In A&J Capital, Inc. v. Law Office of Krug, the Court of Chancery considered whether a manager of a Delaware limited liability company (“LLC”) was properly removed under the LLC’s operating agreements. In particular, the dispute centered on whether the plaintiff, a manager of the LLC, was removed “for cause” as the LLC’s Operating and Management Agreement required. Vice Chancellor Slights held for the plaintiff, finding the removal provisions in the LLC’s operating agreements were not properly followed.
The Delaware LLC, LA Metropolis Condo I, LLC, was formed to raise investment capital under a federal government program entitled EB-5. Under this program, foreign nationals could become lawful permanent residents of the United States if they made qualified foreign investments in a new commercial enterprise in the United States. The LLC consists of two hundred Chinese nationals who contributed to a $100 million loan to develop residential and commercial space in downtown Los Angeles, California. The loan was extended to Greenland LA Metropolis Development, LLC, a Delaware LLC and an affiliate of the largest state-owned real estate developer in China. Henry Global Consulting Group, a Chinese company, solicited investments for the LLC. Henry Global Consulting Group named Urban Harmony as the LLC’s Class A Manager. The plaintiff, A&J Capital Inc. (“A&J”), was named the Class B Manager of the LLC, in exchange for a management fee.
A dispute arose between Greenland and A&J concerning a newly drafted prepayment plan, allowing Greenland to repay the loan before the maturity date in order to free up capital. The prepayment plan included a prepayment fee to A&J, bargained for by both parties. However, Greenland became concerned that A&J would not commit the redeployed investment funds to Greenland on favorable terms once the original loan was repaid and Greenland opposed the proposed prepayment plan. Under Greenland’s direction, the prepayment plan was eventually rejected by the Members in a vote. The Law Office of Krug, guided by Greenland, drafted a request to vote on the removal of A&J. The removal ballot did not identify a basis for removal, nor mention Class Members specific removal rights in the Operating or Management Agreements. The named defendant, Law Office of Krug, was appointed the Class B Manager following A&J’s removal.
The plaintiff, A&J, alleged Greenland became displeased with A&J, colluded with certain members of the LLC to have A&J removed as the Class B Manager, and replaced with the defendant, Law Office of Krug. The Operating Agreement and Management Agreement between the LLC and A&J provided that a Class B Manager may only be removed “for cause.” A&J initiated action under 6 Del C. §§18-110 and 18-111 of the Delaware Limited Liability Company Act, claiming they were removed without cause, and the LLC, through Greenland, guided by the Law Office of Krug, manufactured “cause” after the fact to justify the removal. Thus, Vice Chancellor Slights was tasked with determining whether A&J, the Class B Manager, was properly removed under the terms of the Operating Agreement and the Management Agreement.
The Vice Chancellor considered the language of the Operating Agreement, a contract between Urban Harmony and Investors, and the Management Agreement, a contract between the LLC, A&J, and the Investors. Under the Operating Agreement, a Class B Manager is responsible for day-to-day administration of the LLC, including managing the investment of LLC funds, negotiating, amending and supplementing the terms of the loans made by the LLC and entering any agreement appropriate for the LLC. The Operating Agreement states Class B Members, by a majority vote, have the sole and exclusive right to appoint or remove Class B Managers, and may only remove Class B Managers for “gross negligence, intentional misconduct, fraud or deceit.” The Management Agreement restates the “for cause” requirements for removal of a Class B Manager.
The defendant argued the removal standards set forth in the operating agreements define only standards of conduct. Vice Chancellor Slights disagreed, noting that removal must be justified for “gross negligence,” “intentional misconduct,” “fraud,” or “deceit.” Therefore, the contractually imposed standards of conduct stated the conduct must be either harmful or cause harm to justify removal. Thus, no matter the standard, there must be a risk of harm to the LLC as a result of the Manager’s actions to deviate from the standard of care set forth in the operating agreements.
The Vice Chancellor held that the defendant failed to clearly tie any alleged events justifying removal to one or more of the particular standards listed in the operating agreements. Simply claiming the A&J engaged in conduct that violates all the standards of conduct does not suffice. Therefore, Vice Chancellor Slights held that under 6 Del. C. §§ 18-110 and 18-111, A&J was improperly removed and must be reinstated to the position.
The opinion makes clear that the Court of Chancery will strictly construe the language of the operating agreement when such an agreement is made at arm’s length between the parties. A party seeking to justify the removal of a manager must directly tie evidence to a particular standard or standards as set forth in the operating agreements, and a general claim that a manager deviated from standards of gross negligence, intentional misconduct, fraud or deceit will not pass muster.