Fiduciary Duties—RULLCA § 409: Standards of Conduct for Members and Managers (p. 251)

1. Fiduciary Duties—RULLCA § 409: Standards of Conduct for Members and Managers (p. 251) Donald J. Weidner • RULLCA (2006) § 409, setting out the “Standards of Conduct for Members and Managers,” distinguishes between member-managed LLCs and manager-managed LLCs. • The rules that apply to a member of a member-managed LLC are very similar to the rules that apply to a partner in a general partnership. • The members in a member-managed LLC have a duty of loyalty to the LLC and to the other members that includes the three components in § 409(b): • To account for any benefit derived in the conduct or winding up of the LLC activities, from a use of the LLC’s property, or from the appropriation of an LLC opportunity. • To refrain from dealing as or on behalf of an adverse party. • Note: § 409(e) says: “It is a defense to a claim under subsection (b)(2) and any comparable claim in equity or under common law that the transaction was fair to the limited liability company.” • To refrain from competing with the LLC before dissolution of the LLC.

2. Standards of Conduct for Members and Managers (cont’d) Donald J. Weidner • Note the contrasts with RUPA: • RULLCA § 409(a) does NOT say that the ONLY fiduciary duties are the duties of loyalty and care. (not an exclusive list—does not “cabin” the fiduciary duties). • RULLCA § 409(b) does NOT say that the duty of loyalty is LIMITED to the three mentioned items (not an exclusive list of the aspects of the duty of loyalty—does not “cabin” the duty of loyalty). • RULLCA § 409 provides that it is a defense to an “adverse party” claim that the transaction was “fair”—RUPA does not include such a defense. • RULLCA § 409 does not include RUPA’s statutory recognition of legitimate self interest. • RULLCA § 409 does not include RUPA’s statutory recognition of legitimate third-party transactions. • RULLCA § 409 replaces RUPA’s statutory standard of gross negligence with a reasonable care standard “subject to the business judgment rule.”

3. Standards of Conduct for Members and Managers (cont’d) Donald J. Weidner RULLCA § 409(c): “Subject to the business judgment rule, the duty of care ofa member in a member-managed LLC . . . is to act with the care that a person in a like position would reasonably exercise under similar circumstances and in a manner the member reasonably believes to be in the best interests of the company. In discharging this duty, a member may rely in good faith upon opinions, reports, statements, or other information provided by another person that the member reasonably believes is a competent and reliable source for the information.” (p. 251)

4. Standards of Conduct for Members and Managers (cont’d) Donald J. Weidner • Comment says that, in some circumstances, “an unadorned standard of ordinary care is appropriate for those in charge of a business organization or similar, non-business enterprise.” • “In others, the proper application of the duty of care must take into account the difficulties inherent • in establishing an enterprise’s most fundamental policies, • supervising the enterprise’s overall activities, or • making complex business judgments.” • Comment says that, because LLC law allows “structural flexibility,” it cannot follow corporate law, which distinguishes between the duties of directors and those of officers. • Therefore, its “best of both worlds” approach is “stating a standard of ordinary care but subjecting that standard to the business judgment rule to the extent circumstances warrant.”

5. Standards of Conduct for Members and Managers (cont’d) Donald J. Weidner • In a manager-managed LLC, the managers have the fiduciary duties. • § 409(g)(5), provides that, in a manager-managed LLC: “A member does not have any fiduciary duty to the company or to any other member solely by reason of being a member.” • Comment: this § merely negates a claim of fiduciary duty that is exclusively status based and does not immunize misconduct. • For example, in a manager-managed LLC, a member owning a controlling interest may be liable for oppression. • Just a controlling shareholder in a closely-held corporation may be held liable for oppression. • § 409(d): “A member in a member-managed LLC or a manager-managed LLC shall discharge the duties under this [act] or under the operating agreement and exercise any rights consistently with the contractual obligation of good faith and fair dealing.”

6. Standards of Conduct for Members and Managers (cont’d) Donald J. Weidner Recall one of the “Standards of Conduct” in RUPA § 404(f): “A partner may lend money to and transact other business with the partnership, and as to each loan or transaction the rights and obligations of the partner are the same as those of a person who is not a partner, subject to other applicable law.” RULLCA (2006) removed a similar provision from the preceding version of ULLCA, explaining: “Those provisions originated to combat the notion that debts to partners were categorically inferior to debts to non-partner creditors [which they were under UPA § 40]. That notion has never been a part of LLC law, and so a modern LLC law [need not combat it].” “Moreover, to the uninitiated the language can be confusing because the words might: (i) seem to undercut the duty of loyalty, which they do not; and (ii) deflect attention from bankruptcy law and the law of fraudulent transfer, which assuredly can look askance at transactions between an entity and an ‘insider.’”

7. The Operating Agreement—Florida Definition and Scope (elaborating on and localizing the material that begins at text p. 255) Donald J. Weidner • Recall that the articles of organization may say little or nothing about the substance of the business or the relationships among the members. These matters are addressed in the operating agreement, which is analogous to a partnership agreement. • The 2013 LLC Act contains extensive provisions on the operating agreement. • F.S. § 605.0102(45): “’Operating agreement’ means an agreement, whether referred to as an operating agreement or not, which may be oral, implied, in a record, or in any combination thereof, of the members of a limited liability company, including a sole member, concerning the matters described in s. 605.0105(1). The term includes the operating agreement as amended or restated.” • With the exception of a promise to contribute to the LLC, “an operating agreement is not subject to a statute of frauds.” F.S. § 605.0106(6).

