Chapter 5: The Limited Liability Company

Learning Objectives

1. Analyze how the operating agreement functions as the primary constitutional document of a Delaware LLC, and assess which statutory default rules members may override by contract.

2. Distinguish the fiduciary duties a manager owes under the LLC Act from duties that may be contracted for, restricted, or eliminated by the operating agreement, and apply the entire fairness standard to a conflicted manager transaction.

3. Apply the contractual modification doctrine to evaluate whether an express provision permitting member competition displaces the default duty of loyalty, and compare the limits of that doctrine under Delaware and Ohio law.

4. Evaluate the role of the implied covenant of good faith and fair dealing as a gap-filler in LLC operating agreements, and assess when the covenant may operate despite a contractual good faith standard that covers similar ground.

5. Compare the judicial dissolution standard for limited liability companies with analogous standards for corporations and partnerships, and distinguish the two-part test for LLC dissolution from the deadlock test available in corporate law.

The limited liability company emerged as the dominant vehicle for closely held business ventures in the United States during the 1990s. The form combines corporate-type limited liability for all members with the pass-through taxation of a partnership and the contractual flexibility traditionally associated with limited partnerships. Because it does not require the governance formality that corporation law mandates, the LLC is particularly suited to ventures where the principals wish to define their own governance structure, restrict or modify the fiduciary duties they owe one another, and tailor distribution and voting rights to their particular circumstances.

The LLC is a relatively recent addition to American business law. Delaware adopted its LLC Act in October 1992, and every state now has an enabling statute. The form combines corporate-type limited liability with partnership-type contractual flexibility. Unlike the corporation, which is governed by a detailed and partially mandatory statutory framework, the LLC is designed around private ordering. The operating agreement the members negotiate is the primary source of governance rules. The statute supplies default provisions only where the agreement is silent, and in Delaware, even many of those defaults can be modified or eliminated.

The operating agreement occupies a constitutional position in LLC governance. It allocates management authority between members and any designated manager, defines each member's economic rights, establishes voting thresholds for major decisions, specifies how disputes will be resolved, and in Delaware may modify or restrict the fiduciary duties members owe one another. This contractual flexibility is the LLC's distinctive feature, but it is also the source of most LLC litigation. When members disagree about what the operating agreement permits, or when a manager exercises authority in ways the agreement does not expressly address, courts must interpret the agreement as a contract and supply gap-filling doctrine where necessary.

The cases in this chapter trace the principal doctrinal questions of LLC governance. They ask: What does the operating agreement bind, and can it oust the jurisdiction that the statute otherwise provides? What fiduciary duties do LLC managers owe, and to what extent can the operating agreement modify or eliminate them? What is the scope of the implied covenant of good faith and fair dealing, which the statute preserves even when fiduciary duties are eliminated? What happens when the LLC's managers reach a deadlock? And what rights do a member's personal creditors have against the membership interest? These questions, taken together, constitute the governance law of the LLC.

I. The Operating Agreement as Constitution

Delaware's LLC Act, codified at Title 6, Chapter 18 of the Delaware Code, is built around the principle of freedom of contract. Section 18-1101(b) states that "it is the policy of [the Act] to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements." This policy choice has a structural consequence: the operating agreement, not the statute, is the primary source of governance rules. The certificate of formation filed with the Secretary of State is brief and formal. All substantive governance provisions live in the operating agreement, which may be written or oral and need not be filed publicly.

Elf Atochem North America, Inc. v. Jaffari presented the Delaware Supreme Court with its first opportunity to construe the Act comprehensively. The court addressed two foundational questions: whether the LLC itself is bound by an operating agreement that the LLC did not sign, and whether the members' freedom of contract allows the operating agreement to oust the Court of Chancery's jurisdiction that the Act otherwise provides. Both answers shaped the constitutional structure of Delaware LLC law.

1. The dispute arose from a joint venture between Elf Atochem North America, Inc., a Pennsylvania corporation, and Cyrus Jaffari, who had developed an innovative, environmentally friendly industrial solvent. They formed Malek LLC, a Delaware limited liability company, with Elf as the exclusive worldwide distributor and Jaffari as the manager. Their relationship soured, and Elf sued in the Court of Chancery, alleging that Jaffari had breached his fiduciary duty, pushed Malek LLC to the brink of insolvency, and interfered with business opportunities. The operating agreement, however, directed all disputes to arbitration or court proceedings in California. The case required the court to decide whether contractual forum selection could override the statutory grants of jurisdiction to the Court of Chancery.

Guiding Questions

1. The Delaware LLC Act grants the Court of Chancery jurisdiction over claims involving the removal of an LLC manager (Section 18-110) and over derivative claims (Section 18-1001). Yet the court held that the operating agreement's California forum-selection clause overrides those statutory grants. Is that result consistent with the Act's text? What does it reveal about the relationship between statutory default rules and private ordering in Delaware LLC law?

2. The court states that "the LLC is simply [the members'] joint business vehicle." What are the consequences of treating the LLC as a contractual vehicle rather than as a legal entity with interests distinct from those of its members?

3. Malek LLC did not sign the operating agreement, yet the court held the LLC bound by it. What principle does the court rely on? Does that principle extend to other LLC obligations the LLC did not expressly assume?

Elf Atochem N. Am., Inc. v. Jaffari {#elf-atochem-n.-am.-inc.-v.-jaffari .Case-Name-Heading}

Supreme Court of Delaware, 727 A.2d 286 (1999) {#supreme-court-of-delaware-727-a.2d-286-1999 .Case-Name-Heading}

1. VEASEY, Chief Justice:

2. This is a case of first impression before this Court involving the Delaware Limited Liability Company Act (the "Act"). The limited liability company ("LLC") is a relatively new entity that has emerged in recent years as an attractive vehicle to facilitate business relationships and transactions. The wording and architecture of the

3. Act is somewhat complicated, but it is designed to achieve what is seemingly a simple concept--to permit persons or entities ("members") to join together in an environment of private ordering to form and operate the enterprise under an LLC agreement with tax benefits akin to a partnership and limited liability akin to the corporate form.

4. This is a purported derivative suit brought on behalf of a Delaware LLC calling into question whether: (1) the LLC, which did not itself execute the LLC agreement in this case ("the Agreement") defining its governance and operation, is nevertheless bound by the Agreement; and (2) contractual provisions directing that all disputes be resolved exclusively by arbitration or court proceedings in California are valid under the Act. Resolution of these issues requires us to examine the applicability and scope of certain provisions of the Act in light of the Agreement.

5. We hold that: (1) the Agreement is binding on the LLC as well as the members; and (2) since the Act does not prohibit the members of an LLC from vesting exclusive subject matter jurisdiction in arbitration proceedings (or court enforcement of arbitration) in California to resolve disputes,

6. the contractual forum selection provisions must govern.

7. Accordingly, we affirm the judgment of the Court of Chancery dismissing the action brought in that court on the ground that the Agreement validly predetermined the fora in which disputes would be resolved, thus stripping the Court of Chancery of subject matter jurisdiction.

   Facts

8. Defendant below-appellee Cyrus A. Jaffari is the president of Malek, Inc., a California Corporation. Jaffari had developed an innovative, environmentally friendly alternative

9. In the mid-nineties, Elf approached Jaffari and proposed investing in his product and assisting in its marketing. Jaffari found the proposal attractive since his company, Malek, Inc., possessed limited resources and little international sales expertise. Elf and Jaffari agreed to undertake a joint venture that was to be carried out using a limited liability company as the vehicle.

10. Next, Elf, Jaffari and Malek, Inc. entered into a series of agreements providing for the governance and operation of the joint venture. Of particular importance to this litigation, Elf, Malek, Inc., and Jaffari entered into the Agreement, a comprehensive and integrated document 6 See the definition section of the statute, 6 Del. C. § 18-101(7), defining the term "limited liability company agreement" as "any agreement. . . of the . . . members as to the affairs of a limited liability company and the conduct of its business," and setting forth a nonexclusive list of what it may provide.

11. of 38 single-spaced pages setting forth detailed provisions for the governance of Malek LLC, which is not itself a signatory to the Agreement. Elf and Malek LLC entered into an Exclusive Distributorship Agreement in which Elf would be the exclusive, worldwide distributor for Malek LLC. The Agreement provides that Jaffari will be the manager of Malek LLC. Jaffari and Malek LLC entered into an employment agreement providing for Jaffari's employment as chief executive officer of Malek LLC.

12. On April 27, 1998, Elf sued Jaffari and Malek LLC, individually and derivatively on behalf of Malek LLC, in the Delaware Court of Chancery, seeking equitable remedies. Among other claims, Elf alleged that Jaffari breached his fiduciary duty to Malek LLC, pushed Malek LLC to the brink of insolvency by withdrawing funds for personal use, interfered with business opportunities, failed to make disclosures to Elf, and threatened to make poor quality maskant and to violate environmental regulations. Elf also alleged breach of contract, tortious interference with prospective business relations, and (solely as to Jaffari) fraud.

13. The court held that Elf's claims arose under the Agreement, or the transactions contemplated by the agreement, and were directly related to Jaffari's actions

    General Summary of Background of the Act

14. The Delaware Act was adopted in October 1992. The Act is codified in Chapter 18 of Title 6 of the Delaware Code. To date, the Act has been amended six times with a view to modernization. The LLC is an attractive form of business entity because it combines corporate-type limited liability with partnership-type flexibility and tax advantages. 14 See 1 Larry E. Ribstein & Robert R. Keatinge, Ribstein and Keatinge on Limited Liability Companies, § 2.02, at 2 (1998); Martin I. Lubaroff & Paul M. Altman, Delaware Limited Liability Companies, in Delaware Law of Corporations & Business Organizations, § 20.1 (R. Franklin Balotti & Jesse A. Finkelstein eds., 1998).

15. The Act can be characterized as a "flexible statute" because it generally permits members to engage in private ordering with substantial freedom of contract to govern their relationship, provided they do not contravene any mandatory provisions of the Act. 15 See 1 James D. Cox et al., Corporations, § 1.12, at 1.37-.38 (1999).

16. Indeed, the LLC has been characterized as the "best of both worlds." 16 Lubaroff & Altman, note 14, at § 20.1.

    Freedom of Contract and the LLC Agreement

17. HN2[] Section 18-1101(b) of the Act, like the essentially identical Section 17-1101(c) of the LP Act, provides that "it is the policy of [the Act] to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements." Accordingly, the following observation relating to limited partnerships applies as well to limited liability companies:

18. The Act's basic approach is to permit partners to have the broadest possible discretion in drafting their partnership agreements and to furnish answers only in situations where the partners have not expressly made provisions in their partnership agreement. Truly, the partnership agreement is the cornerstone of a Delaware limited partnership, and effectively constitutes the entire agreement among the partners with respect to the admission of partners to, and the creation, operation and termination of, the limited partnership. Once partners exercise their contractual freedom in their partnership agreement, the partners have a great deal of certainty that their partnership agreement will be enforced in accordance with its terms. 27 Martin I. Lubaroff & Paul Altman, Delaware Limited Partnerships § 1.2 (1999) (footnote omitted). In their article on Delaware limited liability companies, Lubaroff and Altman use virtually identical language in describing the basic approach of the LLC Act. Clearly, both the LP Act and the LLC Act are uniform in their commitment to "maximum flexibility." See Lubaroff & Altman, note 14, at § 20.4.

    Members as Real Parties in Interest

19. It is the members who are the real parties in interest. The LLC is simply their joint business vehicle. This is the contemplation of the statute in prescribing the outlines of a limited liability company agreement. 38 See 6 Del. C. § 18-101(7); supra note 6.

    Analysis: The Scope of Statutory Jurisdiction

20. The Court of Chancery was correct in holding that Elf's claims bear directly on Jaffari's duties and obligations under the Agreement. Thus, we decline to disturb its holding.

21. on the substance of Section 18-110(a), Elf is unable to convince this Court that the parties may not contract to avoid the applicability of Section 18-110(a). We hold that, because the policy of the Act is to give the maximum effect to the principle of freedom of contract and to the enforceability of LLC agreements, the parties may contract to avoid the applicability of Sections 18-110(a), 18-111, and 18-1001. 47 See 6 Del. C. § 18-1101(b).

