Last month, in Huatuco v. Satellite Healthcare, C.A. No. 8465-VCG (Del. Ch. Dec. 9, 2013)the Delaware Court of Chancery invoked that state’s “contractarian” approach to limited liability companies in dismissing a 50% member’s complaint seeking judicial dissolution of a deadlocked Delaware LLC.

The court did so based on Section 2.2 of the LLC agreement (read here), entitled “Other Member Rights,” which addressed rights to distributions of assets upon liquidation and preemptive rights, and which also included the following sentence:

“Except as otherwise required by applicable law, the Members shall only have the power to exercise any and all rights expressly granted to the Members pursuant to the terms of this Agreement.”

The court construed Section 2.2 as “reject[ing] all default rights under the [Delaware LLC] Act unless explicitly provided for in the LLC Agreement or ‘otherwise required’ by law.” While the LLC agreement included provisions for voluntary dissolution triggered by defined events, it did not include any reference to involuntary (judicial) dissolution under § 18-802 of the Delaware LLC Act. “Since the LLC Agreement does not expressly contain a right to judicial dissolution,” the court concluded, “the members effectively opted out of the statutory default contained in 6 Del. C. § 18-802.”

Huatuco builds on Chancery Court’s 2008 ruling in R&R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, 2008 WL 3846318 (Del. Ch. Aug. 19, 2008), in which the court classified § 18-802 as permissive rather than mandatory and, citing Delaware’s strong freedom-of-contract policy codified in § 18-1101(b) of the LLC Act, enforced an LLC agreement’s provision explicitly and unambiguously waiving the right to seek judicial dissolution of the LLC. (Read here my post on R&R Capital.)

The question is, does Huatuco take contractarianism too far by finding a dissolution waiver, not based on an explicit waiver as in R&R Capital, but on a provision that generally limits member “rights” to those expressly granted in the LLC agreement?

The plaintiff in Huatuco argued that Section 2.2 as a whole, including the sentence at issue, only addressed the members’ economic rights and did not address the right to seek judicial dissolution which need not be made express pursuant to Section 2.2. The court disagreed, stating that the key sentence “is not qualified by reference to ‘economic’ rights, but instead applies to ‘any and all’ rights, that is, both economic and noneconomic, including a right–or lack thereof–to seek judicial dissolution.” The court also pointed to the sentence’s reference to all rights “pursuant to the terms of this Agreement” and not, as the plaintiff suggested, solely to rights under Section 2.2.

The plaintiff also sought to distinguish his case from the explicit waiver language in the LLC agreement in the R&R Capital case, which provided:

The Members agree that irreparable damage would occur if any member should bring an action for judicial dissolution of the Company.  Accordingly each member accepts the provisions under this Agreement as such Member’s sole entitlement on Dissolution of the Company and waives and renounces such Member’s right to seek a court decree of dissolution or to seek the appointment by a court of a liquidator for the Company.

The court again disagreed, noting that the court’s finding in R&R Capital of a “knowing, voluntary and unambiguous” waiver “is unremarkable and imposes no positive burden on the moving parties to demonstrate anything other than that a binding and unambiguous contract exists between these parties, which contract rejects judicial dissolution.”

The court also rejected the plaintiff’s fallback argument, even if the language of the LLC agreement forecloses judicial dissolution, that as a matter of public policy the court should not deprive the plaintiff of such a remedy where no alternative exit options are available. Among other reasons, the court found that the plaintiff did have an alternative remedy, by suing the other 50% member for claimed breaches of the LLC agreement and, if successful in doing so, exercising his contractual right to purchase the other member’s interest in the company.

Which brings me back to the question I posed above about the breadth of Huatuco‘s contractarian approach. The argument goes something like this:

  • The fundamental right to seek judicial recourse in the context of disputes among co-owners of closely-held entities exists independent of contract.
  • The co-owners can, if they so chose, by express provision contractually waive such rights to seek judicial recourse, including judicial dissolution.
  • A contractual provision regulating the circumstances under which a voluntary dissolution can occur does not, expressly or impliedly, limit the right to seek judicial dissolution.
  • A contractual provision generally limiting the co-owners’ “rights” to those “required by law” or “expressly granted” by the contract does not, without more, constitute an express waiver of judicial dissolution, the seeking of which by judicial process does not constitute the exercise of a substantive “right.”  Rather, it is one of an assortment of equitable remedies that a court may impose under the circumstances contemplated by LLC Act § 18-802. The distinction between rights and remedies is particularly appropriate when, as provided in Section 12.13 of the Huatuco LLC agreement, the parties have agreed that “[t]he remedies under this Agreement are cumulative and do not exclude any other remedies to which any person may be lawfully entitled, whether at law or in equity, or otherwise.”
  • Were it otherwise, the co-owners would have no rights to seek judicial recourse for any breach of contractual or common-law rights or for any remedy at law or in equity unless expressly granted the right to do so in the owners’ agreement.
  • For instance, the LLC agreement in Huatuco does not include a provision expressly granting members the right to bring a derivative action on the LLC’s behalf pursuant to Delaware LLC Act § 18-1001, but I doubt anyone would argue the omission forecloses that right. Indeed, the court in Huatuco postulated the plaintiff’s right to sue to enforce a compulsory transfer of membership interest, yet the LLC agreement contains no express provision granting such right of action.
  • Waiver of the right to seek judicial dissolution therefore should be enforced only to the extent made explicit in the owners’ agreement, akin to the rule adopted in Kelly v. Blum, 2010 WL 629850, 2010 Del Ch LEXIS 37 (Del. Ch. 2010), that to be enforceable an LLC agreement’s waiver of management’s fiduciary duties must be expressed explicitly by “clear and unambiguous” provision.

At least since 2008, when the R&R Capital decision was issued, practitioners who draft Delaware LLC agreements know they can eliminate a member’s right to seek judicial dissolution by express provision. They now know, based on Huatuco, that a general limitation-of-rights clause, without even mentioning judicial dissolution, can achieve the same result. Still, given the critical importance of the right to seek judicial dissolution, I think a more prudent rule would require an express waiver.

Finally, those dealing with New York LLC agreements ought not to be overly concerned about Huatuco being followed by a New York court. First, New York’s LLC Law has no counterpart to Delaware’s codified freedom-of-contract policy. Second, around the same time as the R&R Capital decision, Nassau County Commercial Division Justice Stephen Bucaria held in Matter of Youngwall that a provision in an operating agreement waiving the right to seek judicial dissolution of a New York LLC is void and unenforceable as against public policy (read here).

Update June 7, 2014:  The Delaware Supreme Court yesterday entered a summary order affirming Chancery Court’s ruling in Huatuco (read here) solely on the ground that the lower court correctly interpreted and reconciled the LLC agreement’s several provisions addressing dissolution, withdrawal, and remedies for breach. The Court expressly declined to reach the larger issue raised on appeal, whether § 18-802 provides a non-waivable right to seek judicial dissolution, based on the plaintiff-appellant’s failure to “fairly present” the argument in the underlying Chancery Court proceedings. That issue therefore will live for another case, another day.