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A recent Delaware Court of Chancery decision is required reading for anyone who wants to know the requirements for validly transferring a member’s interest in an LLC, for example, upon death or bankruptcy of a member. 

In Gurney-Goldman v. Goldman, C.A. No. 2023-1124-JTL (Del. Ch. July 12, 2024), the court explained some aspects of the Delaware LLC Act in connection with the transfer of membership interests that, in the court’s words: “To put it mildly, [. . .] is not a well developed area of Delaware law.” Slip op. at 31. See Section 18-705.

As a bonus of sorts, the decision also features an exemplary overview of the dissolution process for both LLCs and corporations. See footnote 69.

Factual Background

The essential factual background involves four siblings who inherited a real estate empire in New York City involving “literally hundreds of entities.” Although the siblings hired one of the largest New York law firms to create the legal structure for their business, the court observed that entity formalities were not always observed and that some of the LLCs did not have any written operating agreements.

Moreover, there were no documents establishing the transfer of interest in key entities from the widow of the patriarch to the siblings. The management structure was not formalized. The 2 siblings who were the primary decision-makers did not have clear documentation to establish the basis of their authority.

After one of the two siblings who had historically been the decision-makers for the operation of the business passed away, his son sought to take over the role of his father in managing the business but the remaining sibling who historically managed the business did not agree that the son had a right to take over his father’s managerial role.

The LLC at the heart of this case, SG Windsor, did not have a written LLC agreement.

Issues Addressed

The litigation sought: (1) a declaration that SG Windsor is a member-managed entity; (2) that the estate of the sibling who historically was a co-manager of the LLC became a member of SG Windsor or, to the extent the estate is only an assignee, that the son is able to exercise governance rights in his capacity as an executor to the estate.

Key Takeaways

There are many principles in this epic decision of both well-settled and not well-traveled aspects of the Delaware LLC Act that should be of interest to anyone who either forms or litigates Delaware LLCs.

  • Under the LLC Act, the default rule is that an LLC is member-managed.  See 6 Del. C. § 18-402.

LLC Agreement Terms/Formation

  • Although SG Windsor did not have a written LLC agreement, the statute allows for an LLC agreement to be “oral or implied.”  See § 18-101(9).
  • The court explained that an implied agreement is one inferred from the conduct of the parties “though not expressed in words.”  See cases cited at footnote 16.
  • The court explained that to prove an implied agreement, the court must be able to infer “as a fact, from conduct of the parties showing, in light of the surrounding circumstances, their tacit understanding. The failure to object may be treated as acceptance.”  See Slip op. at 13-14 and footnotes 19-20.

Appointment of Manager

  • The court referred to “manager” as a term of art under the LLC Act, which defines it as a person who is either named as a manager in the LLC agreement or designated pursuant to a similar instrument.  This term of art should be distinguished from the colloquial use of the word manager where, as here, a person manages the company without the formal title or documentation giving him that title. See § 18-101(12).  See Slip op. at 16.

Transfer of Membership Interests in LLC

  • The default rule under the LLC Act when a member transfers its member interest is that the recipient of the interest does not automatically become a member.  See § 18-702. Rather, the recipient only holds the right of an assignee. Slip op. at 20-21.
  • The assignee does not receive any of the governance rights associated with the interest, nor does an assignee have the right to seek books and records or seek statutory dissolution.  Slip op. at 21 and footnotes 40-42.
  • The court explained the reasons for the default rules include the “pick-your partner principle” which underlies § 18-702(b)(3), and which essentially tries to avoid a situation where a new co-manager is imposed on a member as opposed to a new “passive co-investor.”  Slip at. 21-26.

How to Become a Member

  • To implement that principle, the LLC Act addresses: “(i) what a member is, and (ii) how an assignee becomes a member.  Slip op. at 23.
  • § 18-301 describes how an assignee becomes a member. After the formation of an LLC, the requirements for becoming a member are described in § 18-704(a). Those two ways include: (1) pursuant to provisions in the LLC Agreement; or (2) upon the affirmative vote or written consent of all the members of the LLC.

Death of Member

  • The court instructed that the death of a member who was a natural person terminates that person’s membership. See footnote 52 and accompanying text.
  • A member’s interest in an LLC, like other personal property, transfers by operation of law to the estate of the deceased member.

§ 18-705 – Rights of Personal Representative

  • § 18-705 authorizes the personal representative of a deceased or disabled member to exercise all the member’s rights only as provided in § 18-705, and those rights are limited as an assignee as compared to plenary rights.
  • The court was not persuaded by the Schedule K-1 forms that the parties used because those forms offer two options: (i) general partner or LLC member-manager, or (ii) limited partner or other LLC member. The second box was checked for the three living siblings and the estate, which is inconsistent with the positions taken by the parties in the lawsuit.

