Can a California Court Order Managerial Removal for a Delaware LLC?
Under the “internal affairs doctrine,” the laws of an LLC’s state of formation will usually govern matters concerning its internal affairs — i.e., matters peculiar to the relationships among or between the entity and its stakeholders. As stated in California Corporations Code section 17708.01(a), the law of the state in which an LLC is formed governs “its internal affairs, and the authority of its members and managers.” Courts have interpreted the internal affairs doctrine to require application of the laws from an LLC’s state of formation to some claims, and to prohibit California courts from ordering dissolution of LLCs formed out of state.
An opinion recently filed by California’s Fourth Appellate District — Iwanaka v. Doi — addresses the issue. While the Iwanaka opinion is unpublished and therefore not binding precedent, it still provides a useful guidepost.
Facts: Delaware LLC embroiled in litigation in California court
Plaintiffs Kimiko Iwanaka and George Tetsuo Doi (Plaintiffs) sued their brother Kunio Doi (Doi). Doi was the co-manager of Doi Properties, LLC, and the LLC was named as a nominal defendant with derivative claims asserted on its behalf. The complaint sought judicial dissolution of the LLC under California Corporations Code section 17707.03. The complaint also alleged breach of fiduciary duty and sought an accounting. The Plaintiffs also later petitioned the court to remove Doi as a member and manager of the LLC.
Doi Properties was formed as a Delaware LLC, and its operating agreement designated Delaware law as its governing law. However, the LLC had an office in Riverside, California, three of its four members were California residents (the fourth lived in Hawaii), and conducted no business outside of California.
Iwanaka and Doi were co-managers, each with a 50% interest in the LLC. This arrangement led to deadlock and disputes, culminating in the lawsuit.
Trial court: judgment entered removing manager and dissolving LLC
The trial court entered a judgment: (1) granting the Plaintiffs’ petition to remove Doi as a member and manager of the LLC, and (2) ordering the dissolution of the LLC.
Later, after Doi filed a motion to enforce the judgment (arguing that Plaintiffs were delaying the windup and dissolution), the trial court questioned whether it had subject matter jurisdiction to dissolve a Delaware LLC.
After further briefing, the court concluded it lacked subject matter jurisdiction. The trial court entered a new judgment dismissing the entire case without prejudice.
Court of Appeal: partially reversed; California court had jurisdiction to order managerial removal, but not dissolution
The Court of Appeal partially reversed.
The court’s opinion began by reaffirming the internal affairs doctrine, which prevented the California trial court from ordering the judicial dissolution of the Delaware LLC. The court held that a “claim seeking dissolution of a business entity touches on quintessential internal governance issues” and the “near-universal view” is that “the courts of one state do not have the power to dissolve a business entity formed under another state’s laws.” The “general rule” is that “only the courts of the jurisdiction under whose law the limited liability company is organized have the capacity to order its dissolution.”
As such, the trial court was correct in ultimately concluding that it lacked jurisdiction to order Doi Properties dissolved. The portion of the original judgment ordering dissolution was void based on the trial court’s lack of jurisdiction, and was therefore properly vacated later by the trial court.
However, the Court of Appeal held that a “different analysis is required” for the portion of the trial court’s judgment removing Doi as a member and manager of Doi Properties. While that claim required the application of Delaware law as set forth in the LLC’s operating agreement, that was not a jurisdictional issue. “California courts are fully capable of applying Delaware law, and do so when the internal affairs doctrine requires.”
Accordingly, “the trial court had jurisdiction to make orders affecting the membership and management of Doi Properties, even though it is a Delaware entity[.]” That aspect of the trial court’s judgment was not void, and should not have been vacated by the trial court.
The Court of Appeal modified the original judgment to eliminate the void order that Doi Properties be dissolved and reinstated the judgment ordering the removal of Doi as a member and manager. It reversed the trial court’s second judgment (which had dismissed the entire case).
Lesson
Under the internal affairs doctrine, a California court cannot order the dissolution of an entity formed in a different state, but can apply another state’s law to resolve membership and managerial disputes.