22. Here, the parties contracted as clearly as practicable when they relegated to California in Section 13.7 "any" dispute "arising out of, under or in connection with [the] Agreement or the transactions contemplated by [the] Agreement . . . ." 48 Agreement, § 13.7.

Notes and Questions

1. Elf Atochem is sometimes described as establishing the "primacy of contract" in Delaware LLC law. Compare that principle with the role of the corporate charter in Delaware corporation law: the charter governs internal relationships, but shareholders cannot freely opt out of mandatory statutory provisions such as the duty of loyalty in conflict-of-interest transactions. Is the LLC model of contractual primacy better or worse for investors who lack negotiating power when they join a venture?

2. The court notes that Malek LLC was bound by the operating agreement even though it did not sign it, because the members' agreement governs "the affairs of a limited liability company and the conduct of its business." Does this reasoning mean that an LLC can never resist enforcement of an unfavorable operating agreement provision, even one that was negotiated before the LLC existed?

3. The LLC Agreement in Elf Atochem was 38 single-spaced pages. Most LLC operating agreements are far shorter, sometimes only a few pages. Consider the cases that follow in this chapter: each turns, in part, on what the operating agreement said or failed to say. What are the risks of a short operating agreement that relies heavily on statutory defaults?

4. Section 18-1001 of the Delaware Act permits a member to bring a derivative action on behalf of the LLC. The court held that the forum-selection clause in the Agreement applied to derivative claims as well as direct ones, because the derivative claim arose "under the Agreement or the transactions contemplated by the Agreement." Does this reasoning effectively allow an operating agreement to eliminate derivative litigation even where a manager has committed fraud?

II. Fiduciary Duties of LLC Managers

When a manager of an LLC engages in a transaction that benefits the manager at the expense of the LLC, the question arises: what standard of conduct applies? In the corporate context, the answer is well established: directors acting in their own interest must satisfy the entire fairness standard, which encompasses both fair dealing (fair process) and fair price. In the LLC context, the answer depends first on the operating agreement, because Delaware law permits members to modify or restrict fiduciary duties by contract. If the agreement does not expressly address the standard, courts must determine whether the agreement's language, though not using the words "entire fairness" or "fiduciary duty," nonetheless contractually imposes that standard.

Gatz Properties, LLC v. Auriga Capital Corp. addressed that interpretive question and supplied a significant holding: a contractual provision requiring arm's-length pricing for affiliated transactions was the functional equivalent of the entire fairness standard, even though the agreement nowhere used the term. The Delaware Supreme Court further held that a manager who acted in bad faith and made willful misrepresentations could not invoke the operating agreement's exculpation clause. The case illustrates how contractual language designed to govern self-dealing can be enforced as the equivalent of equitable fiduciary standards.

1. Gatz Properties, LLC and Auriga Capital Corp., together with other minority investors, formed Peconic Bay, LLC in 1997 to hold a long-term ground lease and develop a golf course on Long Island. The Gatz family, through Gatz Properties, was designated as manager and controlled over 85 percent of the Class A membership interests. In 2007, anticipating the impending termination of the golf course operator's sublease, Gatz began receiving expressions of interest from a third-party buyer, RDC Golf Group. Rather than negotiate with RDC, Gatz stonewalled the bidder, commissioned a flawed appraisal based on incomplete information, and then engineered a rigged auction at which he was the only bidder. Gatz purchased Peconic Bay for $50,000 cash plus assumption of the LLC's debt. Minority investors collectively received $20,985.

Guiding Questions

1. The LLC Agreement's Section 15 required that affiliated transactions be on terms "no less favorable to the Company than the terms and conditions of similar agreements which could then be entered into with arms-length third parties." The court held this language imposed the entire fairness standard. Is that interpretive move correct? Does the arm's-length pricing requirement also impose a fair dealing obligation, or only a fair price requirement?

2. The court states that Section 15's "safe harbor" -- a majority-of-the-minority approving vote -- would have shifted the burden of proof on fairness. Gatz did not seek minority approval. Why not? What does this tell us about the practical relationship between procedure and substantive fairness in LLC conflict-of-interest transactions?

3. Because the manager acted in bad faith and made willful misrepresentations, the court held that the LLC Agreement's exculpation clause did not protect him. What is the policy rationale for permitting exculpation in some circumstances but not others? Compare this to the limits on exculpation clauses in Delaware corporate law under Section 102(b)(7) of the DGCL.

Gatz Properties, LLC v. Auriga Capital Corp. {#gatz-properties-llc-v.-auriga-capital-corp. .Case-Name-Heading}

Supreme Court of Delaware, 59 A.3d 1206 (2012) {#supreme-court-of-delaware-59-a.3d-1206-2012 .Case-Name-Heading}

1. In resolving this dispute between the controlling member-manager and the minority investors of a Delaware Limited Liability Company ("LLC"), we interpret the LLC's governing instrument (the "LLC Agreement") as a contract that adopts the equitable standard of entire fairness in a conflict of interest transaction between the LLC and its manager. We hold that the manager violated that contracted-for fiduciary duty by refusing to negotiate with a third-party bidder and then, by causing the company to be sold to himself at an unfair price in a flawed auction that the manager himself engineered. For that breach of duty the manager is liable. Because the manager acted in bad faith and made willful misrepresentations, the LLC Agreement does not afford him exculpation.

   Factual and Procedural History

2. The instrument that governed Peconic Bay was the Amended and Restated Limited Liability Company Agreement (the "LLC Agreement"). The Gatz family and their affiliates controlled over 85% of the Class A membership interests, and over 52% of the Class B membership interests of Peconic Bay. The LLC Agreement requires that 95% of all cash distributions first be made to the Class B members until they recoup their investment. Thereafter, the cash distributions are to be made to all members pro rata.

3. The LLC Agreement designated Gatz Properties as manager. Gatz Properties

4. was managed and controlled by William Gatz ("Gatz"), who also managed, controlled, and partially owned Gatz Properties.2 Because at all relevant times William Gatz was the sole actor on behalf of Gatz Properties, this Opinion sometimes refers to Gatz Properties or the Gatz family interests as "Gatz."

5. majority membership interest approval.) To finance the golf course construction, Peconic Bay borrowed approximately $6 million, evidenced by a Note secured by the property. The LLC Agreement contemplated that Gatz Properties, as manager, would collect rent from the third-party golf course operator, make the required payments on the Note, and then distribute the remaining cash as the LLC Agreement provided.

6. On March 31, 1998, Peconic Bay entered into a sublease (the "Sublease") with American Golf Corp., a national golf course operator. The Sublease ran for a term of 35 years, but granted American Golf an early termination right after the tenth year of operation. Under the Sublease, American Golf would pay rent to Peconic Bay, starting at $700,000 per year and increasing annually by $100,000, until leveling out to $1 million per year in 2003. American Golf would also pay additional rent amounting to 5% of the revenue from its golf course operations. Under the Ground Lease between Gatz Properties and Peconic Bay, the revenue-based portion of the rent would "pass through" directly to Gatz Properties.

7. The golf course's operations were never profitable. Both sides characterized American Golf

8. In August 2007, Matthew Galvin, on behalf of RDC Golf Group, Inc. ("RDC"), contacted Gatz and expressed an interest in acquiring Peconic Bay's long-term lease. Galvin asked Gatz to permit RDC to conduct basic due diligence, and told Gatz that he was willing to enter into a confidentiality agreement. Gatz refused to provide the requested due diligence information, and moreover, criticized Galvin's gross revenue projections of $4 million as overly optimistic.

9. Nevertheless, Galvin

10. On December 29, 2007, Galvin responded that RDC "may have an interest north of $6 million," and asked Gatz to suggest a target range

11. On January 22, 2008, Galvin proposed a "Forward Lease" whereby RDC would take over the Sublease from American Golf if American Golf exercised its 2010 early termination option. RDC would maintain the Sublease's noneconomic features, but would renegotiate the rent terms. Again, Gatz made no response. The reason is that Gatz himself wanted to acquire the Sublease and Peconic Bay's other assets.

12. The proof is that one week earlier, on January 14, 2008, Gatz had written to Peconic Bay's minority investors and offered to purchase their interests for a "cash price equal to the amount which would be distributed for those interests as if [Peconic Bay's] assets sold for a cash price of $5.6 million as of today." Gatz characterized his offer as equivalent to a sale price

13. of over $6 million, by not having to pay certain related closing costs and prepayment penalties that would result if the buyer were a third party. The Gatz letter then informed the minority investors that "[n]egotiations with RDC have broken off with their best offer of $4.15 million being rejected. Offering a counter proposal of $6 million to RDC as Bill Carr suggested did not receive majority approval from the members." What Gatz did not tell the minority investors was that Galvin had expressed an interest in negotiating an offer "north of $6 million," and that Gatz had never responded. As his "bottom line," Gatz offered the minority members $734,131, conditioned on their unanimous acceptance.

14. All but one of the minority members rejected that offer. Gatz then changed strategy and hired Laurence Hirsh to appraise the property, but without giving Hirsh complete information. Gatz did not inform Hirsh of Galvin's $4.15 million offer, of Galvin's gross revenue projections of $4 million which implied a value of $6 to 8 million, or that American Golf was a "demoralized operator." As a result, Hirsh relied solely on American Golf's historical financials and data from comparable courses in

15. Assisted by Blank Rome, Gatz next hired an auctioneer in February 2009. Although Gatz claimed to have considered three different auction firms, he hired Richard Maltz of Maltz Auctions, Inc. ("Maltz"). Maltz specialized in "debt related" sales and conducted the majority of its work in connection with bankruptcy court proceedings, but had never auctioned off a golf course. Gatz and Maltz entered into an agreement in late May 2009, whereby the golf course would be marketed for 90 days, after which the auction would take place on August 18, 2009. As actually carried out, the marketing effort consisted of small-print classified advertisements in general circulation newspapers and in a few magazines,

16. online advertisements on websites, and direct mailings. At trial, Maltz was unable to produce documents or testimony evidencing the content of the direct mailings. The Court of Chancery found no credible evidence that any golf course brokers, managers, or operators had ever been contacted. The court also found that Gatz had not informed Maltz about the RDC bids or suggested that Maltz contact Galvin.6 Although Galvin did eventually learn of the auction, he decided not to bid, in part because of the auction terms.

17. On August 18, 2009, the day of the auction, Maltz informed Gatz that he (Gatz) would be the only bidder. Gatz then proceeded to bid and then to purchase Peconic Bay for $50,000 cash plus assumption of the LLC's debt. The minority members collectively received $20,985. Maltz received $80,000 for his services. At trial Gatz admitted that "had there been another bidder at the Auction, he 'might have bid higher' than $50,000."10 Auriga, 40 A.3d at 872.

19. "both his contractual and fiduciary duties" to Peconic Bay's minority members.11 Id. at 843.

20. The court awarded damages of $776,515 calculated as of January 1, 2008, plus prejudgment interest at the statutory rate, compounded monthly.12 Id. at 880.

    Analysis: Did Gatz Owe Fiduciary Duties to the Other Members?

21. A. Did Gatz Owe Fiduciary Duties To The Other Members Of Peconic Bay?

22. The pivotal legal issue presented on this appeal is whether Gatz owed contractually-agreed-to fiduciary duties to Peconic Bay and its minority investors. Resolving that issue requires us to interpret Section 15 of the LLC Agreement, which both sides agree is controlling. Section 15 pertinently provides that:

23. Neither the Manager nor any other Member shall be entitled to cause the Company to enter into any amendment

24. of any of the Initial Affiliate Agreements which would increase the amounts paid by the Company pursuant thereto, or enter into any additional agreements with affiliates on terms and conditions which are less favorable to the Company than the terms and conditions of similar agreements which could then be entered into with arms-length third parties, without the consent of a majority of the non-affiliated Members (such majority to be deemed to be the holders of 66-2/3% of all Interests which are not held by

25. The Court of Chancery determined that Section 15 imposed fiduciary duties in transactions between the LLC and affiliated persons. We agree. HN3[] To impose fiduciary standards of conduct as a contractual matter, there is no requirement in Delaware that an LLC agreement use magic words, such as "entire fairness" or "fiduciary duties." Indeed, Section 15 nowhere expressly uses either of those terms. Even so, we construe its operative language18 The operative language of Section 15 is "on terms and conditions which are less favorable to the Company than the terms and conditions of similar agreements which could then be entered into with arms-length third parties, without the consent of a majority of the non-affiliated Members".

