My latest ethics column for The Bencher, the publication of the American Inns of Court, on the titular topic, is reprinted below courtesy of the publisher. I have been writing an ethics column for The Bencher for the last 25 years.

Before I provide an overview of the basic standards that apply to inform the decision about whether a judicial officer should recuse himself or herself, or otherwise be disqualified from presiding over a particular lawsuit, I want to share some practical wisdom I have learned from several judges with whom I am close to personally—but before whom I would never appear in a courtroom to argue a case.

When a reasonable person familiar with the relevant facts earnestly believes that an issue of a judge’s impartiality might reasonably be raised in a pending lawsuit, that person should explore an appropriate informal means of presenting that issue to the presiding jurist. That approach provides an informal opportunity to the judicial officer to make his or her own assessment of the issue in an appropriate manner that might make a formal motion unnecessary.

This topic is covered in books dedicated solely to judicial disqualification, as well as in heavily footnoted law review articles, but this short ethics column is only intended to cover the highlights. Over the past 25 years of publishing these ethics columns I have, in a few instances, touched on topics that are related to the standards that regulate the judicial branch. See, e.g., Francis G.X. Pileggi, “Fifth Circuit Orders Recusal of Trial Judge,” The Bencher (July/August 2011); Francis G.X. Pileggi, “Professionalism and Judges,” The Bencher (July/August 2015) (describing earlier behavior of attorney as indication of judicial demeanor as a later member of court); Francis G.X. Pileggi, “Resources for Judicial Ethics Research,” The Bencher (January/February 2022).

Applicable standards include Canon 2 of the Code of Conduct for United States Judges, which provides that a judge should avoid impropriety and the appearance of impropriety in all activities. Canon 2(A) states that “[a]n appearance of impropriety occurs when reasonable minds, with knowledge of all the relevant circumstances disclosed by a reasonable inquiry, would conclude that the judge’s honesty, integrity, impartiality, temperament, or fitness to serve as a judge is impaired.” (emphasis added).

The rubric to avoid even the appearance of impropriety applies to both professional and personal conduct. The federal statute that governs judicial conduct requires that: “Any justice, judge, or magistrate judge of the United States shall disqualify himself in any proceeding in which his impartiality might reasonably be questioned.” 18 U.S.C. § 455(a).

“[T]he test for recusal under § 455(a) is whether a reasonable person, with knowledge of all the facts, would conclude that the judge’s impartiality might reasonably be questioned.” In re Kensington Int’l, Ltd., 368 F.3d 289, 296 (3rd Cir. 2004)(emphasis added). See generally 12 Moore’s Federal Practice-Civil § 63.35 (2022). (Although mere friendship, for example with counsel, ordinarily is insufficient to warrant recusal, unusual circumstances may require recusal.)

Section 144 of Title 18, unlike Section 455, refers specifically to the appearance of a lack of impartiality as it relates to parties—as compared to counsel. See generally Geyh, Alfini, & Sample, 1 Judicial Conduct and Ethics § 4.07[3], Matthew Bender & Co., 2020). The Comment to Rule 2.3 of the Delaware Judges’ Code of Judicial Conduct notes that manifestations of bias or prejudice can include epithets, slurs, references to personal characteristics, or threatening, intimidating, or hostile acts.

The public policy animating the disqualification rules is the need to inspire public confidence in the public perception that the due process requirement of a fair trial before a fair tribunal appears to be provided to all parties and their counsel in litigation. The emphasis is on how the circumstances appear to a reasonable person with knowledge of the relevant facts—not whether actual lack of impartiality can be proven. See, e.g., Richard E. Flamm, Judicial Disqualification: Recusal and Disqualification of Judges § 5.1, at 104 (3rd edition, Banks & Jordan, 2017).

Notwithstanding the applicable standards, appropriate efforts to informally seek the recusal of a judge, and if necessary, formal motions to disqualify, should only be pursued in those rare circumstances when one’s duty to the client, as well as broader duties, make it absolutely necessary.  Even then, they should be brought reluctantly, only after thorough research, careful analysis, extensive soul-searching, confidential vetting with colleagues, and with conscientious consideration of all the aspects and ramifications of such an unpleasant process.

