Texas Business Organizations Code Section 11.314 provides:
A district court in the county in which the registered office or principal place of business in this state of a domestic partnership or limited liability company is located has jurisdiction to order the winding up and termination of the domestic partnership or limited liability company on application by an ower of the partnership or limited liability company if the court determines that:
(1) the economic purpose of the entity is likely to be unreasonably frustrated;
(2) another owner has engaged in conduct relating to the entity’s business that makes it not reasonably practicable to carry on the business with that owner; or
(3) it is not reasonably practicable to carry on the entity’s business in conformity with its governing documents.
The statute provides that the company becomes subject to district court jurisdiction to order winding up and termination if a petitioning member satisfies one or more of three tests, which we will refer to as the “economic purpose test,” the “owner conduct test,” and the “reasonable practicability test.” No Texas cases have applied section 11.314 to an LLC, and only a small number of cases apply the same statute to partnerships. However, courts in other jurisdictions have applied statutes with wording essentially identical to the three tests set forth in section 11.314 to a wide variety of circumstances. This post considers the "reasonable practicability" test under 11.314(3). This is by far the most common test applied in dissolution actions involving LLCs.
Reasonable Practicability Test
The reasonable practicability test stated in section 11.314(3) is whether “it is not reasonably practicable to carry on the entity’s business in conformity with its governing documents.” Texas courts interpreting the “reasonably practicable” language in the limited partnership context have held that the provision “is unambiguous, and the legislature’s intent is clear; we therefore apply its plain and ordinary meaning.” The Colorado Court of Appeals interpreting identical language in the Colorado LLC statute held: “Based on these common definitions, we conclude that to show that it is not reasonably practicable to carry on the business of an LLC, a party seeking a judicial dissolution must establish that the managers and members of the company are unable to pursue the purposes for which the company was formed in a reasonable, sensible, and feasible manner.” “Not reasonably practicable” to carry on the business does not mean impossible. A Delaware court reasoned that “[d]issolution of an entity chartered for a broad business purpose remains possible upon a strong showing that a confluence of situationally specific adverse financial, market, product, managerial, or corporate governance circumstances make it nihilistic for the entity to continue.” Courts have considered a number of factors in determining reasonable practicability: “These include, but are not limited to: (1) whether the management of the entity is unable or unwilling reasonably to permit or promote the purposes for which the company was formed; (2) whether a member or manager has engaged in misconduct; (3) whether the members have clearly reached an inability to work with one another to pursue the company’s goals; (4) whether there is deadlock between the members; (5) whether the operating agreement provides a means of navigating around any such deadlock; (6) whether, due to the company’s financial position, there is still a business to operate; and (7) whether continuing the company is financially feasible. No one of these factors is necessarily dispositive. Nor must a court find that all of these factors have been established in order to conclude that it is no longer reasonably practicable for a business to continue operating.” “Not Reasonably Practicable to Carry on Business” The reasonable practicability test has two operative concepts. The first is the practicability of carrying on the business, and the second is the practicability of doing so in conformity with the governing documents. If an LLC is simply not able to carry on the business for which it was created, then it obviously cannot satisfy the reasonable practicability test. There are a number of reasons that business have been dissolved due to the inability to carry on their business at all.
Failure of Stated Purpose
Limited liability companies fail the reasonable practicability test if they were formed for a specific purpose and are then unable to pursue that purpose for some reason. Examples include a company formed for the purpose of operating TGI Fridays restaurants at DFW airport that loses its lease at the airport, a company formed to operate a horse racing track that fails to obtain a racing license, and a company formed to operate a professional hockey team that fails to obtain the franchise. When a company “cannot effectively operate under the operating agreement to meet and achieve the purpose for which it was created,” dissolution has been allowed. Courts often look to an LLC’s company agreement to determine the “purpose” of the business when determining whether an LLC should be dissolved under the reasonable practicability test. However, this analysis is of limited utility for most companies in Texas because LLCs formed in Texas may state that they are formed for “any lawful purpose.”
A more obvious example of a business that is not reasonably practicable to carry on is one that is failing financially. Courts have ordered dissolution under the reasonable practicability standard when the LLC “is financially unfeasible.” “Dissolution generally has been deemed appropriate . . . when the company is failing financially.” A business that is not financially viable will fail to achieve the purposes stated in its governing documents—no matter what they are.
Another reason that it is not reasonably practicable to carry on the business at all is when the company’s decision-making capacity is deadlocked. “[A] deadlocked management board is a quintessential example of a situation justifying a judicial dissolution.” Under Texas law, a deadlock can occur in an LLC any time there are an equal number of managers (or members in a member-managed company), and the company agreement does not provide for weighted voting or some tie-breaking mechanism. Unless otherwise provided in the company agreement, “[e]ach governing person, member, or committee member of an LLC has an equal vote at a meeting of the governing authority, members, or committee of the company, as appropriate.” “[I]f that deadlock cannot be remedied through a legal mechanism set forth within the four corners of the operating agreement, dissolution becomes the only remedy available as a matter of law.” Where the parties are able to resolve the deadlock by, for example, lawfully expelling a member or purchasing his interest, dissolution will be denied. However, courts do not consider a deadlock to be resolved where one party has control as a practical matter and cannot be ousted because of the deadlock. As the Delaware Chancery Court has stated, “this court has rejected the notion that one co-equal fiduciary may ignore the entity’s governing agreement and declare himself the sole ‘decider.’”
“In Conformity with the Governing Documents”
Section 11.314(3) modifies the concept of “not reasonably practicable to carry on the entity’s business” with the phrase “in conformity with its governing documents.” Limited liability companies that cannot function at all because they are financially defunct, because they are unable to pursue the specific purpose for which they were formed, or because the company cannot function due to its management being hopelessly deadlocked, are easy cases. Some courts have effectively limited dissolution of LLCs under statutes similar to section 11.314 to those specific instances. However, the plain language of section 11.314 demands a broader reading. The South Dakota Supreme Court noted: “There is no dispute that the ranching and livestock operation, as a business, can continue despite the sisters’ dissension. However, the question is whether it is reasonably practicable for the company to continue in accordance with the operating agreement.” A reading of the statute that limits its application to the question of whether the company is able to carry on its business at all would render the phrase “in conformity with its governing documents” superfluous. If the review of the governing documents is limited to the stated purpose of the entity (which will almost always be “any lawful purpose”), then only the certificate of formation should be referenced, not the governing documents. The company agreement frequently does not address the company’s purpose; the function of the company agreement is to govern the relations among the members, manager, and officers and other internal affairs of the company. One can certainly envision situations in which the LLC is otherwise perfectly capable of carrying on its business to achieve “any lawful purpose” but fails to do so in a manner that complies with the terms that its governing documents set forth to govern the relations of the members and the internal affairs of the company. Section 11.314 grants the court jurisdiction to order winding up in those situations. One Texas court has rejected a narrow reading of the language, and as noted below, most courts in other jurisdictions do as well.
This post is taken from an article recently published by Hopkins Centrich Law in the University of Houston Law Center's Houston Business and Tax Law Journal. Download a copy of the article with the full analysis and case citations: