In Rostowsky v. Hirsch, C.A. No. 2022-0004-SG (Del. Ch. Oct. 15, 2024), the Delaware Court of Chancery addressed the ownership interest held by plaintiff, Ari Rostowsky, in a business he formed with the defendants, Laura Hirsch and Lisa True, even though he was not included as a member under the LLC operating agreement. The business was formally structured as a Delaware LLC, Aither Health (Aither). Aither is a service business related to administration of health insurance claims.

Background

The parties, including Rostowsky, created the company together. The parties made clear in their business plan that Rostowsky was a “Founder” of the company. Hirsch and True did not disclose to him that they had executed an LLC operating agreement that excluded him, and Rostowsky expected and attempted to facilitate an LLC operating agreement that would acknowledge his interest.

Rostowsky worked for more than a year without pay based on his understanding that the waxing value of his equity would eventually compensate him, and Hirsch and Ture relied on Rostowsky to secure a startup loan for the business from a company in which his father was a principal. The million-dollar loan was made without collateral, was not convertible to equity, and was guaranteed only personally by Hirsch and True. This loan was based on a business plan that referred to Hirsh, True, and Rostowsky as “the Founders,” and Rostowsky’s father testified that he would not have approved the loan absent the parties holding Rostowsky out as a co-owner. In an email to Rostowsky by True, copied to Hirsch, True stated that Rostowsky owned 15% of Aither’s business. Hirsch did not dissent.

Rostowsky eventually left his work for Aither. Subsequently, the parties disagreed about Rostowsky’s stake in Aither, which Rostowsky argued should be one-third, and which Hirsch and True insisted was inchoate and unvested.

Once suit was brought, Rostowsky claimed that he was a member of the LLC. In the alternative, Rostowsky argued that he was entitled to a share of the business under promissory estoppel.

The court found that while Rostowsky was not admitted as a member of Aither pursuant to its operating agreement, he was entitled to a remedy pursuant to promissory estoppel.  The court explained that the record demonstrated that Hirsch and True made a promise to Rostowsky that he would be an owner of Aither with a 15% interest, that Hirsch and True reasonably expected to induce action or forbearance on the part of Rostowsky, that Rostowsky reasonably relied on Hirsch’s and True’s promise and took actions to his detriment, and the promise was binding because injustice could be avoided only by enforcement of the promise. Therefore, the court held that Hirsch and True were estopped from asserting that Rostowsky was not a 15% owner of Aither’s business, although not a member of the LLC under the LLC operating agreement.

Key Takeaways

  • Delaware courts can enforce ownership interest based on promissory estoppel, even without a party being a member of the business’s LLC agreement.
  • Promissory estoppel is enforced when a party can prove by clear and convincing evidence that a promise was made, it was the reasonable expectation of the promisor to induce action or forbearance on the part of the promise, the promisee reasonably relied on the promise and took action to his detriment, and such promise is binding because injustice can be avoided only by enforcement of the promise.
  • Make sure to execute a clear and comprehensive LLC agreement that includes ownership interests when forming an LLC.