Any commercial or corporate litigator who needs to pursue claims against a dissolved entity should read the recent Delaware Court of Chancery opinion in Capone v. LDH Management Holdings LLC, C.A. No. 11687-VCG (Del. Ch. April 25, 2018). In essence, the court nullified the certificate of cancellation that had dissolved the LLC in this case because no reserves were set aside, as required by statute, for claims that the executives of the LLC were aware of before they dissolved the company. In effect, the court revived or resurrected the LLC so that claims could be made against it. Presumably (though not expressly addressed in the court’s decision), this might also allow for individual claims to be made against the managers of the LLC as well.
The factual background of this case involves members of an LLC whose equity was subject to a call, which the company made. Shortly after the valuation of that equity was made, a portion of the parent entity was sold for an amount that suggested that the valuation of the equity subject to a call was grossly insufficient. The record suggests that the higher valuation, based on offers for the sale of the company received very shortly after the valuation date, was known or reasonably expected, at or about the time the valuation was made. The court found that the management of the LLC was aware of the claims that the valuation was lower than it should have been, but the LLC was dissolved without any reserves being set aside for those claims. The nullification issue was presented to the court in the procedural context of cross-motions for summary judgment.
Overview of Legal Principles Involved and Court’s Analysis
Section 18-804(b)(1) of the Delaware LLC Act requires a dissolving LLC to “make reasonable provision to pay all claims and obligations, including all contingent, conditional or unmatured contractual claims, known to the limited liability company.” Section 18-804(b)(3) requires than an LLC undergoing the wind-up process must make provisions that are likely to be sufficient to cover claims that have not yet been made formally, but that “based on facts known to the LLC, are likely to arise or to become known to the LLC within 10 years after the date of dissolution.” Section 18-804(b)(2) applies similarly to actual claims formally pending.
Types of Claims Requiring a Reserve
The court may nullify a certificate of cancellation if an LLC is not wound up in accordance with the LLC Act, which has the effect of reviving the LLC so that claims may be brought against it. Section 18-804(b)(1) has a broad scope and requires provision for all claims–including “contingent, conditional or unmatured” claims that are known to the LLC. Although there is flexibility regarding what a “reasonable provision” is under the circumstances, the purpose of Section 18-804 is to provide “mandatory protection” to creditors if an LLC dissolves and winds up its affairs. See footnote 119, citing cases explaining that due to the dearth of caselaw in this area, decisions on this topic involving corporations and LPs can be applied by analogy–and vice versa.
Notice of Claims
The court analyzed whether the LLC had actual knowledge of the claims, as Section 18-101(5) requires actual–not constructive knowledge. A thorough review of the facts, including emails from the claimants to the management of the LLC articulating the view that the claimants’ membership interests were not valued in compliance with the good faith requirements of the LLC agreement, satisfied the court that the notice requirement was met. The knowledge of the LLC’s key officers is imputed to the LLC.
Although the court provided a hypothetical frivolous claim that might allow for no reserve to be made, the court explained that “even a relatively weak claim may justify a reserve” especially where, as in this case, the claim raises the prospect of a large damages award. The court instructed that a claim is not frivolous simply because it will likely be unsuccessful, but rather the inquiry should be whether the claim “lacks even a good-faith arguable basis in law”. (emphasis in original). See footnote 158, citing cases that explore the nuances of that analysis. The court reasoned that based on the details of this case, there was a good-faith arguable basis in law for the substantial claims that the LLC was aware of. See also footnote 165 for another hypothetical the court provides to illustrate its reasoning in support of its conclusion on this point.
The court held that that the managers of the LLC were aware of the non-frivolous claims at the time of the dissolution and the LLC Act required creation of a reserve to cover the claims. Because the LLC failed to do that, it was dissolved in violation of Section 18-804(b)(1), and the court, therefore, nullified the certificate of cancellation.