C.A. No. 3017-CC (Del. Ch. January 13, 2009)
The Petitioner, Fisk Ventures, LLC (“Fisk”), filed a lawsuit seeking dissolution of Genitrix, LLC (“Genitrix” or the “Company”) under Section 18-802 of the Delaware Limited Liability Company Act, 6 Del. C. §§ 18-101, et seq. (the “LLC Act”), and moved for judgment on the pleadings. The Company’s LLC Agreement (the “LLC Agreement”) provided that the Company “shall be dissolved and its affairs wound up only on the first to occur of the following: (a) the written consent of Members holding at least 75% of the Membership Interests, voting as provided in § 3.5; and (b) the entity of a decree of judicial dissolution of the Company under Section 18-802 of the Act.” The Court observed that “[s]ince the managing members are hopelessly deadlocked to the extent that 75% of the membership interest will not be voted in favor of dissolution, the only other opportunity for members seeking dissolution would be through a decree of judicial dissolution….”
Under Section 18-802 of the LLC Act, a court may dissolve an LLC “whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.” The Court, by analogizing to the corresponding provision under the Delaware Revised Uniform Limited Partnership Act and cases interpreting such provision, found that the test “is whether it is ‘reasonably practicable’ to carry on the business . . . not whether it is impossible.” The Court also noted that Section 18-802 does not lay out a specific test for finding what is “reasonably practicable,” but that there were several factual circumstances that have been commonly discussed in case law: “(1) the members’ vote is deadlocked at the Board level; (2) the operating agreement gives no means of navigating around the deadlock; and (3) due to the financial condition of the company, there is effectively no business to operate.” The Court stated that these circumstances are “not individually dispositive; nor must they exist for a court to find it no longer reasonably practicable for a business to continue operating.” In this case, however, the Court found that all three factual circumstances had been met.
With respect to the deadlock, the Court noted that there was no “tie-breaking” clause in the LLC Agreement and that the Genitrix had been deadlocked for almost five years over the most basic issues concerning the Company and that there was no provision in the LLC Agreement that would enable the board to fix the deadlock. The Court also noted that the LLC Agreement was negotiated by “sophisticated parties engaged at arm’s length negotiation” and that the voting section of the agreement was carefully drafted to prevent domination by one party and, in turn, also created the potential likelihood of a deadlock without a remedy. Lastly, the Court determined that Genitrix was in a “dire financial condition,” finding that the Company “ha[d] no office, no capital funds, no grant funds and generate[d] no revenue,” and therefore, it was not reasonably practicable to carry on the business.
In opposition to the judicial dissolution, the Respondent, Andrew Segal (“Segal”), argued that, because Fisk had a “Put Right” under the LLC Agreement, which would require the Company to buy its shares at their fair market value, Fisk had an “exit mechanism” and an alternative to judicial dissolution. The Court disagreed and found that a Put Right “grants its owner an option, to be freely exercised at the will and pleasure of its holder.” The Court stated that it was likely that Fisk was not exercising the Put Right because it was not in its best interest. Because the Agreement did not mention any condition where Fisk was required to exercise the Put Right, the Court would not force Fisk to exercise it when it was not in its best interest. The Court stated that this would be “second guess[ing] a party’s business decision” and the Court was not permitted to do so.
Segal also argued that the dissolution should be denied because it would destroy any value the Company had in certain patent rights it had licensed relating to the Company’s core technology. This argument was premised on the fact that the license agreement was not assignable except “in connection with the sale or transfer of all or substantially all of Genitrix’s equity and assets,” and, according to Segal, a future purchaser would not be “free to operate without a license from [the licensor].” The Court found this argument unconvincing and stated that a purchaser could enter into a separate licensing agreement with the licensor to use its patent or the original license agreement could be renegotiated. Most importantly, the Court reiterated that this deal involved sophisticated parties who knowingly crafted and entered into the LLC Agreement with the likely fate of a deadlock.
Therefore, the Court granted the petitioner’s motion for judgment on the pleadings and ordered the dissolution of Genitrix.
Finally, it is worth noting that Chancellor Chandler repeatedly highlighted that the event of judicial dissolution was “in accordance with the LLC Agreement” even though the right to seek judicial dissolution arose from Section 18-802 of the LLC Act. For this reason, it may be prudent to always include in an LLC Agreement a provision stating that the LLC will terminate in the event of an order of dissolution. This inclusion would ensure an event of judicial dissolution would never be open to question.
The full opinion is available here.