Can an Executor Exercise Member-Manager Powers under § 18-705

  • The court explained that this is not a well-developed area of Delaware law, but the court did a deep dive with extensive citations to treatises, case law and other learned commentary.
  • In the course of a short law review article  on § 18-705, the court elucidated several key points.
  • A consequential point for single-member LLCs is the court’s instruction that pursuant to § 18-801(a)(4), the general rule is that when the member of a single-member LLC who is a natural person dies, the default rule is that the LLC is dissolved.
  • Regarding dissolution, in connection with the deep dive into § 18-705, the court provided an illuminating footnote that spans over 4 pages and that provides a paradigmatic encapsulation of the stages of dissolution for both a corporation and an LLC. The court explained that the shuttering of an entity involves: “ … two distinct events that bracket an intermediate period of activity. The first event is dissolution, marking the point at which the entity enters the intermediate period called winding up.  The second event is termination, which takes place after the entity completes winding up.”  See footnote 69.

Stages of Dissolution for LLC and Corporation

  • The court went into further detail by comparing the stages for dissolution of a corporation and an LLC. Referring to DGCL § 278, the court described the Certificate of Dissolution as marking the start of the 3-year winding-up period that includes things such as marshalling assets and distributing any remaining assets after payment of liabilities. At the end of the winding-up period, the corporation’s existence terminates.
  • As for an LLC, dissolution marks the start of the winding-up period.  See § 18-801(a). The winding-up period is similar to that of a corporation. See § 18-803, § 18-804. At the end of the winding-up process an authorized person files a Certificate of Cancellation. See § 18-203.

§ 18-705 Needs Fixing

  • The court suggested that the language in § 18-705 referring to termination makes little sense based on the foregoing overview of termination ending the existence of an LLC, and that the legislature should consider a clarification and refinement of the language in the statute. See footnote 69.

History of § 18-705

  • The court provides an extensive historical overview of the origin of § 18-705 and the limits of the power of a personal representative of a deceased member.  See Slip op. 31-69.

A recent Delaware Court of Chancery ruling is a gem, notwithstanding—or maybe because of—its brevity, that addresses the minimum allegations required to seek dissolution of a business entity, and deserves a place in the pantheon of Delaware decisions.  It presents itself to the world in the form of a short and humble Order that simply recites core principles while denying a motion to dismiss a petition for the dissolution of an LLC. It is a big win for acknowledging the nuanced dynamics of business relationships in a closely-held entity. 

In Walter v. McManus, C.A. No. 2024-0412-NAC, Order (Del. Ch. June 7, 2024), the Court restated several key principles of law regarding the dissolution of LLCs or corporations that I highlight below in bullet points.

[Initially, I note that among the most exemplary discussions of the minimum requirements for surviving a motion to dismiss a petition for dissolution of a business entity are those in the Chancery decision of T&S Hardwoods, highlighted on these pages.]

Highlights of other dissolution decisions on these pages over the last 20 years are available at this link.

Highlights of Walter v. McManus:

  • The first paragraph of the Order describes several “convincing” factors that support a judicial dissolution such as an operating agreement that gives no means of navigating around a deadlock, or the existence of a board level voting deadlock—but the Order wisely at least implies that there is no express per se requirement for a deadlock.
  • The Court astutely observed that: it is not necessary to suggest that the business must be “metaphorically ablaze to state a reasonably conceivable claim to dissolve.”
  • Importantly, the Court instructed that the counterpart corporate statute, DGCL Section 273, is often used by analogy to apply to dissolution cases under the LLC Act. The court sagely reasons that the corporate dissolution statute: “does not mandate that the parties struggle until they have destroyed their relationship entirely and jeopardized their business.”
  • Although it is not required to be so pled, the Court found it relevant that there was “grave risk to the business, even if it is entirely profitable, via a residual inertial status quo.”
  • Delaware law does not require a member to plead she made a performative proposal she knew would be dead-on-arrival as a predicate to seeking judicial resolution.” (citing Seokoh, 2021 WL 1197593, at * 11.) (also distinguishing Arrow, 2009 WL 1101682, as not based on deadlock.)
  • Both the T&S Hardwoods Chancery opinion described on these pages, and this decision demonstrate a sensitivity to the exigencies of the nuanced business dynamics in closely-held entities, and that recognition supports a standard that is more closely aligned to no-fault divorces, as opposed to some opinions at the trial-court level that have attempted to impose additional requirements that are not in the statute, but instead are akin to requiring a purity test in order to establish a deadlock.
  • Lastly, but perhaps of at least equal importance to other principles stated in this Order, is that it remains an insufficient basis to oppose dissolution if a party has an option to sell his interest to a third party, because it would be inequitable to force a party to exercise an option to sell, when that option to sell is entirely voluntary, as an alternative to dissolution.

It would exalt artifice over pragmatism to require talismanic or magic words to be used in pleadings, or to require pleadings that, figuratively speaking, must describe “someone’s hair on fire” in order for one’s investment to be freed from the bondage of a dysfunctional group of a few business owners

Over the nearly two decades that I have maintained this blog, I have written about a fair number of court decisions involving statutory dissolution. The recent Delaware Court of Chancery decision styled:  In re Neworld Energy Holdings LLC, C.A. No. 2023-0282-MTZ (Del. Ch. August 24, 2023), granted a motion to dismiss based on an arbitration clause in an LLC Agreement that the court found to require arbitration of statutory dissolution claims. 

Seminal Delaware Opinion on Arbitrablity

Relying on the seminal Delaware Supreme Court decision in James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76, 79 (Del. 2006) (highlighted on these pages here and which this author argued before the Delaware Supreme Court), the court addressed those situations where an issue of substantive arbitrability should be determined by the court or an arbitrator.  In this decision, the court explained that the arbitration provision, which incorporated the American Arbitration Association Rules, evidenced a “clear and unmistakable intent to submit arbitrability issues to an arbitrator.”  The court determined that the agreement involved in this case provided an exception for seeking equitable relief–but that did not apply to a request for statutory dissolution. 

Additional Case Law Support

The court also found support for its reasoning in two other Delaware cases that applied the Willie Gary decision:  Blackmon v. O3 Insight, Inc., 2021 WL 868559 (Del. Ch. Mar. 9, 2021, and McLaughlin v. McCann, 942 A.2d 616, 622-35 (Del. Ch. 2008).  The court also referred to the recent United States Supreme Court decision in Henry Schein, Inc. v. Archer & White Sales, Inc., 139 S.Ct. 524, 529 (2019)(highlighted on these pages here and here), regarding the position that a court possesses no power to decide an arbitrability issue when there is clear and unmistakable evidence that the parties intended to delegate issues of substantive arbitrability to an arbitrator. 

The court also noted in closing, in support of its decision. another Chancery opinion that concluded:

“There is nothing inherent in the claim for judicial dissolution that could not be fully and fairly litigated in the context of an arbitration.” (citing Johnson v. Foulk Road Med. Ctr. P’ship, 2001 WL 1563693, at *1-2 (Del. Ch. Nov. 21, 2001)).

The Court of Chancery exercised its discretion to appoint a guardian ad litem to assist the court in determining the appropriate amount to reserve as security for unknown liabilities in connection with dissolving a corporation pursuant to the optional court-supervised procedure contemplated by DGCL Sections 280 and 281(a). In the matter styled In Re Riviera Resources, Inc., C.A. No. 2022-0862-JTL (Del. Ch. March 20, 2023), the Court observed that there is not much guidance in the case law on the appointment of a guardian in this context–which makes this an important decision on many levels for those involved in corporate litigation in Delaware and equity practitioners generally.

There is much to commend this opinion and it deserves more extensive commentary than I have time to provide. Suffice it to emphasize for this short blog post that the decision is required reading for anyone who needs to know the latest iteration of Delaware law on the covered topic.

But I want to mention one point in closing. The opinion is characteristically buttressed by scholarship and refers to the latest book from Professor Stephen Bainbridge, one of the nation’s most prolific corporate law scholars, in the context of reciting a few bedrock principles of Delaware corporate law:

Directors owe duties to the corporation for the ultimate benefit of its stockholders as residual claimants. In re Trados Inc. S’holder Litig., 73 A.3d 17, 40–41 (Del. Ch. 2013). The pull of fiduciary obligation thus calls on directors to favor the common stockholders. See Frederick Hsu Living Tr. v. ODN Hldg. Corp., 2017 WL 1437308, at *17–20 (Del. Ch. Apr. 14, 2017). And directors have a natural affinity for stockholders, because that is the constituency who elects them. See Stephen M. Bainbridge, The Profit Motive: Defending Shareholder Value Maximization 73–74 (2023).

Slip op. at 18.

A recent decision of the Delaware Court of Chancery is noteworthy for clarifying the less-than-clear case law regarding what specific factual allegations in support of a petition for judicial dissolution of an LLC would survive a motion to dismiss. In the case styled: In re: Dissolution of T&S Hardwoods KD, LLC, C.A. No. 2023-0782-MTZ (Del. Ch. Jan. 20, 2023), the court denied a motion to dismiss a summary proceeding for judicial dissolution under Section 18-802 of the Delaware LLC Act.[1]  In denying the motion to dismiss in this matter, the court provided refreshing clarification of the types of allegations that will survive a motion to dismiss in connection with seeking judicial dissolution of an LLC.[2]

Important Issues Addressed by the Court

         The court concluded that the petition for judicial dissolution survived a motion to dismiss based on allegations of:  (i) deadlock among the members; (ii) inability to function; and (iii) lack of any equitable exit mechanism.  Id. at 1. 

Brief Background Facts

         The basic facts underlying the petition for judicial dissolution in this matter involved a 50/50 joint venture between a lumber supplier and a lumber wholesale distributor.  As the court described it, the venture was initially profitable, but the relationship between the two members eventually splintered and collapsed.

         This short synopsis assumes the reader is familiar with the basic principles involved in a petition for judicial dissolution.  The thorough factual summary in the court’s opinion will be abbreviated.  The parties formed their joint venture with the expectation that T&S Hardwoods, Inc. (“T&S”) would provide a steady lumber supply for Robinson Lumber Company, Inc. (“RLC”) to resell.  The joint venture, owned 50/50 by T&S and RLC, would provide T&S with financing between the period when it cut the lumber and when the end customers paid their invoices.

         The parties memorialized their understanding with both an LLC agreement and a contemporaneous joint venture agreement.  The majority stockholder of T&S, Thompson, as well as the owner and president of RLC, Robinson, were the only two managers of the manager-managed LLC.  

         The joint venture was called T&S Hardwoods KD LLC (the “Company”).  The LLC agreement requires that “for most decisions” the managers must reach an unanimous agreement.[3]  The two managers had different responsibilities. Eventually the relationship of the two managers deteriorated.  T&S claimed that the Company owes it for over $9 million in lumber even though the Company has over $5.2 million in cash and over $700,000 in receivables.

         One of the managers unilaterally terminated the viewing access of the other member to the Company’s bank and loan accounts.  In addition to the pending judicial dissolution proceedings, there are two separate lawsuits that each of the members and each of the managers filed against each other.

         RLC filed a derivative action against the other manager and the other member before the dissolution petition was filed. The other member also filed a lawsuit, in Georgia, against the remaining manager and the remaining member.  In an effort to resolve the disputes, T&S sent RLC an offer to trigger a buy/sell purchase option under the LLC agreement–but that was not accepted and did not result in either a purchase or a sale of either member’s interest.

Allegations in Petition

         The petition for dissolution includes allegations that: (i) the other manager is causing the Company not to pay for lumber sold by the remaining member; (ii) the managers are not able to agree on certain aspects of running a business; (iii) the respondent manager is using assets of the Company to facilitate loans to his own company; (iv) the remaining member is using its control over company finances to freeze out the petitioning member; and (v) there is an absence of trust between the parties.

         Based on the foregoing, the petition claims that the statutory standard is satisfied to the extent that:  “it is no longer reasonably practicable to carry on the business of the Company . . . in conformity with the parties’ agreements.”

Court’s Analysis

         The court recited the familiar and plaintiff-friendly standard for a motion to dismiss under Rule 12(b)(6).  For example, the court observed the aspect of the well-settled standard that includes the following nuance:  “Indeed, it may, as a factual matter, ultimately prove impossible for the plaintiff to prove his claims at a later stage of the proceeding, but that is not the test to survive a motion to dismiss.”  See footnote 22 and accompanying text.

Sufficiency of Petition Seeking Judicial Dissolution at Motion to Dismiss Stage

         The court provided a helpful overview of the prerequisites for seeking judicial dissolution under Section 18-802 of the Delaware LLC Act which allows the court to decree dissolution:  “on application by or for a member or manager . . . of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.”  Slip op. at 11. 

         The court added that dissolution has been found to be appropriate in the following circumstances:

  • The LLC’s management has become so dysfunctional . . . that it is no longer practicable to operate the business, such as in the case of deadlock.  Id.[4]
  • Existence of a Deadlock.  The court described deadlock in the context of judicial dissolution as referring to:  “The inability to make decisions and take action.”  Slip op. at 12.[5] 

Court’s Analysis of Adequately Pled Deadlock

         The court described the starting point of an analysis involving LLCs as the agreement between the parties, based on the objective theory of contracts.

         The petition in this matter alleged that the only two managers of the Company are:  “no longer able to work together or make decisions for the Company, which . . . requires unanimity for most decisions.”  Slip op. at 14.  The court cites at footnote 39 several decisions to support its position that deadlock was sufficiently pled. 

         Although this case involved a 50/50 ownership structure, in this writer’s view, the fact that unanimity was required should not distinguish it from an LLC with more-than two members that also requires unanimity for important decisions.[6]

         In the joint venture in this case, T&S Hardwoods KD, LLC, one of the members caused the Company to refuse to pay the other member, and once the Company sold its current inventory unless the managers unanimously decided to source it from someone else, the current inventory would be depleted.

         The court described the many other disputes between the parties that supported deadlock: 

         (1)     Each member accused the other of improper actions in connection with operating the business, including financial wrongdoing and secrecy;

         (2)     One member tried to trigger a buyout under the LLC Agreement, “but the parties could not bring that to fruition.”  Slip op. at 15.

         (3)     Instead of working through their issues as managers of the Company, the two managers have filed separate lawsuits against each other.

         (4)     The respondent in this petition admitted that there was “no longer any trust among the managers.”  Slip op. at 15.

