Delaware Court of Chancery Dismisses Claims Relating to Sale of Company Against Private Equity Majority Owner

Background

In 2017, WP Investors acquired a majority stake in CityMD, an urgent care provider with locations in New York and New Jersey originally owned by its physician members, including plaintiffs. In August 2019, CityMD entered into a merger with Summit Medical Group, which resulted in a new Delaware limited liability company called WP CityMD Topco LLC (“CityMD” or the “Company”). Following the 2019 merger, WP Investors owned Class A units representing a 60% ownership interest in the Company, with CityMD’s non-Warburg investors holding a 17% interest via ownership of the Company’s Class B units. The relationship among the unitholders was governed by the Limited Liability Operating Agreement of WP CityMD Topco LLC (the “LLC Agreement”).

As relevant here, the LLC Agreement provided two forms of protection for minority unitholders (the “Minority Protection Provisions”). First, each class of unitholders was to receive the “same form and amount of consideration” based on their “[p]ro [r]ata [p]ortion” in the event of an “Extraordinary Transaction,” which included any transaction involving a change in control. Minority unitholders also enjoyed tag-along rights, which allowed them to participate in future secondary sale transactions on the “same terms as private equity-affiliated members.” The LLC Agreement provided that these provisions could be amended upon the consent of the majority of any class of unitholders whose rights would be adversely affected. Central to the court’s opinion, the LLC Agreement also stated that WP Investors owed no fiduciary or other duties to the Company or its members beyond a duty to comply with the LLC Agreement. So long as WP Investors complied with the terms of the LLC Agreement, they were permitted to “act exclusively in … their own interest and without regard to the interests of any other person.”

In November 2022, CityMD executed a merger agreement with Village Practice Management Company LLC (“VillageMD”), a primary care-provider majority owned by Walgreens. The terms of the merger agreement with VillageMD included a variable compensation structure for the Company’s investors dependent on the class of units held. Class A unitholders would receive all cash consideration, while Class B unitholders would receive a mix of cash and equity in VillageMD (more specifically, WP Investors would receive approximately $3.3 billion cash while minority unitholders would receive approximately $1.6 billion cash and $2.05 billion equity). Due to the disparate consideration contemplated by the merger agreement, the LLC Agreement was required to be amended to remove the Minority Protection Provisions, and the merger was conditioned on securing such amendment. After the merger agreement was signed, Class B unitholders received a “detailed information statement” regarding the merger, separate outside counsel was retained for minority unitholders, and the Company also held several information sessions to discuss the merger with unitholders. The requisite votes for the amendment and merger were eventually secured, with both named plaintiffs voting in favor. The transaction closed on January 3, 2023. About a year later, Walgreens disclosed a $12.4 billion goodwill impairment charge on VillageMD due to downward revisions in the company’s forecasted financial results. The plaintiffs, former class B unitholders, filed this purported class action four weeks later.

Takeaways

Parties cannot rely on the covenant of good faith and fair dealing to end-run the express terms of a contract. The complaint contained no allegations of violations of the LLC Agreement, relying principally instead on a claim for breach of the implied covenant of good faith and fair dealing in connection with the elimination of the minority’s tag-along right. Plaintiffs argued that there was an “implicit term” in the LLC Agreement prohibiting the WP Investors from taking any action to frustrate the Class B unitholders’ minority protections. The court rejected this argument, holding that the covenant of good faith and fair dealing is “‘best understood as a way of implying terms in [an] agreement, whether employed to analyze unanticipated developments or to fill gaps in the contract’s provisions.’ It ‘does not apply when the contract addresses the conduct at issue, but only when the contract is truly silent concerning the matter at hand.’” Stated differently, it only can apply where “the contract has a gap,” and may not be “used to circumvent the parties’ bargain.” Here, the “LLC Agreement explicitly addressed the matters at issue,” setting out “requirements to amend its terms,” therefore leaving “no gap for the implied covenant to fill.” In particular, the LLC Agreement, in provisions typical for private-equity controlled businesses, permitted amendments that “‘disproportionately affect in a material and adverse manner’ a class of unitholders relative to another class so long as the amendment receives the ‘prior written consent’ of a majority of the affected class.” As a result, according to the court, the implied covenant could not be used to “infer language that contradicts a clear exercise of an express right.”

