When you're forming an LLC for Massachusetts clients, any of
five powerful factors may require you to form it under the Delaware
Limited Liability Company act, 6 Del. C. section 18-101
et seq. (the "Delaware act") rather than under the
Massachusetts Limited Liability Company act (the "Massachusetts
act"). This may be so even though the LLC will operate primarily or
entirely in Massachusetts - and even though many key provisions of
the Massachusetts act are the same as or closely similar to
provisions of the Delaware act and are obviously derived from
them.
However, as discussed at the end of this article, forming
Delaware LLCs can involve significant hazards for Massachusetts
clients and their lawyers.
The five factors potentially requiring the use of the Delaware
act are these:
Sophisticated investors. Many sophisticated
investors and lenders, both U.S. and foreign, and their
professional advisers, including especially their lawyers, are
familiar with the Delaware act and feel comfortable working with
Delaware LLCs. However, many of them are unfamiliar with the
Massachusetts act and thus are reluctant to do business with
Massachusetts LLCs. If, now or in the future, your Massachusetts
LLC formation clients will be dealing with sophisticated U.S. or
foreign investors or lenders, you may have to form their LLCs under
the Delaware act.
"Everyone's second choice." The
non-Massachusetts members of a multi-member LLC will often want the
LLC to be formed under the LLC act of their home jurisdiction, not
under the Massachusetts act. However, the Delaware act is widely
regarded as the preeminent U.S. LLC act. Thus, the normal
compromise will be the Delaware act. As the saying goes,
"Everyone's second choice is Delaware."
The Delaware courts. The Delaware Court of
Chancery and the Delaware Supreme Court are widely viewed as the
best U.S. business courts, and they process LLC litigation and
other business litigation faster than the courts of most or all
other U.S. jurisdictions. The availability of the Delaware courts
to handle Delaware LLC internal disputes, especially disputes
involving high financial stakes, is a major reason for choosing to
form LLCs for Massachusetts clients under the Delaware act rather
than the Massachusetts act.
Specific Delaware act provisions. The Delaware
act contains numerous provisions that can be highly useful to
particular clients but for which there is no corresponding
provision in the Massachusetts act. For example:
- Section 18-1101(b). The cardinal
provision of the Delaware act is section 18-1101(b), which provides
that "[i]t is the policy of this [act] to give the maximum effect
to the principle of freedom of contract and to the enforceability
of limited liability company agreements [the Delaware term for
operating agreements]." This provision gives LLC promoters,
members, managers and others with significant LLC stakes a high
degree of confidence that the courts will enforce even the most
unusual and creative terms of their LLC agreement, including terms
that may appear to judges and other third parties to be
oppressive.
- Sections 18-101(7) (seventh sentence) and
18-302(e). Delaware act section 18-101(7) (seventh
sentence) provides that persons that are not parties to LLC
agreements may nevertheless have rights under them. Under Delaware
act section 18-302(e), an LLC agreement may provide that the
parties to the agreement may not amend it except with the approval
of a third party. These two sections can provide crucial benefits
to LLC promoters and others that have substantial stakes in LLCs
but that do not want the potential risks and burdens of LLC
membership.
- Section 18-404(d) (second sentence).
Delaware act section 18-404(d) (second sentence) provides in effect
that under specified circumstances, an LLC agreement may authorize
actions by managers (including even actions by a single
manager in a multi-manager LLC) without a meeting, without
prior notice and without a vote. This provision, too, can provide
powerful protections and benefits to LLC promoters and others,
including lenders, that have important LLC stakes.
- Series LLCs. Delaware act section
18-215 provides for "series" LLCs. Series under section 18-215
function like single-member LLC subsidiaries of parent LLCs.
However, no separate filing or franchise tax is required in order
to establish a series, and each series is statutorily insulated
from claims not only against other series but even, amazingly, from
claims against the parent.
Delaware case law. While there are as yet very
few broadly significant Massachusetts LLC
cases,1 there is an extensive body of
Delaware LLC case law, and this body of law is growing rapidly. In
addition, in deciding Delaware LLC claims, the Delaware courts
routinely apply the vast body of Delaware corporate and limited
partnership cases.
The leading Delaware LLC case is Elf Atochem North America,
Inc. v. Jaffari, 727 A.2d 286 (Del. 1999). Among other things,
this case resoundingly reinforces the plain meaning of Delaware act
section 18-1101(b) (the "freedom-of-contract" provision noted
above). Furthermore, it holds that even seemingly mandatory
Delaware act provisions normally must be construed as non-mandatory
unless they are intended to protect third parties. This holding
constitutes a uniquely powerful weapon in drafting LLC agreements
to protect LLC promoters and others with significant LLC
stakes.
However, use of the Delaware act can involve significant
hazards.
The complexity of the Delaware act. The
Delaware act is the lengthiest and most complex of U.S. LLC acts,
and it contains many pitfalls for lawyers unfamiliar with it. For
example, it contains several key provisions that appear on their
face to be merely permissive provisions but that are probably best
construed as default provisions - i.e., as provisions that
will govern an LLC as if they were mandatory provisions unless the
LLC agreement expressly alters them. See, e.g., Delaware act
section 18-601 (concerning interim distributions); and Delaware act
section 18-402 (third sentence) (concerning manager removals).
Thus, you shouldn't form Delaware LLCs unless either (i) you
yourself possess substantial Delaware act expertise; or (ii) you
associate yourself with another lawyer who possesses it.
Delaware litigation of internal LLC disputes.
Delaware LLCs and their managers are subject under the Delaware act
to Delaware service of process. See Delaware act section 18-104(a)
(requiring Delaware LLCs to have Delaware registered agents and
offices); section 18-109(a) (providing that serving as a Delaware
manager constitutes consent to Delaware service of process).
Excellent as the Delaware courts may be, your LLC clients and the
members and managers of their LLCs may not want to face the risk of
defending Delaware lawsuits.
Exposure of non-Delaware lawyers to Delaware long-arm
jurisdiction. Under a Delaware Court of Chancery decision
called Sample v. Morgan, 935 A.2d 1046 (Del. Ch. 2007),
non-Delaware lawyers, even if they have only the most minimal
Delaware contacts, may be subject to the long-arm jurisdiction of
the Delaware courts in malpractice claims and other claims relating
to Delaware LLCs.
To sum up: There are many situations in which you may owe it to
your Massachusetts LLC formation clients to form LLCs for them
under the Delaware act. But doing so may involve significant risks
- not only for them, but also for you. n
The Author
John M. Cunningham is of counsel to McLane,
Graf, Raulerson & Middleton, Professional Association, and
works in its Woburn, Massachusetts, and Manchester, New Hampshire,
offices. He is the author of Drafting Limited Liability Company
Operating Agreements and, with Vernon Proctor of the Delaware bar,
he is the co-author of Drafting Delaware LLC Agreements. Both books
are published by Wolters Kluwer Law & Business. He is licensed
to practice law in Massachusetts and New Hampshire. He publishes a
weekly blog on LLC formation practice at www.cunninghamonoperatingagreements.com.
Note
- These principally include Pointer v. Castellani, 455 Mass. 537,
918 N.E.2d 805 (Mass. S.J.C. 2009) (fiduciary case); Billings v.
GTFM, LLC, 449 Mass. 281, 867 N.E.2d 714 (Mass. S.C. 2007)
(derivative jurisdiction); Smith v. Shining Rock Golf Cmty., LLC,
2007 Mass. Super. LEXIS 222 (2007) (veil-piercing case); Rapoza v.
Talamo, 2006 Mass. Super Lexis 531 (2006) (dissolution upon LLC
deadlock).