In sum:  The court also reasoned that the allegations were sufficient to survive a motion to dismiss the dissolution petition because taken together, the allegations: 

“support the reasonable inference that the Company’s managers and owners cannot resolve their disputes and cannot work together.” 

Slip op. at 15.[7]   

         The allegations and inferences supporting the dissolution in the Petition led to the court’s observation that: 

“The LLC cannot take any meaningful action without the two sides reaching unanimous decisions and . . . [unless] the managers work together . . ..” 

Slip op. at 15-16.

         The court further reasoned that dissolution was appropriate in situations like the instant one where:  “The two members . . . have stopped interacting and are instead engaged in litigation to resolve the disputes, further demonstrating the need for judicial dissolution.”  Slip op. at 16 (citing Haley, 864 A.2d at 96).[8]

         The court referred to the two pending lawsuits that each of the members filed against each other, in addition to the dissolution proceeding and explained that: “the existence of some ongoing business does not preclude a finding of deadlock.”  Slip op. at 16 (citing Fisk Ventures, 2009 WL 73957, at *4) (emphasis added).

         The informational asymmetry with one member accusing the other of ceasing to provide information about the finances of the Company and denying access to the bank and loan accounts of the Company, was additional factual support for the court’s conclusion.

Allegations in Petition Sufficient

         The court emphasized that: “These allegations reflect a continuing breakdown in the members’ and managers’ relationships,” concluding that:  “The Petition adequately alleges the managers are deadlocked.”  Slip op. at 17.

Petition Adequately Pleads Statutory Test: that “It is not Reasonably Practicable to Carry On the Business in Conformity with the Parties, Agreements”

         The court rejected the arguments in the motion to dismiss that relied on the common language in the LLC agreement that the purpose of the Company was to “engage in any lawful activities . . ..” This reliance failed in the face of the contemporaneous agreement among the parties that expressed a more specific purpose for a very specific type of business to be operated.

         The court explained that judicial dissolution is appropriate where the purpose of the entity was either not fulfilled or impossible to carry out, but when analyzing the purpose the court can look to not only the purpose clause in an organizational document, but also other evidence that may be used to inform the analysis.  Slip op. at 18. (citing Meyer Nat. Foods, 2015 WL 3746283, at *3) (explaining that in addition to the purpose clause other evidence of purpose may be helpful as long as the court is not asked to engage in speculation).[9]

Whether the LLC Agreement Offers an Exit Mechanism that Precludes Dissolution

         The court explained why the buy-sell option in the LLC agreement did not serve as a sufficient method for a party to exit the LLC equitably. 

         In deciding whether a viable exit mechanism in the LLC agreement existed as a basis for denying a dissolution claim, the court emphasized that such an exit mechanism must be “equitable in its operation.”  Slip op. at 21.[10]

         Notably, the court distinguished a recent decision that granted a motion to dismiss prior to trial in a summary dissolution proceeding in the matter styled: In re Doehler Dry Ingredient Solutions, LLC, which is currently on appeal before the Delaware Supreme Court.  The T&S Hardwoods court distinguished the exit mechanism in the Doehler case, finding that the buy-sell provision in Doehler was different.[11]

         In this particular case, the buy-sell provision was optional, and did not force a buyout of any member.  The court supported its reasoning with reference to Fisk Ventures, LLC v. Segal, 2009 WL 73957, at *5, which reasoned that:  “It would be inequitable for this court to force a party to exercise its option when the party deems it in its best interest not to do so.”  Slip op. at 22-23. 

         The buy-sell option in the instant case did not provide an exit mechanism that would resolve a deadlock because it would “not allow Thompson [the member seeking dissolution] to separate himself from the Company.”  Slip op. at 23.

         As applied to the instant matter, the court reasoned that the buy-sell provision would not “equitably effect the separation of the parties” as it would leave the departing member:  “with no upside potential, and no protection over the considerable downside risk” of having to cure any default by the Company.  Slip op. at 23-24. [12]

         The court also noted with emphasis that because there is no mechanism in the LLC agreement to resolve the deadlock, that fact also provides another reason the parties “cannot operate the Company in conformity with the LLC agreement.”  See footnote 24 (citing Vila, 2010 WL 3866098, at *7) (when an LLC agreement requires that there be agreement between two managers for business decisions to be made, those two managers are deadlocked over serious issues, and the LLC agreement provides no alternative basis for resolving the deadlock, it is not “reasonably practicable” to continue to carry on the LLC business “in conformity with its limited liability company agreement.”) (citations omitted).

         In sum:  The court concluded that dissolution is not foreclosed by the buy-sell provision because it would be inequitable to force the parties to engage in that buy-sell procedure.

         Takeaway:  Petitions for judicial dissolution of an LLC are often factually determinative. It remains challenging to address the factual nuances at the motion to dismiss stage in a summary proceeding, but this decision provides helpful instruction on what allegations suffice to allow a claim to proceed to trial.