26. as an explicit contractual assumption by the contracting parties of an obligation subjecting the manager and other members to obtain a fair price for the LLC in transactions between the LLC and affiliated persons. Viewed functionally, the quoted language is the contractual equivalent of the entire fairness equitable standard of conduct and judicial review.19 We previously have reached

27. a similar result in the partnership context. See Gotham Partners, supra, 817 A.2d at 171. In Gotham, we affirmed the Court of Chancery's finding, which the parties did not contest, that the Partnership Agreement imposed entire fairness obligations. Section 7.05 of that Agreement permitted self-dealing transactions, "provided that the terms of any such transaction are substantially equivalent to terms obtainable by the Partnership from a comparable unaffiliated third party," reflecting the fair price prong. Section 7.10, which required an independent audit committee to review and approve the self-dealing transactions, reflected the fair dealing prong. Id. The LLC Agreement language employed in this case is substantially identical. Section 15 explicitly mandates a fair price analysis, but offers as a safe harbor a majority-of-the-minority vote. We interpret that contractual obligation here, as we did in Gotham, as the contracted-for functional equivalent of entire fairness.

28. We conclude that Section 15 of the LLC Agreement, by its plain language, contractually adopts the fiduciary duty standard of entire fairness, and the "fair price" obligation which inheres in that standard. Section 15

29. imposes that standard in cases where an LLC manager causes the LLC to engage in a conflicted transaction with an affiliate without the approval of a majority of the minority members. There having been no majority-of-the-minority approving vote in this case, the burden of establishing the fairness of the transaction fell upon Gatz. That burden Gatz could easily have avoided. If (counterfactually) Gatz had conditioned the transaction upon the approval of an informed majority of the nonaffiliated members, the sale of Peconic Bay would not have been subject to, or reviewed under, the contracted-for entire fairness standard.20 That result contrasts with the outcome that it would obtain in the traditional corporate law setting, where an informed majority-of-the-minority shareholder vote operates to shift the burden of proof on the issue of fairness. Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d 1110, 1117 (Del. 1994).

30. Gatz's admissions in the pleadings and during his cross examination at trial confirm

31. our contractual interpretation. In his Answer to Auriga's First Amended Complaint, Gatz admitted four times that he owed "certain fiduciary duties."21 App. to Ans. Br. B 44 ("Admitted only that Gatz Properties is Manager of PBG and owes certain fiduciary duties as a result thereof."); id. at B 45 ("Admitted that Gatz is the manager and an equity holder of Gatz Properties. It is also admitted that Gatz Properties is Manager of PBG and owes certain fiduciary duties as a result thereof."); id. at B 46 ("Admitted that Gatz Properties is [the] Manager of PBG and owes certain fiduciary duties as a result thereof."); id. ("Admitted that Gatz Properties knew it owed fiduciary duties.").

Notes and Questions

1. The court held that Section 15's language was the "contracted-for functional equivalent of entire fairness," even though the agreement used neither that term nor the words "fiduciary duty." Is this interpretive move consistent with the plain language of the LLC Act, which requires that fiduciary duties be "provided for" in the agreement? Or is the court reading a fiduciary standard into contractual language that could have been interpreted as a simple pricing restriction?

2. Delaware's LLC Act, Section 18-1101(c), permits the operating agreement to "restrict or eliminate" fiduciary duties. Can the operating agreement also impose duties that are stricter than the fiduciary standard? For example, could an operating agreement require the manager to obtain three independent valuations and a majority-of-minority vote for any self-dealing transaction, even a minor one? What are the practical implications of that flexibility?

3. Gatz admitted in his pleadings that he owed "certain fiduciary duties." The court noted this admission four times as confirmation of its contractual interpretation. What lesson should drafters take from Gatz's admissions? How should a manager respond to a complaint that alleges fiduciary duty violations when the operating agreement does not use those words?

4. Olmstead, addressed in Section VII of this chapter, concerns a single-member LLC. How would the majority's reasoning about the charging order in that case interact with the fiduciary duty analysis in Gatz? If Gatz were the sole member, would the minority investors' claims have differed?

III. Contractual Modification of Fiduciary Duties

If the operating agreement can impose fiduciary obligations by adopting arm's-length pricing requirements, it can also modify or eliminate default fiduciary duties that members would otherwise owe one another. Ohio's LLC statute, like Delaware's, permits the operating agreement to "limit or define the scope of the fiduciary duties imposed upon its members." The critical question is how far that permission extends: can the agreement permit a member to compete directly with the LLC and take its core business opportunity?

McConnell v. Hunt Sports Enterprises answers that question in the affirmative where the operating agreement's text is sufficiently clear. The case arose from competition for a National Hockey League franchise in Columbus, Ohio, and turns on the plain language of a single provision: Section 3.3 of the Columbus Hockey Limited operating agreement. When the LLC's majority investor walked away from an arena lease the NHL required, another member stepped in and obtained the franchise himself. The court held that Section 3.3 permitted the competing member's conduct, because the language of the provision could not have been broader.

1. In 1996, the National Hockey League decided to grant new franchises. Columbus business leaders formed Columbus Hockey Limited (CHL), an Ohio LLC, to apply for a Columbus franchise. Members included John McConnell, Wolfe Enterprises, Hunt Sports Group, Pizzuti Sports, and Buckeye Hockey. CHL's operating agreement provided in Section 2.1 that the company's purpose was "to invest in and operate a franchise in the National Hockey League." The members planned to house the team in a new publicly financed arena, but the arena funding proposal failed at the ballot box in May 1997. When the NHL gave Columbus a deadline to submit a lease commitment, Hunt Sports Group rejected the arena terms negotiated by Nationwide Insurance. McConnell, persuaded that the franchise opportunity would otherwise be lost, signed the arena lease in his individual capacity, formed a new ownership group (COLHOC), and was awarded the Columbus franchise. Hunt Sports Group sued for breach of fiduciary duty.

Guiding Questions

1. Section 3.3 of the CHL operating agreement stated that members "shall not in any way be prohibited from or restricted in engaging or owning an interest in any other business venture of any nature, including any venture which might be competitive with the business of the Company." The court found this language clear and unambiguous. Is that finding persuasive? Does the word "other" in "any other business venture" imply that the competing venture must be different in kind from CHL's business, not merely a competing one?

2. The court held that Section 3.3 of an operating agreement may contractually eliminate the default fiduciary duty not to compete with one's LLC. Does the same reasoning apply in Delaware, where Section 18-1101(c) permits operating agreements to "restrict or eliminate" duties? What are the limits of that permission? Could an operating agreement authorize a manager to steal assets from the LLC?

3. Even if the operating agreement permitted McConnell to compete with CHL, he still had potential fiduciary duties as a member. The court examined those duties as well. What did the court find, and why? Consider the relationship between the contractual right to compete and the residual duty of good faith.

McConnell v. Hunt Sports Enterprises {#mcconnell-v.-hunt-sports-enterprises .Case-Name-Heading}

Court of Appeals of Ohio, Tenth District, 132 Ohio App. 3d 657 (1999) {#court-of-appeals-of-ohio-tenth-district-132-ohio-app.-3d-657-1999 .Case-Name-Heading}

The Statutory and Contractual Framework

1. An operating agreement of a limited liability company may, in essence, limit or define the scope of the fiduciary duties imposed upon its members.

2. A fiduciary has been defined as a person having a duty, created by his or her undertaking, to act primarily for the benefit of another in matters connected with such undertaking. A claim of breach of fiduciary duty is basically a claim for negligence that involves a higher standard of care. In order to recover, one must show the existence of a duty on the part of the alleged wrongdoer not to subject such person to the injury complained of, a failure to observe such duty, and an injury proximately resulting therefrom. These principles support our conclusion that a contract may define the scope of fiduciary duties between parties to the contract.

4. In general terms, members of limited liability companies owe one another the duty of utmost trust and loyalty. However, such general duty in this case must be considered in the context of members' ability, pursuant to operating agreement, to compete with the company.

   Facts

5. On June 17, 1997, John H. McConnell and Wolfe Enterprises, Inc. filed a complaint for declaratory judgment in the Franklin County Court of Common Pleas against Hunt Sports Enterprises, Hunt Sports Enterprises, L.L.C., Hunt Sports Group, L.L.C. (hereinafter collectively referred to as "Hunt Sports Group") and Columbus Hockey Limited ("CHL"). CHL was a limited liability

6. In 1996, the National Hockey League ("NHL") determined it would be accepting applications for new hockey franchises. In April 1996, Gregory S. Lashutka, the mayor of Columbus, received a phone call from an NHL representative inquiring as to Columbus's interest in a hockey team. As a result, Mayor Lashutka asked certain community leaders who had been involved in exploring professional sports in Columbus to pursue the possibility of applying for an NHL hockey franchise. Two of these persons were Ronald A. Pizzuti and Mr. McConnell.

7. Mr. Pizzuti began efforts to recruit investors in a possible franchise. Mr. Pizzuti approached Lamar Hunt, principal of Hunt Sports Group, as to Mr. Hunt's interest in investing in such a franchise for Columbus. Mr. Hunt was already the operating member of the Columbus Crew, a professional soccer team whose investors included Hunt Sports Group, Pizzuti, Mr. McConnell, and Wolfe Enterprises, Inc. Mr. Hunt expressed an interest in participating in a possible franchise. The deadline for

8. On October 31, 1996, CHL was formed when its articles of organization were filed with the secretary of state pursuant to R.C. 1705.04. The members of CHL were Mr. McConnell, Wolfe Enterprises, Inc., Hunt Sports Group, Pizzuti Sports Limited, and Buckeye Hockey, L.L.C. 1 In its answer and counterclaim, Hunt Sports Group averred that Ameritech was also a member of CHL. Ameritech's name does not appear on Schedule A of the operating agreement; however, the record reflects that Ameritech contributed $ 25,000 to CHL and was considered a member of CHL. (August 13, 1997 deposition of Ronald A. Pizzuti, p. 36-37.) Ameritech's membership status is not an issue in this appeal.

9. forth the terms between the members. Pursuant to section 2.1 of CHL's operating agreement, the general character of the business of CHL was to invest in and operate a franchise in the NHL.

10. On May 6, 1997, the sales tax issue failed. The day after, Mayor Lashutka met with Mr. Hunt, and other opportunities were discussed. The mayor also spoke with Gary Bettman, commissioner of the NHL, and they discussed whether or not an alternate plan for an arena was possible. Also on May 7, 1997, Dimon McPherson,

11. chairman and chief executive officer of Nationwide Insurance Enterprise ("Nationwide"), met with Mr. Hunt, and they discussed the possibility of building the arena despite the failure of the

12. Mr. McConnell stated that if Mr. Hunt would not step up and lease the arena and, therefore, get the franchise, Mr. McConnell would. Hunt Sports Group did not contact Nationwide on May 30, 1997.

13. Mr. Hunt indicated the lease was unacceptable. Ameritech and Buckeye Hockey, L.L.C. indicated that if Mr. Hunt found it unacceptable then they too found it unacceptable. Mr. Pizzuti and Mr. Wolfe agreed to participate along with Mr. McConnell. John Christie, president of JMAC, Inc., the personal investment company of the McConnell family, left the meeting and joined Mr. Ellis. Mr. Christie informed Mr. Ellis that Mr. McConnell had accepted the term sheet and was signing it in his individual capacity. The term sheet contained a signature line for "Columbus Hockey Limited"

14. as the franchise owner. Mr. Ellis phoned his secretary and had her omit the name "Columbus Hockey Limited" on her computer from under the signature line and fax the change to Mr. Ellis at Mr. Pizzuti's office. Mr. McConnell then signed the term sheet as the owner of the franchise. Mr. Christie faxed the signed lease term sheet to Mr. Bettman that day along with a cover letter and a description of the ownership group. Such ownership group was identified as: John H. McConnell, majority owner, Pizzuti Sports, L.L.C., John F. Wolfe and "up to seven (7) other members." The cover letter indicated that the attached material signified an amendment to the November 1, 1996 application from the city.

