Delaware Court of Chancery Refuses to Second-Guess Contractual Valuation Method

In a recent Chancery Court case, Peco Logistics, LLC v. Walnut Investment Partners, L.P. and Walnut Private Equity Fund, L.P. (C.A. No. 9978-CB), Chancellor Bouchard considered a challenge from two investors to the valuation of their interests in PECO Logistics, LLC (the "Company") in connection with the exercise of their put right under the Company's operating agreement. 

The LLC Agreement of the Company provides that investors in the Company may voluntarily sell their preferred units back to the Company (the "Put Right").  The LLC Agreement further provides that "upon exercise of the Put Right, the Company must retain a nationally recognized valuation firm to determine the fair market value of the preferred units in accordance with a specified formula, and the Company must repurchase the preferred units for the determined value.  Finally, the LLC Agreement provides that both the Company "and the investors 'shall be bound by the determination' of the valuation firm."

In the case, the Company is seeking a declaration that it complied with its LLC Agreement with respect to the Put Right, and the investors are challenging the validity of the valuation firm's determination of the value of their preferred units.  The Court upholds the valuation process and the valuation firm's determination.  Chancellor Bouchard writes: "[w]hen parties to a contract agree to be bound by a contractually established valuation methodology, this Court will respect their right to order their affairs as they wish and refrain from second-guessing the substantive determination of value."

Key Take-away: absent ambiguity or bad faith behaviors, the Chancery Court will enforce contracts, and LLC Agreements in particular, as written.  The Court pointed out that the parties to the LLC Agreement could have provided for a method of judicial review of the determination of the valuation firm.  However, when such judicial review is not a bargained-for part of the parties' contract, the Court will not circumvent the parties' agreement.