SHOULD OPERATING AGREEMENTS YOU DRAFT FOR MULTI-MEMBER LLCs REQUIRE THE MEMBERS TO WAIVE THEIR RIGHT TO APPLY
FOR JUDICIAL DISSOLUTIONS OF THEIR LLCs?

By John M. Cunningham

Many U.S. LLC acts contain provisions authorizing courts, upon application by members, to dissolve LLCs because their continuation will be “impracticable.” A typical example of such a provision is Section 134 of the New Hampshire LLC Act, entitled “Judicial Dissolution Upon Application by a Member.” This section provides as follows (in italics):

I. Unless the operating agreement provides otherwise, upon application by a member, the superior court may decree the dissolution of a limited liability company in any of the following circumstances:

(a) It is not reasonably practicable for the limited liability company to carry on its business.

(b) A voting deadlock has occurred among the members and, upon the occurrence of the deadlock, the members have been unable to break the deadlock; and because of the deadlock, either irreparable injury to the limited liability company is threatened or being suffered or the limited liability company’s business and internal affairs can no longer be conducted to its advantage.

II. In a proceeding brought under paragraph I, a court may order a remedy other than dissolution.

The phrase “reasonably practicable”in the above provision is obviously very broad, and the courts have applied judicial waiver provisions to address not only member deadlocks but also a wide range of other situations, including serious negative changes in an LLC’s commercial situation and serious member and management misconduct.

The problem with judicial dissolutions of multi-member LLCs is, obviously, that these dissolutions will generally result in the liquidation of the LLC and thus very possibly in the termination of its business and any going-concern value it may have.

In addition, the very process of litigating a member’s application for a judicial dissolution of the LLC may itself be highly disruptive of both the business of the LLC and the relationship among its members and managers,it may result in major legal fees and other litigation-related expenses, and, during and after the litigation, it may damage the business reputation of the members.

In other words, dissolution for impracticability is a powerful remedy that can be easily abused by both majority and minority LLC members.

Nevertheless, whenever you are planning or drafting an operating agreement for a multi-member LLC, you should consider including in it a waiver by the members ofany right they may have to apply for a judicial dissolution of their LLC, unless, of course,these applications are unavailable under the governing LLC actorcase law.

In this connection, it should be noted that a recent decision of the Delaware Court of Chancery entitled Huatuco v. Satellite Healthcare, 2013 WL 6460898 (Del. Ch. Dec. 9, 2013),contains an express and sweeping authorization for these waivers on the basis of LLC freedom of contract. However, at this writing, the Huatuco decision is being appealed to the Delaware Supreme Court.

Whether you should seek to include the above waiver in an operating agreement may, of course, vary greatly depending on the situation of your client. Here, however, are a few broad guidelines on how to address this issue:

  • At least 55 percent of all LLCs are single-member LLCs. About 35 percent are two-member LLCs. Only about 10 percent or less have three or more members. For single-member LLCs, the issue of whether the operating agreement should permit applications for judicial dissolution is obviously irrelevant. As for two-member LLCs: A substantial majority of these LLCs are 50/50 partnerships in which each member has equal economic and voting rights. Because of the costs and disruptions outlined above, neither member of most 50/50 LLCs will ordinarily want the other to have the right to apply for judicial dissolution.
  • As for unequal two-member LLCs, it is probable that the majority members of these LLCs will generally want the operating agreement to prohibit applications for judicial dissolutions, while the minority members will normally oppose this prohibition. (If the majority members want to dissolve the LLC, most LLC acts will permit them to do so by simple majority vote without any need for application to a court.)
  • As for LLCs with three or more members, my guess is for the same reasons as stated above, majority members will want to bar the above applications and minority members will want to permit them.
  • However, if the operating agreement does barmembers from applying for judicial dissolutions, the members of any multi-member LLC, regardless of the number of its members, should make sure that the agreement contains an alternative remedy if there is a deadlock among the members or if one or more of the members believe there are other compelling reasons to dissolve the LLC. In the case of two-member LLCs, a Texas shoot-out provision or an arbitration provision may make sense. In the case of other kinds of multi-member LLCs, arbitration alone may make sense.

Here are a few additional provisions that, alone or in combination, can be used in LLC operating agreements to address judicial dissolution issues:

  • Members may apply for judicial dissolution, but only in arbitration.
  • Members may apply for judicial dissolutions, but only if a specified voting requirement is met. This may mean requiring, for example, a vote by a majority of the non-applying members, a vote by a supermajority of non-applying members, or a vote by a specified minority of non-applying members, such as one-third of these members.
  • Members may apply for judicial dissolution, but if the court denies the application, the applicant must pay the legal fees of the LLC and the non-applying members.

But here’s the take-away: Whether or not you include in an operating agreement a bar on applications for judicial dissolution, make sure you give the issue careful thought.

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