{"id":262,"date":"2024-08-09T16:28:18","date_gmt":"2024-08-09T20:28:18","guid":{"rendered":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/?p=262"},"modified":"2024-08-26T16:20:14","modified_gmt":"2024-08-26T20:20:14","slug":"breaching-on-purpose-what-to-do-about-willful-breach","status":"publish","type":"post","link":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/2024\/08\/09\/breaching-on-purpose-what-to-do-about-willful-breach\/","title":{"rendered":"Breaching on Purpose: What to Do About “Willful Breach”"},"content":{"rendered":"

One of the hallmarks of contract law is that it is not fault-based.\u00a0 A court, and especially a \u2018contractarian\u2019 Delaware court, only looks at whether <\/i>a party performed the duties the contract imposes, not why.\u00a0 <\/i>If parties want to be able to excuse performance for the \u2018right\u2019 reasons, or to trigger extra protections against breach for the \u2018wrong\u2019 reasons \u2013 that is, if they want to depart from the default no-fault analysis \u2013 then they need to write those reasons into the contract language itself.\u00a0 In the recent XRI Investment Holdings, LLC v. Holifield<\/i><\/a>\u00a0<\/i>decision, the Court of Chancery examined a contract that did just that, containing provisions triggered by a finding of \u201cwillful breach,\u201d but left that term undefined.\u00a0 Thus, the Court had to answer the question: what is <\/i>a \u201cwillful breach\u201d of contract?<\/p>\n

In XRI<\/i>, an LLC\u2019s operating agreement required the LLC to advance legal fees to its members for LLC-related litigation, but allowed the LLC to recoup those fees if the litigation found the member had acted with \u201cgross negligence or willful breach\u201d of the LLC operating agreement. In the litigation, the LLC sued a member to challenge the putative transfer of the member\u2019s membership interest in the LLC to an entity he controlled.\u00a0 In accordance with the agreement, the LLC advanced the member\u2019s legal fees to defend against the LLC\u2019s suit against him.\u00a0 The LLC prevailed in a 2022 decision<\/a> that found the transfer breached the LLC\u2019s operating agreement and was void, a finding the Delaware Supreme Court affirmed in an opinion last year<\/a>.\u00a0 In these post-remand proceedings, the LLC sought to recoup those previously-advanced legal fees under the argument that the member\u2019s attempt to transfer his membership interest had \u201cwillfully breached\u201d the LLC operating agreement.<\/p>\n

As the Court explained, clauses specifying remedies for \u201cwillful\u201d breach are common in commercial contracts, especially in merger agreements,\u00a0but more often than not, the commercial contracts themselves do not supply a definition of \u201cwillful breach.\u201d\u00a0 In addition, despite the frequency of undefined \u201cwillful breach\u201d clauses, no prior Delaware decision provided a default definition.\u00a0 \u00a0 Scholarly sources the Court examined suggest three different possible measures of when a breach of contract becomes \u2018willful.\u2019<\/p>\n

Under the most expansive standard, a breach\u00a0is \u2018willful\u2019 if the breaching party simply did the breaching act on purpose.\u00a0 A middle definition further requires the breaching party to subjectively understand at the time that the act violated the contract.\u00a0 A narrow definition requires a further showing that the breaching party acted with malice.<\/p>\n

The XRI<\/i> decision does not identify a one-size-fits-all definition of willful breach.\u00a0 But in evaluating the facts of this case, since \u201cwillful breach\u201d followed \u201cgross negligence\u201d in the same sentence of the operating agreement,\u00a0the Court construed such placement as embodying a meaning that goes beyond mere voluntary action, in line with the middle definition.\u00a0 At least in the context of \u201cgross negligence and willful breach,\u201d conduct must be undertaken in subjective cognizance that it is a breach in order to be \u201cwillful.\u201d\u00a0 Since the Court also found that the member had known the LLC operating agreement prohibited the transfer and did it anyway, the court held that the breach was willful under that standard and ordered the member to repay the LLC for his litigation costs, which were in the millions.<\/p>\n

The Court’s decision has consequences well beyond the relatively niche world of advancement-recoupment actions.\u00a0 Because protections against \u201cwillful breach\u201d occur so frequently in merger agreements without a contractual definition of the term (in the decision, the Court noted that in a study of over 1,000 merger and acquisition agreements while \u201ca majority tie damages to a concept of willful breach, less than one third of public deals, and under one tenth of private deals, define the term\u201d), the default rules supplied by Delaware case law may prove significant in cases involving mergers and acquisitions, which are among the marquee subject areas of Delaware litigation.<\/p>\n

Moreover, recent amendments to the Delaware General Corporate Law (\u201cDGCL\u201d), which we have previously discussed outside this blog<\/a>, have added an additional dimension of importance.\u00a0 As previously discussed, the amendments authorize the inclusion of corporate governance provisions in stockholder agreements, but the outer bounds of inclusion of such provisions remains unknown.\u00a0 The DGCL amendments have already set off a flurry of discussion among practitioners and scholars over what happens when such a stockholder agreement requires a corporate fiduciary to act one way while their fiduciary duties command the opposite.\u00a0 If a fiduciary, in the face of such contradictory duties, prioritizes the fiduciary duty over the contractual one, is that breach \u201cwillful\u201d?\u00a0 With the court\u2019s answer to that question unknown, parties may want to consider addressing it themselves through an express provision in the contract for added clarity.<\/p>\n

Finally, with \u201cwillful breach\u201d terms so common in the context of mergers & acquisitions agreements, XRI v. Holifield<\/i><\/a> demonstrates the prudence of parties setting out an express definition within the body of their agreements to ensure the parties have clarity on its meaning.<\/p>\n","protected":false},"excerpt":{"rendered":"

One of the hallmarks of contract law is that it is not fault-based.\u00a0 A court, and especially a \u2018contractarian\u2019 Delaware court, only looks at whether a party performed the duties the contract imposes, not why.\u00a0 If parties want to be able to excuse performance for the \u2018right\u2019 reasons, or to trigger extra protections against breach … <\/p>\n

Continue reading “Breaching on Purpose: What to Do About “Willful Breach””<\/span><\/a><\/p>\n","protected":false},"author":598,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[2],"tags":[],"ppma_author":[166],"class_list":["post-262","post","type-post","status-publish","format-standard","hentry","category-general"],"authors":[{"term_id":166,"user_id":598,"is_guest":0,"slug":"mbgonen","display_name":"Michael Gonen","avatar_url":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-content\/uploads\/sites\/16\/2023\/01\/gonenmichael-100x100.jpg","0":null,"1":"","2":"","3":"","4":"","5":"","6":"","7":"","8":""}],"_links":{"self":[{"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/posts\/262","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/users\/598"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/comments?post=262"}],"version-history":[{"count":0,"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/posts\/262\/revisions"}],"wp:attachment":[{"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/media?parent=262"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/categories?post=262"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/tags?post=262"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.duanemorris.com\/delawarebusinesslaw\/wp-json\/wp\/v2\/ppma_author?post=262"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}