Delaware's answer to management deadlock in the limited liability company: judicial dissolution.

• Author: Gruebner, Meghan

1. INTRODUCTION II. BACKGROUND A. Delaware's Commitment to Freedom of Contract for Limited Liability Companies B. The Court's Right to Dissolve the LLC 1. Analogies to Limited Partnerships 2. Analogies to Corporations C. Haley v. Talcott and Judicial Dissolution III. ANALYSIS: THE DEADLOCK PROBLEM A. The Court's Case-Specific Analysis B. The Court's Borrowing of Other Governance Statutes 1. Delaware General Corporation Law Section 273 2. Delaware Revised Uniform Limited Partnership Act Section 17-802 IV. RECOMMENDATION V. CONCLUSION I. INTRODUCTION

   The combination of corporate and partnership forms in a limited liability company (LLC) has appealed to many entrepreneurs and has caused the LLC form not only to emerge as an alternative business governance structure, but also to explode as a favored corporate regime. (1) Delaware adopted its first LLC statute in 1992, and over 150,000 Delaware LLCs formed in the following decade. (2) By 1996, tens of thousands of LLCs had been formed and all fifty-one United States jurisdictions had adopted LLC statutes. (3)

   LLC statutes have been enacted and amended quite rapidly since the adoption of the first LLC statute. The LLC has evolved into more of a distinct form and less of a hodgepodge of existing corporate and limited partnership rules. (4) However, the LLC is still a relatively new governance regime when compared to the partnership structure, which existed as a common law form of organization long before the first limited partnership statute had been adopted in 1822.

   There is currently very little case law interpreting LLC statutes or agreements, but the entity's rising popularity will cause litigation involving LLC agreements and statutes to increasingly appear before the courts. It is uncertain whether or not a unique LLC jurisprudence will develop, but courts will undeniably look to existing forms--general or limited partnerships or corporations--and apply the rationale and principles behind them to disputes involving LLCs. (5) Indeed, the Delaware Limited Liability Company Act draws on many of the provisions of Delaware's well-accepted limited partnership statute, the Delaware Revised Uniform Limited Partnership Act, and the Delaware General Corporation Law. (6)

   This Note will explore an unsettled area of law for LLCs--the possibility of judicial dissolution. Part II of this Note will discuss the purposes behind the provisions of the Delaware Limited Liability Company Act and introduce the focus of this Note, the contentious case of Haley v. Talcott. (7) Part III will discuss the corporate deadlock problem faced by the parties in Haley and try to explain the basis for the court's decision. Part IV will discuss what the case suggests for future Delaware LLCs and Delaware courts facing disputes involving LLC judicial dissolution.

2. BACKGROUND

   1. Delaware's Commitment to Freedom of Contract for Limited Liability Companies

      In forming an LLC, members must comply with statutory requirements (8) and should draft an operating agreement. The operating agreement is similar to the partnership agreement of a general partnership and stipulates the governing rules of the particular firm. (9) Inconsistent provisions in LLC operating agreements displace conflicting statutes if the statutes supply default, rather than mandatory, controls.

      Most LLC statutes have few mandatory provisions, giving the parties great freedom to construct their governing rules. (10) Delaware's statute is the most permissive (11)--"It is the policy of [the Delaware Limited Liability Company Act] to give maximum effect to the principle of freedom of contract and to the enforceability of [Delaware] limited liability company agreements." (12) The Delaware Limited Liability Company Act's basic attitude is to give LLC members broad discretion in determining their LLC governing structure and rules. (13)

   2. The Court's Right to Dissolve the LLC

      All LLCs dissolve (terminate) upon certain events enumerated in the particular state's LLC statute. (14) One of the enumerated events of dissolution in Delaware says that the Court of Chancery may dissolve an LLC if one of its members claims that it is not "reasonably practicable to carry on the business" in accordance with the purpose of the LLC agreement. (15) The key word in that section is "may"--which means that the court is not compelled to decree dissolution of an LLC, but may exercise discretion to do so. As mentioned above, because litigation involving LLC disputes is sparse, courts are likely to look at other existing forms of corporate governance when determining whether to grant dissolution. Parts II.B.1 and II.B.2 explore this idea.