Footnotes:

[1] Notably, motions to dismiss in summary proceedings, when the case involves material, nuanced factual issues are disfavored–but are nonetheless often permitted.

[2] In the interest of full disclosure, the author of this synopsis was counsel for the petitioner.

[3] Note that LLC Agreements for closely-held LLCs with more than two members also often require unanimity for key decisions–a fertile field for deadlock.

[4] See also cases cited at footnote 27.  For example:  In re: GR BURGR LLC, 2017 WL 3669511, at *6 (Del. Ch. Aug. 25, 2017) (citing In re Arrow Inv. Advisors, 2008 WL 1101682, at *3 (Del. Ch. Apr. 23, 2009)); Mehra v. Teller, 2021 WL 300352 at *19 (Del. Ch. Jan. 29, 2021) (“serious managerial issues, such as strategic visions, major initiatives, and the operation and control of a company, will typically satisfy the qualitative requirements imposed by statute and common law for dissolution.”)  (citing Vila v. BVWebTires LLC, 2010 WL 3866098, at *7 (Del. Ch. Oct. 1, 2010)).

[5] Citing In re: GR BURGR, 2017 WL 3669511, at *6 (citing Meyer Nat. Foods LLC v. Duff, 2015 WL 3746283, at *3 (Del. Ch. June 4, 2015)); Accord Acela Invs. LLC v. DiFalco, 2019 WL 2158063, at *26 n. 276 (Del. Ch. May 17, 2019) (“In the context of a dissolution claim, ‘deadlock’ means disagreement and discord between the parties.”)

[6] Footnote 39 cited cases such as Haley v. Talcott, 864 A.2d 86 (Del. Ch. 2004) and In re:  GR BURGR, 2017 WL 3669511, at *7 (explaining dissolution is appropriate where there are no circumstances indicating that the parties would want to associate with each other in the future); In re Silver Leaf, L.L.C., 2005 WL 2045641, at *10 (Del. Ch. Aug. 18, 2005) (explaining a company that has a 50/50 ownership split and requires a majority for decisions cannot continue to function as a business where the two sides disagree on how to run it); In re:  GR BURGR, 2017 WL 3669511, at *6-7 (an unbreakable deadlock can form a basis for dissolution even if a company is still engaged in marginal operations, in a case involving two 50% owners).

[7] In support of that allegation being a factor in supporting a dissolution petition, the court cited cases such as Fisk Ventures, 2009 WL 73957, at *4 (finding dissolution appropriate given the parties’ history of discord and disagreement); Symbiont.io, Inc. v. Ipreo Hldgs., LLC, 2021 WL 3575709, at *58-59 (Del. Ch. Aug. 13, 2021) (explaining dissolution is appropriate where any suggestion the parties could work together to operate the business is a “fantasy”); and In re Shawe, 215 WL 4874733, at *26-28 (finding deadlock over issues including distributions to members, pursuit of acquisitions, expense true-ups to reconcile personal uses of company funds, and a hiring and retention of personnel).  See Slip op. at n. 41.

[8] The court cited another Court of Chancery decision that found dissolution proper in an LLC structure where the petitioner demonstrated an indisputable deadlock between to 50/50 members.  Slip. at 16 (citing Haley v. Talcot, 864 A.2d at 88-89) (referring to that case as finding dissolution appropriate between two 50/50 members of an LLC who created a business for mutual benefit and profit but:  “were deadlocked about the business strategy and future of the LLC”).

[9] See also footnote 55 citing a case explaining that even though some agreements may be entered into contemporaneously and will be reviewed together, one of those agreements may be considered subordinate to the other.

[10] Citing Haley, 864 A.2d at 95 (“When the agreement itself provides a fair opportunity for the dissenting member who disfavors the inertial status quo to exit and receive the fair market value of his interest, it is at least arguable that the limited liability company may still proceed to operate practicably under its contractual charter because the charter itself provides an equitable way to break the impasse”); Seokoh, 2021 WL 1197593, at *8 (explaining this court “has emphasized that a judicial decree of dissolution is typically inappropriate when the entity’s constitutive documents provide an equitable and effective means of overcoming the deadlock.”) (citations omitted) (emphasis supplied)); Vila, 2010 WL 3866098, at *8 (“Of course, the existence of a deadlock would not necessarily justify a dissolution if the LLC agreement provided a means to resolve it equitably.”) (citations omitted) (emphasis added)).

[11] The exit provision in the instant matter (and in the Doehler matter that this writer has appealed) does not provide a guaranteed exit at all. The court in Doehler viewed the exit mechanism in Doehler as an actual exit mechanism even though it gave the recipient of a offer to sell (offeree): the option of requiring the offeror to buy the interest in the LLC of the offeree–instead of allowing the offeror to sell and exit. Whether Doehler provided an equitable exit mechanism is an issue pending appeal before the Delaware Supreme Court.

