Contrived LLC Deadlock Doesn’t Cut the Delaware Dissolution Mustard
September 26, 2022
The statutes authorizing judicial dissolution of Delaware LLCs (LLC Act § 18-802) and New York LLCs (LLC Law § 702) essentially are the same: the petitioner must show that it is no longer “reasonably practicable” to carry on the business in conformity with the LLC’s operating agreement. Not much guidance there.
Delaware’s Chancery Court got a head start over New York’s courts in crafting a standard for determining when the statute is satisfied. Coincidentally or not, a string of the earliest, major Chancery Court decisions construing § 802 involved 50/50 deadlock cases (Haley v Talcott , Silver Leaf , Fisk Ventures , Lola Cars , Vila v BVWebTies ). Those primordial opinions crafted what has become a standard explication of the statute’s requirements — even showing up in dissolution cases pleading grounds other than deadlock! Here’s how the Fisk Ventures opinion put it:
The text of § 18-802 does not specify what a court must consider in evaluating the “reasonably practicable” standard, but several convincing actual circumstances have pervaded the case law: (1) the members’ vote is deadlocked at the Board level; (2) the operating agreement gives no means of navigating around the deadlock; and (3) due to the financial condition of the company, there is effectively no business to operate.
In each of the above-mentioned cases, the deadlock was uncontested or at least found by the court to be genuine, i.e., there was no argument and/or no finding that the petitioner had manufactured a deadlock in bad faith for the very purpose of seeking dissolution.
The closest to that I saw is then-Vice Chancellor Strine’s passing remark in the Vila case that “this is not a case in which Vila in bad faith manufactured a phony deadlock.”
The next closest to that remark that I could find involving a Delaware LLC, at least temporally (and oddly from a jurisdictional standpoint), is a 2016 Tennessee Chancery Court opinion in which the court cited that same remark in Vila in support of the court’s decision denying the plaintiff’s motion for a summary judgment of judicial dissolution of a Delaware LLC. In that case the plaintiff proffered evidence from which the factfinder could reasonably infer that dissolution based on alleged deadlock was sought in bad faith to secure for plaintiff’s sole benefit the LLC’s business opportunity.
The wait for the Delaware Chancery Court to squarely address and uphold a defense to a petition to dissolve a Delaware LLC under § 802 based on manufactured deadlock, is over. Earlier this month, in In re Dissolution of Doehler Dry Ingredient Solutions, LLC, Mem. Op., C.A. No. 2022-0354-LWW [Del. Ch. Sept. 15, 2022], Vice Chancellor Lori W. Will dismissed at the pleading stage a dissolution petition on the ground, among others, that the petition’s allegation of deadlock based on petitioner’s declared intent to withhold future consents from certain “critical” actions was a “contrived attempt to manufacture deadlock.” Let’s take a closer look.
The Petition in Doehler
The 9-page petition in Doehler alleges that the subject LLC was formed in 2017 to manufacture and market dried food ingredients. The petitioner (Davis), a 25% member through his wholly-owned company and one of the LLC’s managers, cited “irreconcilable differences” with the other members and managers who allegedly:
- inequitably “froze out” Davis as a manager and member;
- refused to pay Davis for services that the LLC agreement directs him to perform;
- breached fiduciary duties owed to Davis and the LLC;
- violated provisions in the LLC agreement including incurring certain debt in excess of $25,000 without the required unanimous member consent and failing to comply with the LLC agreement’s buy-out provisions;
- hacked Davis’s email inbox; and
- formed a competing company using the LLC’s resources.
The Dismissal Motion
The respondents filed a pre-answer motion to dismiss the petition, among other procedural grounds that I’ll leave aside, arguing that the petition’s allegations failed to plead a valid claim for judicial dissolution of the LLC under § 802. More specifically, respondents argued that, even assuming the truth of the petition’s allegations, the petitioner’s removal as a manager and member in breach of the LLC agreement, the hacking of his emails, etc., “do not rise to the level of corporate dysfunction required for judicial dissolution.” The respondents also cited the LLC agreement’s provision that “provides a procedure for resolving deadlock, of which Davis does not seek to avail himself (or even reference),” and argued that the petition does not allege that the LLC’s business purpose has become impossible to fulfill. (Read here respondents’ brief.)
