Business & Corporate Articles

Dispute Resolution Techniques in LLCs

RULLCA and the Delaware Limited Liability Company Act and case law make it clear that LLCs are contractual relationships and the LLC acts provide great flexibility for parties in tailoring their relationship.  Drafters of LLC operating agreements should certainly discuss the need for and possible terms of a mechanism for resolving disputes among the members with clients and the possible consequences if disagreement over continuing the business of an LLC arises and the parties are deadlocked and are left to the default provisions of the applicable LLC Act, including a possible involuntary dissolution proceeding overseen by a court.  (And the courts, when asked to intervene, do so enthusiastically.)  It seems to go without saying that these considerations should be at the top of a draftsperson’s list whether the arrangement is a 50-50 deal between the LLC members, where unanimous votes on various issues are required, where obtaining the approval of someone holding that right may be problematic and even where obtaining a majority vote may fail.

Some of the situations that might trigger disputes among members of an LLC include: LLC’s purpose can no longer be fulfilled where the “purpose” clause is very broadly drafted and the member does not want to be in any other business with the other members; there has been a breach of the operating agreement or the relationship among members has gone sour; disagreement among members on strategies, goals and ways of attaining them; or the member wants out in order to lock in and enjoy gains achieved.

Almost always each of the foregoing events will involve disputes, so it makes real sense to have a dispute resolution mechanism in place that is short of requiring arbitration or litigation. 

Here is a list (far from exhaustive) of some of the more common approached for the resolution of disputes:

1.Baseball Arbitration (most effective for a monetary dispute).  Essentially, each side provides an arbitrator with a proposed monetary amount or solution and the arbitrator picks one of the amounts or solutions.  A variation is called night baseball arbitration.  The arbitrator considers the issues and renders an award which is adjusted to conform to the closest of the parties’ proposals.

2.Put and Call.  Permits a member to put or require the company (and/or other members) to buy the interest of the “putting” member based on the occurrence of one of a number of triggering events.  A Call essentially permits the “calling” member to buy the interests of the members receiving the call.  Typically requires a valuation following the put and may also involve structuring an installment sale depending on value.

3.Texas Shoot Out or Dutch Auction or Chinese Fire Drill.  One member offers to either buy the other member’s interest at a particular valuation or sell the offering member’s interest using the same valuation method.  Permits gaming and favors a party with substantial resources compared to the party receiving the offer.

4.Rotating/Alternating or Casting Vote Mechanisms.  There is a dispute between member A and member B.  Member A may make the decision in this instance and member B gets to make the decision in the next dispute.  Also possible to game.

5.Use of an outside trusted advisor, who will make the decision.

Each of the foregoing has its positive and negative aspects and each requires extreme care in drafting.  In spite of that, negotiated resolutions of deadlock situations will almost always be superior to the cost and angst of a full scale binding arbitration or litigation.

-- Bob Copeland 

**This article is for information purposes only and does not contain or convey legal advice.  The information herein should not be relied upon in regard to any particular facts or circumstances without first consulting an attorney. Any views expressed are those of the author only and not of the SDCBA or its Business & Corporate Law Section.**