).

At some point in the build-up to the project, the Minority Members’ representative to the Board of Managers, Marshall Cooper (“Cooper”), learned (while acting as a Manager of SMP) that the full value of the mineral deposits were worth at least $600 million. However, Cooper did not inform the other Managers of SMP or the plaintiffs, but rather, he only informed the Minority Members.

Thereafter, according to the Complaint, the Minority Members and other members of the Lippo Group embarked on a course of action to take control over the deposits, and in the process, the Minority Members used their Blocking Rights to block reasonable financing proposals for SMP and deny access to needed debt financing to continue SMP’s and CSM’s operations. Then, when the plaintiffs tried to save the Company with a $5 million equity infusion, DXS and PacNet filed a declaratory judgment action to enforce their approval rights of any issuance of additional equity interests to new or existing Members and the entering into of any agreement by SMP or CSM with respect to incurring any material debt or pledging any of their assets as security for any creditor. An affiliate of the Minority Members also took steps to acquire the loan from Noble so as to be in a priority position when SMP and CSM inevitably collapsed. In the end, SMP had to waive the Insider Sale Prohibition in order to obtain a further forbearance from Noble, which allowed the affiliate of the Minority Members to acquire the loan. As a result of these actions, CSM ultimately did file for bankruptcy, and yet another affiliate of the Minority Members was able to acquire the mineral deposits out of the bankruptcy proceeding at a bargain price.

After the bankruptcy sale, the plaintiffs sued Cooper, the Minority Members, various affiliates of the Minority Members and Noble on a multitude of theories, including breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, tortious interference with contract, civil conspiracy and fraud. The defendants then filed a motion to dismiss on various grounds including service and jurisdictional issues and for failure to state viable claims under Rule 12(b)(6).

In an interesting and winding opinion, the Court in Skye analyzed the various claims alleged by the plaintiffs against the defendants’ motion to dismiss. In the end, the Court granted the defendants’ motion in part and denied the motion in part. Significantly, the Court specifically refused to dismiss the breach of contract and breach of fiduciary duty claims brought against Cooper and the Minority Members based on the facts that were pled.

As to Cooper (the Manager appointed by the Minority Members), the Court looked specifically at the language of the LLC Agreement which incorporated the traditional duties of care and loyalty of a director of a Delaware corporation, and found that the plaintiffs had sufficiently pled its claims against Cooper for a breach of his traditional fiduciary duty of loyalty through his alleged actions which included (i) using confidential information to benefit himself and the Minority Members without disclosing the information to the other Managers and the plaintiffs; (ii) using his position as Manager to deny capital to SMP and CSM to increase the defendants’ leverage over SMP; (iii) lying to the other Managers; and (iv) refusing to attend Board meetings to prevent needed actions from being taken.

As to the Minority Members, the Court rejected the Minority Members’ argument that the “sole and absolute discretion” language eliminated all fiduciary duties of the Members related to the exercise of members’ Blocking Rights. The Court disagreed, and while it found that the LLC Agreement modified the members’ fiduciary duties, it did not eliminate all common law fiduciary duties for the members. The Court noted that “[I]f the SMP Agreement’s drafters wished to exempt members from the fiduciary duty of loyalty, they could do so only with express disclaimer language, not by implication.” The Court further noted, “[T]o the extent that an Agreement purports to insulate a [fiduciary] from liability even for acts of bad faith . . . it should do so in the most painstakingly clear terms.’

Thus, the analysis then turned to what common law fiduciary duties existed for members. For this analysis, the Court looked to Delaware corporate law, and found that under Delaware corporate law, a minority owner (owning less than 50% of the voting power) can still have fiduciary duties if the minority owner exercises control over the business and affairs of the corporation. Thus, the issue in this case was whether the Blocking Rights were sufficient to give the Minority Members control over the affairs of SMP. The Court, under the facts as alleged in this case, said it did.

The Blocking Rights were very significant to the Court. While it did not give the Minority Members per se control, in the context of the Noble loan, the Court noted that the “Blocking Rights amounted to a self- destruct button that allowed DXS and PacNet to wield control by driving SMP into the ground if it suited their interests.” The Court concluded that “when blocking rights empower a minority investor to channel the corporation into a particular outcome, they contribute to an inference of control. Here, the plaintiffs make an even stronger case as the Blocking Rights did more than channel SMP to a particular outcome . . . the Blocking Rights gave the minority members the unilateral power to shut SMP down – full stop.”

As a result, the Court concluded that the plaintiffs’ complaint plead a reasonably conceivable claim that DXS and PacNet exercised actual control over SMP, and that it created a reasonable inference that the Minority Members breached their duties by exercising control in bad faith with intent to harm SMP.

Takeaways

This case is interesting in that it is the reverse of the typical breach of fiduciary duty case, where the minority members are typically asserting claims against the managers or majority members. In Skye, it is the majority members bringing an action against the minority members.

In this case, it seems pretty clear on the facts alleged that the exercise of blocking rights by the minority members (along with other conduct) was made in bad faith with the specific intent to harm the entity and usurp the value of the mineral deposits for their own benefit (or the benefit of their affiliates) to the exclusion of the other members. How far courts will go to find that blocking rights constitute “actual control” remains to be seen.

Clearly, blocking rights provided to minority members over certain actions are not unusual and should not impose fiduciary duties on the minority members as a matter of law. However, to the extent the blocking rights allow the minority members to arguably shut down the LLC’s operations, fiduciary duties on the minority members may very well be triggered. This is something to keep in mind when drafting operating agreements or negotiating blocking rights on behalf of clients acquiring minority ownership interests.

In addition, most state laws allow parties, in their operating agreement, to contractually eliminate the fiduciary duties of the members and managers to the LLC and to one another. Whether this is a good thing may be a matter of perspective. However, as this case points out, a complete elimination of fiduciary duties must be done through “clear and unambiguous language” in the operating agreement The mere fact that the members are allowed to act or vote in their “sole and absolute discretion” does not necessarily mean that all fiduciary duties of the members are waived.

February 25, 2021/by Business