Business Law

Business Law News 2018, ISSUE 3

Reserving For a Delaware LLC

Phil Jelsma

Phil Jelsma is a tax partner at the San Diego law firm of Crosbie Gliner Schiffman Southard & Swanson LLP (CGS3). He specializes in real estate taxation, closely held businesses, investment, tax and nonprofit organizations. He was formerly a tax partner with Luce Forward Hamilton & Scripps LLP and McKenna Long & Aldridge LLP. He is an Adjunct Professor at the University of San Diego Law School and is a graduate of Stanford Law School. He is the Executive Editor of the CEB Publication "Understanding Fiduciary Duties in Business Entities."

For the last eighteen years, I have been told numerous times that Delaware LLCs are superior to California LLCs. On many occasions, lawyers, generally in firms much larger than my own, have explained to me that my proclivity for using California LLCs is parochial and antiquated. They point to certain actual and perceived advantages in using Delaware LLCs, such as faster formation, a flat franchise tax of $300 as opposed to California’s gross receipts fee, no bi-annual statements of information, greater flexibility, and a superior judiciary. Being a transactional lawyer in a real estate firm, well aware of California’s ten-year statute of limitations on construction defect claims,1 I have pointed out to them the language in Delaware’s LLC Act section 18-804, which requires that a dissolving LLC make provision for claims that are likely to arise or become known to the LLC within ten years after the date of dissolution. Wouldn’t a dissolving LLC in real estate development need to reserve for potential construction defects claims? They generally respond that that the section 18-804 language does not mean anything and therefore is unimportant.

The recent case of Capone v. LDH Management Holdings, LLC,2 which was decided by Vice Chancellor Glassock, suggests that those words in fact do mean something. Defendant LDH Management Holdings ("Management Holdings") held a 15% profits interest in Louis Dreyfus Highbridge Energy LLC ("LDH"). Another defendant, LD HMH MM LLC, was the managing member. It was also a wholly owned subsidiary of LDH. These equity interests gave two plaintiffs, former employees of LDH, an indirect profits interest in LDH of 1.5% and .7%, respectively.3 Under the Management Holdings Limited Liability Company ("LLC") Agreement, it had the right to redeem the units of any LDH employee who was terminated without cause. The call right was exercised at the fair market value of the units as of the last day of the last fiscal year preceding the fiscal year in which the call notice was given. Management Holdings redeemed the plaintiffs’ units as of April 12, 2011, so the relevant date for determining value of the units was December 31, 2010.

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