CHAPTER SEVEN

DISPUTES AND EXIT STRATEGIES

June 2010

by David C. Tingstad

with Elizabeth F. Jennings

Beresford Booth, PLLC

145 Third Avenue South, Suite 200

Edmonds, Washington 98020

(425) 776-4100

DavidT@beresfordlaw.com

and

by Duff Bryant

Stoel Rives LLP

600 University Street, Suite 3600

Seattle, WA 98101

(206) 624-0900

dbryant@stoel.com

TABLE OF CONTENTS

CHAPTER SEVEN

DISPUTES AND EXIT STRATEGIES

David C. Tingstad and Duff Bryant

I. INTRODUCTION II. PIERCING THE VEIL

A. FRAUD

B. DISTRIBUTION LIABILITY

C. DEFAULT IN CAPITAL CONTRIBUTIONS

D. SINGLE-MEMBER LLCs

E. FORMATION DEFECTS

F. RIGHTS AND REMEDIES FOLLOWING VEIL PIERCING III. FIDUCIARY DUTIES A. DUTY OF CARE

B. DUTY OF LOYALTY

C. DUTY OF GOOD FAITH AND FAIR DEALING

D. MODIFICATION OF DUTIES

E. SAMPLE LLC AGREEMENT PROVISIONS

F. DE FACTO PARTNERSHIPS IV. PLANNING AHEAD IN THE LLC AGREEMENT V. DISSOLUTION STRATEGIES A. DISSOLUTION GENERALLY

B. PROCESS

C. LIABILITY VI. SAMPLE PLAN OF LIQUIDATION

I. INTRODUCTION

Each time a limited liability company is formed, the new members often focus on the

positive synergies being created and business prospects and profits that await the newly

formed venture, while blissfully ignoring unpleasant topics like potential disputes,

resolution of governance stalemates, dissolution and other exist strategies. It is often the

lawyers’ responsibility to raise these unpleasant topics and force the parties to focus on

and address the same.

The following briefly outlines certain issues the members and, if applicable, the managers

of a Washington limited liability company (“LLC”) may face with respect to disputes,

governance stalemates and dissolution and other exit strategies. We also provide sample

language for the limited liability company agreement of the LLC (the “LLC

Agreement”) intended to deal with certain of these issues. In particular, these materials

address the following:

Piercing the veil of the LLC and how the same may give rise to disputes or

claims

Fiduciary duties of members and managers of the LLC and how the same may

give rise to disputes or claims

Avoiding, planning for and handling disagreements among the members or

managers of the LLC, including certain exit strategies

LLC dissolution strategies and process

Although these materials cannot replace the necessary advice of legal counsel when

dealing with the identified topics, these materials will hopefully serve as a tool in

uncovering, understanding and addressing some of the issues central to LLC disputes and

exit strategies.

These materials are limited in scope to LLCs governed by the Washington Limited

Liability Company Act set forth in Chapter 25.15 RCW (“LLC Act”).

II. PIERCING THE VEIL

In general, members and managers of an LLC are not personally liable for the LLC’s

debts, obligations, and liabilities under RCW 25.15.125. However, there are certain

exceptions to this rule where the LLC form may be pierced (“piercing the veil”) and

individual members and managers may be personally liable, either to the LLC or to a

third party (including other members). In order to minimize the risk of being held

personally liable for the LLC’s debts, obligations and liabilities, a member and manager

must first understand how and when the veil may be pierced. Once the members and

managers are equipped with that understanding, they should use the LLC Agreement to

address the consequences and likely disputes between the members, managers and the

LLC that follow a veil piercing event.

A. FRAUD

One situation where a member may be personally liable to a third party is under the

theory of fraud. This is accomplished when respecting the LLC form would work

injustice, mirroring the individual liability found under the theory of piercing the

corporate veil. When the business form is being used to commit some sort of fraud by

shielding a member from liability, that business form will be pierced to correct this

injustice.