There is no claim for coercion in the absence of fiduciary duties. Plaintiffs also asserted that the LLC Agreement contained an implied term that WP Investors and the Company would not eliminate the Minority Protection Provisions through a “coerced” amendment to permit differential consideration. Plaintiffs claimed that this implied term, which reflected their “reasonable expectations when they signed the LLC Agreement,” prevented conditioning the minority’s ability to obtain the merger consideration on waiving these provisions. The court refused to see it this way, characterizing plaintiffs’ claims as “wish[ing] for a different deal.” The deal plaintiffs actually agreed to “expressly allowed the WP Investors to ‘act exclusively in [their] own interest[s] and without regard to the interest of any other Person.’” It also provided in multiple provisions that, to “the fullest extent permitted by law,” no LLC member, manager, or — to the extent affiliated with WP Investors — officer of the Company “shall have any fiduciary or other duty to the Company or its Subsidiaries or Members” other than to comply with the LLC Agreement. Therefore, there was “no reasonably conceivable basis to conclude the WP Investors or Company’s actions ‘frustrat[ed] the fruits of the bargain that the [plaintiffs] reasonably expected.’”

Delaware courts will uphold elimination of fiduciary duties in the LLC context. The court squarely rejected plaintiffs’ contention, based on analogies to controlling stockholder caselaw, that “wrongful conduct ‘in the corporate context’ constitutes a ‘violation of the LLC Agreement.’” In analyzing an implied covenant claim, the court “is not resolving whether a ‘fiduciary acted fairly when engaging in the challenged transaction as measured by duties of loyalty and care.’” Instead, the court measures “good faith” and “fairness” against the “terms and purpose of the contract.” In short, “fiduciary duty claims are not a replacement for implied covenant claims.” To the contrary, “Delaware law upholds the elimination of fiduciary duties in LLC agreements,” and respecting that principle mandates that courts not “‘bend an alternative and less powerful tool’ — the implied covenant — ‘into a fiduciary substitute.’”

The court addressed the importance of accurate disclosure to minority unitholders in seeking their prior approval of the LLC Agreement amendments. Plaintiffs argued that the implied covenant required “full material disclosure” before the vote, and that the information statement lacked “all material information” regarding the elimination of tag-along rights and WP Investors’ conflicts of interest. In rejecting this argument, the court observed that the information statement accurately disclosed the disparate consideration to be paid to WP Investors and minority unitholders, and that the purpose of the amendments was to permit such a result. The information statement also disclosed that Alston & Bird was retained as counsel for the minority, and that unitholders could contact the firm with any questions regarding the transaction. In addition, the LLC Agreement addressed notice to unitholders and required only “[r]easonable and sufficient notice of each [member] meeting” to Class A and Class B unitholders. The court reasoned that if the parties desired to address substantive disclosures, they could have done so via an express provision in the LLC Agreement. The court’s conclusion should serve as an important reminder that, notwithstanding the flexibility afforded WP Investors in the LLC Agreement, where a contract requires a vote in order to consummate a transaction, the vote needs to be based on accurate disclosure of material information. If the information statement had omitted certain material information, the court could have determined that the consent to eliminate the Minority Protective Provisions was invalid, despite ostensible compliance with the LLC Agreement.

