In re Carlisle Etcetera LLC ( 2015 )

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
IN RE CARLISLE ETCETERA LLC, )
a Delaware limited liability company. ) C.A. No. 10280-VCL
OPINION
Date Submitted: March 9, 2015
Date Decided: April 30, 2015
Kurt M. Heyman, Aaron M. Nelson, PROCTOR HEYMAN ENERIO LLP, Wilmington,
Delaware; Attorneys for Well Union U.S. Holdings, Inc. and Well Union Capital Limited.
David J. Margules, Sean J. Bellew, Erika Caesar, BALLARD SPAHR LLP, Wilmington,
Delaware; Thomas M. Wood, IV, NEUBERGER, QUINN, GIELEN, RUBIN &
GIBBER, P.A., Baltimore, MD; Attorneys for Tom James Company.
LASTER, Vice Chancellor.
In 2012, petitioner Well Union Capital Limited (―WU Parent‖) and respondent
Tom James Company (―James‖) formed Carlisle Etcetera LLC, a Delaware limited
liability company (―Carlisle‖ or the ―Company‖). They executed a simple form of
operating agreement (the ―Initial LLC Agreement‖) in which they committed to work
promptly on a more detailed operating agreement to replace the original one.
After the Company was formed, WU Parent transferred its member interest to a
wholly owned subsidiary called Well Union U.S. Holdings, Inc. (―WU Sub‖). James
knew about the transfer, did not object, and treated WU Sub as a member from that point
on. For purposes of the Delaware Limited Liability Company Act (the ―LLC Act‖),
however, the transfer rendered WU Sub an assignee, rather than a member.
WU Parent and James never reached agreement on a replacement operating
agreement. Other disputes arose, and the relationship deteriorated. Deadlock prevailed at
the manager level, where the Initial LLC Agreement called for a board of directors (the
―Board‖) to serve as the singular manager of the Company. The Board has four members,
two appointed by WU Parent and two by James. They split 2-2 on key issues.
Both sides eventually recognized that they could not manage the Company jointly
and that one side needed to buy out the other. Despite some initially positive signs, they
could not agree on a buyout procedure or a price.
During the venture‘s halcyon days, the Board appointed a James executive as the
Company‘s CEO. Through the CEO, James controls the Company‘s day-to-day
operations. With the Board deadlocked, the CEO has been operating free of any
oversight. Given its advantaged position, James does not see the deadlock as a problem
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and feels no urgency to alleviate it. During negotiations over the buyout, James sought to
use its privileged position to extract concessions from WU Sub.
WU Sub turned to this court for assistance. It filed this action, in which it
petitioned to dissolve the Company. James moved to dismiss on the grounds that WU
Sub is an assignee, not a member, and that an assignee lacks standing to petition for
statutory dissolution under Section 18-802 of the LLC Act. 6 Del. C. § 18-802. In an
amended petition, WU Parent joined as a co-petitioner.
This decision holds that WU Parent and WU Sub lack standing to petition for
statutory dissolution under Section 18-802. The motion is denied, however, because WU
Sub has standing to seek dissolution in equity.
I. FACTUAL BACKGROUND
The facts for purposes of the motion to dismiss are drawn from the allegations of
the verified amended petition for dissolution, which is the currently operative pleading, as
well as from the documents that it incorporates by reference. In the current procedural
posture, the well-pled allegations of the petition are assumed to be true, and the
petitioners receive the benefit of all reasonable inferences.
A. The Formation Of The Company
James describes itself as the world‘s largest manufacturer and retailer of custom
clothing that uses a business model in which tailors come directly to customers‘ homes or
offices. The Connaught Group, Ltd. (―Connaught‖) used a similar business model to sell
women‘s clothing, but it filed for bankruptcy in 2012. Before the filing, James tried
unsuccessfully to purchase Connaught to expand its own direct-sales operation.
2
The Royal Spirit Group (―Royal Spirit‖) is a premium apparel supplier
headquartered in Hong Kong that serves luxury fashion brands and upscale retailers.
Connaught was one of its customers, and Royal Spirit ranked as Connaught‘s largest
trade creditor in bankruptcy. Royal Spirit attempted unsuccessfully to buy Connaught‘s
assets from the estate to carry on its business.
Having failed in their separate acquisition bids, James and Royal Spirit decided to
team up. They created the Company to ―acquire . . . [Connaught‘s assets] . . . and
operat[e] the Business.‖ Initial LLC Agreement ¶ 2.3(a). Royal Spirit formed WU Parent,
a Hong Kong entity, as the vehicle through which it would participate in the joint
venture. The Initial LLC Agreement recited that WU Parent and James each contributed
$10 million in capital to the Company in return for a 50% member interest. The purchase
price for Connaught‘s assets turned out to be $22.2 million, comprising $20 million in
cash plus forgiveness of certain claims by Royal Spirit against the bankruptcy estate. WU
Parent and James actually contributed $11.1 million each.
The Initial LLC Agreement established a manager-managed LLC in which the
Board served as the sole manager of the Company. The Initial LLC Agreement assigned
to the Board the ―exclusive responsibility and authority for the conduct of the Company‘s
business, except to the extent that certain matters may be expressly reserved by law or
this Agreement to the Members.‖ Id. ¶ 4.1(c). It further specified that the Board
possessed ―overall authority and responsibility for the conduct of the business and affairs
of the Company,‖ including ―without limitation, all matters that may be granted or
delegated to a ‗manager‘ or to a member under the Act.‖ Id. ¶ 4.1(a).
3
The Initial LLC Agreement created a Board with four members. WU Parent and
James each received the right to appoint two members. Id. ¶ 4.1(b). All Board decisions
require ―unanimous approval.‖ Id. ¶ 4.1(d).
