The plaintiff filed suit in the Delaware Court of Chancery and, among other things, alleged that Adkins’ outside counsel advised the General Governors and General Members, but not plaintiff or the Pearl City Governors, regarding the bona fides of the plaintiff’s purported unit acquisitions and the plaintiff’s attempt to name a seventh board member, and regarding the Grain Delivery Agreement dispute.

The plaintiff sought documents from Adkins outside counsel and, when the firm asserted attorney-client privilege, moved to compel production of documents concerning three topics: outside counsel’s retention and billing, the Grain Delivery Agreement, and plaintiff’s attempt to place a seventh board member. Outside counsel argued that the plaintiff lacked standing to assert its board designees’ right to access company documents and that the plaintiff and Adkins became adverse through the plaintiff’s attempt to acquire additional membership interest because doing so threatened to alter the company’s ability to be taxed as a partnership.

The court granted the plaintiff’s motion in part and denied it in part and ruled, among other things, that: (1) outside counsel may withhold documents concerning the Grain Delivery Agreement because section 5.15 of the operating agreement waived conflicted governors’ access to them and demonstrated that the plaintiff and Adkins were adverse regarding that agreement; (2) plaintiff has standing to assert its board designees’ access rights because it has the same right of access as the board designees, and nothing in the operating agreement barred the designees from accessing privileged material; and (3) outside counsel may not withhold documents related to the control dispute because Adkins should be neutral in that matter, its counsel should act for the benefit of all members, and outside counsel failed to demonstrate adversity.

The court discussed the legal standards applicable when a company’s counsel asserts privilege against an equity-holder or board member seeking discovery, explaining that equity-holders can overcome privilege on a showing of good cause, while board members’ right to information is “essentially unfettered,” except in three situations: limitation by agreement, privilege asserted by a special committee, and sufficient adversity between the company and board member:

The privilege issue takes on added complexity when company counsel asserts attorney-client privilege as a basis to withhold information from an owner or board member. Owners, such as stockholders, may overcome the privilege as asserted by company counsel upon a showing of “good cause.” As for board members, their “right to information is essentially unfettered in nature…[and] extends to privileged material.” “The same general rule applies to LLCs and their managers and regardless of the basis for the privilege assertion – attorney-client or work product.”

Most general rules have exceptions, and the law of attorney-client privilege as applied to board members and company counsel is no different. Our law is now settled that, as exceptions to the general rule, privileged information may be withheld from current directors in three situations:

First, a board member can limit his or her rights by agreement ex ante. Second, a board can form a special committee excluding the director, that committee can engage legal counsel, and then that committee’s communications would be protected. Third, privileged information can be withheld “once sufficient adversity exists” between the board member and the entity, such that the board member “could no longer have a reasonable expectation that he was a client” of counsel to the entity.

The court denied in part the plaintiff’s motion to compel the LLC’s outside counsel to produce documents, finding counsel is entitled to withhold documents reflecting legal advice concerning a contract between the plaintiff and the Company because the Company’s operating agreement designated the contract a “related transaction” that only disinterested members of the board of governors may consider or vote on, and as to which only disinterested governors may receive documents, such that the plaintiff both contractually waived its right to access company legal advice on the topic and demonstrated itself to be adverse to the company regarding it:

[C]ompany counsel may withhold documents from a board member on the ground of attorney-client privilege when that board member either has agreed, usually contractually, that he will not have access to certain company information, or when the board member and the company are sufficiently adverse to one another with respect to a matter that the company’s counsel no longer represents the board member as to that matter. Here, both exceptions apply to [company counsel’s] advice to [the LLC] and [defendants] regarding the [disputed contract between plaintiff and the LLC].

Under Section 5.15 of the [Company’s] Operating Agreement, the [disputed contract] is deemed a “Related Transaction” as it is a “contract between [the plaintiff] and a Member ([the plaintiff]).” With respect to Related Transactions, Section 5.15 makes clear that only Disinterested Governors, in this case [defendants], shall “consider, debate or vote” on matters related to “any such Related Transaction.” Section 5.15 also directs that “all non-Disinterested Governors [i.e., the plaintiff] shall not be entitled to vote or to receive any documents or communications of or to the Company with respect to such Related Transaction.”

Thus, under Section 5.15, [the plaintiff] has both contractually waived its right to receive privileged information from the Company’s counsel related to the [disputed contract], and has confirmed its adverse relationship with the Company related to that contract. Accordingly, the Motion is denied as relates to [the Company counsel’s] [disputed contract]-related documents.

