Background
The company, Doehler Dry Ingredient Solutions, LLC, is a Delaware limited liability company with its principal place of business in Indiana. The company is governed by an LLC agreement, which provides that the company is managed by a board of managers. The Doehler board of managers initially included (i) the petitioner, Russell Davis; respondents (ii) Garry Beckett and (iii) Stuart McCarroll; and (iv) non-party J. Patrick O’Keefe. Petitioner Davis was allegedly the beneficial owner (through another entity controlled by the petitioner) of 25 percent of the company. The second 25 percent of the company was owned by Respondent Beckett. The remaining 50 percent was owned by Respondent Doehler North America, Inc., a subsidiary of a German company.
By March 2022, a dispute had emerged between Davis and the other board members. On March 24, 2022, board members representing a majority of the company’s ownership voted by written consent to remove Davis from the board and to limit Davis’s ability to invoice the company for compensation for services. The same day, Davis accused Beckett of hacking Davis’s corporate email accounts and sharing information with Andreas Klein, the chairman of Doehler North America’s German parent company.
According to Davis, other disagreements arose between Davis and the other board members, including that (i) at least one of the other board members argued that a prior separate agreement controlled (rather than the terms of the LLC agreement), and (ii) Beckett allegedly formed one or more of his own companies to compete with the company. Davis also alleged that the LLC agreement was violated when the company incurred more than $25,000 of debt without unanimous member consent and when Doehler North America sought to purchase Davis’s interests in the company. The Court found that Davis’s descriptions of these alleged other disagreements were “vague at best.”
On April 20, 2022, Doehler North America filed an action against Davis (and the entity controlled by Davis) in Delaware District Court alleging that Davis breached the LLC agreement by refusing to sell his units in the company to Doehler North America. The next day, Davis filed this petition in Delaware Chancery Court seeking judicial dissolution of the company under section 18-102 of the Delaware LLC Act. Davis contended that judicial dissolution was warranted because of “[i]rreconcilable differences among the members and managers.”
Respondents Doehler North America, McCarroll, and Klein filed a motion to dismiss or stay the Chancery action. Davis, in turn, filed a motion for partial summary judgment.
Analysis
The respondents moved to dismiss pursuant to Court of Chancery Rules 12(b)(1), 12(b)(2), and 12(b)(6). First, under Rule 12(b)(1), the respondents argued that the petition should be dismissed in its entirety because the Court of Chancery lacks subject matter jurisdiction. Second, under Rule 12(b)(2), the respondents argued that the Court lacked personal jurisdiction over Klein. Third, under Rule 12(b)(6), the respondents argued that the petition should be dismissed for failure to state a claim.
Subject matter jurisdiction
Section 18-802 of the Delaware LLC Act grants the Court of Chancery jurisdiction of LLC dissolution proceedings. The respondents argued that the Court nevertheless lacked jurisdiction under the doctrine set forth by the United States Supreme Court in Princess Lida of Thurn & Taxis v. Thompson, 305 U.S. 456 (1939). The Princess Lida doctrine applies where there is a prior pending action and two conditions are met: (1) the litigation in both actions is in rem or quasi in rem in nature, and (2) the relief sought requires the second court “to exercise control over the property in dispute and such property is already under the control of the first court.” The respondents argued that the Court of Chancery must decline jurisdiction in favor of the prior federal action.
The Court explained that, in this case, while the present Court of Chancery action is in rem, the federal action is for breach of contract ‒ which is “a classic in personam action.” The respondents argued that the action was in rem or quasi in rem because it sought specific performance of Davis’s obligation to sell his units in the company. Hence, the argument was that that action concerned the property (i.e., the units). The Court rejected this argument, explaining that “an action for specific performance of a contract, even where it relates to property, is in personam insofar as it is sought to compel performance by the defendant.”
The Court further explained that even if the federal action could be viewed as quasi in rem, the property interests at issue in the two matters are not the same. The only property arguably at issue in the federal action is Davis’s membership units in the company. The property at issue in the Chancery action is the company itself. For these reasons, the Court of Chancery found that it had subject matter jurisdiction and declined to dismiss on the basis of Rule 12(b)(1).
Personal jurisdiction
The Court applies a two-step analysis in determining whether it has personal jurisdiction over a non-resident defendant. First, the Court asks whether service of process is authorized by statute. If so, then the Court asks whether the defendant has sufficient minimum contacts with Delaware such that the exercise of jurisdiction “does not offend traditional notions of fair play and substantial justice.” The petitioner bears the burden of showing a basis for the Court’s exercise of personal jurisdiction.
