In In re: Dissolution of T&S Hardwoods KD, LLC, C.A. No. 2023-0782-MTZ (Del. Ch. Jan. 20, 2023), a claim for judicial dissolution of a joint venture LLC survived a motion to dismiss challenge. The Court of Chancery, reviewing the claim under the lenient motion to dismiss standard, found that the petitioners sufficiently alleged deadlock between the LLC’s two managers, the absence of a valid exit mechanism that could resolve the deadlock, and the impracticability of carrying on the LLC’s business.
The company at issue was a joint-venture LLC created by a lumber supplier and a lumber wholesale distributor. The supplier and distributor each owned 50% of the company, and the company was manager-managed by two managers—one from the supplier and one from the distributor. Although the governing LLC agreement required the two managers to reach unanimous agreement for most company decisions, the distributor was charged with control over the company’s finances and determining how much and when to pay the supplier for lumber. The LLC agreement also included a buy/sell provision that gave a member the option to sell its stake in the company upon proper notice. In addition to a LLC agreement, the supplier and distributor entered into a joint venture agreement that outlined the nature of the relationship and various commercial terms and obligations among the company, distributor, and supplier.
The joint venture started out fruitful, but eventually the relationship between the supplier and the distributor deteriorated. Among other things, the supplier alleged that the distributor caused the company to stop paying the supplier for lumber that it would supply to the company and subsequently terminated the supplier’s viewing access to the company’s bank and loan accounts. This caused the supplier to stop providing the company with lumber altogether.
By August of 2022, the distributor had filed derivative litigation in Delaware alleging that the supplier-manager had breached fiduciary duties, and the supplier had filed its own lawsuit in Georgia alleging that the distributor-manager had breached his fiduciary duties.
In September of 2022, the company and supplier filed a petition pursuant to 6 Del. C. §18-802 seeking to dissolve the company based upon “deadlock” among the company’s managers.
The court’s analysis was guided by settled Delaware law that judicial dissolution of a Delaware LLC is granted sparingly and reserved for situations where management “has become so dysfunctional … that it is no longer practicable to operate the business.” A showing of “deadlock” between managers (or those charged with management), i.e., the inability to make decisions and take corporate action, is an instance where judicial dissolution may be available. Conversely, the court keenly acknowledged that judicial dissolution is not available merely because a LLC’s business venture is not performing as its members had hoped or expected.
The court found that the petitioners’ allegations of “extreme dysfunction” between the company’s two managers were sufficient, at the pleadings stage, to evidence deadlock. Critical to the court’s determination were allegations that the company’s two managers had stopped interacting due to their disputes and were instead litigating against one another. Their level of dysfunction was further “amplified” by the LLC agreement’s unanimity requirements.
Although Delaware law may foreclose judicial dissolution if there is an enforceable contractual exit mechanism that would fairly extract the deadlocked parties, the court found that a forced buyout was not possible in these circumstances because the buy/sell provision was optional and not mandatory. Moreover, the court found that enforcing the buy/sell option would not “equitably effect the separation of the parties” because the supplier-manager would still be personally liable as a guarantor on the company’s credit agreement.
The court further found the petitioners had made a prima facie showing of impracticability of carrying on the company’s business because the parties’ commercial arrangement was frustrated. The LLC agreement’s purpose clause was broad—providing that the company’s purpose was to “engage in any lawful activities for which limited liability companies may be formed” under Delaware’s LLC act—but the court determined that, for this specific analysis, the LLC agreement was subordinate to the joint venture agreement, the latter of which demonstrated a business purpose of operating a joint venture between the supplier and distributor based on a lumber supply and distribution arrangement between the supplier and the company. This was consistent with other Delaware authority that permits the court to consider of evidence of business purpose that is outside the organizing documents so long as the court is not speculating and especially to avoid resolving a dispute on a “technicality.”
The T&S decision is a cautionary tale of the failure to plan for the worst. While the goal of a joint venture may be to build and maintain partnerships and profitable businesses, it is still important to plan upfront in organizing documents for the very real possibility that relationships can (and do) sour. As exemplified in T&S, conflict can lead to deadlock and, taken to the extreme, forced dissolution. In particular, where management is shared and equal. Fortunately, there are numerous methods to account for and resolve conflict among management, a few of which jump from the court’s analysis in the T&S case. Consideration should be given as to whether unanimous approval by management is necessary, and if so, the extent of the decisions that should require unanimity. If unanimity is required, a negotiated and contractual resolution process may avoid log-jamming the business and avoid potential material and irreversible harm. Consideration should also be given to a mandatory buy/sell option.