[12] The court explained that in the Haley v. Talcott case, “even though the exit mechanism in that case allowed a member to sell his interest to the other member at fair market value, the court found in that case that the exit mechanism was not equitable because it did not allow the departing member to make a clean break, in light of personal liability on a bank guarantee and therefore, it was inequitable to force the member to use the exit mechanism . . . [and] was not an adequate remedy.”  Slip op. at 23.

Anyone who needs to know the latest iterations of Delaware law regarding the intricacies and nuances of the dissolution of a corporation and the related winding-up process–needs to read the recent Delaware Court of Chancery decision styled: In re Altaba, Inc., C.A. No. 2020-0413-JTL (Del. Ch. Oct. 8, 2021). This scholarly and extensive analysis of statutory dissolution of corporations and the related winding-up process, weighing in at 66 pages, could easily qualify as a law review article.

Selected Background Facts:
The context of this decision involved a company that dissolved in October 2019, and elected to pursue the optional court-approved process to wind-up its affairs. In May 2020, the company filed proceedings to ask the court to determine the appropriate amount and form of security for various claims. The company also requested court approval to make interim distributions.

The company was previously known as Yahoo, Inc., and was purchased in 2016 by Verizon. Shortly after the agreement to sell to Verizon, a major attack by hackers resulted in monumental data breaches. As a result, the company agreed to indemnify Verizon for 50% of the financial responsibility for class actions filed in connection with the data breach. A settlement of the class actions was reached and approved by a federal district court, but that decision is on appeal.

Key Issue Addressed

One of the issues for Chancery to decide was the appropriate amount and form of the security for the dissolved company to maintain in the event that the settlement was reversed or overturned on appeal. The company wanted to only maintain security for the 50% of the settlement that the district court approved, but Verizon wanted a much larger number to cover the risk that the court of appeals would not approve the settlement of the class action, and if then the case went to trial.

Highlights:
• The court engaged in a deep dive into the doctrinal underpinning, public policy and statutory procedures required in the winding-up process for a dissolved corporation. The codification of the “absolute priority rule” to make stockholders wait until creditors are paid also was explored. See Slip op. at 22-27.
• The court explained that a dissolved corporation can pursue one of two paths to wind-up its affairs based on the statutory scheme in Sections 280, 281 and 282 of the Delaware General Corporation Law.
• The Court referred to one as the “default path” in which the board decides the amount of security for any claims by creditors of the dissolved corporation. But this approach leaves open the risk that unhappy creditors will challenge the amount or form of security and pursue claims against board members and possibly stockholders as well.
• The court called the second option under the statutory dissolution scheme the “elective path.” Under this statutory option, the dissolved company can seek court approval for the amount and form of security for claims. This approach gives the board and stockholders the protection of court approval against any claims by creditors that the amount of security was not sufficient. See Slip op. at 27-31.
• The court explained that there are three general categories of claims, and three different corresponding standards that apply to each category of claims. The court discussed at length the applicable standard for each category in order to determine if sufficient provisions are made to cover claims against the dissolved corporation. See Slip op. at 38-39.
• The court applied the applicable standard to determine the appropriate form and amount of security for the claim by Verizon in this matter. Id. at  49-60.
• The court discussed the public policy considerations in connection with allowing claims against a dissolved corporation and the need for dissolved corporations to deal fairly with the creditors who have those claims.
• The statute provides for an initial three-year winding-up period, but the statute allows also for automatic extensions of that initial three-year period. See Slip op. 60-64 and footnote 22.
• In this scholarly and thoughtful analysis of the statutory winding-up process for dissolved corporations, the court explains the reasons for its determination of the amount of security for Verizon, including its perception of the expert testimony presented in this matter. See Slip op. 64-66.

Delaware will retain jurisdiction over a dissolution claim notwithstanding a mandatory New York forum selection clause, according to the recent Delaware Court of Chancery opinion in Seokoh, Inc. v. Lard-PT, LLC, C.A. No. 2020-0613-JRS (Del. Ch. March 30, 2021). This case involved the petition for dissolution of a Delaware LLC while litigation between the parties also was filed in New York. The LLC agreement had a deadlock provision but it was not effective for resolving the parties’ dispute. For example, there was no formula or deadline for a buyout.

Several important statements of Delaware law make this 45-page decision noteworthy (and blogworthy), as well as well-worth the time to read the whole opinion for those who need to know the latest iteration of Delaware law on the following topics:

  • Although Delaware courts generally enforce forum selection clauses, even when they require disputes to be litigated in a foreign forum–this is a notable exception: when a petition for dissolution of a Delaware LLC is filed pursuant to Section 18-802 of the Delaware LLC Act. See footnote 43. (The parties in this case agreed to the foregoing exception and the Court noted that they were correct in doing so.)
  • This opinion features a useful recitation of the factors the court will consider under Section 18-802 in order to determine if the statutory prerequisites for an LLC dissolution have been satisfied. See Slip op. at 24 to 27 and footnotes 119 to 128.

