Thursday, May 14, 2015

An LLC is More Than a Private Agreement

An LLC is More Than a Private Agreement
      It has been often asserted that a limited liability company is, substantively, simply an agreement among the members (and sometimes the managers) as to the operation of a business which is functionally defined exclusively by that private agreement.  The persons taking this view, while typically recognizing that a state filing is necessary in order to cause an LLC to come into existence, have minimize the importance of this filing, affording it only “ministerial” importance.  A recent decision of the Delaware Chancery Court In re Carlisle Etcetera LLC., has questioned that frame of reference.

      The aspect of the decision hereunder consideration arose out of the Court’s assessment of whether or not it had any power in equity, as contrasted with under the controlling LLC Act, to award judicial dissolution of the company.  It was clear that the party moving for judicial dissolution, not having been admitted as a member, but being a mere assignee of a membership interest, did not have standing to move for judicial dissolution under the act, that capacity being limited to members and managers of the LLC. See Del. Code Ann. tit. 6, § 18-802.  But from that determination the Court considered whether it could, under its equity jurisdiction, consider dissolution of the LLC.
      Looking back to the historic law of partnerships, and referencing the venerable Joseph Story, Commentaries on Equity Jurisprudence, it was observed that courts could in equity dissolve partnerships and as well appoint receivers.  If § 18-802 were the exclusive means of bringing about the judicial dissolution of an LLC, “it would have to divest this court of a significant aspect of its traditional equitable jurisdiction.”  2015 WL 1947027, *8.  From there the Carlisle Court observed that § 18-802 neither states that it is exclusive nor that it overrides equitable jurisdiction, and thus the rules of equity are otherwise incorporated in the LLC Act.  See Del. Code Ann. tit. 6, § 18-1104.

      Looking perhaps to future challenges to equitable jurisdiction even as the conclusion in this case is back stepped, it was observed that efforts by the legislature to limit the Chancery Court’s equity jurisdiction would raise constitutional problems.
      Moving from the Court’s equitable powers, it next considered the question of “what is an LLC?”  After noting that under R & R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, 2008 WL 3846318 (Del. Ch. Aug. 19, 2008), the parties to an operating agreement may waive the right to move for statutory judicial dissolution, “In my view, the ability to waive dissolution under Section 18-802 does not extend to a party’s standing to seek dissolution in equity.”  2015 WL 1947027, *10.  From thus the Court wrote:
In concluding that parties to an LLC agreement could waive the right to seek dissolution under Section 18-802 the R & R Capital decision relied heavily on arguments by commentators to the effect that a Delaware LLC should be viewed as a purely contractual entity to which principles of equity (including fiduciary duties) do not apply.  Reasonable minds could disagree about that proposition.  But whatever one’s personal thoughts might have been on the matter, the General Assembly in 2013 adopted an amendment to the LLC Act inconsistent with the purely contractarian view.

Of particular relevance to dissolution the purely contractarian view discounts core attributes of the LLC that only the sovereign can authorize, such as its separate legal existence, potentially perpetual life, and limited liability for its members.  See 6 Del. C. §§ 18-201, 18-303.  To my mind, when a sovereign makes available an entity with attributes that contracting parties cannot grant themselves by agreement, the entity is not purely contractual.  Because the entity has taken advantage of benefits that the sovereign has provided, the sovereign retains an interest in that entity.  That interest in turn calls for preserving the ability of the sovereign’s courts to oversee and, if necessary, dissolve the entity.  Put more directly, an LLC agreement is not an exclusively private contract among its members precisely because the LLC has powers that only the State of Delaware can confer.  Those powers affect the rights of third parties, who at a minimum must take into account the LLC’s separate legal existence and its members’ limited liability shield.  Just as LLCs are not purely private entities, dissolution is not a purely private affair.  It involves third party claims, which have priority in the dissolution process.  See id. §§ 18803, 18-804 (describing winding up and priorities for distribution of assets).  Because an LLC takes advantage of benefits that the State of Delaware provides, and because dissolution is not an exclusively private matter, the State of Delaware retains an interest in having the Court of Chancery available, when equity demands, to hear a petition to dissolve an LLC.
Id. at *11 (citations omitted).
      An LLC is more than a private agreement, and the state has a legitimate interest in policing its activities at least as necessary to protect third parties.
     Other aspects of the In re Carlisle Etcetera LLC decision have been reviewed HERE.

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