Delaware Chancery Court Orders Venture Capital Firm To Increase Terminated LLC Member's Payout In Post-Trial Opinion

Author:Mr Jason Halper, Nathan M. Bull and James Fee
Profession:Cadwalader, Wickersham & Taft LLP
 
FREE EXCERPT

On August 13, 2018, Vice Chancellor Travis Laster of the Delaware Court of Chancery ordered Domain Associates, LLC ("Plaintiffs," "Domain," or the "Firm"), a venture capital firm, to pay its former member, Nimesh Shah ("Defendant" or "Shah"), the fair value of his 12.1% member interest as of the date he was forced to withdraw from the LLC, potentially worth millions of dollars. Domain had contended that Shah was entitled only to the amount of his capital account balance, or approximately $438,000. In his post-trial opinion, Vice Chancellor Laster also found the individual members of Domain jointly and severally liable for breaching the Domain LLC Agreement when they voted to force him to withdraw on April 18, 2016 but did not pay him his share of the fair value of the business. Significantly, after concluding that the LLC Agreement was silent as to the payout for a forced-out member, the Court looked not only to the Delaware Limited Liability Company Act (the "LLC Act") but also to the Delaware Revised Uniform Partnership Act (the "Partnership Act") for guidance because Domain operated in a manner akin to a general partnership, as distinct from other governance structures. The decision provides important guidance for drafting operating agreements governing Delaware entities, understanding the potential sources of law that may guide a court adjudicating intra-entity disputes, and in litigating disputes involving these agreements.

BACKGROUND

Founded in 1985, Domain is a venture capital firm that at the relevant time focused on the biopharmaceutical, diagnostic, and medical device sectors, the last of which was Shah's area of expertise. The LLC Agreement permitted the members to force any other member to withdraw from the Company provided that the vote of the non-withdrawing members was unanimous. The LLC Agreement also addressed members who voluntarily retire or withdraw by operation of law due to insanity, bankruptcy, or death. In those instances, the LLC Agreement provided that such withdrawing member shall be paid "in exchange for his entire interest in the Company, an amount equal to . . . Member's capital account." The LLC Agreement was silent as to the amount to be paid following a forced withdrawal.

Shortly after Shah became an equity member, Domain began to question its commitment to medical device investments. On January 19, 2016, Domain's founders asked Shah to leave and proceeded to engage Shah in several months of discussions regarding the economic terms of his departure. After Shah rejected Domain's terms and refused to withdraw voluntarily, the other members voted unanimously to force Shah to withdraw on April 18, 2016. Domain and its members took the position that, upon his forced withdrawal, Shah was only entitled to the value of his capital account in return for his member interest. According to Domain's records, Shah's capital account had a balance of $438,353.05, and Domain sent Shah a check for that amount. Shah returned the check and asserted that he was entitled to 12.1% of Domain's cash on hand on his withdrawal date, or $1,553,667, because he viewed that amount to be the fair value of his interest.

THE DECISION

After reviewing the terms of the...

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