When to Seek Judicial Dissolution of an LLC

Key Takeaways: When to Seek Judicial Dissolution of an LLC

• What is Judicial Dissolution? A court-ordered termination of an LLC when voluntary dissolution is not an option.
• When Should You Seek It?
  • Deadlock among members preventing essential business decisions.
  • Conflicts that make business operations impossible.
  • Fraud, oppression, or misconduct by controlling members.
  • The LLC can no longer fulfill its intended purpose.
• Legal Standards for Judicial Dissolution:
  • Strict Approach (New York, Delaware): Only granted when the LLC is no longer “reasonably practicable.”
  • Broader Approach (Uniform LLC Act States): Courts may dissolve an LLC for deadlock, oppression, or fraud.
• How to Proceed? Consult a business litigation attorney to evaluate your legal options and protect your rights.

  ---

There are times when disputes among members of a limited liability company can reach the point where continuing the business becomes impossible. When the conflicts are intractable, a lawsuit for judicial dissolution is a way for the owners to find a remedy .

The remedies available to LLC members in a judicial dissolution action vary from state to state, and it is critical to owners to have a clear understanding of what is and is not possible Some states, such as New York and Delaware, are narrow in the remedies available, assuming that the members are best able to manage their affairs through contracts between them. This “strict approach” permits judicial dissolution only when it is “not reasonably practicable” to continue operations in compliance with the LLC’s operating agreement.

Other states, particularly those that have enacted the Uniform Limited Liability Company Act (ULLCA), offer a more flexible framework. In these states, members can pursue judicial dissolution on broader grounds, including minority oppression, illegality, and fraudulent behavior.

In addition, the courts in ULLCA states have broader authority to craft tailored remedies such as compelled buyouts of member interests or the sale of the business as a going concern. We examine here the legal standards for judicial dissolution, and provied a general comparison of the narrow and more flexible approaches, as well as the remedies available to members facing irreconcilable disputes.

What Is Judicial Dissolution?

Judicial dissolution is a court-ordered termination of an LLC. It is distinct from voluntary dissolution, where members agree to cease operations and wind up the company’s affairs, and administrative dissolution, which occurs when an LLC fails to comply with state filing requirements. Judicial dissolution is typically sought when:

• Members are deadlocked on significant business decisions.
• The LLC has become unmanageable due to conflicts or mismanagement.
• A member’s rights are being violated through oppressive or fraudulent behavior.

Dissolution is a term that describes the process of closing a business. It requires the owners to wind up the business, which means to marshal the assets of the business, pay the debts and then distribute what is left to the owners. Once a company is dissolved, it contines to exist for the winding up process only and is prohibited from taking new business.

---

I am a lawyer, a certified valuation analyst, and a certified exit and succession planner.  I have worked with closely held business owners throughout my career. Contact me with questions about managing your closely held business and protecting your rights as an owner.

---

However, as we discuss here, in the management of closely held businesses, judicial dissolution in many states gives the court the ability to impose other equitable remedies that do not require the business to close its doors.

Two Legal Frameworks for Judicial Dissolution

The laws governing judicial dissolution fall into two main categories, depending on the state:

1. The Narrow Approach (exemplified by New York and Delaware) In these states, dissolution is limited to cases where continuing the LLC is no longer “reasonably practicable.”
2. The Flexible Approach (modeled on the ULLCA) Half the states and the District of Columbia have adopted the ULLCA, under which courts may recognize broader grounds for dissolution, including minority oppression, illegality, and fraud.

A Narrow ‘Contractarian’ Approach: New York and Delaware

New York and Delaware are business-friendly legal environments. LLCs are creatures of contract and courts in those states will always attempt to apply a contractarian approach in which the agreements of the members govern. Under the “not reasonably practicable” standard, courts consider whether:

• The LLC can achieve its stated purpose as outlined in the operating agreement.
• The business is profitable.
• The operating agreement provides a mechanism to resolve disputes or deadlock.
• The LLC is capable of continued operations that are fair to the members.

Common Grounds for Judicial Dissolution in Strict States

1. Deadlock: Deadlock often occurs in member-managed LLCs where the division of ownership prevents decisions on critical issues. In these cases, the majority or unanimous agreement that may be required prevents any decision from being made. When the deadlock threatens the business with irreparable harm, courts generally intervene.
2. Inability to Pursue its Purpose: If the LLC’s stated business purpose becomes unattainable—due to market changes, member conflicts, or other factors—continuation may no longer be reasonable.
3. Severe Dysfunction: Dysfunction caused by mismanagement, fraud, or breaches of fiduciary duty can sometimes meet the “not reasonably practicable” standard, but the bar is high.

Remedies in Strict state courts in New York and Delaware typically prioritize remedies that preserve the LLC if possible. These may include appointing a receiver to manage the business temporarily or requiring mediation to resolve disputes. Dissolution is seen as a last resort.

