Court of Chancery Rules on Transfer of Membership Interest
By: Nicholas J. Caggiano, Jr.
Shannon S. Frazier
Jonathan G. Strauss
Court of Chancery holds that LLC membership interest can be assigned by 30% member to 20% member without consent of 50% member; Resulting deadlock to be resolved by anology to corporate law.
Achaian, Inc. v. Leemon Family LLC et. al, CA No. 6261-CS (August 9, 2011).
This case involves a dispute among the members of Omniglow, LLC, a Delaware limited liability company that manufactures glowsticks. Founded in 2005, the LLC originally had a single member, Omniglow Corporation, but in 2006, the LLC was sold which resulted in the LLC having three members: Leemon Family LLC (“Leemon”) owned 50%; a trust (the “Holland Trust”) owned 30%; and Achaian, Inc. (“Achaian”) owned the remaining 20%. All were admitted as members, however from a reading of the case it is evident that the limited liability company agreement (or “operating agreement”) was never properly amended to reflect the fact that the LLC no longer had a single member. A dispute as to control of the LLC emerged, with Leemon allegedly trying to assert control. The Holland Trust sold its membership interest to Achaian. Achaian then sued for judicial dissolution claiming that it held 50% of the voting interests and asserting a deadlock with Leemon.
There are 2 interesting aspects of this case. First, the Court considered the issue of whether one member could sell its voting interest to another member without the consent of the third member. Under the LLC Act, unless otherwise provided in the operating agreement, the sale by a member of its LLC interest does not entitle the assignee to become a member or have any voting power – it is purely an assignment of economic rights such as the right to receive distributions and tax allocations. Leemon claimed that the Holland Trust’s assignment to Achaian only conveyed economic rights, not voting power. Vice Chancellor Strine disagreed, reasoning that since the operating agreement defined “Interest” broadly to mean “entire ownership interest”, and provided that a Member may transfer “all or any portion of its Interest” to any person at any time, the Holland Trust could transfer its voting power to Achaian. In essence, the operating agreement modified the statutory default rule. Leemon countered that such a transfer was not possible without its consent, since the operating agreement provided that no person shall be admitted as a Member without the written consent of all members. The plaintiff, Achaian, argued that since it was already a member, it need not be re-admitted. Leemon argued that, given the statutory default rule, and no provision of the operating agreement dealing specifically with this situation, Achaian should not be able to change the voting structure of the LLC without Leemon’s consent. In other words, Leemon wanted Achaian to be separately admitted as a member with respect to its additional 30% Interest acquired from the Holland Trust. Vice Chancellor Strine agreed with Achaian and found that the operating agreement, taken as a whole, allowed the members to transfer voting power amongst themselves, and that Holland Trust had transferred voting power to Achaian. The take aways are that, in the world of Delaware limited liability companies, (i) the “contract is king” – the operating agreement will normally prevail over the statute (with certain exceptions – as there are provisions of the LLC Act that may not be altered or waived), and (ii) a limited liability company interest normally represents an economic interest only but an operating agreement may explicitly provide for a transfer of more than an economic interest. Thus, care must be taken to make sure that the operating agreement clearly and adequately addresses the needs of all members.
The second interesting aspect is that the Court stated that since Achaian had successfully obtained 50% voting power, the judicial dissolution of the LLC would be treated like a dissolution of a 50/50 joint venture corporation under Section 273 of the Delaware General Corporation Law. Vice Chancellor Strine originally took this approach in Haley v. Talcott. Under Section 18-802 of the LLC Act, the test for judicial dissolution depends only on a finding that it is “not reasonably practicable to carry on the business in conformity” with the operating agreement. However, by incorporating the corporate test, the Court seems to be requiring that in the case of a deadlocked 50/50 LLC joint venture, a plaintiff seeking judicial dissolution must plead the three elements of DGCL 273: that there are (1) two 50% stockholders; (2) engaged in a joint venture; (3) who are unable to agree upon whether to discontinue the business or how to dispose of its assets.
