Supreme Court Clarifies Limits of Judicial Equitable Review of LLC Agreements

The Delaware Supreme Court issued a momentous decision recently that should be read by all those who want to know the latest iteration of Delaware law on the limits of judicial equitable review of LLC Agreements.

In Holifield v. XRI Investment Holdings LLC, Del. Supr., No. 407, 2022 (Sept. 7, 2023), the Delaware Supreme Court determined that freedom of contract in the context of LLC agreements extends to “contractually specified incurable voidness.” This 77-page decision from Delaware’s high court reviewed a 154-page decision of the Court of Chancery that was highlighted on these pages.

This is the type of decision that could justify a law review article, but for purposes of this short blog post, I will only highlight key parts of the decision that should justify a careful reading of the decision in its entirety.

Basic Factual Context

The background of the case involves complex, extensive facts, but for purposes of these brief highlights, the most important context involved whether or not the parties to an LLC Agreement could determine, in connection with an attempted transfer of interests, that failure to comply with certain conditions would make a transaction “incurably void” such that it would not be subject to judicial equitable review and remedies—even if it might result in an inequitable holding by the court.

• The trial court found that it was bound to uphold the “contractual incurable voidness” based on the Delaware Supreme Court’s CompoSecure II opinion. Slip op. at 32.
• See footnote 82 noting that it was not an issue on appeal that, generally, the equitable defense of acquiescence is available as a defense to claims at law.
• The Supreme Court explained why it would not reconsider its decision in CompoSecure II which the appellant and the trial court urged. Slip op. at 43 – 44.
• The Supreme Court provided guidance on why the primacy of freedom of contract embodied in the LLC Act supported the CompoSecure II decision—which endorsed private ordering to a degree “not available in the corporate context.” Slip op. at 44.
• The Delaware Supreme Court instructed that “. . . particularly in the alternative entity context, equity will not save a bad contract.” Slip op. at 46. See cases cited at footnotes 118 to 120.
• The high court also provided a primer on basic Delaware law regarding contract interpretation principles. Id. at 47.
• The Supreme Court emphasized that the freedom of contract allowed in LLC agreements extends to “contractually specified incurable voidness.” Id.
• Although the Supreme Court acknowledged that there are limits to private ordering, and that Delaware courts retain an inherent measure of authority and equitable power regarding LLC agreements: equity cannot always override the plain language of an LLC agreement with respect to incurable voidness. Id. at 47-48.
• By comparison, corporate bylaws cannot alter the directors’ fiduciary obligations “and the attendant equitable standards a court will apply enforcing those obligations.” Slip op. at 49. See also footnotes 136 to 142 and accompanying text.
• The Delaware Supreme Court emphasized that its CompoSecure II opinion “did not hold, or even suggest, that in every case where the parties used the word ‘void’, a non-compliant act will be incurably void.” Id. at 65. If the use of the word in some circumstances is ambiguous, a different analysis is possible.
• The court declined to require “talismanic magic words to contract for incurable voidness in an LLC agreement.” Id. at 66.
• The case was remanded to address damages and recoupment. Id. at 77.