The court's decision in R&R Capital LLC indicates that sponsors of limited liability companies that feature in securitization transactions may wish to include restrictions on the ability to put such companies into bankruptcy.
In a case of first impression under Delaware law, the Delaware Court of Chancery recently affirmed restrictions on the ability to dissolve limited liability companies. In R&R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, CA No. 3803-CC (Del. Ch. Aug. 19, 2008), the court enforced a provision in multiple limited liability company (LLC) agreements, which waived each member's right to seek judicial dissolution of the limited liability company. Such waivers, although often included in limited liability company agreements, have heretofore gone untested under Delaware law. In light of this decision, special purpose entities may continue to include such waivers in their organizational documents and restrictions on bankruptcy filings, more confident of their enforceability under Delaware law, to bolster bankruptcy remote status.
The petitioners in this case were members of seven Delaware limited liability companies and members of the sole member of another two entities (collectively, the LLCs), all nine of which comprised a racehorse ownership venture. The petitioners sought judicial dissolution of the LLCs or, alternatively, the appointment of a receiver to wind up the affairs of the LLCs. The LLC agreements governing the nine LLCs specified certain instances in which a member could petition for dissolution. The LLC agreements limited the application of a member's right to petition for dissolution to (1) withdrawal of a member, (2) the affirmative vote of all members, (3) the sale of all or substantially all of the company's assets, (4) the conversion of the company into a corporation or (5) upon the entry of a decree of judicial dissolution. The respondent LLCs sought to dismiss the petitioners' suit on the grounds that the petitioners waived their rights to petition for judicial dissolution under the LLC agreement.
The waiver at issue in this case provided that: "The Members agree that irreparable damage would occur if any member should bring an action for judicial dissolution of the Company. Accordingly, each Member accepts the provisions under this Agreement as such Member's sole entitlement on Dissolution of the Company and hereby waives and renounces such Member's right to seek a court decree of dissolution or to seek the appointment by a court of a liquidator for the Company." Despite this explicit waiver and the agreement of all parties that judicial dissolution would cause "irreparable harm," the petitioners nonetheless sought judicial dissolution of the respondent LLCs following a breakdown in the racehorse ownership venture among allegations of self-dealing. In support of their petition for dissolution, the petitioners advanced two theories—first, that the waiver in question was contrary to the provision of the Delaware Limited Liability Company Act, 6 Del. C. §§ 18-101 et seq (the LLC Act) relating to service of process on managers, and, second, that enforcement of the waiver would be contrary to Delaware's public policy.
The court rejected the petitioners' statutory arguments and found nothing to indicate that a waiver of a member's right to petition the court for dissolution or the appointment of a receiver would violate the LLC Act. The court found that the petitioners' reliance on 6 Del. C. § 18-109(d) was misplaced. This section provides, among other things, that " a member ... may not waive its right to maintain a legal action or proceeding in the courts of the State of Delaware with respect to matters relating to the organization or internal affairs of a limited liability company." 6 Del. C. § 18-109(d). The court held that this provision was a venue provision, prohibiting members from executing organizational documents that would strip the Delaware courts of jurisdiction.
The court also rejected the argument that the waivers at issue in the case were void as contrary to Delaware's public policy. The court emphasized freedom of contract and noted that sophisticated parties, in devising an internal governance structure, may identify legitimate reasons to limit or remove members' ability to petition the court for dissolution, including avoiding a winding up of the company upon the caprice of one member in favor of dissolution. In explaining the flexibility with respect to governance contemplated in the LLC Act, the court cited Haley v. Tolcott for the proposition that "a principle attraction of the [limited liability company] form of entity is the statutory freedom granted to members to shape ... their own approach to common business 'relationship' problems," 864 A.2d 86, 88 (Del. Ch. 2004). This flexibility in governance structure is one of the primary advantages of the limited liability company form and, as such, is the public policy of Delaware.
Limited liability companies feature with some frequency in the typical securitization structure, through which a sponsor seeks to transfer assets to a bankruptcy-remote special purpose entity. One of the primary concerns in structuring such transactions is the maintenance of separation between the sponsor and the special purpose entity, such that the sponsor's assets are not consolidated with those of the special purpose entity in the event of the latter's insolvency. In addition, restrictions are generally placed on the ability of a sponsor to effect a voluntary bankruptcy filing. Although the Chancery Court's decision does not affect the rights of third-party creditors vis-à-vis the special purpose entity, it does suggest that limited liability companies may be insulated from judicial dissolution at the hands of a dissatisfied member. Restrictions on bankruptcy filings in corporate documents would seem to fall into the same category. Thus, participants in securitization transactions should have more confidence that the Delaware courts will respect their choices with respect to internal governance of limited liability companies.
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