Francis G.X. Pileggi, Esquire, is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith LLP. He comments on legal ethics as well as corporate and commercial decisions on his blog. He is the author of American Legal Ethics: A Retrospective from 1997–2018 (Outskirts Press 2018).

The UCLA Law School will be the venue for a conference on the American Law Institute’s pending Restatement of the Law, Corporate Governance. I have been asked to be on a panel that will discuss “Corporate Governance and Private Companies” and whether public and private companies may deal with corporate governance issues differently. On the panel with me will be:
• Pierre Gentin, CLO, McKinsey & Co.
• Douglas Moll, Professor, University of Houston Law Center
• Adam B. Weiss, CLO, Relativity

Conference on the American Law Institute’s Restatement on Corporate Governance

Please view the agenda and topics here. 

The Annual Tulane Corporate Law Institute in New Orleans, held on March 23 and 24 this year, attracts leading practitioners in corporate and commercial law from around the country, including a somewhat disproportionately large number of lawyers from Delaware–as well as members of the Delaware judiciary who participate in panel presentations. For those who seek to avoid blasphemy in matters of Delaware corporate law, it remains helpful to hear the insights from the members of the Delaware courts who have the last word on Delaware corporate law orthodoxy.

The seminar spans two full days, but for purposes of this blog post, I’ll highlight only a few sound bites from two of the presentations that focus exclusively on Delaware law. The seminar was founded in large part by the late, great Delaware Supreme Court Justice Andrew G.T. Moore, who was a graduate of Tulane Law School, which sponsors and organizes the annual event. A few blogs posts over the last 18 years have provided highlights from a handful of the prior 34 seminars.

One panel was entitled: Delaware Developments:

The panel members for the above topic discussed the recent amendment to the Delaware General Corporation Law providing for officer exculpation.  Notably, it is not identical to the director exculpation provisions.  It only applies to selected officers and has yet to be universally adopted by most public companies since its August 2022 passage.  A recent expedited transcript ruling of March 29, 2023, in the Delaware Court of Chancery involving the Fox Corp and Snap, relates to the adoption of officer exculpation amendments to the corporate charter and DGCL § 242 that provide some insights on this new amendment.

Recent cases applying Caremark claims have been enjoying more traction than historically has been the case since the Caremark decision was issued about three decades ago.  See, e.g., the recent McDonald decision applying Caremark duties to officers.

Another panel member discussed caselaw that addresses when someone with less than 50% ownership of a company can be deemed a controlling stockholder, which triggers duties and standards that may become outcome-determinative.  Hint:  It requires a holistic and comprehensive analysis.

Another panel was entitled: Institutional Role of Delaware Courts in Business Disputes

Members of the Delaware Supreme Court and Delaware Court of Chancery on this panel discussed the long-term track record of Delaware courts handling cases of substantial complexity on an expedited basis applying a capacious scope of potential remedies with an extensive body of case law to rely on for many business issues decided by jurists who devote a large part of their time to those types of cases.  The recent Twitter v. Musk case was a good example.

This article was prepared by Frank Reynolds, who has been following Delaware corporate law and writing about it in various publications for more than 35 years.

The Delaware Chancery Court recently addressed a novel attorney-client privilege issue in an  appraisal action, ruling FairXchange LLC could not shield the merger deal knowledge of its dual-role director/investment funds manager  from two  plaintiff investor funds because both the funds and the director were in a ‘”circle of confidentiality” in Hyde  Park Venture Partners Fund III L.P. et. al. v. FairXchange LLC , C.A. No. 2022-0344-JTL  memorandum opinion issued (Del. Ch. Mar. 9, 2023).

In his March 9 memorandum opinion, Vice  Chancellor Travis Laster granted the motion of two venture  capital investment fund plaintiffs to compel discovery of information about  how the FairXchange’s  board set the price in a sale of the  company to Coinbase Global, Inc.  And he denied the company’s bid to force the funds to destroy whatever privileged merger information Weiss may have shared with the fund. 

He said the question is ‘whether the Company can invoke the attorney- client privilege against the funds to withhold documents that they otherwise would be required to produce.’ The answer is “No,” he said, and set out the reasons why this case is not an exception to that confidentiality rule.

Corporate counsel could profit from reading the vice chancellor’s review of those exceptions and the opinions he cited as the foundation for that March 9 decision.  “Since 1992, Delaware law has recognized that when a director represents an investor, there is an implicit expectation that the director can share information with the investor,” he noted. 

