Delaware Reminds LLCs: Breaking Up Is Hard to Do

In In re: Dissolution of Doehler Dry Ingredient Solutions, LLC (Sept. 15, 2022), the Delaware Court of Chancery recently restated the high bar for a claim for judicial dissolution to succeed. Following his removal by written consent, a minority member and former manager of a Delaware limited liability company brought a claim for judicial dissolution of the entity. The former manager alleged that judicial dissolution was warranted due to alleged breaches of the company’s operating agreement, a potential voting deadlock on important matters, and alleged breaches of fiduciary duties.

The Court of Chancery restated the statutory requirement for judicial dissolution, under which the court may order dissolution of a limited liability company upon application by a member “whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.” The availability of dissolution is limited to a very narrow set of circumstances, which the Court of Chancery considered successively.

The former manager failed to show that “management had become so dysfunctional […] that it [was] no longer practicable to operate the business.” The Court of Chancery emphasized that it would only consider an existing deadlock at the management level, not a prospective deadlock that would result from the petitioner’s withholding future consent. Here, the petitioner alleged that he would withhold consent in future (i.e., prospective) votes on matters requiring unanimous member consent. In doing so, the petitioner failed to show that the company was effectively deadlocked at the member of management level.

Furthermore, the Court of Chancery indicated that it would turn to the operating agreement to analyze whether it provided for a mechanism designed to resolve an actual deadlock. The operating agreement of the limited liability company at issue contained a buy-sell option, a provision allowing one member to make an offer to purchase the other members’ interests. Upon receipt of the offer notice, the other members must either purchase all of the units at the offer price or sell all of their units at this price. The buy-sell option applies “in the event that the Members become deadlocked with respect to any decision that materially and adversely affects the Corporation’s business as a resolute of their dispute.”

The operating agreement also provided for a contractual process for dissolution. The company would be dissolved “upon the occurrence of an event of dissolution,” or in the event that the buy-sell option failed to resolve the deadlock.

The Court of Chancery indicated that such terms would have prevented the judicial dissolution of the company, even if it had faced an actual deadlock situation (by opposition to a prospective one). The Court of Chancery will systematically turn to the operating agreement to assess whether any existing mechanism can remedy a voting deadlock.

In doing so, the Court of Chancery defers to the operating agreement, a contract which was negotiated and agreed upon by the parties, rather than judicial intervention. The Court of Chancery will have the parties abide by the operating agreement, refusing to order judicial dissolution where the agreement provides for functional mechanisms designed to resolve deadlocks, such as the buy-sell option in this case.

The former manager also failed to prove that the “defined purpose of the entity [had] become impossible to fulfill.” As long as a limited liability company can continue to perform its functions, as stated in the operating agreement, it will not face judicial dissolution. Here, the limited liability company agreement stated that the purpose of the entity was to “act as a vehicle for its members to invest in the dry foods business.” The petition did not allege that the limited liability company was no longer performing this function. The Court of Chancery held that judicial dissolution was not warranted.

The Court of Chancery clarified that even if the petitioner’s allegations were found to be true, including his eviction as a member, breaches of fiduciary duties, and a conspiracy to commit malfeasance, it would not have ordered judicial dissolution for as long as the company was able to operate in accordance with its governing documents.

Takeaways

• Delaware law imposes a high bar for a claim for judicial dissolution to succeed.
• Including mechanisms designed to prevent or resolve deadlock situations, such as a buy-sell option, will contribute to shielding a limited liability company from the risk of judicial dissolution.
• Courts will look to the purpose provision of a limited liability company to evaluate whether it may continue to operate.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.