United States: Chancery Court Reiterates 'Contractarian' Nature Of LLC Law

Finding that sometimes "a lie is just a lie," the Delaware Chancery Court, in an opinion deciding a dispute between rival Italian grocers in Rehoboth Beach, Del., reinforced the principle that Delaware LLC law is "contractarian" and held that the plain meaning of an operating agreement trumped claims stemming from a "lie" by a withdrawing member of an LLC.

The dispute in Touch of Italy Salumeria & Pasticceria v. Frank and Louie's Italian Store, C.A. No. 8602-VCG (Del. Jan. 13, 2014), arose from the withdrawal by Louis Bascio as a member of the Touch of Italy Salumeria & Pasticceria LLC, and his subsequent opening of a competing Italian deli and grocery store, Frank and Louie's Italian Store on the same block as Touch of Italy.

Touch of Italy's amended and restated limited liability company agreement provided that a member could withdraw after giving notice. Bascio gave notice of his withdrawal as a member and told the other members of Touch of Italy that he was moving to Pennsylvania and would not compete with Touch of Italy after his withdrawal. Ten weeks later, Bascio and his brother Frank Bascio formed Bascio Bros. Italy LLC, which then opened Frank and Louie's.

Touch of Italy argued that Louis Bascio's "lie" gave rise to a breach of the LLC agreement, a breach of fiduciary duty to the company and his fellow members and a breach of the covenant of good faith and fair dealing under the LLC agreement.

The court found that the LLC agreement in clear terms permitted each member the right of withdrawal, and did not put any constraint on post-withdrawal competition. Further, the LLC agreement did not require that a withdrawing member obtain consent from one or more other members. The court concluded that even with all reasonable inferences drawn in the plaintiffs' favor, there were no grounds to find a breach of contract.

"This particular LLC agreement was written to allow members to readily withdraw, without triggering any obligation to forgo competition thereafter. Thus, Louis [Bascio] faced no legal impediment to withdrawing and opening Frank and Louie's as a competing grocery."

The court reasoned that had Louis Bascio been candid with the other members about his plans to compete, the other members could not have prevented his withdrawal from the company and could not have prevented him from competing with Touch of Italy.

Vice Chancellor Sam Glasscock III found it significant that there was no noncompete provision in the LLC agreement, while such provisions are a common contract term. "In reality, this complaint is an attempt to achieve a result-restraint on post-withdrawal competition-that the members could have but chose not to forestall by contract," he said.

The court similarly dismissed counts for fraud and negligent misrepresentation because of the absence of reliance, a necessary element in each count. The complaint alleged Louis Bascio misrepresented that he intended to withdraw from Touch of Italy to open a competing business, both actions that are permitted under the LLC agreement. The plaintiffs' argument that, armed with knowledge of Louis Bascio's true intent, they would have "objected" is "legally meaningless."

Glasscock found that the claims were "an attempt to bootstrap a tort (or equitable) claim out of the contract claim that I have already found to be illusory."

The court also denied a claim for breach of the covenant of good faith and fair dealing, which "applies to prevent a party from denying his contractual partners the benefit of their bargain based upon a circumstance unanticipated by the parties." Glasscock held that the right of a member to withdraw was specifically addressed in the LLC agreement. And the possibility that a member might withdraw and engage in competition with Touch of Italy was foreseeable.

"The members here decided to forgo such a contractual provision, an omission the plaintiffs obviously now regret," Glasscock said.

The court reasoned that to grant the plaintiffs' claim would be to impose a noncompete provision where none exists, which would be "in direct contravention of the policy behind the law pertaining to LLCs, which supports the right to contract freely."

The court also rejected the plaintiffs' theory that Louis Bascio had breached his fiduciary duties. The court, without deciding whether Bascio had fiduciary duties to the members and the company, found that there were no factual allegations relevant to the time when Bascio was a member of Touch of Italy. Instead, the claim is focused on the formation of a competing business 10 weeks after his withdrawal. Because Bascio did not owe any fiduciary duties after his withdrawal from the company, the claim failed.

"Delaware's law with respect to LLCs, as this court has repeatedly noted, is explicitly contractarian; it allows those associating under this business format to structure their relationship in the way they believe best suits them and their business," the court held.

Previously published by the Delaware Business Court Insider

Michael R. Lastowski is a member of Duane Morris and the head of its Wilmington office. Licensed to practice in Delaware, Pennsylvania and New York, he primarily represents Chapter 11 debtors. Christopher M. Winter, a partner with the firm, is a Delaware business lawyer who focuses his practice on Chapter 11 bankruptcy law and proceedings, commercial and corporate finance and transactions, and Delaware corporate and alternative entity law.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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