General Provisions of Delaware LLC Law Do Not Trump Specific Provisions of LLC Agreement

On December 14, 2017, the First Department issued a decision in Estate of Calderwood v. ACE Group International LLC, 2017 NY Slip Op. 08750, holding that the general provisions of the Delaware law limited liability company regarding personal representatives did not trump the specific provisions of an LLC agreement, explaining:

According to defendants, under the terms of the LLC Agreement, at the time of Alex's death he became a "Withdrawing Member" and "cease[d] to be a Member of the Company" and his successor in interest, the Estate, retained only the rights to distributions.

The Estate, however, argues that § 18-705 of the Delaware Limited Liability Company Act (LLC Act) is a mandatory provision pursuant to which the personal representative of a deceased member may exercise all of the member's rights, notwithstanding the limitations contained in the LLC Agreement. Section 18-705 provides that if a member who is an individual dies the member's personal representative may exercise all of the member's rights for the purpose of settling the member's estate or administering the member's property, including any power under a limited liability company agreement of an assignee to become a member.

The Estate argues that because section 18-705 refers to all of the member's rights, the statute does not limit the rights of a personal representative to those rights given to a successor in interest under the LLC Agreement. We disagree. First, under the Act, the parties to an LLC agreement have substantial authority to shape their own affairs and in general, any conflict between the provisions of the Act and an LLC agreement will be resolved in favor of the LLC agreement. Second, the LLC Act's primary function is to fill gaps, if any, in a limited liability company agreement. This gap-filling provision is not required here because the LLC Agreement specifically addresses the exact situation in which the parties currently find themselves.

In an effort to further bolster its argument that section 18-705 controls here, the Estate relies on the lack of the phrase unless otherwise provided in a limited liability company agreement in section 18-705 as evidence of its mandatory status. However, and as noted by the motion court, this argument has already been considered and rejected by the Delaware courts. Also notable, section 18-705 contains the phrase may exercise, which connotes the voluntary, not mandatory or exclusive, set of options.

We also reject the Estate's argument that section 18-705 is likely to be mandatory under Delaware law because the purpose of section 18-705 is, in part, to protect third-party successors in interest. The Estate contends that section 18-705, in this case, protects vulnerable heirs' interests by allowing them to exercise all of the deceased member's rights. However, and as the motion court correctly stated, to hold that § 18-705 alters a member's rights upon death in a manner contravening the LLC Agreement is inconsistent with the well settled law articulated by the Delaware courts - that the substantive rights of LLC members are governed by contract. This interpretation is in line with Chancellor Chandler's statement in R & R Capital, LLC, that for Shakespeare, it may have been the play, but for a Delaware limited liability company, the contract's the thing. Ultimately, it is the contract that compels the Court's decision in this case because it is the contract that defines the scope, structure, and personality of limited liability companies. Thus, whether section 18-705 is mandatory or permissive, we, nonetheless, find that in this case, it does not override section 9.7(b) of the LLC Agreement.

(Internal quotations and citations omitted).

This decision touches on an area of commercial litigation that is a significant part of our practice: disputes regarding the ownership and control of closely-held businesses. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding such a dispute.