OXBOW CARBON & MINERALS HOLDINGS, INC., INGRAHAM INVESTMENTS LLC, OXBOW CARBON INVESTMENT COMPANY LLC, WILLIAM I. KOCH, and OXBOW CARBON LLC, Plaintiffs and Counterclaim Defendants-Below, Appellants, v. CRESTVIEW-OXBOW ACQUISITION, LLC, CRESTVIEW-OXBOW (ERISA) ACQUISITION, LLC, CRESTVIEW PARTNERS, L.P., CRESTVIEW PARTNERS GP, L.P., CRESTVIEW ADVISORS, L.L.C., and LOAD LINE CAPITAL LLC, Defendants and Counterclaim Plaintiffs-Below, Appellees.
No. 536, 2018
IN THE SUPREME COURT OF THE STATE OF DELAWARE
January 17, 2019
Submitted: December 19, 2018; Court below: Court of Chancery of the State of Delaware, C.A. Nos. 12447-VCL, 12509-VCL
Before STRINE, Chief Justice; VALIHURA, VAUGHN, SEITZ and TRAYNOR, Justices, constituting the Court en Banc.
Upon appeal from the Court of Chancery. AFFIRMED in part and REVERSED in part.
Stephen C. Norman, Esquire, Jaclyn C. Levy, Esquire, Potter Anderson & Corroon LLP, Wilmington, Delaware. Of Counsel: David B. Hennes, Esquire (argued), C. Thomas Brown, Esquire, Adam M. Harris, Esquire, Elizabeth D. Johnston, Esquire, Ropes & Gray LLP, New York, New York for Appellants Oxbow Carbon & Minerals Holdings, Inc., Ingraham Investments LLC, William I. Koch and Oxbow Carbon Investment Company LLC.
Kenneth J. Nachbar, Esquire, Thomas W. Briggs, Jr., Esquire, Richard Li, Esquire, Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware. Of Counsel: R. Robert Popeo, Esquire, Michael S. Gardener, Esquire, Breton Leone-Quick, Esquire, Mintz, Levin, Cohn, Ferris, Glovsky & Popeo, P.C., Boston, Massachusetts for Appellants Oxbow Carbon LLC.
Kevin G. Abrams, Esquire, Michael A. Barlow, Esquire, April M. Kirby, Esquire, Abrams & Bayliss LLP, Wilmington,
J. Clayton Athey, Esquire, John G. Day, Esquire, Prickett, Jones & Elliott, P.A., Wilmington, Delaware. Of Counsel: Dale C. Christensen, Jr., Esquire, Michael B. Weitman, Esquire, Seward & Kissel, LLP, New York, New York for Appellee Load Line Capital LLC.
VALIHURA, Justice:
Two of Oxbow Carbon LLC‘s (“Oxbow“) minority Members—Crestview Partners, L.P. and Load Line Capital LLC (together, the “Minority Members“)—have attempted to force a sale of Oxbow over the objection of Oxbow‘s majority Members, William I. Koch and his affiliates (the “Koch Parties“).1 This dispute centers on the proper interpretation of the governing Third Amended and Restated Limited Liability Company Agreement (the “LLC Agreement“). Although the Court of Chancery found that the minority investors affiliated with Koch—Ingraham Investments LLC and Oxbow Carbon Investment Company LLC (collectively, the “Small Holders“)—could block the sale unless it met certain payment conditions, the court nonetheless found a contractual gap in the LLC Agreement because the Board did not specify the terms and conditions under which the Small Holders acquired their units. Using the implied covenant of good faith and fair dealing, the Court of Chancery filled that gap by implying a “Top-Off” option for the Small Holders’ units, effectively stripping them of the right to block the proposed transaction.
On appeal, Oxbow claims that (1) the trial court improperly applied the implied covenant, (2) there was no contractual gap, (3) Oxbow did not breach the LLC Agreement, and (4) the court‘s rulings on remedies are erroneous. We hold that the Court of Chancery correctly interpreted the LLC Agreement‘s plain language, but erred by finding a contractual gap concerning the admission of the Small Holders. Thus, we AFFIRM in part and REVERSE in part the Court of Chancery‘s February 12, 2018, decision, and VACATE the August 1, 2018, decision on remedies.
I. Background Facts2
Oxbow, the leading third-party provider of marketing and logistics services to the global petcoke market, is a Delaware LLC controlled by William I. Koch through Oxbow Carbon & Minerals Holdings, Inc. (“Oxbow Holdings“).3 Koch serves as Oxbow‘s CEO and Chairman of the Board. To finance two possible acquisitions in 2006, Oxbow explored investment by outside private equity firms. Crestview, a new firm
The LLC Agreement was executed on May 8, 2007.6 Oxbow Holdings made the largest capital contribution of $483,038,499.86 in return for 4,830,385 units—almost 60% of Oxbow‘s equity—and the right to appoint six Board members. Several of Koch‘s family
members and affiliates also invested, which meant that Koch and his affiliates owned a combined 67% of Oxbow‘s equity. Crestview made a capital contribution of $190 million and received nearly 1.9 million units—a 23.48% equity stake—and appointed Hurst and Volpert to the Oxbow Board. Coumantaros made a capital contribution of $75 million through Load Line Capital LLC (“Load Line“) in return for 750,000 units, representing 9.27% of Oxbow‘s equity. Load Line was entitled to one Board appointment and appointed Coumantaros to Oxbow‘s Board. Additionally, the Minority Members received a put option that could be exercised after seven years, beginning May 8, 2014 (the “Put Right“). If Oxbow rejected the put, the party exercising the Put Right could attempt to force an “Exit Sale” of all of Oxbow‘s units.
In the fall of 2010, Oxbow pursued an acquisition of International Commodities Export Corporation, a large sulfur-trading business. As a part of the acquisition, Oxbow allowed the sulfur company executives to purchase equity in Oxbow. Around the same time, Koch proposed to the Board that members of his family have an opportunity to simultaneously invest in Oxbow with the sulfur company executives. On April 28, 2011, the Board—including the Minority Members’ representatives—voted unanimously to issue units to Koch‘s family members and the sulfur company executives at $300 per unit. Koch‘s family members invested through Ingraham Investments LLC (“Family LLC“), and the sulfur company executives invested through Oxbow Carbon Investment Company LLC (“Executive LLC“). Koch has controlled Family LLC from its inception, and he is the sole manager of Executive LLC‘s managing member.
The Board did not immediately implement the transactions, however, as there were other details to sort out with the sulfur company executives. During that time, Oxbow‘s then-CFO, Zach Shipley, alerted Koch and Oxbow‘s corporate secretary to certain procedural requirements in the LLC Agreement that the Board did not follow in its April 28, 2011, vote. In an email, Shipley wrote:
In the context of [Oxbow] selling new equity to members of Bill‘s family, it has been drawn to my attention that the
Operating Agreement of [Oxbow] gives all members certain rights of participation in any equity [issuance] by the Company. . . . I don‘t think this will have a practical effect on the ultimate outcome of the equity sales to Bill‘s family, but it does present a procedural requirement. Basically, we have to offer equity to all members at $300 per unit. . . . I expect that, at $300/unit, no one but the intended buyers will buy additional equity, but if they do, maybe that is a good thing. [T]his does raise a question about whether we need to get a slightly different approval from the Board.7
The issuance of units to Koch‘s family members also implicated Article III, Section 3(d)(11) of the LLC Agreement (the “Related Party Provision“), which triggers the need for a “Supermajority Vote,” defined as approval from a majority of the Board, which approval had to include the Load Line director and at least one Crestview director. Oxbow did not get any additional approvals from the Board for the issuance to Koch‘s family members. Further, the court found that the Small Holders did not provide Oxbow with the required signature pages and representations and warranties until 2016.
The Board reevaluated its earlier approval of the issuance of new units to Executive LLC on November 9, 2011, and raised the total number of units to be issued without
changing the price. But the Board failed to address the issue of preemptive rights or otherwise comply with the requirements for admitting new Members.8 Nevertheless, Oxbow issued 66,667 units to Family LLC for $20 million on December 23, 2011, and issued 50,000 units to Executive LLC on March 12, 2012, for $15 million. Following those investments, the Small Holders owned a combined 1.4% of Oxbow‘s equity. And as with the Board vote in April 2011, the Minority Members’ Board representatives consented in 2012 to the distribution of funds from the Small Holders’ investment.9 Crestview believed it was giving the Small Holders “a great discount,” and Crestview received about $8.2 million from these 2012 distributions.10
As Crestview explored an exit from Oxbow around the time the Small Holders were admitted, Morgan Stanley was advising Oxbow and Crestview that Oxbow‘s units could be publicly offered at around $400 per unit and that the stock would trade up to around $500 per unit. The LLC Agreement provided Crestview with an option to exit Oxbow via the Put Right beginning on May 8, 2014, the seventh anniversary of the effective date of its investment. Alternatively, if the put failed, Crestview could force an Exit Sale of all
Oxbow‘s units under certain conditions. One of
By 2013, Koch had become concerned that Crestview was focused on achieving liquidity for its investment. In response to this concern, Crestview agreed to postpone the date by which it could exercise its Put Right for Oxbow to buy its units, or, in the event Oxbow rejected the Put Right, its right to force an Exit Sale. Crestview and Oxbow amended the LLC Agreement to incorporate this postponement, which they repeated three times before litigation commenced.12 In February 2014, with the Minority Members’ seven-year holding period coming to an end, the parties negotiated Amendment No. 3. The amendment, negotiated after the Small Holders invested, addressed the Exit Sale Right. Notably, the Minority Members did not bargain for a change to the “all, but not less than
all”13 language in the definition of “Exit Sale,” even though the parties removed that limitation for the Minority Members’ Put Right.14
With an Exit Sale looming, Oxbow searched for replacement capital to redeem Crestview‘s units. During that process, Christina O‘Donnell became a key player. O‘Donnell had begun working with Koch as a consultant to his family office, Renegade Management, Inc., where she performed well and gained Koch‘s trust. In 2014, Koch elevated O‘Donnell to become a member of Oxbow‘s Board and CEO of Renegade Management. She also served as the president of Family LLC and Vice President of Oxbow Holdings. These positions gave O‘Donnell significant oversight responsibility of Koch‘s financial holdings.
In the midst of a “management crisis” in December 2014 and early 2015, however, O‘Donnell developed close relationships with Eric Johnson, Oxbow‘s President, and Volpert and Hurst. Johnson was at odds with Koch and felt indebted to Crestview following his promotion to President of Oxbow. Eventually, O‘Donnell, Johnson, Volpert, and Hurst concluded that Koch should step down from Oxbow‘s leadership. They evaluated several options, including
empowering Johnson to run Oxbow, or bringing in an outside investor to purchase enough of Koch‘s units to give Crestview and the new investor a majority stake. When they attempted to convince Koch to take a leave of absence to address personal matters, Koch viewed their suggestion as an attempt to undermine his control.
Amid the heightening tension between Oxbow and Crestview, Koch instructed O‘Donnell to run the capital-raising process necessary to purchase some or all of Crestview‘s units. Koch also informed O‘Donnell that he did not want Crestview involved in that process. O‘Donnell disregarded that instruction and continued working with Crestview to find outside investors in an effort to remove Koch. O‘Donnell and Crestview communicated secretly, using private email accounts, texts, and phone calls. They also reported to potential investors that Koch would transition the CEO role to Johnson and sell enough equity to give up control of Oxbow—even though Koch had committed to do neither. As a result of their efforts, Oxbow received proposed term sheets from ArcLight, Energy Capital Partners, and Trilantic Capital Partners.
Koch disliked the proposed term sheets because he thought they threatened his control of Oxbow. At O‘Donnell‘s suggestion, Koch sought legal counsel and hired Mintz, Levin, Cohen, Ferris, Glovsky & Popeo, P.C. (“Mintz Levin“) to advise him personally. Koch conferred with Mintz Levin and confirmed that the proposed term sheets would be disastrous for his control over Oxbow. Meanwhile, O‘Donnell and Crestview attempted to promote a transaction with one of the three private equity firms, which would result in Koch giving up control in favor of Johnson. Koch and Mintz Levin concluded from these efforts “that O‘Donnell, Johnson, and Crestview were trying to use the capital raise to stage
a coup.”15 Despite his feeling that O‘Donnell had betrayed him, Koch opted to keep her at Oxbow.
Koch proceeded to take control of the capital-raising process, and, in June 2015, he informed the Board that Crestview‘s interests were at odds with Oxbow‘s interests. He further informed O‘Donnell and Johnson that they could no longer be involved in the process. Crestview exercised its Put Right on September 28, 2015, and demanded that Oxbow purchase all of its units.16 Oxbow had until January 19, 2016, to accept the put and acquire the Minority Members’ units. If it did not, Crestview could attempt to force an Exit Sale. Per the LLC Agreement, Oxbow Holdings sought to hire an investment banker and eventually retained Evercore Group L.L.C. (“Evercore“) to conduct a valuation of Oxbow. If Evercore‘s valuation was within ten percent of the figure calculated by Crestview‘s investment banker, Duff & Phelps, LLC, the fair market value for purposes of the Put Right would be the average of the two. Otherwise, the parties would retain a third investment bank and the median of the three valuations would control.
Meanwhile, Oxbow retained Goldman Sachs in October 2015 to raise capital capable of satisfying the put. None of the offers solicited by Goldman exceeded $120 per unit for a minority stake. The trial court found some evidence that the offers could have been low because of Crestview‘s attempt to influence this process. For example,
into a control deal with the bidder.17 O‘Donnell and Johnson continued to secretly communicate with Crestview and held private meetings with possible bidders, including Trilantic and ArcLight.
During the valuation and bidding process, legal counsel for Koch and Oxbow explored ways to handle the put. Aside from Oxbow‘s preferred option—raising capital to accept the put, thereby nixing any Exit Sale—the attorneys for Koch and Oxbow proposed three options: (1) negotiate a reduced redemption amount with the Minority Members; (2) reject or ignore the put and permit Crestview to exercise its right to an Exit Sale, but then dispute the validity of the Exit Sale because the Small Holders did not satisfy the 1.5x Clause; or (3) accept the put and take the position that Oxbow only had the ability to redeem units periodically over time. Koch‘s advisors also proposed going public or merging with a public shell company, which would eliminate the Minority Members’ ability to exercise the Put Right. However, Evercore advised that there was no time to conduct an IPO.
In November 2015, Evercore submitted its fair market valuation of Oxbow at $145 per unit—far lower than the Minority Members’ valuation of $256.56. Because the
valuations differed by more than ten percent, the parties hired Moelis & Company, which advised that the fair market value of Oxbow was $169 per unit. As the median of the three valuations, this figure set the fair market value for the Put Right. The directors appointed by Oxbow Holdings unanimously rejected the put on January 19, 2016, and Koch instructed Oxbow and its counsel to “obstruct [and] derail” the Exit Sale.18
Crestview exercised its right to an Exit Sale on January 20, 2016. To kick off the Exit Sale process, Oxbow began looking for an investment bank to conduct the sale. Crestview had a strong preference for Goldman Sachs and, behind the scenes, Hurst, Volpert, Johnson, and O‘Donnell discussed how to convince Koch to hire Goldman. O‘Donnell, who now had been sidelined by Koch, emailed Johnson, saying:
Let‘s take [Koch‘s] company from him quickly, not a day of relief, put him through the hell he put us through, let‘s find $30 million of cost savings if he‘s not running it. Let‘s make it very personal, just like he did.
Let‘s remind him we know things about him as well. Let‘s take his plane, his job,
and when it‘s over let‘s drink his wine before you take me dancing.19
Oxbow eventually hired Goldman Sachs, but Johnson and O‘Donnell suggested that Crestview adopt “the ambush approach” and act as though they had little interest in selling, and then once Oxbow hired Goldman, they would “sell hard.”20 On March 16, 2016,
ArcLight sent Oxbow, Crestview, and Load Line a letter of intent to acquire one-hundred percent of Oxbow‘s equity for $176.59 per unit.
On June 10, 2016, the Koch Parties filed suit against the Minority Members, Hurst, and Volpert, primarily seeking a declaratory judgment that its interpretation of the LLC Agreement was correct and that the Small Holders could block the Exit Sale. After Koch initiated this litigation and fired Johnson, ArcLight dropped out, not wanting to buy into a pending lawsuit. When the Minority Members asserted counterclaims and sought a declaratory judgment to enforce their interpretation of the LLC Agreement, the Koch Parties filed a separate 144-page complaint against Crestview, Volpert, Hurst, O‘Donnell, and Johnson, asserting additional claims of contractual and fiduciary breaches. The Court of Chancery consolidated the actions and the parties cross-moved for summary judgment.
In its summary judgment opinion, the Court of Chancery suggested that the Minority Members essentially made a “fairly litigable” implied covenant argument:
The Minority Members stress that the 1.5x Return Clause would be satisfied except for the Small Holders. They argue with some force that given the overall structure of the agreement and the concept of the Exit Sale, they never would have agreed that investors with a stake as small as the Small Holders’ would be able to block the operation of the Exit Sale Right. That is an implied covenant argument, and it is fairly litigable. One can posit that in the original bargaining position, had the current situation been discussed, then the Minority Members would have insisted on the ability to compensate the Small Holders separately, rather than lose the efficacy of the threat that put teeth into the Put Right. It is also true that the Company, [Oxbow Holdings], and Koch did not historically act as if the Small Holders were an impediment to the Exit Sale Right. But the current cross-motions for summary judgment are not about the implied covenant. They are about the plain language of the Exit Sale Right, which is contrary to the Minority Members’ position.21
Although it had raised the implied covenant sua sponte, the court held in its summary judgment order that the “Highest Amount Interpretation” controlled. Under the Highest Amount Interpretation, to initiate an Exit Sale, each Oxbow Member must participate and receive 1.5 times its initial investment by pro rata distribution, resulting in equal consideration for each Member. The trial court rejected Crestview‘s primary interpretation—the “Leave Behind Theory“—which would allow Crestview to force an Exit Sale of all Members who met the 1.5x Clause through pro rata distribution of Exit Sale proceeds, while leaving behind Members who did not satisfy the 1.5x Clause.
Heeding the court‘s suggestion, the Minority Members amended their counterclaims and added a count for breach of the
Small Holders’ Rights Gap Theory, argued only the Top-Off Gap Theory, and claimed that the gap should be filled with a Top-Off payment.
The parties proceeded through discovery and to trial in July 2017. The Court of Chancery held that the Highest Amount Interpretation was the only reasonable reading of the LLC Agreement based on its plain language, but it ruled in favor of the Minority Members on the basis of the Small Holders’ Rights Gap implied covenant theory. As explained more fully below, the trial court found a contractual “gap” concerning the Small Holders’ admission. After finding a gap, the court used the implied covenant to allow the Minority Members to satisfy the Small Holders’ 1.5x threshold using a Seller Top-Off, thereby allowing for an Exit Sale. On October 10, 2018, the Koch Parties appealed to this Court and the parties submitted a Joint Motion for Expedited Proceedings, which this Court granted on October 25, 2018.
II. Key Terms of the LLC Agreement
The terms central to this dispute concern the admission of the Small Holders and the provisions impacting the Exit Sale process. Under Article IV, Section 5 of the LLC Agreement, Oxbow‘s Board possesses the power to admit new Members (the “New Member Provision“). That section provides:
Section 5. Additional Members. Subject to Article XIII, Section 5, upon the approval of the Directors, additional Persons may be admitted to the Company as Members and Units may be created and issued to such Persons as determined by the Directors on such terms and conditions as the Directors may determine at the time of admission. The terms of admission may provide for the creation of different classes or series of Units having different rights, powers and duties. As a condition to being admitted as a Member of the Company, any Person must agree to be bound by the terms of this Agreement by executing and delivering a counterpart signature page to this Agreement,
and make the representations and warranties set forth in Section 7 below as of the date of such Person‘s admission to the Company. The address, Percentage Interest and Capital Contribution of each such additional Member shall be added to Exhibit A, which shall thereby be amended.23
”Member” or ”Members” means any Person named as a member of the Company on Exhibit A attached hereto and includes any Person subsequently admitted as a Member.24
The admission of additional Members requires certain formalities. Article XIII, Section 5(a) of the LLC Agreement (the “Preemptive Rights Provision“) states: “Subject to the terms and conditions of this Section 5, each Member will have the right to purchase its ‘pro rata share’ of any Equity Securities (as defined below) that the Company may, from time to time, propose to issue and sell after the Effective Date. . . .”25 The remainder of Section 5 contains additional procedural requirements regarding the issuance of new equity securities. Most notably, Section 5(b) requires written notice concerning new equity issuances:
(b) Exercise of Rights. If the Company proposes to issue Equity Securities, the Company will give each Member written notice of its intention, describing the Equity Securities and the price and terms and conditions upon which such Equity Securities are to be issued and/or sold. Such Member will have 20 calendar days from its receipt of such notice to elect to purchase up to its pro rata share of the Equity Securities for the price and upon the terms and conditions specified in the notice by providing written notice to the Company which include the quantity of Equity Securities to be purchased. Notwithstanding the foregoing, the Company will not be required to offer or
sell such Equity Securities to such Member if such action would result in any of the consequences set forth in Article XIII, Section 2(a)–(e).26
Additionally, certain related-party transactions are prohibited absent supermajority approval by the Board under the Related Party Provision:
(d) Except as contemplated in an Approved Summary Annual Budget, the Company shall not take, and shall cause its Subsidiaries not to take, any of the following actions without a Supermajority Vote (provided, that the consent of the Crestview Directors (only one of which shall be required to consent) and the Load Line Director shall not be unreasonably withheld, delayed or conditioned in any event):
. . .
(11) the Company‘s or any Subsidiary‘s entering into, terminating or amending any transaction, agreement or arrangement with or for the benefit of any Member or any of its Affiliates (or any member of their “immediate family” as such term is defined in Rule 16a-1 of the Securities Exchange Act of 1934) . . . .27
Article XIII, Section 8(a) of the LLC Agreement contains the Minority Members’ Put Right:
(a) Subject to the terms herein, and provided that the Company (or its successor) is not Publicly Traded, Crestview shall possess the right and option
(the “Put Right“), exercisable in its sole discretion, to require the Company to purchase in cash for Fair Market Value (the “Put Price“) all or any portion of the Member Interest and Units then held by Crestview, but in no case less than twenty-five percent (25%) of the Member Interest and Units held by Crestview prior to the first such exercise of its Put Right. . . . In the event Crestview does not exercise its Put Right within sixty (60) calendar days following an event described in the foregoing clauses (ii) or (iii), Load
Line shall possess the Put Right, subject to the same limitations described herein (including the foregoing proviso). . . .28
Amended Section 8(e) of Article XIII (the “Exit Sale Right“) sets forth the rights of the Minority Members in the event that Oxbow rejects the put:
(e) If (x) the Company rejects the Put Notice in writing or fails to respond to the Put Notice within 180 calendar days of its receipt and (y) the Company is not Publicly Traded:
(A) if at such time Crestview owns ten percent (10%) or more of the outstanding Member Interests and Units of the Company, the Exercising Put Party may require all of the Members to engage in an Exit Sale, on the terms set forth in Section 7(c), Section 7(d) and Section 9(b), in which the aggregate consideration to be received by such Members at the closing of such Exit Sale equal or exceed Fair Market Value; provided, that the Exercising Put Party may not require any other Member to engage in such Exit Sale unless the resulting proceeds to such Member (when combined with all prior distributions to such Member) equal at least 1.5 times such Member‘s aggregate Capital Contributions through such date . . . .29
The definition of an “Exit Sale” is essential to the interpretation of the Exit Sale Right. Article I of the LLC Agreement defines an Exit Sale as:
[A] Transfer of all, but not less than all, of the then-outstanding Equity Securities of the Company and/or all of the assets of the Company to any non-Affiliated Person(s) in a bona fide arms‘-length transaction or series of related transactions (including by way of a purchase agreement, tender offer, merger or other business combination transaction or otherwise).30
A transfer requires “all, but not less than all” Equity Securities (the “All Securities Clause“). Thus, for an Exit Sale to take place at the unitholder level, the All Securities Clause means that no Member can be left behind.
Upon the exercise of the Exit Sale Right, the parties had an obligation to use “reasonable efforts” to effectuate the Exit Sale under Article XIII, Section 8(f) (the “Reasonable Efforts Provision“):
(f) If the Exercising Put Party elects to require all of the Members to engage in an Exit Sale pursuant to Section 8(e) above . . . each party hereto agrees to use its reasonable efforts to take or cause to be taken or do or cause to be done all things necessary or desirable to effect such Exit Sale. Without limiting the generality of the foregoing, each Member shall vote for, consent to and raise no objections against any Exit Sale pursuant to this Section 8(f) and shall
enter into customary definitive agreements in connection therewith.31
As stated in the Exit Sale Right, any Exit Sale must take place “on the terms set forth in [Article XIII,] Section 7(c), Section 7(d) and Section 9(b)” (collectively, the “Equal Treatment Requirements“). Section 7(c) provides for a pro rata allocation of expenses for an Exit Sale:
Importantly, Section 7(d) states that any Exit Sale must be on equal terms and conditions (the “Equal Treatment Provision“): “In the case of both a Tag-Along Transfer and an Exit Sale, (A) each Unit Transferred in such Tag-Along Transfer and Exit Sale shall be Transferred on the same terms and conditions as each other Unit so Transferred . . . .”33 And like Section 7(c), Section 9(b) provides for a pro rata allocation of indemnification expenses:(c) In the case of both a Tag-Along Transfer and an Exit Sale, each Member shall be obligated to pay only its pro rata share (based on the aggregate consideration received by such Member in respect of the Units Transferred by such Member) of expenses incurred in connection with a consummated Tag-Along Transfer or Exit Sale to the extent such expenses are incurred for the benefit of all Members and are not otherwise paid by the Company or another Person.32
(b) No Member shall be obligated in connection with any such Exit Sale (i) to agree to indemnify or hold harmless the Person to whom the Units are being sold with respect to any indemnification or other obligation in an amount in excess of the net proceeds paid to the such [sic] Member in connection with such Exit Sale or (ii) to enter into any non-competition, non-solicitation or other similar arrangement; provided, further, that such indemnification or other obligations shall be pro rata as among the Members other than with respect to representations made individually by a Member (e.g., representations as to title or authority of such Member or the lack of any encumbrance on any of the Units to be sold by such Member). Allocation of the aggregate purchase price payable in an Exit Sale will be determined by assuming that the aggregate purchase price was distributed to [Oxbow Holdings] and the remaining Members in accordance with Article XI, Section 1 hereof.34
The last sentence of the provision quoted above states that proceeds from an Exit Sale will be distributed in accordance with Article XI, Section 1 (the “Distribution Provision“), which in turn refers to Section 2 of Article XI. These sections provide:
Section 1. Distributions. Subject to such conditions as may be imposed under any Financing Arrangements and to the prior payment of distributions pursuant to Article XI, Section 2, all Net Cash Flow shall be distributed on a quarterly basis to the Members in accordance with their Percentage Interests within 45 calendar days after the end of each Fiscal Quarter . . . .
Section 2. Mandatory Distributions. Prior to making any distributions in respect of any quarter pursuant to Article XI, Section 2, the Company will make quarterly distributions to each Member, to the extent of Net Cash Flow, in an amount equal to such Member‘s Maximum Permitted Tax Amount; provided, that if the amount of Net Cash Flow is
not sufficient to make the foregoing payments in full, the amount that is available will be distributed in the same proportion as if the full amount were available. . . .35
Thus, Section 2 of Article XI states that, prior to quarterly distributions, Oxbow will first pay the Members “in an amount equal to such Member‘s Maximum Permitted Tax Amount . . . .”36 After that, Section 1 of Article XI provides that the remaining Net Cash Flow—including the Exit Sale proceeds—will be distributed “in accordance with their Percentage Interests.”37
III. The Court of Chancery‘s Decision
The Court of Chancery first evaluated the Small Holders’ status as Members and held that they had not been properly admitted, but that the doctrine of laches barred the Minority Members’ claim that they were not Members. Next, the court considered competing interpretations of the LLC Agreement to determine whether the Minority Members could force an Exit Sale. The court held that the plain language of the LLC Agreement did not allow the Minority Members to force an Exit Sale unless the Small Holders would receive 1.5x their initial capital contributions in the transaction, taking into account distributions received. Because the per unit amount must clear this requirement for every Member, and because every Member must receive the same amount, all Members must receive the highest amount needed to satisfy the 1.5x Clause for any particular Member. However, the court further held that a gap exists in the LLC Agreement relating to the terms on which the Small Holders had become Members. Relying on the implied covenant, the court “filled the gap” with a Seller Top-Off and held that the Minority Members can force an Exit Sale. Finally, the court held that Oxbow breached the Reasonable Efforts Provision, and, in a later opinion, crafted remedies in favor of the Minority Members.38
The trial court issued a 176-page post-trial opinion detailing the extrinsic evidence relating to the LLC Agreement and conduct of the parties, which it ultimately determined to be irrelevant in analyzing the plain meaning of the LLC Agreement. Because we conclude that the court erred in employing the implied covenant to imply a Seller Top-Off right, and because we agree with the Vice Chancellor‘s analysis of the plain meaning of the LLC Agreement, we confine our discussion below to those aspects of the trial court‘s post-trial decision.
A. The Small Holders’ Status as Members
The Minority Members argued at trial that Oxbow did not properly admit the Small Holders in 2011 and 2012. Specifically, Oxbow did not comply with the Preemptive Rights Provision, obtain supermajority approval under the Related Party Provision, or obtain the proper signatures, representations, and warranties under the New Member Provision at the time of the Small Holders’ investment.
The Court of Chancery held that Oxbow had the power as an entity to issue new units and to admit new Members, and so the failures to comply with the LLC Agreement were voidable acts subject to
- The Minority Members’ Board representatives were present and participated in the 2011 vote to issue new units to the Small Holders. As part of the admission of the Small Holders, Crestview received about $8.2 million and its representatives believed that they were being undercompensated relative to Oxbow‘s true value.
- In 2012, Oxbow began listing the Small Holders as Members in a section of the monthly management reports titled “Member Equity.” Specifically, the January 2012 report listed Family LLC as a Member and showed that $20 million had been distributed to the Members. Likewise, the April 2012 report listed Executive LLC as a Member and showed the distribution of $15 million. The Minority Members received these reports for seventy-two consecutive months.
- Oxbow‘s audited financial statements for 2011, 2012, and 2013, which the Minority Members received, reported the issuance of units to the Small Holders and identified those entities as Koch-controlled affiliates.
- In 2012 and 2013, Oxbow‘s auditor classified the Small Holders as Members in its report to the Audit Committee, which Hurst chaired.
