Kirksey v. Grohmann: LLC dissolution is proper when member deadlock leaves no meaningful way to move forward.

• Author: Murphy, Ellie J.
• Position: Limited liability company

In Kirksey v. Grohmann, the South Dakota Supreme Court held that judicial dissolution of a limited liability company ("LLC") was warranted when its members were deadlocked in disagreement over whether the company should continue joint ownership or dissolve the LLC and sell its sole asset, a large piece of family ranch land. Ultimately, the court determined that the statutory standard for judicial dissolution was satisfied on two grounds. First, the members' relationships had deteriorated such that the economic purpose of the LLC was unreasonably frustrated. Second, it was no longer reasonably practicable to carry on the company's business in conformity with the articles of organization and the operating agreement. In a case of first impression, South Dakota's high court correctly determined that the statutory standard for judicial dissolution was satisfied because member deadlock left half of the LLC members with all of the power and the other half incapable of influencing the company's direction. For practitioners moving forward in South Dakota, this case should be narrowly applied because of the exceptional factual circumstances of the case. Further, as legal doctrines related to the LLC continue to unfold, courts should recognize LLCs as individualized entities and seek to honor the parties' agreement and the specific purpose for which the LLC was formed.

1. INTRODUCTION

   Despite its relative youth, the limited liability company ("LLC") has become the most popular way to organize a business both across the nation and here in South Dakota. (1) The LLC offers its members limited liability, advantageous tax treatment, and flexibility in selecting a management scheme. (2) Since its first appearance in the United States in 1977, (3) all fifty states have adopted LLC-enabling legislation. (4) Because the LLC has not been fully tested within the justice system, courts continue to explore fundamental aspects of legal doctrine related to the entity. (5)

   The South Dakota Supreme Court seized the Opportunity to address LLC law in the landmark case of Kirksey v. Grohmann. (6) In Kirksey, the court addressed the statutory standard for judicial dissolution of an LLC formed under South Dakota law. (7) The court emphasized that the four sisters formed the Kirksey Family Ranch, LLC "contemplating equal ownership and management, yet ... an impenetrable deadlock" (8) left two sisters powerless to influence the company's future. (9) In reaching its decision, the court rightfully considered the language of the operating agreement and the specific purpose of the LLC. (10) Ultimately, the court recognized forced dissolution as a drastic remedy, but it found the remedy appropriate given the sisters' uniquely unfair stalemate. (11)

   This note will examine the history, characteristics, and statutory landscape of the LLC. (12) It will also discuss the remedy of judicial dissolution. (13) Further, this note determines that the Kirksey court properly awarded dissolution because of the severe inequality in bargaining power between the sisters. (14) This note concludes that this decision should be construed narrowly and applied only in closely analogous situations. (15) Lastly, this note discusses alternative remedies to dissolution and other claims that could have been sought by the plaintiffs in Kirksey. (16)

2. FACTS AND PROCEDURE

   When Grace Kirksey died in July of 2001, she left behind four daughters and a sizeable plot of family ranch land. (17) The land encompassed 2,769 acres in Butte County, South Dakota, and 401 acres in Crook County, Wyoming. (18) The land had been in the Kirksey family for over 100 years and was inherited by Grace's four daughters: Lucille Ruby, Lorraine Kirksey, Dorothy Grohmann, and Eileen Randell. (19)

   In October of 2002, the sisters formed Kirksey Family Ranch, LLC with each sister taking a quarter interest. (20) The sole asset of the LLC was the Kirksey family land. (21) The sisters formed the LLC in order to (1) gain the benefit of a special use valuation for estate tax purposes, (2) ensure that the land remained within the Kirksey family, and (3) keep ownership of the property with the sisters, rather than their spouses. (22) The sisters chose to operate under a manager-managed scheme and selected Grohmann, the eldest sister, to serve as the company's manager. (23)

   After forming the LLC, Grohmann, Randell, and Kirksey leased land from the LLC for purposes of grazing livestock. (24) The lease specified a term of five years to be automatically renewed, yet lacked a provision for updating the rent charged under the lease. (25) Additionally, the lease provided that the LLC, as landlord, was to pay all real estate taxes and insurance. (26)

