IN RE CARLISLE ETCETERA LLC, a Delaware limited liability company.
C.A. No. 10280-VCL
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
Date Submitted: March 9, 2015
Date Decided: April 30, 2015
LASTER, Vice Chancellor.
David J. Margules, Sean J. Bellew, Erika Caesar, BALLARD SPAHR LLP, Wilmington, Delaware; Thomas M. Wood, IV, NEUBERGER,
OPINION
In 2012, petitioner Well Union Capital Limited (―WU Parent‖) and respondent Tom James Company (―James‖) formed Carlisle Etcetera LLC, a Delaware limited liability company (―Carlisle‖ or the ―Company‖). They executed a simple form of operating agreement (the ―Initial LLC Agreement‖) in which they committed to work promptly on a more detailed operating agreement to replace the original one.
After the Company was formed, WU Parent transferred its member interest to a wholly owned subsidiary called Well Union U.S. Holdings, Inc. (―WU Sub‖). James knew about the transfer, did not object, and treated WU Sub as a member from that point on. For purposes of the Delaware Limited Liability Company Act (the ―LLC Act‖), however, the transfer rendered WU Sub an assignee, rather than a member.
WU Parent and James never reached agreement on a replacement operating agreement. Other disputes arose, and the relationship deteriorated. Deadlock prevailed at the manager level, where the Initial LLC Agreement called for a board of directors (the ―Board‖) to serve as the singular manager of the Company. The Board has four members, two appointed by WU Parent and two by James. They split 2-2 on key issues.
Both sides eventually recognized that they could not manage the Company jointly and that one side needed to buy out the other. Despite some initially positive signs, they could not agree on a buyout procedure or a price.
During the venture‘s halcyon days, the Board appointed a James executive as the Company‘s CEO. Through the CEO, James controls the Company‘s day-to-day operations. With the Board deadlocked, the CEO has been operating free of any oversight. Given its advantaged position, James does not see the deadlock as a problem and feels no urgency to alleviate it. During negotiations over the buyout, James sought to use its privileged position to extract concessions from WU Sub.
WU Sub turned to this court for assistance. It filed this action, in which it petitioned to dissolve the Company. James moved to dismiss on the grounds that WU Sub is an assignee, not a member, and that an assignee lacks standing to petition for statutory dissolution under
This decision holds that WU Parent and WU Sub lack standing to petition for statutory dissolution under
I. FACTUAL BACKGROUND
The facts for purposes of the motion to dismiss are drawn from the allegations of the verified amended petition for dissolution, which is the currently operative pleading, as well as from the documents that it incorporates by reference. In the current procedural posture, the well-pled allegations of the petition are assumed to be true, and the petitioners receive the benefit of all reasonable inferences.
A. The Formation Of The Company
James describes itself as the world‘s largest manufacturer and retailer of custom clothing that uses a business model in which tailors come directly to customers‘
Having failed in their separate acquisition bids, James and Royal Spirit decided to team up. They created the Company to ―acquire . . . [Connaught‘s assets] . . . and operat[e] the Business.‖ Initial LLC Agreement ¶ 2.3(a). Royal Spirit formed WU Parent, a Hong Kong entity, as the vehicle through which it would participate in the joint venture. The Initial LLC Agreement recited that WU Parent and James each contributed $10 million in capital to the Company in return for a 50% member interest. The purchase price for Connaught‘s assets turned out to be $22.2 million, comprising $20 million in cash plus forgiveness of certain claims by Royal Spirit against the bankruptcy estate. WU Parent and James actually contributed $11.1 million each.
The Initial LLC Agreement established a manager-managed LLC in which the Board served as the sole manager of the Company. The Initial LLC Agreement assigned to the Board the ―exclusive responsibility and authority for the conduct of the Company‘s business, except to the extent that certain matters may be expressly reserved by law or this Agreement to the Members.‖ Id. ¶ 4.1(c). It further specified that the Board possessed ―overall authority and responsibility for the conduct of the business and affairs of the Company,‖ including ―without limitation, all matters that may be granted or delegated to a ‗manager‘ or to a member under the Act.‖ Id. ¶ 4.1(a). The Initial LLC Agreement created a Board with four members. WU Parent and James each received the right to appoint two members. Id. ¶ 4.1(b). All Board decisions require ―unanimous approval.‖ Id. ¶ 4.1(d).