WU Parent appointed Thomas Hebestreit and Sze Sum Chu as its designees. Id. ¶
4.1(b). James appointed Sergio Casalena and James Brubaker as its designees. Id.
Casalena is currently CEO of James; Brubaker was the CFO of James. The Initial LLC
Agreement designated Brubaker as CEO of the Company. Id. ¶ 4.2(b).
B. WU Parent Transfers Its Interest To WU Sub.
In early 2012, Royal Spirit analyzed whether, for tax purposes, it should hold its
member interest in the Company through a United States-domiciled entity. After
exploring the issue internally, Royal Spirit communicated with James about its plan to
hold its interest in the Company through a wholly owned subsidiary. Among other
communications, James received an email from a Royal Spirit employee dated May 10,
2012, that attached a memorandum analyzing the relevant tax issues. The memorandum
contemplated WU Parent forming a wholly owned subsidiary that would act as a
―blocker‖ entity for tax purposes. In response, the Company‘s CEO, Brubaker, informed
Royal Spirit that he had read the memorandum and knew that the ―US blocker
corporation‖—WU Sub—was ―already established.‖ From that point on, the Company
identified WU Sub as the holder of a 50% member interest in its tax filings. The
Company‘s accountants identified WU Sub as ―an equal member of the Company.‖
During this period, the parties worked on a more detailed LLC agreement (the
―Proposed LLC Agreement‖). The draft notably referred to WU Sub, not WU Parent, as a
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member of the Company. The draft contemplated that if an initial member transferred its
membership interest to a wholly owned affiliate, then the affiliate would be admitted
automatically as a member. The parties did not finalize the Proposed LLC Agreement
because their relationship seemed amicable, and business matters took precedence.
C. The Relationship Sours.
Disputes initially arose over additional tax planning measures that Royal Spirit
advocated. Among other ideas, Royal Spirit suggested transferring the Company‘s
intellectual property to an offshore entity. James agreed at first, then reconsidered.
By 2013, Royal Spirit became concerned that the Company was not performing as
anticipated. Royal Spirit proposed hiring a creative director. James disagreed.
In early 2014, Royal Spirit sought to call a Board meeting to consider removing
Brubaker as CEO. In a lengthy response, Casalena took the position that neither side had
the votes to call a meeting unilaterally. He expressed James‘ firm opposition to removing
Brubaker, hiring a creative director, and transferring the Company‘s intellectual property
to an offshore entity. Casalena asked that Hebestreit and other Royal Spirit
representatives stop contacting Brubaker outside of quarterly Board meetings.
Casalena followed up with a letter dated February 10, 2014. His letter made clear
that James no longer wished to continue with the parties‘ joint venture:
[W]e have also concluded that we do not want to continue in business with
you. Your approach to giving advice is unhelpful and often offensive . . . .
[T]here is a proper way to discuss differences of opinion and we are not
seeing this from you.
It seems to be a waste of your time and our time to continue to try to
persuade each other of our respective points of view regarding the
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management of the company. If we continue in this way, our mutual
investment will be damaged.
Therefore we think that the only sensible course is for one or the other of us
to own the company and run it as they see fit.
At December 31, 2013, the book value of Carlisle Etcetera is $23,024,741.
Tom James is willing to sell its 50% share to Royal Spirit for its half of the
book value, $11,512,371, paid in cash within thirty days. If Royal Spirit is
unwilling to buy out Tom James‘ share, Tom James is willing to buy out
Royal Spirit‘s share at the same price under the same terms.
In an e-mail exchange on May 14, a Royal Spirit representative proposed a more nuanced
buyout process, which Brubaker approved.
By May 28, 2014, the parties were drafting an interest purchase agreement to use
in connection with a buyout. That document referred to WU Sub as a member of the
Company, not WU Parent.
By letter dated July 2, 2014, Royal Spirit informed James that it wished to
purchase James‘ interest in the Company. Discussions quickly stalled. During the
negotiations, James told Royal Spirit pointedly that if a deal could not be worked out,
Royal Spirit was stuck because James could perpetuate the deadlock and continue
operating the Company as it wished.
D. This Litigation
On October 24, 2014, WU Sub filed a petition seeking judicial dissolution of the
Company because of deadlock at the member and manager levels. The petition named the
Company and James as respondents. On November 7, James moved to dismiss on the
ground that WU Sub lacked standing to seek a judicial dissolution under Section 18-802
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of the LLC Act. WU Sub filed an amended petition on November 13 that added WU
Parent as a co-petitioner. James renewed its motion to dismiss.
II. LEGAL ANALYSIS
James has moved to dismiss the petition pursuant to Rule 12(b)(6) for failure to
state a claim on which relief can be granted. In a Delaware state court, the pleading
standards under Rule 12(b)(6) ―are minimal.‖ Cent. Mortg. Co. v. Morgan Stanley Mortg.
Capital Hldgs. LLC, 27 A.3d 531, 536 (Del. 2011).
When considering a defendant‘s motion to dismiss, a trial court should
accept all well-pleaded factual allegations in the Complaint as true, accept
even vague allegations in the Complaint as ―well-pleaded‖ if they provide
the defendant notice of the claim, draw all reasonable inferences in favor of
the plaintiff, and deny the motion unless the plaintiff could not recover
under any reasonably conceivable set of circumstances susceptible of proof.
Id. The operative test in a Delaware state court thus is one of ―reasonable conceivability.‖
Id. This standard asks whether there is a ―possibility‖ of recovery. Id. at 537 n.13. The
test is more lenient than the federal ―plausibility‖ pleading standard. Id. at 537.
James contends that WU Parent and WU Sub lack standing to seek dissolution
because (i) Section 18-802 of the LLC Act only permits members and managers to seek
dissolution, (ii) neither WU Parent nor WU Sub is a member or manager, and (iii)
Section 18-802 is the exclusive extra-contractual method of dissolving an LLC. In my
view, James is right on the first two points but wrong on the third.
