Search results for: dissolution

Meyer Natural Foods LLC v. Duff, C.A. No. 9703-VCN (Del. Ch., June 4, 2015). This Court of Chancery letter ruling is noteworthy to the extent that the Court granted dissolution of an LLC despite: (i) no deadlock (one member owned 51%); (ii) an ongoing profitable company; (iii) language in the LLC agreement barring voluntary dissolution; (iv) the ability of the LLC to continue to operate within the scope of its purpose clause, at least in theory; and (v) the court went beyond the four-corners of the agreement to explore the core purpose of the LLC. Specifically, notwithstanding an integration clause, the court considered other agreements that were contemporaneously entered into by the parties in connection with the formation of the LLC, only one of which had a Delaware choice of law clause. That factual consideration was key to addressing the “practicability” requirement for dissolution in 16 Del. C. Section 18-802

Key facts as noted by the Court:

The operative facts here are that PNB’s business depended on the integrated supply and distribution of natural beef, the Output and Supply Agreement is no longer effective, Respondents no longer believe that non-compete obligations apply, and no one wants to remain in the business as originally structured.

This decision should be juxtaposed with other rulings denying requests for dissolution even in the face of a deadlock, for example, as highlighted on these pages. But see recent decision highlighting broad equitable basis for court to consider dissolution of an LLC.

Courtesy of Kurt Heyman of Proctor Heyman Enerio LLP, who represented the party seeking the dissolution of an LLC in a decision issued today by the Court of Chancery, we have the following highlights of the important opinion:

The Court of Chancery, per Vice Chancellor Laster, just issued an Opinion denying a motion to dismiss the petition for dissolution in In re Carlisle Etcetera LLC, C.A. No. 10280-VCL (Del. Ch. Apr. 30, 2015).  This decision appears to be the first in Delaware to provide strong support for the concept of “equitable dissolution” of LLCs.

The respondent, Tom James Company, moved to dismiss on the grounds that the petitioners lacked standing to seek judicial dissolution under Section 18-802 of the LLC Act, because neither was a member of the LLC as a result of (a) the LLC agreement’s silence on the issue of assignments and (b) the original member’s (WU Parent) assignment of its interest to its wholly owned subsidiary (WU Sub).  (See Section 18-702 of the LLC Act regarding the effect of assignments where the LLC agreement is silent on the issue.)

The Vice Chancellor agreed with Tom James’ argument, notwithstanding the fact that Tom James was aware of the assignment when it occurred and treated the assignee as a member, and therefore held that the petitioners lacked standing to seek judicial dissolution under Section 18-802.

However, in a lengthy analysis of the Court’s equitable jurisdiction, the Vice Chancellor found that the assignee nevertheless had standing to seek “dissolution in equity,” and consequently denied the motion to dismiss.  The critical holding of the case is as follows:

“James argues that because neither WU Parent nor WU Sub can seek statutory dissolution under Section 18-802, this case must be dismissed. In my view, James errs in contending that Section 18-802 is the exclusive extra-contractual means of obtaining dissolution of an LLC.  Under the facts of this case, WU Sub has standing to seek dissolution in equity.”

Because the Court took pains to note that its finding was based on “the facts of this case,” a careful analysis of those facts is necessary before concluding that the decision applies to other cases.

Supplement: On May 4, 2015, the Court granted a motion for summary judgment in this case. The Order provides a helpful description, with citations to authority, of those circumstances in which a deadlock will warrant dissolution–because not all deadlocks will justify a dissolution by the court. The same day the Court also entered an Order appointing a Receiver to oversee the dissolution. This Order provides helpful details that address the powers of a Receiver and scope of a Receiver’s role in connection with a dissolution.

By coincidence, a day before the initial decision in the above case, another member of the Court of Chancery issued a separate decision in an unrelated case that also involved an issue of standing to pursue an claim for dissolution of an LLC pursuant to Section 18-802. See Hampton v. Turner, C.A. No. 8963-VCN (Del. Ch. Apr. 29, 2015). Proctor Heyman Enerio LLP also represented a party in this Hampton case.

Huatuco v. Satellite Healthcare,et al., C.A. No. 8465-VCG (Del. Ch. Dec. 9, 2013).

Issue Addressed:  Whether the provisions of the LLC agreement waived the statutory right to dissolution that a member of an LLC would otherwise have, pursuant to Section 18-802 of the Delaware LLC Act. Short Answer:  Yes.

Brief Overview:

This pithy and useful opinion analyzes the terms of an LLC agreement in light of the well-settled principle that Delaware LLC law is based on a contractarian view that the parties can agree to almost anything in an LLC agreement, and can waive rights to almost anything, with limited exceptions such as the inability to waive the covenant of good faith and fair dealing.  See 6 Del. C. Section 18-1101(c).