WU Parent appointed Thomas Hebestreit and Sze Sum Chu as its designees. Id. ¶ 4.1(b). James appointed Sergio Casalena and James Brubaker as its designees. Id. Casalena is currently CEO of James; Brubaker was the CFO of James. The Initial LLC Agreement designated Brubaker as CEO of the Company. Id. ¶ 4.2(b).
B. WU Parent Transfers Its Interest To WU Sub.
In early 2012, Royal Spirit analyzed whether, for tax purposes, it should hold its member interest in the Company through a United States-domiciled entity. After exploring the issue internally, Royal Spirit communicated with James about its plan to hold its interest in the Company through a wholly owned subsidiary. Among other communications, James received an email from a Royal Spirit employee dated May 10, 2012, that attached a memorandum analyzing the relevant tax issues. The memorandum contemplated WU Parent forming a wholly owned subsidiary that would act as a ―blocker‖ entity for tax purposes. In response, the Company‘s CEO, Brubaker, informed Royal Spirit that he had read the memorandum and knew that the ―US blocker corporation‖—WU Sub—was ―already established.‖ From that point on, the Company
During this period, the parties worked on a more detailed LLC agreement (the ―Proposed LLC Agreement‖). The draft notably referred to WU Sub, not WU Parent, as a member of the Company. The draft contemplated that if an initial member transferred its membership interest to a wholly owned affiliate, then the affiliate would be admitted automatically as a member. The parties did not finalize the Proposed LLC Agreement because their relationship seemed amicable, and business matters took precedence.
C. The Relationship Sours.
Disputes initially arose over additional tax planning measures that Royal Spirit advocated. Among other ideas, Royal Spirit suggested transferring the Company‘s intellectual property to an offshore entity. James agreed at first, then reconsidered.
By 2013, Royal Spirit became concerned that the Company was not performing as anticipated. Royal Spirit proposed hiring a creative director. James disagreed.
In early 2014, Royal Spirit sought to call a Board meeting to consider removing Brubaker as CEO. In a lengthy response, Casalena took the position that neither side had the votes to call a meeting unilaterally. He expressed James‘ firm opposition to removing Brubaker, hiring a creative director, and transferring the Company‘s intellectual property to an offshore entity. Casalena asked that Hebestreit and other Royal Spirit representatives stop contacting Brubaker outside of quarterly Board meetings.
Casalena followed up with a letter dated February 10, 2014. His letter made clear that James no longer wished to continue with the parties‘ joint venture:
[W]e have also concluded that we do not want to continue in business with you. Your approach to giving advice is unhelpful and often offensive . . . . [T]here is a proper way to discuss differences of opinion and we are not seeing this from you.
It seems to be a waste of your time and our time to continue to try to persuade each other of our respective points of view regarding the management of the company. If we continue in this way, our mutual investment will be damaged.
Therefore we think that the only sensible course is for one or the other of us to own the company and run it as they see fit.
At December 31, 2013, the book value of Carlisle Etcetera is $23,024,741. Tom James is willing to sell its 50% share to Royal Spirit for its half of the book value, $11,512,371, paid in cash within thirty days. If Royal Spirit is unwilling to buy out Tom James‘ share, Tom James is willing to buy out Royal Spirit‘s share at the same price under the same terms.
In an e-mail exchange on May 14, a Royal Spirit representative proposed a more nuanced buyout process, which Brubaker approved.
By May 28, 2014, the parties were drafting an interest purchase agreement to use in connection with a buyout. That document referred to WU Sub as a member of the Company, not WU Parent.
