This article provides a framework for addressing the importance of adopting deadlock-breaking mechanisms in limited liability company (LLC) operating agreements as an alternative to seeking judicial dissolution when a deadlock arises in an LLC.
The problems arising from deadlock in the management of an LLC are obvious to almost all practitioners, so we will not spend too much time discussing them, but a few points bear addressing. First, deadlocks in an LLC typically arise in a number of circumstances involving important decisions, including:
- the failure of equal members or managers to reach agreement;
- the failure to obtain a required majority vote;
- the failure to obtain a required approval from a member with approval rights; and
- the failure to obtain unanimous consent where unanimity is required.
Second, the failure to provide deadlock-breaking mechanisms that address any or all of the above in an operating agreement will result in significant expense, hard feelings, loss of time, and possible mediation, arbitration, or litigation—all of which are covered later in this article. Third, the ultimate stage of unresolved deadlock often will result in dissolution of the LLC, which typically involves excessive expense, lost opportunity, and bitter consequences for the members of the LLC.
If a deadlock arises and an LLC has not adopted a deadlock-breaking mechanism in the operating agreement, the parties most often will turn to a court seeking judicial dissolution, or a court-ordered alternative to dissolution, to resolve the deadlock. “Dissolution” has been a term of art in the law of unincorporated entities since at least the time of Roman law. Joseph Story, Commentaries on the Law on Partnership § 266 at 408 (2d ed. 1850) (“The Roman law . . . declared that partnership might be dissolved in various ways. . . .”).
Under the Revised Uniform Limited Liability Act (RULLCA) promulgated by the Uniform Law Commission (last revised in 2013), a limited liability company is dissolved, and its activities and affairs must be wound up, upon the occurrence of any of the following:
- an event or circumstance that causes dissolution under the operating agreement;
- the affirmative vote or consent of all the members;
- the passage of 90 consecutive days during which the company has no members unless, before the end of the period:
- consent to admit at least one specified person as a member is given by transferees owning the rights to receive a majority of distributions as transferees at the time the consent is to be effective; and
- at least one person becomes a member in accordance with the consent;
- upon application by a member, the entry by the appropriate state court of an order dissolving the company on the grounds that:
- the conduct of all or substantially all the company’s activities and affairs is unlawful;
- it is not reasonably practicable to carry on the company’s activities and affairs in conformity with the certificate of organization and the operating agreement; and
- the managers or those members in control of the company:
- have acted, are acting, or will act in a manner that is illegal or fraudulent; or
- have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the applicant (“oppression” of one or more members in an LLC is a basis for judicial dissolution under RULLCA, but not in many other state LLC acts, even in some states that have adopted RULLCA-based LLC acts, such as Florida); or
- the signing and filing of a statement of administrative dissolution by the Secretary of State.
Deadlock as Grounds for Judicial Dissolution
Most state statutes rely on the judicial-dissolution provisions of the LLC Act as the judicially imposed remedy when the members or managers are deadlocked and are without a clear and effective private ordering provision to control the resolution of the deadlock. Of course, there are numerous problems with leaving resolution of member or manager deadlock disputes to the courts.
Under most states’ LLC Acts and case law, a Member or Manager may seek judicial dissolution in a judicial proceeding if it is established that:
- the conduct of all or substantially all of the activities and affairs of the LLC are unlawful;
- it is not reasonably practicable to carry on the company’s activities and affairs in conformity with its articles and operating agreement;
- the members or managers in control of the LLC are acting or are reasonably expected to act in a manner that is illegal or fraudulent;
- LLC assets are misappropriated or wasted, causing irreparable injury to the LLC or to one or more of its members; or
- the members or managers of the LLC are deadlocked in the management of the LLC’s activities or affairs, the members or managers are unable to break the deadlock, and irreparable injury to the LLC is threatened or suffered.
The Court’s Power to Provide Alternative Remedies in Deadlock
It is important to note that some state statutes (e.g., Florida) that provide for deadlock as grounds for judicial dissolution also expressly provide in such a proceeding that the court has more flexibility than simply ordering dissolution. Such statutes typically include language such as the following: “in a proceeding brought under [the section addressing judicial dissolution] the court may order a remedy other than dissolution.” Consequently, one must be prepared for the court to fashion a remedy that one or more of the parties did not anticipate and would not appreciate, e.g., mandating that one of the members be bought out by the company or other member(s). Additionally, courts have exercised their equitable powers to fashion alternative remedies even though the statute does not contain the express statutory provision described above.
For example, in Lyons v. Salamone, 32 A.D.3d 757, 758, 821 N.Y.S.2d 188 (N.Y.A.D. 1 Dept. 2006), the court held: “[w]e reject plaintiff’s argument that the absence of a provision in the Limited Liability Company Law expressly authorizing a buyout in a dissolution proceeding rendered the IAS court without authority to grant the parties mutual buyout rights, and find that it is an equitable method of liquidation to allow either party to bid the fair market value of the other party’s interest in the business, with the receiver directed to accept the highest legitimate bid.
In the infamous Delaware case of Haley v. Talcott, 864 A.2d 86, 97 (Del. Ch. 2004), the court ordered dissolution under the “not reasonably practicable standard” even though the operating agreement provided a put mechanism as a method for avoiding the impasse, noting that the operating agreement did not expressly substitute the put mechanism for the judicial-dissolution remedy, and holding that the put mechanism was not fair and equitable because it would leave the exiting member personally liable on a mortgage.
The take-away from Haley is that, if a put is intended to be part of the “reasonably practicable” solution to a deadlock in the operation of the LLC, the operating agreement must explicitly state as much, and must expressly acknowledge that it is to be enforced by a court in lieu of the court exercising its equitable power to fashion a different remedy. Of course, in many states, such a provision must withstand any challenge that it is “manifestly unreasonable” and therefore unenforceable (perhaps because it results in imposing company liabilities on the remaining members and exempting the exiting member from those liabilities).