A. Statutory Standing To Seek Dissolution Under Section 18-802
Section 18-802 of the LLC Act addresses dissolution. It states that ―[o]n
application by or for a member or manager the Court of Chancery may decree dissolution
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of a limited liability company whenever it is not reasonably practicable to carry on the
business in conformity with a limited liability company agreement.‖ 6 Del. C. § 18-802.
By its terms, this language limits the right to seek statutory dissolution under Section 18-
802 to members and managers of an LLC. As to this issue, James is correct.
B. WU Parent And WU Sub’s Status As Members Or Managers
To petition for statutory dissolution under Section 18-802, WU Parent and WU
Sub must be members or managers of the Company. Neither claims to be a manager. The
Initial LLC Agreement makes clear that the Board, acting collectively, is the manager of
the Company. WU Parent and WU Sub do claim to be members.
Taking the allegations of the petition as true, WU Parent cannot be a member. WU
Parent was a member of the Company, but it assigned its interest to WU Sub. Under
Section 18-702(a) of the LLC Act, ―[a] limited liability company interest is assignable in
whole or in part except as provided in a limited liability company agreement.‖ Id. § 18-
702(a). The Initial LLC Agreement was silent about assignability, so the interest was
freely assignable.
WU Parent lost its status as a member of the Company when it assigned all of its
interest in the Company to WU Sub. Under Section 702(b)(3) of the LLC Act, ―[u]nless
otherwise provided in a limited liability company agreement: . . . (3) [a] member ceases
to be a member and to have the power to exercise any rights or powers of a member upon
assignment of all of the member‘s limited liability company interest.‖ Id. § 18-702(b)(3).
By operation of law, once WU Parent assigned its interest in the Company to WU Sub,
WU Parent ―cease[d] to be a member‖ and could no longer exercise a member‘s right to
8
seek statutory dissolution. See Eureka VIII LLC v. Niagara Falls Hldgs. LLC, 899 A.2d
95, 114 (Del. Ch. 2006) (Strine, V.C.) (noting that an assignment ―typically results in the
statutory divestiture of a membership interest‖). Under the facts as pled, WU Parent
cannot petition for statutory dissolution.
The analysis for WU Sub is more complex. As an initial matter, James is correct
that WU Sub did not automatically become a member by receiving WU Parent‘s interest.
Under Section 18-702(b)(1) of the LLC Act, ―[u]nless otherwise provided in a limited
liability company agreement: . . . (1) [a]n assignment of a limited liability company
interest does not entitle the assignee to become . . . a member.‖ 6 Del. C. § 18-702(b)(1).
The Initial LLC Agreement did not provide otherwise, so under the facts as pled, the
transfer of WU Parent‘s interest made WU Sub an assignee, not a member.
By default under the LLC Act, only a member can petition for statutory
dissolution, not an assignee. Section 18-702(b)(1) reinforces this reading by stating that
―[u]nless otherwise provided in a limited liability company agreement: . . . (1) [a]n
assignment of a limited liability company interest does not entitle the assignee . . . to
exercise any rights or powers of a member.‖ Id. § 18-702(b)(1). Section 18-702(a)
similarly provides that
the assignee of a member‘s limited liability company interest shall have no
right to participate in the management of the business and affairs of a
limited liability company except as provided in a limited liability company
agreement or, unless otherwise provided in the limited liability company
agreement, upon the affirmative vote or written consent of all of the
members of the limited liability company.
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Id. § 18-702(a). The Initial LLC Agreement did not give assignees the right to seek
statutory dissolution. Without more, therefore, WU Sub cannot claim to be a member or
exercise the rights of a member, so WU Sub cannot seek statutory dissolution.
But there is more. The petition alleges that WU Sub became a de facto member by
consent of the parties. Citing Section 18-301(b)(1) of the LLC Act, WU Sub argues that it
became a member under the LLC Act once its status as a member was ―reflected in the
records of the limited liability company.‖ Id. § 18-301(b)(1). WU Sub further argues that
the tax forms and draft agreements that identified WU Sub as a member were ―records of
the [Company].‖ In my view, WU Sub jumps too hastily to this aspect of Section 18-301.
Several sections of the LLC Act bear on the admission of WU Sub as a member.
Section 18-101(11) states that the term ―‗[m]ember‘ means a person who is admitted to a
limited liability company as a member as provided in § 18-301 of this title.‖ Id. § 18-
101(11). Section 18-301, entitled ―Admission of members,‖ addresses a variety of
contexts in which persons may become members. Subsection 18-301(b) states:
After the formation of a limited liability company, a person is admitted as a
member of the limited liability company:
...
(2) In the case of an assignee of a limited liability company interest, as
provided in § 18-704(a) of this title and at the time provided in and upon
compliance with the limited liability company agreement or, if the limited
liability company agreement does not so provide, when any such person‘s
permitted admission is reflected in the records of the limited liability
company.
Id. § 18-301(b)(2).
10
Through this language, Section 18-301(b) distinguishes between (i) the act of
admitting an assignee as a member and (ii) the point when the admission becomes
effective. First, the assignee must be admitted ―as provided in § 18-704(a).‖ Once this has
happened, the admission takes effect ―at the time provided on and upon compliance with
the limited liability company agreement.‖ The subsection continues with an additional
clause that addresses the point when the admission becomes effective if the operating
agreement is silent, explaining that in that event, the admission becomes effective ―when
any such person‘s permitted admission is reflected in the records of the limited liability
company.‖ The phrase ―permitted admission‖ relates back to the first step of the
process—admission ―as provided in § 18-704(a)‖—which indicates that an assignee
cannot establish membership simply by pointing to ―records of the limited liability
company.‖ There must have been a ―permitted admission.‖
The statutory path finishes with Section 18-704(a), which identifies two
possibilities for a ―permitted admission.‖
An assignee of a limited liability company interest may become a member:
(1) As provided in the limited liability company agreement; or
(2) Unless otherwise provided in the limited liability company agreement,
upon the affirmative vote or written consent of all of the members of the
limited liability company.
