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
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.