Judicial Dissolution of Trio of LLCs Awarded Notwithstanding the Absence of “Deadlock”

 

Judicial Dissolution of Trio of LLCs Awarded Notwithstanding
the Absence of “Deadlock”

In a summer, 2020 decision, the Court of Appeals reversed the trial court and awarded judicial dissolution of three LLCs (the trial court had denied judicial dissolution of two of the three) were it was clear that the two equal members could not and would not cooperate with respect to management of the LLCs. Unbridled Holdings, LLC v. Carter, 607 S.W.3d 188 (Ky. App. 2020).

Arvin and Carter were the two members of three LLCs, Southern Tax Services, LLC, Kentucky Property Management, LLC and Unbridled Holdings LLC. Each LLC was member managed, and each had unilateral authority with respect to “the ordinary and day-to-day decisions concerning the business affairs” of the LLC. Through the summer of 2015, Arvin manage the day-to-day operations, when the relationship between the two of them broke down over a personal dispute not otherwise related to either company. Arvin wanted to terminate the relationship embodied in the three LLCs, but the operating agreements of each company require the consent of both members to dissolve. Perhaps not surprisingly in light of the breakdown of the personal relationship between the two of them, Carter would not grant consent to dissolution. In consequence, Arvin brought an action for judicial dissolution of the three LLCs.

Arvin based his claim for judicial dissolution on the assertion that it is no longer “reasonably practicable” for he and Carter to operate the LLCs. In each instance, the purpose provision as set forth in the operating agreements enabled each LLC to engage in “all transactions of any or all lawful business for which limited liability companies may be formed under the laws of the State of Kentucky.” While the trial court ordered the dissolution of Southern Tax Services, judicial dissolution of the two other LLCs was denied, the trial court reasoning that there existed no deadlock because the operating agreement enabled each member, acting unilaterally, to carry on the business and affairs of the LLCs. Arvin appealed, arguing that deadlock is not a precondition to judicial dissolution and that doing so would modify the statutory standard of impracticability into a standard of impossibility.

The appellate court noted that the state legislature did not define “not reasonably practicable” and that there were no published cases in Kentucky interpreting the standard. The court looked to decisions in other states, but noted that there was no one definition or standard. Curiously there was no reference made to Blue Equity Holdings Kentucky, LLC v. Cobalt Riverfront Properties, 2019 WL 4127610 (Ky. App. 2019), wherein the “not reasonably practicable” standard was discussed. The court agreed with Arvin that the statute could not mean that it must be impossible to carry on business – if it did, the legislature would have used the word “impossible” instead of “not reasonably practicable.” It was also noted that decisions in other states generally found the standard to be met by circumstances short of general deadlock, and that the Kentucky legislature must not have meant to require deadlock or, again, it would have used the word deadlock.

“Having extensively surveyed case law from other jurisdictions, we believe the ‘not reasonably practicable’ standard requires the trial court to conduct a multifaceted analysis which takes into account a number of different factors that goes well beyond whether there is a technical deadlock.”

The court referenced Gagne v. Gagne, the Colorado case that first considered the “not reasonably practicable” standard under Colorado law, which also stated that impossibility is not required and then laid out several factors to consider. The factors the court in Gagne identified are:

§  Whether the management of the entity is unable or unwilling reasonably to permit or promote the purposes for which the company was formed;

§  Whether a member or manager has engaged in misconduct ;

§  Whether the members have clearly reached an inability to work with one another to pursue the company’s goals;

§  Whether there is deadlock between the members;

§  Whether the operating agreement provides a means of navigating around any such deadlock;

§  Whether, due to the company’s financial position, there is still a business to operate;

§  Whether continuing the company is financially feasible.

The Unbridled court adopted the multifactor approach, indicating it provided the proper amount of flexibility and discretion to order dissolution even in cases that fall short of deadlock or complete frustration of or total impossibility to carry out the purpose of the company. The court then vacated the trial court’s decision and remanded the case to the lower court to determine, based on a new framework developed by the appellate court, whether the impracticability standard had been met.

 

Application for Judicial Dissolution of LLC By A Non-Member Dismissed

Application for Judicial Dissolution of LLC By a Non-Member Dismissed

      The Delaware Limited Liability Company Act, and specifically section 18-802 thereof, provides that an LLC may be judicially dissolved “[o]n application by or for a member or manager.” In a recent decision, an application for judicial dissolution brought by neither a member nor a manager was dismissed. SolarReserve CSP Holdings v. Tonopah Solar Energy, LLC, C.A. No. 2019-0791-J RS, 2020 WL 1291638 (Del. Ch. March 18, 2020).

