Tuesday, October 22, 2019

Judicial Dissolution of LLC Denied

Judicial Dissolution of LLC Denied

In a recent decision rendered by the Supreme Court of South Dakota it reversed a holding of the trial court granting judicial dissolution of an LLC. Rather, on the facts and applying the “no longer practicable to operate in accordance with the operating agreement” standard, it was found that there did not exist a basis for dissolution. Dysart v. Dragpipe Saloon, LLC, 2019 S.D. 52, ___ N.W.2d ___, 2019 WL 4197232 (2019).

At the time of this action, the LLC had four members. The operating agreement identified the purpose of the LLC as:

To engage in all lawful activities, including, but not limited to, owning, purchasing, taking, leasing, or otherwise holding or acquiring real property and any interest or right in real property and any improvements thereon, and to hold, own, operate, control, maintain, manage and develop such property and interests in any manner that may be necessary, useful or advantageous … [to the] company. 2019 WL 4197232, *1.

In addition, the operating agreement provided that any member could withdraw and receive the fair market value of their interest in the company.

The LLC owned 74 acres of land, upon which had been built a bar that is open only 10 days a year during the Sturgis Motorcycle Rally. The part of the property not utilized by the bar had been leased for farming. Also, after having been in operation for several years, the LLC organized a campground on its property, initially making it available for free to participants in the Rally; charges for using the campground were instituted in 2013. Having been formed in 2003 and granted a malt beverage license in 2004, the company was first profitable in 2015, posting “modest profits” in 2016 and 2017. Although not explicit in the opinion, it appears that through 2015 the members had funded the amounts due on the mortgage for the LLC’s property.

When a planned sale of the interests of two of the members, Dysart and Heinrich, fell through, and after one of the members refused to sign a listing agreement for the property, the plaintiffs in this action (Dysart and Heinrich) filed this action for judicial dissolution. While they would prevail in the trial court, that decision was reversed by the South Dakota Supreme Court.

Under the South Dakota LLC Act (SDCL § 47-34A-801(a)(4)), an LLC may be judicially dissolved on the application of a member if:

·         “the economic purpose of the company is likely to be unreasonably frustrated;” or

·         “it is not otherwise reasonably practicable to carry on the company’s business in conformity with the articles of organization and the operating agreement.”

Providing caution as to the application of this capacity, the court wrote:

An involuntary judicial dissolution represents an exceptional level of intervention into the otherwise private agreement of an LLC’s members. It should be unavailable merely to resolve disagreements among owners or relieve an owner of an investment decision later regarded as improvident. Rather, judicial dissolution is permitted only in those instances where it is expressly authorized under our statutes. Id., *3 (citation omitted).

From there, the court held:

In this case, we believe the circuit court incorrectly concluded that compulsory judicial dissolution was permitted under SDCL 47-34A-801(a)(4)(i) and (iii). As to the latter basis, we believe the circuit court’s findings fail to support the legal conclusion that it is no longer practicable for Dragpipe to continue to operate in accordance with its operating agreement. The operating agreement broadly states Dragpipe’s purpose as “owning, purchasing, taking, leasing, or otherwise holding or acquiring real property” and to “hold, own, operate, control, maintain, manage and develop such property and interests in any manner that may be necessary, useful or advantageous[.]” Here, Dragpipe did, in fact, “purchas[e] ... real property” that it now “hold[s], own[s], operate[s], maintain[s] [and] manages[s.]” Continuing to do so is no less practicable now than it has been throughout Dragpipe’s history of operation.

The fact that the Appellees believe it to be a prudent time to sell Dragpipe’s real property and realize the gain from their investments does not mean Dragpipe is unable to continue to operate in accordance with its stated purposes. Nor do the historic losses or Dragpipe’s failure to return income distributions to its members render its operation impracticable. In more recent years, Dragpipe’s performance has improved and yielded profitable results, if not large cash returns, for its members. It may well be that the Appellees have grown weary of Dragpipe’s lukewarm revenue outcomes over the years, but that does not, itself, mean that Dragpipe is not “carry[ing] on the company’s business in conformity with ... the operating agreement[.]”

A similar analysis applies to the circuit court’s separate determination that “the economic purpose of the LLC is likely to be unreasonably frustrated.” Relying again upon the circuit court’s findings contained in this record, we believe the court erred in its legal conclusion. In the absence of an order directing judicial dissolution, Dragpipe will continue to operate more or less as it has since its inception. Even if, as the circuit court found, the principal means of making money for Dragpipe’s members will ultimately be through the sale of the real property, that does not mean that the members’ failure to reach a consensus about a proposed sale here is likely to frustrate Dragpipe’s economic purpose.

Under the plain and unambiguous terms of the operating agreement, the Appellees can resign and receive the fair market value of their interests. In the event the members do not agree upon the fair market value, the operating agreement states that the value will be determined by an independent appraiser. Yet, the Appellees have not availed themselves of this option. Nor does it appear they have continued in their efforts to sell their interests outright. The other two members do not object to such a sale and, in fact, the prior sale of Weast’s interest to Kerwin was successful without the need for judicial intervention or dissolution.

Beyond this, there is no “impenetrable deadlock” and no indication that a member or member-faction is benefitting from the disagreement regarding the proposed sale of Dragpipe’s real estate to the prejudice of the other members. The circuit court’s determination that the members were “at a standstill” is attached to the implicit legal conclusion that Dragpipe must sell its real estate now. However, we do not perceive the same degree of urgency when we interpret the text of Dragpipe’s operating agreement and consider the legal standards for judicial dissolution. Id., *3-4.

As have other decisions, including Blue Equity Holdings Kentucky, LLC v. Cobalt Riverfront Properties, LLC, 2019 WL 4127610 (Ky. App. Aug. 30, 2019), this decision highlights the importance of the “purpose” clause of an operating agreement. In this decision, as was as well the case in the Blue Equity Holdings decision, it was found that the company was acting entirely within its defined purpose and, on that basis, judicial dissolution should not be awarded. With respect to purpose clauses generally, see, e.g., Rutledge, Purpose: If You Don’t Know Where You Are Going, How Will You Know If You Have Arrived, J. Passthrough Entities (Nov./Dec. 2017) 37. HERE IS A LINK to that article.

Peter Mahler, in his blog New York Business Divorce, reviewed this same decision in a posting titled Chicken Sh*t Bingo Fans Rejoice: The Dragpipe Saloon Survives a Dissolution Scare (September 23, 2019).  HERE IS A LINK to that posting.

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