Washington LLCs: Dissenters' Rights and Attorneys' Fees
The Washington Supreme Court recently reversed a trial court and Court of Appeals decision on an award of attorneys’ fees to an LLC dissenter. Humphrey Indus., Ltd. v. Clay St. Assocs., LLC, No. 82687-1, 2010 Wash. LEXIS 1004 (Wash. Nov. 10, 2010). The Humphrey case stands out because there are so few reported cases on LLC dissenters’ rights, and because the five-to-four decision required the LLC to comply strictly with the statute’s 30-day period for paying the dissenter the value of its LLC interest. Clay Street Associates, LLC was formed in 1997 to hold a single real estate property. In 2004 most of the members decided to approve a sale of the property. The LLC agreement required unanimous member approval, and member Humphrey Industries, Ltd. refused to approve the sale. Circumvention of Unanimity. The other members then eliminated the unanimity requirement by approving a merger of the LLC into a new LLC that did not require unanimity for a sale of the property. (Unless the LLC agreement provides otherwise, a merger requires the approval of only a majority of the member interests, measured by their capital contributions to the LLC. RCW 25.15.400.) Members have the right to dissent from a merger of a Washington LLC and obtain the fair value of their member interest in cash. RCW 25.15.430. Humphrey exercised its dissenter’s right and demanded the fair value of its LLC interest. Dissenters’ Rights. Dissenters’ rights, sometimes called appraisal rights, originated with corporations: Essentially, an appraisal is the method of paying shareholders for taking their property; it is the statutory means whereby shareholders can avoid the conversion of their property into other property not of their choosing and is given to shareholders as compensation for the abrogation of the common-law rule that a single shareholder could block a merger. The purpose of these statutes is to protect the property rights of dissenting shareholders from actions by majority shareholders that alter the character of their investment. 12B William Meade Fletcher, Fletcher Cyclopedia of the Law of Corporations § 5906.10, at 386-87 (rev. vol. 2009) (footnotes omitted). Some but not all of the states have provisions for dissenters’ rights in their LLC Acts. For example, besides Washington, California, Florida, Minnesota, and New York have statutory provisions for LLC dissenters’ rights. Delaware’s LLC Act has no provision for dissenters’ rights, but it authorizes an LLC’s operating agreement or a merger agreement to provide contractual appraisal rights. DLLCA § 18-210. The Merger. The LLC’s merger became effective December 7, 2004. The LLC was required by the statute to pay Humphrey the fair value of its member interest within 30 days, RCW 25.15.460(1), but the LLC lacked funds. It proceeded to sell the real estate, and on May 27, 2005 paid Humphrey its estimate of the fair value of Humphrey’s member interest as of the merger date, plus interest. Humphrey disputed the LLC’s valuation and demanded a larger amount. Litigation ensued, the LLC made a settlement offer, settlement talks broke off, and the litigation went to trial. The trial court found that the LLC had undervalued Humphrey’s interest and ordered the LLC to pay Humphrey an additional $60,588. Attorneys’ Fees. Then the parties argued over attorneys’ fees. The statute says that in a proceeding over the valuation of a dissenter’s member interest, the court may assess attorneys’ fees and expert fees: (a) Against the limited liability company and in favor of any or all dissenters if the court finds the limited liability company did not substantially comply with the requirements of this article; or RCW 25.15.480(2). These provisions are similar to those in the Model Business Corporation Act and in many state corporate statutes. E.g., RCW 23B.13.310. Trial Court Ruling. The trial court found that the LLC had violated the Act by not paying Humphrey for its interest within 30 days of the merger as required by RCW 25.15.460(1). But, said the court, the LLC had “substantially complied” because it lacked the funds to pay, moved expeditiously to sell the real estate to generate funds to pay Humphrey, and paid interest on the delay period. Further, the trial court found that Humphrey acted arbitrarily, vexatiously, and not in good faith in pursuing its dissenters’ rights claim. It therefore awarded attorneys’ fees and expenses to the LLC. Humphrey appealed and the Court of Appeals affirmed. Supreme Court Weighs In. The Washington Supreme Court in Humphrey saw the 30-day payment requirement differently. The court characterized the purpose of the 30-day requirement as ensuring that dissenters have immediate