      Tonopah Solar Energy, LLC was originally organized as a single member LLC in which SolarReserve CSP Holdings, LLC was the sole member. Over time and in connection with a variety of financings, SolarReserve conveyed its interests in Tonapah to several other holding companies and as well borrowed money from the US Department of Energy. In turn, SolarReserve also entered into a joint venture agreement with Cobra Thermosolar Plants, Inc. to build a solar power facility. Ultimately, after a default in the Department of Energy borrowing, SolarReserves was removed from its position of ultimate control over Tonopah. In connection with this suit, SolarReserve alleges that Tonopah was insolvent and being unable to build its plats, it was no longer practicable for Tonopah to carry on its business. On that basis, it was requested that the court dissolve Tonopah. Tonopah resisted, which led to this decision.

      Parsing the current ownership and control structure of Tonopah, the court determined that SolarReserve was not a member, but rather an indirect investor. Further, turning to the argument it should order dissolution on equitable principles, the court deferred, concluding that doing so would create rights in SolarReserve that it did not already have. Rather, to the extent in SolarReserve continue to hold any interest in Tonopah, there was an intervening holding company from which all of the membership interests in Tonopah had been pledged to secure the now defaulted Department of Energy loan.

You Cannot “Fail” Until You Try

You Cannot “Fail” Until You Try

       Peter Mahler, in his blog New York Business Divorce, has reviewed a resent New York decision addressing judicial dissolution for failure by the shareholders to elect directors. In this case, Gupta v. E.J.'s Bucket Buddies, Inc., No. 650952/2019, 2020 WL 4258756 (N.Y. Sup. Ct. July 24, 2020), because there had actually been no meetings convened for the purposes of electing directors, there had been no failure to elect directors. Hence, that basis for seeking judicial dissolution of the corporation was unavailable.

      Peter's review of this decision was posted on August 10 in an article titled Dissolve For Failure to Elect a Board? Better Demand an Election First. HERE IS A LINK to that posting.

     This decision is as well of interest to Kentucky attorneys as the Kentucky Business Corporation Act contains an almost verbatim (as compared to the New York statute reviewed in this decision) provision.

New York Court Rejects Judicial Dissolution of Successful Ongoing Business

New York Court Rejects Judicial Dissolution of Successful Ongoing Business

      In a recent decision from New York, it rejected a minority member’s application for judicial dissolution of an LLC that, objectively, was apparently quite successful. While the plaintiff member’s claims for breach of the operating agreement with respect to the majority owners’ acquisition of certain interest in the company in violation of a right of first refusal and a request for an accounting survived, the business itself will, at least for the time being, continue. Matter of Felzen v. PEI Mussle Kitchen, LLC, 2017 N.Y. Slip Op 31831(U), 2017 WL 3834841 (Sup. Ct. NY County Sept. 1, 2017).

      Franklin C. McRoberts, writing for the blog New York Business Divorce, has reviewed this decision in a posting titled LLC’s Purpose Being Achieved? Business Doing Fine? Good Luck Getting Judicial Dissolution (Oct. 2, 2017). HERE is a link to that review.

Your Ways Are Not Our Ways

Your Ways Are Not Our Ways

“Your ways are not our ways” are words said by Dracula in the movie Bram Stoker’s Dracula; Transylvania and Victorian London being rather dissimilar.  They apply as well today when assessing the law of other states; different states can have entirely different, but each equally legitimate, rules.  This principle applies when assessing a recent decision out of New York and considering if the same result would happen in Kentucky.

Peter Mahler, in his excellent New York Business Divorce blog, recently reviewed a New York decision on minority shareholder oppression, Matter of Digeser v. Flach, 2015 NY Slip Op 51609(U), a case in which the heirs of the founders of a pair of companies had a falling out.  The minority shareholder found his management position and employment in the corporations terminated, and brought suit seeking judicial dissolution on the basis of oppression.  Flach, the majority shareholder, also terminated the employment of Digeser’s sons and engaged in a variety of other actions that Digeser asserted were oppressive.  Ultimately both the trial court and the court of appeals would determine that oppression had taken place, allowing the action for judicial dissolution of the corporations to proceed. Peter excellent review of the case, through which the decision itself can be assessed, is available AT THIS LINK.

But is this good law in Kentucky?  Probably not.  The New York law governing corporations includes, at § 1104-a(1), “oppression” as a basis for seeking judicial dissolution.  Kentucky, at KRS § 271B.14-300(2)(b) does not include oppression as a basis for dissolution.  In fact, when this provision was drafted, the MBCA included “oppression” as a basis for dissolution; that term was removed from the final Kentucky act.  While no Kentucky court has yet addressed the matter, it would seem that whether or not particular conduct is “oppressive” as to the rights of a minority shareholder is a pointless determination; even in the face of oppression there is no statutory basis for judicial dissolution.

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.

