Guidance On Judicial Dissolution Of An LLC
In Washington, a court may order the dissolution of an LLC when “it is not reasonably practicable to carry on the limited liability company’s activities in conformity with the certificate of formation and the limited liability company agreement…” RCW 25.15.274. While there is no guidance from Washington about the applicable standard, the Iowa Supreme Court recently provided some guidance that may prove helpful to Washington practitioners.
Barkalow v. Clark, a case heard by the Iowa Supreme Court, considers the same “not reasonably practicable” standard for judicial dissolution (Iowa Code 489.701(1(d(2))). The Iowa Supremes analyzed the “not reasonably practicable” standard and provided insight into how RCW 25.15.274 could apply in the state of Washington.
Barkalow v. Clark
In 2009, Tracy Barkalow, Bryan Clark, Jeff Clark, and Joe Clark formed an LLC known as Outside Properties. The purpose of Outside Properties was “to invest in real estate holdings.” Each member received a management certificate evidencing a 25% membership interest in the LLC. Over time, Outside Properties acquired several rental properties next to a college football stadium. The properties were all financed by either the seller, a bank, or the three Clarks (not Barkalow).
In 2010, the members agreed to amend their operating agreement for estate planning purposes, providing each of their respective sets of children with 14% nonvoting interest in the LLC, while each member retained an 11% voting interest. Member Barkalow was upset that his voting power was reduced to 11%. Tensions continued to rise as Barkalow arranged for $117,617.70 in retroactive management fees be paid to his solely owned management company, along with $27,585.75 for the costs of a class action settlement that Outside Properties had not been a party to. In December of 2015, a $1,080,000 balloon payment was due to a seller. Barkalow declined to contribute additional capital, but Bryan, Jeff, and Joe Clark contributed $333,956.62 each to cover the payment. The capital contributions diluted Barkalow’s capital position to less than 1%. In the meantime, Outside Properties was profitable and continued to make money.
In 2017, Barkalow filed suit against Bryan, Jeff, and Joe, seeking an order to dissolve Outside Properties and award damages for breach of contract, breach of fiduciary duty, economic duress, and civil conspiracy. The court found Barkalow wrongfully converted assets to his management company and ordered him to pay $153,203.45 plus interest. However, the district court granted Barkalow’s request to dissolve the LLC finding that it was no longer reasonably practicable to continue its business. This decision was appealed to the Iowa Supreme Court who reversed the district court’s order directing the dissolution of Outside Properties.
Considerations
The Iowa Supreme Court elaborated on three main points relating to the “not reasonably practicable” standard.
- There must be an unbreakable deadlock.
- Management of the entity must be shown to be unwilling or unable to reasonably permit or promote the stated purpose of the entity to be realized or achieved.
- Is continuing the entity is financially unfeasible? (Mizrahi v Cohen NYS 2013).
None of the three conditions are present in Barkalow v. Clark, therefore the Supreme Court reversed the trial court’s decision and refused to dissolve the LLC. The court went on to state that judicial dissolution is a last resort: “Dissolution is not a wide-ranging mechanism for doing equity, but a drastic remedy to be ordered when an LLC is truly in an unmovable logjam or cannot as a practical matter carry on its contracted purpose.”
Takeaways
Every LLC Agreement needs to have a clearly drafted, unique “purpose” clause. The vast majority of LLC Agreements I review say something like the “the LLC is formed for any lawful purpose”. When considering judicial dissolution, how can a court apply the “reasonably practicable” test stated above with only an “any lawful purpose” clause in the LLC Agreement? Answer: it cannot.
In addition, the Barkalow Court’s comment that judicial dissolution is a “drastic remedy” is consistent with my experience. Courts are reluctant to interfere in a private, closely held company if the company is solvent. Judicial dissolution is tough to obtain, except in a 50-50 deadlocked company that is losing money.
To learn more about judicial dissolution of LLCs, please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.