Christopher L. Messa
Partner, Corporate and Business Transactions
Christopher A. Zoida
Associate, Corporate and Business Transactions
- Judicial dissolution under Section 18-802 of the Delaware Limited Liability Company Act is an extreme remedy that Delaware courts will grant only sparingly.
- An LLC’s inability to achieve its business objectives is not sufficient to plead a case for judicial dissolution.
- Specific factual allegations evidencing deadlock, inability to function and lack of equitable exit mechanisms are required to survive a motion to dismiss in a judicial dissolution case.
- While this case is consistent with existing Delaware case law, the Court of Chancery provided an excellent analysis of the types of facts necessary to support a successful dissolution case.
The Court of Chancery of the State of Delaware (the “Court”) recently addressed the standard by which a petition for the judicial dissolution of a limited liability company (“LLC”) is reviewed at the motion to dismiss stage in the case, In re: Dissolution of T&S Hardwoods, KD, LLC, 2023 WL 334674 (Del. Ch. Jan. 20, 2023). This case involved a lumber supplier and lumber wholesaler that formed an LLC (the “Company”) governed by an LLC agreement (the “LLC Agreement”) and a separate joint venture agreement (the “JV Agreement”). After the relationship of the supplier and wholesaler soured, the supplier filed for judicial dissolution of the Company claiming deadlock, inability to function and lack of equitable exit mechanisms. In response to the wholesaler’s motion to dismiss, the Court held that the supplier adequately stated a claim for dissolution and denied the wholesaler’s motion.
This case provides an excellent review of Delaware law on judicial dissolution for LLCs, and a detailed analysis of what factual allegations should be made to survive a motion to dismiss.
Section 18-802 of the Delaware Limited Liability Company Act (the “Act”) statutorily grants the Court the power to dissolve an LLC on application by a member or manager of such company. To do so, the Court must determine that “it is not reasonably practicable [for a company] to carry on the business in conformity with a limited liability company agreement.” Thus, dissolution under Section 18-802 is appropriate where an “LLC’s management has become so dysfunctional . . . that it is no longer practicable to operate the business, such as the case of deadlock.”
A “deadlock” exists when management of an LLC cannot take action or make decisions with respect to the operation of the LLC or its business.[i] In assessing whether dissolution is appropriate due to deadlock, the Court will look to the management and ownership structure of the LLC as well as its LLC agreement to guide its analysis. Relevant facts considered by the Court include, but are not limited to, whether: (i) the managers or members are “able to work together or make decisions” for the LLC, (ii) the LLC “has a 50/50 ownership structure”, (iii) unanimity or a majority vote is required for the LLC to take action or make business decisions, and (iv) there is a “mechanism in the LLC [a]greement to resolve the deadlock”. For example, dissolution of an LLC is proper where two 50/50 members cannot agree “about the business strategy or future of the LLC,” thereby creating a deadlock. Dissolution is also proper where “two [50/50] members . . . stop interacting and are instead engaged in litigation to resolve the[ir] disputes, further demonstrating the need for judicial dissolution.”
The Court also indicated that judicial dissolution is appropriate where an LLCs “defined purpose . . . was fulfilled or impossible to carry out.” To make this determination, “the Court looks to the parties’ foundational contractual agreement and asks whether it is reasonably practicable to carry on the business in line with that purpose, not whether the purpose . . . has been completely frustrated.” The Court will typically look to the purpose provision in the organizational documents of an LLC as evidence of its purpose, but may also review “other additional evidence . . . to inform the analysis”, such as a joint venture agreement. In the present case, the Court first looked to the Company’s LLC Agreement which contained a broad purpose provision indicating that it was “to engage in any lawful activities for which [LLCs] may be formed under the Act.” The Company’s JV Agreement, however, provided more specific information with respect to its purpose than the LLC Agreement. Further, the JV Agreement indicated that the parties “entered into it [t]o induce” each of the Company’s members to enter into the LLC Agreement, thereby making the LLC Agreement “subordinate to the JV Agreement in this way.” Thus, the Court must view related agreements, such as the JV Agreement and the LLC Agreement, that are “entered into contemporaneously . . . together and in their entirety”. The Court will not limit its analysis “to the purpose clause of an LLC agreement where doing so would resolve the dispute on a technicality.”
Even if a deadlock exists, judicial dissolution may be inappropriate if a company’s LLC agreement can provide a “reasonable exit mechanism” for the parties. A movant seeking the “dismissal of a petition for judicial dissolution based on a contractual exit plan . . . must demonstrate, as a matter of law, that the exit mechanism can actually extract [the parties] fairly.” In making this determination, the Court will consider whether a viable and equitable exit mechanism exists. For example, an exit mechanism is not equitable where the departing member continues to maintain personal liability on a guaranty agreement for the company after exiting such company. Such provision does “not equitably effect the separation of the parties as it could leave . . . [the] departing member with no upside potential, and no protection over the considerable downside risk of having to cure any default” of the LLC. Conversely, the Court has found a valid exit mechanism to exist where a buy-sell provision creates “an obligation in the non-offering members to either purchase the offering member’s units or sell their own” and is “mandatory in the event that the Members become deadlocked with respect to any decision that materially and adversely affects the Corporation’s business as a result of their dispute.” However, here, the buy-sell provision in the Company’s LLC Agreement is not mandatory; rather, it “is optional at all times, even in the case of deadlock” and does not obligate the “buyout of any member upon deadlock”. As such, the optional buy-sell provision in this instance does not afford “an exit mechanism that the parties agreed, ex ante, would resolve their deadlock.”
Berger Harris LLP has provided this article for informational purposes only. It contains the opinion of the authors which are not necessarily the opinion of Berger Harris LLP. This material is not intended to be legal advice and it does not create an attorney-client relationship with the authors, Berger Harris LLP or any of their affiliates or clients.
[i] In re: Dissolution of T&S Hardwoods, KD, LLC, 2023 WL 334674 at 11–12 (citing In re: GR BURGR, 2017 WL 3669511, at *6) (citations omitted).