15. On June 17, 1997, the NHL expansion committee recommended to the NHL board of governors that Columbus be awarded a franchise with Mr. McConnell's group as owner of the franchise. On this same date, the complaint in the case at bar was filed. On or about June 25, 1997, the NHL board of governors awarded Columbus a franchise with Mr. McConnell's group as owner. 2 The ownership group is now formally known as COLHOC Limited Partnership ("COLHOC"). Portions of the record indicate COLHOC was formed before the June 9, 1997 meeting. JMAC, Inc. is the majority owner, and JMAC Hockey L.L.C. is the general partner of COLHOC. JMAC Hockey L.L.C. signed the general partnership agreement on June 26, 1997.

16. Hunt Sports Group, Buckeye Hockey, L.L.C. and Ameritech have no ownership interest in the hockey franchise.

    Analysis: The Meaning of Section 3.3

17. shown the parties did not intend section 3.3 to mean members could compete against CHL and take away CHL's only purpose.

18. Section 3.3 of the operating agreement states:

19. Members May Compete. Members shall not in any way be prohibited from or restricted in engaging or owning an interest in any other business venture of any nature, including any venture which might be competitive with the business of the Company *** .

20. Appellant's interpretation of section 3.3 goes beyond the plain language of the agreement and adds words or meanings not stated in the provision. Section 3.3, for example, does not state "members shall not be prohibited from or restricted in engaging or owning an interest in any other business venture that is different from the business of the company." Rather, section 3.3 states: " *** any other business venture of any nature *** ." (Emphasis added.) It then adds to this statement: " *** including any venture which might be competitive with the business of the Company *** ." The words "any nature" could not be broader, and the inclusion of the words " *** any venture which might be competitive with the business of the Company *** " makes it clear that members were not prohibited from engaging in a venture that was competitive with CHL's investing

21. in and operating an NHL franchise. Contrary to appellant's contention, the word "other" simply means a business venture other than CHL. The word "other" does not limit the type of business venture in which members may engage.

22. Hence, section 3.3 did not prohibit appellees from engaging in activities that may have been competitive with CHL, including appellees' participation in COLHOC. Accordingly, summary judgment in favor of appellees was appropriate, and appellees were entitled to a declaration that section 3.3 of the operating agreement

23. permitted appellees to request and obtain an NHL hockey franchise to the exclusion of CHL.

24. In summary, there are no genuine issues of material fact, appellees are entitled to judgment as a matter of law and reasonable minds could only conclude that section 3.3 of the operating agreement allowed appellees to request and obtain an NHL franchise to the exclusion of CHL, Mr. McConnell did not breach the operating agreement by forming COLHOC and competing against CHL, and Mr. McConnell did not breach the operating agreement for allegedly

25. refusing to call for or provide additional capital for CHL. Therefore, summary judgment in favor of appellees on count one of the first amended complaint and on counts one and three of appellant's counterclaim was appropriate.

Notes and Questions

1. The court held that Section 3.3's language "could not be broader" in permitting members to compete. After McConnell, what language would a careful drafter use to prevent members from competing? What language would a careful drafter use to ensure that members may compete even more broadly? Is there any competitive conduct that cannot be permitted by operating agreement?

2. The operating agreement in McConnell was not drafted with the NHL franchise opportunity in mind. The court found that its plain language, applied to unexpected circumstances, permitted McConnell to take the very business CHL was formed to pursue. Is this a good outcome from a contractual standpoint? What does it suggest about the importance of drafting for specific contingencies?

3. McConnell v. Hunt Sports illustrates the difference between a right to compete and an obligation of disclosure. Even if Section 3.3 permitted McConnell to pursue the franchise, did he have a duty to disclose to the other members what he was planning? Consider how the doctrine of the implied covenant, addressed in the next section, might apply.

4. Ohio's LLC statute provides that the operating agreement may "limit or define the scope of the fiduciary duties imposed upon its members." Delaware's Section 18-1101(c) permits the operating agreement to "restrict or eliminate" fiduciary duties. Is there a meaningful difference between "limit and define" and "restrict or eliminate"? Consider how a court applying Delaware law might decide McConnell differently.

IV. Manager Authority and the Duty of Loyalty

The operating agreement of a manager-managed LLC vests broad authority in the manager to conduct the LLC's business without calling a members' meeting. Delaware's LLC Act, Section 18-404(d), further provides that managers may act by written consent without prior notice and without a meeting when the managers having the minimum required votes sign a written consent. This mechanism facilitates efficient decision-making in closely held ventures where calling formal meetings is impractical.

But the written consent mechanism can be abused. VGS, Inc. v. Castiel confronted exactly that scenario: two of three managers used the written consent mechanism in secret, without notice to the third manager, to merge the LLC into a corporation that stripped the majority investor of control. Vice Chancellor Steele held that while a majority of the Board technically had authority to act by written consent without notice under the statute, the two managers who did so breached their duty of loyalty to the LLC and to Castiel, the controlling investor, by acting clandestinely in circumstances where they knew advance notice would have allowed Castiel to protect his majority interest.

1. David Castiel formed Virtual Geosatellite LLC to pursue a Federal Communications Commission license to operate a satellite communications system. Virtual Geosatellite Holdings, Inc. ("Holdings"), controlled by Castiel, initially held the sole membership interest. Ellipso, Inc., also controlled by Castiel, and Sahagen Satellite Technology Group LLC, controlled by Peter Sahagen, later joined as members. Pursuant to the LLC Agreement, Holdings owned 63.46 percent of the equity, Sahagen Satellite owned 25 percent, and Ellipso owned 11.54 percent. Castiel, as controlling equity holder, had the power to appoint two of the three managers on the Board of Managers. Ultimately Castiel and Sahagen disagreed about strategy, and Sahagen convinced Quinn, Castiel's own appointee, to join him in merging the LLC into VGS, Inc. They acted by written consent without notifying Castiel, who would have removed Quinn before the merger if he had known.

Guiding Questions

1. The court reads Section 18-404(d) in light of the equitable maxim that "equity looks to the intent rather than to the form." Is that approach consistent with the statute's plain text, which says that managers "may take such action without a meeting, without prior notice and without a vote"? What is the purpose of the "without prior notice" language?

2. The court holds that the written consent procedure is appropriate for "a constant or fixed majority" but not for an "illusory, will-of-the-wisp majority which would implode should notice be given." Is that distinction workable? How does a manager know in advance whether the majority is "constant or fixed"?

3. VGS illustrates that the operating agreement's governance structure can be exploited by a minority investor who recruits a manager appointed by the majority. How should a majority investor protect against this risk in drafting the operating agreement? Consider what provisions Castiel might have demanded.

VGS, Inc. v. Castiel {#vgs-inc.-v.-castiel .Case-Name-Heading}

Court of Chancery of Delaware, 2000 Del. Ch. LEXIS 122 (Aug. 31, 2000) {#court-of-chancery-of-delaware-2000-del.-ch.-lexis-122-aug.-31-2000 .Case-Name-Heading}

Memorandum Opinion

1. One entity controlled by a single individual forms a one "member" limited liability company. Shortly thereafter, two other entities, one of which is controlled by the owner of the original member,

2. become members of the LLC. The LLC Agreement creates a three-member Board of Managers with sweeping authority to govern the LLC. The individual owning the original member has the authority to name and remove two of the three managers. He also acts as CEO. The unaffiliated third member becomes disenchanted with the original member's leadership. Ultimately the third member's owner, also the third manager, convinces the original member's owner's appointed manager to join him in a clandestine strategic move to merge the LLC into a Delaware corporation. The appointed manager and the disaffected third member do not give the original member's owner, still a member of the LLC's board of managers, notice of their strategic move. After the merger, the original member finds himself relegated to a minority position in the surviving corporation. While a majority of the board acted by written consent, as all involved surely knew, had the original member's manager received notice beforehand that his appointed manager contemplated action against his interests he would have promptly attempted to remove him. Because the two managers acted without notice to the third manager under circumstances where

3. they knew that with notice that he could have acted to protect his majority interest, they breached their duty of loyalty to the original member and their fellow manager by failing to act in good faith. The purported merger must therefore be declared invalid.

4. The parties tried this case from June 15, 2000 through June 23, 2000. In further detail below, I describe the case's relevant facts and explain the rationale for my ruling.

   I. Facts

5. David Castiel formed Virtual Geosatellite LLC (the "LLC") on January 6, 1999 in order to pursue a Federal Communications Commission ("FCC") license to build and operate a satellite system which its proponents claim could dramatically increase the "real estate" in outer space capable of transmitting high speed internet traffic and other communications. 1 In more technologically precise terms, the LLC's purpose was "to construct, launch and operate a global fixed-satellite service system employing nongeostationary satellites in subgeosynchronous elliptical orbits developing the related [ground] segment and offering the related communications services." LLC Agreement, at 15, § 4.01(a).

6. When originally formed, it had only one Member - Virtual Geosatellite Holdings, Inc. ("Holdings"). On January 8, 1999, Ellipso, Inc. ("Ellipso") joined the LLC as its second Member. Several weeks later, on January 29, 1999, Sahagen Satellite Technology Group LLC ("Sahagen Satellite") became the third Member of the LLC.

7. David Castiel controls both Holdings and Ellipso. Peter Sahagen, an aggressive and apparently successful venture capitalist, controls Sahagen Satellite.

8. Pursuant to the LLC Agreement, Holdings received 660 units (representing 63.46% of the total equity in the LLC), Sahagen Satellite received 260 units (representing 25%), and Ellipso received 120 units (representing 11.54%). The founders vested management of the LLC in a Board of Managers. As the majority unitholder, Castiel had the power to appoint, remove, and replace two of the three members of the Board of Managers. Castiel, therefore, had the power to prevent any Board decision with which he disagreed. Castiel named himself and Tom Quinn to the Board of Managers. Sahagen named himself as the third member of the Board.

9. Not long after the formation of the LLC, Castiel and Sahagen were at odds. Castiel contends that Sahagen wanted to control the LLC ever since he became involved, and that Sahagen repeatedly offered, unsuccessfully, to buy control of the LLC. Sahagen maintains that Castiel ran the LLC so poorly that its mission had become untracked, additional necessary capital could not be raised, and competent managers could

10. not be attracted to join the enterprise. Further, Sahagen claims that Castiel directed LLC assets to Ellipso in order to prop up a failing, cash-strapped Ellipso. At trial, these issues and other similar accusations from both sides were explored in great detail. For our purposes here, all that need be concluded is the unarguable fact that Castiel and Sahagen had very different ideas about how the LLC should be managed and operated.

11. Sahagen ultimately convinced Quinn that Castiel must be ousted from leadership in order for the LLC to prosper. As a result, Quinn (Castiel's nominee) covertly "defected" to Sahagen's camp, and he and Sahagen decided to wrest control of the LLC from Castiel. Many LLC employees and even some of Castiel's lieutenants testified that they believed it to be in the LLC's best interest to take control from Castiel.

12. On April 14, 2000, without notice to Castiel, Quinn and Sahagen acted by written consent to merge the LLC under Delaware law into VGS, Inc. ("VGS"), a Delaware corporation. Accordingly, the LLC ceased to exist, its assets and liabilities passed to VGS, and VGS became the LLC's legal successor-in-interest. VGS's Board of Directors is comprised of Sahagen,

13. Quinn, and Neel Howard. Of course, the incorporators did not name Castiel to VGS's Board.

14. On the day of the merger, Sahagen executed a promissory note to VGS in the amount of $ 10 million plus interest. In return, he received two million shares of VGS Series A Preferred Stock. VGS also issued 1,269,200 shares of common stock to Holdings, 230,800 shares of common stock to Ellipso, and 500,000 shares of common stock to Sahagen Satellite. Once one does the math, it is apparent that Holdings and Ellipso went from having a 75% controlling combined ownership interest in the LLC to having only a 37.5% interest in VGS. On the other hand, Sahagen and Sahagen Satellite went from owning 25% of the LLC to owning 62.5% of VGS.

