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October 22, 2019

Wenske v. Blue Bell Creameries, Inc.: Delaware Court of Chancery Illuminates Limits of Zapata Special Litigation Committees in Alternative Entity Context.

Wenske v. Blue Bell Creameries, Inc.: Delaware Court of Chancery Illuminates Limits of Zapata Special Litigation Committees in Alternative Entity Context.

 

By Michelle P. Quinn, Esq. and Richard I. G. Jones, Jr., Esq.

 

In Wenske v. Blue Bell Creameries, Inc.[1], the Delaware Court of Chancery held that a corporate general partner of a Delaware limited liability partnership could not employ a special litigation committee (“SLC”) to wrest control of derivative litigation back from plaintiff limited partners after the Court had previously determined that demand against the general partner was excused as futile.  Not only does the case highlight important distinctions between the use of SLCs in the corporate and alternative entity contexts; the decision also suggests ways that operating agreements could be drafted to avoid a similar outcome.

Wenske arose out of a tragic bacterial outbreak at America’s third largest ice cream manufacturer that left three people dead and cost Blue Bell a 50% decline in revenues and widespread layoffs.  In a July 2018 opinion,[2] the Court of Chancery partially denied defendants’ motion to dismiss after determining that the limited partners of Blue Bell Creameries, LLP (the “Partnership”) were excused from making a pre-suit demand on the corporate general partner, Blue Bell Creameries, Inc. (“BBGP”), because BBGP faced a substantial likelihood of liability for breach of its contractual duties under the Partnership’s limited partnership agreement (LPA).[3]

Almost a year after the Court’s ruling on the motion to dismiss, BBGP’s board appointed two new directors and designated them the sole members of a special board committee.  The special committee then appointed three non-board members to serve on a special litigation committee (“SLC”) and empowered the SLC to investigate and decide whether pursuing the limited partners’ claims was in the Partnership’s best interest.  Defendants moved to stay the litigation to allow the SLC time to complete its investigation and plaintiffs opposed this motion.

After noting that litigation is typically stayed to allow for a validly initiated SLC investigation, the Court addressed the threshold question of whether the SLC was properly constituted.  In the corporate context, this inquiry entails performing a “head count” to determine whether a majority of the directors is independent; however, in the alternative entity context, “the court does not draw a distinction between a general partner and the members of its board of directors when assessing conflicts.”[4]  Instead, the conflict analysis “focuses on the general partner as an entity, not the individual members of its decision-making apparatus.”[5]

This means that, “unless the limited partnership has agreed to include features of a corporation’s governance structure that would mandate a different approach, the court makes no determination of conflicts at the board level when assessing whether a corporate general partner is fit to consider a demand.”[6]  The Court went on to explain the implication of this distinction:

[A]n exclusive general partner, in contrast to a conflicted corporate board, retains no power to investigate a derivative claim or to determine whether to pursue the claim once the general partner has been deemed conflicted.  And the general partner cannot cure its disability by appointing new members to its board of directors, or by contacting out its authority to manage the litigation asset to third parties because it no longer has that authority.[7]

After observing that the Delaware Revised Uniform Limited Partnership Act (“DRULPA”) and the LPA allowed BBGP to appoint an agent to act on its behalf, the Court referenced agency principals to determine that, by virtue of a principal’s inherent control over an agent, any agent appointed by BBGP would necessarily be disabled by BBGP’s conflict of interest.  Accordingly, “the Court’s finding that BBGP is disabled from considering a demand ends the inquiry.”[8] The Court therefore declined to stay discovery.

For transactional attorneys, special care should be taken in drafting operating agreements for alternative entities to avoid a situation in which the entity itself is unable to act due an inability to cure a conflict at the management level.  Providing a mechanism in the operating agreement of an entity to resolve such conflicts when the primary management of the entity is otherwise conflicted would prevent situations such as that found in Wenske.  Such provisions also have broader application outside the special litigation committee context, potentially permitting the cure of other conflicts that may prevent an entity from acting in its own best interest and the best interests of its equity holders.

From a litigators standpoint, we note that this decision has been certified by the Court of Chancery for interlocutory appeal to the Delaware Supreme Court, with oral argument expected early in 2020.  Please stay tuned for more developments on this interesting issue following the Supreme Court’s decision.

Ms. Quinn is a partner in the corporate transactional group at Berger Harris LLP.  Ms. Quinn’s practice focuses on advising partnerships, limited liability companies and business trusts on matters of Delaware law, particularly regarding entity governance, contract interpretation and fiduciary duties.

Mr. Jones is a partner in the corporate and commercial litigation group at Berger Harris LLP.  Mr. Jones litigates a wide range of matters involving Delaware corporations and alternative entities, primarily in the Delaware Court of Chancery and Commercial Division of the Delaware Superior Court.

[1] Wenske v. Blue Bell Creameries, Inc., 2019 WL 4051007 (Del. Ch. Aug. 28, 2019), Slights, V.C.

 

[2] Wenske v. Blue Bell Creameries, Inc., 2018 WL 3337531 (Del. Ch. July 6, 2018).  This decision is worth reading in its own right because, inter alia, it illustrates that demand excusal in the alternative entity context is heavily dependent upon the terms of the entity’s organizational documents.

[3] Id. at *19.

 

[4] Wenske, 2019 WL 4051107 at *4.

 

[5] Id.

 

[6] Id. (citing DiRenzo v. Lichenstein, 2013 WL 5503034, at *18 (Del. Ch. Sept. 30, 2013), holding that demand is required where board of corporate general partner was elected by and owes fiduciary duties to limited partners). [PULL AND ANALYZE CASE].

[7] Id.

 

[8] Id. at *6.