8. The Operating Agreement—Florida Freedom of Contract to Order One’s Affairs (cont’d) Donald J. Weidner The referenced F.S. § 605.0105(1) provides that, “except as otherwise provided in subsections (3) and (4) [the LLC Act’s mandatory rules], the operating agreement governs the following: (a) Relations among the members as members and between the members and the [LLC]. (b) The rights and duties under this chapter of a person in the capacity of manager. (c) The activities and affairs of the company and the conduct of those activities and affairs. (d) The means and conditions for amending the operating agreement.” The 2013 Act gives the parties almost unlimited, “freedom of contract” to order their affairs as they see fit in their operating agreement.

9. The Operating Agreement—Florida Default and Mandatory Rules Donald J. Weidner • Much of the LLC Act consists of default rules that apply in the absence of a provable agreement to the contrary. The statute provides a default--or “off the rack”-- operating agreement. F.S. § 605.0105(2). • Technically, a pre-formation agreement is not an operating agreement because there are not yet “members” of an LLC. • However, some of the rules in the LLC Act are mandatory rules that the parties are not free to contract away. • Subsection (3) lists the Act’s mandatory (or “nonwaivable”) rules with the introductory declaration: “An operating agreement may not . . . . “ • For example, the operating agreement may not: • “Vary the grounds for dissolution specified in s. 605.0702.” (including judicial dissolution at the request of a member or a manager) • “Unreasonably restrict the right of a member to maintain an action under §. 605.0801-605.0806.” (the provisions allowing a member to bring a direct or a derivative action against the firm, another member or a manager) • “Unreasonably restrict the duties and rights stated in s. 605.0410” (concerning member access to books and records)

10. The Operating Agreement—More of Florida’s Mandatory Rules Donald J. Weidner • The operating agreement may not: “Relieve or exonerate a person from liability for conduct involving bad faith, willful or intentional misconduct, or a knowing violation of law.” F.S. § 605.0105(g). • The “mandatory” provisions concerning the duty of loyalty, the duty of care, and other fiduciary duties, are in §§ 605.0105(3)(e) and (f) and § 605.0105(4). • In short, the operating agreement may “alter or eliminate” the three fundamental aspects of the duty of loyalty stated in F.S. § 605.04091(2)(a)-(c) and “any other fiduciary duty,” if not “manifestly unreasonable.” • Contracting away all fiduciary duties is controversial and, as the cases we are about to cover indicate, not as easy to accomplish as it might sound. • F.S. § 605.0105(3)(p) also has a non-Uniform rule prohibiting an operating agreement from indemnifying a member or manager “in cases involving certain misconduct (including bad faith, willful or intentional misconduct, a knowing violation of law, or breach of fiduciary duties or the obligation of good faith and fair dealing.” Louis T.M. Conti and Gregory M. Marks, Florida’s New Revised LLC Act, Part I, 87 Fla. B. J. (Sept/Oct. 2013).

11. The Operating Agreement—Florida Rules on Effect on LLC, Members, Managers and Transferees Donald J. Weidner • In addition to the F.S. § 605.0102(45) definition of operating agreement and the § 605.0105 distinction between default and mandatory rules, there are two additional detailed sections of rules concerning operating agreements. • F.S. § 605.0106 generally concerns the effect of the operating agreement on members and on the LLC itself. Perhaps most fundamentally: “(1) [An LLC] is bound by and may enforce the operating agreement, regardless of whether the company itself has manifested assent to the operating agreement. “(2) A person who becomes a member of [an LLC] is deemed to assent to, is bound by, and may enforce the operating agreement, regardless of whether the member executes the operating agreement. * * * “(4) A manager of [an LLC] or a transferee is bound by the operating agreement, regardless of whether the manager or transferee has agreed to the operating agreement.”

12. The Operating Agreement: Not An “Ordinary Commercial Contract” Donald J. Weidner • May a member sue another member or a manager for breach of the operating agreement? • Stated differently, do a member’s or a manager’s duties under the operating agreement run to the LLC, to the other members, or both? • The RULLCA Commentary states that an operating agreement “typically” presents “different circumstances” than an “ordinary” commercial contract: “Although in ordinary contractual situations it is axiomatic that each party to a contract has standing to sue for breach of that contract, within [an LLC] different circumstances typically exist. A member does not have a direct claim against a manager or another member merely because the manager or other member has breached the operating agreement. Likewise, a member’s violation of this act does not automatically create a direct claim for every other member. To be able to have standing in his, her, or its own right, a member plaintiff must be able to show a harm that occurs independently of the harm caused or threatened to be caused to the [LLC].”

13. The Operating Agreement: Not An “Ordinary Commercial Contract” (cont’d) Donald J. Weidner As this last quote suggests, this perception of the distinctive nature of the operating agreement affects whether a dissatisfied member has a right to bring a direct action or is instead confined to a derivative action. Florida follows RULLCA in this regard. To quote from Florida’s leading case distinguishing direct from derivative actions, DinuroInvestments, LLC v. Camacho, 141 So.3d 731, 738 (Fla.3dD.C.A. 2014): “Unfortunately, many operating agreements and statutes do not specify who owes a particular duty, and to whom that duty is owed. Indeed, [the Florida LLC Act] subjects all managing members to a duty of loyalty and care that is owed ‘to the [LLC] and all of the members of the [LLC]’.” Indeed, a member’s right to enforce the operating agreement is a default rule that can be contracted away.