- The Minority Members did not challenge the Small Holders’ status as Members until August 31, 2016. Hurst testified that he was aware of the Small Holders’ investments in 2012 and “just didn‘t make a big deal about it.”40
Thus, the Court of Chancery held that laches barred the Minority Members’ claim that the Small Holders are not Members.
B. The Highest Amount Interpretation Controls
During this litigation, the Court of Chancery considered the parties’ various shifting interpretations of the LLC Agreement to determine whether the Minority Members could force an Exit Sale. Oxbow advanced the Highest Amount Interpretation, meaning that Exit Sale proceeds must satisfy the 1.5x Clause for each Member based upon pro rata allocation of proceeds resulting from the Exit Sale, and that all Members must participate and receive the same consideration. The Minority Members, however, argued that the language of the LLC Agreement contemplated the Leave Behind Theory. Alternatively, if Members cannot be left behind in an Exit Sale, the Minority Members argued that a Top-Off payment should be implied. Using a Top-Off, some holders would receive greater consideration to satisfy the 1.5x Clause.
Although it had already determined in its summary judgment order that the Highest Amount Interpretation controlled, the Court of Chancery reconsidered the issue in its post-trial opinion “[f]or the sake of completeness.”41 The court stated
outstanding Equity Securities of the Company“—the Leave Behind Theory collapses.42 In fact, the court noted several times that Koch had negotiated for a “Blocking Option” in 2007 to prevent the Small Holders from being left behind in an Exit Sale.43
The Court of Chancery then turned its attention to whether the LLC Agreement contemplates a Top-Off. The court held that the combined effect of the Equal Treatment Requirements is to “require equal and ratable treatment of members in an Exit Sale.”44 Most notably, Section 7(d) expressly incorporates equal treatment, stating that units transferred in an Exit Sale “shall be Transferred on the same terms and conditions as each other Unit so Transferred . . . .”45 The court further noted that “[t]he price that a member receives for its units is a term of the transfer.”46 Thus, Section 7(d) itself “forecloses having certain members receive greater consideration—different terms—than others.”47
Next, the Court of Chancery considered and rejected the Waterfall Top-Off Theory, noting that the Exit Sale Right lacks any language permitting a priority return on capital. Instead, it held that “the Distribution Provisions establish a payment scheme that forecloses priority returns.”48 In fact, the distribution provisions of the LLC Agreement require proceeds in an Exit Sale to be distributed “first so that members receive their Maximum Permitted Tax Amount, then pro rata ‘in accordance with their Percentage Interests.‘”49
The Court of Chancery held that “[w]hen the 1.5x Clause is read in conjunction with the All Securities Clause and Equal Treatment Requirements, including the Distribution Provisions, then neither the Leave Behind Theory nor a Top-Off is reasonable.”51 The Vice Chancellor found that “[t]he final LLC Agreement did not expressly provide for a top-off right.”52 Thus, “[t]he practical result of these provisions when read together is to mandate the Highest Amount Interpretation.”53 The trial court explained that, under the Highest Amount Interpretation:
[If] an Exit Sale does not satisfy the 1.5x Clause for any member, then it cannot proceed. To satisfy the 1.5x Clause for all members and to pay all members the same consideration, the Exit Sale must provide all members with the highest amount necessary to satisfy the 1.5x Clause for any member.54
The Vice Chancellor repeatedly emphasized that the Highest Amount Interpretation was the only reading that gives meaning to the LLC Agreement as a whole.55 Although the trial court considered extrinsic evidence, it held that “[b]ecause the plain language of the Exit Sale Right mandates the Highest Amount Interpretation, extrinsic evidence is not relevant.”56 It observed, however, that although it reveals a range of views about the 1.5x Clause, the evidence “does not change the fact that the Highest Amount Interpretation is the only reading that gives meaning to the 1.5x Clause, the Exit Sale definition, and the Equal Treatment Requirements, including the Distribution Provisions.”57 And for good measure, the trial court reinforced that the Highest Amount Interpretation “is the only reasonable reading of the LLC Agreement.”58
C. But the Trial Court Finds a Contractual Gap
The trial court next addressed the Minority Members’ contention that the Koch Parties could not rely upon the Highest
In analyzing these competing contentions, the court first considered the New Member Provision, which states that additional Members may be admitted and that “Units may be created and issued to such [new Members] as determined by the Directors on such terms and conditions as the Directors may determine at the time of admission.”59 Those terms “may provide for the creation of different classes or series of Units having different rights, powers and duties.”60 The court held that “[b]y deferring until a later point the question of what rights subsequent members would have, the LLC Agreement created a gap.”61
Next, the court considered various facts which it found supported the finding of a gap in 2011. First, the relevant Board minutes and the resolutions the Board adopted did not specify “the rights that the members of Koch‘s family or the former sulfur-company
executives would have as members.”62 Second, the resolutions employed the term “shares of Company stock,” which “implied a common-stock-like instrument without special rights, powers, preferences, or privileges, such as a preferential right to receive 1.5 times invested capital before being forced to engage in a sale.”63 Third, the court reasoned that Oxbow‘s failure to comply with corporate formalities had “created a gap regarding the terms on which the Small Holders became members.”64 Had Oxbow followed the proper formalities, it is “impossible to know what would have happened” given the Supermajority Vote requirement, which the Minority Members could have used as leverage to limit the Small Holders’ ability to invoke the 1.5x Clause.65 Accordingly, the trial court held that “[t]he Minority Members proved at trial that a gap exists in the parties’ contract relating to the terms on which the Small Holders became members.”66
The Court of Chancery next considered whether to imply a provision to fill that gap, noting that “[t]o supply an implicit term, the court ‘looks to the past’ and asks ‘what the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting.‘”67 Because the gap concerns the admission of the Small Holders, the court held that the relevant “time of contracting” was 2011, not when the parties executed the LLC Agreement in 2007. The Vice Chancellor concluded,
“[t]he evidence convinces me that it was possible, but unlikely, that the parties would have agreed to a Waterfall Top-Off.”68 However, the evidence did convince
IV. Analysis
The Koch Parties claim that the Court of Chancery erred by: (1) applying the implied covenant of good faith and fair dealing to the LLC Agreement; (2) finding that a gap exists in the LLC Agreement regarding the operation of the 1.5x Clause; (3) holding that Oxbow Holdings breached the LLC Agreement‘s Reasonable Efforts Provision; and (4) awarding a contingent “backstop” remedy to the Minority Members, along with their pro rata share of certain legal fees and expenses. The Minority Members raise as their lead argument in defense of the trial court‘s opinion an argument they did not raise below, namely, that the
plain language of the LLC Agreement permits a Top-Off. Secondarily, they then defend the trial court‘s implied covenant analysis. For the following reasons, we conclude that the Court of Chancery correctly held that the Highest Amount Interpretation is the only reading that gives meaning to the 1.5x Clause, the Exit Sale definition, and the Equal Treatment Requirements, including the Distribution Provisions. However, we hold that the trial court erred in finding a contractual gap and in applying a Seller Top-Off. Thus, the effect of our decision is that the plain language of the LLC Agreement gives the Small Holders a right to block an Exit Sale by operation of the Highest Amount Interpretation.