6 Del. C. § 18-704(a).
The Initial LLC Agreement was silent on the admission of an assignee as a
member. Under Section 18-704(a), WU Sub‘s only route to a ―permitted admission‖ was
―upon the affirmative vote or written consent of all of the members of the limited liability
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company.‖ If that happened, then the ―permitted admission‖ would become effective
once WU Sub‘s admission was ―reflected in the records of the limited liability company.‖
In my view, the reference in Section 18-704(a) to an ―affirmative vote or written
consent‖ means the type of formal action of members contemplated by Section 18-302 of
the LLC Act, which addresses voting rights. Section 18-302(c) contemplates that action
by members will take place at meetings and explains that
[a] limited liability company agreement may set forth provisions relating to
notice of the time, place or purpose of any meeting at which any matter is
to be voted on by any members, waiver of any such notice, . . . quorum
requirements, voting in person or by proxy, or any other matter with respect
to the exercise of any such right to vote.
Id. § 18-302(c). Section 18-302(d) contemplates the alternative of members taking action
by written consent without a meeting.
Unless otherwise provided in a limited liability company agreement, on any
matter that is to be voted on, consented to or approved by members, the
members may take such action without a meeting, without prior notice and
without a vote if consented to, in writing or by electronic transmission, by
members having not less than the minimum number of votes that would be
necessary to authorize or take such action at a meeting at which all
members entitled to vote thereon were present and voted.
Id. § 18-302(d). The correspondence between these two methods of action and the
language of Section 18-704 leads me to conclude that the latter provision contemplates
member action taking one of those forms. The phrase ―affirmative vote or written
12
consent‖ appears rarely in the LLC Act, and other appearances involve similar occasions
for formal member action.1
The need for formal member action comports with the policies underlying this
aspect of the statutory regime. As Chief Justice Strine observed, writing as a Vice
Chancellor, ―[t]here are likely two motivations for the statutory default rules in §§ 18–
702, 18–704(a), and 18–301 concerning the assignment of a limited liability company
interest and the assignee‘s possible (and subsequent) admission as a member of the
LLC.‖ Achaian, Inc. v. Leemon Family LLC, 25 A.3d 800, 804 n.14 (Del. Ch. 2011). The
first was tax-related and is now outdated. The imposition of statutory limitations on the
free alienability of LLC member interests formed a critical part of early attempts ―to
create an entity that, as a matter of tax law, is classified as a partnership with each owner
treated as a partner, but whose owners are shielded by state law from automatic personal
liability,‖ an effort since rendered superfluous by the Treasury Department‘s adoption of
1
See, e.g., 6 Del. C. § 18-215 (contemplating termination of a series in a series
LLC ―upon the affirmative vote or written consent of the members of the limited liability
company associated with such series‖); id. § 18-801 (contemplating dissolution ―upon the
affirmative vote or written consent of the members of the limited liability company‖); id.
§ 18-806 (contemplating revocation of dissolution by ―affirmative vote or written
consent‖). Other sections of the LLC Act use the term ―written consent‖ to denote formal
company action having legal significance. See id. § 18-102(3) (permitting domestic
limited liability company to use name similar to that of another entity with permission of
other entity in the form of a ―written consent‖ filed with the Delaware Secretary of State);
id. § 18-304 (identifying circumstances in which a person ceases to be a member ―unless
otherwise provided in a limited liability company agreement, or with the written consent
of all members‖); id. § 18-904 (permitting foreign limited liability company to use name
similar to that of another entity with permission of other entity in the form of a ―written
consent‖ filed with the Delaware Secretary of State).
13
the ―check-the-box‖ tax classification regime. Daniel S. Kleinberger, Two Decades of
“Alternative Entities”: From Tax Rationalization Through Alphabet Soup To Contract As
Deity, 14 Fordham J. Corp. & Fin. L. 445, 447-54 (2009). When the LLC Act was
drafted, however, the tax implications were significant, so it is logical that the LLC Act
would require formal member action to admit an assignee.
―The second reason for the default rules in the [LLC] Act regarding the
transferability of [member] interests may rest on the notion that one generally is entitled
to select his own business associates in a closely held enterprise, like an LLC.‖ Achaian,
25 A.3d at 804 n.14. ―The policy that underlies § 18–702(b)(3) is that ‗it is far more
tolerable to have to suffer a new passive co-investor one did not choose than to endure a
new co-manager without consent.‘‖ Eureka VIII LLC, 899 A.2d at 115 (quoting Milford
Power Co., LLC v. PDC Milford Power, LLC, 866 A.2d 738, 760 (Del. Ch. 2004)). It
makes sense that the LLC Act would require formal member action to accept a new
business partner, rather than contemplating de facto membership or the constructive
admission of assignees.
In this case, the Company only had two members. Once WU Parent transferred its
member interest and WU Sub became an assignee, James was the sole remaining member
and controlled the vote on WU Sub‘s admission. The petition does not plead any formal
action by which James voted or acted by written consent to admit WU Sub as a member.
Assuming for purposes of analysis that the tax forms and draft agreements were
―records‖ of the LLC for purposes of Section 301(b)(1), there was never a ―permitted
admission‖ that could be reflected on those records.
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Based on the allegations of the petition, James is correct that WU Sub is not a
member who can seek statutory dissolution. Neither petitioner can.
