Reserving for a Delaware Llc

• Publication year: 2018
• Author: Phil Jelsma

Reserving For a Delaware LLC

Phil Jelsma

Phil Jelsma is a tax partner at the San Diego law firm of Crosbie Gliner Schiffman Southard & Swanson LLP (CGS3). He specializes in real estate taxation, closely held businesses, investment, tax and nonprofit organizations. He was formerly a tax partner with Luce Forward Hamilton & Scripps LLP and McKenna Long & Aldridge LLP. He is an Adjunct Professor at the University of San Diego Law School and is a graduate of Stanford Law School. He is the Executive Editor of the CEB Publication "Understanding Fiduciary Duties in Business Entities."

For the last eighteen years, I have been told numerous times that Delaware LLCs are superior to California LLCs. On many occasions, lawyers, generally in firms much larger than my own, have explained to me that my proclivity for using California LLCs is parochial and antiquated. They point to certain actual and perceived advantages in using Delaware LLCs, such as faster formation, a flat franchise tax of $300 as opposed to California's gross receipts fee, no bi-annual statements of information, greater flexibility, and a superior judiciary. Being a transactional lawyer in a real estate firm, well aware of California's ten-year statute of limitations on construction defect claims,¹ I have pointed out to them the language in Delaware's LLC Act section 18-804, which requires that a dissolving LLC make provision for claims that are likely to arise or become known to the LLC within ten years after the date of dissolution. Wouldn't a dissolving LLC in real estate development need to reserve for potential construction defects claims? They generally respond that that the section 18-804 language does not mean anything and therefore is unimportant.

The recent case of Capone v. LDH Management Holdings, LLC,² which was decided by Vice Chancellor Glassock, suggests that those words in fact do mean something. Defendant LDH Management Holdings ("Management Holdings") held a 15% profits interest in Louis Dreyfus Highbridge Energy LLC ("LDH"). Another defendant, LD HMH MM LLC, was the managing member. It was also a wholly owned subsidiary of LDH. These equity interests gave two plaintiffs, former employees of LDH, an indirect profits interest in LDH of 1.5% and .7%, respectively.³ Under the Management Holdings Limited Liability Company ("LLC") Agreement, it had the right to redeem the units of any LDH employee who was terminated without cause. The call right was exercised at the fair market value of the units as of the last day of the last fiscal year preceding the fiscal year in which the call notice was given. Management Holdings redeemed the plaintiffs' units as of April 12, 2011, so the relevant date for determining value of the units was December 31, 2010.

The Management Holdings LLC Agreement provided the following definition of fair market value:

"Fair Market Value" shall mean, with respect to a Unit of a particular Series, the amount that would be distributed as of any relevant date if (x) all of the assets of LDH and its subsidiaries had been sold at their Gross Asset Value (adjusted immediately prior to such deemed sale by the [Management Holdings] Board in good faith and in consultation with the LDH Board), (y) the proceeds of such sale (after payment of any liabilities of LDH subsidiaries other than liabilities of LDH and its subsidiaries associated with the Plan Income or Expense) had been distributed to the members of LDH (including the Company) upon liquidation of LDH in accordance with the LDH Agreement (assuming for this purpose that all Units are Vested Units) and (z) the amount of such distribution of the Company had been distributed the Members in accordance with the Section 8.3.

The LLC Agreement also stated that:

[t]he Gross Asset Value of all Company assets shall be adjusted to equal their respective gross fair market value as determined by the Managing Member, immediately prior to the following times: . . . (ii) the

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