In Aibar Huatuco, M.D. v. Satellite Healthcare, CA No. 8465-VCG (Del. Ch. Dec. 9, 2013), the Delaware Court of Chancery held that a member’s right to petition the Delaware Court of Chancery to dissolve the company in the event of deadlock pursuant to Section 18-802 of the Delaware Limited Liability Company Act (the “Act”), may be eliminated by a general contractual provision limiting the member’s rights to those expressly set forth in the LLC’s operating agreement.

Background

Satellite Dialysis of Tracy, LLC (“Satellite”) is a Delaware limited liability company which owns and operates dialysis facilities in California.  Satellite has two members, plaintiff Dr. Aibar Huatuco and defendant Satellite Healthcare.  Each member holds a fifty percent interest in Satellite, and defendant Satellite Healthcare manages the company.  In 2010, plaintiff personally guaranteed several Satellite loans at defendant’s request.  Defendant subsequently modified the loans to increase the borrowing limits under the loan and to add a borrowing base covenant that immediately placed Satellite in default—each without plaintiff’s consent or knowledge.  Defendant also sought to force plaintiff out of Satellite as both a member and as the company’s chief medical officer.  Thereafter, on April 8, 2013, plaintiff sought judicial dissolution of the company under Section 18-802 of the Act, permitting the Court of Chancery to dissolve a Delaware LLC when it is “no longer reasonably practicable to carry on the business in conformity with a limited liability company agreement.”  Defendant moved to dismiss plaintiff’s petition.

Defendant argued that Satellite’s operating agreement (the “Operating Agreement”) foreclosed a right of judicial dissolution based on two pertinent provisions.  First, Section 2.2 of the Operating Agreement stated, in pertinent part:

The respective rights of each Member to share in the capital and assets of the LLC, either by way of distributions or upon liquidation, will be determined by reference to the Percentage Interest of such Member; and each Member’s interest in the profits and losses of the LLC shall be established as provided herein. Except as otherwise required by applicable law, the Members shall only have the power to exercise any and all rights expressly granted to the Members pursuant to the terms of this Agreement. No Member shall have any preemptive right.

(emphasis added).  Second, Section 8.1 of the Operating Agreement provided that Satellite shall be dissolved upon the happening of three identified events, none of which constituted a judicial dissolution:

Section 8.1 Dissolution. The LLC shall be dissolved, its assets disposed of, and its affairs wound up, on the first to occur of the following: (i) the approval of a Super Majority-in-Interest of the Members to dissolve the LLC; (ii) the sale or other disposition of all
all of the LLC’s assets and distribution to the Members of the net proceeds thereof; or (iii) upon the happening of any other event of dissolution specified in the Certificate of Formation or this Agreement.

The parties agreed that Section 8.1 of the Operating Agreement did not expressly provide a right to judicial dissolution.  However, plaintiff argued that neither Section 8.1, nor Section 2.2 constituted a knowing, voluntary and unambiguous waiver of a statutory right to judicial dissolution as required under prior case law.

The Court’s Analysis

In reviewing the defendant’s motion to dismiss, the Court began with the proposition that the Act provides default provisions applicable to Delaware LLCs only where the parties have not opted out of the Act’s default rules or the default provisions of the Act are mandatory.  The Court found that by virtue of Section 2.2, the parties expressly disclaimed the application of all of the Act’s default rules except to the extent the LLC Agreement otherwise provided or as required by applicable law.  In so finding, the Court rejected plaintiff’s argument that Section 2.2 only disclaimed statutory economic rights.  The Court held instead that Section 2.2—“Other Member Rights”—served as a “catch-all,” disclaimer of miscellaneous statutory rights associated with membership in an LLC, including the right of a member to petition for a judicial dissolution in the event of deadlock. 

According to the Court, the foregoing interpretation of Section 2.2 of the Operating Agreement comported with R & R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, 2008 WL 3846318 (Del. Ch. Aug. 19, 2008), in which the Delaware Court of Chancery upheld a provision in an LLC agreement purporting to eliminate members’ rights to judicial dissolution except as expressly granted therein.  In R & R Capital, LLC, the Court of Chancery further held that a contractual waiver of the judicial dissolution right set forth in Section § 18-802 of the Act must be “knowing, voluntary and unambiguous.”  However, in Huatuco, the Court downplayed the significance of that finding, calling it “unremarkable” and requiring only a showing of a binding and unambiguous contract which rejects judicial dissolution.  The Court found that defendant easily made this showing by invoking Sections 2.2 and 8.1 of the Operating Agreement.  In the instant case, the Court of Chancery also found that the policy underlying the Act supported its decision:

Permitting waiver of a contractual right to judicial dissolution, or enabling opting out of the statutory right altogether, is consistent with the broad policy of freedom of contract underlying the LLC Act, and comports with the Act’s approach of supplying default provisions around which members may contract if they so choose.

Slip op. at 11-12. 

Further, the Court of Chancery concluded that Delaware law does not prohibit the members of a LLC from voluntarily eliminating by contract a statutory right to petition the Court of Chancery to dissolve in the event of deadlock.  The Court also held that it would not be inequitable to prohibit plaintiff from bringing an action for judicial dissolution because plaintiff had available means of extracting himself from the venture other than judicial dissolution.  Specifically, plaintiff could pursue an action against defendant for breach of the Operating Agreement and, if successful, could exercise a contractual right to purchase defendant’s interest in the company.  In short, because the Operating Agreement did not expressly contain a right to judicial dissolution, Section 2.2 operated as an effective opt-out of the statutory default right to judicial dissolution contained in Section § 18-802 of the Act.