C. Equitable Standing To Seek Dissolution
James argues that because neither WU Parent nor WU Sub can seek statutory
dissolution under Section 18-802, this case must be dismissed. In my view, James errs in
contending that Section 18-802 is the exclusive extra-contractual means of obtaining
dissolution of an LLC. Under the facts of this case, WU Sub has standing to seek
dissolution in equity.
―[T]his Court, as a court of equity, has the power to order the dissolution of a
solvent company and appoint a receiver to administer the winding up of those assets.‖
Weir v. JMACK, Inc., 2008 WL 4379592, at *2 (Del. Ch. Sept. 23, 2008). Justice Story
described the ―power to dissolve the partnership during the term for which it is
stipulated‖ as one of the ―strongest cases to illustrate the beneficial operation of the
jurisdiction‖ of a court of equity. 2 Joseph Story, Commentaries on Equity Jurisprudence
§ 915 (W.H. Lyon, Jr. ed., 14th ed. 1918) [hereinafter Story]. The implementation of a
dissolution decree would require the appointment of a receiver, which is likewise an
equitable remedy that forms part of this court‘s equitable powers. 2 Courts of equity have
2
See Brill v. Southerland, 14 A.2d 408, 413 (Del. 1940) (recognizing the court‘s
discretionary power to appoint a receiver); Ross Hldg. & Mgmt. Co. v. Advance Realty
Gp., LLC, 2010 WL 3448227, at *6 (Del. Ch. Sept. 2, 2010) (same); 2 Story § 914 (―[I]f
necessary, a manager or receiver will be appointed to close the partnership business and
make sale of the partnership property.‖); see also Ct. Ch. R. 148 (listing rules applicable
to cases in which receivers are appointed ―whether such receivers or trustees are
appointed pursuant to a statute . . . or pursuant to the inherent authority of the Court‖).
15
long had the power to appoint receivers in cases ―where the partners themselves are
wholly unable to agree as to the management of the property and the settlement of the
partnership affairs.‖ 4 John Norton Pomeroy, Equity Jurisprudence § 1333(1) (Spencer
W. Symons ed., 5th ed. 1941) [hereinafter Pomeroy]. Justice Story viewed the
appointment of a receiver favorably in suits for dissolution when ―one [partner] has
wrongfully excluded the other from participation‖ in the management of the business. 2
Story § 914 n.1.
For Section 18-802 to provide the exclusive method of dissolving an LLC, it
would have to divest this court of a significant aspect of its traditional equitable
jurisdiction. Section 18-802 does not state that it establishes an exclusive means to obtain
dissolution, nor does it contain language overriding this court‘s equitable authority. To
the contrary, the LLC Act elsewhere recognizes that equity backstops the LLC structure
by providing generally that ―the rules of law and equity‖ shall govern in ―any case not
provided for in this chapter.‖ 6 Del. C. § 18-1104.
If Section 18-802 did purport to establish an exclusive means to obtain dissolution
and override a significant portion of this court‘s traditional equitable jurisdiction, then the
validity of that aspect of the provision would raise serious constitutional questions.
Article IV, Section 10 of the Delaware Constitution provides that this court ―shall have
all the jurisdiction and powers vested by the laws of this State in the Court of Chancery.‖
Del. Const. art. IV, § 10. The Delaware Supreme Court has held that this provision vested
in the Court of Chancery ―all the general equity jurisdiction of the High Court of
Chancery of Great Britain as it existed prior to the separation of the colonies,‖ except
16
―where a sufficient remedy exists at law.‖ DuPont v. DuPont, 85 A.2d 724, 727 (Del.
1951). In light of this provision, the high court held that the General Assembly cannot
enact legislation that reduces this court‘s jurisdiction below the constitutionally
established minimum, unless there is an adequate remedy at law. Id. at 729. As the
Delaware Supreme Court explained, Article IV, Section 10
intended to establish for the benefit of the people of the state a tribunal to
administer the remedies and principles of equity. They secured them for the
relief of the people. This conclusion is in complete harmony with the
underlying theory of written constitutions. Its result is to establish by the
Judiciary Article of the Constitution the irreducible minimum of the
judiciary. It secures for the protection of the people an adequate judicial
system and removes it from the vagaries of legislative whim.
Id. See generally Lyman Johnson, Delaware’s Non-Waivable Duties, 91 B.U. L. Rev.
701, 702, 716-18 (2011).
Although this court‘s equitable jurisdiction is measured by the ―the general equity
jurisdiction of the High Court of Chancery of Great Britain as it existed prior to the
separation of the colonies,‖ the Delaware Supreme Court has recognized that the scope of
that jurisdiction is not limited by the extent of British scientific, technological, and legal
knowledge at the time of the handover. ―Historically, equity jurisdiction ‗has taken its
shape and its substance from the perceived inadequacies of the common law and the
changing demands of a developing nation.‘‖ Schoon v. Smith, 953 A.2d 196, 204 (Del.
2008) (quoting Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate and Commercial
Practice in the Delaware Court Of Chancery § 2-2[a], at 2-2 (2006)). ―It cannot be said
too forcefully that the general powers of the Court of Chancery refers to that complete
system of equity as administered by the High Court of Chancery of Great Britain.‖
17
Glanding v. Indus. Trust Co., 45 A.2d 553, 558-59 (Del. 1945) (emphasis added). It is the
―complete system‖ of equity that this court inherited and administers, not the temporally
specific subject matter of eighteenth century cases.
To stress this point, the Delaware Supreme Court in Schoon quoted from a wide
range of sources that demonstrate the continuing and evolving role of equity. The high
court started with Pomeroy:
[T]he Chancellor always has had, and always must have, a certain power
and freedom of action, not possessed by the courts of law, of adapting the
doctrines which he administers. He can extend those doctrines to new
relations, and shape his remedies to new circumstances, if the relations and
circumstances come within the principles of equity, where a court of law in
analogous cases would be powerless to give any relief.