RCW 25.15.060: Members of a limited liability company shall be personally liable for

any act, debt, obligation, or liability of the limited liability company to the extent that

shareholders of a Washington business corporation would be liable in analogous

circumstances. In this regard, the court may consider the factors and policies set forth in

established case law with regard to piercing the corporate veil, except that the failure to

hold meetings of members or managers or the failure to observe formalities pertaining to

the calling or conduct of meetings shall not be considered a factor tending to establish

that the members have personal liability for any act, debt, obligation, or liability of

liability of the limited liability company if the certificate of formation and limited liability

company agreement do not expressly require the holding of meetings or members or

managers.

Applying the law associated with piercing the corporate veil to LLCs, a plaintiff must

show that the business form was used to violate or evade a duty and that the corporate or

LLC veil must be disregarded in order to prevent loss to an innocent party. Chadwick

Farms Owners Ass’n v. FHC LLC, 166 Wn.2d 178, 200, 207 P.3d 1251 (Wash. 2009).

Using the LLC form to commit fraud can result in the members of the LLC being

personally liable for the actions of the business. In the 1982 case of Meisel v. M&N

Modern Hydraulic Press Co., the Washington Supreme Court set out the test for

disregarding the corporate entity in terms of two factors: (1) The corporate form must be

intentionally used to violate or evade a duty; and (2) Disregard must be necessary and

required to prevent unjustified loss to the injured party. Thus, through RCW 25.15.060,

the same principles and case law that apply to piercing the corporate veil can be used to

support a piercing of the LLC form. Typically, the injustice referred to in piercing the

corporate veil is one involving fraud, misrepresentation, or some form of manipulation of

the corporation to the stockholder’s benefit and the creditor’s detriment.

B. DISTRIBUTION LIABILITY

A member can also be personally liable to the LLC when he receives a distribution in

violation of RCW 25.15.235. An LLC violates the provision if it makes a distribution to

its members at a time when it would not be able to pay its debts as they became due in the

usual course of business or when all of the liabilities of the LLC exceed the fair value of

the assets of the LLC. An individual member violates the provision if the member knew

this at the time of distribution. If so, the member shall be liable to the LLC for the amount

of the distribution. Personal liability will not attach if the member did not know of the

violation or if three years have passed since the date of distribution.

C. DEFAULT IN CAPITAL CONTRIBUTIONS

RCW 25.15.195(3): A limited liability company agreement may provide that the interest

of any member who fails to make any contribution that the member is obligated to make

shall be subject to specified penalties for, or specified consequences of, such failure. Such

penalty or consequence may take the form of reducing or eliminating the defaulting

member’s proportionate interest in a limited liability company, subordinating the

member’s limited liability company interest to that of nondefaulting members, a forced

sale of the member’s limited liability company interest, forfeiture of the member’s limited

liability company interest, the lending by other members of the amount necessary to meet

the member’s commitment, a fixing of the value of the member’s limited liability company

interest by appraisal or by formula and redemption or sale of the member’s limited

liability company interest at such value, or other penalty or consequence.

Under RCW 25.15.195(1), a member is obligated to the LLC to perform any promise to

contribute cash or property or to perform services. An LLC Agreement may provide that

the interest of a member who fails to fulfill the obligation may incur penalties. These

penalties can reduce or eliminate the member’s proportional interest in the LLC. As such,

the member is personally liable to the LLC under the member’s contractual obligation to

contribute to the LLC.

D. SINGLE-MEMBER LLCs

Single-member LLCs require special considerations in relation to personal liability and

piercing the veil of the LLC. A single-member LLC may be scrutinized as being merely

an alter ego for the individual and thus the LLC form may be susceptible to being pierced

for liability purposes. The LLC Agreement for a single-member LLC should clearly set

forth the relationship between the LLC and the individual member, such as duties

imposed, the timing of distributions, how the LLC is to be managed, and how transfers of

money or property should be handled. Setting out the boundaries and making sure the

member complies with these provisions will help prevent against a veil piercing issue.