14. The Operating Agreement: Not An “Ordinary Commercial Contract” (cont’d) Donald J. Weidner • Dinuro confirms that a member does not owe a direct duty to other members simply by signing the operating agreement: • “[U]nlike a typical bilateral contract, where both signing parties owe duties to one another, operating agreements establish a more complicated and nuanced set of contractual rights and duties.” Dinuro, 141 So.3d at 741. • Quoted with approval in Silver Crown Investments, LLC v. Team Real Estate Management, LLC, 2018 WL 46979718 at *4 (S.D. Fla. 2018). • Dinuro stated a presumption that members are not directly liable to one another for promises they make in the operating agreement. • This presumption can be overcome by a provision stating that members shall be directly liable to one another for breaches of its terms.

15. Florida Tracks RULLCA Standards of Conduct for Members and Managers Donald J. Weidner • F.S. § 605.04091, setting out the “Standards of Conduct for Members and Managers,” applies to members in member-managed LLCs and managers in manager-managed LLCs. “(1) Each manager of a manager-managed [LLC] and member of a member-managed [LLC] owes fiduciary duties of loyalty and care to the [LLC] and members of the [LLC].” “(2) The duty of loyalty includes” three components in subsections (2)(a)-(c): • To account for any benefit derived in the conduct or winding up of the LLC activities, from a use of company property, or from the appropriation of a company opportunity. • To refrain from dealing as or on behalf of an adverse party. • To refrain from competing with the firm prior to its dissolution. • Except to the extent provided in F.S. § 605.1005(3), these are default rules.

16. Standards of Conduct: Florida Tracks Rules Permitting Eliminating Fiduciary Duties Donald J. Weidner F.S. § 605.0105(3) states that an operating agreement may not: “(e) Eliminate the duty of loyalty or the duty of care under s. 605.04091, except as otherwise provided in subsection (4).” F.S. § 605.0105(4)(c) states: “(c) If not manifestly unreasonable the operating agreement may: “1. Alter or eliminate the [three] aspects of the duty of loyalty under s. 605.04091(2); “2. Identify specific types or categories of activities that do not violate the duty of loyalty; “3. Alter the duty of care, but may not authorize willful or intentional misconduct or a knowing violation of law; and “4. Alter or eliminate any other fiduciary duty.” [added to the 2013 LLC Act in 2015]

17. Standards of Conduct: Role of Florida Courts Reviewing Elimination of Fiduciary Duties (cont’d) Donald J. Weidner F.S. § 605.0105(5) provides that courts, not juries, get to decide what is “manifestly unreasonable:” “(5) The court shall decide as a matter of law whether a term of an operating agreement is manifestly unreasonable under paragraph 3(f) [dealing with the obligation of good faith and fair dealing] or paragraph (4)(c) [dealing with the duties of loyalty, care, and “any other fiduciary duty”] . The court: “(a) Shall make its determination as of the time the challenged term became part of the operating agreement and shall consider only circumstances existing at that time; and “(b) May invalidate the term only if, in light of the purposes, activities, and affairs of the [LLC], it is readily apparent that: “1. The objective of the term is unreasonable; or “2. The term is an unreasonable means to achieve the provision’s objective.”

18. Standards of Conduct: Further Rule Supporting Restrictions on Fiduciary Duties Donald J. Weidner There are additional provisions to support the contractual limits on fiduciary duties. When the Legislature added the ability to contract away “any other fiduciary duty,” it also amended F.S. § 605.0111, entitled “Rules of construction and supplemental principles of law:” “(1) It is the intent of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of operating agreements . . . . “(2) To the extent that, at law or in equity, a member, manager, or other person has duties, including fiduciary duties . . . , the duties . . . may be restricted, expanded, or eliminated, including in the determination of applicable duties and obligation under this chapter, by the operating agreement, to the extent allowed by s. 605.0105. “(3) Unless displaced by particular provisions of this chapter, the principles of law and equity, including the common law principles relating to the fiduciary duties of loyalty and care, supplement this chapter.”

19. Salm v. Feldstein (2005) (p. 257) Donald J. Weidner Plaintiff and Defendant each had an equal interest in an LLC that owned an automobile dealership. The defendant, who was the managing member of the LLC, purchased the interest of the plaintiff co-member pursuant to a redemption and settlement agreement dated June 2, 2003. The agreement provided for a $3.75 million payment to the plaintiff, plus a consulting contract for a 5-year aggregate sum of $1.35 million. The defendant allegedlyrepresented the value of the dealership as between $5 and $6 million and failed to disclose that a nonparty had made an offer to buy it for $16 million.

20. Salm v. Feldstein (cont’d) Donald J. Weidner • The agreement: • stated that each party had an opportunity to investigate and evaluate the assets, operation, books, records and financial condition of the company • disclosed, in general terms, that the Defendant had received offers to purchase the dealership and that he may continue to entertain offers • stated that the consideration in the agreement may be less than “the true value” • provided that the plaintiff was entitled to retain his shares • stated that no representations were made to plaintiff that are not in the agreement. • Two days after this redemption and settlement agreement, the defendant sold the dealership to the nonparty for $16 million. • In light of the disclosures and disclaimers in the agreement, should plaintiff be awarded his share in the $16 million sale of the dealership?