The court ruled that the plaintiff had the same right to the Company’s documents as the plaintiff’s board designees and, therefore, the plaintiff had standing to assert their rights. The court observed that similar conclusions were reached in Moore Business Forms, Inc. v. Cordant Holdings Corp., C.A. No. 13911-VCJ, 14595-VCJ, memo. op. (Del. Ch. June 4, 1996) and AOC Limited Partnership v. Horsham Corp., C.A. No. 12480-VCC, memo. op. (Del. Ch. May 5, 1992), and found nothing in the Company’s operating agreement that would bar the plaintiff’s designees from accessing privileged information:

[The plaintiff] maintains that this court’s decision in [Moore Business Forms, Inc. v. Cordant Holdings Corp.] directly refutes [company counsel’s] standing argument. After carefully reviewing Moore and related authority, I agree. In Moore, a preferred stockholder (Moore), who was contractually permitted to designate a member (Rogers) to the board of the company at issue (Holdings), sought production of Holdings’ privileged information in the litigation, and Holdings objected that Moore was a stockholder, not a member of the board. The court rejected the distinction Holdings asked the court to draw and ordered production:

The relationship between Moore and Holdings is defined by the Stockholders’ Agreement. Mr. Rogers’ position as a Holdings director derived entirely from his status as Moore’s designee pursuant to that Agreement. All parties understood that Mr. Rogers would be acting as Moore’s representative on the Holdings Board and that his tenure as a director would be at Moore’s pleasure. The Stockholders Agreement cannot reasonably be construed otherwise. Nothing in the Stockholders Agreement precludes Moore from receiving any information imparted to Mr. Rogers. It therefore follows that if Mr. Rogers was entitled to the disputed communications by virtue of his position as a Holdings director, then Moore would also be entitled to these communications by virtue of the Stockholders’ Agreement.

As in Moore and [AOC Limited Partnership v. Horsham Corp.], [the plaintiff here] “is just as much the client of [the Company counsel’s] as the [plaintiff’s board designees or the other board members] are.” Nothing in the Operating Agreement would restrict [the plaintiff’s designees’] right to access privileged information from [the Company’s] counsel... And while the Operating Agreement, at Section 8.9, does provide that [the Company’s] counsel “shall not be deemed engaged by any Member,” and that no privilege shall exist between Members and company counsel, that provision does not purport to limit the right of Board members to access company privileged information.

The court entered an order compelling the Company’s outside counsel to produce privileged materials – holding the plaintiff is entitled to materials related to the control dispute because the LLC should be neutral as to that issue. The court rejected counsel’s reliance on SBC Interactive, Inc. v. Corporate Media Partners, C.A. No. 15987-VCJ, opinion (Del. Ch. Dec. 8, 1997; rev. Dec. 9, 1997), which concerned a party’s inability to seek privileged information in the absence of an agreement creating an attorney-client relationship. The court also rejected the argument that the plaintiff and the Company became adverse when plaintiff’s acquisition of additional membership interest allegedly threatened the Company’s tax status, explaining that outside counsel failed to demonstrate that the plaintiff wanted to harm the Company:

Of course, as a general matter, [the Company] should be neutral as to [the control dispute]. The dispute here, as is common in such matters, is between competing factions of directors designated by competing factions of owners. [The Company’s counsel] argues this case is different from the typical control dispute because [the plaintiff’s] unit acquisitions threaten [the Company’s] qualification to continue to be taxed as a partnership for federal income tax purposes, thereby rendering [the plaintiff] and [the Company] adverse. I disagree.

First, [the Company’s counsel] has not demonstrated, as is its burden as the proponent of the privilege, that [the plaintiff] has a desire to impair [the Company’s] federal tax status or otherwise adversely affect the Company. Indeed, [the plaintiff] maintains it has done nothing that would place [the Company’s] tax status in jeopardy and has no intent to do so. [Defendants] disagree and have advanced this point as a basis to challenge [the plaintiff’s] recent acquisition of units and related claim to control of the Board. If...Company counsel, has developed an expert opinion that [the plaintiff] is placing [the Company’s] favorable tax status in jeopardy, it should be sharing that advice with all members of the Board, not just [the defendants], for the sake of all members.

Second, and relatedly, [the Company’s counsel] simply should not be taking sides in this control dispute... In this regard, [the Company counsel’s] reliance upon [SBC Interactive, Inc.] is misplaced. There, the court held that a party cannot seek privileged information when there is no agreement or other understanding between that party and counsel that an attorney-client relationship has been created between them. Here, neither [the plaintiff] nor [the defendants] have an agreement or understanding with [company counsel] that the firm will serve as counsel to either faction. Indeed, the Operating Agreement makes clear that no such relationship exists. Yet, [the Company counsel] has shared its advice regarding this control dispute...with [other members] (through [the defendants]) but not with either [the plaintiff’s board designees] or [the plaintiff] itself. In the interests of all concerned...Company counsel should be sharing its legal advice with both factions. This is particularly so given that both factions are represented by their own counsel... [Defendants] are well represented by counsel here and [the Company counsel] should not be contributing to their defense efforts... [The Company counsel’s] interest is to ensure that both factions are informed of the Company’s rights, obligations, risks and exposures vis-a-vis its members. [Company counsel] has no basis on this record to withhold that advice from any member of the Board.

Takeaways

• In summary proceedings in Delaware, which often have expedited schedules, discovery is necessarily (and appropriately) limited.
• Delaware LLC’s and their managers, like directors of Delaware corporations, have a right to information that is “essentially unfettered in nature...[and] extends to privileged material.”
• Unless otherwise restricted by contract, such as in an LLC operating agreement, an equity-holder in a Delaware LLC that has the right to designate members to the LLC’s board has the same right to the Company’s documents as the equity-holder’s board designees.
• In limited circumstances, company counsel may withhold documents from a director – or a manager of a Delaware LLC – on the ground of attorney-client privilege, such as when that board member has agreed contractually that they will not have access to certain company information, or when the board member and the company are sufficiently adverse to one another with respect to a matter.

Client Alert 2020-546