|October 5, 2012|
Previously published on October 1, 2012
I want to write about neighboring New Jersey’s recent adoption of the Revised Uniform Limited Liability Company Act and, in particular, the changes to its LLC dissolution provisions, but first some background:
Between 1988, when the IRS recognized partnership tax classification for limited liability companies formed under Wyoming’s pioneering LLC statute, and the mid-1990s, all 50 states adopted enabling statutes for LLCs.
Many states, including New York, adopted LLC statutes brewed from a melange of ingredients found in the limited partnership and business corporation laws, with a dash of the 1992 ABA Prototype LLC Act thrown in. When it came to the subject of involuntary, judicial dissolution, most if not all of those statutes, including those of New York (LLC Law §702) and New Jersey (NJSA §42:2B-49) borrowed almost verbatim from the language of the uniform limited partnership laws, authorizing dissolution when it is “not reasonably practicable to carry on the business” in conformity with the organizational articles or the operating agreement. Relatively few LLC dissolution statutes utilized the more expansive standard found in most state laws governing judicial dissolution of close corporations based on the controlling shareholders’ fraudulent or “oppressive” acts against the minority shareholders. Likewise, the LLC statutes in states like New York and New Jersey included no analog to the statutory buy-out remedies provided for in the business corporation laws.
Over time, if not immediately, this became a distinction with a big difference. In New York, the 1545 Ocean Avenue case was the first major, appellate pronouncement that judges considering petitions to dissolve LLCs may not rely on the dissolution standards under the business corporation laws and, following the Delaware Chancery Court’s lead, that the inquiry in LLC dissolution cases is a contract-based analysis that centers on management’s ability to achieve the LLC’s stated purpose and its financial feasibility in the context of the operating agreement. In New Jersey, an appellate panel in Denike v. Cupo, 394 N.J. Super. 357 (App. Div. 2007), and a federal district court in Casella v. Home Depot U.S.A., Inc., 2010 WL 3001919 (DNJ July 28, 2010), likewise rejected the application to LLCs of the business corporation statute’s dissolution provisions, including the minority oppression provision.
Generally speaking, then, the dilemma of the “trapped-in” minority LLC member — that is, a minority member who fails to bargain for protection against majority abuse or exit rights in the operating agreement — has grown in lockstep with the growing popularity of the LLC form as the closely held business entity of choice.
The Uniform Limited Liability Company Act
The National Conference of Commissioners on Uniform State Laws (NCCUSL) did not promulgate its first generation Uniform Limited Liability Company Act (ULLCA) until 1996, that is, after the wave of LLC laws already had swept the nation. Contrary to the general trend of those laws, the grounds for dissolution under ULLCA §801 included, along with the widely-adopted ”not reasonably practicable to carry on the business in conformity with the operating agreement,” a provision akin to that found in oppressed minority shareholder statutes for corporations, namely, ”the managers or members in control of the company have acted, are acting, or will act in a manner that is illegal, oppressive, fraudulent, or unfairly prejudicial to the petitioner.” The official comments to §801 likewise suggested a corporate-style buy-out remedy for an aggrieved member.
Only a handful of states enacted ULLCA, and only one of them — Illinois — was a major commercial jurisdiction. The late, great Professor Larry Ribstein, whom I interviewed for this blog, in a 2008 article in the Virginia Law & Business Review, attributed ULLCA’s ”dismal adoption record” to “drafting compromises” and its inclusion of “idiosyncratic provisions that reflected the influence of lawyers and other powerful interest groups.”
In 2006, the NCCUSL promulgated its Revised Uniform Limited Liability Company Act (RULLCA). The Commissioners re-codified ULLCA §801 as RULLCA §701 and modified it to provide for judicial dissolution of LLCs on the non-waivable grounds that the managers or those members in control of the company are acting illegally, fraudulently or ”in a manner that is oppressive and was, is, or will be directly harmful to the applicant”. It also made explicit in §701(b) the court’s authority to “order a remedy other than dissolution,” although this provision was left subject to override in the operating agreement.
Five years later, in May 2011, the ABA’s Committee on LLCs, Partnerships and Unincorporated Entities published its Revised Prototype Limited Liability Company Act. Section 706 of the Revised Prototype authorizes judicial dissolution when it is not reasonably practicable to carry on the LLC’s activities in conformity with the operating agreement, with no provision for oppression, fraudulent conduct, etc. The Act’s introductory section merely comments that the dissolution provisions “were modified slightly to align with the typical provisions provided under other limited liability company acts.”
