Reconciling oppression with an LLC agreement

The application of the “oppression” remedy is one of the stickiest remaining problems in LLC law. This is really a holdover from the law of close corporations, where the courts and legislatures had to give members some way out of very closely held firms that had not adopted the partnership solution – dissolution at will.

The remedy might have been thought to be unnecessary once closely held firms could be LLCs and have limited liability without being “durable” corporations. But LLC statutes generally do not provide for dissolution-at-will. So there is still some need for the oppression remedy in this context. 

The problem with the remedy is that it may be hard to square with the contract. After all, the whole reason for the remedy is that the contract does not provide for exit, yet the court is providing one. One might say that the parties in effect adopted the statutory default rules, including the oppression remedy. But it still may not be clear how the parties wanted those defaults to fit with their agreement. Also, if the oppression remedy is mandatory, did they really have a choice?

Chancellor Chandler’s recent (January 13) opinion in Fisk Ventures, LLC v. Segal, 2009 WL 73957 (HT Pileggi) provides the best way yet out of this conundrum.

First some background. The two parties to this biotech firm sharply disagreed over its future. One of the parties that had provided the funding to date refused either to provide more or to drop its power to veto additional funding that would have diluted its interest. So this was basically a disagreement over the firm’s future.

In an earlier opinion, discussed here, Chancellor Chandler refused to limit the member’s power to exercise its veto power under the LLC agreement, emphasizing freedom of contract under Delaware law. So this set up the deadlock. What to do?

The Chancellor held that the deadlock made it not “reasonably practicable” to continue operating:

When such a company has no office, no employees, no operating revenue, no prospects of equity or debt infusion, and when the company's Board has a long history of deadlock as a result of its governance structure, more than ample reason and sufficient evidence exists to order dissolution.

Again, the Chancellor emphasized that “Limited Liability Companies are creatures of contract, ‘designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved.’"

But what about the oppression remedy's potential to trump the agreement? Well, here the agreement itself provided for dissolution per the LLC Act.

That left it for the court to apply the act. The Chancellor did so by parsing carefully through the agreement. The directors were obviously deadlocked. The key question is whether the obstinate member had to use its “put” under the agreement to sell out and get out of the way. The court held that the agreement didn’t require exercise of the put.

Also, although the put-holder was acting in its self interest, it had a right to do so under the agreement:

* * * Fisk Ventures has the right to protect itself against what it perceives as Company actions that would diminish the value of its stake in Genitrix. This Court will not substitute its business judgment for that of Fisk Ventures simply because Segal believes that will be in his best interest.”* * *

Finally, Segal's argument that Fisk Ventures cannot seek judicial dissolution because it comes to the Court with unclean hands is without merit. The LLC Agreement is a negotiated contract and Fisk Ventures has the right to attempt to maximize its position in accordance with the LLC Agreement's terms. If Fisk Ventures chooses to exercise its leverage under the LLC Agreement to benefit itself, it is perfectly within its right to do so. 

The plaintiff thought that dissolution would destroy the value of the firm’s non-transferable patent license. But:

The value of the Whitehead Agreement is hotly contested and I am unconvinced that any potential value it theoretically might have could not be accessed through a fair and proper sale of the asset. One thing is certain, however. These parties will never be able to reach agreement on how to dispose of this asset, whatever its potential value.

The court concluded:

Ultimately, even if the financial progress of Genitrix is impeded by the deadlock in the boardroom, if that deadlock cannot be remedied through a legal mechanism set forth within the four corners of the operating agreement, dissolution becomes the only remedy available as a matter of law. The Court is in no position to redraft the LLC Agreement for these sophisticated and well-represented parties.

This case involves a long-lived corporate dispute that resulted in devastating deadlock to Genitrix's Board and the loss of significant value to all involved. Genitrix's Board is hopelessly deadlocked, and the LLC Agreement fails to anticipate that risk by prescribing a solution to the Board conflict.

This is how you reconcile the seemingly unreconcilable: the agreement, and a statutory remedy that is, and is not, part of the agreement.

One more thing: Delaware does offer a way around oppression: you can enforceably waive the remedy in the agreement.  This is arguably a critical piece of the overall contractual approach to oppression. In Delaware, even if the parties had not (as here) put the oppression remedy in the agreement, they would essentially have agreed to it without waiving it.  Indeed, that argument is potentially available outside of Delaware, since the parties can agree everywhere to oppression by organizing in Delaware. 

Comments

[RPB]

1. Seems to me that the court got this one wrong.

Early on, it misstated the statutory test as whether it was reasonably practicable to continue to operate. The test is whether it is reasonably practicable to carry on the business in conformity with the agreement. I think this focuses the analysis on the agreement.

The put is the key. The court misconceived its task to be whether to order exercise of the put. It didn't have to do that to avoid dissolution. It only had to decide whether the agreement contained provisions that allowed the business to be operated in conformity with it--and the put is that provision.

The court announced that if a deadlock cannot be resolved through "a legal mechanism set forth within the four corners of the operating agreement," then the court has to decree dissolution--turning a blind eye to the put, which is just such a legal mechanism. Somehow, the court felt it had to find a compulsory mechanism; there's nothing in the statute about that.

Finally, the court said that because the company's dire financial straits left it with no reasonably practical means to operate the business, dissolution was required. That completely misstates the test. The statute says nothing about financial condition.

2. With due respect, I don't see how the good Professor concludes that a party with a put right needs a judicially created exit remedy for "oppression."

3. Has the good Professor blogged on another Delaware dissolution case--In Re Seneca Investments? The members took the strange course of agreeing that the Delaware corporation law governed their LLC, and the court applied both statutes.

[Larry Ribstein]

This comment is wrong, and the court and my post are correct. The business is deadlocked unless the agreement provides for some mechanism for resolving the disagreement. As long as the put holder can decide not to exercise the put, the put is obviously no more a mechanism for resolving the disagreement than requiring a vote holder to vote with the other faction would be. The argument misconceives the whole concept of deadlock. There may be a good argument against dissolution here, but this isn't it.

[Anne Champetier (France)]

Sorry, my last question was not clear. As I now see you can moderate comments, I may reformulate my concerns.

In this case (Fisk Ventures LLc), "the parties had not put the oppression remedy in the agreement, which means, they had agreed to it "(default rule),

What then if the judge had recongnized this was oppression on the part of the 25% member?
Would another remedy be available, to allow board to circumvent the deadlock?

THe answer seems to be a negative one. THere is no other remedy unless the agreement allows so under Delaware LLC statutory law. Then oppression case will only give rise to compensatory damages? It is still very unclear.