      1. Analogies to Limited Partnerships

         Courts may look to the provisions of partnership statutes and the case law interpreting them when deciding matters involving LLC disputes. For instance, the Delaware Revised Uniform Limited Partnership Act (DRULPA) includes an analogous provision to section 18-802 of the Delaware Limited Liability Company Act--section 17-802--that allows the Court of Chancery to dissolve a limited partnership when "it is not reasonably practicable to carry on the business in conformity with the partnership agreement." (16) The Delaware Court of Chancery rarely exercises its discretion to dissolve a partnership under section 17-802, generally reasoning that its power to order dissolution is "narrow and limited." (17) In assessing whether judicial dissolution pursuant to section 17-802 is appropriate, the Court of Chancery must determine the business purpose of the limited partnership and the general partners' continuing ability to realize that purpose while operating in conformity with the partnership agreement. (18)

         For example, in two cases involving limited partnerships, Cincinnati Bell Cellular Systems Co. v. Ameritech Mobile Phone Service, Inc. (19) and Red Sail Easter Ltd. Partners v. Radio City Music Hall Productions, Inc., (20) the Delaware Court of Chancery refused to grant judicial dissolution. In the first case, a regional telephone company entered into a limited partnership agreement for the provision of cellular mobile services and later sought judicial dissolution, claiming that the partnership was less profitable than it could have been. (21) The court held that, although the partnership's returns were not as great as its competitors, it was meeting its stated purpose of providing cellular services; (22) therefore, judicial dissolution would be improper.

         The second case involved a limited partnership whose business purpose was to finance the production of the Easter Show at Radio City Music Hall. The limited partners filed for judicial dissolution when their working relationship with the general partner deteriorated. (23) The court denied the limited partners' request for judicial dissolution, reasoning that the partnership was successfully carrying on the business of presenting the Easter Show in New York and of exploiting the licensed right to present road shows of the Easter Show as contemplated by the partnership agreement. (24)

         Conversely, in another case involving a limited partnership, PC Tower Center, Inc. v. Tower Center Development Associates Ltd. Partnership, (25) the Delaware Chancery Court exercised its discretion and found dissolution necessary under section 17-802.26 The limited partnership was formed to acquire, own, and operate a mercantile center. (27) When it was obvious to the general partner that the property was not operating at an economic gain (and was not expected to do so during the term of the net lease), he sought judicial dissolution, claiming that it was no longer reasonably practicable to carry on the business of the limited partnership at a loss. (28)

         The court elaborated on the standard of dissolution pursuant to section 17-802. It stated that the standard set forth by the legislature--"whenever it is not reasonably practicable to carry on the business"--was meant precisely to mean reasonable practicability, not impossibility. (29) Consequently, the court held that, because the partnership could not service its debt, it was no longer "reasonably practicable"--although possible--to carry on the purpose of the partnership agreement, namely, to use the property "for profit and as an investment." (30)

         The petitioner also set forth two more reasons, which are similar to the facts of Haley, to explain why the partnership could no longer carry on its business purpose in a reasonably practicable manner. First, the petitioner was in a position of irreconcilable conflict with the other partners, to whom he owed a fiduciary duty. (31) Second, the partners were in a deadlock--incapable of agreeing on a manner in which to enforce the rights of the partnership. (32) Although the petitioner presented these two reasons, the court did not expressly use them as a basis for its decision to dissolve the limited partnership.

      2. Analogies to Corporations

         Similarly, Delaware courts often resolve disputes involving LLCs by looking to the Delaware General Corporation Law (DGCL) and its related case law. For example, DGCL section 273 provides for judicial dissolution of a joint venture corporation consisting of two stockholders. (33) The plaintiff in Haley analogized its situation to that of a joint venture consisting of two stockholders, subsequently arguing that the court should have paralleled its analysis of section 18-802 of the Limited Liability Company Act to that of section 273 of the DGCL. (34) The purpose of section 273 is to provide a speedy mechanism for dissolving a joint-venture corporation and to supervise the distribution of assets when two equal shareholders are in a voting deadlock. (35)

         Take, for example, Arthur Treacher's Fish & Chips, Inc., (36) a case involving the issue of judicial dissolution under DGCL section 273. In this case, petitioner and respondent each owned fifty percent of a joint venture corporation--Arthur Treacher's Fish & Chips restaurants...