21. Salm v. Feldstein (cont’d) Donald J. Weidner • The New York court said that, as the managing member, the defendant was under a fiduciary duty to make full disclosure of all material facts. • Citing Meinhard v. Salmon • “Moreover, because the defendant had a fiduciary relationship with the plaintiff, the disclaimers contained in the contract, upon which the defendant relies, did not relieve him of the obligation of full disclosure.”

22. Pappas v. Tzolis (2012) (p. 257) Donald J. Weidner • Plaintiff Pappas, Plaintiff Ifantopoulos and Defendant Tzolis formed and managed an LLC to enter into a long-term lease of a building. • In exchange for a proportionate share in the LLC: • Pappas contributed $50,000 (40%) • Ifantopoulos contributed $25,000 (20%) • Tzolis contributed $50,000 (40%) • Pursuant to the January 2006 Operating Agreement, Tzolis agreed to post and maintain a security deposit of $1.1 million and was permitted to sublet the building. • The Operating Agreement also provided: • Any of the three members “could engage in business ventures and investments of any nature whatsoever, whether or not in competition with the LLC, without obligation of any kind to the LLC or to the other Members.” • Should the parties be allowed to waive a duty not to compete? • Other fiduciary duties were apparently not waived in the Operating Agreement.

23. Pappas v. Tzolis (cont’d) Donald J. Weidner • Business disputes arose immediately, and 5 months later, Tzolis “took sole possession ofthe property, which was subleased by the LLC to a company he owned,” for the rent payable by the LLC plus $20,000 per month (which his company has failed to pay). • According to the two plaintiffs, Tzolis was obstructing the leasing of the building to third parties. • Just one year after formation, Tzolis purchased the membership interests of the two plaintiffs for $1,000,000 (40% interest) and $500,000 (20% interest) (20X what they paid for them). At the Closing, the three executed: • An Agreement of Assignment and Assumption; and • A Certificate in which the plaintiffs represented that, as sellers, they had “performed [their] own due diligence in connection with [the] assignments . . . engaged [their] own legal counsel, and [were] not relying on any representation by Steve Tzolis, or any of his agents or representatives, except as set forth in the assignments and other documents delivered to the undersigned Sellers today, and that “Steve Tzolis has no fiduciary duty to the undersigned Sellers in connection with [the] assignments.” Tzolis made reciprocal representations as Buyer.

24. Pappas v. Tzolis (cont’d) Donald J. Weidner 7 months after Tzolis bought out the 60% interest of two plaintiffs for a total of $1.5 million, the LLC, now owned entirely by Tzolis, assigned the lease to third party for $17.5 million. When plaintiffs learned of this, they sued Tzolis, claiming that he breached his fiduciary duty to them by failing to disclose the negotiations with the third party who bought the lease. They also claim that Tzolis “represented to them that he was aware of no reasonable prospects of selling the lease for an amount in excess of $2.5 million.” The Trial Court dismissed all the of the plaintiffs’ eleven claimed causes of action against Tzolis, citing both the Operating Agreement and the Certificate. A divided intermediate appellate court allowed four of the claims against Tzolis to move forward, and certified the question of the correctness of its decision to the N.Y. Court of Appeals.

25. Pappas v. Tzolis (cont’d) Donald J. Weidner • Claim #1: Breach of Fiduciary Duty of Disclosure. • Tzolis countered: By executing the Certificate, the plaintiffs expressly released him from all claims based on a breach of fiduciary duty. • The Certificate stated: “Tzolis has no fiduciary duty to the undersigned Sellers in connection with [the] assignments” • A much broader waiver than the permission to compete in the Operating Agreement • The court quoted from its Centro opinion: • A “sophisticated principal is able to release its fiduciary from claims—at least where . . . the fiduciary relationship is no longer one of unquestioning trust—so long as the principal understands that the fiduciary is acting in its own interest and the release is knowingly entered into.” • Here, it added: • “Where a principal and fiduciary are sophisticated entities and their relationship is not one of trust, the principal cannot reasonably rely on the fiduciary without making additional inquiry.” • “The test, in essence, is whether, given the nature of the parties’ relationship at the time of the release, the principal is aware of information about the fiduciary that would make reliance on the fiduciary unreasonable.”

26. Pappas v. Tzolis (cont’d) Donald J. Weidner • In Centro, “plaintiffs—seasoned and counseled parties negotiating the termination of their relationship—knew that defendants had not supplied them with the financial information to which they were entitled, triggering “a heightened degree of diligence.” In this context, “the principal cannot blindly trust the fiduciary’s assertions.” • Here, the defendant had been “uncooperative” and “intransigent” to the plaintiffs’ preferences with regard to the sublease. • “The relationship between plaintiffs and Tzolis had become antagonistic, to the extent that plaintiffs could no longer reasonably regard Tzolis as trustworthy. Therefore . . . the release [of all fiduciary duties] contained in the Certificate is valid, and plaintiffs cannot prevail on their cause of action alleging breach of fiduciary duty.” • “Plaintiffs were in a position to make a reasoned judgment about whether to agree to the sale of their interests to Tzolis. The need to use care to reach an independent assessment of the value of the lease should have been obvious to plaintiffs, given that Tzolis offered to buy their interests for 20 times what they had paid for them a year earlier.”