Background

Ira Weiss was one of three directors on the Fairxchange board when Coinbase made an acquisition offer that split the board: Weiss wanted to look at other options but the other two sought to move ahead with the Coinbase deal and resented Weiss’ opposition so much that they allegedly shut Weiss out of further sale negotiations and induced their preferred shareholder allies to remove him from the board.

When the sale was completed, investors Hyde Park Venture Partners Fund III L.P. and Hyde Park Venture Partners Fund III Affiliates LP filed an appraisal action claiming they did not get fair value for their shares.  In discovery battles, FairXchange tried to force the funds to destroy information given Weiss as a director–even though he was the funds’ manager and a partner in their parent venture capital firm.

Exceptions not applicable

The court listed three recognized methods by which a corporation can alter that default rule, but said none of them were in effect here because FairXchange did not act to preserve privilege:

First, as frequently happens, the parties can address the matter by contract, such as through a confidentiality agreement.

Second, the board of directors can form a committee that excludes the director, at which point the committee can retain and consult confidentially with counsel.

 Third, once a sufficient adversity of interests has arisen and becomes known to the director, the director cannot reasonably rely on corporate counsel as to the matters where the interests of the director and corporation are adverse.

Access to info foremost

The vice chancellor said, “A director’s ability to access corporate information affects whether a corporation can claim that a communication was confidential as to the director and thereby invoke the attorney-client privilege.  A director’s right to information is “essentially unfettered in nature,” and that right includes access to privileged material.  He said, “Directors of Delaware corporations are generally entitled to share in legal advice the corporation receives.” In re WeWork Litig., C.A. No. 2022-0344-JTL, 250 A.3d 901, 908 (Del. Ch. 2020).

“Under the joint client approach, the director starts inside the circle of confidentiality. Without the expectation of confidentiality on which privilege depends, the corporation cannot invoke the privilege against the director,” the vice chancellor ruled.

The Funds’ motion to compel was granted. “The Company cannot invoke the attorney-client privilege to withhold materials created between November 14, 2019, and December 8, 2021, except that the Company can assert the attorney-client privilege regarding communications relating to Weiss’s books-and-records request after he sent it on December 7.” The Company’s request for a destruction order was denied.

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 from the Delaware Court of Chancery clarifies the scope of a charging lien that attorneys may impose on the money available as a result of a lawsuit in which the client incurred unpaid legal fees. AutoLotto, Inc. v. J. Streicher Financial, LLC, C.A. No. 2022-0661-MTZ (Del. Ch. March 2, 2023).

Previous blog posts on these pages have discussed a decision by the Delaware Supreme Court in the Katten case, and in the Chancery decision in the Zutrau case that have addressed other nuances of the same issue. 

Most lawyers expect payment for their services pursuant to a fee agreement. Therefore, this decision, which clarifies the scope of the charging lien that an attorney may enforce to collect unpaid fees, and the limitations on what fees incurred by the client can be be subject to a lien imposed on what particular funds, is important when a lawyer or a law firm tries to collect unpaid legal fees incurred in connection with multiple lawsuits or multiple transactions that were handled for the same client.

The title of this blog post is a paraphrase from a description in a recent article by Reuters about a case in the Delaware Court of Chancery against The Walt Disney Company, based on Section 220 of the Delaware General Corporation Law, that went to trial this past Wednesday. As of this writing, on Sunday evening, I’m not aware of a post-trial decision yet.

Regular readers of these pages over the last 18 years will be forgiven if they have grown weary of the hundreds of blog posts with highlights and commentary about Delaware decisions involving DGCL Section 220: the statute that gives stockholders the right, in some circumstances, to obtain certain corporate records. My anecdotal recent observation is that the number of 220 cases filed continues apace. That state of affairs makes sense in light of the Delaware Supreme Court and the Court of Chancery exhorting equity practitioners to “use the tools at hand”, such as Section 220, to obtain as much information as possible before deciding if a plenary suit is worthwhile. Yet, those familiar with 220 cases know they can be expensive and not always “summary in nature” especially if the trial court decision is appealed–and the court may decide after trial not to grant access to the requested documents.