15. There can be no doubt why Sahagen and Quinn, acting as a majority of the LLC's board of managers did not notify Castiel of the merger plan. Notice to Castiel would have immediately resulted in Quinn's removal from the board and a newly constituted majority which would thwart the effort to strip Castiel of control. Had he known in advance, Castiel surely would have attempted to replace Quinn with someone loyal to Castiel who would agree with his views. Clandestine machinations

16. were, therefore, essential to the success of Quinn and Sahagen's plan.

    II. Analysis: A. The Board of Managers Did Have Authority to Act by Majority Vote

17. A. The Board of Managers did have authority to act by majority vote.

18. Section 8.01(b)(i) of the LLC Agreement states that, "the Board of Managers shall initially be composed of three (3) Managers." Sahagen Satellite has the right to designate one member of the initial board, and if the Board of Managers increased in number, Sahagen Satellite could "designate a number of representatives on the Board of Managers that is less than Sahagen's then current Percentage Interest." 2 LLC Agreement, at § 8.01 (b)(i).

19. If unanimity were required, the number of managers would be irrelevant - Sahagen, and his minority interest, would have veto power in any event. The existence of language in the LLC Agreement discussing expansion of the Board is therefore quite

20. telling.

21. Also persuasive is the fact that Section 8.01(c) of the LLC Agreement, entitled "Matters Requiring Consent of Sahagen," provides that Sahagen's approval is needed for a merger, consolidation, or reorganization of the LLC. If a unanimity requirement indeed existed, there would have been no need to expressly list matters on which Sahagen's minority interest had veto power.

22. Section 12.01(a)(i) of the LLC Agreement also supports Sahagen's argument. This section provides that the LLC may be dissolved by written consent by either the Board of Managers or by Members holding two-thirds of the Common Units. The effect of this Section is to allow any combination of Holdings and Sahagen Satellite, or Holdings and Ellipso, as Members, to dissolve the LLC. It seems unlikely that the Members designed the LLC Agreement to permit Members holding two-thirds of the Common Units to dissolve the LLC but denied their appointed Managers the power to reach the same result unless the

23. Castiel takes the position that while the Members can act by majority vote, the Board of Managers can act only by unanimous vote. He maintains that if the Board fails to agree unanimously on an issue the issue should be put to an LLC Members' vote with the majority controlling. The practical effect of Castiel's interpretation would be that whenever Castiel and Sahagen disagreed, Castiel would prevail because the issue would be submitted to the Members where Castiel's controlling interest would carry the vote. If that were the case, both Sahagen's Board position and Quinn's Board position would be superfluous. I am confident that the parties never intended that result, or if they had so intended, that they would have included plain and simple language in the agreement spelling it out clearly.

24. B. By failing to give notice of their proposed action, Sahagen and Quinn failed to discharge their duty of Loyalty to Castiel in good faith

    B. By Failing to Give Notice of Their Proposed Action, Sahagen and Quinn Failed to Discharge Their Duty of Loyalty to Castiel in Good Faith

25. Unless otherwise provided in a limited liability company agreement, on any matter that is to be voted on by managers, the managers may take such action

26. without a meeting, without prior notice and without a vote if a consent or consents in writing, setting forth the action so taken, shall be signed by the managers having not less than the minimum number of votes that would be necessary to authorize such action at a meeting (emphasis added).

27. Therefore, the LLC Act, read literally, does not require notice to Castiel before Sahagen and Quinn could act by written consent. The LLC Agreement does not purport to modify the statute in this regard.

28. Those observations can not complete the analysis of Sahagen and Quinn's actions, however. Sahagen and Quinn knew what would happen if they notified Castiel of their intention to act by written consent to merge the LLC into VGS, Inc. Castiel would have attempted to remove Quinn, and block the planned action. Regardless of his motivation in doing so, removal of Quinn in that circumstance would have been within Castiel's rights as the LLC's controlling owner under the Agreement.

29. Section 18-404(d) has yet to be interpreted by this Court or the Supreme Court. Nonetheless, it seems clear that HN2[] the purpose of permitting action by written consent without notice is to enable LLC managers to take

30. quick, efficient action in situations where a minority of managers could not block or adversely affect the course set by the majority even if they were notified of the proposed action and objected to it. The General Assembly never intended, I am quite confident, to enable two managers to deprive, clandestinely and surreptitiously, a third manager representing the majority interest in the LLC of an opportunity to protect that interest by taking an action that the third manager's member would surely have opposed if he had knowledge of it. HN3[] My reading of Section 18-404(d) is grounded in a classic maxim of equity - "Equity looks to the intent rather than to the form." 3 DONALD J. WOLFE, JR. & MICHAEL A. PITTENGER, CORPORATE AND COMMERCIAL PRACTICE IN THE DELAWARE COURT OF CHANCERY, at vii (1998) (listing the maxims of equity). See also Westendorf v. Gateway 2000, Del. Ch., 2000 Del. Ch. LEXIS 54, *19, C.A. No. 16913, 2000 WL 307369, at *5, Steele, V.C. (March 16, 2000) ("A long-standing equitable maxim states that equity looks to the intent rather than to the form"); Infinity Investors Limited v. Takefman, Del. Ch., 2000 Del. Ch. LEXIS 13, *16, C.A. No. 17347, 2000 WL 130622, at *5, Chandler, C. (Jan. 28, 2000) ("As equity looks to the intent rather than to the form, this Court should not permit parties to manipulate procedural rules for the purpose of avoiding resolution on the merits"); The Estate of Helen Lattimore Speare, Del. Ch., 1982 Del. Ch. LEXIS 530, *9, 2000 WL 130622, at *4, Brown, C. (Aug. 11, 1982) (quoting the maxim and citing 2 POMEROY, EQUITY JURISPRUDENCE, § 363 - § 384 (5th ed. (1941)))

31. In this hopefully unique situation, this application of the maxim requires construction of the statute to allow action without notice only by a constant or fixed majority. It can not apply to an illusory, will-of-the wisp majority which would implode should notice be given. Nothing in the statute suggests that this court of equity should blind its eyes to a shallow, too clever by half, manipulative attempt to restructure an enterprise through an action taken by a "majority" that existed only so long as it could act

32. in secrecy.

33. and Castiel, their fellow manager. Castiel or his entities owned a majority interest in the LLC and he sat as a member of the board representing entities and interests empowered by the Agreement to control the majority membership of the board. The majority investor protected his equity interest in the LLC through the mechanism of appointment to the board rather than by the statutorily sanctioned mechanism of approval by members owning a majority of the LLC's equity interests. It may seem somewhat incongruous, but this Agreement allows the action to merge, dissolve or change to corporate status to be taken by a simple majority vote of the board of managers rather than rely upon the default position of the statute which requires a majority vote of the equity interest. Instead the drafters made the critical assumption, known to all the players here, that the holder of the majority equity interest has the right to appoint and remove two managers, ostensibly guaranteeing control over a three member board. When Sahagen and Quinn, fully recognizing that this was Castiel's protection against actions adverse to his majority interest, acted in secret, without notice, they failed to discharge

34. their duty of loyalty to him in good faith. They owed Castiel a duty to give him prior notice even if he would have interfered with a plan that they conscientiously believed to be in the best interest of the LLC. 4 I make no ruling here as to whether I believe the merger and the resulting recapitalization of the LLC was in the LLC's best interests, nor do I rule here regarding the wisdom of Castiel's actions had he in fact been able to remove Quinn before the merger.

35. Instead, they launched a preemptive strike that furtively converted Castiel's controlling interest in the LLC to a minority interest in VGS without affording Castiel a level playing field on which to defend his interest. "[Another] traditional maxim of equity holds that equity regards and treats that as done which in good conscience ought to be done." 5 WOLFE & PITTENGER, supra, at § 2-3(b)(1)(i), citing 2 JOHN NORTON POMEROY, A TREATISE ON EQUITY JURISPRUDENCE § 363 et seq. (5th ed. (1941)).

36. In good conscience, under these circumstances, Sahagen and Quinn should have given Castiel prior notice.

    III. Conclusion

37. III. Conclusion

38. For the reasons stated above, I find that a majority vote of the LLC's Board of Managers could properly effect a merger. But, I also find that Sahagen and Quinn failed to discharge their duty of loyalty to Castiel in good faith by failing to give him advance notice of their merger plans under the unique circumstances of this case and the structure of this LLC Agreement. Accordingly, I declare that the acts taken to merge the LLC into VGS, Inc. to be invalid and the merger

Notes and Questions

1. Vice Chancellor Steele reads Section 18-404(d) to allow action without notice only by a "constant or fixed majority." This reading adds a gloss to the statute's text. Is it a legitimate exercise of equity jurisdiction, or does it effectively rewrite the written consent provision? How should the Delaware General Assembly respond if it disagrees with the court's interpretation?

2. The court holds that Sahagen and Quinn breached their duty of loyalty to Castiel by failing to give advance notice. But notice would have allowed Castiel to remove Quinn -- an act that would itself have been contested. The court says it makes no ruling on whether the merger was in the LLC's best interests. Does this approach leave the underlying dispute unresolved? What should happen next?

3. VGS illustrates that a majority investor who protects control through the power to appoint and remove managers is vulnerable to losing that protection if an appointed manager defects. How should a majority investor structure the LLC to protect against that risk? Consider what provisions Castiel might have negotiated that could have prevented what happened.

4. Compare the duty analysis in VGS with the analysis in Gatz Properties. In Gatz, the manager owed duties because the operating agreement contractually imposed them. In VGS, the managers owed duties under the LLC Act's default fiduciary rules. Which source of duty is more reliable as a protection for minority investors?

V. The Implied Covenant of Good Faith and Fair Dealing

Delaware law and most state LLC statutes preserve one protection that the operating agreement cannot eliminate: the implied covenant of good faith and fair dealing. The implied covenant fills contractual gaps; it supplies terms the parties would have agreed to had they considered the issue during their original negotiations. It is not a free-floating duty and does not ask what is fair given the parties' current circumstances. Rather, it asks what they would have agreed to ex ante, when the agreement was first made. The LLC Act, Section 18-1101(c), explicitly provides that the operating agreement "may not eliminate the implied contractual covenant of good faith and fair dealing."

Gerber v. Enterprise Products Holdings, LLC illustrates both the power and the limits of the implied covenant in a highly contractualized limited partnership context (the principles are identical for LLCs under Section 17-1101(d), which contains the same preservation of the implied covenant). Enterprise Products GP, the general partner, had negotiated a limited partnership agreement that replaced fiduciary duties with a contractual good faith standard, created a Special Approval process for conflict-of-interest transactions, and established a "conclusive presumption of good faith" when the general partner relied on expert opinion. The Delaware Supreme Court held that Section 17-1101(d) preserved the implied covenant absolutely, but that the covenant's gap-filling function left it unable to override an express contractual provision covering the same ground.

1. EPE was a Delaware limited partnership engaged in the oil and gas business. Its limited partnership agreement had been carefully negotiated to eliminate traditional fiduciary duties and replace them with a contractual good faith standard. Gerber, an EPE limited partner, challenged two transactions: a 2009 sale of Teppco GP (a general partner entity) by EPE to Enterprise Products LP, and a 2010 merger of EPE into Enterprise Products LP. Both transactions involved Dan Duncan, who controlled EPE, Enterprise Products GP, and Enterprise Products LP simultaneously, creating a conflict of interest. The transactions received "Special Approval" from an independent committee, which in turn relied on fairness opinions from Morgan Stanley. Gerber alleged that the Morgan Stanley opinions were inadequate and that the general partner acted in bad faith.