The parties rejected all of the default provisions that would otherwise apply under the Delaware LLC Act, and expressly limited the rights of the LLC members to those expressly provided for in the LLC agreement.  The right of a member to seek judicial dissolution under Section 18-802 in the context of a member deadlock where it is not “reasonably practicable” to carry on the business of the LLC, was waived.  The Court distinguished the cases highlighted on these pages involving similar issues, such as R&R Capital, LLC v. Buck & Doe Run Valley Farms LLC and Lola Cars Int., Ltd. v. Krohn Racing, LLC.

In closing, an educational footnote in the opinion is especially blogworthy.  Footnote 2 notes that the Court does not address the issue of whether parties to an LLC agreement may divest the Court of its authority as a matter of equity to order a dissolution in all circumstances, even where it appears manifest that equity so requires:  “leaving, for instance, irreconcilable members locked away together forever like some alternative-entity version of Sartre’s Huis Clos … .”  The Court found that no such equitable considerations were present in this case.

The preceding quote is destined to be cited often in submissions to the court seeking dissolution in future deadlock cases. The reference is to a play by Sartre that is often translated with the title of “No Exit“. The play is a depiction of the afterlife in which three deceased characters are punished by being locked into a room together for eternity.

 UPDATE: The Supreme Court affirmed this decision in an Order, without addressing the broader policy issues.

Wiggs v. Summit Midstream Partners, LLC, C.A. No. 7801-VCN (Del. Ch. March 28, 2013).

This opinion addresses: claims for breach of fiduciary duty in the context of an LLC agreement, which waived all fiduciary duties, and also addresses a claim based on the implied covenant of good faith and fair dealing, as well as a judicial dissolution claim based on Sections 18-802 and 18-803 of Title 6 of the Delaware Code (the Delaware LLC Act). The court dismissed the entire complaint but the judicial dissolution analysis is the most noteworthy.

Judicial Dissolution Under LLC Act

The court recognized that judicial dissolution is “a limited remedy that Delaware courts grant sparingly.”  See footnote 135.  The court often looks to the limited partnership dissolution statute in the absence of extensive case law involving Section 18-802 of the LLC Act.

Two situations where the court has ordered dissolution are:  “(1) Where there is a deadlock that prevents the corporation from operating; and (2) Where the defined purpose of the entity is fulfilled or impossible to carry out.”  See footnote 137 and 138.  There was no deadlock in this situation and in evaluating whether the defined purpose of the entity was either fulfilled or impossible to carry out, the court:  “must assess whether it is reasonably practicable to carry on the business of the limited partnership, and not whether it is impossible.”  See footnote 139.

The court looks to the purpose clause in the governing agreement and determines whether the business can continue in accordance with that stated purpose.  See footnotes 141 and 142.

The court quoted from the purpose clause in the LLC agreement which was very broad and essentially allowed for “any lawful activity”.  Based on that broad purpose clause, which allowed the entity to engage in any lawful activity, the court determined that the plaintiffs did not plead a “reasonably conceivable” claim that it was “no longer reasonably practicable for [the LLC] to operate in accordance with its broad purpose clause.”

 

In the Matter of Krafft-Murphy Company, Inc., C.A. No. 6049-VCP (Del. Ch. Feb. 4, 2013).

Issue Addressed

This case addresses a question of first impression in Delaware: Whether a receiver should be appointed more than 10-years after the dissolution of a Delaware corporation when the dissolved corporation’s only assets are liability insurance policies.  The Court observed that this specific issue had not yet been squarely addressed previously in Delaware law.

Brief Overview of Case

The respondent company has moved in various other courts to dismiss asbestos-related tort suits that were filed more than 10 years after its dissolution.  The petitioners filed this action seeking the appointment of a receiver for the respondent company based on the perceived existence of undistributed assets in the form of liability insurance coverage.  The respondent is a former corporation that was involved for decades in the business of plastering and spray insulating.  Due to the nature of its business, the respondent has been subject to hundreds of asbestos-related tort suits.  The respondent dissolved in 1999, which was 7 years after ceasing operations.  This decision is based on opposing motions for summary judgment related to a petition for the appointment of a receiver for a dissolved corporation.

Brief Summary of Legal Analysis

Delaware law allows for the appointment of a receiver whenever a dissolved corporation has undistributed assets.  The Court first examined whether insurance liability contracts are undistributed assets of a Delaware corporation that has been dissolved for more than 10 years.  In order to address the question, the Court first had to determine whether a dissolved corporation is amenable to suits brought more than 10 years after dissolution. 

The Court concluded that the respondent company is not amenable to asbestos-related tort suits commenced more than 10 years after its dissolution.  Therefore, based on the facts of this case, the insurance contracts were deemed to be valueless.  Because the company did not have any undistributed assets, the Court found the appointment of a receiver unnecessary.

Overview of Background

Although they were not named as parties in this case, it was alleged that the “real parties in interest” sponsoring the litigation for the company were various insurance companies obligated to defend and settle asbestos-related claims against the company under liability insurance contracts.  Those insurance companies included Travelers, CNA and Great American Insurance Company.