In this case, the petitioner did not allege any direct connection between Klein and the company. Klein was the chairman of Doehler North America’s German parent company, but he was not a past or present manager of the company itself. The only basis for personal jurisdiction pled in the petition was a conspiracy theory. The Court explained that the conspiracy theory of jurisdiction is “narrowly and strictly construed,” requiring the petitioner to establish each of five elements: (1) the existence of a conspiracy, (2) Klein’s membership in that conspiracy, (3) a substantial act or substantial effect in furtherance of the conspiracy in Delaware, (4) that Klein knew or had reason to know of the act in Delaware or effect in Delaware, and (5) the act or effect was a direct and foreseeable result of conduct in furtherance of the conspiracy. The Court explained that the test ultimately turns on “the imputation to the alleged conspirator of meaningful activity on behalf of the conspiracy which occurred and caused effects in Delaware.” The petitioner is required to assert specific facts in support of each element.
The Court found that the petitioner failed “to make the requisite showing that a tangible act or omission actually took place in Delaware.” Davis alleged only that a conspiracy existed between Klein and Beckett, in furtherance of which Beckett hacked into Davis’s corporate email. Even if these events are assumed to be true, there is still no allegation that any of them took place in Delaware. That the allegation conspiracy caused harm to a Delaware entity (i.e., the company) was not sufficient. Instead, Davis would have needed to show that an actual act or effect occurred within the state. For these reasons, the Court found no personal jurisdiction over Klein.
Failure to state a claim
Section 18-802 of the Delaware LLC Act provides that a court may order the dissolution of an LLC, upon application by a member or manager, where “it is not reasonably practicable to carry on the business in conformity with [its] limited liability company agreement.” The Court explained that given the “extreme nature” of judicial dissolution, it is granted sparingly. The remedy is limited to situations where “the LLC’s management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business.” The two paradigm examples are “a voting deadlock” or “where the defined purpose of the entity has become impossible to fulfill.”
Despite the “minimal” pleading standard under Rule 12(b)(6), the Court found that the petitioner fell “well short” of pleading a dissolution claim. First, the petitioner did not allege facts supporting an inference that the company is deadlocked at the member or manager level. Instead, the petitioner’s argument of “deadlock” focused on the allegation that the members of the company violated the LLC agreement by incurring more than $25,000 in debt without the unanimous consent of the members. However, the petition framed this issue as a breach of contract, not a deadlock. The Court further found that the petition provided no facts from which the Court could assess whether that breach was reasonably conceivable.
The petitioner further alleged that the entity he controls (and through which he owns his units of the company) would decline to approve nine upcoming actions “critical to the LLC” for which unanimous member consent is required. The Court rejected this grounds, explaining that this argument “fails to identify any existing deadlock” but instead only concerns “prospective deadlock if the petitioner withholds future consent.” The Court considered this to be a “contrived attempt to manufacture deadlock.” And, even if Davis had adequately alleged deadlock, the Court found that dissolution would still be unavailable because the LLC agreement itself provides for remedies in the case of deadlock (either through a “Buy-Sell Option” or a contractual dissolution process).
The Court likewise found that the petitioner’s allegations “do not demonstrate that the defined purpose of the entity has become impossible to fulfill.” The Court found nothing in the petition suggesting that the company was unable to continue operating in accordance with its business purpose.
Instead, the petitioner’s request for dissolution appeared to be entirely based on his removal as a manager, the attempted removal of him as a manager, alleged breaches of fiduciary duty, and the vaguely described “conspiracy.” The Court held that these allegations (even if true) “do not suggest that [the company] is suffering the rare fate of being a company that is unable to operate in accordance with its governing document.” On these grounds, the Court found failure to state a dissolution claim, dismissing the action in its entirety.
Takeaways
- Under the Princess Lida test for subject matter jurisdiction, a court will decline subject matter jurisdiction only where the prior action and the current action are both in rem or quasi in rem proceedings concerning the same property interest.
- Judicial dissolution is still considered an “extreme” remedy that will only be employed where an LLC can no longer practicably operate its business. The paradigm examples are voting deadlock or “where the defined purpose of the entity has become impossible to fulfill.” Further, where the LLC agreement contains its own remedies for deadlock, the Court need not order dissolution.
- Deadlock must exist at the time of the petition. A petitioner cannot manufacture voting deadlock by alleging that he will withhold his consent from future actions. Nor is mere disagreement between the members, or attempts to oust one of the members by the other members, sufficient for deadlock.
Client Alert 2022-399
