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Court Finds Potentially Defective Conversion of an LLC Valid

By | August 15, 2021

Often in M&A transactions one stumbles across conversions to and from LLCs that do not strictly adhere with statutory formalities or terms of related limited liability company agreements.  The Delaware Court of Chancery considered the validity of a conversion of a Delaware LLC to a Puerto Rico LLC in In re Coinmint, LLC which was effected without technical compliance with the Delaware LLC Act and the related Operating Agreement.

As background, the Court found Prieur Leary controlled 18.5% of Coinmint through Mintvest Capital Ltd.   Ashton Soniat controlled the balance of Coinmint through Coinmint Living Trust, or CLT.

On or about January 19, 2018, the Company filed a Certificate of Conversion with the Delaware Secretary of State and the Secretary of State. On January 25, Coinmint domesticated in Puerto Rico. As of that date, Coinmint became and was thereafter operated as a Puerto Rican entity. Mintvest contested the Conversion, claiming that Leary was unaware of the Conversion until September 2019 and that the Conversion was invalid because Leary never authorized it on Mintvest’s behalf.

The Court advised that actions that do not comport with an operating agreement’s terms may be void or voidable. Void acts are those the entity itself has no implicit or explicit authority to undertake or those acts that are fundamentally contrary to public policy. Stated differently, they are acts that the entity lacks the power or capacity to effectuate. Voidable acts are within the power or capacity of an entity, but were not properly authorized or effectuated by the representatives of the entity. The Court also advised that drafters of operating agreements are also free to use their flexibility in contracting to agree that failure to follow certain procedures means an otherwise voidable action is void.

Summarizing, the Court stated where:

  • the Delaware Limited Liability Company Act enables the entity or its representatives to take certain action as distilled in the operating agreement;
  • the operating agreement implements that grant of authority and prescribes certain approvals for effectuating it; and
  • the operating agreement does not expressly deem the action void for failure to obtain those approvals,

that action will be “voidable, not void,” as the entity and its representatives could have carried out the action had “the proper approvals had been obtained.” Such voidable breaches of LLC agreements are subject to equitable defenses, including waiver, estoppel, and laches.

Coinmint’s Operating Agreement did not specify the manner of authorizing a conversion.  Therefore the Court reviewed the Delaware Limited Liability Company Act. Section 18-216 of the Act governs conversion of a Delaware limited liability company. Section 18-216(b) supplies a default rule that is subject to contractual variation, not a mandatory rule.  It provides that if the limited liability company agreement does not specify the manner of authorizing a conversion of the limited liability company and does not prohibit a conversion of the limited liability company, the conversion shall be authorized in the same manner as is specified in the limited liability company agreement for authorizing a merger or consolidation that involves the limited liability company as a constituent party to the merger or consolidation.

The Operating Agreement’s relevant terms required two steps to effect a merger:

  • majority Member consent under Section 4.6,
  • followed by formal Board approval via meeting or written consent, under Sections 4.3(f) and 4.4.

It was undisputed that the Managers did not approve the Conversion at a board meeting or secure written consents. But in view of CLT’s majority stake and the interplay of Sections 4.3(f), 4.4, and 4.6, that failure rendered the Conversion voidable under the Operating Agreement, rather than void.

Section 4.6 of the Operating Agreement conditioned the Board’s power to effectuate a conversion on the consent of a “Majority of Members” who “in the aggregate, own more than fifty percent (50%) of the Sharing Ratios owned by all of the Members.”  That provision provided:

Notwithstanding anything to the contrary contained in this Agreement, without the consent of Majority of Members, neither the Board nor any Manager or Officer shall have the power or authority . . . . [t]o effect a merger or plan of exchange of the Company . . . .

Failure to obtain that majority consent would strip the Board and any Manager of its power to effectuate a merger, or, in this case, the Conversion. If a conversion were completed without the consent of the Majority of Members, then it would be void ab initio, not voidable.

But in other parts of the opinion the Court found Mintvest was diluted to 18.2%, and CLT held 81.8%. CLT alone “own[ed] more than fifty percent (50%) of the Sharing Ratios owned by all of the Members.” So CLT alone could give consent of the “Majority of Members” and did so. As a result, the Board retained the power to authorize the Conversion.

With majority Member consent, conversion must then follow Section 4.4 of the Operating Agreement, which provides that “all actions of the Board provided for here in shall be taken either at a meeting and evidenced by written minutes thereof . . . or by written consent without a meeting.”

If a conversion is challenged because the Board did not formally authorize it under Sections 4.3(f) and 4.4, that failure is voidable and subject to equitable defenses. CLT and Mintvest’s failure to comply with Section 4.3 and 4.4’s formalities on Coinmint’s behalf is ratifiable because the Company could lawfully accomplish it “if it d[id] so in the appropriate manner.”

The Court held Mintvest’s challenge to the Conversion as improperly authorized under Sections 4.3(f) and 4.4 was barred by the equitable defenses.  The record showed Leary was intimately involved in pursuing redomestication in Puerto Rico and invoked that decision in several Company initiatives.  Nothing in the record indicated that Leary objected to the Conversion as it was taking place or after.  The record reflected that Leary participated in the Conversion and did not object to it on Mintvest’s behalf until filing the action in the Delaware Court of Chancery. Because Leary  confirmed the Conversion on multiple occasions he therefore waived the Operating Agreement’s Board vote and consent requirements.

Contact Steve Quinlivan for more information.

Topics: 
M&A, Private Equity