When two or more people become owners of a limited liability company and embody their relationship in an operating agreement, they usually see sunshine and rainbows in their future. They have an idea, they have a corporate structure, and they have each other.

But there comes a point in the life of many a multi-member LLC where that sunshine and those rainbows from the early days turn into a large stop sign. Disagreements about some aspect of the LLC’s operations or a personal conflict sometime lead to deadlock and an inability to operate the LLC together—and consistent with their operating agreement. As a result, at least one of the owners wants to end the relationship.

A well-crafted operating agreement will provide provisions that allow co-owners to resolve disputes without invoking the nuclear option of dissolving the entity. These dispute resolution devices often come in the form of call and put options triggered by a variety of events. Delaware LLC law is protective of the parties’ buy-out provisions by allowing waiver of the right to “judicial dissolution,” which is a fancy way of saying a court-ordered dissolution of an LLC. The Pennsylvania LLC statute, however, prohibits waiver of the right to judicial dissolution, creating a potential end run around bargained-for buy-out provisions contained in the operating agreement.

Judicial dissolution of an LLC

 When the owners of an LLC dissolve it, they terminate its operations, pay off its debts, and fairly distribute whatever is left among themselves. Once the dissolution process plays out, the LLC ceases to exist.

Many LLC owners dissolve their corporate entities without having to step foot in court. But the Pennsylvania LLC statute allows for judicial dissolution of an LLC when it is “not reasonably practicable” to continue operating the company in accordance with the original certificate of organization and operating agreement. The Delaware LLC statute provides for judicial dissolutions in a similar way.

Pennsylvania’s LLC statute expressly prohibits waivers of judicial dissolution in an LLC operating agreement (Pa. C.S.A. § 8815(c)(15)). In other words, Pennsylvania LLC owners cannot take judicial dissolution off the table when describing in their operating agreements the circumstances in which their LLCs can be dissolved. This means that in Pennsylvania, LLC owners always have a judicial dissolution option when they no longer see eye-to-eye with their co-owners.

Things are different a few miles south on I-95. Unlike Pennsylvania, Delaware allows LLC owners to agree to waive the right to judicial dissolution in their operating agreements. Thus, Delaware LLC owners can explicitly state in their operating agreements that the LLC cannot be dissolved through a court proceeding.

In Delaware, no (judicial dissolution) means no (judicial dissolution)

A 2013 case in the Delaware Chancery Court, Huatuco v. Satellite Healthcare, 2013 WL 6460898 (Del. Ch. Dec. 9, 2013), aff’d, 93 A.3d 654 (Del. 2014), illustrates the Chancery Court’s unwillingness to rewrite the language of an LLC operating agreement to allow judicial dissolution when the parties, through that language, appeared to have waived their rights to it.

Despite the plaintiff in the case appearing to have a solid argument that the defendant breached their LLC agreement (giving him a contractual right under the agreement to purchase the defendant’s interest in the company), he instead filed a complaint with the court seeking judicial dissolution.

The court, relying on the following language of the LLC agreement, held that the plaintiff waived his right to a judicial dissolution:

“Except as otherwise required by applicable law, the Members shall only have the power to exercise any and all rights expressly granted to the Members pursuant to the terms of this Agreement.”

Not only was this provision silent as to the parties’ ability to seek judicial dissolution, the court noted that the parties considered and addressed dissolution rights in other sections of the LLC agreement but did not mention judicial dissolution as an option.

Looking at the LLC agreement as a whole, the court found that the agreement contained other provisions, including cross-purchase provisions, that allowed the plaintiff to terminate his business relationship with his co-owner without judicial dissolution. Ultimately, the court respected the parties’ bargained-for contractual language and was unwilling to read the terms of the LLC agreement to allow for a judicial dissolution option when none was suggested by the parties.

In Pennsylvania, it is not possible to waive judicial dissolution

 Given the difference between the Pennsylvania and Delaware LLC statutes, if the parties in the Huatuco case were co-owners of a Pennsylvania LLC, we might be looking at a different outcome.

It is likely that the judge in the case would have found the language of the LLC agreement I highlighted above to be an invalid waiver of the right to judicial dissolution. As a result, the plaintiff would have been able to seek judicial dissolution and potentially avoid the agreed-upon provisions in the LLC agreement that provided ways for him to terminate his business relationship with his co-owner other than through judicial dissolution.

This alternative ending can be problematic because it negates the purpose of including buy-out provisions in the operating agreement—to avoid dissolving a viable business.

But is Pennsylvania that disrespectful of bargained-for buy-out provisions? Is Delaware that rigid?

If a party can seek judicial dissolution in Pennsylvania notwithstanding buy-out provisions in the operating agreement, why bother including them?

In practice, Pennsylvania courts are loath to dissolve a viable company and try to avoid doing so. The existence of buy-out provisions in an operating agreement offer courts an avenue to avoid dissolution. For example, a court might determine that it is “reasonably practicable” for deadlocked owners to operate a company in accordance with its operating agreement when that operating agreement contains buy-out provisions. See e.g., Potter v. Brown, 195 A. 901, 903–04 (Pa. 1938); Staiger v. Holohan, A.3d 622, 624 (Pa. Super. Ct. 2014) (applying Potter to dissolution pursuant to 15 Pa.C.S.A. § 8871 (A)(4)(ii) and concluding that “[t]he partnership [in Potter] was operating according to the agreed-upon terms, and, thus, dissolution was not warranted.”).

Delaware’s statute appears to create the possibility of locking feuding members in perpetual combat if the operating agreement waives judicial dissolution but provides no buy-out provisions. The court in Huatuco left open the possibility that it could judicially dissolve an LLC over a waiver if the operating agreement failed to provide any alternative to leaving members “locked away together forever like some alternative entity version of Sartre’s Huis Clos.” (https://en.wikipedia.org/wiki/No_Exit) Huatuco, 2013 WL 6460898, at *1, n. 2.

The Takeaway: Non-Judicial Dispute Resolution Provision Remain the First and Best Way to Avoid Judicial Dissolution

The ultimate takeaway here is the most obvious. Robust buy-out provisions in an operating agreement are the best way to avoid the nuclear option of judicial dissolution. Consistent with Delaware’s general preference to honor the agreements of the parties, its LLC statute and courts expressly permit the wavier of judicial dissolution. Even in Pennsylvania, most courts would prefer to avoid judicial dissolution if possible. Well-crafted buy-out provisions give them a viable way to do so.