4-3 decision by the NY Court of Appeals illustrates the risks of friendly handshake deals and SPVs

February 17, 2025 | By Patrick T. McCloskey

A recent decision by the New York Court of Appeals (Behler v. Kai-Shing Tao), is yet another cautionary tale on the risk of relying on an oral promise from a friend, especially when investing money. In this case, that risk was compounded by investing through a special purpose vehicle (SPV) controlled by the defendant.

In a 4-3 decision, the Court, applying Delaware law, affirmed the dismissal of claims for promissory estoppel and breach of contract based on an oral agreement between close friends of 20 years.

Judge Singas’ majority opinion ruled the oral promise was later extinguished because the written amended limited liability company (LLC) agreement for the SPV contained a standard integration clause (referred to throughout the opinion as a “merger clause”) that “supersede[d] all prior and contemporaneous understandings, agreements, representations and warranties, both written and oral, with respect to such subject matter.” The plaintiff never signed this written amended LLC Agreement, but that did not change the outcome because under Delaware law a member is bound by the LLC agreement even if the member does not execute it.¹

Facts

The defendant is the CEO and Chairman of Remark Holdings, Inc., a public company, and also the sole manager of Digipac LLC, a Delaware limited liability company. Digipac is an SPV through which defendant evidently routes friend and family investments in Remark.

The plaintiff had reservations about investing in Remark through Digipac (citing “the inherent difficulty in liquidating shares of a limited liability company”) so he and the defendant, who had been close friends for over 20 years, had an oral agreement whereby plaintiff agreed to invest $3 million in Digipac and, in exchange, the defendant promised that (i) if Remark’s stock price hit $50, defendant would cause Digipac to sell its shares of Remark and distribute plaintiff his pro rata cut of the proceeds; and (ii) if the stock price did not hit $50, the defendant “would provide [plaintiff] with an exit opportunity from Digipac based on the value of Digipac’s Remark holdings on the fifth anniversary of the investment.” At the time of the oral agreement, Digipac was governed by its initial LLC agreement, with the defendant as the sole member and exclusive authority to amend.

Almost two years later, the defendant unilaterally amended the LLC agreement. He did not seek input from the plaintiff and the plaintiff never signed it.

Remark’s stock price never hit $50 and plaintiff’s portion of Digipac’s Remark holdings as of the fifth anniversary was approximately $11.6 million (based on a share price of roughly $9.15). At a meeting months before the fifth anniversary, the defendant acknowledged and discussed the looming deadline but failed to cash out the plaintiff. At a dinner months after the deadline, the plaintiff confronted the defendant who admitted his breach of the oral promise to provide the exit opportunity.

Law

The plaintiff sued for promissory estoppel and breach of contract and sought an order directing the defendant to purchase his Digipac interest for $11.6 million. The defendant moved to dismiss on the grounds that the oral promise was superseded by Digipac’s written amended LLC Agreement, which contained a standard integration clause. The trial court granted the motion to dismiss and the First Department affirmed in a 3-2 decision.

We similarly reject plaintiff’s assertion that he is a party to the oral agreement in his personal capacity, but a party to the amended LLC agreement in his membership capacity. The consideration the plaintiff received from the oral agreement was, in part, a guaranteed exit from his Digipac investment, which implicates, and in fact assumes, plaintiff’s role as a Digipac member. Indeed, plaintiff admitted in his pleadings that he would not have entered into the oral agreement without this promise because he feared difficulty in exiting his investment, a concern regarding corporate structure. To accept the notion that either plaintiff or defendant entered into this oral agreement in a capacity which somehow shields this agreement, which exclusively pertains to plaintiff’s Digipac investment rights, from the reach of Digipac’s operating agreement would contradict basic principles of contract interpretation and upend the goal of [Section 18-101(9) of the Delaware Limited Liability Company Act (DLLCA)] to give clarity and certainty to members that the operating agreement governs the LLC [citing Section 18-1101(b) of the DLLCA].

This reasoning drew strong opposition in Judge Rivera’s dissent:

I also disagree with the majority’s conclusion that plaintiff must have entered into the exit opportunity agreement in his corporate capacity. The parties do not dispute—and cannot dispute—that plaintiff was an individual with no relationship to Digipac when he entered into the exit opportunity agreement. . . Thus, the exit opportunity involves plaintiff and defendant as individuals. In contrast, plaintiff and defendant are implicated in the amended operating agreement solely in their respective roles as member and manager of Digipac. Further, the amended operating agreement does not just involve plaintiff and defendant; rather, it involves Digipac itself and its entire body of members. Indeed, no one disputes that plaintiff could not hold Digipac liable for performance of any aspect of the exit opportunity agreement. Accordingly, the agreements were reached by different parties in different capacities.

The majority acknowledged the outcome might seem harsh, but recited the First Department’s observation that the plaintiff failed to scrutinize the LLC agreement and condition his investment with clear written contracted-for rights:

Though an outcome whereby one member to a contract unilaterally extinguishes his contractual obligation, even after the other party has performed, may appear “harsh”, the Appellate Division correctly observed that Delaware law “unambiguously advises prospective investors in a closely held LLC (especially one considering a multimillion-dollar investment) to scrutinize the existing LLC agreement and condition their investment upon the clear written delineation thereunder of . . . their contracted-for rights in the event of any future amendments to the LLC agreement”. Despite his reservations about investing in an LLC, plaintiff, who admits to having some business experience, failed to take the appropriate measures to protect the terms of the oral agreement from defendant’s explicit unilateral authority to amend the LLC agreement.

