Chancery Deems Deadlock-Based Dissolution Valid
In Mehra et al. v. Teller et al., C.A. No. 2019-0812-KSJM, 2021 WL 300352, (Del. Ch. Jan. 29, 2021), the Delaware Court of Chancery upheld the dissolution of a Delaware limited liability company (the “LLC”) effected by a provision in the LLC’s operating agreement whereby a deadlock in the LLC’s two-person board triggered an automatic dissolution of the LLC. Plaintiff minority member and manager, and defendant majority member and manager, operated the LLC under a control-sharing provision that required unanimity for board action. Upon a deadlock-based dissolution, however, the LLC’s primary asset – its interest in a subsidiary – would be distributed to the LLC’s members (plaintiff and defendant) pro rata based on their disproportionate equity interests in the LLC. While the operating agreement afforded the members equal distribution rights with respect to the subsidiary post-deadlock, it did not require the control-sharing provision to carry through.
Mismanagement – attributed to plaintiff – caused business to flounder and distributions to cease. Plaintiff, however, could not be removed from the board (the member vote threshold could not be surpassed without him), so defendant created a board deadlock to trigger the automatic dissolution of the LLC, exit the control-sharing agreement, and carry on at the helm of the subsidiary without plaintiff on-board. It worked.
Plaintiff sued and argued that defendant breached the operating agreement and his fiduciary duties in effecting the dissolution by way of the manufactured deadlock. The Court held that the deadlock, despite being contrived, was genuine due to defendant’s subjective pre-contrivance belief that plaintiff should no longer manage the subsidiary, resulting in an irreconcilable disagreement. Under the same rationale, the Court held that defendant did not violate the operating agreement’s requirement that he act in good faith. The Court further held that defendant’s scheme did not constitute a violation of his duty of loyalty, as the evidence was at odds with plaintiff’s contention that defendant was motivated solely by his personal desire for control over the LLC’s cash flows.
This article was originally published by Business Law Today in March 2021 and can be read here.