Id. at 204-205 (quoting 1 Pomeroy § 60). The Schoon court similarly quoted from Justice
Story, who explained that equity ―has an expansive power, to meet new exigencies; and
the sole question, applicable to the point of jurisdiction, must from time to time be[ ]
whether such rights and wrongs do exist, and whether the remedies [therefore] in other
courts, and especially in the courts of common law, are full, and adequate to redress.‖ Id.
(quoting 1 Story § 53). The high court also cited McClintock on Equity for the proposition
that ―the chancellors could adapt their system to meet changing needs without resorting
to the fiction that they were merely interpreting and applying former rules, but the
tendency to follow the path laid out by former chancellors was strong.‖ Id. at 205
(quoting McClintock on Equity § 4 (2d ed. 1948)). The Schoon court even quoted from
Woolley’s Delaware Practice, which stated:
It may safely be affirmed that the whole body of equity principles, both of
right and remedy, was brought hither by our ancestors, together with the
18
common law, on their emigration from England, as a part of their heritage
of liberty. Much of it, no doubt, lay dormant for a long period, no occasion
or demand for a resort to portions of it for many purposes having arisen, but
gradually as the increasing population of the new country begot new
relations, there arose controversies and contests growing out of business,
and the necessities for the redress of injuries which resulted from the breach
of duties or the non-performance of obligations, that called for the use of
the means to enforce observance through ancient remedies.
Id. (quoting 1 Woolley’s Delaware Practice § 56 (1906)).
Given the weight of these authorities, the extensive discussion in Schoon, and the
decisions in DuPont and Glanding, I cannot accept the contention that because the
nascent practice of entity law as it existed at the time of the colonies‘ separation had not
yet envisioned LLCs, they fall outside the domain of equity. 3 Decisions addressing the
dissolution of LLCs have recognized the continuing role of equity. 4 Most notably, in
3
But see CML V, LLC v. Bax, 28 A.3d 1037, 1045 (Del. 2011) (distinguishing
precedents because the LLC is ―a business entity that did not exist in 1792‖). Excluding
LLCs and other post-eighteenth century entities from the domain of equity based on
when the governing statues were adopted would represent a radical form of constitutional
originalism that even the strongest judicial proponents of that doctrine have not
embraced. Applied by analogy to the United States Constitution, where originalist
reasoning has been more prevalent, it would mean that core constitutional protections
would not extend to modern technology, such as cell phones or computers, simply
because of when they were invented. Even Justices Scalia and Thomas, among the most
vigorous champions of originalism, have not gone so far. For example, in 2012, Justice
Scalia authored and Justice Thomas joined a decision in which the United States Supreme
Court affirmed that the Fourth Amendment‘s protection against unreasonable searches
and seizures applied to evidence obtained by attaching a GPS-based tracking device to a
car. United States v. Jones, 132 S. Ct. 945 (2012). Justices Scalia and Justice Thomas
likewise joined a 2014 decision applying Fourth Amendment protection to cellular
phones. See Riley v. California, 134 S. Ct. 2473 (2014).
4
See, e.g., In re Mobilactive Media, LLC, 2013 WL 297950, at *33 (Del. Ch. Jan.
25, 2013) (noting that ―the Court of Chancery, in the exercise of its equitable powers,
may decide whether it should issue a decree of dissolution‖ (emphasis in original)); Vila
19
Haley, this court reviewed a contractual exit mechanism in a two-member operating
agreement and determined that it did not provide the exiting member with ―an adequate
remedy.‖ 864 A.2d at 88. Chief Justice Strine, writing as a Vice Chancellor, explained
that the existence of an exit mechanism was not sufficient; it had to be a ―reasonable exit
mechanism‖ that provided ―a fair opportunity for the dissenting member who disfavors
the inertial status quo to exit.‖ Id. at 96. On the facts of the case, the Chief Justice found
that it was ―not equitable to force [the locked-out member] to use the exit mechanism‖
and ordered dissolution. Id. at 98.
This case also differs from Bax, where the Delaware Supreme Court affirmed a
decision of this court holding that creditors of an insolvent LLC lacked standing to sue
derivatively under Section 18-1002 of the LLC Act. On appeal, the plaintiff-appellant
contended that the LLC Act could not deprive the Court of Chancery of jurisdiction to
recognize a creditor‘s standing in equity to sue derivatively. The Delaware Supreme
Court rejected that argument for a series of reasons, culminating in its recognition that
creditors of an LLC have ample remedies available at law. Bax, 28 A.3d at 1046. As
Chief Justice Strine had explained while a member of this court, the premise of granting
creditors equitable standing to sue derivatively
v. BVWebTies LLC, 2010 WL 3866098, at *6 (Del. Ch. Oct. 1, 2010) (Strine, V.C.)
(―[T]he ultimate determination of whether a decree of dissolution should issue is
committed to this court‘s equitable discretion.‖); Haley v. Talcott, 864 A.2d 86, 98 (Del.
Ch. 2004) (declining to consign parties to contractual exit mechanism where it was ―not
equitable to force [one 50% owner] to use the exit mechanism in this circumstance‖).
20
is not unproblematic. Arguably, it involves using the law of fiduciary duty
to fill gaps that do not exist. Creditors are often protected by strong
covenants, liens on assets, and other negotiated contractual protections. The
implied covenant of good faith and fair dealing also protects creditors. So
does the law of fraudulent conveyance. With these protections, when
creditors are unable to prove that a corporation or its directors breached any
of the specific legal duties owed to them, one would think that the
conceptual room for concluding that the creditors were somehow,
nevertheless, injured by inequitable conduct would be extremely small, if
extant.
