Background of the case
Two sophisticated parties, Patrick Montague (Montague) and Mark Buller (Buller), entered into a joint venture for the purpose of pursuing real estate investments. The parties formed a Delaware LLC as their joint venture vehicle. Montague had a 52 percent interest in the joint venture LLC, and the remaining 48 percent was owned by Buller and affiliates of Buller. Buller provided financing for the joint venture LLC and Montague contributed his subject-matter expertise.
The joint venture was governed by an LLC operating agreement (the Operating Agreement). Under the Operating Agreement, each of the members of the joint venture would be personally liable for repayment due on a line of credit that Buller, as financier, extended to the joint venture based on each member’s respective percentage of interest in the joint venture LLC. The Operating Agreement also required Buller and Montague to purchase “key man” life insurance in the amount of $250,000, naming the joint venture LLC as the beneficiary of the insurance. Neither Buller nor Montague ever purchased the required key man life insurance.
Because Buller was the financing source for the joint venture LLC, concerns were raised regarding what would happen to advances on the line of credit that Buller extended to the joint venture LLC in the event Buller became deceased or otherwise incapacitated. Separate from the key man insurance Buller agreed to (but did not) purchase under the Operating Agreement, Buller had a life insurance policy through his employer. Buller and his wife executed an authorization that would allow the transfer of funds from the employer-based life insurance policy to the joint venture LLC to cover the balance on the line of credit.
Buller died unexpectedly, less than two months after the Operating Agreement was executed. Four additional advances were made on the line of credit following Buller’s death, bringing the total amount advanced to approximately $120,000. The joint venture LLC never received the death benefit from Buller’s employer-based life insurance. The joint venture LLC ultimately dissolved without repaying the money Buller advanced.
Buller’s estate filed suit in the Delaware Superior Court against Montague, seeking 52 percent of the total amount Buller advanced, plus accrued interest, because Montague owned 52 percent of the joint venture LLC interest and had agreed, in the Operating Agreement, to be personally liable for any balance due on the line of credit Buller advanced based on Montague’s percentage of ownership interest.
Montague moved for summary judgment arguing, among other things, that Buller’s failure to purchase the key man life insurance, as required under the Operating Agreement, excused Montague’s performance under the Operating Agreement, including Montague’s obligation to be personally liable for a portion of the line of credit balance. Buller’s estate argued that all parties agreed to orally modify the Operating Agreement to eliminate the obligation to purchase key man life insurance. Montague, in response, argued that the Operating Agreement expressly precluded any oral modification because the Operating Agreement states “no Member, without the prior written consent of all other Members, shall amend … the Operating Agreement.”
The Court’s decision
The Delaware Superior Court emphasized that the no-oral-modification clause in the Operating Agreement did not preclude an oral amendment of the Operating Agreement, explaining “[i]t is well-settled Delaware law ‘that contract provisions deeming oral modifications unenforceable can be waived by a course of conduct.’” It is also well-settled under Delaware law that commercial parties’ “freedom to contract” is paramount, and Delaware courts will enforce the parties’ contractual agreement as long as the terms are not illegal or otherwise repugnant to Delaware’s public policy. However, even where parties have unambiguously agreed that a contract can only be modified in writing, Delaware law permits a party to argue the contract was modified orally.
As explained by the Delaware Superior Court in Estate of Buller, “a party seeking to prove an oral modification bears a heightened burden and must prove the intended change to the written agreement with sufficient ‘specificity and directness as to leave no doubt of the intention of the parties to change what they previously solemnized by formal document.’” (emphasis added). The Superior Court cited, as support, a decision from the Delaware Court of Chancery that quoted a decision from the Superior Court and was later affirmed by the Delaware Supreme Court. This indicates Delaware state courts, across multiple levels, are willing to hold an agreement with a no-oral-modification clause can be modified orally if the heightened evidentiary burden is satisfied.
The Delaware Superior Court held that Buller’s estate, as the party seeking to prove an oral modification, failed to meet the heightened burden required to prove the parties to the Operating Agreement intended to waive by oral agreement the requirement that Buller purchase the key man life insurance policy. The Court acknowledged that “[t]he facts asserted by [Buller’s estate] demonstrate the expected assignment of Buller’s existing [employer-based] policy; however, the facts do not demonstrate that an agreement to substitute the existing policy for the $250,000 key man policy.” The Court noted that the minutes of the joint venture LLC meetings did not evidence that Buller’s assignment of his employer-based life insurance policy was “in lieu of the existing obligation” under the Operating Agreement requiring Buller to obtain the key man life insurance.
Even viewing the facts in the light most favorable to Buller’s estate, the Delaware Superior Court rejected Buller’s estate’s claims that the other three members of the joint venture LLC - all of whom are affiliates of Buller - would “testify that the assignment of the [employer-based] policy was in lieu of getting the [key man] policy.” Had the joint venture LLC meeting minutes evidenced the parties’ intention to substitute Buller’s employer-based life insurance for the key man life insurance, the Court’s determination would have likely been different because the Court would have been presented with further evidence, beyond Buller’s affiliates’ intended testimony, that the parties to the Operating Agreement intended more than a mere assignment of Buller’s employer-based life insurance.
Key takeaways
Delaware law recognizes contracts that contain no-oral-modification clauses can be modified orally because no-oral-modification clauses can be waived by course of conduct.
A party seeking to prove an oral modification to a contract that contains a no-oral-modification clause bears a heightened evidentiary burden and must prove the intended change to the written agreement with sufficient specificity and directness as to leave no doubt of the intention of the parties to modify orally what they previously agreed could only be modified in writing.
Companies formed under Delaware law, including corporations and non-corporate entities such as limited liability companies or limited partnerships, should be careful to include sufficient detail in the company meeting minutes to ensure that governance decisions are well documented and accurately reflect decision-making relating to governance matters.
Client Alert 2020-191