The petitioner’s brief (read here) on the one hand countered that the petition was not based solely on deadlock and adequately alleged non-deadlock grounds for judicial dissolution, namely, that the LLC’s purpose “has been frustrated” and that “dysfunction among the members makes it no longer reasonably practicable to carry on the business of the LLC.”
On the other hand, the petitioner argued that the petition adequately alleged deadlock as concerns debt over $25,000 incurred without the requisite unanimous member consent. The petitioner’s brief further contended (although not alleged in the petition) that the LLC agreement set forth nine other “critical actions” which require unanimous approval of the members, “but for which [petitioner], as a member, does not approve.” Among those “critical actions,” the brief mentions the distribution of profits, the adoption of a business plan or future budgets, and the making of loans over a $25,000 threshold. Leaving no doubt as to his future intentions, the brief declares that petitioner “will not approve any distribution of profits” and “will not agree” to adopt any business plan or future budget. He also declares that he “cannot and does not approve of any additional loans, including the loan currently proposed.”
The Court’s Decision
The bulk of the legal analysis in VC Will’s 21-page decision is taken up with her discussion of the respondents’ challenges to the court’s subject matter jurisdiction based on a prior pending federal case involving the respondents’ claim to compel a contractual buyout of the petitioner’s membership interest (challenge rejected) and personal jurisdiction over one of the individual defendants (challenge upheld). I won’t address here either of those issues, though the subject matter jurisdiction argument, turning on the U.S. Supreme Court’s 1939 decision in the Princess Lida case, is an interesting and unusual one in the business divorce arena.
VC Will’s discussion of the petition’s failure to state a claim begins at page 15 of the opinion. At page 17, she sets forth the generally applicable principles under § 802:
“Given its extreme nature, judicial dissolution is a limited remedy that this court grants sparingly” [quoting Arrow Investors]. Its availability is limited to situations where “the LLC’s management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business, such as in . . . a voting deadlock or where the defined purpose of the entity has become impossible to fulfill” [quoting BET FRX v Myers]. The Petition falls well short of satisfying this arduous standard.
“First,” VC Will continues, “the petitioner does not allege facts supporting an inference that the Company is deadlocked at the member or manager level.” The petition’s allegation that the other members approved without unanimous consent a loan over the $25,000 threshold was framed “as an issue of breach of contract–not deadlock.”
Then comes the money quote, where VC Will rejects Davis’s reliance on the nine “critical actions” and his declared intent not to approve any one of them going forward:
Davis also contends that [he] will decline to approve “nine actions critical to the LLC” for which unanimous consent is required under the LLC Agreement. His argument fails to identify any existing deadlock. Rather, it concerns prospective deadlock if the petitioner withholds future consent. This contrived attempt to manufacture deadlock cannot support a claim for judicial dissolution. [Italics in original.]
In a footnote to that passage, VC Will cites two Chancery Court decisions involving deadlocked corporations and one — Mehra v Teller — involving an LLC. The one involving an LLC, however, involved a complaint seeking to invalidate a contractually triggered dissolution based on deadlock, not a judicial dissolution petition under § 802. Which allows me to say that Doehler appears to be first Delaware Chancery Court § 802 case dismissing a claim for dissolution alleging deadlock where the allegations of deadlock are found to be “contrived” or “manufactured.”
If I’m right about that, it also allows me to say with a little Empire State pride that Doehler is the rare LLC business divorce case in which Delaware Chancery Court lagged behind New York. My evidence? The Manhattan Commercial Division’s 2019 decision in the Advanced 23 case that I wrote about here, where the court dismissed an LLC Law § 702 dissolution petition by a 50% co-managing member of a realty holding LLC based on his own conduct in breach of the operating agreement designed to “force dissolution” and “push” the other 50% members “out of the building.”
Finally, after dissing the petition’s deadlock allegations, VC Will also found that, even had the petition adequately alleged deadlock, “dissolution would still be unavailable because the deadlock could “be remedied through a legal mechanism set within the four corners of the operating agreement,” referring to the LLC agreement’s buy-sell provisions of which “Davis did not avail himself.” VC Will also held that the petition did not adequately allege that the stated purpose of the LLC has become impossible to fulfill or is that the LLC is not currently performing its functions, or is otherwise unable to operate in accordance with the LLC agreement.
My thanks to Delaware attorney Kurt Heyman for sharing the parties’ publicly filed briefs. Kurt represented the Doehler respondents.