By letter dated July 2, 2014, Royal Spirit informed James that it wished to purchase James‘ interest in the Company. Discussions quickly stalled. During the negotiations, James told Royal Spirit pointedly that if a deal could not be worked out, Royal Spirit was stuck because James could perpetuate the deadlock
D. This Litigation
On October 24, 2014, WU Sub filed a petition seeking judicial dissolution of the Company because of deadlock at the member and manager levels. The petition named the Company and James as respondents. On November 7, James moved to dismiss on the ground that WU Sub lacked standing to seek a judicial dissolution under
II. LEGAL ANALYSIS
James has moved to dismiss the petition pursuant to Rule 12(b)(6) for failure to state a claim on which relief can be granted. In a Delaware state court, the pleading standards under Rule 12(b)(6) ―are minimal.‖ Cent. Mortg. Co. v. Morgan Stanley Mortg. Capital Hldgs. LLC, 27 A.3d 531, 536 (Del. 2011).
When considering a defendant‘s motion to dismiss, a trial court should accept all well-pleaded factual allegations in the Complaint as true, accept even vague allegations in the Complaint as ―well-pleaded‖ if they provide the defendant notice of the claim, draw all reasonable inferences in favor of the plaintiff, and deny the motion unless the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof.
Id. The operative test in a Delaware state court thus is one of ―reasonable conceivability.‖ Id. This standard asks whether there is a ―possibility‖ of recovery. Id. at 537 n.13. The test is more lenient than the federal ―plausibility‖ pleading standard. Id. at 537.
James contends that WU Parent and WU Sub lack standing to seek dissolution because (i)
A. Statutory Standing To Seek Dissolution Under Section 18-802
B. WU Parent And WU Sub’s Status As Members Or Managers
To petition for statutory dissolution under
Taking the allegations of the petition as true, WU Parent cannot be a member. WU Parent was a member of the Company, but it assigned its interest to WU Sub. Under
WU Parent lost its status as a member of the Company when it assigned all of its interest in the Company to WU Sub. Under
The analysis for WU Sub is more complex. As an initial matter, James is correct that WU Sub did not automatically become a member by receiving WU Parent‘s interest. Under
By default under the LLC Act, only a member can petition for statutory dissolution, not an assignee.
the assignee of a member‘s limited liability company interest shall have no right to participate in the management of the business and affairs of a limited liability company except as provided in a limited liability company agreement or, unless otherwise provided in the limited liability company agreement, upon the affirmative vote or written consent of all of the members of the limited liability company.
But there is more. The petition alleges that WU Sub became a de facto member by consent of the parties. Citing
Several sections of the LLC Act bear on the admission of WU Sub as a member.
After the formation of a limited liability company, a person is admitted as a member of the limited liability company:
. . .
(2) In the case of an assignee of a limited liability company interest, as provided in § 18-704(a) of this title and at the time provided in and upon compliance with the limited liability company agreement or, if the limited liability company agreement does not so provide, when any such person‘s permitted admission is reflected in the records of the limited liability company.
Through this language,
The statutory path finishes with
An assignee of a limited liability company interest may become a member:
(1) As provided in the limited liability company agreement; or
(2) Unless otherwise provided in the limited liability company agreement, upon the affirmative vote or written consent of all of the members of the limited liability company.
The Initial LLC Agreement was silent on the admission of an assignee as a member. Under
In my view, the reference in
[a] limited liability company agreement may set forth provisions relating to notice of the time, place or purpose of any meeting at which any matter is to be voted on by any members, waiver of any such notice, . . . quorum requirements, voting in person or by proxy, or any other matter with respect to the exercise of any such right to vote.
Unless otherwise provided in a limited liability company agreement, on any
matter that is to be voted on, consented to or approved by members, the members may take such action without a meeting, without prior notice and without a vote if consented to, in writing or by electronic transmission, by members having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all members entitled to vote thereon were present and voted.
