Iowa Supreme Court Reverses Family-Operated LLC Dissolution
On May 14, 2021, the Iowa Supreme Court released an opinion regarding a family dispute over an LLC. The district court dissolved the LLC after disagreement broke out between several members. The Supreme Court reversed the dissolution, finding that the district court resolved the issues creating deadlock and that the LLC could fulfill its intended purpose.
Interested in purchasing real estate, Tracy Barkalow approached his brother-in-law, Bryan Clark, to lend him money. After discussion, the pair decided to involve Bryan’s two brothers, Jeff and Joe Clark, to create an LLC with the purpose of investing in real estate. The four agreed to each contribute one-fourth of the down payment and installment payment. Because Tracy did not have the funding, the Clark brothers verbally agreed to loan him the money.
According to the LLC’s founding documents, each member would initially have a 25% equity interest proportionate to their original contribution. The members would not be required to give additional capital, but ownership interest was subject to change based on any additional contributions. The LLC acquired several more properties with the Clark brothers continuing to loan the down payments to the LLC.
The relationship between Tracy and two of the brothers eventually deteriorated. Tracy made several unilateral decisions on behalf of the LLC including halting repayments to the Clark brothers and paying his own company for management fees. In 2015, the LLC was in danger of defaulting on outside financing. The Clark brothers made additional capital contributions of $333,956. Tracy declined to follow suit, but instead chose to expand his own personal real estate portfolio.
At a member meeting in 2016, the Clark brothers voted to make another round of capital contributions to pay off the Clark loans. They also offered to buy Tracy’s 25 percent ownership share at fair market value. Tracy, who did not pay for his initial capital contribution until September of 2016, declined both offers. He then brought this lawsuit for dissolution of the LLC and sought damages for breach of fiduciary duty. The court declined to award damages and denied Tracy’s request for dissolution based on majority oppression. Nevertheless, the court granted the petition for dissolution under the theory of impracticability. Two of the brothers appealed the dissolution and Tracy cross-appealed.
Oppressive Conduct of Majority Members
The Court first considered Tracy’s cross-appeal on whether the brothers acted oppressively by diluting Tracy’s ownership interest in the LLC through the additional capital contributions in 2015 and 2016. A member of an LLC may apply for judicial dissolution on the grounds that the controlling members have acted in an oppressive and harmful manner towards the applicant. Iowa Code § 489.701(1)(e)(2). Oppressive conduct includes behavior that frustrates the reasonable expectations of the minority shareholder. Baur v. Baur Farms, Inc., 832 N.W.2d 663, 674 (Iowa 2013).
The Court concluded that Tracy’s expectations were not reasonable. He did not contribute any capital to the LLC, but rather allowed the brothers to finance the real estate venture. At times, Tracy even prevented the LLC from obtaining outside funding. The Court determined that Tracy’s expectations were not reasonable as the LLC’s founding documents clearly contemplated the potential of additional capital being needed—and thereby reducing a declining member’s ownership share—in order to achieve the LLC’s real estate investment purpose. Noting that the Clark brothers’ offer to buy Tracy’s share undermined his claim, the Court affirmed the denial of dissolution based on majority oppression.
Dissolution of an LLC due to impracticability
Next, the Court considered whether the district court erred in dissolving the LLC based on impracticability. A court may grant an application for dissolution if “[i]t is not reasonably practicable to carry on the company’s activities in conformity with the certificate of organization and the operating agreement.” Iowa Code § 489.701(1)(d)(2).
Turning to other jurisdictions for guidance, the Court found that courts will order dissolution when there is unbreakable deadlock between the members or if the LLC cannot fulfill its intended purpose. In this case, the district court had already resolved the deadlock over the issues of capital contributions and Tracy’s breach of fiduciary duty claim. Additionally, the LLC became financially successful over the course of the litigation and continued to fulfill its intended purpose of investing in real estate. Accordingly, the Court reversed the order dissolving the LLC.
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