The company involved, Krafft-Murphy, ceased operations in 1991 and filed a Certificate of Dissolution in 1999 pursuant to 8 Del. C. Section 275, although it did not provide notice of its dissolution to creditors, and its directors did not adopt a formal plan of dissolution.

Petitioners sought the appointment of a receiver for a dissolved corporation pursuant to 8 Del. C. Section 279.  The company sought to dismiss the petition, and petitioners moved to perfect service by publication pursuant to 10 Del. C. Section 3111(b) and Rule 4(d)(4) or alternatively under Rule 4(d)(7).  The motion to perfect service of process was granted 

The Court previously issued an opinion at 2011 WL 5420808 (Del. Ch. Nov. 9, 2011), highlighted on these pages here, which denied the company’s motion to dismiss and addressed those situations which warranted the appointment of a receiver under DGCL Section 279.  In that opinion, the Court determined that the company had not shown that the statutory language of Section 281(b) and Section 279, or the overall statutory scheme for dissolution, compels the conclusion that there is an absolute bar against the appointment of a receiver for the sole purpose of allowing claimants to bring claims against the dissolved corporation more than 10 years after its dissolution.

In the current procedural posture, the company’s overarching argument is that the appointment of a receiver is unwarranted due to the liability insurance contracts of the company not being assets of the company, because the company is not amenable to suits brought after 10 years.

Overview of Dissolution Analysis

The Court began its analysis of the dissolution issue by reviewing the history and statutory scheme of dissolution.  The Court referred to the common law view of dissolution as a civil death of the company, but that in order to avoid depriving creditors of the ability to sue, statutory authority prolongs the life of a corporation past its date of dissolution.  That authority is provided in 8 Del. C. Section 278.

Section 278 provides that a dissolved corporation automatically continues for a term of 3 years following its dissolution “or for such other longer period as the Court of Chancery shall in its discretion direct.”

The Court explained that the intention of the statute was to balance the competing public policy interests of ensuring that claimants against the corporation had a fair period in which to assert claims, and ensuring that directors, officers and shareholders of a dissolved corporation could have repose from claims regarding the dissolved corporation.  The latter interest of ensuring repose is addressed in 8 Del. C. Sections 280 through 282.  See footnotes 34 and 35 and accompanying text.

The Court also explained that Section 279, which provides for the appointment of a receiver for a dissolved corporation, functions “primarily for the benefit of shareholders and creditors where assets remain undisposed of after dissolution.”  See footnotes 37 and 38.

Dissolution Procedure Options in Delaware

The Court also instructed that Section 280 through 282 of the Delaware General Corporation Law “create a detailed process, which entails judicial involvement, by which dissolving corporations can essentially smoke out claims, pay off claims in accordance with statutory priorities, and establish reserves for contingent claims.”  See footnotes 40 through 43.

The Court observed that the dissolving corporation has the option of selecting from one of two procedures upon dissolution:  (1) The elective procedures in Sections 280 and 281(a); or (2) The default procedures under Section 281(b).

The procedure in Sections 280 and 281(a) provide for a judicial process where the Court of Chancery approves amounts set aside for corporate claimants. This judicial process protects the directors and shareholders from potential future claims arising from the distribution of assets upon dissolution.  See footnotes 44 through 48 and accompanying text.

The Court explained that although the judicial approval under Sections 280 and 281(a) for dissolution protects directors and shareholders from personal liability, and Section 281(b) at least nominally provides for similar protection, in reality, the non-judicial procedure under Section 281(b) still comes with a risk of litigation about whether or not there was compliance with the statutory standard of  “reasonably likely to be sufficient” in terms of the amount set aside for creditors.  Thus, the Court explained that:  “reliance upon the mechanism of Section 281(b) may present a risky situation for corporate directors regardless of their good faith and due care.”  (citing In re RegO Co., 623 A.2d 92, 97 (Del. Ch. 1992)).

Epilogue

The Court provided an analysis of how the insurance policies in this case should be treated in terms of ownership and asset classification, and then concluded that there is no evidence that the legislature intended to extend corporate liability beyond 10 years.  Moreover, the Court noted that Section 280(c)(3) does not contemplate that corporations will need to provide for claims brought more than 10 years after dissolution.  See footnote 58. 

The Court also distinguished the case of In re Texas Eastern Overseas, 2009 WL 4270799 (Del. Ch. Nov. 30, 2009), highlighted on these pages here.  In part, the Court distinguished that case on the basis that the suit in that case was filed only 7 years after the company’s dissolution and not beyond 10 years.

Therefore, because the Court found that the claims in the instant case were not asserted until more than 10 years after the date of dissolution, the company does not have any undistributed assets, and therefore the appointment of a receiver is unwarranted.

McElroy v. Schornstein, C.A. No. 7233-CS (Del. Ch. June 20, 2012).