The need for formal member action comports with the policies underlying this aspect of the statutory regime. As Chief Justice Strine observed, writing as a Vice Chancellor, ―[t]here are likely two motivations for the statutory default rules in §§ 18–702, 18–704(a), and 18–301 concerning the assignment of a limited liability company interest and the assignee‘s possible (and subsequent) admission as a member of the LLC.‖ Achaian, Inc. v. Leemon Family LLC, 25 A.3d 800, 804 n.14 (Del. Ch. 2011). The first was tax-related and is now outdated. The imposition of statutory limitations on the free alienability of LLC member interests formed a critical part of early attempts ―to create an entity that, as a matter of tax law, is classified as a partnership with each owner treated as a partner, but whose owners are shielded by state law from automatic personal liability,‖ an effort since rendered superfluous by the Treasury Department‘s adoption of the ―check-the-box‖ tax classification regime. Daniel S. Kleinberger, Two Decades of ―Alternative Entities‖: From Tax Rationalization Through Alphabet Soup To Contract As Deity, 14 Fordham J. Corp. & Fin. L. 445, 447-54 (2009). When the LLC Act was drafted, however, the tax implications were significant, so it is logical that the LLC Act would require formal member action to admit an assignee.
―The second reason for the default rules in the [LLC] Act regarding the transferability of [member] interests may rest on the notion that one generally is entitled to select his own business associates in a closely held enterprise, like an LLC.‖ Achaian, 25 A.3d at 804 n.14. ―The policy that underlies
In this case, the Company only had two members. Once WU Parent transferred its member interest and WU Sub became an assignee, James was the sole remaining member and controlled the vote on WU Sub‘s admission. The petition does not plead any formal action by which James voted or acted by written consent to admit WU Sub as a member. Assuming for purposes of analysis that the tax forms and draft agreements were ―records‖ of the LLC for purposes of
Based on the allegations of the petition, James is correct that WU Sub is not a member who can seek statutory dissolution. Neither petitioner can.
C. Equitable Standing To Seek Dissolution
James argues that because neither WU Parent nor WU Sub can seek statutory dissolution under
―[T]his Court, as a court of equity, has the power to order the dissolution of a solvent company and appoint a receiver to administer the winding up of those assets.‖ Weir v. JMACK, Inc., 2008 WL 4379592, at *2 (Del. Ch. Sept. 23, 2008). Justice Story described the ―power to dissolve the partnership during the term for which it is stipulated‖ as one of the ―strongest cases to illustrate the beneficial operation of the jurisdiction‖ of a court of equity. 2 Joseph Story, Commentaries on Equity Jurisprudence § 915 (W.H. Lyon, Jr. ed., 14th ed. 1918) [hereinafter Story]. The implementation of a dissolution decree would require the appointment of a receiver, which is likewise an equitable remedy that forms part of this court‘s equitable powers.2 Courts of equity have
long had the power to appoint receivers in cases ―where the partners themselves are wholly unable to agree as to the management of the property and the settlement of the partnership affairs.‖ 4 John Norton Pomeroy, Equity Jurisprudence § 1333(1) (Spencer W. Symons ed., 5th ed. 1941) [hereinafter Pomeroy]. Justice Story viewed the appointment of a receiver favorably in suits for dissolution when ―one [partner] has wrongfully excluded the other from participation‖ in the management of the business. 2 Story § 914 n.1.
For
If
intended to establish for the benefit of the people of the state a tribunal to administer the remedies and principles of equity. They secured them for the relief of the people. This conclusion is in complete harmony with the underlying theory of written constitutions. Its result is to establish by the Judiciary Article of the Constitution the irreducible minimum of the judiciary. It secures for the protection of the people an adequate judicial system and removes it from the vagaries of legislative whim.
Id. See generally Lyman Johnson, Delaware’s Non-Waivable Duties, 91 B.U. L. Rev. 701, 702, 716-18 (2011).
Although this court‘s equitable jurisdiction is measured by the ―the general equity jurisdiction of the High Court of Chancery of Great Britain as it existed prior to the separation of the colonies,‖ the Delaware Supreme Court has recognized that the scope of that jurisdiction is not limited by the extent of British scientific, technological, and legal knowledge at the time of the handover. ―Historically, equity jurisdiction ‗has taken its shape and its substance from the perceived inadequacies of the common law and the changing demands of a developing nation.‘‖ Schoon v. Smith, 953 A.2d 196, 204 (Del. 2008) (quoting Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court Of Chancery § 2-2[a], at 2-2 (2006)). ―It cannot be said too forcefully that the general powers of the Court of Chancery refers to that complete system of equity as administered by the High Court of Chancery of Great Britain.‖ Glanding v. Indus. Trust Co., 45 A.2d 553, 558-59 (Del. 1945) (emphasis added). It is the ―complete system‖ of equity that this court inherited and administers, not the temporally specific subject matter of eighteenth century cases.
