Ross Holding and Management Co. v. Advance Realty Group LLC, C.A. No. 4113-VCN (Del. Ch. Sept. 2, 2010), read opinion here. See summary of prior Chancery Court decision in this case here.

This decision addressed the Motion to Amend a complaint to add claims for the appointment of a receiver of an LLC based on allegations of the insolvency of the LLC resulting from gross mismanagement and self dealing. The Court granted the Motion to Amend and allowed the claim for an appointment of a receiver to proceed to trial but deferred ruling on the appointment due to material factual issues.

Neither the Delaware LLC Act nor the agreement of the parties provided for the appointment of a receiver. Although the plaintiff argued for the application by analogy of Section 291 of the DGCL which provides for the appointment of a receiver when a corporation is insolvent, the Court declined that invitation. The case law interpreting Section 291 has been described as employing an “insolvency plus standard” under which the moving party must prove not only that the company is insolvent but also additional facts to demonstrate that the intervention of a neutral third-party is necessary to protect the rights and interests of either the company or the moving parties. See footnote 19.

The LLC Act includes only a single provision addressing when a receiver may be appointed: Section 18-805 of Title 6 of the Delaware Code, which allows for the appointment of a receiver only when the certificate of formation of a limited liability company has been cancelled. Section 18-805 tracks Section 279 of the DGCL which provides for the appointment of a receiver in the corporate context with the notable difference being the circumstances in which a receiver may be appointed. See footnote 23.

Authority to Appoint Receiver of an LLC
The Court concluded that the General Assembly intentionally omitted from the LLC Act a provision analogous to Section 291 of the DGCL. Moreover, the Court reasoned that the separate Section 279 of the DGCL establishes a lesser basis for the appointment of a receiver, but prior to both statutes the courts of equity had long ago developed standards for the appointment of a receiver. Therefore, the Court concluded that there was no need to borrow from the corporate statute due to a more general standard being well-established in equity for the appointment of a receiver.

Prerequisites for the Exercise of the Equitable Power to Appoint a Receiver

Citing somewhat hoary decisions, the Court recited the high threshold that must be met before the Court will exercise its power to impose the extraordinary and drastic remedy of the appointment of a receiver. For example, the Court observed that such a remedy would not be resorted to if “milder measures will give the plaintiff, whether creditor or shareholder, adequate protection for his rights.” The Court also explained that the power would only be exercised “with great caution and only as exigencies of the case appear with proper proof,” especially when an entity continues to function actively. See cases at footnotes 30 to 32.

Citing to a 1945 decision, the Court stated that the equitable powers for the appointment of a receiver may only be utilized “when fraud and gross mismanagement by corporate officers, causing real imminent danger of great loss, clearly appears, and cannot be otherwise prevented.” See footnotes 33 to 35. Moreover, the Court will not appoint a receiver “simply because of errors of judgment in business management.”

The allegations of the plaintiff in this case fell into three categories of mostly self-dealing: (1) The board transferred properties to companies affiliated with management for no consideration while continuing to guarantee underlying loans; (2) The board allowed the company to default on various loans while making unnecessary interest payments on loans to insiders; and (3) Substantial compensation was paid to senior management and board members while other loan obligations were not being met.

In the end, the Court determined that there were too many factual issues to decide at the motion stage but that there were sufficient allegations that, if proven to be true, would support the appointment of a receiver based on the Court’s equitable powers.

Adequate Remedy at Law

The Court concluded that the equitable remedy for the appointment of a receiver would not be barred in this case due to an adequate remedy at law being available, because in part, the claims against the LLC could be impacted by the insolvency of the company between the present time and when a final judgment might be entered. Thus, the Court reasoned that the appointment of a receiver pendente lite would be  considered even though the plaintiffs also sought money damages from defendants – – other than the entity for whom a receiver was sought.