   Soon after the LLC was formed, relationships among the sisters began to deteriorate. (27) Kirksey, who resided in California, stated that Grohmann and Randell failed or refused to share information with her. (28) Grohmann claimed that she always provided Kirksey with necessary information. (29) Because of the fraying relationships, Kirksey sold Grohmann and Randell her livestock and withdrew from the lease in 2003. (30)

   Turmoil among the sisters continued to play out when Ruby made a motion to terminate the lease agreement at a company meeting in May 2006. (31) The operating agreement, however, required a majority vote in order to terminate the lease. (32) Although Kirksey supported the motion, it failed when Grohmann and Randell opposed. (33) Ruby, supported by Kirksey, then moved to dissolve the LLC. (34) Grohmann and Randell likewise opposed the motion to dissolve. (35) Because the LLC's operating agreement required that major actions receive majority approval, the parties were deadlocked. (36)

   With no meaningful way to move the company forward, Kirksey and Ruby filed a petition in circuit court asking for judicial dissolution under S.D.C.L. section 47-34A-801. (37) In moving for dissolution, the sisters argued that the economic purpose of the LLC was unreasonably frustrated and that it was no longer "reasonably practicable to carry on the company's business in conformity with the articles of organization and the operating agreement." (38) Both parties moved for summary judgment. (39) The circuit court denied dissolution, granting summary judgment for the leasing sisters, Grohmann and Randell. (40)

   Kirksey and Ruby appealed to the South Dakota Supreme Court. (41) In an opinion written by Justice Konenkamp, the court reversed the circuit court's decision and remanded "for an order of judicial dissolution and winding up of the company's business[.]" (42) The court held that "the economic purpose of the Kirksey Family Ranch, LLC ... [was] unreasonably frustrated and it ... [was] not reasonably practicable to carry on the LLC's business in conformity with its articles of organization and operating agreement." (43) Justice Meierhenry wrote a concurrence agreeing that judicial dissolution was appropriate because "[n]either the legislation nor the LLC agreement provided a procedure or remedy in the event of a deadlock." (44) Thus, absent such provisions, the LLC was at a "stalemate" and judicial dissolution was appropriate. (45)

3. BACKGROUND

   "So many business organizations, so little time." (46) When starting a business, the sheer number of entity forms can be daunting. (47) Primary considerations in selecting a desired method of organization often include an owner's desired level of control, avoidance of personal liability, securing optimal tax treatment, and the right to exit and quickly liquidate one's investment. (40)

   The LLC, a hybrid entity, is an attractive form of operation because it combines the limited liability of a corporation with the favorable tax treatment of a partnership. (49) Further, the LLC offers flexibility in allowing its "members" (50) to tailor the operation to fit the specified business and management needs of the LLC. (51)

   1. ORIGIN, DEVELOPMENT, AND GROWTH OF THE LLC

      LLC legislation made its first domestic appearance before the Alaska State Legislature in 1975. (52) The Hamilton Brothers Oil Company spearheaded this effort because of their desire for an entity with both limited liability and partnership taxation. (53) After two failed attempts, however, the bill was rejected for political reasons apparently unrelated to the proposed LLC legislation. (54) Though the attempts in Alaska proved unsuccessful, the Hamilton Brothers Oil Company continued its quest to establish the legal legitimacy of the LLC form in the United States. (55)

      Just two years later, the Wyoming legislature took up the cause and became the first state to enact legislation recognizing the LLC form on March 4, 1977. (56) Although the Wyoming legislation was a significant victory for those championing the utilization of LLCs in the United States, looming uncertainty of LLC tax treatment by the Internal Revenue Service ("IRS") halted LLC legislative growth. (57) Over the next five years, Florida was the only state to follow Wyoming's lead when it enacted its own LLC legislation in 1982. (58) It soon became clear that the LLC would not expand nationally until LLC taxation became more settled. (59)

      LLC tax guidance finally emerged in 1988 when the IRS set forth criteria allowing the LLC to be taxed as a partnership upon the satisfaction of certain criteria. (60) Those criteria, as outlined by the IRS in Revenue Ruling 88-76, (61) required application of the corporate characteristics. (62) The corporate characteristics derive from the United States Supreme Court's decision in United States v. Kintner. (63) There, the Court outlined the corporate characteristics, which include: (1) continuity of life, (2) centralized management, (3) limited liability, and (4) transferability of interest. (64) Under the Kintner test, a business faced corporate taxation if it possessed more than two of the corporate Kintner characteristics. (65) Eventually, however, the Kintner regulations...