Because of the close relationship between the member and the entity, it is important for

the single-member LLC to be operated as separate from the individual and a

commingling of assets should be prevented. If the member treats the assets of the LLC as

his own property, the likelihood of veil piercing can be significant. For example, other

jurisdictions have held that a court may disregard the separate LLC entity and its

protective veil when the sole member uses the LLC to defeat justice or perpetuate fraud,

or when conducting his personal and LLC business as if they were one by commingling

the two. See e.g., Bonner v. Brunson, 262 Ga.App. 521, 521-22, 585 S.E.2d 917 (2003)

(single-member of LLC acted as a general contractor of the LLC, but evidence was

insufficient to establish that the owner commingled LLC business with his personal

affairs, so was not personally liable for LLC debts).

E. FORMATION DEFECTS

Failure to comply with statutory requirements can open up a member or manager to

personal liability when an LLC entity is not property formed. Courts take differing views

on whether strict compliance with the statutory rules is necessary for the formation and

operation of a limited liability company. Most courts usually follow a similar approach

taken when dealing with the formation of a corporation. In courts that follow a general

prohibition against de facto corporations, this prohibition will apply to limited liability

companies as well. See e.g., Stone v. Jetmar Properties, LLC, 733 N.W. 480 (Minn. Ct.

App. 2007) (prohibition against de facto corporations extends to LLCs since statute

provides an “indisputably simple route to formal organization” such that it is doubtful

one could make “an unsuccessful colorable attempt to organize a de jure LLC”). In

contrast, some courts will allow the formation of a de facto LLC when a bona fide effort

is make to comply with the LLC statute provisions. See e.g., In re Hausman, 51 A.D.3d

922, 858 N.Y.S.2d 330 (2d Dep’t 2008) (de facto corporation doctrine equally applicable

to LLCs, requiring a showing of “a colorable attempt” to apply with the statutes

governing formation).

If a state does not accept the doctrine of de facto corporations and requires strict

compliance with the statutory provisions, a court will not recognize the formation of a

corporation or LLC. As a result, a de facto partnership may be formed instead, since

actual intent is not required to form a partnership; it must simply be an association of

persons carrying on as owners of a business for profit. See Section F, infra. Thus, a

business entity and its lawyer must be careful to comply with the specific formation

requirements of an LLC or a court may impose a different business entity instead, along

with particular fiduciary duties. See e.g., Simpson v. Thorslund, 151 Wash.App. 276, 211

P.3d 469 (2009) (de facto partnership formed with attempt to form corporation failed).

Additionally, RCW 23B.02.040 imposes personal liability on persons purporting to act as

or on behalf of a corporation, knowing that there has not yet been proper incorporation.

This applies both to situations prior to incorporation and also to postdissolution

transactions not related to the winding up of the corporation. Equiptco Div. Aurora

Equipment Co. v. Yarmouth, 134 Wash.2d 356, 950 P.2d 451 (1998). Therefore, actions

carried out without proper incorporation or during the dissolution period can amount to a

piercing of the corporate veil. Because of the significant carry over of corporation

principles to LLCs in the realm of formation deficiencies and de facto business entities,

one should be cognizant of the statutory requirements of formation of an LLC and the

possible personal liability that may attach when the requirements have not been met.

F. RIGHTS AND REMEDIES FOLLOWING VEIL PIERCING

1. INDEMNIFICATION. If the act or omission of a member or

manager (“Defendant”) results in a veil piercing and the LLC, another member and/or

manager (“Claimant”) suffer a loss as a result of such act or omission, disputes and

claims are likely to arise between the Defendant and Claimant. In anticipation of such

disputes and claims, the members may want to include indemnification provisions

pursuant to which the Defendant agrees to indemnify each Claimant from and against any

and all losses suffered as a result of the Defendant’s act or omission. If there are multiple

Defendants, the members would need to discuss whether the Defendants should be jointly

and severally liable for all losses or just responsible to the losses the Defendant directly

caused. Similarly, multiple Defendants may want to incorporate a contribution concept

in the LLC Agreement, such that if one Defendant has to pay the entire amount of the

claim such Defendant can seek contribution from the other Defendant(s). The

indemnification provisions may include certain limitations and processes that further

facilitate the resolution of disputes and claims and provide greater certainty to the

members as to how disputes and claims will be handled. To maximize the benefit of such

indemnification provisions, the LLC Agreement should state that the indemnification

provisions are the sole and exclusive remedy available to Claimant in the event of a veil

piercing. Otherwise, the Claimant is free to simply ignore the indemnification provision

and pursue other remedies and courses of action. The following is a sample

indemnification provision:

“(a) Indemnification. The following shall apply in the event that any act or

omission of a member or manager (each, an “Indemnifying Party”) causes,

directly or indirectly, another member or manager (each, an “Indemnified

Party”) to become liable for the debts, obligations or liabilities of the LLC (a

“Veil Piercing Event”) except to the extent that the Indemnified Party expressly

agreed, in writing, to be liable for such debts, obligations or liabilities. Subject to

Section (b) below, each Indemnifying Party agrees, jointly and severally with any

other Indemnifying Party, to defend, indemnify and hold each Indemnified Party

harmless from and against any and all damages, liabilities, losses, claims,

judgments, fines, penalties, reasonable costs and expenses (“Losses”), actually

sustained or suffered by any such Indemnified Party based upon or by reason of

the Veil Piercing Event.

(b) Limitations on Indemnification. Notwithstanding anything in Section (a)

to the contrary:

(i) No Indemnifying Party shall be obligated to provide

indemnification for Losses in respect of claims made by any Indemnified Party for

indemnification under Section (a) above until the aggregate amount of all Losses

in respect of claims made by such Indemnified Party for indemnification shall

exceed $___________ (the “Deductible”) in the aggregate, and then only to the

extent that such aggregate amount exceeds the Deductible.

(ii) No Indemnifying Party shall have any liability under any

provisions of this Agreement for any Losses to the extent that such Losses are

caused by actions taken by the Indemnified Parties or their affiliates.

(iii) In connection with calculating the amount of Losses that an

Indemnified Party is entitled to recover under this Section, no party shall be liable

for consequential, special, indirect, incidental, punitive, lost profit or other

expectancy damages, except to the extent consequential, special, indirect,

incidental, punitive, lost profit or other expectancy damages are awarded to a

third party against an Indemnified Party in circumstances in which such

Indemnified Party is entitled to indemnification hereunder or in the event of fraud

or intentional misconduct by such party or its directors, officers, representatives

or other agents; (iv) the maximum amount payable by an Indemnifying Party, in

the aggregate, to all Indemnified Parties for Losses in respect of claims made by

Indemnified Parties for a single Veil Piercing Event shall not exceed an amount

equal to $_____________________.

(iv) Payments by an Indemnifying Party pursuant to this Section shall

be limited to the amount of any liability or damage that remains after deducting

therefrom any insurance proceeds and any indemnity, contribution or other

similar payment actually received by the respective Indemnified Parties from any

third party with respect thereto. An Indemnified Party shall exhaust all of its

remedies against applicable insurers, indemnitors or contributors prior to seeking

indemnification hereunder; provided, however, that nothing in this paragraph (iv)

shall preclude an Indemnified Party from giving notice to an Indemnifying Party

of an indemnity claim prior to exhausting such remedies.

(v) Each Indemnified Party covenants and agrees to use all

reasonable efforts to mitigate or prevent Losses with respect to any Veil Piercing

Event.

(c) Notice; Payment of Losses; Defense of Claims.

(i) An Indemnified Party shall give written notice of a claim for

indemnification under this Section to the Indemnifying Party asserted to be

responsible for indemnification under this Agreement promptly upon learning of

the existence of the facts giving rise to such claim, including receipt of any written

claim by any third party and in any event not later than ten (10) business days

after receipt of any such written claim, specifying in reasonable detail the

amount, nature and source of the claim, including therewith copies of any notices

or other documents received from third parties with respect to such claim, and

specifying all provisions of this Agreement under which indemnity is sought;

provided, however, that failure to give such notice shall not limit the right of an

Indemnified Party to recover indemnity or reimbursement except to the extent that

the Indemnifying Party suffers any prejudice or material harm with respect to

such claim as a result of such failure. The Indemnified Party shall also provide

the Indemnifying Party with such further information concerning any such claims

as the Indemnifying Party may reasonably request.

