Delaware Corporate and Commercial Litigation Blog : Delaware Litigation Lawyer & Attorney : Francis G. X. Pileggi : Corporate, Business, Commercial, Delaware Chancery Court

Harris v. RHH Partners, LP, et al., No. 1198-VCN, (Del. Ch., January 27, 2010), read letter decision here. A prior decision in this case by the Delaware Court of Chancery was highlighted here.

Why This Short Ruling is Noteworthy

This decision in noteworthy because it applies a statute that, comparatively speaking, does not enjoy a copious body of case law interpreting it. The statute in question is the dissolution statute for LPs, Section 17-802 of Title 6 of the Delaware Code. Decisions interpreting this dissolution statute have also been applied by analogy to the counterpart statute in the Delaware LLC Act, Section 18-802. These statutes allow for one to petition to dissolve an LP or an LLC when: "it is not reasonably practicable to carry on the business in conformity with the partnership [or LLC] agreement."

Background

This case involved two parties who owned an LP, called RHH Partners, that in turn owned the personal residence of the sole limited partner who owned 99% of the LP. The remaining 1% was owned by a former friend who was also the general partner. Harris, the 99% owner and general partner, was a New York lawyer by training and appeared in this case pro se, as did the general partner.

Court's Reasoning

Despite a general purpose clause authorizing the LP to operate "for all lawful purposes", the Court  found after hearing testimony that the purpose of the LP "was not entirely clear" though it likely evolved over time. The Court concluded that: "its purpose, however ill-defined, ceased to exist", and therefore, based on Section 17-802, the court held that "it is not reasonably practicable for RHH to carry on the business in conformity with the partnership agreement."

Moreover, the Court reasoned that: (i) leaving the two partners "in any kind of business relationship would serve no useful purpose"; and (ii) there is no apparent purpose for the LP; and (iii) using the LP as a vehicle to own Harris' residence "has no cognizable relationship to any business purpose for which RHH might exist."

Winding-up

Ordering dissolution did not end the discussion. For the winding-up aspect of the case, the Court divided ownership of the sole asset of the LP, the personal residence of Harris, in the same proportion as the two men owned the LP. Thus, Harris received a "99 % fee simple interest " in the real estate, and the other partner received a "1% undivided fee simple interest". The Court noted that before distribution of the assets could be made, Section 17-804 required that creditors be paid.

Postscript

Notwithstanding the unusual procedural aspect of both parties appearing pro se, thus resulting in a less developed factual record and fewer formal legal arguments presented, the issue the Court addressed is sufficiently important, and the case law on the dissolution statute sufficiently meager--by comparison to many corporate statutes for example, that this ruling merited a quick overview.

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In Re: Arrow Investment Advisors, LLC, Del. Ch., No. 4091-VCS (April 23, 2009), read opinion here.

This Chancery Court decision dismissed a petition seeking a dissolution of an LLC pursuant to Section 18-802 of the Delaware LLC Act. Although each year brings more case law interpreting this statute, there is still a comparative paucity of decisions interpreting this section of the LLC Act; thus, this ruling is helpful for purposes of determining when the court will grant a judicial dissolution under the applicable statutory standard.

Prerequisites for Seeking Judicial Dissolution of an LLC

Section 18-802 gives the court the discretion to order judicial dissolution of an LLC  when one demonstrates that: "it is not reasonably practicable to carry on the business in conformity with [the]limited liability agreement." This opinion collects and discusses the Delaware decisions that have discussed this statutory dissolution standard (which reasonable people can easily differ about regarding its application.) See footnotes 10,12,13,14,15, 20, 23, 24 and 28.

Anyone who is involved in the analysis of whether a Delaware LLC can be judicially dissolved  upon the request of only one member or manager, needs to read this decision. In essence, the court reasoned, in part,  that although the member seeking dissolution:

...might be disappointed that he has been ousted from the management of the company, disagree with the tack its current managers are taking, and wish to take his capital out of the company, these are not circumstances from which I can reasonably infer that it has become impracticable for Arrow to provide a return for its investors....

Reasoning for Denying Dissolution

In sum, at the risk of oversimplifying the extensive factual and legal analysis that the opinion provides, the request for dissolution was rejected, and the motion to dismiss the petition was granted, because the LLC agreement had a very broad "purpose clause" that  the LLC was still operating within, and it was not enough that the original business plan was not being followed, nor that the minority member was unhappy with the management or direction of the company.

Even with a broad purpose clause, however, in theory the court explained that dissolution is still possible if it can be established that perpetuation of the entity would be "obviously futile and would not result in business success." (See, e.g., case cited in footnote 20)

Procedurally, the court also observed that asserting claims for breach of fiduciary duty as part of  the petition for dissolution in this case did not strengthen the arguments for dissolution. Moreover, the petitioner did not follow the derivative procedures required for the fiduciary claims that were made. Lastly, as a procedural matter, dissolution proceedings are narrow in scope and usually do not include ancillary claims. See footnote 28.

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Spellman v. Katz, (Del Ch., Feb. 6, 2009), read opinion here. This Delaware Chancery Court opinion involved the appointment of a liquidating trustee to wind-up the LLC where the two 50/50 owners were deadlocked and their Operating Agreement already provided for dissolution.

The same vice chancellor issued a decision a few days later involving a deadlock  between two 50/50 shareholders in a closely-held corporation (as opposed to an LLC as in this case) and the appointment of a custodian in that case, which was highlighted here.

For any business litigator who deals with disputes among or between the owners of  a closely-held LLC or corporation, these two cases are must reading. For now, I will  highlight a few key points in this decision of immense practical application:

• Two doctors, who apparently could not get along together, owned an LLC that was created for the limited purpose  of  building a medical office. They remained personally liable on the mortgage as guarantors but were not otherwise able to disentangle themselves from their "now unwanted" business arrangement via their LLC.
• One doctor  sought a declaration of dissolution per Section 18-802 of the Delaware LLC Act or alternatively an order under Section 18-803(a) to appoint a liquidating trustee to effectuate the winding up of the LLC's affairs, because the operating agreement already provided for  the dissolution by agreement of the members.
• The court's reasoning for appointing a liquidating trustee, which it said it could do under either Section 18-803 or 18-802, should be read to get an understanding of the detailed facts and legal analysis on which the court relied.
• Of useful import was a discussion accompanying footnote 17 for the key principle that a party will be bound by a contract that he signs "even if he said that he did not read it".
• The court  also discussed the derivative pleading requirement and demand futility in the context of LLCs. 

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In Fisk Ventures LLC v. Segal, (Del. Ch., Jan. 13, 2009), read opinion here, (hat tip: Delaware Business Litigation Report), the Delaware Chancery Court dissolved an LLC based on the standard in Section 18-802 of the Delaware LLC Act, that it was not  "reasonably practicable" to carry on the business of the LLC.... Among other reasons, this is a key decision because, comparatively, there are precious few decisions that have interpreted the contours and nuances of that statutory standard.

A previous decision of the court in this case, also important in its own right, and providing additional background facts, was summarized  on this blog here.

This Chancery Court opinion is must reading, in its entirety, by anyone involved in a case that deals with the pursuit of, or defense of, a claim that an LLC should be dissolved.

UPDATE: Nationally-prominent LLC expert, Prof. Larry Ribstein, provides a scholarly analysis of this case, and a comparison to the "oppresion of the minority" claim in close corporations,  here.  Also, Peter Mahler reviews the case here.

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