27. Pappas v. Tzolis (cont’d) Donald J. Weidner • Claim # 2: Fraud and Misrepresentation. • Plaintiffs alleged that the defendant said that he was unaware of a reasonable prospect of selling the lease for more than $2.5 million: • The court responded: • “However, in the Certificate, plaintiffs “in the plainest language announced and stipulated that [they were] not relying on any representations as to the very matter as to which [they] now claim they were defrauded.” • “Moreover, while it is true that a party that releases a fraud claim may later challenge that release as fraudulently induced if it alleges a fraud separate from any contemplated by the release, plaintiffs do not allege that the release itself was induced by any action separate from the alleged fraud consisting of Tzolis’s failure to disclose his negotiations to sell the lease.”

28. Pappas v. Tzolis (cont’d) Donald J. Weidner • Claim #3. Conversion of the Property of Plaintiffs. • There was no conversion of their property rights because they sold their interests in the LLC. • Claim #4. Unjust Enrichment. • No unjust enrichment claim will lie where the parties have entered into a contract dealing with the subject matter. Because the three documents controlled the sale of the interests in the LLC, the claim fails as a matter of law.

29. Solar Cells, Inc. v. True North Partners LLC (2002) (p. 260) Donald J. Weidner • Plaintiff Solar Cells, Inc. was an Ohio Corporation founded in 1987 by McMaster to design, develop, and manufacture processes for solar power. • Defendant True North Partners, LLC was brought in to provide needed financing. • Together, Solar Cells and True North in February of 1999 formed First Solar, LLC as a Delaware LLC to commercialize McMaster’s solar technology. • The Operating Agreement of First Solar required: • Solar Cells to contribute to First Solar patented and proprietary technology the Operating Agreement valued at $35 million. • True North to contribute to First Solar $35 million. • and to loan First Solar an additional $8 million. • In the event of liquidation, True North was to have a priority claim over any claim of Solar Cells (apparently as to debt and equity)

30. Solar Cells, Inc. v. True North Partners LLC (cont’d) Donald J. Weidner • In return for their contributions, Solar Cells and True North each received 4,500 of First Solar’s Class A [voting] membership Units. • Solar Cells also received 100% of First Solar’s Class B [nonvoting] membership Units. • First Solar’s business was conducted by 5 managers: • True North elected 3 (a majority of managers even though it did not have a majority of membership units) and managed the LLC. • Solar Cells elected 2. • After 2 years of failure to produce a marketable product, First Solar’s original funding was depleted. • In March, 2001, First Solar retained investment banker AHH to find a strategic investor. • In the interim, True North agreed to lend an additional $15 million to First Solar (almost doubling their initial $8 million loan). • True North bundled its two loans together for a $23 million commitment through Dec. 31, 2001. • Upon either receipt of outside investment or at the end of its funding commitment, True North had the option to convert some or all of its debt into Class A [voting] Units or retain its investment as a loan with liquidation preferences.

31. Solar Cells, Inc. v. True North Partners LLC (cont’d) Donald J. Weidner • Through March 2002, there were unsuccessful negotiations regarding different alternatives for financing and restructuring First Solar. • Money was projected to run out by end of April 2002. • “On March 5, 2002, True North purported to convert $250,000 of its outstanding loans to First Solar into Class A Units [giving it more than 50%] at a conversion ratio based on a January 8, 2002 AHH valuation of First Solar at $32,000,000.” • The next day, on March 6, 2002, the full Board of Managers met and the True North Managers made no mention of a merger that was being planned. • The next day, “On March 7, 2002, the True North Managers approved the challenged merger of First Solar into FSO, a Delaware LLC wholly owned by True North.” • The managers gave Solar Cells 4 days notice of the merger scheduled to close on March 11, 2002. Solar Cells sues to enjoin the merger. • “In connection with the merger, True North would convert its remaining outstanding loans into equity at the same ratio as the March 5, 2002 conversion. The merger would occur based on a total valuation of First Solar at $32 million with First Solar ownership units being exchanged for ownership units of the surviving company.”

32. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • As result of the merger-related transactions, Solar Cells went from owning 50% of the Class A units of First Solar LLC to owning only 5% of the membership units in the surviving LLC. • True North received 95% ownership in the surviving LLC, which enabled it to elect all three of its managers • As opposed to the right to elect three of the five managers of First Solar, LLC. • Solar Cells, requesting a preliminary injunction of the merger, must establish: • reasonable likelihood of success on the merits of at least 1 claim; • irreparable harm to it if injunction is denied; and • harm to it from a denial outweighs harm to True North from granting it. • Reasonable Likelihood of Success on the Merits. • Although this case in an LLC case, the court applied corporate law. • The Defendants argued that the Business Judgment Rule protected them from the burden of showing “Entire Fairness.”

33. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • There are many definitions of the “business judgment rule,” sometime within the same case, and the rule has been codified in many states. • According to one simple statement from a Delaware corporate case: • “The business judgment rule is a presumption that in making a business decision the directors of a corporation acted [1] on an informed basis, [2] in good faith, and [3] in the honest belief that the action taken was in the best interests of the company. * * * The burden is on the party challenging the decision to establish facts rebutting the presumption.” • The business judgment rule has been said to have two components • Directors are immunized from personal liability if they act in accordance with its requirements. • The courts will not intervene in management decisions. • If the presumption of the business judgment rule is overcome, the burden shifts to the directors , who must then show the transaction represented “entire fairness” to the corporation and its stockholders. • Recall the Gotham Partners case saying that entire fairness had both a procedural aspect (“fair dealing”) and a substantive aspect (“fair price”).

34. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner If the merger had been into an unrelated entity, the business judgment rule would have applied. However, the “entire fairness” standard when: (1) a majority of the directors approving the transaction are interested;or (2) if a majority shareholder stands on both sides of the transactions; or (3) if the plaintiff proves that the presumption of the applicability of the business judgment rule has been overcome for reasons other than an interested director. True North was the majority shareholder and controlled a majority of the managers. True North was on both sides of the merger, which left it better off than Solar Cells. Therefore, unless it has been contracted away, “entire fairness” is triggered. True North said that “entire fairness” had been contracted away. It argued that, in the operating agreement, Solar Cells waived any right to object to transactions on the ground that True North or its Managers were interested parties.

35. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • The Alleged Waiver of the Conflict in Operating Agreement § 4.18(a): • “Solar Cells and [First Solar] acknowledge that the True North Managers have fiduciary obligations to both [First Solar] and to True North, which fiduciary obligations may, because of the ability of the True North Managers to control [First Solar] and its business, create a conflict of interest or a potential conflict of interest for the True North Managers. Both [First Solar] and Solar Cells hereby waive any such conflict of interest or potential conflict of interestandagree that neither True North nor any True North Manager shall have any liability to [First Solar] or to Solar Cells with respect to any such conflict of interest . . . provided that the True North Managers have acted in a manner which they believe in good faith to be in the best interest of [First Solar].” • True North said it only had to meet “good faith belief in best interests” standard. • The court disagreed, saying this language is no bar to imposing the entire fairness standard because the provision only limits “liability stemming from any conflict of interest.” Here the case is only about enjoining the transaction. • Furthermore: “Even if waiver of liability for engaging in conflicting interest transactions is contracted for, that does not mean that there is a wavier of all fiduciary duties to Solar Cells. Indeed, § 4.18(a) expressly states that the True North Managers must act ‘in good faith.’”

36. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • Solar Cells complained that, when the full Board of Managers met, the True North Managers made no mention of the merger they were to approve the next day. • The True North managers said they did everything in accordance with the agreement, they were a majority of the managers and they had a right to act without a meeting. • The True North Managers made no effort to inform the Solar Cell Managers that the action was contemplated, or imminent, at the March 6 meeting. At the earliest, the Solar Cell Managers received notice of the merger as a fait accompli by fax two days later and only a week before it was to be consummated. • “These actions do not appear to be those of fiduciaries acting in good faith. . . . [I]t is not an unassailable defense to say that what was done was in technical compliance with the law. The facts . . . make in likely . . . that the defendants would be required to show the entire fairness of the proposed merger.” • Because the managers were hiding something, they must establish “entire fairness”

37. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • The party with the burden of establishing entire fairness (the True North Managers) must prove both: • Fair Dealing—”pertains to the process by which the transaction was approved and looks at the terms, structure, and timing of the transaction.” • Fair Price—includes all relevant factors “relating to the economic and financial considerations of the proposed merger.” • As to the Fair Dealing [process] aspect of Entire Fairness. • There was no negotiating at all on the terms of the merger. Both the decision on the merger and its approval were made unilaterally by True North through its representative managers. • No advance notice was given of the merger. • The fiduciary does not have free rein to approve any transaction he sees fit regardless of impact upon those to whom he has a fiduciary duty, even though the Operating Agreement permitted action by written consent of a majority of Managers and permitted interested transactions free from personal liability of Managers.

38. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • A. The Fair Dealing [process] aspect of entire fairness (cont’d) • The defendants say the exigencies of the situation, which included Solar Cell’s refusal to negotiate in good faith, dictated the timing of the merger. Solar Cells says this is essentially a plan they had rejected in the past, designed to increase True North’s proportionate share while squeezing out Solar Cells at an unfair price. • Several aspects of provisions supposedly for the protection of Solar Cells are illusory. • They are left with a vote, but it is a 5% vote replacing a 50% vote. • The “market reset” provision raising Solar Cell’s interest in the new entity if third-party financing is obtained in 2002 is “arguably illusory.” True North would be in a position to prevent or delay that financing and would have incentive to do so, as would the third party. • The ability of Solar Cells to invest money on in the surviving entity on the same terms as True North “hardly remedies the harm suffered” as a result of the initial dilution of its interest caused by the merger.

39. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • B. The Fair Price [substantive] Aspect of Entire Fairness. • Solar Cells alleges that True North manipulated the valuation of First Solar in order to advantage itself. When True North wanted to become a buyer of First Solar, it unilaterally caused AHH to create a flawed evaluation that “is less than one-third of the value calculated by AHH only five months earlier.” • True North defends the $32 million January 2002 valuation • Court: there is a reasonable probability that valuation will not be found to be “entirely fair.” • It was a “quick and dirty” analysis based on only one methodology. • Earlier valuations had been based on 3 methodologies and had resulted in valuations ranging from $103 million in August 2001 to $72 million in November 2001 (almost 2x-3x the January 2002 valuation) • It used only a “discounted cash flow” analysis and failed to employ any other method of valuation as a “crosscheck”. • It used a “much lower exit multiple (a 6.9 x free cash flow terminal-year multiple) than did earlier valuation formulae (which used an 11 x free cash flow) terminal year multiple), with no apparent rationale for that lower multiple.” • An exit multiple refers to the terminal multiple at which any given project will be exited. In discounted cash flow using the terminal value methodology, exit multiples are used to obtain a terminal value for the company. Comparable acquisitions should indicate a range of appropriate multiples. • It used a much higher discount rate (35%) than it had used in valuations it performed only a few months earlier (30%).

40. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • “Judicial determinations of fair price in an entire fairness analysis are difficult even after a full trial on the merits.” • Nevertheless, there is a “reasonable likelihood” that the $32 million valuation will not be a fair price because of the recent much higher valuations. • Irreparable Harm. In order to show irreparable harm, the injury must be such that money damages are not an adequate remedy. • Solar Cells argues that it will be harmed irreparably by the dilution of its equity position and voting power. Dilution is not the sole claim of irreparable harm, although the dilution is quite signigicant: a reduction from 50% voting power to 5% voting power. • Solar Cells loses its place at the surviving entity’s new table of only three Managers, all elected by True North. • It is no defense to that concern to say, as True North did, that it controlled the Board of Managers with its 60% vote. “The right to participate in a management group is a valuable right whether or not that participation includes control of the group.” • Damages may be an inadequate remedy because accurately valuing this two-member LLC “may not be possible, as evidenced by the vastly different valuations the parties ascribe to First Solar.” • The possibility of a third-party investor coming on board, allegedly one of the purposes behind the merger, makes interim relief even more important.

41. Solar Cells, Inc. v. True N. Partners LLC (cont’d) Donald J. Weidner • Balance of the Equities. • In contrast to the irreparable harm Solar Cells asserts the merger will cause, the defendants say that, if it is enjoined, First Solar “will run out of money” in days “and will be forced to close down and terminate its employees and liquidate assets in the undesirable setting of a forced sale.” • Court is unpersuaded that True North would let First Solar shut down and liquidate rather than protect its investment for the short period necessary to reach a final judgment in the matter. • Solar Cells indicates that McMaster (the founder of Solar Cells), under the right terms, would be willing to make financing available to First Solar. • The harm to the plaintiff if the injunction is denied must be balanced against the harm to the defendant if it is granted. Even assuming there were no additional infusions, the forced liquidation “is not a harm that would fall solely on the defendants.” Indeed, defendant True North would be entitled, on liquidation, to a priority repayment of its original $35 million capital contribution. • In short, the denial of the injunction results in irreparable harm that would fall solely on the plaintiff whereas the grant of the injunction raises a risk that would be shared by the plaintiff and the defendants and perhaps be borne more heavily by plaintiffs.

42. VGS, Inc. v. Castiel (2000) (p. 267) Donald J. Weidner • The two natural persons involved in this case are founder David Castiel and Peter Sahagan (“an aggressive and apparently successful venture capitalist”). • In general, in “venture capital,” you start with people. In “private equity,” you usually start with an existing company with products and cash flow, and try to restructure it to maximize performance. • Castiel founded Virtual Geosatellite, LLC (“LLC”) on January 6, 1999, to pursue an FCC license to build and operate a satellite system. • The LLC originally had only one member, “Holdings,” a corporation that Castiel controls. Holdings came to have only 63.46% of the total LLC equity. • Two days later, Ellipso, another corporation that Castiel controls, became the second member. Ellipso came to have 11.54% of the total LLC equity. • Several weeks later, Sahagan Satellite, an LLC that Sahagen controls, became the third member, with 25% total LLC equity. • The Operating Agreement vested management of the LLC in a Board of Managers. • “As the majority unitholder [with 75% of the total equity through his control of the two corporate members], Castiel had the power to appoint, remove, and replace two of the three members of the Board of Managers.”

43. VGS, Inc. v. Castiel (cont’d) Donald J. Weidner • “Castiel, therefore, had the power to prevent any Board decision with which he disagreed.” • Castiel named himself and Tom Quinn to the Board of Managers and Sahagen named himself as the third Board Manager. • Castiel and Sahagen had very different ideas about how the LLC should be managed and operated. Sahagen thought that Castiel was a poor manager, hurting the business, and thought he should be in charge. • Within a little more than a year, Sahagen persuaded the Castiel-appointed Board Manager Quinn that Castiel must be ousted from leadership in order for the LLC to prosper. • On April 14, 2000, 15 months after the LLC was formed, Sahagen and Quinn voted, without any notice to Castiel, to merge the LLC under Delaware Law into VGS, a Delaware corporation. • As a result, the LLC ceased to exist, its assets and liabilities passed to VGS, and VGS became the LLC’s legal successor-in-interest.

44. VGS, Inc. v. Castiel (cont’d) Donald J. Weidner The incorporators of VGS named its initial Board of Directors: Sahagen, turncoat Quinn and Neel Howard (NOT Castiel). On the day of the merger, Sahagen executed a promissory note to VGS and received in return 2 million shares of VGS Series A Preferred Stock. VGS also issued common stock to the former members of the LLC: 1,269,000 shares to Holdings (Casteel’s Corp. holding 63.46% in the LLC) , 230,800 shares of common to Ellipso (Casteel’s Corp. holding 11.54% in the LLC), and 500,000 shares to Sahagen for his 25% interest. In short founder Castiel and his two controlled member entities went from having 75% of the total units in the LLC and 2/3 of its Managing Board to having only a 25% interest in VGS, with no representation on its board of directors. Sahagen and his controlled member entity went from having a 25% interest in the LLC and 1/3 of its Managing Board to having a 62.5% interest in VGS (his percentage interest in the total number of shares of both classes of stock), initially controlling all the seats on its board of directors.