A recent blog post highlighted on these pages featured another Chancery decision addressing a deadlock in an LLC that formed the basis of a dissolution petition.

A recent Delaware Court of Chancery decision provided an exemplary analysis of when a deadlock in an LLC might be the basis for a dissolution. In Mehra v. Teller, C.A. No. 2019-0812-KSJM (Del. Ch. Jan. 29, 2021), the court analyzed case law, statutes, and learned commentary that it synthesized in a careful application to the facts of this case.

Two central issues were addressed by the court:

(1) whether there was a failure to achieve votes necessary for board action; and

(2) whether the board deadlock was “genuine” or merely manufactured to force the appearance of a deadlock. See Slip op. at 48.

This 75-page opinion by Vice Chancellor Kathaleen St. Jude McCormick deserves to be read in its entirety, but the key takeaways, in my subjective view, that make this decision especially noteworthy are the following:

(1) The court’s comprehensive and detailed analysis that examines the two determinative issues should be read by anyone who needs to determine whether circumstances of a particular case satisfy the definition of deadlock for purposes of seeking a dissolution. See Slip op. at 48 to 58.

(2) Especially important are footnotes 243 and 244, which explain why the deadlock in this situation was not disingenuous, and was not merely pre-planned for strategic purposes.

(3) The court illustrates why it refused to invalidate the dissolution based on equitable grounds. This explanation by the court provides guidance to address the common defense that the person seeking dissolution is not doing so equitably. See Slip op. at. 69 – 75.

Due to the relative lack of abundant, comprehensive case law analyzing the criteria the court will use to determine the amount of security deemed sufficient for purposes of satisfying DGCL Section 280 in connection with seeking court approval of a dissolution, and related distributions, the recent Court of Chancery decision in the matter of In Re Swisher Hygiene, Inc., C.A. No. 2018-0080-SG (Del. Ch. June 12, 2020), strikes this litigator as noteworthy, or at least blogworthy.

In particular, in this case the court was called upon to determine, in connection with a motion to approve an interim distribution as part of the petition for dissolution, whether the proposed amount of funds to be held in reserve for a pending lawsuit, and other claims, was sufficient security pursuant to DGCL Section 208(c)(1). Footnote 12 includes a citation to two Orders in other cases that addressed similar Section 280 issues. That the court cited two prior Orders, as opposed to citing to prior formal Opinions, is an indication of the relative paucity of robust decisional law on this topic.

By way of an aside and for context, there are two primary ways to pursue a formal dissolution under the Delaware General Corporation Law, as described in a Chancery decision highlighted on these pages a number of years ago. One method is to seek court approval as a “judicial imprimatur” for how creditors are handled, especially if there are insufficient assets to satisfy all pending claims. Another option is non-judicial, which, as the name implies, does not have the benefit of a judicial blessing. A third option, not recognized in the DGCL, and followed in some instances by those who do not have the money, or prefer not to spend the money, to pursue a formal dissolution process–often because the amount of assets at stake may not be worth the expense–may be referred to colloquially as “turning off the lights; closing the door; and walking away.” Not recommended, however.

 

There is a precious paucity of Delaware decisions that thoroughly and directly address the potential equitable dissolution of an LLC, as compared to a statutory dissolution of an LLC based on the LLC Act, but that situation has been ameliorated by the recent Delaware Court of Chancery decision in SolarReserve CSP Holdings LLC v. Tonopah Solar Energy LLC, C.A. No. 2019-0791-JRS (Del. Ch., Mar. 18, 2020). But note that this decision was vacated by the Court of Chancery’s Order dated August 20, 2021.Tonopah did not oppose a Motion to Vacate in this case after the Delaware Supreme Court, by Order dated August 9, 2021, granted a Motion to Vacate a books-and-records Chancery decision issued July 2020 in a case involving the exact same parties–as a result of Tonopah’s bankruptcy filing precluding appellate review.

Even without precedential value, in light of the Aug. 20, 2021 Order vacating the decision, this case may still have some noteworthy aspects, in part, because it is only the second decision (as of March 2020), to both thoroughly and directly address the somewhat esoteric issue of the equitable dissolution of an LLC–other than the Court of Chancery decision styled In re Carlisle Etcetera LLC, 114 A.3d 592 (Del. Ch. 2015). See also, Trusa v. Nepo Chancery decision highlighted on these pages.

Because this writer represents a party in the case, and the appeal period has not yet expired, the only point I want to publicly publish about this case at this time is that it is must reading for anyone interested in the latest iteration of Delaware law on those circumstances when the Court of Chancery, may, or may not, consider equitable dissolution of an LLC when the criteria of the LLC Act cannot be satisfied.