Chicken Sh*t Bingo Fans Rejoice: The Dragpipe Saloon Survives a Dissolution Scare
September 23, 2019
In a moment I’ll explain why you’re looking at a picture of “chicken shit bingo,” but first . . .
The nationwide landscape of statutes and case law governing judicial dissolution of limited liability companies exhibits more state-to-state similarity than dissimilarity.
On the statutory side, this is due in large part to the use of the same model acts in the initial wave of LLC enabling legislation that swept the country in the late 1980s and early 1990s and, of course, the more recent adoption by many states of the Revised Uniform LLC Act.
On the case law side, because all LLC laws share a fundamental deference to the members’ contractual preferences as expressed in the operating agreement, and because the LLC statutes almost invariably include as ground for dissolution the impracticability of the LLC’s continued operation in conformity with the members’ agreement, to a very large extent court decisions in LLC dissolution cases turn on common-law principles of contract interpretation which also tend to uniformity among the states.
All of which is to make the point that, while a steadily increasing focus in my practice and of this blog is New York’s experience with judicial dissolution of LLCs as the newly dominant form of closely held business entity, business divorce practitioners in all states can benefit greatly from staying abreast with LLC case law developments from across the country — and not just Delaware!
Along those lines, two weeks ago I wrote about a recent Kentucky appellate ruling affirming the dismissal of a minority member’s petition to dissolve a single-asset realty holding LLC. That case turned wholly on the court’s reading of the operating agreement’s purpose clause.
In this post, we look at a South Dakota Supreme Court decision issued earlier this month in another LLC dissolution case also involving a single-asset realty holding company with the fanciful name, Dragpipe Saloon, LLC, in which the court reversed the lower court’s order granting a dissolution petition alleging deadlock. In that case, the operating agreement’s purpose clause was one of several interesting issues addressed in the court’s opinion.
The Sturgis Motorcycle Rally
Sturgis, South Dakota is the setting for the Sturgis Motorcycle Rally founded by the Jackpine Gypsies motorcycle club and held every year since 1938 over ten days in August. According to its Wikipedia entry, the Rally’s original focus was racing and stunts, but has since expanded into a huge, festival-like event featuring top-name entertainers and attendance of a half-million or more people.
Among the more colorful facts mentioned in the entry, there were 405 individuals jailed at the 2004 Rally, approximately $250,000 worth of motorcycles are stolen annually, and there have been a number of mysterious, unsolved deaths at the Rally.
Dragpipe Saloon, LLC
In 2003, four friends formed Dragpipe Saloon, LLC to purchase 74 acres of land near Sturgis. On 18 acres they built a bar and camping facilities that are open only during the Rally; the remaining acreage is leased to a farmer. During the Rally Dragpipe also sells t-shirts, hosts food vendors, and provides live entertainment including, you guessed it, “chicken shit bingo” which, I’ve reluctantly learned, is a “real thing” supposedly inspired (gulp) by “cow shit bingo.”
The four members each invested $80,000 in the venture. Under Dragpipe’s operating agreement, the four members each received a 25% membership interest and voting rights. The agreement states that Dragpipe’s purpose
is 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.
The operating agreement authorizes any member to voluntarily resign their membership and obtain the “fair market value of [the member’s] Ownership Interest, adjusted for profits and losses to the date of resignation.” Fair market value is determined by unanimous vote of the members or, failing that, by an independent appraiser.
In 2005, one of the founding members sold her membership interest to a new investor.
Dragpipe had its first profitable year in 2015 and posted modest profits in 2016 and 2017. The members provide labor during the Rally without compensation and have never received income distributions. Profits in 2015 covered mortgage expense previously contributed pro rata by the members and allowed reimbursement of the members’ out-of-pocket expenses.
Two Members Initially Obtain Judicial Dissolution
After the 2015 Rally, two members of Dragpipe found buyers for their membership interests. The other two members had no objection but the proposed sales fell through. In 2017, the two who wanted to sell plus a third member agreed to list the Dragpipe property for sale for $950,000, but the fourth member refused to go along with it.