Issue Addressed: Whether summary proceedings for dissolution under 8 Del. C. § 273 should be permitted to proceed as an exception to the first-filed rule under the McWane doctrine, in light of related actions outside of Delaware addressing Delaware issues.

Short Answer: Not under the circumstances of this case.  Motion to Dismiss granted. Hat tip to Delaware corporate litigator Kurt Heyman for forwarding this case to me.

Background

This action was filed pursuant to DGCL Section 273 seeking judicial dissolution of a business that was owned by two 50% shareholders.  Section 273 allows for a summary proceeding in the nature of a “no-fault business divorce” when there is a deadlock between two 50/50 shareholders.  Curiously, one of the parties previously filed a separate but similar action in New Jersey several months earlier.  The first-filed rule, also known as the McWane doctrine, generally allows the court to exercise discretion to stay or dismiss a second-filed case in favor a prior action pending elsewhere in a court capable of doing prompt and complete justice involving the same parties and the same issues.  An exception to that rule is when a summary statutory proceeding, such as one under Section 273, is filed as a “second action.”  See cases cited at footnote 3. 

The exception to the first-filed rule for summary proceedings is based on the theory that Delaware is the more appropriate forum, when a component of multi-forum litigation involves a summary proceeding, because Delaware has a strong interest in resolving issues concerning the internal affairs of a Delaware corporation promptly and efficiently.  See cases cited at footnote 9.

An important factor here was that the prior filed action in New Jersey resulted in an Order entered by the New Jersey Court that regulated the conduct of the parties and imposed restrictions on the activities of the parties during the pendency of that action. 

Analysis

The Court of Chancery determined that the motion to dismiss the Section 273 summary proceeding should be granted for several reasons.  First, the prior filed action in New Jersey involved substantially the same issues that would need to be determined in Delaware, and the New Jersey Court already entered an order addressing several of those issues, at least preliminarily. 

The Court of Chancery also determined that the attempt by McElroy to proceed in Delaware was undercut by his filing of yet another action in California, the outcome of which would affect the actions of any receiver that might be appointed in Delaware in connection with the dissolution.  Proceeding with the dissolution in Delaware and appointing a Delaware receiver would also interfere with the order that was already issued in New Jersey.

In light of the pending actions in both New Jersey and California involving the same parties and related issues, the Court concluded with reasoning that is eminently quotable:

“Three-ring circuses may delight children at Barnum & Bailey, but in this context, they create the sort of inefficiency, complication, and sheer waste McWane addresses.”

This article by Kevin F. Brady and Francis G.X. Pileggi first appeared in the March 14, 2012 issue of The Delaware Business Court Insider, and reviews the recent Delaware Court of Chancery decision in  Matthew v. Laudamiel, C.A. No. 5957-VCN (Feb. 21, 2012).

The Delaware Court of Chancery recently issued an opinion on an issue of first impression in Delaware.  Apparently no Delaware statutory or case law directly addressed the issue of whether the dissolution and cancellation of an LLC transformed derivative claims into direct claims held proportionately by the members of the LLC.  The Court concluded that, after the filing of the certificate of cancellation, such claims must be brought in the name of the LLC by a trustee or a receiver appointed under 6 Del. C. Section 18-805, or directly by the LLC, or derivatively by its members after reviving the LLC by obtaining a revocation of its certificate of cancellation.

Background

The Court’s 61-page decision in Matthew v. Laudamiel (C.A. No. 5957-VCN,  Del. Ch. Feb. 21, 2012), provides a detailed description of the extensive background facts.  In brief, the case involved Stewart Matthew asserting various claims against his former business associates, including his former fellow members and board of managers of Aeosphere LLC, as well as two companies with which Aeosphere purportedly had business dealings.  All of Matthew’s claims related to the dissolution of Aeosphere which he argued was wrongfully undertaken by the other managers in order to remove him from a potentially lucrative fragrance business.

Two defendant companies with which Aeosphere purportedly had business dealings, Flakt Woods Group and Semco LLC, moved for dismissal based on the lack of subject matter jurisdiction in Delaware.  Semco also moved for dismissal under Court of Chancery Rule 12(b)(6).  The former members and/or managers of Aeosphere, besides Matthew, were Christophe Laudamiel, Roberto Capua and Action 1, srl, an Italian company.  These defendants also asserted counterclaims against Matthew relating to actions he took or did not take in his capacity as a manager of Aeosphere.  Matthew moved for dismissal of many of those claims under Rule 12(b)(6), as well.

Laudamiel was a member, manager and co-CEO of Aeosphere.  Action 1 was a member of Aeosphere.  Capua was a manager of Aeosphere and the majority owner of Action 1.

Preliminarily, the Court noted that motions to dismiss under Court of Chancery Rule 12(b)(6) are usually limited to the facts alleged in the complaint, but the Court may consider documents both integral to and incorporated into the complaint, as well as documents not relied on for the truth of their contents.  In a somewhat noteworthy approach, the Court considered many e-mails referred to in the complaint, as well as the LLC agreement.