North Carolina Court Considers Authority to Hire Legal Counsel on Behalf of LLC and Grounds for Judicial Dissolution

North Carolina Court Considers Authority to Hire Legal Counsel on Behalf of LLC and Grounds for Judicial Dissolution

 

In a recent decision from North Carolina, the court considered the question of who has authority, when one member brings a suit against the LLC, to hire legal counsel on behalf of that LLC. The court addressed as well the standard for judicial dissolution of an LLC, a decision which has application in Kentucky due to the similarity of the statutory formulae.  Battles v. Bywater, LLC, 2014 NCBC 52, 2014 WL 5512304 (October 31, 2014).

 

Battles and Rogers, each individuals, formed two North Carolina LLCs, Bywater and Agiqua.  Battles and Roger were each 50% owners in each LLC; they were also managers of each LLC. Eventually their relationship would break down, it being asserted that Rogers inappropriately disengaged from management after an automobile accident.  At least Bywater had been represented by the Hart Law group (“Hart”), and Rogers consulted with Heart as to how to protect the LLC from, what Battles alleged, was Rogers’ inappropriate conduct.  Battles began moving the bank account of Bywater among various banks at which Rogers did not have signature authority.  Invariably the accounts were frozen when the banks were made aware of the dispute, and they were again moved.  Eventually the account came to rest at a bank at which both Battles and Rogers had signature authority.

 

Rogers retained Asheville Law group (“Asheville”) to represent him versus Battles as to Bywater.  Battles filed suit seeking, among other claims, the judicial dissolution of each LLC.  Rogers then terminated Asheville as his personal counsel and retained it on behalf of the two LLCs, Bywater and Agiqua, against Battles.  Rogers then sought to effect Battles’ expulsion from Bywater on the grounds that Battles’ movement of the Bywater bank accounts justified his expulsion.

 

Battles moved to disqualify Asheville as counsel to the LLCs on the grounds that Rogers, as a 50% member and one of two managers of each of the LLCs, did not constitute a “majority” enabled to act. Rogers responded that Bywater had a written operating agreement pursuant to which Battles was expelled, leaving at a single-member LLC. As to Agiqua, Rogers asserted that the default rules of the LLC act permitted him to act unilaterally, and that absent agreement of a majority of the managers his action is binding.

 

After finding the Bywater’s operating agreement was effective even though never “signed,” the Court bypassed the question of Battles’ expulsion by noting that it was some 10 days after Asheville was hired. Hence, as of that date, Bywater could not have been a single-member LLC. Further, the Court found that Battles’ alleged actions did not satisfy the “stringent requirements for expulsion under the Agreement.”

 

Addressing then the specific authority (or the absence thereof) to retain Asheville, retention that would generate a fee of some $85,000, the Court concluded that this retention was in opposition to Rogers’ authority under the operating agreement.  Specifically, the retention was “other than in the ordinary course of business” and it created “an actual … conflict of interest between a member and the company[.]” In that Rogers had retained Asheville without the “affirmative vote of members holding a majority of the ownership interests,” he acted outside of his authority.

 

Turning to Agiqua and looking to the default rules of the North Carolina LLC Act, and in reliance upon a number of other decisions, the Court found that Rogers did not have the unilateral authority, on behalf of the LLC, to retain counsel.   Is therein noted:

 

To conclude otherwise would leave open the possibility of two equal LLC members each designating competing counsel to represent the same LLC in the same legal action.

 

As such, the motion to disqualify Asheville on behalf of each of the LLCs was granted, and all of the pleadings they had submitted were ordered struck.

 

As to the question of judicial dissolution, the court noted that the North Carolina LLC act, as most recently amended, provides for dissolution if “it is not practicable to conduct the LLCs business in conformance with the operating agreement.”  N.C. Gen. Stat. § 57 D-6-02. Brushing aside the suggestion that mere deadlock amongst the members did not satisfy the statutory requirement on the basis that the prior statute referred to deadlock and the current one does not, the Court held that:

 

It cannot be reasonably argued that continuation of the LLC’s operations is “practicable” where, as in the instant case, the two 50% member-managers are unable to reach agreement with respect to even the most basic management decisions.

 

The Court as well granted the request for a receiver.

 

With respect to the grant of judicial dissolution, the statute in North Carolina is very similar to that in Kentucky although while North Carolina uses a “practicable” standard Kentucky utilizes a “reasonably practicable” standard.  KRS § 275.290(1).  

 

As for the inability in a two member LLC where action requires majority approval and the authority to hire legal counsel when suit is brought, this decision is in no manner an outlier.  For example, and as cited in this decision, on similar facts the Delaware Chancery Court has held there to be no authority to hire counsel. Maitland v. International Registries, LLC, 2008 Del. Ch. Lexis 70 (Del. Ch. June 6, 2008). This problem can be avoided in a well-crafted operating agreement that specifically grants authority to retain counsel on behalf of the company if either of the members should initiate legal action against it.