Amendment to LLC Agreement Tightens Indemnification But Cannot Remove LLC’s Obligation to Indemnify Against Prior Lawsuit

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Amendment to LLC Agreement Tightens Indemnification But Cannot Remove LLC’s Obligation to Indemnify Against Prior Lawsuit

LLC operating agreements sometimes indemnify members, managers, and employees against claims and lawsuits. And like any other agreement, LLC operating agreements can be amended. In a recent Delaware Court of Chancery case, an amendment to an LLC’s operating agreement narrowed the indemnification provisions in a way that precluded an employee’s claim for indemnification against a prior lawsuit. The employee objected that the amendment could not take away his right to be indemnified, and the court agreed. Branin v. Stein Roe Inv. Counsel, LLC, C.A. No. 8481-VCN, 2014 WL 2961084 (Del. Ch. June 30, 2014).

Background. Francis Branin was owner and CEO of a wealth management firm that provided investment counseling and asset management services for high-net-worth individuals. In 2000 his firm was sold, and in 2002 Branin resigned and joined Stein Roe Investment Counsel, LLC (Stein LLC). Later that year Branin’s former company sued him in New York for soliciting his former clients, claiming that he breached an implied covenant that New York law imposed on the seller of a business. That litigation dragged on for ten years, but Branin defended successfully and all claims against him were eventually dismissed.

When Branin joined Stein LLC, its operating agreement contained a broad indemnification clause (the First Version):

To the full extent permitted by applicable law, each Member, Manager or employee of the Company shall be entitled to indemnification from the Company for any loss, damage or claim by reason of any act or omission performed or omitted by such Person in good faith on behalf of the Company and, as applicable, in a manner reasonably believed to be within the scope of the authority conferred on it by this Agreement ….

Id. at *2. This language fairly clearly applied to the lawsuit against Branin and obligated Stein LLC to defend Branin or to cover his defense costs.

A few months after Branin was sued by his former employer, however, Stein LLC amended the indemnification clause to exclude claims for damage incurred by reason of the indemnified party’s “breach of any agreement, express or implied, entered into by such Person with one or more outside parties prior to such Person’s association with the Company” (the Second Version). Id. at *3 (emphasis omitted). The former employer claimed in the New York litigation that Branin breached an implied covenant, so the revised indemnification, if applicable to Branin, would exclude him from its coverage.

When Branin later requested Stein LLC to indemnify him for his New York litigation expenses, the company refused. Branin then filed suit in Delaware seeking indemnification for his attorneys’ fees and costs, which over ten years amounted to more than $3 million.

Court’s Analysis. The principal question in the case was whether Branin had a right to indemnification under the First Version and whether it was superseded by the Second Version. The court first looked to the Delaware LLC Act, which broadly authorizes LLCs to indemnify managers, members, or other persons, subject to standards and restrictions set forth in the LLC agreement. Del. Code Ann. tit. 6, § 18-108. The court then reviewed the language of the First Version and straightforwardly determined that it gave Branin a right to indemnification.

The more complex question was whether the Second Version applied to Branin and superseded the First Version. The court began by examining the policies justifying indemnification. Entities indemnify employees, officers, or directors to encourage them to work for or serve the entity. In this case the First Version was in place when Branin went to work for Stein LLC, and the company benefited from his services. The court then examined several corporate indemnification cases and determined that they generally measured the obligations of the indemnifying company at the time of the events giving rise to the claim or when the lawsuit involving the claim was filed. The court also emphasized the “to the full extent permitted by applicable law” language in the First Version.

The court determined that the First Version created an enforceable right in Branin to be indemnified, which vested when the lawsuit against him was filed. Because Branin’s right was vested it could not be defeated by the Second Version’s later amendment to the indemnification clause.

Stein LLC also argued that Branin was not entitled to indemnification because he was sued in his own personal capacity, not because of actions on behalf of Stein LLC. The court rejected that argument, finding that there was an adequate nexus or causal connection between the New York litigation and Branin’s position with Stein LLC. Branin was an employee of Stein LLC, Stein benefited from the clients who followed Branin when he joined Stein, and the New York litigation involved claims that Branin had improperly solicited the clients of his former company.

The court concluded that the plain meaning of the First Version gave Branin a right to indemnification for the New York lawsuit, and that his right vested and was not rescinded by the Second Version. Branin was not granted judgment on his pleadings, though, because the court determined that there were material factual issues remaining concerning whether he acted in good faith and in a manner he reasonably believed to be within the scope of his authority, as required by the operating agreement. Branin,2014 WL 2961084, at *10.

Comment. Indemnification clauses are often viewed as technical boilerplate. Sometimes they are written in text so dense and turgid that you would think the drafter was being paid by the word with a bonus for unintelligibility. Which is a shame, because the basic concept is fairly simple: indemnification is a way of shifting risk from one party to another. LLC indemnification clauses like the First Version in Branin reflect a business commitment from an LLC to its managers, members, and employees. The commitment is that if are they working for the LLC or acting on its behalf and as a result are sued by a third party, the LLC will defend them, cover the cost of the lawsuit, and pay any award of damages. As the Branin court discussed, such a promise is an inducement to get people to serve in those positions.

Against that backdrop, the result in the Branin case makes perfect sense. An employee goes to work for an LLC whose operating agreement broadly indemnifies employees against third party claims. Later the employee is sued for activities on behalf of the LLC, and rightfully expects the LLC to indemnify him. The LLC, then faced with upholding its promise, amends the operating agreement to renege on its promise and take away its indemnification? Too clever by half, and the Chancery Court opinion in Branin rather thoroughly rejects that ploy.

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