CLIENT ALERT: Delaware Supreme Court Reverses Oxbow Decision Deploying the Implied Covenant to Force an Exit Sale

In this unanimous en banc decision, the Supreme Court of Delaware held that the Court of Chancery erred in deploying the implied covenant of good faith and fair dealing to imply a seller top-off right in an LLC agreement. The Court found that there was simply no gap in the agreement for the implied covenant to fill. 

The case involved a dispute over whether certain minority members (the “Minority Members”) of Oxbow Carbon LLC had a right to compel an “Exit Sale” of the Company under the terms of Oxbow’s governing LLC Agreement. The Court of Chancery held that the plain language of the LLC Agreement permitted the Minority Members to force a sale of the Company only if the sale price met or exceeded the contractually mandated floor price and if all members received the same terms and conditions in a sale. This would allow certain later added members (the “Small Holders”), who were admitted years after the LLC Agreement was negotiated, to prevent a sale unless it met certain payment conditions. The Court of Chancery, however, found a contractual gap in the LLC Agreement because Oxbow’s board did not specify the terms and conditions under which the Small Holders acquired their units when they were admitted. Deploying the implied covenant to fill that gap, the Court of Chancery concluded that an implied right existed for the Minority Members to force an Exit Sale by topping-off the Small Holders so that they received the contractually mandated floor price.

On appeal, the Supreme Court considered whether the implied covenant was properly used to include the top-off provision in the LLC Agreement to allow the Minority Members to force an Exit Sale. The Minority Members argued that the LLC Agreement contains such a gap because the provision allowing the board to admit new members gives the board discretion to determine the rights of the newly admitted members, and the board failed to define those rights.

The Supreme Court rejected this argument, explaining that the implied covenant only comes into play in two situations: 1) where, as argued in this case, a “situation has arisen that was unforeseen by the parties and where the agreement’s express terms do not cover what should happen;” and 2) “when a party to a contract is given discretion to act as to a certain subject and it is argued that the discretion has been used in a way that is impliedly proscribed by the contract’s express terms.” The Court found that the “LLC Agreement delegates responsibility to the Board to set the terms of admission and permits—but does not require—the Board to issue units with different rights and classes.” Thus, absent the imposition of different rights, newly admitted members have the same rights as all members. In addition, the Court noted that it has “declined in other cases to imply new contract terms merely because a contract grants discretion to a board of directors” and that such a grant of discretion is more appropriately viewed as a contractual choice—not a gap. Further, the Court found that there was no argument that the board exercised its contractual discretion in bad faith in admitting the new members. And, at the time of contracting, the parties expressly contemplated that new members could be admitted and placed certain restrictions on the admission process, indicating that they expressly considered the issue. Thus, no gap existed for the implied covenant to fill. The Court concluded by reiterating “that the implied covenant should not be used as ‘an equitable remedy for rebalancing economic interests’—particularly where, as here, the parties are sophisticated business persons or entities.”

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