On December 31, 2013, the Delaware Court of Chancery held in Grace v. Ashbridge LLC that the defendant, a converted Delaware LLC, was not obligated under the plain terms of its operating agreement to authorize advancement and indemnification to a director of the LLC's predecessor corporation for claims arising before the corporation converted into an LLC (No. 8348–VCN, (Del. Ch. Dec. 31, 2013)).

The plaintiff, Charles Grace, was a co-trustee of a family trust that owned shares in Ashbridge Corporation. Grace was the chairman and director of the corporation, which later converted into Ashbridge LLC. As part of the conversion process, Ashbridge adopted an LLC agreement, which contained a provision for indemnification of the company's managers. Grace continued to serve on the LLC's board of managers following the conversion.

In a dispute among the trustees and beneficiaries of the family trust, certain beneficiaries alleged, among other things, that Grace committed breaches of his fiduciary duty during his time as a director of Ashbridge Corporation. While defending against the claims, Grace demanded advancement and indemnification from Ashbridge LLC for attorneys' fees and other costs, based on the offices he held, and continued to hold, in Ashbridge Corporation and Ashbridge LLC, respectively. Grace sued Ashbridge LLC after it refused to indemnify him, and Ashbridge LLC moved to dismiss.

The Delaware Court of Chancery explained that under Delaware law, a successor corporate entity is not liable for the actions of the predecessor entity's directors or officers if the entity has undergone a fundamental change in identity. The court has previously held that a conversion of an LLC into a corporation is considered to be such a change (Bernstein v. TractManager, Inc., 953 A.2d 1003 (Del. Ch. 2007)). In reaching its conclusion in Bernstein, the court reasoned that LLCs and corporations differ significantly with regard to indemnification. In particular, while corporations are required to provide indemnification to a director who successfully defends himself, LLCs have the option to grant or deny indemnification rights through their operating agreements (8 Del. C. § 145(c) and 6 Del. C. § 18-108).

On this basis, the court here granted Ashbridge LLC's motion to dismiss, finding that a conversion from a corporation to an LLC is the same type of fundamental change in identity as the conversion described in Bernstein. Therefore, Grace had to show that the LLC's operating agreement explicitly applied retroactively to the company's predecessor entities. However, the court found that the plain terms of Ashbridge's operating agreement (in which the indemnification provision made reference only to Ashbridge LLC and not its predecessors) made clear that the company did not owe advancement or indemnification rights to any of its predecessor entities or affiliates. Therefore, the court did not order the LLC to advance expenses to Grace or indemnify him for alleged wrongs committed during his time as a director of the predecessor corporation.

The Grace v. Ashbridge LLC decision highlights that advancement and indemnification rights do not automatically survive an entity conversion under Delaware law if the statutory scheme for indemnification differs fundamentally between the two types of entities. Consequently, if a director or member wishes to preserve these rights after conversion, he must be certain that the relevant organizational documents explicitly contemplate those rights.

For more on entity conversions in Delaware, see Delaware Entity Conversion Checklist. For an example of an indemnification obligation in a Delaware certificate of incorporation, see Standard Document, Certificate of Incorporation (Short-form DE): Section 8. For an example of indemnification provisions in a Delaware LLC, see Standard Document, LLC Agreement (Two Member, Managing Member-Managed): Article VIII (Exculpation and Indemnification).