More Failed Boilerplate - Georgia Rejects Arbitration Clause for LLC Dissolution Dispute
Prior Montana Case. I recently blogged about Gordon v. Kuzara, a Montana Supreme Court decision that refused to enforce an LLC agreement’s arbitration clause in a dissolution dispute, here. One member sued for judicial dissolution of the LLC, and the other member responded with a motion to compel arbitration based on an arbitration clause in the LLC’s operating agreement. The court in Gordon refused to require arbitration because the arbitration clause required arbitration only for disputes challenging the operating agreement, any activity under the operating agreement, or any interpretation of the operating agreement. The petitioner in Gordon sought dissolution under Montana’s LLC Act – a statutory remedy – which was not covered by the arbitration clause.
Georgia Rejects Arbitration. Now we have an eerily similar case from Georgia, handed down three weeks before Gordon. Simmons Family Props., LLLP v. Shelton, No. A10A1495, 2010 Ga. App. LEXIS 1116 (Ga. Ct. App. Nov. 30, 2010). Two of the LLC’s three members filed a petition for dissolution under Ga. Code § 14-11-603(a), which provides for court-ordered dissolution using the familiar standard, “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or a written operating agreement.”
The other member filed a motion to stay the petition and to compel arbitration, relying on the following language from the LLC’s operating agreement:
“Any dispute, controversy or claim arising out of or in connection with, or relating to this Agreement or any breach or alleged breach hereof shall, upon the request of any party involved, be submitted to, and settled by, arbitration ….”
Simmons Family, 2010 Ga. App. LEXIS 1116, at *4.
The court pointed out that the dissolution remedy requested under Georgia’s LLC Act is an independent legal mechanism and that the LLC’s operating agreement did not govern dissolution procedures under Section 14-11-603. The mode of dissolution involved therefore did not “arise out of, in connection with or relate to the terms of the operating agreement or any alleged breach thereof.” Id. at *5-6. The court therefore rejected the motion to compel arbitration.
As I suggested in my previous blog on Gordon v. Kuzara, the arbitration clause would have covered a petition for a statutory dissolution if it had included a reference to the interpretation or enforcement of rights under the state’s LLC Act.
Prior Attorneys’ Fees Case from Idaho. A similar result obtained in an Idaho case where attorneys’ fees were sought in a dissolution petition. Last year I blogged about Henderson v. Henderson Investment Properties, LLC, in which an attorneys’ fees clause in an LLC operating agreement was not enforced in an Idaho judicial dissolution case, here. The attorneys’ fees clause only applied to actions to enforce the LLC agreement, and the dissolution petition was for a statutory remedy, independent of the LLC’s operating agreement.
Dysfunctional Boilerplate. In all three of these cases it’s a fair assumption that when the members put their operating agreement together, they expected the arbitration clause or the attorneys’ fees to apply to a petition for a court-ordered, statutory dissolution. In each case their expectations were dashed. Why? Because the attorney that drafted their operating agreement almost certainly relied on a form or an agreement from a prior deal.
The arbitration clause or attorneys’ fees clause may have been old and may have been frequently used in the past by the lawyer, or it may have come from a form book. But when put to the test it was inadequate. As Kenneth Adams points out in his blog on contract drafting: “If a particular bit of contract prose has been reused year after year after year, that’s no guarantee of reliability. Instead, it likely means that no one has subjected it to real scrutiny and that you probably could poke holes in it.”
Contract boilerplate is not necessarily “tried and true.” Think about that clause before reusing it.
“Most people can't think, most of the remainder won't think, the small fraction who do think mostly can't do it very well. The extremely tiny fraction who think regularly, accurately, creatively, and without self-delusion – in the long run, these are the only people who count.” Robert A. Heinlein
LLC's Nevada Lawsuit Almost Ended by Failure to Pay Its $125 Annual Franchise Fee
The plaintiff in AA Primo Builders, LLC v. Washington, No. 53983, 2010 Nev. LEXIS 55 (Nev. Dec. 30, 2010), saw its three-year-old lawsuit thrown out because it failed to pay its annual $125 fee to the Nevada Secretary of State. (“For want of a nail ….”) When the case was dismissed the LLC quickly paid the fee and filed the required annual report, but the trial court refused to allow the LLC to reinstate its lawsuit.
Many states require LLCs to file an annual report and pay an annual fee. For example, besides Nevada’s $125 fee, Delaware’s annual LLC fee is $250, and Washington’s is $69. Delaware Limited Liability Company Act (DLLCA) § 18-1107(b); Wash. Admin. Code § 434-130-090.
Failure to pay the fee or file the annual report can result in the LLC no longer being in good standing (Delaware, DLLCA § 18-1107(h)) or being administratively dissolved (Washington, Wash. Rev. Code § 25.15.280). These are enforcement mechanisms – upon later payment of the fees and filing of the required report, the LLC can be reinstated. DLLCA § 18-1107(i); Wash. Rev. Code § 25.15.290.
Nevada’s LLC Act provides that after an LLC has been in default of its filing and annual fee requirement for 12 months, “the charter of the company is revoked and its right to transact business is forfeited.” Nev. Rev. Stat. § 86.274(2). The LLC may then pay all the accrued fees and apply for reinstatement at any time up to five years after the initial default. Nev. Rev. Stat. § 86.276.
The trial court in AA Primo Builders apparently reasoned that if the LLC could not transact business then it could not maintain a lawsuit, and that the LLC’s reinstatement did not cure its default. On appeal, the Nevada Supreme Court overruled the trial court.