Prod. Res. Gp., L.L.C. v. NCT Gp., Inc., 863 A.2d 772, 789-90 (Del. Ch. 2004) (footnotes
omitted). In a later decision, then-Vice Chancellor Strine revisited these themes:
Both state law and federal law provide a panoply of remedies in order to
protect creditors injured by a wrongful conveyance, including avoidance,
attachment, injunctions, appointment of a receiver, and virtually any other
relief the circumstances may require. . . . [Further,] financial creditors . . .
know how to craft contractual protections that restrict their debtors‘ use of
assets. In a situation when creditors cannot state a claim that such
contractual protections have been breached and cannot prove a fraudulent
conveyance claim, the creditors‘ frustration does not mean that there is a
gap in the remedial fabric of the business law that equity should fill. Rather,
it means that we remain a society that recognizes that reward and risk go
together, and that there will be situations when business failure results in
both equity and debt-holders losing some money.
Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 199 (Del. Ch. 2006)
(footnotes omitted), aff’d sub nom. Trenwick Am. Litig. Trust v. Billett, 931 A.2d 438
(Del. 2007) (TABLE). The LLC Act provides even more means for a creditor to protect
itself at law. See CML V, LLC v. Bax, 6 A.3d 238, 250-53 (Del. Ch. 2010) (discussing
pertinent statutory sections of LLC Act), aff’d, 28 A.3d 1037 (Del. 2011). Thus, to the
extent Section 18-1002 limited the right to bring a derivative action to members or
21
assignees, sufficient remedies for creditors existed at law to avoid any constitutional
problem.5
This court has held that the parties to an LLC agreement can waive by contract the
right to seek statutory dissolution under Section 18-802. See R&R Capital, LLC v. Buck
& Doe Run Valley Farms, LLC, 2008 WL 3846318, *4 (Del. Ch. Aug. 19, 2008). In my
view, the ability to waive dissolution under Section 18-802 does not extend to a party‘s
standing to seek dissolution in equity.
In concluding that parties to an LLC agreement could waive the right to seek
dissolution under Section 18-802, the R&R Capital decision relied heavily on arguments
by commentators to the effect that a Delaware LLC should be viewed as a purely
contractual entity to which principles of equity (including fiduciary duties) do not apply.6
Reasonable minds could disagree about that proposition.7 But whatever one‘s personal
5
Bax, 28 A.3d at 1046; see also 10 Del. C. § 342 (―The Court of Chancery shall
not have jurisdiction to determine any matter wherein sufficient remedy may be had by
common law, or statute, before any other court or jurisdiction of this State.‖); DuPont, 85
A.2d at 728 (noting that the jurisdiction that vested in this court at the time of the
separation of the colonies did not extend to cases ―where a sufficient remedy exists at
law‖).
6
See R&R Capital, 2008 WL 3846318, *4, *7 (citing Myron T. Steele, Judicial
Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability
Companies, 32 Del. J. Corp. L. 1 (2007), and works by Professor Larry Ribstein,
including Larry E. Ribstein, The Uncorporation and Corporate Indeterminacy, 2009 U.
Ill. L. Rev. 131, and Larry E. Ribstein, An Analysis of the Revised Uniform Limited
Liability Company Act, 3 Va. L. & Bus. Rev. 35, 67 (2008)).
7
See Auriga Capital Corp. v. Gatz Props., LLC, 40 A.3d 839, 849-56 (Del. Ch.
2012) (Strine, C.), aff’d, 59 A.3d 1206 (Del. 2012); see also Feeley v. NHAOCG, LLC, 62
A.3d 649, 659-63 (Del. Ch. 2012). See generally Kleinberger, supra, at 460-71
22
thoughts might have been on the matter, the General Assembly in 2013 adopted an
amendment to the LLC Act inconsistent with the purely contractarian view.8
Of particular relevance to dissolution, the purely contractarian view discounts core
attributes of the LLC that only the sovereign can authorize, such as its separate legal
existence, potentially perpetual life, and limited liability for its members. See 6 Del. C. §§
18-201, 18-303. To my mind, when a sovereign makes available an entity with attributes
that contracting parties cannot grant themselves by agreement, the entity is not purely
contractual. Because the entity has taken advantage of benefits that the sovereign has
provided, the sovereign retains an interest in that entity. That interest in turn calls for
preserving the ability of the sovereign‘s courts to oversee and, if necessary, dissolve the
entity. Put more directly, an LLC agreement is not an exclusively private contract among
its members precisely because the LLC has powers that only the State of Delaware can
confer. Those powers affect the rights of third parties, who at a minimum must take into
account the LLC‘s separate legal existence and its members‘ limited liability shield. Just
as LLCs are not purely private entities, dissolution is not a purely private affair. It
(identifying historical, jurisprudential, and policy reasons why LLCs should not be
regarded as purely contractual entities); Sandra K. Miller, The Best of Both Worlds:
Default Fiduciary Duties and Contractual Freedom in Alternative Business Entities, 39 J.
Corp. L. 295, 315-24 (2014) (reviewing empirical studies and presenting data about
alternative entity agreements that undermine premises of purely contractarian approach).
8
See H.B. 126, 147th Gen. Assemb. (Del. 2013) (amending 6 Del. C. § 18-1104 to
provide that ―In any case not provided for in this chapter, the rules of law and equity,
including the rules of law and equity relating to fiduciary duties and the law merchant,
shall govern‖); Miller, supra, at 314 (noting that the debate over the purely contractual
status of LLCs ―was resolved by legislation that was signed into law on June 30, 2013‖).
23
involves third party claims, which have priority in the dissolution process. See id. §§ 18-
803, 18-804 (describing winding up and priorities for distribution of assets). Because an
LLC takes advantage of benefits that the State of Delaware provides, and because
dissolution is not an exclusively private matter, the State of Delaware retains an interest
in having the Court of Chancery available, when equity demands, to hear a petition to
dissolve an LLC. See In re Revlon, Inc. S’holders Litig., 990 A.2d 940, 960 n.8 (Del. Ch.