The first and last paragraphs of the dissenting opinion highlight the harsh result for the plaintiff:

Plaintiff and defendant entered into an agreement to give plaintiff an exit opportunity from defendant’s limited liability company in exchange for a $3 million investment. Defendant thereafter took plaintiff’s money, accepted him as a member of the LLC, and met with him regularly to discuss his investment. For six years, defendant did not deny that the exit opportunity existed and, when plaintiff sought its performance, defendant freely acknowledged his obligations under the agreement. Yet the majority now invokes the [integration] clause of an entirely different agreement to allow defendant to avoid his obligation to the plaintiff. This outcome is contrary to fundamental principles of contract interpretation.

In sum, this dispute concerns a personal agreement between two business partners and friends. Because one of those friends did not live up to his promise, the other now seeks to enforce it against him alone. That effort has simply nothing to do with Digipac’s relationship with its members or the clarity or certainty that they should expect in dealing with Digipac. Rather the majority disrupts the certainty of our well-established motion practice standards by recasting the allegations of the plaintiff’s complaint to refashion the parties’ promise into a corporate commitment. At the very least, plaintiff’s contentions raise ambiguities in the exit opportunity agreement that cannot be resolved on a motion to dismiss. [citations to Delaware case law omitted] The majority ignores these ambiguities and cuts this case short at the outset, leaving defendant with $3 million of plaintiff’s money and plaintiff without recourse.

Lessons

Don’t fund until you are comfortable with a written (not oral) agreement. The knee-jerk reaction here is to criticize the plaintiff for not getting the exit opportunity agreement in writing. However, given the analysis of the majority, that would not have made a difference because the integration clause in the amended LLC agreement covered both extraneous written and oral agreements.

The real lesson to be learned is to hold onto your cash until you (and hopefully your legal counsel), are satisfied with the written terms, a point made by the First Department and cited by the majority opinion. While not discussed above, the plaintiff in this case wired the $3 million in two $1.5 million tranches two years before the LLC agreement was amended. While Delaware law admittedly binds a member to an LLC Agreement even when the member does not execute it, that does not stop an investor from insisting on seeing the LLC agreement and not funding until the investor (and hopefully the investor’s counsel) have comfort with the terms. As with any other deal, once a party funds, all bargaining leverage is lost. For example, in this case the plaintiff could have insisted on a put right in the LLC agreement when the share price hit $50 or otherwise on the fifth anniversary. That put right could have been an obligation of the LLC, the defendant manager, the other members, or any combination of them.

Be cautious with SPVs. Investing through an SPV cedes all control over the investment to management of the SPV. Since the shares were held by the LLC, no liquidity could be obtained unless the manager authorized the LLC’s sale of shares. Plaintiff was clearly concerned about liquidity of the LLC, but he could have addressed that risk by purchasing Remark shares in his own right (something he considered) instead of relying on an oral promise of exit from the defendant (see the next lesson below). Hindsight is 20/20 and there are likely unknown facts, but had the plaintiff purchased the Remark shares himself, he could have sold them for $11.6 million on the fifth anniversary without the blessing of the defendant.²

Don’t let your guard down with “friends”. The plaintiff and the defendant were friends for over 20 years. Evidently that was enough for the plaintiff to take a leap of faith and fund $3 million based on the oral promise of the defendant. I’m sure I’m not the only lawyer who has heard “it’s not an issue, we’re friends,” or words to that effect.

Due diligence. Although it’s not discussed in the opinion, since the defendant is (i) the CEO of Remark; and (ii) the sole manager of Digipac, that renders Digipac an “affiliate” for purposes of Rule 144 under the Securities Act.³ This means the shares owned by Digipac are control securities, meaning they can only be publicly resold in accordance with the volume limits of Rule 144 (unless the resale is registered). In addition, Digipac is almost certainly covered by an insider trading policy of Remark, and these policies typically impose black-out periods and leave narrow trading windows for insiders. Clearly the plaintiff was concerned about the liquidity risks of investing through the LLC, but the securities lawyer in me cannot help but wonder if the plaintiff was made aware of these other constraints before he committed to invest the $3 million through the defendant’s SPV.

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As set forth on the disclaimer page of this website, this post is for general informational purposes only and does not constitute legal advice. No one should rely on the information in this blog post without seeking appropriate legal, accounting, tax or other appropriate advice from an attorney, accountant or other professional properly licensed in the applicable jurisdiction(s).

1 Delaware Limited Liability Company Act § 18-101(9).

2 It’s worth noting that if the plaintiff had in fact purchased the shares himself, it is possible (perhaps likely) that Remark would have imposed a lock-up period or other transfer restrictions. On the other hand, any such restrictions presumably would have lapsed after five years.

3 Digipac is rendered an affiliate because it and Remark are under the common control of the defendant.