Guiding Questions

1. The court holds that the implied covenant cannot be eliminated by the operating agreement, even indirectly through a "conclusive presumption of good faith" that renders the covenant practically unenforceable. How can a provision be prohibited by statute if it is permitted by contract? Consider the difference between "eliminating" and "making practically unenforceable."

2. The court describes the implied covenant as a "gap filler" that asks what the parties would have agreed to had they addressed the issue when they were originally bargaining. How does a court reconstruct what sophisticated parties would have agreed to in a transaction they did not foresee? Is the test objective or subjective?

3. The court notes that the investor who accepted the contractualized LPA was "charged with having assessed and accepted the risks of putting his money in an entity without the comfort afforded by fiduciary duties." Is that assumption realistic for public investors who did not negotiate the partnership agreement? What institutional protections substitute for fiduciary duties in publicly traded limited partnerships?

Gerber v. Enterprise Products Holdings, LLC {#gerber-v.-enterprise-products-holdings-llc .Case-Name-Heading}

Supreme Court of Delaware, 67 A.3d 400 (2013) {#supreme-court-of-delaware-67-a.3d-400-2013 .Case-Name-Heading}

1. The plaintiff, Joel A. Gerber, held limited partnership units ("LP units") of Enterprise GP Holdings, L.P., a Delaware limited partnership ("EPE"). Gerber brought this action in the Court of Chancery on behalf of two classes of former public holders of LP units of EPE. On behalf of the first class ("Class I"), Gerber challenged the sale by EPE in 2009 of Texas Eastern Products Pipeline Company, LLC ("Teppco GP") to Enterprise Products Partners, L.P. ("Enterprise Products LP") (the "2009 Sale"). On behalf of the second class ("Class II"), Gerber challenged the triangular merger in 2010 of EPE into a wholly-owned subsidiary of Enterprise Products LP (the "2010 Merger").1 Class I includes all public holders of EPE LP units who continuously

2. held their units from the date of the 2009 Sale through the date of the 2010 Merger. Class II includes all public holders of EPE LP units on the effective date of the 2010 Merger.

   Statutory Framework

3. HN1[] Section 17-1101(d) of the DRULPA provides that a general partner's duties to a limited partnership or its unitholders, including fiduciary duties, "may be expanded or restricted or eliminated by provision in the [limited] partnership agreement; provided that the [limited] partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing."13 Id. § 17-1101(d).

5. which EPE's general partner and EPE's other fiduciaries would otherwise have been subject. Section 7.9(b) of the LPA expressly provided that the conduct of the general partner or any of its "Affiliates" must be in "good faith," defined as a "belie[f] that the determination or other action is in the best interests of the Partnership":

6. Whenever the General Partner makes a determination or takes or declines to take any other action, or any of its Affiliates causes it to do so, . . . then unless another express standard is provided for in this Agreement, the General Partner, or such Affiliates causing it to do so, shall make such determination or take or decline to take such other action in good faith, and shall not be subject to any other or different standards imposed by this Agreement, any other agreement contemplated hereby or under the Delaware Act or any other law, rule or regulation or at equity. In order

7. for a determination or other action to be in "good faith" for purposes of this Agreement, the Person or Persons making such determination or taking or declining to take such other action must believe that the determination or other action is in the best interests of the Partnership.14 Italics

   The Implied Covenant: Standards and Limits

8. The temporal focus is critical. HN5[] Under a fiduciary duty or tort analysis, a court examines the parties as situated at the time of the wrong. The court determines whether the defendant owed the plaintiff a duty, considers the defendant's obligations (if any) in light of that duty, and then evaluates whether the duty was breached.

9. acted fairly when engaging in the challenged transaction as measured by duties of loyalty and care whose contours are mapped out by Delaware precedents. It is rather a commitment to deal "fairly" in the sense of consistently with the terms of the parties' agreement and its purpose. Likewise HN8[] "good faith" does not envision

10. loyalty to the contractual counterparty, but rather faithfulness to the scope, purpose, and terms of the parties' contract. Both necessarily turn on the contract itself and what the parties would have agreed upon had the issue arisen when they were bargaining originally.

11. The retrospective focus applies equally to a party's discretionary rights. HN9[] The implied covenant requires that a party refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of its bargain. HN10[] When exercising a discretionary right, a party to the contract must exercise its discretion reasonably. The contract may identify factors that the decision-maker can consider, and it may provide a contractual standard for evaluating the decision. HN11[] Express contractual provisions always supersede the implied covenant, but even the most carefully drafted agreement will harbor residual nooks and crannies for the implied covenant to fill. In those situations, what is "arbitrary" or "unreasonable"—or conversely "reasonable"—depends on the parties' original contractual expectations, not a "free-floating" duty applied at the time of the wrong.47 Id. (italics added) (footnotes, citations, and internal quotations omitted).

    The Gap-Filler Doctrine and the Command of Section 1101(d)

12. That reasoning does not parse. HN13[] The statute explicitly prohibits any partnership agreement provision that eliminates the implied covenant. It creates no exceptions for contractual eliminations

13. Suppose that Section 7.10(b) of the LPA provided (instead of its actual language) that "no Partner, or Affiliate of any Partner, shall have any duty, arising out of the implied covenant of good faith and fair dealing, to act in good faith; nor shall a claim that any such duty was breached be enforceable in any court of law or equity." It cannot seriously be argued that that provision (as worded) would survive scrutiny under Section 1101(d) of the DRULPA. In every meaningful sense, that hypothetical LPA provision "eliminates" the implied covenant—a result that the statute plainly proscribes. Under the court's reasoning, however, that (hypothetical) provision would pose no legal obstacle, because it creates an "express right" not to be subject

    The Conclusive Presumption Problem

14. GP breached the implied covenant, that claim [was also] precluded by Section 7.10(b) of the LPA."31 2012 Del. Ch. LEXIS 5, [WL] at *13. The Vice Chancellor went further, by suggesting that the implied covenant could not be invoked despite 6 Del. C. § 17-1101(d), which provides that a "partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing." 2012 Del. Ch. LEXIS 5, [WL] at *13 n.58 (quoting 6 Del. C. § 17-1101(d)). The reason (the court stated) is that the implied covenant is only a "gap filler" that cannot form the basis of a claim based on conduct expressly authorized by a limited partnership agreement. Id. Because Enterprise Products GP had an "express contractual right" to rely upon the opinion of an expert and be conclusively presumed to have acted in good faith, the court could not "infer language that contradicts

15. a clear exercise of that right." 2012 Del. Ch. LEXIS 5, [WL] at *13 (quoting Nemec v. Shrader, 991 A.2d 1120, 1127 (Del. 2010)) (internal quotations omitted). For the reasons discussed in Part IV.A of this Opinion, we reject that reasoning and conclusion.

16. Because the Complaint did not allege a legally sufficient underlying primary claim for breach of a contractual duty or the implied covenant against Enterprise Products GP or its Affiliates regarding the 2009 Sale, the court determined that the secondary liability claims alleged against the remaining Defendants—tortious interference with the LPA and aiding and abetting the general partner's claimed breaches of duty—were a fortiori also legally insufficient. Accordingly, the court dismissed those secondary liability claims as well.32 In concluding this segment of its opinion, the Court of Chancery, with commendable candor, observed that:

17. The facts of this case take the reader and the writer to the outer reaches of conduct allowable under 6 Del. C. § 17-1101. . . . Ultimately, the investor, who is charged with having assessed and accepted the risks of putting his money in an entity without the comfort afforded by fiduciary duties, is left with contractual protections,

Notes and Questions

1. The court distinguishes the implied covenant from a "free-floating duty." But if the implied covenant fills contractual gaps, and the contract was drafted by sophisticated parties who anticipated that conflicts of interest would arise and addressed them through the Special Approval process, is there truly a "gap" for the implied covenant to fill? Or does the Special Approval process itself represent a complete contractual answer to the conflict?

2. The court states that "good faith" under the implied covenant means "faithfulness to the scope, purpose, and terms of the parties' contract" -- not loyalty to the contractual counterparty. This formulation is narrower than the ordinary understanding of good faith as honesty in fact and fair dealing. How does this narrow formulation constrain the use of the implied covenant to police bad conduct?

3. Gerber involves a publicly traded limited partnership, not a closely held LLC. Would the analysis be different in a two-member LLC where one member negotiated the operating agreement and the other signed it without independent counsel? Should the implied covenant be more robust in that context?

4. Section 18-1101(c) of the Delaware LLC Act states that the operating agreement "may not eliminate the implied contractual covenant of good faith and fair dealing." After Gerber, what does this prohibition actually prevent? If a "conclusive presumption of good faith" is not an elimination of the covenant, what would be?

VI. Deadlock and Judicial Dissolution

A two-member LLC with equal voting rights and an unresolved management dispute presents a recurring problem. In corporate law, a shareholder in a closely held corporation may seek judicial dissolution on grounds of oppression or deadlock under statutes such as Section 1104 of the New York Business Corporation Law. LLC law does not import those corporate standards. New York's LLC Law, Section 702, authorizes dissolution "whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement." The critical question is what "not reasonably practicable" means, and whether deadlock alone satisfies that standard.

Matter of 1545 Ocean Avenue, LLC established the New York standard for LLC dissolution and held that deadlock is not, by itself, a basis for dissolution. The court articulated a two-part test: the petitioning member must show either that management is "unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved," or that "continuing the entity is financially unfeasible." The court grounded the analysis in the operating agreement: if the agreement provides a mechanism for unilateral action, deadlock may not prevent the LLC from functioning in conformity with its terms.

1. 1545 Ocean Avenue, LLC was formed in November 2006 to purchase a Long Island property, rehabilitate one building, and construct a second. Each of two members, Crown Royal Ventures and Ocean Suffolk Properties, contributed 50 percent of the capital and appointed one manager: King for Crown Royal, Van Houten for Ocean Suffolk. Van Houten owned his own construction company, VHC, and the managers disagreed about whether VHC should perform the work at issue. King objected to costs billed by VHC but acknowledged that the construction work was "awesome." By April 2007, King announced he wanted to withdraw from the LLC. Despite negotiations over a mutual buyout, renovation of building A continued and was nearly complete when Crown Royal filed for dissolution on grounds of deadlock. The lower court granted the petition. The Appellate Division reversed.

Guiding Questions

1. The court holds that "deadlock" -- a basis for corporate dissolution under Business Corporation Law Section 1104 -- is not an independent ground for LLC dissolution under LLC Law Section 702. What policy rationale supports treating LLCs and corporations differently on this point? Is the LLC's contractual nature sufficient justification for the stricter standard?

2. The court notes that the 1545 LLC's operating agreement permitted each manager to act unilaterally "in furtherance of the business of the entity." This provision effectively prevented deadlock by design. How should a drafter of an LLC agreement choose between requiring unanimity, majority vote, or unilateral authority for manager actions? What are the tradeoffs?

3. The court holds that a derivative claim cannot serve as the basis for dissolution "unless the wrongful acts of a managing member which give rise to the derivative claim are contrary to the contemplated functioning and purpose of the limited liability company." How does a court determine when wrongful conduct crosses that threshold? Does the answer depend on the LLC's stated purpose?

Matter of 1545 Ocean Ave., LLC {#matter-of-1545-ocean-ave.-llc .Case-Name-Heading}

Appellate Division, Second Department, New York, 72 A.D.3d 121 (2010) {#appellate-division-second-department-new-york-72-a.d.3d-121-2010 .Case-Name-Heading}

1. On this appeal, we are asked to determine whether the Supreme Court properly granted the petition of Crown Royal Ventures, LLC (hereinafter Crown Royal), to dissolve 1545 Ocean Avenue, LLC (hereinafter 1545 LLC). For the following reasons, we

2. answer in the negative and reverse the order of the Supreme Court.

   I. Facts

3. 1545 LLC was formed in November 2006 when its articles of organization were filed with the Department of State. On November 15, 2006 two membership certificates for 50 units each were issued respectively to Crown Royal and the appellant, Ocean Suffolk Properties, LLC (hereinafter Ocean Suffolk).