2010) (noting possibility of including a forum selection clause in an entity‘s constitutive
agreement, but envisioning that ―the Delaware courts would retain some measure of
inherent residual authority so that entities created under the authority of Delaware law
could not wholly exempt themselves from Delaware oversight‖).
This approach finds support in Huatuco v. Satellite Healthcare and Satellite
Dialysis of Tracy, LLC, 2013 WL 6460898 (Del. Ch. Dec. 9, 2013), aff’d, 93 A.3d 654
(Del. 2014) (ORDER). The Huatuco opinion followed R&R Capital in holding that the
members of an LLC had waived their right to seek statutory dissolution under Section 18-
802 when they ―specifically considered, and addressed, dissolution and dissolution
rights.‖ Id. at *5. But the Huatuco court reserved decision on ―[w]hether the parties may,
by contract, divest this Court of its authority to order a dissolution in all circumstances,
even where it appears manifest that equity so requires—leaving, for instance,
irreconcilable members locked away together forever like some alternative entity version
of Sartre‘s Huis Clos.‖ Id. at *1 n.2. The Huatuco court did not have to answer that
question because ―considerations fundamental to equity [were] absent.‖ Id.
24
This case presents the type of situation anticipated in Huatuco where equity should
intervene. If the opportunities for dissolution are limited to Section 18-802 and the
specific terms of the Initial LLC Agreement, then dissolution is not an option. WU Parent
and WU Sub lack standing to seek it, and James does not want it. The Company will
continue, with Royal Spirit locked-in as a silent and powerless passive investor.
That situation is contrary to the bargain the parties struck. WU Parent and James
formed the Company as equal business partners. They contributed equal amounts of
capital and brought comparable expertise, with one side acting as a major supplier and
the other as a day-to-day manager. Desiring to seize the opportunity to buy Connaught‘s
assets quickly, they agreed to start with a basic operating agreement in which they
committed to negotiate a more detailed replacement agreement. As reflected by the
Proposed LLC Agreement, the terms of that more detailed agreement contemplate that an
affiliate transfer from WU Parent to WU Sub would result in the automatic admission of
WU Sub as a substitute member. In other words, had the parties finalized the Proposed
LLC Agreement, or acted in accordance with their agreement in principle, then WU Sub
would be a member and have standing to seek dissolution under Section 18-802. Based
on the allegations of the petition, WU Parent engaged in the affiliate transfer with James‘
knowledge and participation, and James subsequently treated WU Sub as a member.
―Equity always attempts to . . . ascertain, uphold, and enforce rights and duties
which spring from the real relations of parties.‖ 2 Pomeroy § 378 (emphasis in original).
―[E]quity regards substance rather than form.‖ Monroe Park v. Metro. Life Ins. Co., 457
A.2d 734, 737 (Del. 1983). Equity also ―regards that as done which in good conscience
25
ought to be done.‖ Id. The real relationship between the parties is a joint venture in which
they are equal participants. Neither party intended to be a ―passive investor . . . subject to
[the other party‘s] unilateral dominion.‖ Haley, 864 A.2d at 95. In good conscience, WU
Sub should be regarded as a member with the power to seek dissolution.
Likewise, the ―real relations‖ of the parties point to a scenario warranting
dissolution. For a time, both sides recognized the need to go their separate ways. James
only changed its mind because of its fortuitous position as the entity‘s de facto manager.
But that reality does not make the status quo a satisfactory alternative. ―Although the
LLC is technically functioning at this point, this operation is purely a residual, inertial
status quo that just happens to exclusively benefit one of the 50% members. . . .‖ Id. at
96. The Initial LLC Agreement made the Board the singular manager of the Company.
Because its four members are deadlocked, the duly authorized manager of the Company
cannot exercise its statutory and contractual authority or carry out its obligation to
manage and direct the business and affairs of the entity. Brubaker may be managing the
Company because of the power vacuum created by the deadlock, but Brubaker is not the
Board. Under the prevailing state of affairs, the Company is operating contrary to the
governance structure set forth in its constitutive agreement.
When considering whether holders of equity in other entities can pursue equitable
causes of action, despite their lack of formal record ownership status, this court has relied
26
on the substance of the relationship and permitted the suits to proceed.9 The same
reasoning employed by Chancellor Seitz in Burry Biscuit supports recognizing an
assignee‘s standing to sue in equity for dissolution: ―Here we have an equitable owner . .
. suing in a court of equity,‖ asserting a cause of action that ―must in this state be brought
in equity,‖ and in a suit that ―does involve an equitable remedy.‖ 60 A.2d at 112.
Consequently, I believe that WU Sub has standing in equity, as an assignee, to seek
dissolution of the Company under the facts alleged in the petition.
III. CONCLUSION
WU Parent and WU Sub lack standing to seek statutory dissolution under Section
18-802. Nevertheless, because WU Sub has standing to seek dissolution in equity, the
motion to dismiss is denied.
9
Rosenthal v. Burry Biscuit Corp., 60 A.2d 106, 111-12 (Del. Ch. 1948) (Seitz,
C.); accord Gamble-Skogmo v. Saks, 122 A.2d 120, 121 (Del. 1956); Jones v. Taylor, 348
A.2d 188, 190-91 (Del. Ch. 1975); Brown v. Dolese, 154 A.2d 233, 239 (Del. Ch. 1959),
aff’d, 157 A.2d 784 (Del. 1960); see also In re Lahood, 2009 WL 803558, *13 n.19
(Bankr. C.D. Ill. 2009) (holding under Illinois law that ―[a] transferee of a member‘s
interest has the right to petition a court for an order compelling the dissolution and
winding up of a limited liability company on equitable grounds‖), aff’d in pertinent part,
437 B.R. 330 (C.D. Ill. 2010).
27