Delaware Court of Chancery Has Inherent Equity Authority to Appoint a Receiver for a Delaware Limited Liability Company

Steven D. Goldberg, Esq.
Wilmington, DE
sgoldberg@stevendgoldberg.com http://www.stevendgoldberg.com
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

The Delaware LLC Act in Section 18-805 provides that the Court of Chancery has the power and authority to appoint a receiver for a LLC which has had its certificate of formation cancelled. The Act is silent on the power of the Court to appoint a receiver for an LLC which has not had its certificate of formation cancelled.

Recently Vice Chancellor Noble decided the case of Ross Holdings and Management Company v. Advance Realty Group, LLC [Ross Holdings v. Advance Realty]. The plaintiffs in their moving papers asserted, among other claims, that Advance Realty Group (ARG) is insolvent as a result of the conduct of the individual defendants and that there is question as to whether ARG is able to continue as a going concern. Plaintiffs seek the appointment of a receiver to manage the company’s affairs in order to prevent the Board from further disposing of the company’s assets for personal gain.

Defendants counter that neither the LLC Act nor the Company Agreement permit the appointment of a receiver in the circumstances alleged.

The Plaintiffs took the position that as the Act is silent, the Court should borrow from the DGCL and look to the corporate case law as developed to determine when it has authority to appoint a receiver for a LLC which has not had its certificate of formation cancelled.

The Court stated at 14:
The LLC Act was written long after our corporate statutes and several of those provisions have been incorporated into the LLC Act. Notably, 6 Del. C. § 18-805 tracks closely 8 Del. C. § 279, the general provision establishing the process for appointing a receiver in the corporate context, with the notable difference being the circumstances in which a receiver may be appointed. This seems to suggest that the omission in the LLC Act of the provision for appointing a receiver in the case of insolvency was an intentional, not an inadvertent, act by the General Assembly.
The Plaintiffs point to case law where courts have borrowed from the
corporate law when the LLC Act was silent as to a particular provision. However, the example that they use, where the court looked to the corporate law to determine the default fiduciary duties that limited liability company members owe to one another duties. Moreover, the LLC Act refers to fiduciary duties, but is silent as to their contours. Our courts had developed standards for the appointment of a receiver long before the codification of 8 Del. C. § 279 and there was no obvious statutory gap in need of filling with respect to the appointment of a receiver on grounds of insolvency. Indeed, some courts have suggested that insolvency may be a
necessary condition for appointing a receiver under the court’s general equitable powers. That § 279 establishes a lesser basis for appointing a receiver does not mean that the rules of equity do not already account for insolvency in determining the appropriateness of appointing a receiver. There is no need to borrow from the corporate statute where a more general standard is well-established in our law, particularly with respect to questions of equity. As such, the Court accepts that a receiver may only be appointed in this case in accordance with its general equity powers.

The Court then considered whether a receiver should be appointed at the current stage of the proceedings. The Court concluded that because there were material facts in dispute that the Court would not at this stage appoint a receiver. (At 15)

Because a receiver is unavailable under either the LLC Act or any version of the Operating Agreement, the only basis for appointing a receiver is by way of the Court’s general equity powers. As a general matter, “the appointment of a receiver is an extraordinary, a drastic and . . . an ‘heroic’ remedy. It is not to be resorted to if milder measures will give the plaintiff, whether creditor or shareholder, adequate protection for his rights.” As such, courts of equity exercise this power “with great caution and only as exigencies of the case appear by proper proof. . . .” This is particularly the case where the entity continues to function actively. As this Court put it many years ago:
“[A] receiver pendente lite for a corporation actively functioning is
never to be justified except under circumstances that show an urgent
need for immediate protection against injury either in the course of
actual infliction or reasonably to be apprehended. As the remedy is a stringent one and fraught often times when asked for with the
possibilities of as much if not more harm than that which it seeks to
avoid, it should be applied with scrupulous care. Only emergent
situations can evoke its application.”
Consequently, a court may utilize its equitable powers to appoint a receiver only “when fraud and gross mismanagement by corporate officers, causing real imminent danger of great loss, clearly appears, and cannot be otherwise prevented.” Moreover, “a receiver will never be appointed except under special circumstances of great exigency and when some real beneficial purpose will be served thereby.” Nor will a court of equity appoint a receiver simply because of errors of judgment in business management.

The Court ordered a trial to determine the facts that are in dispute.