(ii) With respect to any claims or demands by third parties as to which

any Indemnified Party seeks indemnification hereunder (a “Third Party Claim”),

the following additional provisions shall apply. The Indemnified Party shall

provide the Indemnifying Party with prompt notice of its receipt of any claim in

respect of which it shall seek indemnification as a Third Party Claim. By written

notice delivered by the Indemnifying Party to the Indemnified Party at any time

prior to commencement of trial of the Third Party Claim, the Indemnifying Party

may elect to control the defense of such Third Party Claim (such notice, the

“Defense Election”), in which case the Indemnifying Party may defend, contest,

negotiate or settle such Third Party Claim through counsel of its own selection,

and the Indemnified Party shall cooperate with and assist the Indemnifying Party

in the defense of such claim or demand; provided, however, that (A) the

Indemnified Party shall at its election be entitled to participate in such defense, at

their own expense (which shall not be considered a Loss for purposes of this

Section), with counsel of its choosing and (B) the Indemnifying Party will not

settle, compromise, or offer to settle or compromise any such Third Party Claim

without the prior written consent of the Indemnified Party (which consent shall

not be unreasonably withheld), unless such settlement or compromise releases the

Indemnified Party in connection with such Third Party Claim and with no

statement as to or an admission of fault by or on behalf of the Indemnified Parties

and with no nonmonetary relief granted by or imposed upon the Indemnified

Parties. If the Indemnifying Party does not deliver a Defense Election within the

time period described above, the Indemnified Parties shall be entitled to defend,

contest, negotiate or settle such Third Party Claim.

(d) Exclusive Remedy. Subject to the right to seek equitable remedies, the

sole and exclusive remedy of the Indemnified Parties with respect to any and all

claims arising out of, in connection with or relating to the subject matter of a Veil

Piercing Event will be pursuant to the indemnification provisions set forth in this

Section, as applicable; provided that nothing in this Agreement shall release or

otherwise limit a party’s remedies for fraud or intentional misconduct. In

furtherance of the foregoing, each member and manager hereby waive, to the

fullest extent permitted under applicable law, and agree not to assert in any

action or proceeding of any kind, any and all rights, claims and causes of action,

known or unknown, foreseen or unforeseen, which may exist or may arise in the

future (including any such rights, claims or causes of action arising under or

based upon common law or equity) other than claims for indemnification asserted

as permitted by and in accordance with the provisions set forth in this Section 7

and other than claims for fraud or intentional misconduct in connection with the

transactions contemplated hereby.”

2. ASSIGN RESPONSIBILITIES. So that the parties are in a

better position to identify which member or manager is responsible for the piercing of the

veil (and to also help avoid possible veil piercing because the parties clearly understand

their responsibilities), the members should use the LLC Agreement to expressly state

which members and/or managers are responsible for (a) maintaining separate books and

accounts for the LLC, (b) forming the LLC and maintaining the existence of the LLC,

(c) determining whether or not the LLC has sufficient assets to make a distribution and

(d) taking action on behalf of the LLC if a member fails to make a capital contribution.

With respect to a member’s failure to fund a capital contribution, the LLC Agreement

should contain specific rights and remedies for the same.

III. FIDUCIARY DUTIES

The LLC Act is generally silent on the specific fiduciary obligations of members and

managers owed to the LLC and other members. However, RCW 25.15.155 provides

some insight into the nature of duties owed, particularly a duty of care and a duty of

loyalty. While the RCW provision provides a default baseline for members and managers

of the LLC, the level of duty required is ultimately contingent on what is contained

within the LLC Agreement. When present, provisions in the LLC Agreement will govern

the actual fiduciary duties owed by members and managers. The state statute will apply

when the LLC Agreement does not provide an alternate provision regarding that duty.

Although an LLC Agreement may modify the RCW provisions relating to duties owed, it

may not completely eliminate a duty altogether.

Therefore, there is at least a general duty of care and duty of loyalty associated with

members and managers of an LLC, but this duty can be shaped significantly through the

LLC Agreement. Additionally, because the law of fiduciary duties related to LLCs is

underdevelopment in Washington, clear provisions in the LLC Agreement about specific

duties owed can be important in avoiding the ambiguities related to fiduciary duties under

the statute.

