In the contract-centric world of limited liability companies (LLC), the Delaware Court of Chancery’s decision last month in Gurney-Goldman v. Goldman, C.A. No. 2023-1124-JTL (Del. Ch. July 12, 2024), serves as a stark reminder of the perils of informality, the consequences that can befall businesses failing to formalize management succession, and the importance of clear contracting in connection with all things LLC. While the case centers around a factually intricate dispute among siblings who inherited a vast real estate empire, the legal principles highlighted by the Court of Chancery resonate beyond the realm of familial discord, underscoring the importance of contractual specificity in matters of LLC management and succession planning.
Transferring Management of an LLC
The Gurney-Goldman saga unfolded against the backdrop of a sophisticated network of companies, many of which constituted LLCs lacking formal operating agreements or clear documentation regarding the transfer of membership interests. Two siblings, acting as de facto managers of the relevant LLCs, were the “decision-makers” on behalf of the sibling group. However, upon the death of one of these “decision-making” siblings, his son sought to step into his father’s managerial role. The remaining three siblings resisted, resulting in protracted litigation during which the Court of Chancery had to navigate the ambiguous management structure of the LLC in dispute. Relying on the default statutory guidance of the Delaware Limited Liability Company Act (LLC Act, 6 Del. C. § 18-101, et. seq.), the parties’ course of conduct, and relevant estate law, the Court of Chancery concluded the son could not just assume the role of manager upon his father’s death.
One of the key takeaways from Gurney-Goldman is that the transfer by inheritance of a membership interest of a manager of an LLC upon the death of that member/manager does not constitute the transfer of the managerial rights of the deceased member. This general policy, grounded in the “pick-your-partner” principle, safeguards existing members from having new co-managers foisted upon them without consent or advance contractual notice in the LLC’s governing instrument. Thus, while succession planning for members of an LLC is important, transfer of management of the LLC does not occur absent an explicit provision in the governing operating agreement. As Gurney-Goldman demonstrates, the absence of such explicit contractual forethought can lead to protracted and costly litigation.
Section 18-705 of the LLC Act
Of additional interest is the Gurney-Goldman analysis of Section 18-705 of the LLC Act, which governs the rights of personal representatives of a deceased member to exercise the member’s rights. The Court of Chancery notes the statute circumscribes these rights, which are more akin to those of an assignee than a full-fledged member, without the transfer of any “governance rights” the deceased member had in the LLC:
When a member of an LLC transfers its member interests to another person, then by default under the LLC Act the recipient of the interest does not automatically become a member. The recipient only holds the rights of an assignee, which consist of the economic rights associated with the interest, plus the power to sue derivatively. The assignee does not receive any of the governance rights associated with the interest, nor does an assignee have the right to seek books and records or seek statutory dissolution. (Internal citations removed.) (Emphasis added.)1
This distinction underscores the limitations inherent in Section 18-705, indicating that personal representatives, while granted certain rights, do not inherit the full spectrum of privileges enjoyed by active members. Again, this is an example of where clear documentation in an LLC agreement regarding succession planning could avoid disputes regarding membership interests and associated rights.
Perils of Informal Documentation
An example of the challenges presented by informal attention to the governance of an LLC upon the death of a member/manager is the Gurney-Goldman discussion of the Schedule K-1 forms. The K-1 forms, reporting a partner’s or LLC member’s share of income, deductions and credits of the LLC, highlighted the confusion regarding the LLC’s management structure — confusion a concisely drafted LLC agreement could have avoided had it addressed succession planning for transfer of both membership and managerial interests. The forms presented a stark, binary choice: “general partner or LLC member-manager” or “limited partner or other LLC member.” Here, both the living siblings and the estate of the deceased member/manager claimed the latter, suggesting a limited role within the LLC.
However, both sides’ theory of the case contradicted such a limited role as all parties asserted status as members and managers of the LLC. The plaintiffs argued all three living siblings were member/managers, while the defendant/estate argued the son was also a member/manager. Ultimately, the designation as “other LLC member” on the K-1 forms contradicted the parties’ assertions regarding their roles within the LLC.2
While the use of K-1 forms in this case did not benefit either party, it serves as a reminder that even the LLC’s tax forms can prove inconclusive regarding the membership and managerial status for an LLC lacking formal and clear documentation.
Avoiding Similar Disputes
The Gurney-Goldman case underscores the imperative of meticulous documentation and proactive planning in LLC formation, management and succession planning. To the extent possible, an operating agreement should anticipate potential contingencies such as the death or incapacity of a member and, if that member is also a manager, how the LLC will determine who fills that management void. Clarity and precision in drafting can help avoid informal practices that lead to ambiguity and disputes.
While the LLC Act permits oral or implied operating agreements, the tangled dispute featured in the Gurney-Goldman litigation provides valuable insight into the inherent challenges of proving the terms of such agreements. As the Court of Chancery notes, “[p]ermitting oral and implied agreements thus makes the lawyers’ lives easier, even if it makes adjudication harder.” By investing the time and resources to create comprehensive operating agreements that adhere to contract formalities, members and managers of LLCs can safeguard their interests and avoid the pitfalls that ensnared the parties in Gurney-Goldman.
Gurney-Goldman is a cautionary tale, particularly for family-managed LLCs, as the allure of informality collides with the chaotic reality that informal understandings and undocumented practices can have dire consequences. It serves as a poignant reminder that the absence of clear documentation and proactive planning can derail even the most well-intentioned business ventures. By heeding the lessons of this case, members and managers of LLCs can protect the longevity and success of their enterprises.
1 See id at 20-21 (Internal citations removed) (Emphasis added).
2 See id. at 30.