The court found three reasons to allow an LLC whose charter is revoked and then reinstated to continue its litigation. AA Primo Builders, 2010 Nev. LEXIS 55, at *13-14. First, an LLC’s right to “transact business” is separate from its capacity to sue and be sued. Id. Second, the LLC’s reinstatement relates back to the date of forfeiture as if the right to transact business had at all times remained in force. Id. at *14. Third, dismissal of the suit because of forfeiture of the LLC’s charter should not be ordered without first staying the case for a brief time to allow the LLC to reinstate its charter. Id.
The court relied in part on Nev. Rev. Stat. § 86-274(5), which says that if an LLC’s charter is revoked, “the same proceedings may be had with respect to its property and assets as apply to the dissolution of a limited-liability company.” A dissolved LLC must be wound up, and the dissolution does not impair any remedy or cause of action by or against the LLC. Nev. Rev. Stat. § 86-505.
The syllogism runs as follows. Major premise: a dissolved LLC can sue and be sued. Minor premise: an LLC whose charter has been revoked for nonpayment of fees is treated like a dissolved LLC. Conclusion: An LLC whose charter has been revoked can sue and be sued. The Nevada Supreme Court accordingly reversed the trial court and remanded to allow the LLC’s lawsuit to proceed.
It happens fairly frequently that LLCs fail to file their annual report and pay their annual fees. Usually the LLC will eventually learn of the problem and reinstate itself. If a lawsuit is underway, courts in most states will generally allow the LLC to continue with its suit if it is reinstated. Nevada’s statute was not clear on the point because its terminology – revoking the LLC’s charter and forfeiting the LLC’s right to transact business – connotes permanence and a lack of power to operate.
As a policy matter, AA Primo Builders came out the right way. The fact pattern involved an LLC that was properly formed but later failed to pay a modest annual fee and make a routine, administrative annual report. The consequence, revocation its charter, is an enforcement mechanism, a spur to cause the LLC to come into compliance with its reporting and payment obligations.
To take away an LLC’s ability to sue in court because it overlooked paying a smallish annual fee, even though the LLC then pays its annual fees up to date and fills out its forms, would be more than is necessary for the state’s enforcement mechanism. It would be akin to killing the dog to eliminate its fleas.
Montana Court Rejects LLC Agreement's Arbitration Clause
Arbitration of contract disputes is not generally required unless the parties agree to arbitration in their contract. LLC founders will therefore often include mandatory arbitration clauses in their LLC agreement. These are intended to require all disputes about the LLC to be arbitrated instead of being tried in court.
Montana Arbitration Clause. Arbitration clauses are usually enforceable. The Montana Supreme Court, however, recently refused in a case of first impression in Montana to enforce an LLC agreement’s arbitration clause. Gordon v. Kuzara, 2010 MT 275, 358 Mont. 432 (December 21, 2010). The plaintiff in Gordon sought judicial dissolution of the LLC, and the defendant filed a motion to compel arbitration based on the arbitration clause in the parties’ LLC agreement. Peter Mahler has nicely described the case and the court’s reasoning in his New York Business Divorce blog.
The gist of the court’s holding was that arbitration was not mandatory because the arbitration language in the LLC agreement did not cover a request for judicial dissolution. The contract said that arbitration was mandatory if any member was “challenging this agreement, any activity conducted pursuant to this agreement, or any interpretation of the terms of this agreement.” Gordon, 358 Mont. at 432.
That language is broad, but the dissolution petition was not based on a right granted by the LLC agreement. The LLC agreement had no provision requiring judicial dissolution, and the request for a dissolution order was instead based on the statutory remedy under the Montana LLC Act. Mont. Code Ann. § 35-8-902. Although the petitioner cited examples of conduct by the other member to show that the LLC was no longer economically feasible, the court concluded that the request for dissolution was based on the statutory remedy, not the LLC agreement. Gordon, 358 Mont. at 437.
Idaho Attorneys’ Fees. Arbitration is not the only contractual dispute resolution procedure that can turn out to be unavailable when dissolution is sought. Last year I posted about a case in Idaho, Henderson v. Henderson Investment Properties, LLC, where an attorneys’ fees clause in an LLC agreement was not enforced.
The trial court awarded attorneys’ fees in Henderson based on the LLC agreement’s attorneys’ fees clause, which covered actions brought to enforce any provision of the LLC agreement. The Idaho Supreme Court reversed the trial court’s award because the plaintiff did not seek to enforce the LLC agreement, but instead sought judicial dissolution, a statutory remedy.
Drafting Lessons. Both the Montana case and the Idaho case involved contractual clauses that were not enforced because they were not written broadly enough to encompass a petition for the LLC’s dissolution. One case involved a clause requiring arbitration, the other involved a clause requiring the loser to pay the winner’s attorneys’ fees.
In my post on the Henderson case I discussed how the attorneys’ fees clause could have been written to cover a dispute over dissolution, by adding language along the lines of “or to interpret or enforce any rights under the [State] Limited Liability Company Act.” The attorneys’ fees clause would then apply to either a dispute over the terms of the LLC agreement or to a dissolution petition. The broader language I suggest should have changed the result in Gordon, as well.
Another approach would be to add an express reference to dissolution in the attorneys’ fees clause or arbitration clause, as suggested by Peter Mahler in his post. That would remove all doubts about whether dissolution is covered, but would not extend to disputes over other statutorily granted rights that often are not referred to in the LLC agreement. For example, LLC statutes usually require that certain documents and records be provided to members on request.
