This is a case of first impression before this Court involving the Delaware Limited Liability Company Act (the "Act"). The limited liability company ("LLC") is a relatively new entity that has emerged in recent years as an attractive vehicle to facilitate business relationships and transactions. The wording and architecture of the Act is somewhat complicated, but it is designed to achieve what is seemingly a simple concept — to permit persons or entities ("members") to join together in an environment of private ordering to form and operate the enterprise under an LLC agreement with tax benefits akin to a partnership and limited liability akin to the corporate form.
This is a purported derivative suit brought on behalf of a Delaware LLC calling into question whether: (1) the LLC, which did not itself execute the LLC agreement in this case ("the Agreement") defining its governance and operation, is nevertheless bound by the Agreement; and (2) contractual provisions directing that all disputes be resolved exclusively by arbitration or court proceedings in California are valid under the Act. Resolution of these issues requires us to examine the applicability and scope of certain provisions of the Act in light of the Agreement.
We hold that: (1) the Agreement is binding on the LLC as well as the members; and (2) since the Act does not prohibit the members of an LLC from vesting exclusive subject matter jurisdiction in arbitration proceedings (or court enforcement of arbitration) in California to resolve disputes, the contractual forum selection provisions must govern.
Accordingly, we affirm the judgment of the Court of Chancery dismissing the action brought in that court on the ground that the Agreement validly predetermined the fora in which disputes would be resolved, thus stripping the Court of Chancery of subject matter jurisdiction.
Facts1
Plaintiff below-appellant Elf Atochem North America, Inc., a Pennsylvania Corporation ("Elf"), manufactures and distributes solvent-based maskants to the aerospace and aviation industries throughout the world.
For decades, the aerospace and aviation industries have used solvent-based maskants in the chemical milling process.
In the mid-nineties, Elf approached Jaffari and proposed investing in his product and assisting in its marketing. Jaffari found the proposal attractive since his company, Malek, Inc., possessed limited resources and little international sales expertise. Elf and Jaffari agreed to undertake a joint venture that was to be carried out using a limited liability company as the vehicle.
On October 29, 1996, Malek, Inc. caused to be filed a Certificate of Formation with the Delaware Secretary of State, thus forming Malek LLC, a Delaware limited liability company under the Act. The certificate of formation is a relatively brief and formal document that is the first statutory step in creating the LLC as a separate legal entity.
Next, Elf, Jaffari and Malek, Inc. entered into a series of agreements providing for the governance and operation of the joint venture. Of particular importance to this litigation, Elf, Malek, Inc., and Jaffari entered into the Agreement, a comprehensive and integrated document
The Agreement is the operative document for purposes of this Opinion, however. Under the Agreement, Elf contributed $1 million in exchange for a 30 percent interest in Malek LLC. Malek, Inc. contributed its rights to the water-based maskant in exchange for a 70 percent interest in Malek LLC.
The Agreement contains an arbitration clause covering all disputes. The clause, Section 13.8, provides that "any controversy or dispute arising out of this Agreement, the interpretation of any of the provisions hereof, or the action or inaction of any Member or Manager hereunder shall be submitted to arbitration in San Francisco, California...." Section 13.8 further provides: "No action ... based upon any claim arising out of or related to this Agreement shall be instituted in any court by any Member except (a) an action to compel arbitration ... or (b) an action to enforce an award obtained in an arbitration proceeding...." The Agreement also contains a forum selection clause, Section 13.7, providing that all members consent to: "exclusive jurisdiction of the state and federal courts sitting in California in any
Elf's Suit in the Court of Chancery
On April 27, 1998, Elf sued Jaffari and Malek LLC, individually and derivatively on behalf of Malek LLC, in the Delaware Court of Chancery, seeking equitable remedies. Among other claims, Elf alleged that Jaffari breached his fiduciary duty to Malek LLC, pushed Malek LLC to the brink of insolvency by withdrawing funds for personal use, interfered with business opportunities, failed to make disclosures to Elf, and threatened to make poor quality maskant and to violate environmental regulations. Elf also alleged breach of contract, tortious interference with prospective business relations, and (solely as to Jaffari) fraud.
The Court of Chancery granted defendants' motion to dismiss based on lack of subject matter jurisdiction.
Contentions of the Parties
Elf claims that the Court of Chancery erred in holding that the arbitration and forum selection clauses in the Agreement governed, and thus deprived that court of jurisdiction to adjudicate all of Elf's claims, including its derivative claims made on behalf of Malek LLC. Elf contends that, since Malek LLC is not a party to the Agreement, it is not bound by the forum selection provisions. Elf also argues that the court erred in failing to classify its claim as derivative on behalf of Malek LLC against Jaffari as manager. Therefore, Elf claims that the Court of Chancery should have adjudicated the dispute. Finally, Elf argues that the dispute resolution clauses of the Agreement are invalid under Section 109(d) of the Act, which, it alleges, prohibits the parties from vesting exclusive jurisdiction in a forum outside of Delaware.