The LLC agreement provided that Aeosphere was to be managed by a board of managers, which included Matthew, Laudamiel and Capua.  The LLC agreement also provided that board meetings could be called on 24 hours’ notice, and the managers could waive notice.  The LLC agreement also provided that Matthew and Laudamiel had to approve all actions that required the consent of the board, but that in the event that Matthew and Laudamiel would deadlock, Capua was to cast the tie-breaking vote.  However, certain actions such as the winding up of Aeosphere, required “unanimous approval of the board.”

Matthew alleged that Laudamiel and Capua excluded him from the business and misappropriated assets.  On May 3, 2010, Laudamiel and Capua purported to deliver a notice of emergency meeting of the board to be held the next day.  According to the agenda for the meeting, the board would consider and vote on:  (1) dissolution and winding up of Aeosphere; (2) the termination of all employees of Aeosphere; (3) distribution of Aeosphere’s remaining intellectual property.  Matthew did not waive notice of the meeting and notified Laudamiel and Capua that he would not be participating in the meeting and did not consent to the dissolution of Aeosphere.  Nonetheless, Laudamiel and Capua, the only managers present at the emergency meeting, voted to wind-up the affairs of Aeosphere and dissolve it.  They also voted to terminate Matthew as co-CEO and to terminate all other employees of Aeosphere, and to close its offices.  Laudamiel was designated to oversee the winding up and liquidation of Aeosphere, and on May 12, 2010, a certificate of cancellation was filed with the Delaware Secretary of State.

Matthew also alleged that Laudamiel and Capua took several actions to enrich themselves at his expense, both prior to and in connection with the liquidation of Aeosphere.  According to the plaintiff, Laudamiel and Capua misappropriated the most valuable asset of Aeosphere which was a business venture with Flakt Woods.  After the dissolution, they allegedly continued to work with Flakt Woods to develop technology that was intended to be developed by Aeosphere.

Claims

Matthew claimed that Laudamiel and Capua breached the LLC agreement and their fiduciary duties, converted assets of Aeosphere and transferred them after dissolution to entities that the defendants controlled.  The allegation against Action 1, a member of Aeosphere, was that Action 1 breached the LLC agreement.  The allegations against Flakt Woods and Semco were that they aided and abetted the breach of fiduciary duties, and tortiously interfered with the plaintiff’s rights under the LLC agreement and his employment agreement.  Allegations against all the defendants included unjust enrichment and civil conspiracy.

Analysis of Personal Jurisdiction over Flakt Woods

The Court concluded that there was neither general nor specific long-arm jurisdiction over Flakt Woods, and regardless, any assertion of personal jurisdiction would violate the Due Process Clause of the Fourteenth Amendment.  Additionally, although it was not necessary to reach the Rule 12(b)(6) motion to dismiss, the Court also explained that even if there were jurisdiction, the plaintiff failed to state a claim upon which the relief could be granted.

The Court recited the procedural burden pursuant to a motion to dismiss for lack of personal jurisdiction under Court of Chancery Rule 12(b)(2).  The Court explained that once a defendant moves to dismiss under Rule 12(b)(2), the burden rests on the plaintiff to demonstrate the two bedrock requirements for personal jurisdiction:  (1) a statutory basis for service of process; and (2) the requisite “minimum contact” with the forum to satisfy constitutional due process.

The Court also recited the prerequisites for the well-established conspiracy theory of jurisdiction which posits that “where a conspiracy exists, the acts of each co-conspirator with respect to the aim of the conspiracy are attributable to the acts of the other co-conspirators under a theory of agency.”  That five-part test was announced by the Delaware Supreme Court in the case styled Istituto Bancario Italiano SpA v. Hunter Eng’g Co., Inc., 449 A.2d 210, 225 (Del. 1982).  The Court explained that the conspiracy theory of jurisdiction need not be specifically framed as such in the complaint, and although the test speaks in terms of a conspiracy to defraud, the principle is not limited to that particular tort.  Rather, the factors outlined in Istituto Bancario may be satisfied by sufficiently pleading a claim for aiding and abetting a breach of fiduciary duty.  The Court also explained that the filing of a certificate of cancellation satisfies one element of the Istituto Bancario factor because the filing of a corporate instrument such as a certificate of cancellation is considered an act occurring in Delaware.

However, the Court found that the Istituto Bancario test was not met because “a defendant does not purposefully avail himself of a forum without knowledge that an act or effect will occur there.”  The record reflected that Flakt Woods did not know that the conspiracy would have a Delaware nexus until after the goal of the conspiracy had been attained and was completed.  That is, the conspiracy had come to an end by the time Flakt Woods learned of its Delaware connection.  There was no other basis to impose personal jurisdiction on Flakt Woods.

