This post comes to us courtesy of Mitchell Mengden, a law student at the Georgetown University Law Center.
A recent Delaware Court of Chancery decision held that a member forced-out from a member-managed LLC was entitled to the fair value of his membership interest. In the case styled Domain Associates, LLC v. Shah, C.A. No. 12606-VCS (Del. Ch. Aug. 13, 2018), the court addressed a challenge to the payout amount of a member expelled from an LLC by the other members.
The member involved had a membership interest and made a separate capital contribution, but the other members later required him to withdraw from the LLC. This case was based on the member’s claim that he was entitled to a percentage of the company’s cash on hand that correlated with his membership interest. The company, however, took the position that the expelled member was only entitled to the value of his capital account.
The LLC sought a declaratory judgment, and the member filed a counterclaim for breach of contract asserting that the LLC Agreement did not specify the amount of payment due, and that the court should base its decision on the Delaware Limited Liability Company Act (LLC Act).
The court found that the LLC Agreement was unambiguously silent with respect to payout of a member forced to withdrawal. Because the LLC Agreement was silent with respect to payout of a member forced to withdraw, the court turned to the LLC Act to interpret the Agreement. The court noted that Section 18-604 of the LLC Act only applies to voluntary withdrawals. See footnote 140. Instead, the court relied on Section 18-1104 of the LLC Act in finding that “the rules of law and equity . . . shall govern.” See footnote 146.
In determining the fair payout amount for a member forced to withdraw, the court extended to the instant case Chief Justice Strine’s analysis in Hillman v. Hillman, 2006 WL 2434231 (Del.Ch., Aug 23, 2006), which was the subject of a cursory post on these pages. Then-Vice Chancellor Strine held that, under Section 17-1105 of the Delaware Revised Partnership Act, expelled partners are entitled to a payout “equal to the fair value of such partner’s economic interest.” See footnotes 147-49. Under the LLC Act, members are granted the freedom to shape their management structure through the company’s governing instrument. See footnotes 150-52. Because the LLC employed a member-managed model, the court found it appropriate to apply the default rule for partnerships under Section 17-1105.
1) The court reiterated that parties’ intent with respect to the payout of an expelled member is determined, at least initially, by analyzing the four corners of the LLC agreement.
2) The court noted that Chief Justice Strine’s analysis of the Delaware Revised Partnership Act in Hillman can be extended to an LLC depending on the governance structure of the LLC. In this case, because the LLC agreement does not specify the payout for an expelled member, and the LLC employed a member-managed model, akin to a partnership, the member in this case was entitled to a payout “equal to the fair value of such partner’s economic interest.”