The two members who had tried to sell their membership interests did not invoke their right under the operating agreement to resign and receive fair market value. Instead, they filed suit requesting judicial dissolution of Dragpipe and the sale of its assets.
The circuit court granted the request. In a post-trial ruling, the court found that the profit made in 2015-2017 was insufficient to begin repaying the capital contributions made by the members and that the parties were “at a standstill” on whether to sell the property. The court determined that the only way for Dragpipe to make money was to sell its real estate. The court concluded that judicial dissolution was authorized under South Dakota’s LLC Act because Dragpipe’s economic purpose was unreasonably frustrated and because it was not reasonably practicable to carry on its business in conformity with the operating agreement.
Supreme Court’s Reversal
The two members who opposed dissolution appealed to the South Dakota Supreme Court which, in its decision earlier this month, agreed with the appellants and reversed the circuit court’s dissolution order. Dysart v Dragpipe Saloon, LLC, 2019 S.D. 52 [Sup. Ct. S. Dak. Sept. 4, 2019].
The court’s summary of the governing legal principles characterized involuntary judicial dissolution as “an exceptional level of intervention into the otherwise private agreement of an LLC’s members” which
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.
Turning to the facts of the case, the Supreme Court cited five factors undermining the lower court’s dissolution order.
First, the panel determined that the lower court’s findings did not “support the legal conclusion that it is no longer practicable for Dragpipe to continue to operate in accordance with its operating agreement.” Initially focusing on Dragpipe’s purpose as stated in its operating agreement, the court found that:
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.
Second, The appellees’ dissatisfaction with the return on their investment in Dragpipe was not enough to establish frustration of purpose, prompting the court to comment:
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[.]”
Third, the Supreme Court also disagreed with the circuit court’s finding that Dragpipe’s economic purpose was likely to be unreasonably frustrated. Here’s what it said on that score:
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.
Fourth, the operating agreement provided the appellees with the option to resign and receive fair market value for their membership interests as determined either by agreement or independent appraisal, in lieu of dissolution. The appellees “have not availed themselves of this option,” the court wrote, “[n]or does it appear they have continued in their efforts to sell their interests outright” despite the lack of any objection by the appellants to their doing so .
Fifth, the court found “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 lower court’s finding that the members were “at a standstill,” the panel wrote,
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.
For all of these reasons, and upon its conclusion that Dragpipe was operating within its contractually articulated purpose, that it was economically feasible, and that the members “are not effectively deadlocked and have multiple options for resolving their disagreement about the sale of Dragpipe’s real estate,” the court held that “the ‘drastic remedy’ of judicial dissolution is not supported and that the circuit court’s judgment of dissolution must be reversed.”
The Takeaway. The South Dakota Supreme Court’s analysis and the outcome in Dysart likely would be the same had the case arisen under the LLC statutes and case law of any other state. Dysart also underscores the challenges inherent in formulating the operating agreement for a multi-member, single-asset realty holding LLC in which, quite often, non-control members eventually seek to cash out their membership interests without a ready public market for their interests and without ready financing at the company or member level.
But, you ask, didn’t the petitioning members in Dysart have a readily available exit by means of resigning and receiving fair market value for their interests? Yes, they did, but one must assume that they did not exercise that option, and instead went to the trouble and expense of suing for dissolution, because they believed that a forced sale on the open market of Dragpipe’s property and operations would generate a fatter payout on a pro rata basis than an appraisal of fair market value which likely would include marketability and minority discounts.
Finally, Dysart presents a nice contrast with the above-mentioned Kentucky case that I recently wrote about, also involving a single-asset realty holding LLC. In that case, where the court found that the continued operation of the property as a parking lot was consistent with the operating agreement’s purpose clause, I commented that the unsuccessful petitioner’s real problem was the absence of any provision in the operating agreement either requiring the property to be developed and sold within a defined period or, if not, giving him a buyout option. In Dysart, the operating agreement gave the unsuccessful petitioners a buyout option which they declined to employ for whatever reasons.