In this opinion, the Court of Chancery resolved a dispute regarding a put right in an LLC agreement between PECO Logistics, LLC (“PECO”), a Delaware limited liability company, and two of its preferred equity holders, Walnut Investment Partners, L.P. and Walnut Private Equity Fund, L.P. (together, the “Walnut Investors”). The Walnut Investors had the right to compel PECO to purchase their preferred units at a price determined by a valuation firm that would apply a specified multi-step valuation formula. After the Walnut Investors exercised their put right, PECO enlisted a valuation firm to follow the specified process to value the preferred units. The Walnut Investors considered the price determined by the valuation firm to be too low and refused to tender their preferred units. That refusal led to PECO seeking a declaratory judgment enforcing the sale at the valuation price.
The Court of Chancery granted PECO declaratory relief on a motion for judgment on the pleadings. The Court also granted PECO’s motion for judgment on the pleadings against both of the counterclaims that the Walnut Investors had brought in an effort to resist enforcement of the put right. Those counterclaims asserted that the notice exercising the put right modified the LLC Agreement to grant the Walnut Investors a right of refusal, and that PECO breached the implied covenant of good faith and fair dealing.
PECO’s LLC Agreement granted the Walnut Investors the right to “elect to deliver a written notice” to PECO that would require PECO to purchase all of the Walnut Investors’ preferred units. PECO would then be obligated to engage “a nationally recognized valuation firm” to determine the price that must be paid for the units by applying a multi-step valuation formula. In reaching its decision, the Court found that it was “[c]ritical to the dispute in this case” that the LLC Agreement did “not contain any mechanism providing for judicial, arbitral or any other form of review of the valuation firm’s determination.”
In early 2014, the Walnut Investors exercised their put right, despite an ongoing disagreement with PECO about its value. PECO’s Board of Managers, including the Walnut Investors’ General Partner, voted to allow PECO’s CFO to choose between two finalist valuation firms. The CFO selected Duff & Phelps, and the Board approved the resulting engagement letter. Duff & Phelps valued the Walnut Investors’ preferred equity, but the Walnut Investors refused to tender at that price.
Because PECO hired Duff & Phelps, which made reasonable choices about how to apply the valuation formula in the LLC Agreement, the Court issued a declaratory judgment requiring the sale to proceed at the valuation price. The Court emphasized that: “the parties  expressly agreed that the valuation firm’s determination would be binding without providing any mechanism for review of that determination.”
The Court granted judgment on the pleadings against both of the Walnut Investors’ counterclaims. The Walnut Investors’ first counterclaim asserted that PECO’s LLC Agreement had been modified because PECO performed the put right process without objecting to a purported reservation of a right to object to the result of the valuation process in the Walnut Investors’ notice letter. This course of conduct did not prove acceptance of an amendment to the LLC agreement because no consideration supported any amendment. The Walnut Investors’ second counterclaim asserted that PECO breached the implied covenant of good faith and fair dealing. An implied covenant claim based on a contractual valuation process could be legally viable, the Court suggested, if the valuation was not the product of a “genuine impartial judgment on value,” because the company selected a biased valuation firm or took actions (such as adding debt) for the express purpose of changing the valuation. The Court determined that the Walnut Investors challenged only reasonable decisions made by the valuation firm and held: “A decision to select one (even the lesser) of two admittedly reasonable options under the LLC Agreement does not, by definition, constitute arbitrary or unreasonable conduct … especially when that decision was made by an independent third party, rather than the Walnut Investors’ contractual counterparty.”
This opinion demonstrates Delaware’s continuing commitment to enforcing unambiguous contracts as written, especially between sophisticated parties. The Court will enforce the results of a contractually agreed-upon valuation process, even if one of the parties feels aggrieved because certain judgment calls may have gone against them. Nevertheless, it remains conceivable that, in the appropriate case, the Court may intervene to prevent abuse of contractual provisions establishing a valuation process.
The full opinion is available here