Personal Jurisdiction Analysis for Semco

The Court conducted a thorough analysis of whether or not Semco was subject to general jurisdiction under Section 3104(c)(4) of Title 10 of the Delaware Code.  The Court concluded that there was neither a statutory basis for service of process on Semco, nor a basis for exercising personal jurisdiction over Semco that would comport with constitutional due process.

In order to determine whether there were sufficient contacts with Delaware to impose general personal jurisdiction over Semco, the Court reviewed several key facts.  For example, Semco: (i) had no offices nor employees nor bank accounts nor real estate in Delaware; (ii) its sales in Delaware for each of the four years before filing this suit were less than 1% of the total sales.  Although it did have an independent sales agent that worked in Delaware, the Count found the facts insufficient to establish general personal jurisdiction.

Under Section 3104(c)(4), personal jurisdiction may be exercised over a nonresident when tortious injury inside or outside of Delaware is caused “by an act or omission outside of Delaware if the person regularly does or solicits business, engages in any other persistent course of conduct in Delaware, or derives substantial revenue from services, or things used or consumed in Delaware.”  The Court found that this standard could not be met regarding the facts presented against Semco.  That is, the facts did not support an inference that Semco “regularly does or solicits business, engages in any other persistent course of conduct in Delaware or derives substantial revenue from Delaware.”

The Court added that even if jurisdiction would be proper against Semco under the Delaware long-arm statute, the exercise of jurisdiction would be improper under the Due Process Clause.  In order to satisfy constitutional due process, a defendant must engage in sufficient minimum contacts with a forum state to require it to defend itself in that state consistent with “traditional notions of fair play and justice.”  That is, in order to maintain general jurisdiction over a foreign defendant, the facts must establish “continuous and systematic general business contacts with the foreign state.”  After reviewing the contacts that Semco had with Delaware and finding that the limited contacts were unrelated to the causes of action in this case, the Court concluded that they did not meet the “high standard for an assertion of general jurisdiction.”

The Court went on to explain why the motion to dismiss for failure to state a claim under Court of Chancery Rule 12(b)(6) would have been granted – – even if there were personal jurisdiction over Semco.  The Court then discussed each of the claims and defenses in the motion to dismiss under Rule 12(b)(6).

Counterclaims

The Aeosphere defendants brought counterclaims against Matthew, claiming breach of the LLC agreement, the implied covenant of good faith and fair dealing, breach of fiduciary duty, and unjust enrichment.

The Court reviewed the familiar standard and nuances of the implied covenant that attaches to every contract in Delaware by operation of law, as well as the high bar that needs to be met in order to prevail on such a claim.  The Court reasoned that there was “no gap for the implied covenant to fill,” and that there was no breach of the implied covenant because the actions alleged were addressed by the specific terms of the LLC agreement which covered those actions.  The Court explained that it would be inappropriate for it to “supplant or supplement the contractually agreed upon standard” by implying additional terms.  If the allegations violated a standard set forth in the LLC agreement, the appropriate counterclaim is for breach of contract, which was also alleged.

The counterclaim also alleged that Matthew’s refusal to cooperate and the “general assertions of mismanagement” were not sufficient to state a cause of action for breach of the implied covenant.  The Court’s reasoning also is indicative of why generalized and amorphous claims of “mismanagement” are often challenging claims to prevail on, without measurable evidence.

Issue of First Impression: Whether the dissolution and cancellation of an LLC transforms derivative claims into direct claims held proportionately by the LLC’s members.  Answer:  No.

The Court provided a more detailed answer to this unsettled issue by concluding that:  After the filing of the certificate of cancellation, such claims must be brought in the name of the LLC by a trustee or receiver appointed under 6 Del. C. Section 18-805, or directly by the LLC, or derivatively by its members after reviving the LLC (in a related proceeding), by obtain revocation of its certificate of cancellation.

Practice Pointer

The Court explained in footnote 140 that the LLC agreement in this case did not provide a method for how the claims of Aeosphere should be pursued after the filing of its certificate of cancellation.  Therefore, the Court emphasized that it was not addressing the validity of a provision in an LLC agreement that purported to establish an alternative process for pursuing the claims of a cancelled entity.  Rather, the Court explained that this opinion was only addressing the rule that would govern the disposition of such claims in the absence of some other contractually provided process that might displace what the Court referred to as the “background rule.”  Thus, drafters of LLC agreements would be well advised to heed the instruction provided in this opinion at footnote 140.

