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Do Equities Militate Against Restrictions Barring Petition for Dissolution?

July 1, 2015
Albert H. Manwaring, IV
Delaware Business Court Insider

Delaware courts often emphasize the freedom of contract of parties to define their rights, powers, duties, obligations, liabilities and restrictions in a limited liability or operating agreement under the Delaware Limited Liability Company Act (LLC Act). Pursuant to Section 18-802 of the LLC Act, a member or manager may file an application, seeking the Court of Chancery to "decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with a limited liability agreement." Since judicial dissolution under Section 18-802 of the LLC Act is not a mandatory provision of the LLC Act, the right to file for judicial dissolution may be modified, restricted, or waived in an operating agreement, as in R&R Capital LLC v. Buck & Doe Run Valley Farms LLC, 2008 Del. Ch. LEXIS 115 (Del. Ch. Aug. 19, 2008). In an action for judicial dissolution, the Court of Chancery recently had the opportunity to address whether parties had prohibited or restricted in their operating agreement the right of a managing member to file a petition for judicial dissolution under Section 18-802 of the LLC Act.

In Meyer Natural Foods LLC v. DuffC.A. No. 9703-VCN (Del. Ch. June 4, 2015) (Noble, V.C.), the Chancery Court dissolved Premium Natural Beef LLC (PNB) under Section 18-802 of the LLC Act on the grounds that it was no longer reasonably practicable to operate PNB in conformity with its purpose. While concluding that PNB's operating agreement permitted its managing member to file a petition for judicial dissolution in the first instance, the court noted that the equities or an inequitable result also counseled against a strict interpretation that the operating agreement restricted the filing of a petition for judicial dissolution.

Background

PNB's managing member, which owned 51 percent of the capital interests of PNB, filed a petition seeking PNB's judicial dissolution under Section 18-802 of the LLC Act. PNB's operating agreement provided, however, that absent the written consent of a majority in interest of the other members, the managing member "shall have no authority ... to cause [PNB] to undertake or engage in ... the dissolution of [PNB]." The operating agreement later provided that dissolution was nevertheless mandatory upon "entry of a decree of judicial dissolution" or "the determination of the managing member and majority in interest of the other members."

The purpose clause in PNB's operating agreement provided that PNB's purpose was to market, distribute and sell natural beef. As a condition to the operating agreement, the respondent members of PNB entered into an exclusive supply and purchase agreement with the petitioner to provide cattle to PNB. In a contemporaneous purchase agreement between the parties, respondent members were prohibited from owning or operating a competing business to PNB, but these noncompetition covenants ended upon termination of the exclusive supply and purchase agreement. The Oklahoma state court ordered the termination of the supply and purchase agreement as of March 31, 2013.

Judicial Dissolution

The Chancery Court ordered the dissolution of PNB because it was no longer reasonably practicable to operate PNB in conformity with its purpose. First, since the petitioner managing member held 51 percent of PNB, operational voting deadlock, which would impair action on behalf of PNB, was not at issue. Instead, the parties' dispute was over purpose. The court noted that while the purpose clause in the operating agreement was of primary importance in its determination of whether it is reasonably practical to carry on the business in conformity with that purpose, other evidence of purpose may also be helpful provided that "the court is not asked to engage in speculation." The court went on to find that PNB cannot achieve its purpose to market and sell beef supplied by the respondents when their exclusive supply and purchase agreement with the petitioner to provide cattle to PNB was terminated, the respondents no longer provide cattle to PNB, and as a result, the respondents believe that they are no longer barred from competing with PNB under a contemporaneous purchase agreement. But, on the other hand, the petitioner was still required to exclusively manage a business for the sale of beef under the operating agreement, which business was no longer practical to continue without a supply of beef and competition from its own members.

The court then turned to the issue of whether PNB's operating agreement prohibited its managing member from filing a petition for judicial dissolution. Absent written consent of a majority in interest of the other members, the managing member was not permitted to "undertake or engage in ... the dissolution of [PNB]" under the operating agreement. The majority in interest of the other members did not consent to PNB's dissolution. But, the operating agreement later provided that dissolution was mandatory upon "entry of a decree of judicial dissolution." The court found that while the operating agreement prohibited the managing member from causing PNB to take steps to dissolve, the managing member was not barred from filing a petition for judicial dissolution in the first instance. Importantly, to bolster its interpretation that the operating agreement did not restrict the filing of a petition for judicial dissolution, the court recognized that "some authority counsel[ed] against strict interpretation of an LLC agreement where the result would be inequitable." The court then found that the equities weighed in favor of dissolution because issues about ownership and management misconduct could wait for resolution during the wind-up period, the respondents could purchase PNB's assets in a liquidation sale, and dissolution did not affect the respondents' ability to collect damages from the petitioner in the Oklahoma state court action. Accordingly, the court concluded that "the equities, in combination with the foundational requirement of impracticability of continuing its business, weigh[ed] in favor of dissolving PNB."

Decision Impact

Since judicial dissolution under Section 18-802 of the LLC Act is not a mandatory provision of the LLC Act, the right to file for judicial dissolution may be restricted in an operating agreement. But this decision demonstrates that the equities or an inequitable result may counsel against a strict interpretation of any restriction on the right to file an application for judicial dissolution under 6 Del. C. Section 18-802.

Delaware Business Court Insider  |  July 1, 2015