Defendants claim that Elf contracted with Malek, Inc. and Jaffari that all disputes that arise out of, under, or in connection with the Agreement must be resolved exclusively in California by arbitration or court proceedings. Defendants allege that the characterization of Elf's claim as direct or derivative is irrelevant, as the Agreement provides that the members would not institute "any" action at law or equity except one to compel arbitration, and that any such action must be brought in California. Defendants also argue that, in reality, Elf's claims are direct, not derivative, claims against its fellow LLC members, Malek, Inc. and Jaffari.
With regard to the validity of Section 13.7, defendants argue that Section 18-109(d) of the Act is a permissive statute and does not prohibit the parties from vesting exclusive jurisdiction outside of Delaware. Thus, defendants assert that the Court of Chancery correctly held that the dispute resolution provisions of the Agreement are valid and apply to bar Elf from seeking relief in Delaware.
General Summary of Background of the Act
The phenomenon of business arrangements using "alternative entities" has been
Limited partnerships date back to the 19th Century. They became an important and popular vehicle with the adoption of the Uniform Limited Partnership Act in 1916. Sixty years later, in 1976, the National Conference of Commissioners on Uniform State Laws approved and recommended to the states a Revised Uniform Limited Partnership Act ("RULPA"), many provisions of which were modeled after the innovative 1973 Delaware Limited Partnership (LP) Act. Difficulties with the workability of the 1976 RULPA prompted the Commissioners to amend RULPA in 1985.
To date, 48 states and the District of Columbia have adopted the RULPA in either its 1976 or 1985 form.
The Delaware Act was adopted in October 1992. The Act is codified in Chapter 18 of Title 6 of the Delaware Code. To date, the Act has been amended six times with a view to modernization. The LLC is an attractive form of business entity because it combines corporate-type limited liability with partnership-type flexibility and tax advantages.
The Delaware Act has been modeled on the popular Delaware LP Act.
In August 1994, nearly two years after the enactment of the Delaware LLC Act, the Uniform Law Commissioners promulgated the Uniform Limited Liability Company Act (ULLCA).
Policy of the Delaware Act
The basic approach of the Delaware Act is to provide members with broad discretion in drafting the Agreement and to furnish default provisions when the members' agreement is silent.
Although business planners may find comfort in working with the Act in structuring transactions and relationships, it is a somewhat awkward document for this Court to construe and apply in this case. To understand the overall structure and thrust of the Act, one must wade through provisions that are prolix, sometimes oddly organized, and do not always flow evenly. Be that as it may as a problem in mastering the Act as a whole, one returns to the narrow and discrete issues presented in this case.
Freedom of Contract
Section 18-1101(b) of the Act, like the essentially identical Section 17-1101(c) of the LP Act, provides that "[i]t is the policy of [the Act] to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements." Accordingly, the following observation relating to limited partnerships applies as well to limited liability companies:
The Arbitration and Forum Selection Clauses in the Agreement are a Bar to Jurisdiction in the Court of Chancery
In vesting the Court of Chancery with jurisdiction, the Act accomplished at least three purposes: (1) it assured that the Court of Chancery has jurisdiction it might not otherwise have because it is a court of limited jurisdiction that requires traditional equitable relief or specific legislation to act;
Malek LLC's Failure to Sign the Agreement Does Not Affect the Members' Agreement Governing Dispute Resolution
Elf argues that because Malek LLC, on whose behalf Elf allegedly brings these claims, is not a party to the Agreement, the derivative claims it brought on behalf of Malek LLC are not governed by the arbitration and forum selection clauses of the Agreement.
Elf argues that Malek LLC came into existence on October 29, 1996, when the parties filed its Certificate of Formation with the Delaware Secretary of State. The parties did not sign the Agreement until November 4, 1996. Elf contends that Malek LLC existed as an LLC as of October 29, 1996, but never agreed to the Agreement because it did not sign it. Because Malek LLC never expressly assented to the arbitration and forum selection clauses within the Agreement, Elf argues it can sue derivatively on behalf of Malek LLC pursuant to 6 Del.C. § 18-1001.
We are not persuaded by this argument. Section 18-101(7) defines the limited liability company agreement as "any agreement, written or oral, of the member or members as to the affairs of a limited liability company and the conduct of its business."
Notwithstanding Malek LLC's failure to sign the Agreement, Elf's claims are subject to the arbitration and forum selection clauses of the Agreement. The Act is a statute designed to permit members maximum flexibility in entering into an agreement to govern their relationship.
Classification by Elf of its Claims as Derivative is Irrelevant
Elf argues that the Court of Chancery erred in failing to classify its claims against Malek LLC as derivative. Elf contends that, had the court properly characterized its claims as derivative instead of direct, the arbitration and forum selection clauses would not have applied to bar adjudication in Delaware.
In the corporate context, "the derivative form of action permits an individual shareholder to bring `suit to enforce a corporate cause of action against officers, directors and third parties.'"