Dissolution Process

The Court outlined the dissolution process for an LLC provided in Sections 18-801 through 18-806 of Title 6 of the Delaware Code.  After an act of dissolution occurs, an LLC is to be wound up and its assets distributed as provided in Section 18-804.  The persons winding up the LLC’s affairs may prosecute and defend suits on the LLC’s behalf until the filing of the certificate of cancellation.  After the certificate of cancellation has been filed, suits generally may not be brought by or against an LLC.  However, Section 18-805 provides that “at any time” after the filing of a certificate of cancellation, the Court of Chancery may, on application, appoint one or more managers or other persons to act as trustees or receivers “to take charge of the LLC’s property, and to collect the debts and property due and belonging to the LLC, with the power to prosecute and defend in the name of the LLC, suits as may be necessary or proper for the purposes aforesaid.”  The trustee or receiver may also be given the broad power to do other acts which might be done by the LLC and may be necessary for the final settlement of unfinished business of the LLC.

The Court observed that the foregoing provision of the LLC Act is almost identical to Section 279 of the Delaware General Corporation Law, which allows the Court of Chancery to appoint a receiver or trustee with the same powers described in Section 18-805 to conclude the unfinished business of the dissolved corporation.  The Court noted that it often looks to corporate law authorities when interpreting similar statutory provisions.

By comparison to DGCL Sections 278 and 279, the Court observed the intention of the corporate statue: “that a dissolved corporation maintains the authority and ability to sue and be sued incident to the winding up of its affairs.”

Section 18-805 also provides members a method to pursue claims of the LLC in the name of the LLC after the filing of a certificate of cancellation so that one who harmed an LLC would not be “absolved” of any related liability by the filing of a certificate of cancellation even if the members of the LLC could not pursue the claims directly.

The case law regarding the dissolution of LLCs is not as well-developed as it is for corporations, and the procedures are different.  For a helpful discussion on this topic, see Robert Symonds & Matthew O’Toole, Symonds & O’Toole on Delaware Limited Liability Companies, at §16.02.

The statutory analysis of the Court indicated that the undistributed claims of a cancelled LLC may not, on the authority of the statute alone, be asserted directly by the former members of the LLC.  Such claims may be brought in the name of the LLC using the process set forth in Section 18-805, or – – in conjunction with a related action seeking the nullification of the certificate of cancellation of the LLC.  At that point the members might pursue direct or derivative claims.  Footnote 150 referred to another decision which found that a litigant need not bring a separate action seeking nullification of a certificate of cancellation before filing a derivative suit on behalf of the LLC.  The Court dismissed those counterclaims that could only been brought derivatively on behalf of Aeosphere before the certificate of cancellation was filed.  The Court concluded by noting that the former members of the LLC presented virtually no authority to support a contrary conclusion.

———————————————————-

Kevin F. Brady and Francis G.X. Pileggi are both members in the Wilmington, Delaware, office of Eckert Seamans Cherin & Mellott, LLC.  Mr. Brady is a member of the Court of Chancery Rules Committee.

In Achaian, Inc. v. Leemon Family LLC, C. A. No. 6261-CS (Del. Ch. Aug. 10, 2011), read opinion here, the Delaware Court of Chancery issued today a pithy opinion on LLC law that is destined to be cited often regarding the transferability of the interests of members in an LLC, and related interpretations of the Delaware Limited Liability Company Act (the “Act”).

Issue Addressed: The Court formulated the key issue it addressed as follows: “may one member of a Delaware limited liability company assign its entire membership interest, including that interest’s voting rights, to another existing member, notwithstanding the fact that the limited liability company agreement requires the affirmative consent of all of the members upon the admission of a new member, or, must the existing member assignee be readmitted with respect to each additional interest it acquires after its initial admission as a member?”

Holding: In its own words the Court concluded that: “When Omniglow’s LLC Agreement is read as a whole, as it must be, it allows an existing Member to transfer its entire Membership Interest, including voting rights, to another existing Member without obtaining the other Members’ consent. Thus Holland’s assignment of its 30% Interest to an existing Member, Achaian, was effective to vest all of the rights associated with that Interest in Achaian, and Omniglow now has two cooequal Members.”

Amusing Note: Footnote 54 of the opinion features a citation to a song by the Commodores, (pictured above), called Three Time a Lady. The citation was in the context of repudiating the argument of the defendant, which would have required an already admitted member to “become once, twice (or even three times)” a member each and every time that member acquired an additional block of interests in the LLC.

Short Overview of Legal Analysis

Though I expect to supplement this short blurb with commentary by some of the LLC scholars cited in the opinion, in the meantime, I will provide a few selected bullet points.

  • The Court began its analysis with what it referred to as the “now mundane notion” that under the Act, the parties to an LLC agreement have substantial authority to shape their own affairs and that in general, any conflict between the provisions of the Act and an LLC agreement, will be resolved in favor of the LLC agreement”. See footnotes 10 and 11 (voluminous references to treatises and learned commentary on the topic.)
  • The Court recited the primary purpose of the Act as being “to fill gaps, if any, in an LLC agreement”. In this case, because the LLC agreement addressed the issue at hand, that was the starting point in the analysis. The agreement in this case made the LLC interests of members freely transferrable to other members.
  • The Court also added to the growing case law on the statutory interpretation of Section 18-802 of the Act which allows the Court to dissolve an LLC when: “… it is no longer reasonably practicable to carry on [the LLC’s] business in conformity with [the LLC agreement].”
  • Based on the holding relating to transferrability, which resulted in ownership of the LLC being equally split between two 50/50 members, the Court cited to prior Chancery decisions that have applied DGCL Section 273 by analogy. Section 273 allows for one to petition the Court for what in essence is a “no fault divorce/dissolution” when a joint venture is equally owned 50/50 by two parties. In that situation, applicable by analogy in this LLC case, the three prerequisites are: (1) There must be “two 50% stockholders; (2) those stockholders must be engaged in a joint venture; and (3) they must be unable to agree upon whether to discontinue the business or how to dispose of its assets.”

