Phillips v. Hove, C.A. No. 3644-VCL (Del. Ch. Sept. 22, 2011). Read opinion here.
This 52-page post-trial opinion addressed a score of issues related to the fiduciary duties owed by member-managers and the dissolution of an LLC based on a deadlock. The opinion also determined the voting membership of an LLC that lacked an operating agreement. A nuanced issue was also addressed regarding whether a member was merely an assignee or whether the member had voting rights.
The Court was required to sort out a mess of factual ambiguities and conflicting documentation that was occasioned in part by what the Court described as a term sheet that took the place of the controlling document in the absence of an LLC operating agreement.
The Court addressed very important provisions of the Delaware LLC Act such as Section 18-301 (admission of members) and 18-702 (assignment of LLC interests), as well as the dissolution provisions.
The determination about whether a member held the interests in the LLC personally or via an entity impacted whether the transfer of those interests made the transferee a mere assignee that lacked voting rights, which would be the result if the membership interest was personally owned- -or if it was determined that the member controlled his interest through an entity, then the assignment of an interest in that entity would allow the entity member to remain as an original voting member.
The Court found that the ambiguous documents allowed one of the two original members to invest either individually or through an entity.
Key Legal Principles
The Court acknowledged the truism of Delaware LLC law that a member-manager of a Delaware limited liability company owes traditional fiduciary duties to the LLC and its members unless limited by the LLC operating agreement. In this case there was no such agreement. The Court also determined that the evidence presented at trial established – – despite the absence of any formal title, that one of the parties who took control over the cash and inventory of the LLC and sold products from the inventory of the LLC was subject to the jurisdiction of the Court, and based on that exercise of control, owed a duty of loyalty.
The Court determined that because there were two 50-50 owners who were also the two managers of the LLC whose agreement was required for the LLC to take any action, and due to the animosity between the parties and their inability to agree on basic issues, the Court found a deadlock. The fact that the LLC continued to operate marginally was irrelevant to the deadlock.
The Court referred to the Delaware cases on dissolution of an LLC based on either a deadlock or the lack of any procedure or mechanism in the operating agreement to otherwise address a deadlock or deal with a dissolution effectively.
The Court reasoned that it would be both inequitable and ineffective to leave the parties to their contractual dispute resolution mechanism (if there was any), because it was not sufficient to break the deadlock.
In light of the history of the disputes between the parties, the Court determined that its members would not be able to wind down the LLC in an orderly or timely manner and therefore the Court appointed a liquidating trustee to dissolve the LLC and wind up its affairs. The Court provided explicit authority in the opinion for the role of the liquidating trustee.
Court’s Analysis of Conflicting Documents and Electronic “Footprint”
A noteworthy aspect of the Court’s efforts to sort out the conflicting testimony and conflicting interpretation of the documents was to analyze the numerical sequences of the identification numbers on each page from the document management system of the firm that prepared the various organizational documents. Based on the sequence of the identification number printed on the documents as generated by the document management system (e.g., lower assigned numbers were likely created earlier), the Court deduced certain likely dates of origination or dates of creation of certain documents that were sometimes at odds with the date on which the parties referred to the document as being effective.
The Court also refused to shift fees because it found both parties to have unclean hands.