Business Vantage Point Blog

Delaware limited liability companies (LLCs) offer unparalleled contractual flexibility, which can be a significant advantage for founders, investors and other business owners who want to tailor rights, whether economic or governance-related, to the specific deal terms agreed upon by the parties. This flexibility, however, can create risk if the LLC agreement gives one group of members broad powers to amend the LLC agreement without express limitations that protect the other affected members.

Why Amendment Provisions Are Important in Delaware LLC Agreements

An LLC agreement (or operating agreement) is the primary document governing the relationship of a limited liability company’s owners or members. It provides a roadmap for both economics and decision-making among the parties.

Among other provisions, a Delaware LLC agreement typically addresses who has the right to approve fundamental decisions, the requisite threshold for taking such fundamental actions, the different voting rights among classes of members and how the LLC agreement can be amended and by whom.

Delaware law allows LLC agreements to provide for varying classes or groups of members, unequal voting rights and specific amendment procedures, but the express language of the LLC agreement is what matters most.

Under Delaware LLC  law, most provisions of the statute default to the LLC agreement as being the final word on how the LLC will operate. For example, a typical provision of the LLC law will state that “unless the LLC Agreement provides otherwise ….” As such, a broad, vague, or incomplete provision providing for the vote or consent required to amend the agreement or specific sections thereof could lead to major disputes among the members about what actions the company can or cannot take or the validity of such actions, particularly those that materially differ from the core business bargain that was previously negotiated among the members.

When the parties rely on a very general amendment clause, e.g., “This agreement may be amended by majority vote,” there may still be specific key provisions that deserve more scrutiny as to whether a supermajority, class or series vote would be more appropriate to protect the rights of individual members or a particular class or series of ownership.

Such provisions may include:

• Distribution priorities.
• Class voting rights.
• Approval thresholds for major decisions.
• Management rights.
• Exit rights.
• Transfer restrictions.
• Drag-along or tag-along rights.
• Capital contribution obligations.

The problem is not that majority rule is always inappropriate. The problem is that failing to distinguish the approval threshold for routine amendments from the approval threshold for amendments could materially adversely impact certain parties.

A recent Delaware Court of Chancery decision, Lehr v. Aspen Power Partners LLC, underscores why LLC agreement amendment provisions should not be treated as boilerplate. The dispute arose after Aspen Power adopted a Fifth Amended LLC Agreement as part of a restructuring and capital raise, relying on amendment authority that required a particular party’s consent and unanimous board approval — but also contained separate protective consent rights for affected members. Although many of the plaintiffs’ challenges were dismissed, the court allowed breach-of-contract claims to proceed where it was “reasonably conceivable that the amendment adversely modified the Class B plaintiffs’ preemptive rights and economic distribution hurdles without the required prior written consent.”

The case is a useful reminder that an amendment clause must be read together with any class- or member-level veto rights. Even where the formal approval threshold appears satisfied, amendments that impair bargained-for economic or participation rights may still require targeted consent from the affected holders.

Rights That May Require Special Consent

When negotiating a Delaware LLC agreement, the members should, and typically do, give careful thought to concepts that are so fundamental that they require heightened consent.

These types of provisions often relate to:

• Distributions, including preferred returns and tax distributions.
• Voting and approval thresholds.
• Management and officer rights.
• Transfer restrictions.
• Preemptive rights, including anti-dilution protection.
• Drag-along and tag-along rights.
• Dissolution rights.
• Information and inspection rights.
• Capital call obligations.
• Exit rights.

The heightened standard for approving some or all of these decisions depends on the specified deal terms among the parties, including the resulting ownership breakdown. For some provisions, a supermajority vote may be sufficient; for others, unanimous consent or the specific consent of a particular member may be required. The LLC agreement may also require separate approval by a group of members or the written consent of a particular member whose rights would be materially and adversely affected. The clearer the parties are in documenting these rights, the lower the chance of disagreement.

Routine Amendments Can Be Treated Differently

LLC agreements frequently permit flexibility for routine or administrative amendments, such as:

• Correcting notice information.
• Fixing typos.
• Updating schedules to evidence approved actions.
• Modifying provisions that do not materially and adversely affect member rights as compared to other members.

Even for these types of amendments, the LLC agreement should be clear on who can make the change, whether notice is required to the other members and whether the amendment must be in writing — which it always should be.

Drafting Considerations – Amendments

For Delaware LLC agreements, the parties should pay specific attention to the economic and governance terms of the LLC agreement. But they should never forget how those provisions work in tandem with the amendment provisions, as allowing amendments by simple majority vote could lead to significant undesirable changes to originally negotiated rights of minority owners.

Specifically, the parties should ensure that their LLC agreement expressly addresses:

• Which parties may approve amendments.
• Whether certain types of amendments require heightened voting thresholds.
• Whether certain provisions require the approval of a specific class of members.
• That all amendments must be in writing.
• Whether notice of any amendment must be provided to parties that do not consent to the amendment.

Takeaways

Parties to a Delaware LLC agreement should understand that the amendment provision is not boilerplate and should be carefully negotiated. Failure to think through the implications of the amendment provision as it relates to all rights that a member considers key to its bargain could lead to the future loss of that bargain without any recourse to protect its investment.

A well-drafted LLC agreement is clear and unambiguous as to the right to amend the agreement and identifies the specific thresholds for approval, whether majority, supermajority, or unanimous consent. Amendments should always be in writing to memorialize the agreement among the parties.