SUPPLEMENT: Professor Larry Ribstein, whose treatise on LLCs was cited and relied on by the Court in the above opinion, provides his usual learned insights here and explains why he disagrees with the result reached by the Chancellor.

Postscript: Thanks to Delaware litigator Jody Pinckney for forwarding this opinion to me.

Where a dissolved corporation was still in the winding up phase and under the operation of its directors, the Court of Chancery denied a motion to restore its corporate existence and appoint a trustee while litigation filed prior to the filing of the dissolution was still pending.  LeCrenier v. Central Oil Asphalt Corp., C.A. No. 4927-VCN (Del. Ch. Dec. 22, 2010). 

This summary was prepared by Ryan P. Newell of Connolly Bove Lodge & Hutz LLP.

Background

In 2005, Plaintiffs David and Ivy LeCrenier brought a personal injury action in Florida for injuries allegedly a result of exposure to Central Oil’s benzene-containing products.  In 2007, during the pendency of the Florida action, Central Oil filed a certificate of dissolution. During the winding up process, the Plaintiffs filed a claim on Central Oil, which the company denied along with Plaintiffs’ request for a holdback of funds to satisfy a potential judgment.  Plaintiffs subsequently filed this action in Delaware in September 2009 seeking to nullify the certificate of dissolution and to restore Central Oil’s corporate existence because the company allegedly was not properly wound up.  In addition, Plaintiffs sought the appointment of a receiver under 8 Del. C. § 279 to carry out Central Oil’s business.  Central Oil and the individual defendants, who are current and former directors, moved to dismiss.

Motion to Dismiss for Lack of Personal Jurisdiction — Rule 12(b)(2)

As non-residents of Delaware, for there to be personal jurisdiction over the individual defendants, Plaintiffs must show “(1) a statutory basis for service of process; and (2) the requisite ‘minimum contacts’ with the forum to satisfy constitutional due process.”  Plaintiffs argued that personal jurisdiction existed under 10 Del. C. § 3114, which authorizes service over a nonresident director “only where the cause of action is based on such an individual’s breach of fiduciary duty . . . for which the plaintiff has standing to sue – that is a duty which runs to the plaintiff either directly or derivatively.”  Because Plaintiffs did not allege any breach of fiduciary duty, the complaint was dismissed as to the Individual Defendants for lack of personal jurisdiction.

Motion to Dismiss for Failure to State a Claim – Rule 12(b)(6)

Restoration of Corporate Existence

While the Plaintiffs sought an order nullifying the certificate of dissolution and restoring the corporate existence of Central Oil, under 8 Del. C. § 278 the corporate existence of a dissolved corporation is extended for a three year winding up period.  That section also provides that an action against the dissolved corporation is not lost just because of the dissolution. 

Because the Florida action was brought prior to the dissolution filing, Central Oil would retain its corporate existence until the conclusion of that suit.  Thus, because Plaintiffs sought to restore a corporation that was still in existence, this claim was dismissed for failure to state a claim upon which relief can be granted.

Appointment of a Receiver

With Central Oil’s directors still winding up the company and with no allegation that they had been derelict in their duties, the Court found no basis to appoint a trustee and the claim was dismissed. 

Request for Attorneys’ Fees and Costs

In seeking attorneys’ fees and costs, the Defendants argued that their motion “would have been unnecessary had Plaintiffs made any attempt to investigate, even on a cursory level, the facts and law before filing the Complaint . . . .”  The Court noted that under Delaware law, which applies the American Rule, parties generally pay for their own fees and expenses.  However, where a party has exhibited bad faith, an exception to the American Rule exists and fees and costs may be shifted.  Bad faith in this context is more than “a party acting merely under an incorrect perception of its legal rights” but rather “an abuse of the judicial process” and actions that “clearly evidence[] bad faith.”  Delaware courts, despite broad discretion, “will not award attorneys’ fees lightly under this exception.”

While the Court indicated that the Plaintiffs could have been more cooperative in the information gathering stage and while they created confusion with their proposed remedies, the Court did not find bad faith.  Rather, the Plaintiffs had a legitimate concern (whether Central Oil could satisfy a judgment), but simply exhibited a “misguided understanding of the DGCL.”