Tuesday, June 14, 2016

Entity’s structure barred appointment of non-director to special litigation committee, court says

By Kevin Kulling, J.D.

The Delaware Chancery Court has granted summary judgment to a former board member who challenged the appointment of a retired federal judge to serve as the sole member of special litigation committees for two Delaware limited liability companies. The court said that the appointment was improper because the former judge was not a director or manager as required by the corporate-style governance structure chosen by the entities (Obeid v. Hogan, June 10, 2016, Laster, J.).

The parties. Gemini Equity Partners LLC adopted a governance structure paralleling that of a corporation, while the operating agreement for Gemini Real Estate Advisors, LLC adopted a manager-managed governance structure.

William Obeid brought suit contending that Michael Hogan, a retired federal judge who worked as a mediator, could not serve as the sole member of two parallel special litigation committees.

The Gemini entities jointly managed over $1 billion in real estate assets, including hotels and commercial properties. Obeid managed the day-to-day operations of the hospitality division until he was ousted. The internal affairs of the corporate entity, Gemini Equity Partners, were governed by its limited liability company agreement. The agreement established a governance structure paralleling that of a corporation in which power over the entity is vested in a board of directors. Obeid formerly was one of three board members.

Litigation summary. After the two other board members voted to remove Obeid as president and operating manager of Gemini Real Estate Advisors, Obeid filed an action against the two directors. The action claimed that the two had started competing companies using assets that belonged to the Gemini companies. The complaint asserted claims directly based on his rights as a member of the entities and derivatively on behalf of the entities themselves.

Obeid filed a second action claiming that the directors were improperly selling properties belonging to the Gemini entities to a competitor in return for side benefits. Obeid contended that demand was futile for purposes of the derivative claims because the directors suffered from conflicts of interest and divided loyalties that precluded them from exercising their independent business judgment on the matter.

Law firm hired, former judge appointed. After the actions were filed, the Gemini entities hired a law firm to serve as outside counsel, and Obeid contended the hiring was made without his input. During a joint special meeting, the law firm proposed that a retired federal judge be hired to function as a special litigation committee for each entity to investigate, analyze and make recommendations whether to pursue the derivative claims. While the other two directors voted in favor, Obeid voted against.

After Obeid learned that the other directors had hired former Judge Hogan, he brought a challenge in the Delaware Chancery Court.

Summary judgment for plaintiff. The court agreed that the judge could not serve as a one-man special litigation committee for the entity that adopted a governance structure paralleling that of a Delaware corporation. Because the judge was not a director, under Zapata v. Maldonodo, he therefore could not serve in the special committee capacity.

The court said that the LLC agreement substantially re-created the governance structure of a Delaware corporation using language drawn from the corporate domain. Provisions in the agreement established a board-centric governance model tracking that of a corporation and required that each committee consist of one or more of the directors of the company.

“By embracing the governance structure of a corporation and including provisions paralleling Sections 141(a) and (c), the drafters of the [agreement] evidenced their intent to have corporate principles govern the Corporate Board. Those principles include Zapata, under which only a duly empowered committee of directors can serve as a special litigation committee,” the court said.

Not only was Judge Hogan not able to function as a one-man special litigation committee on behalf of Gemini Equity Partners, he similarly was not able to serve as the sole member of a special litigation committee for Gemini Real Estate Advisors because he was not a manager.

The case is No. 11900-VCL.