New Jersey’s Adoption of RULLCA
Last month, New Jersey became the eighth jurisdiction to enact RULLCA. The others are: California, District of Columbia, Idaho, Iowa, Nebraska, Utah and Wyoming.
New Jersey’s new LLC Act will become effective March 20, 2013, for all new LLCs formed after that date and March 20, 2014, for all existing New Jersey LLCs.
Judicial dissolution is only one of the many important changes adopted in the new LLC Act. Some of the others include new default rules for perpetual duration of the LLC; authorization for non-profit LLCs; fiduciary duties; member and manager indemnification; and charging orders.
The section of the statute governing judicial dissolution (“Events Causing Dissolution”) includes in §48(a)(4) substantially the same language from prior law authorizing an application for dissolution by a member when “it is not reasonably practicable to carry on the company’s activities in conformity with one or both of the certificate of formation and the operating agreement.” The new grounds for dissolution, drawn almost verbatim from RULLCA §701, are found in §48(a)(5) which provides:
on application by a member, the entry by the Superior Court of an order dissolving the company on the grounds that the managers or those members in control of the company: (a) have acted, are acting, or will act in a manner that is illegal or fraudulent; or (b) have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the applicant.
Under §11(c)(7) of the new LLC Act, the grounds for dissolution in §48(a)(4) and (5) cannot be varied by the operating agreement.
Section 48(b) of the new LLC Act borrows from New Jersey’s Business Corporation Act to expand upon RULLCA §701(b)’s bare provision authorizing courts to “order a remedy other than dissolution.” First, it allows the court to appoint a “custodian or one or more provisional managers if it appears to the court that such an appointment may be in the best interests of the limited liability company and its members.” Second, it explicitly provides a buy-out remedy under which the court can order the company or any member who is a party to the proceeding to buy or sell his, her or its membership interest, as follows:
The court may . . . order the sale of all interests held by a member who is a party to the proceeding to either the limited liability company or any other member who is a party to the proceeding, if the court determines in its discretion that such an order would be fair and equitable to all parties under all of the circumstances of the case.
Section 48(b), like its sparser template found in §701(b) of RULLCA, is a default provision which can be overridden by the operating agreement.
The Right Policy Choice?
In his article mentioned above, Professor Ribstein criticized RULLCA’s approach to judicial dissolution as “represent[ing] a retreat from the idea that LLCs offer an escape from the problems of the close corporation” and that the “oppression remedy could be an open-ended invitation to litigation and judicial rewriting of contracts.” Call this the strict, Delaware contractarian approach, or perhaps the “moral hazard” argument, which treats the LLC essentially as a contractual arrangement between members and leaves business partners to their own devices to contract for desired exit mechanisms without the uncertainty associated with ex post facto judicial intervention.
Equally powerful voices argue the other side of the issue. Professors Daniel Kleinberger and Carter Bishop, both of whom served as reporters for the NCCUSL committee that drafted the RULLCA, co-authored a November 2006 paper entitled “The Next Generation: The Revised Uniform Limited Liability Company Act” in which they wrote that “[p]roviding a remedy for oppression makes good sense” and that the RULLCA’s “nuanced” approach reflects “a mixture of reliance on judicial good sense and deference to the members’ foresight (i.e., their operating agreement).” They also highlighted the members’ ability in their operating agreement to override the statute’s remedial provisions, “in effect limiting the court (and themselves) to the all-or-nothing remedy of dissolution.”
Another such voice belongs to Professor Douglas Moll, whom I interviewed for this blog, who in 2005 wrote an article for the Wake Forest Law Review entitled “Minority Oppression & The Limited Liability Company: Learning (Or Not) From Close Corporation History” in which he argued that “[b]ecause the ‘seeds’ of oppression are also present in the LLC, . . . LLC minority owners will need a protective oppression doctrine just like their close corporation brethren.”
Time, experience and jurisdictional experimentation ultimately will test the strength or weakness of these competing public policy choices. It also will be interesting to watch how practitioners involved in the formation of LLCs in New Jersey and other states with an oppression statute will or will not draft around the statute’s non-mandatory remedial provisions, e.g., by eliminating or restricting the court’s buy-out options or by bypassing dissolution altogether by deeming the filing of a dissolution petition to be an offer to sell the petitioner’s membership interest on specified terms.