Drafting LLC Agreements for Undesirable Outcomes: Sophisticated investor holds a “put right” but has no basis to challenge valuation on the units that are being “put.”
A Delaware Court of Chancery opinion addresses a dispute arising from two sophisticated investors’ (“Walnut Investors”) challenge of the valuation methodology used in determining the fair market value of the Walnut Investors’ preferred units in PECO Logistics, LLC (“PECO Logistics”).
PECO Logistics is a Delaware LLC managed by a seven-person board. PECO Logistics’ sole asset was its equity interest in PECO Pallet Holdings, Inc., a provider of pallet rental services. PECO Pallet rents pallets to manufacturers who use the pallets to ship grocery products and consumer goods to retailers.
In March 2011, PECO Pallet was acquired. As part of the transaction, certain pre-acquisition stockholders of PECO Pallet, including the Walnut Investors, “rolled over” their existing shares into preferred units of PECO Logistics and became parties to the PECO Logistics, LLC Limited Liability Company Agreement dated as of March 14, 2011 (the “LLC Agreement”).
The LLC Agreement, which was governed by Delaware law, afforded the Walnut Investors a voluntary right to require PECO Logistics to purchase their preferred units (the “Put Units”) during a window of time commencing on the three-year anniversary of the LLC Agreement. Furthermore, the LLC Agreement provided that following written notice of the Put Right, PECO Logistics must engage a nationally recognized valuation firm to determine the fair market value of the Put Units, such determination to be binding on the holder of the Put Right.
The LLC Agreement did not contain any mechanism for judicial, arbitral or any other form of review of the valuation firm’s determination. Neither did it afford the Walnut Investors any right to participate in the selection of the valuation firm or in the valuation process itself after the valuation firm had been selected. (Assuming that both parties had similar bargaining leverage, it may have been helpful to include language that granted the Walnut Investors the right together with PECO Logistics to appoint by mutual agreement a valuation firm.)
The Court held that the parties to the LLC Agreement unambiguously agreed to be bound by the determination of value that the valuation firm made in response to the Walnut Investors’ exercise of the Put Right, and thus that the Court was not free to second-guess the (admittedly reasonable) judgment calls the valuation firm made in applying the valuation methodology in the LLC Agreement to reach its determination.
The Court further stated that the Walnut Investors did not challenge the independence of the valuation firm, nor did they allege any facts demonstrating that PECO Logistics took any action to taint or undermine the valuation process so as to sustain a claim for breach of the implied covenant of good faith and fair dealing.
The rationale for the Court’s ruling is captured in a rhetorical question that then-Chancellor Strine posed: “When parties contractually decide to have a qualified expert with relevant credentials make a determination of value without any indication that the expert’s judgment is subject to judicial review, on what basis would it make sense to infer that the parties intended to have a law-trained judge do a de novo review of the expert’s determination?”1
This opinion demonstrates Delaware’s continuing commitment to enforcing unambiguous contracts as written, especially between sophisticated parties.