Partnerships and LLCs

January 7, 2010

Publication| Limited Liability Company & Partnership Advisory

In Lola Cars International Ltd. v. Krohn Racing, LLC, the Delaware Court of Chancery considered a number of issues in the context of a motion to dismiss two actions, the most interesting issue of which related to judicial dissolution.   In this case, two parties (Lola and Krohn) formed a Delaware LLC to acquire and sell certain types of race cars licensed by the governing body for the Grand Am Series.  The LLC was managed by a two member board, with one member appointed by Lola and one member appointed by Krohn.  Defendant Krohn’s appointment to the board was Jeff Hazel, who was named a defendant in the two actions brought by Lola.  Jeff Hazel was also the CEO of the LLC.

One of the remedies sought by Lola in connection with its first complaint was for judicial dissolution under Section 18-802 of the Delaware LLC Act.  The defendants argued that judicial dissolution was not appropriate and sought its dismissal.  Under Section 18-802, a member or manager may seek judicial dissolution "whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement."  The court cited Fisk Ventures, LLC v. Segal, which had set forth three factual scenarios for a court to consider under Section 18-802’s reasonable practicability standard:  "1) whether the members’ vote is deadlocked at the Board level; 2) whether there exists a mechanism within the operating agreement to resolve this deadlock; and 3) whether there is still a business to operate based on the company’s financial condition."  None of these factors is itself dispositive.  Applying the Fisk analysis to this case, the court felt that the three circumstances were relevant.  Allegations had been made by Lola regarding (i) a deadlock over replacing Jeff Hazel as CEO, (ii) the merely voluntary nature of the buy-out mechanism in the LLC agreement for resolving disputes, and (iii) the insolvency of the LLC.  In analyzing these allegations, the court noted that "the relevant inquiry is not whether the Company cannot possibly continue its business in accord with the Operating Agreement, but rather whether to do so would be reasonably practicable."

While addressing other factors that would support judicial dissolution of the LLC, the court expressly rejected the defendants’ assertion that the LLC agreement specifically overrode the parties’ right to seek judicial dissolution.  The LLC agreement contained provisions for terminating the LLC agreement but did not expressly provide that judicial dissolution could not be sought by any of the parties.  In response to the defendants’ claim that these self-termination provisions prohibited judicial dissolution, the court stated that "[i]t simply cannot be true that a number of nonexclusive, permissive termination clauses in the Operating Agreement can preclude judicial dissolution as provided for in the Act."

For practitioners who want to prevent parties to an LLC agreement from petitioning for judicial dissolution, an express provision to that effect should be contained in the agreement.

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