A Proposal To Permit Equitable Defenses To Noncompliant Acts That Are Described As 'Void' In An LLC Agreement
May 12, 2023 at 03:40 pm IST
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In CompoSecure v. CardUX, 206 A.3d 808 (Del. 2018), the Delaware Supreme Court held that when parties use the word "void" to describe the consequences of a noncompliant act under an LLC agreement, the act is deemed void ab initio, which as a practical matter, means the act is incurably void. With certain limited exceptions, parties cannot later ratify or voluntary fix void acts, and they may not assert equitable defenses to bar a challenge to an alleged void act. This rule effectively allows parties to an LLC agreement to contract out of equity by describing an act as "void" in their agreement.
The consequences of this rule can be harsh and seemingly incompatible with the role of equity in our jurisprudence to ameliorate such results. Accordingly, in XRI Investment Holdings v. Holifield, No. 2021-0619-JTL, ___ A.3d ___ (Del. Ch. Sept. 19, 2022), faced with substantial evidence of the equitable defense of acquiescence to an alleged noncompliant act under an LLC agreement, the Delaware Court of Chancery could not consider this defense under the precepts of CompoSecure. In XRI Investment Holdings, the court held that a co-founder and LLC member's transfer of his units to an entity that he owned was not a permitted transfer under the LLC agreement because he received consideration in the transfer as part of a larger financing transaction. Hence, the court found that the permitted transferee exception was not available, and violated the "No Transfer" provision under the LLC agreement, which in turn, provided that any transfer that violated the "No Transfer" provision was "void." Bound by CompoSecure, the court declared that the transfer of the co-founder's units was void, which left the units in his hands, instead of his transferee entity. Thus, the units were subject to foreclosure by the plaintiff XRI, which maintained an interest in the units as security for a defaulted loan to another entity owned by the co-founder.
The court explained, however, that if the defense of acquiescence was available, then it would have found that XRI acquiesced in the transfer of the co-founder's units, and was barred from challenging the validity of the transfer. The court found that the co-founder satisfied all of the requirements to prove the defense of acquiescence by XRI. Indeed, XRI's CEO worked with the co-founder to obtain the financing that disqualified the transfer under the permitted transferee exception in the LLC agreement. Hence, the XRI CEO knew about the transfer and related financing at the time that the transfer took place. Moreover, XRI's attorneys subsequently reviewed the transfer, concluded that it violated the "No Transfer" provision, but the XRI board nevertheless made a business decision not to challenge the transfer because at the time, the transfer benefitted XRI in terms of priority of its interests in the units in the transferee entity over the co-founder's general creditors. In short, if the defense of acquiescence was available, the units would have remained with the transferee entity, and the co-founder could have potentially avoided any foreclosure on the units, and the harsh result of allowing XRI to capitalize on his units, the value of which apparently far exceeded the amount due on the XRI loan.
Delaware Business Court Insider | October 26, 2022
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Mr Albert H. Manwaring, IV
Morris James LLP
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CompoSecure, Inc. is a technology partner to fintechs and consumers around the globe. The Company is a provider of premium financial payment cards and cryptocurrency and digital asset storage and security solutions. Its payment card technology and metal cards with Arculus security and authentication capabilities delivers premium branded experiences, enable people to access and use their financial and digital assets, and ensure trust at the point of a transaction. The Company designs and manufactures metal cards, which includes contact and dual interface cards. Its primary metal form factors include Embedded Metal, Metal Veneer Lite, Metal Veneer and Full Metal. The Arculus platform is offered through partner-branded solutions, which include a partner-branded version of the Arculus Key card, as well as some or all of the Arculus Cold Storage Wallet and other Arculus products and/or services. Its clients include international and domestic banks, and other credit card issuers.