use of the money which the LLC estimates to be the value of their member interests. Humphrey, 2010 Wash. LEXIS 1004, at *13-14. Humphrey should have received payment within 30 days of the merger date; instead the LLC sent the funds almost six months later. “A six-month deferral of payment is not ‘substantial compliance’ with a statute that unambiguously requires payment ‘within thirty days.’” Id. at *17. The court therefore reversed the Court of Appeals’ determination that the LLC had substantially complied with the LLC Act, and remanded to the trial court to determine whether Humphrey should be awarded attorneys’ fees based on the LLC’s noncompliance with the Act’s 30-day payment requirement. Id. at *20. The court also reversed the award of attorneys’ fees to the LLC. The trial court had concluded that Humphrey had acted arbitrarily, vexatiously, and not in good faith, based on its refusal to accept a settlement offer that would have provided more to Humphrey than it received from the trial court’s valuation award, and based on Humphrey’s conduct in other lawsuits against the LLC. The Supreme Court pointed out that evidence of conduct or statements in settlement negotiations is not admissible to prove the validity or invalidity of a claim or its amount. The court opined that even if the evidence was admitted for a permissible purpose, the record did not establish that Humphrey’s actions were arbitrary, vexatious, or in bad faith. Id. at *21. Ill-Motivated Merger. In a strange aside, the court stated: “If any acts were in bad faith, they were committed by the other members of Clay Street, who sought to bypass the dissenters’ rights statute and section 8.1 of their own LLC Agreement, which specifies that the property ‘shall not be sold, conveyed, and/or assigned without the mutual consent of each of the members.’” Id. at * 21-22 (ellipsis omitted). But after all, the members’ agreement did not require unanimous approval of a merger, and the LLC Act allows the surviving LLC to have different terms in its operating agreement. Where’s the bad faith in taking action allowed by the statute and the LLC agreement, in order to sell an asset and distribute the net proceeds to the members as their interests lie? Delaware’s doctrine of independent legal significance, DLLCA § 18-1101(h), would support the validity of using a merger to eliminate a unanimous voting requirement, but Washington’s LLC Act has no such provision. Holding. The court therefore reversed the trial court’s award of attorneys’ fees against Humphrey, and remanded for consideration of whether, in light of the LLC’s failure to substantially comply with the Act, Humphrey is entitled to attorneys’ fees. Dissent. The dissent contended that the legislature would have been well aware that in some cases 30 days is a short time to accomplish the accounting, appraisal, and other steps required to accomplish a merger and transfer property and assets, and that therefore the legislature must have intended the “substantial compliance” requirement to apply to the 30-day payment period as well as to the other provisions of the dissenters’ rights section. Humphrey, 2010 Wash. LEXIS 1004, at *26-27 (Chambers, dissenting). The majority riposted in a footnote that prudent planning is the answer: “It is likely that the legislature chose 30 days assuming that merging business entities would have the prudence and good faith to lay the groundwork for selling property well before a merger became effective, or seek other financing, so as to meet the statutory requirement.” Id. at * 18 n.11 (majority opinion). Lessons. The obvious lesson for any Washington LLC planning a merger is that if any members dissent, the LLC must be prepared to pay the dissenting members the fair value of their interests within 30 days of the later of the date the merger becomes effective or the date the member’s payment demand is received. The other lesson is a cautionary note for drafters of LLC agreements. A requirement that all members consent before specified actions are taken is not adequate unless mergers also require unanimous consent. The LLC agreement in Humphrey did not require unanimity for a merger, and the LLC was therefore able to merge and eliminate the unanimous voting requirement. A member resisting a unanimous vote will have dissenters’ rights if the LLC uses a merger to get around the voting requirement, but that may be small consolation to the dissenting member.
(b) Against either the limited liability company or a dissenter, in favor of any other party, if the court finds that the party against whom the fees and expenses are assessed acted arbitrarily, vexatiously, or not in good faith with respect to the rights provided by this article.