Simeone v. The Walt Disney Company, C.A. No. 2022-1120-LWW, is not your “average 220 case”. The stockholder seeks corporate records that relate to public actions the company took to oppose lawfully-enacted legislation in Florida that sought to protect kindergarten students from sexually-explicit curriculum in public schools. After that public opposition by the company, and related actions the company took to oppose the new Florida law, the company’s stock lost about $82 billion in market value, according to some public reporting. There is a logical fallacy known by the Latin phrase: post hoc ergo propter hoc. In other words, simply because something follows an action, does not equate with causation. I’m sure economic experts could provide other reasons why the value of the company decreased by about $82 billion afterwards.

But one proximate result of the company’s opposition to the new Florida law that can be quantified more easily is the company’s loss of the “special district” that covered the Disney World theme park that afforded the company special tax treatment and special “self-governance” rights granted by the state–that it lost as a direct result of its public opposition to the new law. Florida’s Governor made it explicit that the loss of those special state-granted benefits was the state’s reaction to the public actions about the new law that the company took.

Lawsuits against companies, including Section 220 cases and plenary stockholder suits, are common when billions in market cap are lost and the loss is arguably related to corporate actions or omissions. That more suits were not filed against The Walt Disney Company in connection with the foregoing actions might be explained–perhaps–by many of the plaintiffs’ firms who typically file major stockholder class actions agreeing with the positions that the Disney Company took in opposition to the Florida law. Of course, there are over one million lawyers in the U.S., and I would never suggest that they are homogenous in their thought, nor would I suggest they all follow the same narrative as The Walt Disney Company did in this particular matter. The alleged ad hominem attack on the plaintiff and his lawyers in this case, however, may shed light on why more suits have not been filed.

For example: the arguments of the company’s lawyers have been described in court pleadings in this Section 220 case to include “anti-Catholic bias” against the plaintiff and his counsel. Wow. This accusation appears to be based in part on the positions taken by the civil rights group that is providing some funding for the suit. That same group recently defended, and obtained a verdict of not guilty, for someone who was arrested in a disgracefully orchestrated manner by the FBI, based on the public expression of his religious beliefs. Newsflash folks: in the year 2023, in some circles–apparently–religious beliefs of a certain ilk can be disfavored with impunity. Stated another way, the zeitgeist and some federal law enforcement agencies encourage disfavoring those beliefs.

Back to the specific details of the Section 220 case in Simeone v. The Walt Disney Company. I will attempt to report on the post-trial decision when it is published, but the best that the plaintiff can hope for in this 220 case is that the court will order that the company produce some documents that explain the circumstances surrounding the positions taken by the company that resulted in the loss of their special sui generis state-granted benefits, as well as–at least arguably–the loss of billions of dollars in the value of their market cap following their vociferous opposition to a law passed by the Florida Legislature that was not aimed at the company or its operations.

A short time ago, much was written (and I was quoted by Bloomberg Law) about a Court of Chancery decision finding that Caremark claims could proceed against the top HR officer of McDonald’s, but a few days ago, the Court of Chancery held that Caremark claims against the Board of Directors in connection with related HR-type claims failed to satisfy the pre-suit demand futility test for derivative suits.

Professor Stephen Bainbridge has a scholarly post about this important decision, which cites to other learned sources, on his eponymous blog that I cannot improve upon. The good professor’s scholarship was cited by the Court of Chancery in its opinion, as it often is in Delaware court decisions on corporate law.

Paying clients are keeping me from blogging updates on other recent decisions, but when one of the nation’s leading corporate law experts writes about a recent decision like this one, it would be superfluous for me to add to the chorus.

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.

Regular readers of these pages over the last 18 years are familiar with one of the nation’s most prolific corporate law scholars: Professor Stephen Bainbridge, who is often cited in Delaware court decisions. His latest book weighs in on the latest craze in corporate law: ESG considerations in addition to the traditional focus on shareholder value.

The good professor provided highlights on the titular topic via his guest post about his latest book: “The Profit Motive: In Defense of Shareholder Value Maximization” at the Corporate Finance Lab blog, which is a Dutch/English legal blog on corporate finance. The post summarizes the arguments in the book rather well: https://corporatefinancelab.org/2023/02/07/the-profit-motive-in-defense-of-shareholder-value-maximization/