Although Elf correctly points out that Delaware law allows for derivative suits against management of an LLC, Elf contracted away its right to bring such an action in Delaware and agreed instead to dispute resolution in California. That is, Section 13.8 of the Agreement specifically provides that the parties (i.e., Elf) agree to institute "[n]o action at law or in equity based upon any claim arising out of or related to this Agreement" except an action to compel arbitration or to enforce an arbitration award.
Sections 13.7 and 13.8 of the Agreement do not distinguish between direct and derivative claims. They simply state that the members may not initiate any claims outside of California. Elf initiated this action in the Court of Chancery in contravention of its own contractual agreement. As a result, the Court of Chancery correctly held that all claims, whether derivative or direct, arose under, out of or in connection with the Agreement, and thus are covered by the arbitration and forum selection clauses.
This prohibition is so broad that it is dispositive of Elf's claims (counts IV, V and VI of the amended complaint) that purport to be under the Distributorship Agreement that has no choice of forum provision. Notwithstanding the fact that the Distributorship Agreement is a separate document, in reality these counts are all subsumed under the rubric of the Agreement's forum selection clause for any claim "arising out of" and those that are "in connection with" the Agreement or transactions "contemplated by" or "related to" that Agreement under Sections 13.7 and 13.8. We agree with the Court of Chancery's decision that:
The Court of Chancery was correct in holding that Elf's claims bear directly on Jaffari's duties and obligations under the Agreement. Thus, we decline to disturb its holding.
The Argument that Chancery Has "Special" Jurisdiction for Derivative Claims Must Fail
Elf claims that 6 Del.C. §§ 18-110(a), 18-111 and 18-1001 vest the Court of Chancery with subject matter jurisdiction over this dispute. According to Elf, the Act grants the Court of Chancery subject matter jurisdiction over its claims for breach of fiduciary duty and removal of Jaffari, even though the parties contracted to arbitrate all such claims in California. In effect, Elf argues that the Act affords the Court of Chancery "special" jurisdiction to adjudicate its claims, notwithstanding a clear contractual agreement to the contrary.
Again, we are not persuaded by Elf's argument. Elf is correct that 6 Del.C. §§ 18-110(a) and 18-111 vest jurisdiction with the Court of Chancery in actions involving removal of managers and interpreting, applying or enforcing LLC agreements respectively. As noted above, Section 18-1001 provides that a party may bring derivative actions in the Court of Chancery. Such a grant of jurisdiction may have been constitutionally necessary if the claims do not fall within the traditional equity jurisdiction.
For example, Elf argues that Section 18-110(a), which grants the Court of Chancery jurisdiction to hear claims involving the election or removal of a manager of an LLC, applies to the case at bar because Elf is seeking removal of Jaffari.
Our conclusion is bolstered by the fact that Delaware recognizes a strong public policy in favor of arbitration.
Validity of Section 13.7 of the Agreement under 6 Del.C. § 18-109(d)
Elf argues that Section 13.7 of the Agreement, which provides that each member of Malek LLC "consents to the exclusive jurisdiction of the state and federal courts sitting in California in any action on a claim arising out of, under or in connection with this Agreement or the transactions contemplated by this Agreement ..." is invalid under Delaware law. Elf argues that Section 13.7 is invalid because it violates 6 Del.C. § 18-109(d).
Subsection 18-109(d) is part of Section 18-109 relating to "Service of process on managers and liquidating trustee." It provides:
Section 18-109(d) does not expressly state that the parties are prohibited from agreeing to the exclusive subject matter jurisdiction of the courts or arbitration fora of a foreign jurisdiction. Thus, Elf contends that Section 18-109(d) prohibits vesting exclusive jurisdiction in a court outside of Delaware, which the parties have done in Section 13.7.
We decline to adopt such a strict reading of the statute. Assuming, without deciding, that Section 109(d) relates to subject matter jurisdiction and not merely in personam jurisdiction, it is permissive in that it provides that the parties "may" agree to the nonexclusive jurisdiction of the courts of a foreign jurisdiction or to submit to the exclusive jurisdiction of Delaware.
Conclusion
We affirm the judgment of the Court of Chancery dismissing Elf Atochem's amended complaint for lack of subject matter jurisdiction.
FootNotes
A limited liability company agreement may be entered into either before, after or at the time of the filing of a certificate of formation and, whether entered into before, after or at the time of such filing, may be made effective as of the formation of the limited liability company or at such other time or date as provided in the limited liability company agreement.
In a written limited liability company agreement or other writing, a manager or member may consent to be subject to the nonexclusive jurisdiction of the courts of, or arbitration in, a specified jurisdiction, or the exclusive jurisdiction of the courts of the State of Delaware, or the exclusivity of arbitration in a specified jurisdiction or the State of Delaware....
(Emphasis added.)
Agreement, § 13.8.
Agreement, § 13.7.
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