Monday, May 11, 2015

Delaware Chancery Court addresses important decision including requirements foradmission of assignee as a member, standing to bring an action for judicial dissolution and availability of equitable dissolution

Delaware Chancery Court addresses important decision including requirements for admission of assignee as a member, standing to bring an action for judicial dissolution and availability of equitable dissolution

     In a recent decision, Delaware's Chancery Court addressed a variety of important issues regarding limited liability companies and as well the equitable jurisdiction of the Chancery Court. With respect to LLCs, the Court explained the requirements for admission of an assignee as a member, holding that it requires a formal affirmative act. In addition, the Court affirmed the statutory rule that standing to bring an action for judicial dissolution is restricted to a member or manager, and an assignee is neither. Still, the underlying complaint was not dismissed as the court found that the assignee may have standing to seek equitable dissolution. In re Carlisle Etcetera. LLC, C.A. No. 10280-VCL, 2015 WL 1947027 (April 30, 2015).
      Carlisle Etcetera, LLC (the “Company” or “Carlisle”) was formed and owned equally by Well Union Capital Limited (“WU Parent”) and Tom James Company (“James”). The Company was in turn managed by a four member board, half of whose members were appointed by WU Parent and half by James. In addition, the Company had an executive staff including a CEO, which position was filled by a James executive appointed by that Board. The relationship between WU Parent and James ultimately soured, and despite some initial negotiations they were unable to agree to a price by which one side would buy out the other. With the board deadlocked, the Company CEO operated the Company essentially free of any oversight. In consequence, “James did not see the deadlock as a problem and [felt] no urgency to alleviate it.” Also, on a date not defined in the opinion vis-à-vis the organization of the company, but clearly early on, WU Parent assigned its interest in Carlisle to a “wholly-owned subsidiary that would act as a ‘blocker’ entity for tax purposes.” There was no dispute that the James representatives in Carlisle were aware of this transfer; whether they had consented to the substitution of the new WU Subsidiary (“WU Sub”) as replacement member would be an important aspect of this decision.
      Unable to agree as to a buyout of one party by the other, WU Sub filed an action in the Delaware Chancery Court seeking the judicial dissolution of the Company. When James challenged the capacity of WU Sub to bring an action for judicial dissolution, asserting it was not a member, a WU Parent joined in the action. As is detailed below, that did not cure the deficiency.
      This opinion was rendered in response to the James’ 12(b)(6) motion.

Standing to Seek Judicial Dissolution

      James asserted that neither of the WU entities had standing to seek judicial dissolution on the basis that judicial dissolution is a right afforded the members, and neither was a member. In furtherance thereof, while WU Parent may have initially been a member of the Company, it transferred its entire membership interest in the Company to the WU Sub. While that constituted WU Sub as a assignee of the interest, that assignment also terminated WU Parent’s position as a member. In that WU Sub was never admitted as a substitute member, it could not exercise any rights of a member. Essentially, James asserted that it and it alone was a continuing member in Carlisle. On this argument it would prevail.
      Under the Delaware LLC Act, when a member assigns all of their economic interest in a venture, the assignor member ceases to be a member in the company. See Del. Code Ann. § 702(b)(3). [It should be noted that this rule under the Delaware LLC Act is different than the rule under the Kentucky LLC Act.] In the face thereof, WU Sub argued that James had consented to its admission as a substitute member, arguing for de facto status based upon it being listed in the Carlisle tax forms and as well the identification of WU Sub as a member in the draft revised (but never executed) operating agreement. “WU Sub argues that it became a member under the LLC Act once his status as a member was “reflected in the records of the limited liability company.”, citing Del. Code Ann. § 18-301 (b)(1).
      Carefully parsing the statute, the Court found that was not the case. Rather, while the timing of admissions as a member may be determined by when a member’s admission is “reflected in the records of the limited liability company,”, that reflection does not of itself constitute admission. Rather, a formal act of the other members to the admission is required.
      Hence, WU Sub was not a member and could not move for judicial dissolution.

Equitable Dissolution

      Notwithstanding that neither WU Sub nor WU Parent had capacity to move for judicial dissolution of Carlisle, LLC, the Chancery Court consider whether they could do so on an equitable basis. In consideration thereof, the Court provided several pages of analysis as to how the equitable jurisdiction of the Chancery Court could be employed and when that jurisdiction is limited consequent to the existence of a comprehensive legal regimen. Based upon the facts presented, the Court determined that WU Sub, as the holder of equity in Carlisle even as it is not a formal record owner, may seek equitable dissolution of the Company.
     A few thoughts:
·         Notwithstanding the asserted certainty of Delaware law, decisions such as this highlight the fact that Delaware law is often fact specific (as is the right of a Court of Equity) and is far more fluid than many people would think. In this instance, the statute affords a member the right to seek judicial dissolution. A nonmember, who cannot seek judicial dissolution, is still allowed to move for equitable dissolution.
·         One basis cited in support of the Court's determination that equity should intervene and possibly allow dissolution is that the parties had negotiated, but never executed, an amended operating agreement which would have substituted WU Sub as a member who, inter alia, would then have had the capacity to move for judicial dissolution. If courts are going to allow such reliance, parties negotiating amended agreements need to take great care to legend their discussions so as to not give rise, based upon preliminary documents, to new rights.

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