Waiving judicial dissolution: our remedies oft in ourselves do lie

The helpful Francis Pileggi brings news of Chancellor Chandler’s recent opinion in In R & R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, 2008 WL 3846318 (Del.Ch., Aug. 19, 2008) (no link yet). As Mr. Pileggi summarizes, the court enforced a clause explicitly waiving the members’ right to seek judicial dissolution.

The case involves litigation all over the country involving various entities that own land and race horses. (The Chancellor quotes one of the judges in a related case as remarking that race horses are a “[g]reat way to lose money.”)

In this opinion, the court first dismissed a dissolution claim brought by the owners of the LLC that was a sole member of the subject LLC because the Delaware statute, 18-803, requires the suit to be brought by a member or manager or their personal representative or assignee.

The other entities had the following clause:

Waiver of Dissolution Rights.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 held this didn’t conflict with another clause of the agreement providing for dissolution on court decree because the waiver provision applied only to actions by a member, and not one for a member (i.e., by the personal representative or assignee).

The court then addressed the main issue: whether this waiver is enforceable. This was an important open question. The courts are jealous of their power to be a final arbiter in these disputes, and judicial dissolution arguably operates as a safety valve when other aspects of the agreement fail.

As I discuss in Ribstein & Keatinge Sec. 11:5, n. 27 and here, there's some authority for letting the parties substitute arbitration for judicial dissolution if the arbitration clause is very carefully drafted. (Given this tendency to strictly interpret judicial dissolution waivers, I think the defendant dodged the bullet there. Let that be a lesson to those who stick boilerplate dissolution clauses in the agreement.) But what if the agreement, though clear, includes no safety valve – that is, it doesn't merely substitute arbitration.  Would that be enforceable?

Chancellor Chandler said yes. He emphasized Delaware’s strong public policy favoring freedom of contract, as he and other Delaware judges often have in recent cases (see, e.g., here for discussion a recent Chandler opinion and here for the Delaware Supreme Court’s view).

The Chancellor’s opinion includes four important principles:

First, it makes clear just how strong Delaware’s freedom-of-contract principle is – so strong, that a clear enough agreement (note the language of the clause here, quoted above) can bar plaintiff’s last-resort judicial dissolution remedy. As the court emphasized (footnote omitted):

The allure of the limited liability company. . . would be eviscerated if the parties could simply petition this court to renegotiate their agreements when relationships sour. Here, the sophisticated members of the seven Waiver Entities knowingly, voluntarily, and unambiguously waived their rights to petition this Court for dissolution or the appointment of a receiver under the LLC Act. This waiver is permissible and enforceable because it contravenes neither the Act itself nor the public policy of the state.

Second, the Chancellor provides an overall approach to the mandatory-enabling divide in the Delaware statute. A provision is mandatory only if the statute explicitly says it is. And those provisions are usually the ones protecting third parties.

Third, the court stresses that the parties have good reasons for opting out of litigation. In other words, instead of the usual emphasis on the benefits of protecting plaintiffs, we get a welcome analysis of the benefits of enforcing waivers like this:

[T]here are legitimate business reasons why members of a limited liability company may wish to waive their right to seek dissolution or the appointment of a receiver. For example, it is common for lenders to deem in loan agreements with limited liability companies that the filing of a petition for judicial dissolution will constitute a noncurable event of default. In such instances, it is necessary for all members to prospectively agree to waive their rights to judicial dissolution to protect the limited liability company. Otherwise, a disgruntled member could push the limited liability company into default on all of its outstanding loans simply by filing a petition with this Court.

Fourth, for those concerned about eliminating the remedy of last resort, the Chancellor noted that in fact there is a remaining "backstop" (Deborah DeMott's word) – the implied contractual covenant of good faith and fair dealing. In this case, the petitioners still had available a potential suit against the party that the petitioners had characterized as the wrongdoer. The outcome of that suit will depend on the contract, determined in the light of the implied covenant.

Finally, I can’t leave this case without noting the court’s heavy reliance on two writers whose birthdays happen to fall on the same day. The first is yours truly who is cited in n. 21 on the importance of uncorporations’ flexibility (Rise of the Uncorporation); on the role of mandatory rules in protecting third parties (Ribstein & Keatinge, Sec. 4:16); and as one whose “scholarship on limited liability companies has been frequently cited by both this Court and the Supreme Court, emphasizes that it is the rigor with which Delaware courts apply the contractual language of LLC Agreements that makes limited liability companies successful” (n. 44, citing The Uncorporation and Corporate Indeterminacy, and my article on RULLCA).

Who’s that other guy? He's the one who's cited in the first note as saying “the contract’s the thing” (or some such thing); and in the last note as saying, “our remedies oft in ourselves do lie.”