45. VGS, Inc. v. Castiel (cont’d) Donald J. Weidner • The court interpreted the Operating Agreement to dispense with the default rule that the Managing Board was required to act with unanimity in the case of a merger--a majority vote was sufficient. • The Operating Agreement specifically provided that 25% owner Sahagen’s approval is needed for a merger, consolidation, or reorganization of the LLC. • Yet he was not going to even notice the 75% owner Castiel about the merger vote. • The Operating Agreement had no similar provision requiring Castiel’s consent to a merger, presumably because his attorney thought Castiel was sufficiently protected by giving him control over the selection of a majority (2 of the 3) of the Managing Board members. • Sometimes both a belt and suspenders makes sense. • The LLC may be dissolved by written consent of either • the Board of Managers or • by Members owning 2/3 of the Common Units. “It seems unlikely” that the Managers would be required to act with unanimity given that Members holding only 2/3 of the units could dissolve.

46. VGS, Inc. v. Castiel (cont’d) Donald J. Weidner • Del. LLC § 18-404(d) states as a default rule that managers can act without a meeting and without a vote if written consents are signed by the managers who have the number of votes necessary to act. • The court accepted that the statute, “read literally,” does not require notice to Castiel before Sahagan and Quinn [the other two managers] could act by written consent.” • However, the other two managers knew that if they had notified Castiel of what they planned to do, Castiel would have removed Quinn and blocked the planned action. • As the LLC’s controlling owner under the Agreement, Castiel had the right, for any motivation, to remove a Managing Board Member that he had appointed. • Therefore, it was technically permissible for Sahagan and Quinn, as a majority of the Board, to act without a meeting.

47. VGS, Inc. v. Castiel (cont’d) Donald J. Weidner • However, the court said that § 404(d) was never intended “to enable two managers to deprive, clandestinely and surreptitiously, a third manager representing the majority interest in the LLC of an opportunity to protect that interest by taking an action that the third manager’s member would surely have opposed if he had knowledge of it.” • The third manager was representing “the majority interest in the LLC” • “Nothing in the statute suggests that this court of equity should blind its eyes to a shallow, too clever by half, manipulative attempt to restructure an enterprise through an action taken by a ‘majority’ that existed only so long as it could act in secrecy.” • “Sahagen and Quinn each owed a duty of loyalty to the LLC, its investors and Castiel, their fellow manager. Castiel or his entities owned a majority interest in the LLC and he sat as a member of the board representing entities and interests empowered by the Agreement to control the majority membership of the board.”

48. VGS, Inc. v. Castiel (cont’d) Donald J. Weidner • Note that Castiel could have drafted the agreement differently: • “The majority investor protected his equity interest in the LLC through the mechanism of appointment to the board rather than by the statutorily sanctioned mechanism of approval by members owning a majority of the LLC’s equity interests.” • Court suggests it seems “somewhat incongruous” to allow a simple majority vote of the Board to approve “the action to merge, dissolve or change to corporate status” against the wishes of a majority of the equity interest. • Here, the drafters made “the critical assumption” that the right to appoint two of the three managers guaranteed control over the board. • “When Shagen and Quinn, fully recognizing that this was Castiel’s protection against actions adverse to his interest, acted in secret, without notice, they failed to discharge their duty of loyalty to him in good faith. They owed Castiel a duty to give him prior notice even if he would have interfered with a plan that they conscientiously believed to be in the best interests of the LLC.” • In effect, the Agreement gave him a tool and they secretly took it away.

49. VGS, Inc. v. Castiel (cont’d) Donald J. Weidner • The parties argued over the standard to be applied to the actions taken by Sahagen and Quinn. • Sahagen and Quinn argued for the Business Judgment Rule and Castiel argued for the Entire Fairness Standard. • The court said the Business Judgment Rule was unavailable to benefit or protect Shagen and Quinn because their actions as managers breached their duty of loyalty. • They “intentionally used a flawed process to merge the LLC onto VGS, Inc., in an attempt to prevent the member with a majority equity interest in the LLC to protect himself in the manner anticipated” by the LLC Agreement. • Note: Quinn was an “allegedly disinterested and independent member” • Further analysis, even under the Entire Fairness standard, was not necessary • Presumably because there was no procedural fairness. • Therefore, the court ordered the merger rescinded.

50. Racing Inv. Fund 2000, LLC v. Clay Ward Agency, Inc. (2010) Donald J. Weidner • The LLC Operating Agreement contained a “capital call” provision that obligated the members “to contribute to the capital of the Company, on a prorated basis in accordance with their respective Percentage Interests, such amounts as may be reasonably deemed advisable by the Manager from time to time in order to pay operating, administrative, or other business expenses of the Company . . . .” • The LLC became insolvent and a creditor argued that this provision made individual members liable for the debts of the LLC. The trial court apparently granted relief to the creditor. Denied: • The provision does require members to contribute additional capital as reasonably deemed advisable by the Manager. The Manager could have made a capital call for the amounts owed to this creditor. However, the provision is “a not-uncommon, on-going capital infusion provision, not a valid debt-collection mechanism by which a court can order a capital call and, by so doing, impose personal liability on the LLC’s members for the entity’s outstanding debt.”