In Dysart v. Dragpipe Saloon, LLC, 2019 S.D. 52, the South Dakota Supreme Court emphasized just how drastic the circumstances must be to warrant judicial dissolution of a limited liability company. A disagreement among LLC members as to the direction of the LLC is not enough on its own. Rather, the disagreement must subvert the purpose of the LLC or cause an operational deadlock that cannot be resolved under the terms of its operating agreement.
Dragpipe Saloon, LLC (“Dragpipe”), owns 74 acres northeast of Sturgis including 18 acres used to operate a bar during the notorious Sturgis Motorcycle Rally. At the time of suit, Dragpipe had just begun turning a modest profit after years of unprofitability. Three members of the four member LLC wanted to sell Dragpipe’s property for a large payout. However, one member refused and two members filed suit seeking judicial dissolution and an order authorizing the sale of Dragpipe’s assets.
The circuit court granted dissolution and sale, citing the disagreement among the members about whether to sell the LLC’s real property. In doing so, the court relied on South Dakota’s Limited Liability Company Act (“LLC Act”) and Dragpipe’s operating agreement.
Under the LLC Act, an LLC may be dissolved by judicial decree, upon application by a member or a dissociated member for several reasons including if 1) the economic purpose of the company is likely to be unreasonably frustrated; or 2) it is not otherwise reasonably practicable to carry on the company’s business in conformity with the articles of organization and the operating agreement. SDCL 47-34A-801(a)(4).
Dragpipe’s operating agreement broadly states the LLC’s purpose as “owning, purchasing, taking, leasing, or otherwise holding or acquiring real property” and to “hold, own, operate, control, maintain, manage and develop such property and interests in any manner that may be necessary, useful or advantageous.” Dysart, ¶ 17. In addition, the operating agreement permitted members to resign and receive fair market value for their interest, or sell that interest outright.
The South Dakota Supreme Court reversed because neither cited statutory basis for dissolution was satisfied, emphasizing that the remedy is available only where it is “expressly authorized” by the LLC Act. Id. ¶ 15. Even though several members believed it was time to sell Dragpipe’s real property, Dragpipe could nonetheless continue to fulfill the broad economic purpose set forth in its operating agreement. Moreover, neither the historic losses nor Dragpipe’s failure to return income distributions to its members rendered its operation impracticable. And, dissenting members could exercise their right to exit the LLC by resigning or selling their membership to resolve their disagreement.
The court distinguished its decision in Kirksey, where judicial dissolution was authorized because the economic purposes of the LLC were likely to be unreasonably frustrated and because continuing the LLC's business was no longer practicable. Id. ¶ 16. The members in Kirksey were four sisters who had formed the LLC and contributed their equal interests in ranch land inherited from their mother. Two sisters were also tenants who leased the ranch land under terms that became increasingly favorable to them as the value of the land appreciated dramatically. They resisted efforts by the other two sisters to terminate the lease and sell the land, resulting in an “impenetrable deadlock” because there was no method of resolving the dispute under the operating agreement. Id. ¶ 21 (quoting Kirksey v. Grohmann, 2008 S.D. 76, 754 N.W.2d 825). While forced dissolution was an extreme remedy, that the tenant-sister faction wielded disproportionate power over the other two sisters and judicial dissolution was statutorily authorized.
In Dysart, there was no similar impenetrable deadlock as the members had alternatives to resolve this dispute under the operating agreement. This decision emphasizes that involuntary judicial dissolution represents an exceptional level of intervention into the otherwise private agreement of an LLC’s members, and is available only where the statutory grounds are satisfied.
At Novack and Macey, we have extensive experience advising shareholders involved in closely held company disputes, as well as advising companies on how to avoid disputes in the first place. For more information about our services, please contact Dana Taylor at 312.419.6900 or firstname.lastname@example.org.