A. The Minority Members Abandoned the Small Holders’ Rights Gap Theory
Earlier in this litigation, the Minority Members advanced two theories under the implied covenant of good faith and fair dealing: the Small Holders’ Rights Gap and the Top-Off Gap. Under the Small Holders’ Rights Gap Theory, the LLC Agreement contains a contractual gap because the New Member Provision gives the Board discretion to determine the rights of newly-admitted Members, and because the Board failed to define those rights at the time of the Small Holders’ admission. The Top-Off Gap Theory posits that a gap exists in the Exit Sale Right because it does not expressly permit or prohibit a Top-Off payment.
As noted above, the court first raised, sua sponte, an implied covenant theory in its summary judgment order, and then the Minority Members added an implied covenant claim in their Second Amended Counterclaim. However, they did not specifically argue
the Small Holders’ Rights Gap Theory relied on by the Court of Chancery.72
and that the Highest Amount Interpretation controls.75 But the trial court then implied a Seller Top-Off, nonetheless, based on the Small Holders’ Rights Gap Theory. In sum, the Court of Chancery first suggested the implied covenant theory sua sponte, rejected the primary Top-Off implied covenant theory that the Minority Members advanced pre- and post-trial, and held that a Top-Off was not reasonable under a plain reading of the contract, but then relied on the abandoned Small Holders Rights Gap Theory to ultimately imply a Top-Off payment right.76
We see another disconnect in the post-trial opinion. The trial court held that laches bars any challenge to the Small Holders’
Members did not appeal) does not bar the assertion of an implied covenant claim, we conclude that the implied covenant claim is meritless.
B. The Court of Chancery Erred by Finding a Small Holders’ Rights Gap
Questions of law and contractual interpretation are reviewed de novo.78 We conclude that the trial court erred in holding that “a gap exists in the parties’ contract relating to the terms on which the Small Holders became members.”79
A plain reading of the New Member Provision shows that the parties contracted to leave the terms of new Members’ admission to the discretion of the Board. The New Member Provision states that “Units may be created and issued to such [new Members] as determined by the Directors on such terms and conditions as the Directors may determine at the time of admission,” and those terms ”may provide for the creation of different classes or series of Units having different rights, powers and duties.”80 The LLC Agreement‘s definition of “Member” “means any Person named as a member of the Company on Exhibit A attached hereto and includes any person subsequently admitted as a Member.”81 In other words, the LLC Agreement delegates responsibility to the Board to set the terms of admission and permits—but does not require—the Board to issue units with different rights or classes.82 Absent the Board‘s imposition of different rights for newly issued units, the
definition of “Member” suggests that use of that term in the LLC Agreement, including
The record shows that the Board admitted the Small Holders without imposing a different set of rights. The Subscription Agreement—which was addressed to the Board—set the price terms and number of units, and it stipulated that Family LLC “agrees to be bound by the terms of the” LLC Agreement.83 The Minority Members’ Board representatives then signed consents for the distribution of $20 million from Family LLC‘s investment, and the Minority Members received about $11.4 million as a result.84 Further, the Board resolutions in April 2011 and the Board minutes in November 2011 only set terms regarding the price and number of units to be issued. Although the court took issue with the fact that the Board resolutions used the phrase “shares of Company stock” rather than “units,”85 it appears that the parties used the term “unit,” “share,” and “stock” interchangeably.86 Moreover, the 1.5x Clause is not “preferential,” as the trial court
concluded, but rather applies to “any other Member“—which includes the Small Holders.87 Because the Board chose not to specify different rights, the terms of the LLC Agreement—including the unambiguous Exit Sale Right—apply with equal force to the Small Holders.
We have declined in other cases to imply new contract terms merely because a contract grants discretion to a board of directors. For example, in Blaustein v. Lord Baltimore Capital Corp., 84 A.3d 954 (Del. 2014),88 we considered a plaintiff‘s claim that a Shareholder Agreement included implied terms about share repurchasing.89 The relevant provision stated that “the Company may repurchase Shares upon terms and conditions agreeable to the Company and the Shareholder who owns the Shares to be repurchased . . . .”90 Noting that “[t]he implied covenant of good faith and fair dealing cannot be employed to impose new contract terms that could have been bargained for but were not,” we held that the permissive language “gives both parties complete discretion in deciding whether, and at what price, to execute a redemption transaction.”91 We did not explicitly address whether a gap existed in Blaustein, but our reasoning in that case suggests—as do the facts here—that conferring discretion to the Board was a contractual choice to grant authority to the Board—not a gap. And although the vesting of a Board with discretion does not relieve the Board of its
obligation to use that discretion consistently with the implied covenant of good faith
Here, at the time of contracting in 2007, the parties contemplated that new Members could be admitted, and they placed certain restrictions on the Board‘s discretionary authority in the admission process. For example, the Preemptive Rights Provision protects
existing Members from dilution, and the Related Party Provision requires supermajority approval for conflicted transactions. These provisions suggest that the parties considered the impact of new Members but decided to delegate other issues affecting unitholder rights to the Board. In addition to the Preemptive Rights and Related Party Provisions, the parties anticipated differing scenarios regarding a possible Exit Sale. For example, Oxbow Holdings’ Exit Sale Right, contained in Article XIII, Section 9(a) of the LLC Agreement, implements a 2.5x threshold limited to Crestview and Load Line.94 By contrast, the Minority Members’ Exit Sale Right in Article XIII, Section 8(e) contains a 1.5x threshold and it applies to “any other Member.”95
of reading the LLC Agreement and bargaining for the rights they now seek through litigation.97
In addition, the trial court did not persuasively explain why being alerted to the Preemptive Rights and Related Party Provisions would have caused the Minority Members to bargain for additional rights.98 As to the Supermajority Vote under the Related Party Provision, the court noted that the Minority Members “could have blocked the issuance and forced a negotiation.”99 But the Crestview and Load Line directors voted in favor of the April 2011 resolutions and signed the consent forms regarding transfer of the funds from Executive LLC‘s unit-purchase.100 The court cited no evidence that the Minority Members felt that their hands were tied or that their vote was otherwise invalid. Further, Hurst was aware of the Small Holders’ investments and “just didn‘t make a big deal about
it.”101 Instead, the Small Holders paid $35 million for their units, and the Minority Members promptly accepted the resulting $11 million distributions.102
The crucial problem with the Court of Chancery‘s reasoning is that it posits that a gap was created in the parties’ contract because they did not give adequate attention to the effect that the admission of new Members at a higher entry price would have on the Exit Sale Right provisions of
But even if the record lacked an explanation for the parties’ failure to focus on this issue, the Court of Chancery‘s use of that failure to generate a gap would still be incorrect.
