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Delaware Supreme Court Holds Operating Agreement May Void Related Party Contract

The Delaware Supreme Court recently held that a limited liability company’s operating agreement may void a contract entered into between the company and a related party. In CompoSecure, LLC v. CardUX, LLC, 2018 Del. LEXIS 496 (Del. Nov. 7, 2018), one of CompoSecure, LLC’s directors founded CardUX, LLC for the purpose of marketing and selling CompoSecure’s metal credit cards.  The parties memorialized their arrangement with a written sales agreement, under which CompoSecure agreed to pay CardUX commissions in exchange for sales.  CompoSecure then received a lucrative order from Amazon, resulting in significant commissions owing to CardUX.  CompoSecure, however, refused to pay.  CardUX subsequently filed suit and received a $17 million judgment against CompoSecure. 

At the trial court level, CompoSecure primarily argued that its failure to comply with a “related party provision”—which required the approval of the company’s directors, investors, and certain of its members to enter into a related party transaction—rendered the sales agreement invalid.  The trial court disagreed, holding that CompoSecure’s failure to comply with the provision rendered the agreement voidable, and that the company impliedly ratified the agreement, resulting in liability to CompoSecure.  On appeal, CompoSecure shifted its position.  Rather than focusing on the related party provision, CompoSecure argued that a separate “restricted activities provision” voided the agreement, as that provision explicitly voided any contract entered into by the company that required the company to make expenditures in excess of $500,000 a year if the company’s directors, investors, and certain of its members failed to approve the contract.  The Delaware Supreme Court agreed:  while the common law rule rendered the agreement voidable under the related party provision, the express language of the restricted activities provision trumped the common law rule and could render the agreement void and incapable of being ratified.  The court ultimately remanded the case to the trial court to determine whether the sales agreement constituted a restricted activity within the meaning of the company’s operating agreement.