The Flexible Approach: ULLCA States

In contrast, states that follow the ULLCA provide more expansive grounds for judicial dissolution. The ULLCA reflects a modern understanding of LLC disputes, allowing courts to address member oppression and other issues that strict states may not recognize.

Grounds for Judicial Dissolution in ULLCA States

Minority Oppression Courts in ULLCA states may dissolve an LLC if majority members or managers engage in conduct that is oppressive to minority members. Examples include:

• Denying minority members access to financial records.
• Withholding distributions or profits.
• Excluding minority members from decision-making without justification.

Illegality

If an LLC is engaged in illegal activities, such as fraudulent practices or regulatory violations, judicial dissolution may be warranted to protect the public and the interests of other members. 

Fraud or Mismanagement

Courts may dissolve an LLC if its managers or members engage in fraudulent behavior, gross mismanagement, or self-dealing that harms the business or other members.

Impracticability

Like strict states, ULLCA jurisdictions also allow dissolution when it is no longer “reasonably practicable” to carry on the business in accordance with the operating agreement.

Remedies in ULLCA States

ULLCA states provide courts with broad discretion to craft equitable remedies tailored to the circumstances of the case. These include:

1. Sale of the Business as a Going Concern Instead of dissolving the LLC and liquidating its assets, courts may order the sale of the business as a whole. This approach maximizes the value of the company and ensures that creditors and members receive fair compensation.
2. Compelled Buyouts A court may order one member to buy out another’s interest in the LLC. This remedy is particularly common in cases of minority oppression, where the oppressed member seeks to exit the business while receiving fair value for their stake.
3. Forced Sale of Membership Interests Conversely, a court may compel a member to sell their interest if their conduct has harmed the LLC or other members.
4. Appointment of a Custodian or Receiver If dissolution is not appropriate, courts can appoint a neutral third party to manage the LLC temporarily. This remedy allows the business to continue while disputes are addressed.
5. Alternative Remedies Depending on the circumstances, courts may also:
   • Amend the operating agreement to address disputes or provide new governance mechanisms.
   • Require arbitration or mediation as an alternative to dissolution.
   • Order specific performance of the operating agreement’s terms.

Filing for Judicial Dissolution

The process for seeking judicial dissolution varies by state but generally involves the following steps:

1. Consult an Attorney Dissolution is a complex legal process with significant consequences. Consulting an experienced attorney is essential to evaluate your case and develop a strategy.
2. Review the Operating Agreement The operating agreement is often the key document in dissolution cases. It may include provisions for resolving disputes, deadlocks, or buyouts that must be exhausted before seeking judicial dissolution.
3. File a Lawsuit with the Court A member seeking dissolution must file a petition in the appropriate court, detailing the grounds for dissolution and providing evidence to support the claim.
4. Serve Notice to the LLC Members All members must receive notice of the petition, ensuring they have an opportunity to respond.
5. Court Proceedings The court will evaluate the evidence and arguments, considering whether dissolution is warranted and whether alternative remedies might resolve the dispute. The time to resolve a lawsuit for judicial dissolution varies widely depending on the nature of the issues.
6. Wind Up the LLC If the court orders dissolution, the LLC must wind up its affairs. This involves liquidating assets, paying debts, and distributing remaining proceeds to members.

Practical Considerations

Protecting Your Interests in the LLC

If you are involved in a dispute that may lead to judicial dissolution, it is crucial to protect your interests:

• Document Evidence: Keep detailed records of financial transactions, communications, and meeting minutes to support your claims.
• Understand Your Rights: Familiarize yourself with state law and your operating agreement to anticipate potential outcomes.
• Explore Alternatives: Consider whether buyouts, mediation, or other remedies might resolve the dispute without court intervention.

Choosing the Right Strategy

The framework in your state will significantly influence your strategy. In strict states like New York and Delaware, dissolution is difficult to achieve, so building a strong case under the “not reasonably practicable” standard is essential. In ULLCA states, broader grounds and remedies provide more options, but your approach should align with your long-term goals.

Conclusion

Judicial dissolution is a powerful remedy for LLC members facing irreconcilable disputes, but the laws governing its application vary widely across states. New York and Delaware view the issue narrowly, generally limiting dissolution to cases where the business cannot function under its operating agreement. A compelled sale of the business as a going concern is sometimes available as remedy, but the other remedies that courts apply in ULLCA states generally are not as available. I

n contrast, ULLCA states provide a more flexible framework, allowing dissolution for minority oppression, illegality and fraud, as wll as impracticability. Courts in these states also have broad discretion to impose tailored remedies, such as forced buyouts or the sale of the business as a going concern.

At the Business Divorce Group at Weiner Law, we understand the challenges of navigating LLC disputes and the complexities of judicial dissolution. Our team works with LLC members to evaluate their options, protect their interests, and achieve fair outcomes, whether through dissolution, buyouts, or alternative remedies. Contact Weiner Law’s Business Divorce Group today to discuss your situation and explore the best path forward for your business.