Delaware courts continue to vindicate the contractual rights and obligations of limited liability company and limited partnership members. Khan is just the most recent Delaware decision to reaffirm Delaware’s strong respect for freedom of contract in the LLC or LP context. See, e.g., AG Mobile Holdings LP v. HIG Mobile LPI, 2025 WL 501088, at *11-12 (Del. Ch. Feb. 13, 2025) (rejecting an implied covenant claim in favor of enforcing the express terms of the limited partnership agreement); Cantor Fitzgerald AP v. Ainslie, 312 A.3d 674, 692 (Del. 2024) (concluding that forfeitures in limited partnership agreements should enjoy equal footing with any other bargained for contractual term); Exit Strategy, LLC v. Festival Retail Fund BH, L.P., 2023 WL 4571932, at *18-19 (Del. Ch. July 17, 2023) (holding that an implied covenant claim cannot resurrect fiduciary duties expressly replaced in the limited partnership agreement).

Contractual governance arrangements in the corporate context are significantly more complex. The freedom of contract principles animating respect for the governance arrangements in Khan do not translate neatly to the corporate context. Indeed, Vice Chancellor Will repeatedly drew distinctions between the contract law principles governing the LLC Agreement and fiduciary duty principles that apply to corporate directors, officers, and controllers. That is not to say corporate stakeholders cannot impact governance via contractual arrangements. For example, the recently enacted Delaware General Corporation Law (DGCL) Section 122(18) empowers corporations to contract with stockholders (in exchange for such minimum consideration as determined by the board of directors), including to confer broad governance rights on stockholders, so long as the contract is not contrary to the certificate of incorporation or would be contrary to Delaware law if contained in the certificate of incorporation (other than choice of forum provisions). Section 122(18) was enacted in response to a Delaware Court of Chancery decision, West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, invalidating a stockholder agreement conferring broad consent powers on the company’s founder (in his capacity as a stockholder) over actions typically within the board’s discretion to approve. The Moelis court reasoned that the agreement violated DGCL Section 141(a), providing that every Delaware corporation “shall be managed by or under the direction of a board of directors, except as may be otherwise provided in [the DGCL] or in [the corporation’s] certificate of incorporation.” Section 122(18) provides a non-exhaustive list of permissible provisions in such stockholder agreements, including that the corporation may agree to: (a) restrict or prohibit itself from taking actions specified in the contract, (b) require the approval or consent of one or more persons before taking specified actions, and (c) covenant that the corporation or one or more persons will take, or refrain from taking, actions specified in the contract.

While reflecting a freedom-of-contract ethos, there are important limitations on the impact of the provision. For instance, the corporation’s charter can expressly limit the permissible scope of stockholder agreements. In addition, Section 122(18) does not relieve directors, officers, or controlling stockholders of their fiduciary obligations, including with respect to entering into, performing under, or breaching a stockholder agreement. All of which is to say that corporate stakeholders need to carefully consider any potential intra-corporate contractual arrangements against the requirements of the corporation’s charter, the DGCL, and the board’s fiduciary duties as articulated in existing caselaw.

The Khan decision, in dicta, calls into question the ability to rely on releases contained in letters of transmittal where the release is not contained or referred to in the merger agreement itself. The merger agreement required minority unitholders to sign and return a letter of transmittal to receive the merger consideration. The transmittal letter “included a broad release concerning the Merger Agreement and Amendment” of the LLC Agreement. Both of the plaintiffs “signed and returned letters of transmittal, receiving millions of dollars in merger consideration.” Given its decision, the court did not need to decide whether the releases were enforceable, as defendants argued, or unenforceable for lack of consideration, as asserted by plaintiffs. The court observed, however, that the issue was not clear cut: the information statement “told unitholders that the releases were a condition to receiving the merger consideration and the Merger Agreement attached a copy of the letter of transmittal,” but, at the same time, the merger agreement “did not mention the releases in the body of the agreement itself and was signed before the Information Statement discussing the releases was distributed.” While the court did not decide whether this omission would have rendered the releases unenforceable, for future drafting, it is worth considering making clear in the merger agreement that the letter of transmittal and any release and covenants contained therein are conditions to receipt of merger consideration.

This has been published by Harvard Law School Forum on Corporate Governance.