Based on its own detailed findings, the Court of Chancery held that the parties agreed and expected that the Small Holders would be admitted as Members.104 As such, whatever mistake the parties subjectively made about the implications of admitting new Members does not operate to create a contractual gap. And, the well-reasoned analysis of the Court of Chancery as to laches also shows why there is no inequity to the Minority Members in applying the provisions of the LLC Agreement as written.105 The Small Holders were admitted as Members; everyone understood that they were Members; the Minority Members only challenged their status four years after they were admitted as part of this litigation; the Small Holders paid for the right to be Members; and the Minority Members received $11.4 million of that cash as part of a distribution. They therefore cannot in good faith argue that the Small Holders are not Members. Thus, as Members, the Small Holders have the rights and privileges of other Members. As such, the formula for applying the Exit Sale Provision simply had to be applied on that basis, and an Exit Sale could only be insisted upon by the Minority Members if all Members, including the Small Holders, received 1.5x their initial capital contribution.106
The implied covenant of good
be most chary about implying a contractual protection when the contract could easily have been drafted to expressly provide for it.”113
We decline to apply the implied covenant here because no gap exists concerning the admission of the Small Holders, and because the admission of new Members and their impact on the Exit Sale process could have been anticipated. As explained above, the Minority Members bargained for certain protections regarding the admission of new Members. The parties could have also limited the 1.5x Clause to certain Members, excluded subsequently admitted Members, removed the “all, but not less than all” language, as the parties did with their 2014 amendment to the Put Right,114 or revised the Exit Sale Right to include a Top-Off option when they amended that provision in 2014—after the Small Holders invested and after Crestview began contemplating an exit.115
For certain, the parties are in a far different position than they were in 2007 or 2011. As the Court of Chancery recognized, since the Minority Members exercised the Exit Sale Right nearly nine years after finalizing the LLC Agreement, Oxbow‘s management has changed, Koch has lost some of his initial bargaining leverage, and—at least compared to Crestview‘s expectations around 2011—the value of Oxbow has declined.116 However, we reiterate that the implied covenant should not be used as “an equitable remedy for rebalancing economic interests”117—particularly where, as here, the parties are sophisticated business persons or entities.118
In sum, we agree with the Court of Chancery that the Highest Amount Interpretation is the only reading that gives effect to the LLC Agreement as a whole, but we hold that the trial court erred in finding a gap in the LLC Agreement and in using the implied covenant to imply a Seller Top-Off right.
C. The Minority Members did not Fairly Present their New Plain Language Argument Below
Consistent with the parties’ shifting theories in this litigation, the Minority Members’ answering brief on appeal now casts their implied covenant Top-Off argument below as a plain language claim. Specifically, they argue that the Exit Sale Right and the Equal Treatment Provisions are silent as to whether the Minority Members can redistribute
their Exit Sale proceeds in the form of a Top-Off, and that a Top-Off fulfills the purposes of the LLC Agreement. In other words, they ask us to imply a Top-Off based upon the LLC Agreement‘s plain language. Because this argument was not fairly presented below, however, we decline to reach its merits.
Not only was this new plain language theory not fairly presented below, it conflicts with the positions the Minority Members actually did take.119 In fact, their principals acknowledged that there was no such right to a Top-Off payment in the LLC Agreement. For example, Hurst testified in deposition:
Q: Now, did Crestview ever negotiate for the right to be able to make a top-off payment in the event that the exit sale did not result in the fair market value being achieved?
. . .
A: I don‘t believe so.
. . .
Q: You didn‘t tell the investment committee that you understood that Crestview had a top-off payment right, did you? A: We did not have a top-off payment right.120
Further, in the proceedings below, the Minority Members argued that “the LLC Agreement contains a gap because it does not explicitly permit or prohibit a top-up payment to a particular member to satisfy the 1.5x Clause.”121 Thus, we conclude that the Minority Members’ new “plain language” argument is waived.
D. We Vacate the Court of Chancery‘s Remedies Decision
The Koch Parties contend that the Court of Chancery erroneously determined that they breached the Reasonable Efforts Provision and that the court‘s remedies constitute error. Specifically, the Koch Parties argue that “because there was no Exit Sale available that could satisfy the LLCA‘s express requirements under prevailing market conditions, there was no Exit Sale for Oxbow Holdings to use reasonable efforts to effectuate.”122 We agree and, accordingly, vacate the remedies ruling of August 1, 2018.
V. Conclusion
For the foregoing reasons, we AFFIRM in part and REVERSE in part the Court of Chancery‘s February 12, 2018, decision, and we VACATE the court‘s August 1, 2018, remedies decision.
Notes
Id. at A703.If the Court concludes the Small Holders are Members of Oxbow, it must “fill the gap” and determine what rights the Board would have “determined” for them “at the time” of admission had the issue been discussed. The Board would not have granted the Small Holders the right to block an Exit Sale and would have permitted them to be left behind in an Exit Sale. The Court should declare that the Small Holders, even if Members, cannot block an Exit Sale.