4. On the same date that the membership certificates were issued, an operating agreement was executed by Ocean Suffolk and Crown Royal. The operating agreement provided for two managers: Walter T. Van Houten (hereinafter Van Houten), who was a member of Ocean Suffolk, and John J. King, who was a member of Crown Royal. Each member of 1545 LLC contributed 50% of the capital which was used to purchase premises known as 1545 Ocean Avenue in Bohemia (hereinafter the property) on January 5, 2007. 1545 LLC was formed to purchase the property, rehabilitate an existing building, and build a second building for commercial rental (hereinafter buildings A and B, respectively).

5. It was agreed by Van Houten and King that they would solicit bids from third parties to perform the necessary demolition and construction work to complete the project.

6. Ocean Suffolk alleges that when there were no bona fide bidders, the managers agreed to allow VHC to perform the work, while Crown Royal maintains that VHC began demolition and reconstruction on building A without King's consent. In rehabilitating the existing building, Van Houten claims that he discovered and remediated various structural flaws with the claimed knowledge and approval of King or another member of Crown Royal.

7. King wanted architect Gary Bruno to review the blueprints upon which VHC began demolition since it had been started without the necessary building permits. In addition, King claimed that VHC did not have the proper equipment to efficiently

8. do the excavation and demolition work, causing the billing to be greater than necessary. VHC billed 1545 LLC the sum of $97,322.27 for this work. King claims that he agreed 1545 LLC would pay VHC's invoice on the condition that it would no longer unilaterally do work on the site. Notwithstanding King's demand, VHC continued working on the site. Despite

9. The Suffolk County Department of Health required an environmental review whereby a so-called "hot spot" was detected by an environmental engineering firm which proposed to remediate it for $6,500. F&E, the company recommended by Crown Royal to do the remediation work, estimated that the cost for the environmental remediation work would be about $6,675. King claims that Van Houten objected to F&E and had another firm do a separate evaluation without King's approval, while Van Houten asserts that although F&E eventually charged $8,229.63 for its work, payment to F&E by 1545 LLC was made with his approval. Moreover, Van Houten claimed that the separate evaluation was paid for by Ocean Suffolk out of its own account.

10. Following this incident, King contended that tensions between King and Van Houten escalated. King asserted that things could not continue as they were or else the project would not be finished in an economical or timely manner. King claimed that Van Houten refused to meet on a regular basis; that he proclaimed himself to be a "cowboy";

11. and that Van Houten stated he would "just get it done." Nevertheless, King acknowledged that the construction work undertaken by VHC was "awesome."

12. By April 2007, King announced that he wanted to withdraw his investment from 1545 LLC. He proposed to have all vendors so notified telling them that Van Houten was taking over the management of 1545 LLC. As a result, Van Houten viewed King as having resigned as a manager of 1545 LLC.

13. Ultimately, King sought to have Ocean Suffolk buy out Crown Royal's membership in 1545 LLC or, alternatively, to have Crown Royal buy out Ocean Suffolk. In the interim, King had his attorney send a "stop work" request to Van Houten.

14. There ensued discussions regarding competing proposals for the buyout of the interest of each member by the other. No satisfactory resolution was realized. Nevertheless, despite disagreement among the members during this difficult period, VHC

    IV. The Statutory Standard for Dissolution

15. [1] Article 7.4 of the operating agreement provides, "any matter not specifically covered by a provision of the [operating agreement], including without limitation, dissolution of the Company, shall be governed by the applicable provisions of the Limited Liability Company Law." Accordingly, dissolution of 1545 LLC is governed by Limited Liability Company Law article VII.

16. III

17. This proceeding was commenced by order to show cause and verified petition seeking the dissolution of 1545 LLC and related relief. The sole ground for dissolution cited by Crown Royal is deadlock between the managing members arising from Van Houten's alleged violations of

18. Limited Liability Company Law § 702 provides for judicial

19. dissolution as follows:

20. HN1[] "On application by or for a member, the supreme court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement" (emphasis added).

21. The Limited Liability Company Law came into being in 1994. Many of its provisions were amended in 1999 (L 1999, ch 420) to track changes in federal tax code treatment of such entities (see Peter A. Mahler, When Limited Liability Companies Seek Judicial Dissolution, Will the Statute Be Up to the Task?, 74 NY St BJ 5 [June 2002]). Such amendments included changes in how the withdrawal of a member was to be treated (Limited Liability Company Law § 606) and events of dissolution which relate back to the operating agreement (Limited Liability Company Law § 701).

22. Although various provisions of the Limited Liability Company Law were amended, Limited Liability Company Law § 702 was neither modified nor amended in 1999. HN2[] In declining to amend Limited Liability Company Law § 702, the Legislature can only have intended the dissolution standard therein provided to remain the sole basis for judicial dissolution of a limited liability company (see McKinney's Cons Laws of NY, Book 1, Statutes §§ 74, 153, 191). Phrased

23. differently, since the Legislature, in determining the criteria for dissolution of various business entities in New York, did not cross-reference such grounds from one type of entity to another, it would be inappropriate for this Court to import dissolution grounds from the Business Corporation Law or Partnership Law to the Limited Liability Company Law.

24. [2] In the absence of applying Business Corporation Law or Partnership Law dissolution factors to the analysis of what is "not reasonably practicable," the standard for dissolution under Limited Liability Company Law § 702 remains unresolved in New York. However, Limited Liability Company HN8[] Limited Liability Company Law § 702 is clear that unlike the judicial dissolution standards in the Business Corporation Law and the Partnership Law, the court must first examine the limited liability company's operating agreement (see Matter of Spires v Lighthouse Solutions, LLC, 4 Misc 3d at 432) to determine, in light of the circumstances presented, whether it is or is not

25. "reasonably practicable" for the limited liability company to continue to carry on its business in conformity with the operating agreement (id. at 433). Thus, the dissolution of a limited liability company under Limited Liability Company Law §702 is initially a contract-based analysis.

    V. Application of the Standard

26. King and Van Houten did not always agree as to the construction work to be performed on the 1545 LLC property. King claims that this forced the parties into a "deadlock." HN10[] "Deadlock" is a basis, in and of itself, for judicial dissolution under Business Corporation Law § 1104. However, no such independent ground for dissolution is available under Limited Liability Company Law § 702. Instead, the court must consider the managers' disagreement in light of the operating agreement and the continued ability of 1545 LLC to function in that context.

27. It has been suggested that judicial dissolution is only available when the petitioning member can show that the limited liability company is unable to function as intended or that it is failing financially (see Schindler v Niche Media Holdings, 1 Misc 3d 713, 716, 772 NYS2d 781 [2003]). Neither circumstance is demonstrated by the petitioner here. On

28. the contrary, the purpose of 1545 LLC was feasibly and reasonably being met.

29. Here, a single manager's unilateral action in furtherance of the business of 1545 LLC is specifically contemplated and permitted. Article 4.1 of the 1545 LLC operating agreement states: "At any time when there is more than one Manager, any one manager may take any action permitted under the Agreement, unless the approval of more than one of the Managers is expressly required pursuant to the Agreement or the Act" (emphasis added). This provision does not require that the managers conduct the business of 1545 LLC by majority vote. It empowers each manager to act autonomously and to unilaterally bind the entity in furtherance of the business of the entity. The 1545 LLC operating agreement, however, is silent as to the issue of manager conflicts. Thus, the only basis for dissolution can be if 1545 LLC cannot effectively operate under the operating agreement to meet and achieve the purpose for which it was created. In this case, that is

30. the development of the property which purpose, despite the disagreements between the managing members, was being met. As the Delaware Chancery Court noted in Matter of Arrow Inv. Advisors, LLC,

31. HN12[] "The court will not dissolve an LLC merely because the LLC has not experienced a smooth glide to profitability or because events have not turned out exactly as the LLC's owners originally envisioned;

32. such events are, of course, common in the risk-laden process of birthing new entities in the hope that they will become mature, profitable ventures. In part because a hair-trigger dissolution standard would ignore this market reality and thwart the expectations of reasonable investors that entities will not be judicially terminated simply because of some market turbulence, dissolution is reserved for situations in which the LLC's management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business, such as in the case of a voting deadlock or where the defined purpose of the entity has become impossible to fulfill …

33. Here, the operating agreement avoids the possibility of "deadlock" by permitting each managing member to operate unilaterally in furtherance of 1545 LLC's purpose.

    The Two-Part Dissolution Test

34. "not reasonably practicable" standard, we hold that HN14[] for dissolution of a limited liability company pursuant to Limited Liability Company Law § 702, the petitioning member must establish, in the context of the terms of the operating agreement or articles of incorporation, that (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible.

    VI. Conclusion

35. [3] HN15[] Dissolution is a drastic remedy (see Matter of Arrow Inv. Advisors, LLC, 2009 Del Ch LEXIS 66, *2, 2009 WL 1101682, *2 [2009]). Although the petitioner has failed to meet the standard for dissolution enunciated here, there are numerous other factors which support the conclusion that dissolution of 1545 LLC is inappropriate

36. under the circumstances of this case.

Notes and Questions

1. The court applies the "not reasonably practicable" standard by looking first to the operating agreement and asking whether the LLC's purpose can still be achieved despite the members' disagreement. This is a contract-based inquiry. Should the court also consider whether the LLC has become a trap for one member -- i.e., whether one member cannot exit except at a severe economic disadvantage? Compare the buyout remedy available in corporate law under New York Business Corporation Law Section 1118.

2. The court quotes Matter of Arrow Investment Advisors, LLC, 2009 WL 1101682 (Del. Ch. 2009), for the proposition that "dissolution is reserved for situations in which the LLC's management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business, such as in the case of a voting deadlock or where the defined purpose of the entity has become impossible to fulfill." Does "voting deadlock" support dissolution without meeting the two-part test? How do you reconcile that language with the court's holding that deadlock is not an independent ground?

3. The 1545 LLC operating agreement contained a dispute resolution mechanism that Crown Royal never used. The court notes this in its analysis. What lessons should members draw about using available contractual remedies before seeking judicial dissolution? Is judicial dissolution a remedy of last resort?

4. After Matter of 1545 Ocean Avenue, what would Crown Royal have to show to obtain dissolution? Consider whether the LLC's economic situation had changed: building A was nearly complete, building B had not been started, and the members could not agree on buyout terms. Would those facts satisfy the two-part test?

VII. Creditor Rights and the Charging Order

A member's interest in an LLC has two components: economic rights (the right to receive distributions and a share of profits and losses) and governance rights (the right to participate in management). When a member's personal creditor seeks to satisfy a judgment against the member, the creditor's access to these two components is governed by the charging order mechanism, derived from partnership law. A charging order entitles the creditor to receive distributions from the LLC to which the member would otherwise be entitled, but does not give the creditor governance rights or the right to liquidate the LLC's assets. The charging order thus protects nondebtor members from having an outsider thrust into their management.

In a multi-member LLC, the charging order's protective function is clear: the nondebtor members should not be forced to share management with a stranger simply because one member has personal financial difficulties. But in a single-member LLC, there are no nondebtor members to protect. Olmstead v. FTC asked whether the charging order nonetheless remains the exclusive creditor remedy. The Florida Supreme Court held it does not: because the sole member may freely transfer the entire membership interest, a court may order the member to surrender all right, title, and interest in the LLC to satisfy a judgment, without confining the creditor to the charging order mechanism.

1. Shaun Olmstead and Julie Connell, through corporate entities, operated a credit card fraud scheme. The FTC sued and obtained a judgment for over $10 million in restitution. Among the assets subject to that judgment were several single-member Florida LLCs owned by Olmstead and Connell. The FTC obtained an order requiring the appellants to endorse and surrender their entire membership interests in the LLCs to a receiver. The Eleventh Circuit certified to the Florida Supreme Court the question of whether Florida law permitted such a remedy, or whether Section 608.433(4) of the Florida LLC Act confined the FTC to the charging order remedy.

Guiding Questions

1. The court rests its holding on the principle that the sole member of a single-member LLC may freely transfer the entire membership interest. That voluntary transfer right means that the interest is "freely and fully alienable," and therefore subject to execution under Florida's general levy-and-sale statute. Does this reasoning suggest that the charging order is a special protection for nondebtor members, not a general creditor limitation? How should multi-member LLC creditors use Olmstead's reasoning?

