The Delaware Court of Chancery recently took the concept of freedom of contract to a new level.
Under Delaware’s LLC statute, 6 Del. C. § 18-802, an LLC member may apply to the Court of Chancery for judicial dissolution of an LLC “whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.” The Court of Chancery has already determined that this statutory right to judicial dissolution is not mandatory, but, instead, may be expressly waived by the terms of an LLC agreement. But what happens when waiver language in an LLC operating agreement is not so explicit?
The Court of Chancery addressed this situation in Huatuco v. Satellite Healthcare. Huatuco involved an LLC that owned and operated dialysis facilities in California. Dr. Aibar Huatuco (“Dr. Huatuco”) and Satellite Health Care (“SHC”) each owned 50% of the LLC. Before long, however, Dr. Huatuco and SHC were at odds over various issues, including Dr. Huatuco’s loans to the LLC and his potential replacement as medical director. When the parties couldn’t resolve their difference, Dr. Huatuco filed a complaint seeking judicial dissolution of the LLC.
This is where things get interesting. The LLC agreement contained the following disclaimer: “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.” SHC argued that this disclaimer evidenced the parties’ intent to relinquish any rights not required by law or expressly granted in the LLC agreement. According to SHC, since judicial dissolution was not expressly granted as a right under the LLC agreement, and was not a mandatory right under Delaware law, it was unavailable to Dr. Huatuco. The Court of Chancery agreed, finding that the LLC agreement had waived the members’ right to judicial dissolution.
Should the Court have been so quick to find a waiver of the right to judicial dissolution? Other commentators have noted that there are other rights not explicitly granted by the LLC agreement in Huatuco, such as the right to bring a derivative action, which would likely not be found to be waived by the disclaimer provision. And where did the court’s decision leave Dr. Huatuco, who argued that, if judicial dissolution were not allowed, he would have no way of exiting the LLC? The Court stated that he could still sue SHC for breach of the LLC agreement and, if successful, purchase its interest in the LLC. But is that really a preferable outcome, compared with the relatively simple process of judicial dissolution?
Huatuco is important for all those small business owners who are incorporated under Delaware law and serves as a reminder that all operating agreements should be carefully drafted by an experienced corporate law attorney.