The Revised Uniform Limited Liability Company Act (2006) or “RULLCA” continues to gain momentum as it spreads across the United States. Currently, fourteen states plus the District of Columbia have adopted RULLCA including California, Florida, and two of New York’s neighbors — New Jersey and Vermont. If and when adopted by Pennsylvania and Connecticut, where RULLCA legislation already has been introduced, New York will be surrounded by RULLCA jurisdictions with the exception of Massachusetts. RULLCA legislation also is pending in Illinois and South Carolina.
Of greatest interest to business divorce lawyers are (1) RULLCA’s relatively expansive grounds for judicial (involuntary) dissolution of LLCs including oppressive conduct by managers and authorizing remedies other than dissolution, i.e, buy-out, and (2) RULLCA’s provision, completely foreign to LLC laws in New York and elsewhere, authorizing judicial dissociation (expulsion) of a member under certain circumstances.
The two provisions have a lot in common. Indeed, there’s substantial overlap between the statutory grounds for dissolution and dissociation under RULLCA. A recent appellate ruling out of the District of Columbia provokes examination of the strategic choice to be made when initiating a business divorce litigation whether to pursue dissolution, dissociation, or both.
RULLCA’s Dissolution and Dissociation Statutes
LLC statutes in New York and many other non-RULLCA states provide as the sole ground for judicial dissolution that it “is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement” — essentially mimicking the limited partnership law’s counterpart provision.
RULLCA’s drafters took a less cramped approach to judicial dissolution. While preserving the not-reasonably-practicable standard from partnership law, they also imported as additional grounds for dissolution provisions drawn from statutes governing dissolution of close corporations including oppression and unlawful or fraudulent conduct. Thus RULLCA Section 701 (a) (4) defines as an event of dissolution:
(4) on application by a member, the entry by [the appropriate court] of an order dissolving the company on the grounds that:
(A) the conduct of all or substantially all the company’s activities and affairs is unlawful;
(B) it is not reasonably practicable to carry on the company’s activities and affairs in conformity with the certificate of organization and the operating agreement; or
(C) the managers or those members in control of the company:
(i) have acted, are acting, or will act in a manner that is illegal or fraudulent; or
(ii) have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the applicant . . ..
Importantly, Section 701 (a) (5) gives the court the authority to “order a remedy other than dissolution” such as buyout in cases brought under Subsection (a) (4) (C) based on illegality, fraud, or oppression, although the official comment to the provision makes clear that it is a default rule that “can be overridden by the operating agreement” and that “the members may agree to restrict or eliminate a court’s power to craft a lesser remedy, even to the extent of confining the court (and themselves) to the all-or-nothing remedy of dissolution.”
Then there’s judicial dissociation of a member, the authorization for which is found in RULLCA Section 602 (6) providing that a person “is dissociated as a member when”
(6) on application by the limited liability company or a member in a direct action under Section 801, the person is expelled as a member by judicial order because the person:
(A) has engaged or is engaging in wrongful conduct that has affected adversely and materially, or will affect adversely and materially, the company’s activities and affairs;
(B) has committed willfully or persistently, or is committing willfully or persistently, a material breach of the operating agreement or a duty or obligation under Section 409; or
(C) has engaged or is engaging in conduct relating to the company’s activities and affairs which makes it not reasonably practicable to carry on the activities and affairs with the person as a member
Two of my prior posts (here and here) discussed a pair of New Jersey appellate decisions upholding member expulsion rulings under the no-fault standard found in that state’s version of Section 602 (6) (C). The official comment to the provision, which is a default rule subject to modification or elimination in the operating agreement, cites other cases in which expulsion was ordered based on the member’s misconduct.
As mentioned above, any of the grounds for dissociation under RULLCA Section 602 (6), on the right facts, can be re-shaped as grounds for judicial dissolution under RULLCA Section 701 (a) (4) — and vice versa.
Reese v Newman
In a decision last month by the District of Columbia Court of Appeals in Reese v Newman, No. 14-CV-283 [D.C. Ct. App. Feb. 11, 2016], the court affirmed the lower court’s post-trial order which opted to dissolve the subject LLC rather than expel one of its two members, even though the jury verdict’s finding supported both remedies.
The case involves a falling out between the two owners of a construction management company, one of whom (Newman) filed an action for judicial dissolution under the D.C. Code’s analog to RULLCA Section 701 (a) (4) (C) based on allegations of oppression, breach of fiduciary duty, and fraud. The other member (Reese) opposed dissolution and counterclaimed to expel Newman under the D.C. Code’s analog to RULLCA Section 602 (6).
At trial, the jury was asked to make specific findings on the statutory grounds for dissolution based on Reese’s conduct, and for expulsion based on Newman’s conduct. The jury returned findings supporting both judicial dissolution and Newman’s dissociation. The trial judge opted to dissolve the LLC and not to expel Newman.
Reese appealed, arguing that the dissociation statute’s introductory clause (“a person shall be dissociated as a member from a limited liability company when . . .”) removes the trial court’s discretion and required it to expel Newman based on the jury’s findings. Reese also argued that the “compulsory” dissociation remedy trumps dissolution because of the dissolution statute’s provision, based on RULLCA Section 701 (a) (5), authorizing the court to order a remedy other than dissolution.
The appellate panel disagreed, pronouncing that Reese’s “interpretation places a command on the trial judge that does not exist.” First, the court held that as a matter of statutory construction, the use of the word “shall” in the dissociation statute’s introductory clause “does not require the judge to expel the member if any of the enumerated conditions are established.” Rather, the statute means that “when a judge has used her discretion to expel a member of an LLC by judicial order, under any of the enumerated circumstances . . ., that member shall be dissociated” (italics in original).
Second, the court pointed out a similarly placed use of the word “shall” in the dissolution statute which also includes the provision authorizing alternate remedies based on RULLCA 701 (a) (5). Said the court: “If that language does not make the rest of the section mandatory in the dissolution section, and we are persuaded that it does not, it cannot be said that the ‘shall’ in the introduction of the dissociation section does the opposite.”
Third, the court found solid support for its holding in the official comment to RULLCA Section 602 (6), which states that “[w]here grounds exist for both dissociation and dissolution, a court has the discretion to choose between the alternatives.” Were it otherwise, the court wrote, “when grounds for both dissolution and dissociation were present, dissolution would never be mandated by a court because dissociation of a member would always necessarily trump it.”
Reese is one of the very few available court decisions addressing the interplay between RULLCA’s dissolution and dissociation statutes. In that case one member sought dissolution and opposed dissociation; the other sought dissociation and opposed dissolution. But what about situations in RULLCA jurisdictions where one side has the option to proceed under both statutes seeking dissociation as an alternative to dissolution or vice versa?
It’s not a far-fetched scenario, particularly in an LLC with two 50% co-managing members. Following Reese‘s logic, if the petitioning member establishes grounds both for dissolution and dissociation, he or she cannot then insist that the court only grant the petitioner’s first-choice remedy. Petitioner’s counsel clearly must give forethought to these vital strategic implications of the choice of remedy. The petitioner’s strategic calculus arguably is made even more complex by the possibility under RULLCA that dissociation can be ordered as an “other remedy” available to the trial judge under Section 701 (a) (5), also keeping in mind that the effect of dissociation under RULLCA Section 603 is not buy-out but to demote the dissociated member to non-voting, non-managing holder of an economic interest in the LLC.