Lola Cars International Ltd. v. Krohn Racing, LLC, C.A. Nos. 4479 and 4886-VCN (Aug. 2, 2010), read opinion here. See summaries of prior Chancery decisions in this case here and here.
This is a post-trial decision which, as the Court described it, “deals with a business relationship gone awry.” The parties asserted claims for breach of contract and breach of fiduciary duty, with one member seeking control over the company or in the alternative, dissolution. The Court found that neither the breach of contract nor the fiduciary duty claims were proven at trial and because the members agreed on a contractual mechanism through which an unhappy party may exit the company, the Court denied a request for dissolution.
This 82-page decision with 278 footnotes is one that could be the subject of substantial coverage, but for purposes of this short blog post I will highlight several key parts of the ruling only. For more background factual description, refer to the two prior Chancery decisions in this matter that were highlighted on this blog at the above links.
The Court observed the established Delaware law that a manager of a limited liability company owes the entity and its members the traditional fiduciary duties of care and loyalty unless those duties are contractually eliminated by agreement among the members. See footnote 84 (citing Kelly v. Blum and Bay Center Apartments Owner LLC v. Emery Bay PKI, LLC) (both decisions have been summarized on this blog).
The Court made it clear that in order to prove a violation of the duty of care the claimant must show that gross negligence was committed, which has been defined as “reckless indifference” or conduct beyond the “bounds of reason.” See footnotes 86 and 87. The Court acknowledged that fee shifting for bad faith litigation practice is rare in the Court of Chancery which generally follows the American Rule. See footnotes 250 and 252. In response to arguments that one party knowingly advanced frivolous claims and defenses and engaged in a pervasive pattern of needlessly antagonist litigation behavior, the Court concluded that although Lola “could have raised fewer procedural hurdles, . . . such is litigation,” and therefore the request for fee shifting was denied.
Beginning on page 74 of the decision, an important discussion of Section 18-802 of the Delaware LLC Act addressed the application by one member for dissolution based on the argument that it “is not reasonably practicable to carry on the business in conformity with a Limited Liability Company Agreement.” See cases and commentary cited at footnotes 254 through 262.
The Court observed that regarding the prerequisites for dissolution under Section 18-802, it
“is a high standard. And, as the statute makes clear, even if the standard of ‘not reasonably practicable’ is met, the decision to enter a decree of dissolution nonetheless rests with the discretion of the Court. The Court’s discretion has been guided by, among other considerations: (1) Whether there is a deadlock between the members at the board level; (2) Whether the Operating Agreement gives a means of navigating around the deadlock; and (3) Whether, due to the company’s financial position, there is still a business to operate. Of course, ‘these factual circumstances are not individually dispositive; nor must they all exist for a Court to find it no longer reasonably practicable for a business to continue operating’.”
The Court found that there was no deadlock between the members “as that word is commonly used” and although the board was split evenly, the agreement of the parties provided for management of the daily affairs to be vested in one person who cannot be removed unilaterally.
Importantly, the Court found that the Operating Agreement between the parties contains a means by which members may work around their difficulties including in the event of a deadlock. Although the procedure may not provide for a precise or an ideal remedy, or make the parties happy, it provides a path for the disgruntled party to exit the business if he so chooses.
The Court concluded by emphasizing that “a party to a Limited Liability Company Agreement may not seek judicial dissolution simply as a means of freeing itself from what it considers a bad deal.” See footnote 275 through 278. The Court reasoned that “endorsing such a rule would allow for one party – – unfairly – – to defeat the reasonable expectations of its counterparty.”
An important fact in this case is that the agreement between the parties allowed for disentanglement, and it is not for the Court to terminate or rewrite an Operating Agreement because the disentanglement provisions may not be ideal for one party. In the end, the Court denied the request for dissolution and it directed the parties to the procedures in the agreement for extricating themselves from their predicament.
Bonus Supplement: Professor Larry Ribstein, the nation’s foremost expert on LLCs, has provided scholarly insights on this decision here.