Bylined Articles

Chancery Court Limits Reach of Indemnification Provision

By Michael R. Lastowski and Christopher M. Winter
September 18, 2013
Delaware Business Court Insider

Michael R. Lastowski
Michael Lastowski
Christopher M. Winter
Christopher Winter

In Costantini v. Swiss Farms Stores Acquisition, C.A. 8613-VCG (September 5, 2013), the Chancery Court ruled that an indemnification provision that mirrored the corporate statute did not extend to the partner of one of its members who had the ability to designate a manager of the LLC.

In a letter opinion issued this month, Vice Chancellor Sam Glasscock III interpreted the operating agreement of Swiss Farms Stores Acquisition LLC, which contained indemnification provisions that mirrored the Delaware corporate statute for mandatory and permissive indemnification, Delaware General Corporation Law Section 145. The relevant provision of the operating agreement provided indemnification to "a member of the board of managers, an officer, an employee or an agent of the company" to the extent "successful on the merits or otherwise" in defending a claim.

Glasscock ruled that the language clearly covered Edmond Costantini Jr., who was a member of the board of managers of Swiss Farms. However, the court declined to extend the reach of the indemnification provision to James Kahn, who was a partner in the Kahn Quinn Partnership, a member of Swiss Farms that had the ability to designate a manager of Swiss Farms.

Glasscock had previously found that the underlying breach of fiduciary duty claims brought by the company against Costantini and Kahn were time-barred under the doctrine of laches. Here, he further found that the "successful on the merits or otherwise" language in the indemnification provision applied to a successful assertion of a technical defense such as laches. The complaint alleged that the Kahn Quinn Partnership, not its designee, acted as a manager on the LLC's board of managers and "in the process assumed for all of its partners, including defendant Kahn, multiple fiduciary duties to Swiss Farms."

Kahn argued that because he was sued as a fiduciary of Swiss Farms, he was entitled to indemnification as a fiduciary. Kahn also argued that the "agent" language was broad enough to include him as an indemnitee. Glasscock rejected the arguments, reasoning that the operating agreement indemnification provision was unambiguous and that Kahn simply did not fall into any of the categories entitled to indemnification. Kahn was not a manager, officer, employee or agent of Swiss Farms. He was merely a partner in a partnership that was a member of Swiss Farms.

"The purpose of the statutory language imported into the operating agreement is to allow ... entities to attract talented individuals to act on behalf of the company by limiting the burdens of potential litigation against them. The purpose, obviously, does not extend to those who, like Mr. Kahn, were not acting on behalf of the entity."

The court acknowledged the result may appear unfair to some, but said it "is simply the unfairness (if unfairness it is) that results from application of the traditional American rule on legal fees and costs, which provides that the prevailing party must bear her own fees and costs."

The Swiss Farms opinion may counsel expanded language in indemnification provisions in limited liability company agreements that seek to protect the agents and principals of business entities that serve as members and managers of Delaware limited liability companies. As Glasscock acknowledged in the Swiss Farms opinion, an LLC is a creature of contract and, unlike a corporation, is free to expand indemnification rights and obligations in its limited liability company agreement.

Michael R. Lastowski is a member of Duane Morris and the head of its Wilmington office. Licensed to practice in Delaware, Pennsylvania and New York, he primarily represents Chapter 11 debtors.

Christopher M. Winter, a partner with the firm, is a Delaware business lawyer who focuses his practice on Chapter 11 bankruptcy law and proceedings, commercial and corporate finance and transactions, and Delaware corporate and alternative entity law.

Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.