In the context of judicial dissolution, deadlock refers to the inability to make decisions and take action, such as when two fifty-percent owners disagree as to the management of the company and the operating agreement requires a majority vote, but gives no reasonable means of navigating around the deadlock. The recent decision in In re: GR BURGR, LLC v. Seibel (“BURGR”) exemplifies the court’s discretionary power to dissolve a limited liability company under 6 Del. C. § 18-802, when the operating agreement is silent.
In BURGR, GR US Licensing, LP (“GRUS”), an entity affiliated with celebrity chef Gordon Ramsey, partnered with Rowen Seibel to form GR BURGR, LLC (“GRB”), a Delaware LLC, with each owning a fifty-percent membership interest. GRB’s only source of revenue was a licensing agreement with Caesars Entertainment Corporation (“Caesars”). Caesars conditioned the rights and obligations of each member under the licensing agreement upon Caesars’ sole and exclusive judgment that GRB, its members, and affiliates are not (and do not become) “unsuitable persons.” Upon a determination of unsuitability, the parties must terminate the relationship with the person at issue or else the licensing agreement would be terminated.
In 2016, Seibel pled guilty to felony tax-related offenses. Following the sentence, Caesars declared Seibel an “unsuitable person” and informed GRB it must separate from Seibel or the licensing agreement would be terminated. Due to Seibel’s refusal to leave the company, Caesars was left with no choice but to terminate the licensing agreement. Shortly thereafter, GRUS petitioned for judicial dissolution.
Pursuant to 6 Del. C § 18-802, the Delaware Court of Chancery “may decree dissolution of a LLC whenever it is not reasonably practicable for it to carry on the business in conformity with its operating agreement.” In determining the “not reasonably practicable” standard, the court will consider whether: (1) the members’ vote is deadlocked; (2) the operating agreement gives reasonable means of navigating around the deadlock; and (3) due to the financial condition of the company, there is effectively no business to operate. None of the factors are individually dispositive; nor is it required all of the factors exist to meet the standard.
In BURGR, the Delaware Court of Chancery found it difficult to imagine how the LLC could be any more dysfunctional or deadlocked. All decisions made by the managers required a majority vote and the LLC Agreement provided no mechanism by which to break the deadlock. The relationship between the managers became “acrimonious” as evidenced by counterclaims and other litigation proceedings between the parties. Furthermore, it was not reasonably conceivable that the deadlock would be broken in the future. Neither Ramsey, nor his entity GRUS, wished to be associated with Seibel due to his conviction, and communication between the parties ceased altogether. The court found judicial dissolution to be the proper remedy because it was not reasonably practicable for the LLC to act in conformity with its operating agreement. Although judicial dissolution is granted sparingly, and is an extreme remedy of last resort, it is properly ordered when the management of the business becomes so dysfunctional or its business purpose is so thwarted that it is no longer practicable to operate the business.
Two-thirds of the 1.8 million business entities in Delaware are limited liability companies. Therefore, when the LLC agreement requires a majority vote, it is vital to provide deadlock breaking-mechanisms that explicitly and unambiguously state the mechanism members wish to employ in lieu of judicial dissolution. Some well-known deadlock breaking mechanisms include: (1) buy/sell provisions; (2) partition or sale of the company or assets; (3) rotating vote; (4) external tiebreaker; (5) put/call clause; and (6) waiving the right to seek judicial dissolution.
Under a buy/sell provision one owner will offer to buy the interest from the other deadlocked owner, and the offeree must either accept and sell their interest, or purchase the offeror’s interest. The value of the interest is typically decided by an “appraisal” model, in which an independent, qualified expert evaluates the fair market value of the interest to be purchased or a “shotgun” model, in which the parties will have a predetermined set price. Unsurprisingly, both mechanisms have proven effective at forcing parties to find a way to break or avoid a deadlock.
Similar to the buy/sell provision, the possibility of partition of the LLC or sale of the company or assets has helped “force” members to find a way to resolve their deadlock. For obvious reasons, forced sale of the company or assets is typically reserved for extreme situations in which it can be easily divided among members. Typically, the agreement will give one or both members the right to cause a sale, subject to a right of first offer or right of first refusal, along with some preemptive measures to ensure the assets are sold for a particular price or percentage.
The rotating vote, sometimes referred to as a casting vote, is a mechanism that allows owners to rotate the tie-breaking decision whenever there is a deadlock. Owners will include a list of “major issues” that are likely to arise. If a deadlock arises, one owner may “cast” another vote, thus breaking the deadlock. The next time there is a deadlock, the casting vote is given to the other owner, and so on and so forth.
In an external tiebreaker, the parties will defer the tie-breaking decision to a predetermined person(s), which may include: a group such as the board of an affiliated entity, inside or external professional advisors, or industry expert(s). However, this method has its downsides because it takes the power away from the members, gives it to a third party, and adds time and expense.
Although put/call clauses are among the most popular and widely used mechanisms, they are heavily negotiated and require careful drafting. Essentially, when forming the LLC agreement the parties agree upon certain “trigger events” that, once they occur, allow one party to exercise a put or call. A “put” creates the right to sell membership interest (sometimes subject to the right of first refusal), where a “call” is right to purchase the members interest.
Waiving the right to seek judicial dissolution does not “break” deadlock, but there are legitimate business reasons to seek dissolution. For instance, it is common for lenders to deem the filing of a petition for judicial dissolution will constitute an incurable default. Having all the members waive the right to petition for dissolution will protect the company if a disgruntled member files for dissolution and causes the LLC to default.
In R & R Capital, LLC v. Bunk & Doe Run Valley, LLC, the Delaware Court of Chancery upheld a provision in an LLC agreement in which members waived the right to petition for dissolution and appoint a receiver. The provision stated:
[t]he Members agree that irreparable damage would occur if any member should bring an action for judicial dissolution of the Company. Accordingly each member accepts the provisions under this Agreement as such Member’s sole entitlement on Dissolution of the Company and waives and renounces such Member’s right to seek a court decree of dissolution or to seek the appointment by a court of a liquidator for the Company.
The court reasoned that neither the Delaware LLC act nor its policy precludes such a waiver, and the operating agreement does not vary the statutory rights of nonparties, such as third-party creditors. While a member or manager can waive their right to seek dissolution, they cannot waive the rights of others to make such an application for them. Because a decree of judicial dissolution may be entered upon “application by or for a member or manager,” it is possible that a court could enter a decree of dissolution and that the members have waived their right to seek such a decree.
In sum, it is well settled under Delaware Law that limited liability companies are “creatures of contract rather than statute.” Limited liability companies allow individuals to “create an organization that reflects their perception of the appropriate relationships among the parties, most conducive to their interests, as represented by their mutual agreement.” However, when members choose not to exercise their contractual freedom and fail to explicitly provide a reasonable mechanism by which to break a deadlock, they recognize the possibility of judicial dissolution, and submit themselves to the discretion of the court.
Andrew is a second year student at Widener University Delaware Law School and a Staff Member on the Delaware Journal of Corporate Law.