2. The dissent argues that the majority "crushes a very important element for all LLCs in Florida" and that its reasoning applies with equal force to multi-member LLCs, rendering all LLC assets vulnerable. Is the dissent's reading of the majority opinion correct? Does the majority's reasoning about the single-member context imply anything about multi-member LLCs?

3. The court notes the contrast between the LLC Act's charging order provision (which does not say "exclusive remedy") and Florida's partnership and limited partnership acts (which do say "exclusive remedy"). If the Florida Legislature subsequently amended the LLC Act to add the word "exclusive," how would the case be decided differently? What does this suggest about the importance of express statutory drafting?

Olmstead v. FTC {#olmstead-v.-ftc .Case-Name-Heading}

Supreme Court of Florida, 44 So. 3d 76 (2010) {#supreme-court-of-florida-44-so.-3d-76-2010 .Case-Name-Heading}

1. CANADY, J.

2. In this case we consider a question of law certified by the United States Court of Appeals for the Eleventh Circuit concerning the rights of a judgment creditor, the appellee Federal Trade Commission (FTC), regarding the respective ownership interests of appellants Shaun Olmstead and Julie Connell in certain Florida single-member limited liability companies (LLCs). Specifically, the Eleventh Circuit certified the following question: "Whether, pursuant to Fla. Stat. § 608.433(4), a court may order a judgment-debtor to surrender all 'right, title, and interest' in the debtor's

4. single-member limited liability company to satisfy an outstanding judgment." Fed. Trade Comm'n v. Olmstead, 528 F.3d 1310, 1314 (11th Cir. 2008). We have discretionary jurisdiction under article V, section 3(b)(6), Florida Constitution.

5. The appellants contend that the certified question should be answered in the negative because the only remedy available against their ownership interests in the single-member LLCs is a charging order, the sole remedy authorized by the statutory provision referred to in the certified question. The FTC argues that the certified question should be answered in the affirmative because the statutory charging order remedy is not the sole remedy available to the judgment creditor of the owner of a single-member limited liability company.

6. For the reasons we explain, we conclude that the statutory charging order provision does not preclude application of the creditor's remedy of execution on an interest in a single-member LLC. In line with our analysis, we rephrase the certified question as follows: "Whether Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor's single-member limited liability company

7. to satisfy an outstanding judgment." We answer the rephrased question in the affirmative.

   I. Background

8. The appellants, through certain corporate entities, "operated an advance-fee credit card scam." Olmstead, 528 F.3d at 1311-12. In response to this scam, the FTC sued the appellants and the corporate entities for unfair or deceptive trade practices. Assets of these defendants were frozen and placed in receivership. Among the assets placed in receivership were several single-member Florida LLCs in which either appellant Olmstead or appellant Connell was the sole member. Ultimately, the FTC obtained judgment for injunctive relief and for more than $ 10 million in restitution. To partially satisfy that judgment, the FTC obtained--over the appellants' objection--an order compelling appellants to endorse and surrender to the receiver all of their right, title, and interest in their LLCs. This order is the subject of the appeal in the Eleventh Circuit that precipitated the certified question we now consider.

   II. Analysis: A. Nature of LLCs and Charging Orders

9. A. Nature of LLCs and Charging Orders

10. rights that are related to the restrictions applicable in the partnership context. In particular, the transfer of management rights in

11. an LLC generally is restricted. This particular characteristic of LLCs underlies the establishment of the LLC charging order remedy, a remedy derived from the charging order remedy created for the personal creditors of partners. See City of Arkansas City v. Anderson, 242 Kan. 875, 752 P.2d 673, 681-683 (Kan. 1988) (discussing history of partnership charging order remedy). The charging order affords a judgment creditor access to a judgment debtor's rights to profits and distributions from the business entity in which the debtor has an ownership interest.

    B. Statutory Framework for Florida LLCs

12. HN2[] The rules governing the formation and operation of Florida LLCs are set forth in Florida's LLC Act. In considering the question at issue, we focus on the provisions of the LLC Act that set forth the authorization for single-member LLCs, the characteristics of ownership interests, the limitations on the transfer of ownership interests, and the authorization of a charging order remedy for personal creditors of LLC members.

13. HN3[] Section 608.405, Florida Statutes (2008), provides that "[o]ne or more persons may form a limited liability company." A person with an ownership interest in an LLC is described as a "member,"

14. which is defined in section 608.402(21) as "any person who has been admitted to a limited liability company as a member in accordance with this chapter and has an economic interest in a limited liability company which may, but need not, be represented by a capital account." The terms "membership interest," "member's interest," and "interest" are defined as "a member's share of the profits and losses of the limited liability company, the right to receive distributions of the limited liability company's assets, voting rights, management rights, or any other rights under this chapter or the articles of organization or operating agreement." § 608.402(23), Fla. Stat. (2008). Section 608.431 provides that "[a]n interest of a member in a limited liability company is personal property."

15. HN4[] Section 608.432 contains provisions governing the "[a]ssignment of member's interest." Under section 608.432(1), "[a] limited liability company interest is assignable in whole or in part except as provided in the articles of organization or operating agreement." An assignee, however, has "no right to participate in the management of the business and affairs" of the LLC "except as provided in the articles of

16. consent." Section 608.433(4) sets forth the provision-mentioned in the certified question--which authorizes the charging order remedy for a judgment creditor of a member:

17. On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company membership interest of the member with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of such interest. This chapter does not deprive any member of the benefit of any exemption laws applicable to the member's interest.

    D. Creditor's Remedies Against the Ownership Interest in a Single-Member LLC

18. Since the charging order remedy clearly does not authorize the transfer to a judgment creditor of all an

19. As a preliminary matter, we recognize the uncontested point that HN7[] the sole member in a single-member LLC may freely transfer the owner's entire interest in the LLC. This is accomplished through a simple assignment of the sole member's membership interest to the transferee. Since such an interest is freely and fully alienable by its owner, section 56.061 authorizes a judgment creditor with a judgment for an amount equaling or exceeding

20. HN8[] The limitation on assignee rights in section 608.433(1) has no application to the transfer of rights in a single-member LLC. In such an entity, the set of "all members other than the member assigning the interest" is empty. Accordingly, an assignee of the membership interest of the sole member in a single-member LLC becomes a member--and takes the full right, title, and interest of the transferor--without the consent of anyone other than the transferor.

21. Section 608.433(4) recognizes the application of the rule regarding assignee rights stated in section 608.433(1) in the context of creditor rights. It provides a special means--i.e., a charging order--for a creditor to seek satisfaction when a debtor's

22. Section 608.433(4)'s provision that a "judgment creditor has only the rights of an assignee of [an LLC] interest" simply acknowledges that a judgment creditor cannot defeat the rights of nondebtor members of an LLC to withhold consent to the transfer of management rights. The provision does not, however, support an interpretation which gives a judgment creditor of the sole owner of an LLC less extensive rights than the rights that are freely assignable by the judgment debtor. See In re Albright, 291 B.R. 538, 540 (D. Colo. 2003) (rejecting argument that bankruptcy trustee was only entitled to a charging order with respect to debtor's ownership interest in single-member LLC and holding that "[b]ecause there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate"); In re Modanlo, 412 B.R. 715, 727-31 (D. Md. 2006)

23. Our understanding of section 608.433(4) flows from the language of the subsection which limits the rights of a judgment creditor to the rights of an assignee but which does not expressly establish the charging order remedy as an exclusive remedy. The relevant question is not whether the purpose of the charging order provision--i.e., to authorize a special remedy designed to reach no further than the rights of the nondebtor members of the LLC will permit--provides a basis for implying an exception from the operation of that provision for single-member LLCs. Instead, the question is whether it is justified to infer that the LLC charging order mechanism is an exclusive remedy.

24. any way suggest that the charging order is an exclusive remedy.

25. In this regard, the charging order provision in the LLC Act stands in stark contrast to the charging order provisions in both the Florida Revised Uniform Partnership Act, §§ 620.81001-.9902, Fla. Stat. (2008), and the Florida Revised Uniform Limited Partnership Act, §§ 620.1101-.2205, Fla. Stat. (2008). Although the core language of the charging order provisions in each of the three statutes is strikingly similar, the absence of an exclusive remedy provision sets the LLC Act apart from the other two statutes. With respect to partnership interests, the charging order remedy is established in section 620.8504, which states that it "provides the exclusive remedy by which a judgment creditor of a partner or partner's transferee may satisfy a judgment out of the judgment debtor's transferable interest in the partnership." § 620.8504(5), Fla. Stat. (2008) (emphasis added). With respect to limited partnership interests, the charging order remedy is established in section 620.1703, which states that it "provides the exclusive remedy which a judgment creditor of a partner or transferee may use to satisfy a judgment out of the judgment

26. debtor's interest in the limited partnership or transferable interest." § 620.1703(3), Fla. Stat. (2008) (emphasis added).

27. "[W]here HN10[] the legislature has inserted a provision in only one of two statutes that deal with closely related subject matter, it is reasonable to infer that the failure to include that provision in the other statute was deliberate rather than inadvertent." 2B Norman J. Singer & J.D. Shambie Singer, Statutes and Statutory Construction § 51:2 (7th ed. 2008). "In the past, we have pointed to language in other statutes to show that the legislature 'knows how to' accomplish what it has omitted in the statute [we were interpreting]." Cason v. Fla. Dep't of Mgmt. Services, 944 So. 2d 306, 315 (Fla. 2006); see also Horowitz v. Plantation Gen. Hosp. Ltd. P'ship, 959 So. 2d 176, 185 (Fla. 2007); Rollins v. Pizzarelli, 761 So. 2d 294, 298 (Fla. 2000).

28. The same reasoning applies here. The Legislature has shown--in both the partnership statute and the limited partnership statute--that it knows how to make clear that a charging order remedy is an exclusive remedy. The existence of the express exclusive-remedy provisions in the partnership and limited partnership statutes therefore

29. In sum, we reject the appellants' argument because it is predicated on an unwarranted interpretive inference which transforms a remedy that is nonexclusive on its face into an exclusive remedy. Specifically, we conclude that there is no reasonable

    III. Conclusion

30. III. CONCLUSION

31. HN12[] Section 608.433(4) does not displace the creditor's remedy available under section 56.061 with respect to a debtor's ownership interest in a single-member LLC. Answering the rephrased certified question in the affirmative, we hold that a court may order a judgment debtor to surrender all right, title, and interest in the debtor's single-member LLC to satisfy an outstanding judgment.

Notes and Questions

1. The majority holds that a court may order the debtor to surrender all right, title, and interest in a single-member LLC. The dissent argues that this effectively liquidates the LLC's assets for the benefit of a personal creditor, obliterating the distinction between the member's personal liability and the LLC's separate obligations. Who has the better argument? Consider that the LLC's creditors still have claims against the LLC's assets after the membership interest is transferred.

2. After Olmstead, single-member LLCs in Florida are no longer reliable asset-protection vehicles for their sole members. Many states have amended their LLC statutes to add "exclusive remedy" language. Is such legislation good policy, or does it create an impenetrable shield for bad actors like Olmstead? How should legislatures balance the policy of encouraging business investment against the policy of protecting judgment creditors?

3. The charging order was originally designed to protect nondebtor partners in a partnership. In that context, forcing a creditor to become a member of a partnership without the consent of the other partners would unfairly burden innocent third parties. Does the same rationale apply to prevent a creditor from acquiring a multi-member LLC interest without the consent of the other members? Consider how you would advise a client who is the sole member of an LLC and has significant personal debts.

4. Under Olmstead's reasoning, suppose a judgment creditor of the sole member of a Florida single-member LLC seeks to satisfy a $2 million judgment. What remedies are available to the creditor? How does the analysis change if the LLC has three members with equal economic interests? Does Olmstead's rationale -- that the sole member may freely transfer the entire membership interest -- have any application in the multi-member context where nondebtor members have a cognizable interest in not having a stranger thrust into the governance of their enterprise?