Nathaniel Stuhlmiller, Richards, Layton & Finger

In two opinions decided in February 2018, CompoSecure v. CardUX, (Del. Ch. Feb. 1, 2018, revised Feb. 12, 2018), and In re Oxbow Carbon Unitholder Litigation, (Del. Ch. Feb. 12, 2018), the Delaware Court of Chancery held that certain actions were not ultra vires under the limited liability company agreements at issue and were thus capable of ratification under Delaware common law. On appeal, the Delaware Supreme Court subsequently reversed the lower court decision in CompoSecure and cited the lower court's ratification decision in Oxbow approvingly. The decisions in CompoSecure and Oxbow seemingly turned on a narrow issue: whether or not the limited liability company agreement expressly provided that an action not taken in compliance with its terms was “void.” When read together, these decisions highlight the powerful effect, and potentially unintended consequences, of using a “void” provision in the governing documents of Delaware alternative entities.

CompoSecure involved a contractual dispute arising out of CompoSecure's agreement to pay CardUX, an affiliate of one of CompoSecure's managers, a commission on certain sales of its metal credit card products. CompoSecure's limited liability company agreement contained two provisions that allegedly were not complied with when CompoSecure entered into the agreement. The first provision, the “Related Party Provision,” required special approval for transactions between CompoSecure and related parties, such as CardUX; the second, the “restricted activities provision,” provided that certain activities would be “void and of no force or effect whatsoever” if they did not receive certain prior board and member approvals.

CompoSecure filed suit in the Court of Chancery, arguing that despite performing under the sales agreement for a time, the agreement was void because CompoSecure had not obtained the necessary approvals under the related party provision and the restricted activities provision. The Court of Chancery disagreed, holding that CompoSecure's failure to comply with its own limited liability company agreement at most rendered the agreement voidable and that CompoSecure had effectively ratified the contract by performance. The Court of Chancery's analysis focused primarily on the related party provision, but it indicated that it would have reached the same result under the restricted activities provision, assuming that it applied.

In CompoSecure v. CardUX, (Del. Nov. 7, 2018), the Supreme Court agreed with the Court of Chancery's analysis with respect to the related party provision, but ultimately reversed and remanded the case for further consideration as to whether the restricted activities provision applied to the contract. The Supreme Court distinguished the two provisions on the basis that the restricted activities provision included express language not found in the related party provision, specifically that acts subject to the provision would be “void” if the necessary approvals were not obtained. The Supreme Court stated that ordinarily a contract would be voidable for failing to comply with a contractual provision, but the use of the term “void” in the restricted activities provision was a “game-changer” that would trump the common law rule and render the sales agreement void and incapable of being ratified by CompoSecure's subsequent performance if it applied.

Oxbow involved a dispute between the members of Oxbow Carbon regarding, among other things, whether certain members had been properly admitted in accordance with Oxbow's limited liability company agreement. The Court of Chancery held that, even assuming for purposes of its analysis that the proper procedures had not been followed to admit the members, the plaintiffs were barred by laches from challenging the admission of the members in question because the relevant parties had notice of their purported admission and treated them as valid members for years. Notably, the Court of Chancery also based its decision, in part, on the fact that the admission provision did not require that admissions not in accordance with the provision would be “void.” In Oxbow Carbon & Minerals Holdings v. Crestview-Oxbow Acquisition, (Del. Jan. 17, 2019), the Supreme Court did not directly address the admission issue, but did cite approvingly the Court of Chancery's “well-reasoned analysis” of the laches issue, which in turn had been predicated on the Court of Chancery's finding that the admission of the members was at most voidable and not void.

The Court of Chancery in Oxbow indicated that “when dealing with LLCs, Delaware courts have not approached membership determinations with the same strict eye for formalities” as they have when analyzing the validity of stock issuances by a Delaware corporation. Despite indications to the contrary in Oxbow, it seems clear from the Supreme Court's opinion in CompoSecure that Delaware courts may require strict adherence to such formalities even in the alternative entities context where the limited liability company agreement expressly provides that actions not taken in accordance therewith are “void.”

While these cases could be viewed as merely examples of holding the parties to the terms of their agreement, liberal use of “void” provisions in a limited liability company agreement could lead to unintended consequences and harsh results. For example, if the limited liability company agreement in Oxbow had included a “void” provision with respect to member admissions, then the Delaware courts, in keeping with the Supreme Court's reasoning in CompoSecure, may have been required to unwind years of transactions and distributions made by Oxbow to those that had reasonably believed that they were in fact members. Indeed, in the absence of an effective means to ratify acts subject to a “void” provision (even by court order), Delaware courts may in the future be in the unenviable position of invalidating acts in the alternative entities context even where doing so would lead to inequitable results.

The Delaware legislature has adopted Sections 204 and 205 of the General Corporation Law of the State of Delaware to provide Delaware corporations and other adversely effected parties with a statutory means to ratify defective corporate acts that would otherwise be void under Delaware law. But no such statutory “fix” is currently available for Delaware alternative entities. As a result, alternative entities should carefully consider whether to include provisions declaring actions “void” in their limited liability company agreements, and should be aware of the risk that the failure to strictly adhere to such a provision could result in a defective act that cannot be properly ratified under current Delaware law.

Nathaniel J. Stuhlmiller ([email protected]) is an associate at Richards, Layton & Finger. He focuses his practice on transactional matters involving Delaware corporations, including mergers and acquisitions, corporate governance and corporate finance.