To stress this point, the Delaware Supreme Court in Schoon quoted from a wide range of sources that demonstrate the continuing and evolving role of equity. The high court started with Pomeroy:
[T]he Chancellor always has had, and always must have, a certain power and freedom of action, not possessed by the courts of law, of adapting the doctrines which he administers. He can extend those doctrines to new relations, and shape his remedies to new circumstances, if the relations and circumstances come within the principles of equity, where a court of law in analogous cases would be powerless to give any relief.
Id. at 204-205 (quoting 1 Pomeroy § 60). The Schoon court similarly quoted from Justice Story, who explained that equity ―has an expansive power, to meet new exigencies; and the sole question, applicable to the point of jurisdiction, must from time to time be[ ] whether such rights and wrongs do exist, and whether the remedies [therefore] in other courts, and especially in the courts of common law, are full, and adequate to redress.‖ Id. (quoting 1 Story § 53). The high court also cited McClintock on Equity for the proposition that ―the chancellors could adapt their system to meet changing needs without resorting to the fiction that they were merely interpreting and applying former rules, but the tendency to follow the path laid out by former chancellors was strong.‖ Id. at 205 (quoting McClintock on Equity § 4 (2d ed. 1948)). The Schoon court even quoted from Woolley’s Delaware Practice, which stated:
It may safely be affirmed that the whole body of equity principles, both of right and remedy, was brought hither by our ancestors, together with the common law, on their emigration from England, as a part of their heritage of liberty. Much of it, no doubt, lay dormant for a long period, no occasion or demand for a resort to portions of it for many purposes having arisen, but gradually as the increasing population of the new country begot new relations, there arose controversies and contests growing out of business, and the necessities for the redress of injuries which resulted from the breach of duties or the non-performance of obligations, that called for the use of the means to enforce observance through ancient remedies.
Id. (quoting 1 Woolley’s Delaware Practice § 56 (1906)).
Given the weight of these authorities, the extensive discussion in Schoon, and the decisions in DuPont and Glanding, I cannot accept the contention that because the nascent practice of entity law as it existed at the time of the colonies‘ separation had not yet envisioned LLCs, they fall outside the domain of equity.3 Decisions addressing the dissolution of LLCs have recognized the continuing role of equity.4 Most
Haley, this court reviewed a contractual exit mechanism in a two-member operating agreement and determined that it did not provide the exiting member with ―an adequate remedy.‖ Id. at 88. Chief Justice Strine, writing as a Vice Chancellor, explained that the existence of an exit mechanism was not sufficient; it had to be a ―reasonable exit mechanism‖ that provided ―a fair opportunity for the dissenting member who disfavors the inertial status quo to exit.‖ Id. at 96. On the facts of the case, the Chief Justice found that it was ―not equitable to force [the locked-out member] to use the exit mechanism‖ and ordered dissolution. Id. at 98.
This case also differs from Bax, where the Delaware Supreme Court affirmed a decision of this court holding that creditors of an insolvent LLC lacked standing to sue derivatively under
Prod. Res. Gp., L.L.C. v. NCT Gp., Inc., 863 A.2d 772, 789-90 (Del. Ch. 2004) (footnotes omitted). In a later decision, then-Vice Chancellor Strine revisited these themes:
Both state law and federal law provide a panoply of remedies in order to protect creditors injured by a wrongful conveyance, including avoidance, attachment, injunctions, appointment of a receiver, and virtually any other relief the circumstances may require. . . . [Further,] financial creditors . . . know how to craft contractual protections that restrict their debtors‘ use of assets. In a situation when creditors cannot state a claim that such contractual protections have been breached and cannot prove a fraudulent conveyance claim, the creditors‘ frustration does not mean that there is a gap in the remedial fabric of the business law that equity should fill. Rather, it means that we remain a society that recognizes that reward and risk go together, and that there will be situations when business failure results in both equity and debt-holders losing some money.
Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 199 (Del. Ch. 2006) (footnotes omitted), aff’d sub nom. Trenwick Am. Litig. Trust v. Billett, 931 A.2d 438 (Del. 2007) (TABLE). The LLC Act provides even more means for a creditor to protect itself at law. See CML V, LLC v. Bax, 6 A.3d 238, 250-53 (Del. Ch. 2010) (discussing pertinent statutory sections of LLC Act), aff’d, 28 A.3d 1037 (Del. 2011). Thus, to the extent
This court has held that the parties to an LLC agreement can waive by contract the right to seek statutory dissolution under
In concluding that parties to an LLC agreement could waive the right to seek dissolution under
thoughts might have been on the matter, the General Assembly in 2013 adopted an amendment to the LLC Act inconsistent with the purely contractarian view.8
Of particular relevance to dissolution, the purely contractarian view discounts core attributes of the LLC that only the sovereign can authorize, such as its separate legal existence, potentially perpetual life, and limited liability for its members. See
This approach finds support in Huatuco v. Satellite Healthcare and Satellite Dialysis of Tracy, LLC, 2013 WL 6460898 (Del. Ch. Dec. 9, 2013), aff’d, 93 A.3d 654 (Del. 2014) (ORDER). The Huatuco opinion followed R&R Capital in holding that the members of an LLC had waived their right to seek statutory dissolution under
This case presents the type of situation anticipated in Huatuco where equity should intervene. If the opportunities for dissolution are limited to
That situation is contrary to the bargain the parties struck. WU Parent and James formed the Company as equal business partners. They contributed equal amounts of capital and brought comparable expertise, with one side acting as a major supplier and the other as a day-to-day manager. Desiring to seize the opportunity to buy Connaught‘s assets quickly, they agreed to start with a basic operating agreement in which they committed to negotiate a more detailed replacement agreement. As reflected by the Proposed LLC Agreement, the terms of that more detailed agreement contemplate that an affiliate transfer from WU Parent to WU Sub would result in the automatic admission of WU Sub as a substitute member. In other words, had the parties finalized the Proposed LLC Agreement, or acted in accordance with their agreement in principle, then WU Sub would be a member and have standing to seek dissolution under
Likewise, the ―real relations‖ of the parties point to a scenario warranting dissolution. For a time, both sides recognized the need to go their separate ways. James only changed its mind because of its fortuitous position as the entity‘s de facto manager. But that reality does not make the status quo a satisfactory alternative. ―Although the LLC is technically functioning at this point, this operation is purely a residual, inertial status quo that just happens to exclusively benefit one of the 50% members. . . .‖ Id. at 96. The Initial LLC Agreement made the Board the singular manager of the Company. Because its four members are deadlocked, the duly authorized manager of the Company cannot exercise its statutory and contractual authority or carry out its obligation to manage and direct the business and affairs of the entity. Brubaker may be managing the Company because of the power vacuum created by the deadlock, but Brubaker is not the Board. Under the prevailing state of affairs, the Company is operating contrary to the governance structure set forth in its constitutive agreement.
When considering whether holders of equity in other entities can pursue equitable causes of action, despite their lack of formal record ownership status, this court has relied on the substance of the relationship and permitted the suits to proceed.9 The same reasoning employed by Chancellor Seitz in Burry Biscuit supports recognizing an assignee‘s standing to sue in equity for dissolution: ―Here we have an equitable owner . . . suing in a court of equity,‖ asserting a cause of action that ―must in this state be brought in equity,‖ and in a suit that ―does involve an equitable remedy.‖ 60 A.2d at 112. Consequently, I believe that WU Sub has standing in equity, as an assignee, to seek dissolution of the Company under the facts alleged in the petition.
III. CONCLUSION
WU Parent and WU Sub lack standing to seek statutory dissolution under
LASTER
Vice Chancellor.