The Court of Chancery Orders Dissolution of a Limited Liability Company Solely on Equitable Grounds
By Eric Feldman and B. Ashby Hardesty, Jr.
The Delaware Chancery Court held that the assignor of a limited liability company interest and its assignee, neither of which was a member or manager of the limited liability company, both lacked standing to petition for judicial dissolution of the limited liability company under Section 18-802 of the Delaware Limited Liability Company Act (the “LLC Act”). However, the Court went on to further hold that the assignee nonetheless had standing to seek judicial dissolution of the limited liability company in equity. Subsequent to such decision, the Court later issued an order granting the petitioners’ motion for summary judgment seeking judicial dissolution, representing the first time that a Delaware court has dissolved a limited liability company entirely on equitable grounds.
In In re Carlisle Etcetera, Well Union Capital Limited (“WU Parent”) and Tom James Company (“Tom James”) formed a two member Delaware limited liability company (the “LLC”), adopting a very basic operating agreement, with the intent to later amend and restate the operating agreement. The LLC was managed by a four member board, with each member entitled to appoint two of the board managers, and the entire board designated as the “manager” of the LLC. Additionally, a Tom James executive was appointed by the board as the CEO of the LLC. After formation, WU Parent transferred all of its limited liability company interest in the LLC to its wholly-owned subsidiary (“WU Sub”), of which Tom James was aware, and to which it did not object. The parties later began to negotiate an amended and restated operating agreement, which reflected Tom James and WU Sub as the members of the LLC.
Thereafter, and before the amended and restated operating agreement was entered into, the relationship between the parties soured. The LLC’s board, which required unanimity to act, became deadlocked on all key decisions and therefore could not manage the LLC. As a result, the Tom James affiliated CEO generally ran the operations of the LLC unsupervised and with unfettered discretion. WU Parent and Tom James recognized that a buyout was necessary. They could not agree on a buyout procedure or price, however, so WU Sub, later joined by WU Parent, petitioned to dissolve the LLC under Section 18-802 of the LLC Act. Tom James moved to dismiss the petition, arguing that (1) WU Sub lacked standing because it was an assignee, not a member; (2) WU Parent lacked standing because it had ceased to be a member by assigning all of its limited liability company interest; and (3) Section 18-802 of the LLC Act was the exclusive method for judicially dissolving a Delaware limited liability company.
Regarding Tom James’ first and second arguments, the Court held that neither WU Parent nor WU Sub had standing to petition for judicial dissolution pursuant to Section 18-802 of the LLC Act, as neither was a member or manager of the LLC, which are the only categories of persons permitted to bring such an action pursuant to the LLC Act. The Court found that the operating agreement did not alter or impact the relevant statutory defaults under the LLC Act. Accordingly, the Court found that once WU Parent assigned all of its interest to WU Sub, WU Parent ceased to be a member of the LLC by default under Section 18-702 of the LLC Act. Similarly, the Court found that WU Sub did not automatically become a member of the LLC when it received WU Parent’s interest. The Court explained that under the LLC Act, “membership” (and a transfer of rights as a member) requires admission pursuant to the provisions of the operating agreement and/or the LLC Act. As the LLC’s operating agreement was silent on the issue, the Court determined that admission of WU Sub as a member required the express approval of Tom James, which was never specifically received, despite the fact that Tom James had been treating WU Sub as a member and that the draft amended and restated operating agreement reflected it as such. For these reasons, both WU Parent and WU Sub lacked standing to petition for judicial dissolution under Section 18-802 of the LLC Act.
However, significantly, the Court also held that Section 18-802 of the LLC Act was not the exclusive method or authority for judicially dissolving an LLC and that therefore WU Sub had standing to petition for judicial dissolution in equity. The Court reasoned that holding otherwise would “divest [it] of a significant aspect of its traditional equitable jurisdiction” and raise serious questions under the Delaware Constitution. The Court also rejected historical arguments that limited liability companies fell outside of its jurisdiction with respect to this issue. Finally, the Court concluded that because the LLC took advantage of benefits that Delaware provided, Delaware retained an interest in having the Court available, when equity demanded, to hear a petition to dissolve the LLC. For these reasons, the Court held that even though WU Parent and WU Sub lacked standing to petition for statutory judicial dissolution at law, WU Sub could do so at equity.
A few days following its decision that standing to proceed existed on equitable grounds, the Court issued an order granting WU Parent’s and WU Sub’s motion for summary judgment seeking judicial dissolution of the LLC. The Court found that dissolution was warranted because deadlock existed on various business matters at both the member and manager level, including on facially significant issues such as the removal of the CEO, and the operating agreement provided no exit mechanism or other means for navigating around the deadlock. Additionally, the Court found that allowing the status quo, in which the CEO was entirely running the LLC, and thereby exercising de facto control over the LLC, not only solely benefited Tom James, but was contrary to the management contemplated by the operating agreement.
In re Carlisle Etcetera, C.A. No. 10280-VCL (Del. Ch. April 30, 2015) (Laster, V.C.).