Court of Chancery Rules on Retirement From LLC
By: Nicholas J. Caggiano, Jr.
Shannon S. Frazier
Jonathan G. Strauss
Court of Chancery holds that where majority LLC members agreed to allow a member to retire, the member was not entitled to “fair value” for his interest under 6 Del.C. §18-604.
Glenn B. Showell v.William H. Pusey et al, CA No. 3970-VCG (September 1, 2011).
This case involves a Sussex county accounting firm organized as a Delaware limited liability company (“LLC”). The LLC was governed by an operating agreement and a supplemental agreement (collectively, the “LLC Agreement”) that provided, among other things, for the LLC’s repurchase of a member’s interest upon a “Retiring Event”, which was defined as the member’s death, bankruptcy or disability. The repurchase price following a Retiring Event was based on the member’s percentage interest applied to the LLC’s liquidation value. The LLC Agreement expressly prohibited voluntary retirement or withdrawal by any member, which the court found to be consistent with the statutory default rule in 6 Del.C. §18-603. Notwithstanding this prohibition, the retiring member, Mr. Showell, and another member, Mr. Pusey, who together held 90% of the LLC interests, agreed that Mr. Showell could voluntarily retire as a member of the LLC. Importantly, although they agreed on Mr. Showell’s retirement, they did not reach an agreement regarding the value Mr. Showell should receive for surrendering his 29% LLC interest. Litigation then ensued to determine what Mr. Showell should get.
The current “default rule” in Section 18-603 of the Delaware LLC Act is that members may not voluntarily resign prior to the dissolution and winding up of the limited liability company unless the limited liability company agreement provides otherwise. This rule only applies to LLCs formed after July 31, 1996. Prior to that time, §18-603 permitted members to resign upon not less than 6 months' prior written notice and receive “fair value” for their interests under §18-604. Section 18-604, if applicable, compensates the resigning member for his “right to share in distributions” from the LLC – i.e. the “enterprise value” -- unless the LLC Agreement “provides otherwise”. Section 18-604 has remained essentially the same since 1996.
Mr. Showell argued that, since the parties agreed to his retirement, he should receive the “fair value” for his interest under §18-604. The defendants countered that he was due nothing since he had no contractual or statutory right to retire voluntarily. Alternatively, they argued that he should receive his share of the liquidation value of the LLC. The Court agreed with the defendants, finding that the LLC Agreement did not permit voluntary retirement, and had its own formula for Retiring Events, hence the “fair value” obligation in Section 18-604 was not applicable. The Court reasoned that the members’ agreement to permit Mr. Showell’s retirement was effectively a modification of the LLC Agreement to treat this as a “Retiring Event”. Hence, the LLC Agreement’s liquidation value method “provided otherwise” negating the “fair value” default rule in §18-604.
The moral of this story is, as always, when dealing with Delaware LLCs, “the contract is king.” The “default rules” of the Delaware LLC Act will not apply if the LLC agreement “provides otherwise”. In this case, the LLC Agreement did not precisely contemplate the situation, but the Court nevertheless found a way to apply the provisions of the LLC Agreement “in an attempt to harmonize Showell’s ‘retirement’ with the intent of the parties”. Thus, the parties’ intent trumped the statute.
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