A. DUTY OF CARE

RCW 25.15.155(1): Unless otherwise provided in the limited liability company

agreement, a member or manager shall not be liable, responsible, or accountable in

damages or otherwise to the limited liability company or to the members of the limited

liability company for any action taken or failure to act on behalf of the limited liability

company unless such act or omission constitutes gross negligence, intentional

misconduct, or a knowing violation of law.

The general rule for liability and the standard of duty of care is that a manager or member

of an LLC is not liable to the LLC or the other members for an action or omission, unless

the act or omission constitutes gross negligence, intentional misconduct, or a knowing

violation of the law. A member or manager in charge of the operations of the

organization, who is grossly negligent in its action or inaction or intentionally takes

wrongful actions or fails to act, resulting in damage to the organization, may have

violated a duty of care.

Because it is acknowledged that the role of members in a member-managed LLC is

analogous to that of a partner in a general partnership, the law governing partnerships can

generally be used to interpret the standard for LLCs. Bishop of Victoria Corp. Sole v.

Corp. Business Park, LLC, 138 Wash.App. 443, 456, 158 P.3d 1183 (2007). For

example, the LLC provision contains language similar to that found in UPA and RUPA,

which adopts a gross negligence standard as well. Although it is unclear whether courts

will actually apply equivalent standards for partners and LLC managers, UPA and RUPA

analysis could be helpful in recognizing the boundaries and application of the duty of

care. Additionally, it may be helpful to note that Washington adopts the grossly negligent

standard over the standard found in some other jurisdictions which describes the duty of

care as being what an ordinarily prudent person in a like position would exercise under

certain circumstances. Thus, the threshold for duty of care in Washington may be

satisfied easier than in some other jurisdictions.

The LLC Agreement itself can expand or restrict the scope of the duty of care, but cannot

completely eliminate it. Under RCW 25.15.040, the LLC Agreement can reduce the duty

of care standard to avoiding intentional misconduct or a knowing violation of law. This

modification of the duty seems to be as far as the LLC Agreement may go in reducing the

liability of a member or manager without completely eliminating the duty altogether and

therefore violating the LLC statutes.

B. DUTY OF LOYALTY

RCW 25.15.155(2): Unless otherwise provided in the limited liability company

agreement, every member and manager must account to the limited liability company and

hold as trustee for it any profit or benefit derived by him or her without the consent of a

majority of the disinterested managers or members, or other persons participating in the

management of the business or affairs of the limited liability company from (a) any

transaction connected with the conduct or winding up of limited liability company or (b)

any use by him or her of its property, including, but not limited to, confidential or

proprietary information of the limited liability company or other matters entrusted to him

or her as a result of his or her status as a manager or member.

In general, members and managers are subject to a duty of loyalty which means that the

manager or manager is to act in the LLC’s interest rather than his own, acting without an

obvious conflict of interest. Specifically, the LLC Act requires a member or manager to

account to the LLC and hold as trustee any profit or benefit derived from the winding up

of the company or from use of the LLC’s property, done without the consent of a

majority of disinterested managers or members.

Because the role of members in a member-managed LLC is analogous to that of partners

in a general partnership, the UPA and RUPA provisions relating to a partner’s conduct

are helpful in interpreting the scope of the LLC duty. Although the partnership provisions

are not identical to that for LLCs, courts have interpreted the general duty of loyalty to

involve the prohibition of a member or manager using company property for personal

benefit, misappropriating a company opportunity, competing with the company, and

engaging in self-dealing.

Although courts generally read these actions into the duty of loyalty, either informed

consent or a provision in the LLC Agreement can modify the requirements for a member

or manager under the duty of loyalty. While the LLC Agreement cannot completely

eliminate the duty, it can reduce the duty of loyalty to an extent that allows, for example,

a certain degree of self-dealing or appropriation of the company’s opportunities under

specified circumstances. It is unclear, however, how far the courts will allow an LLC

Agreement to reduce this duty.

C. DUTY OF GOOD FAITH AND FAIR DEALING

RCW 25.15.040(2)(a): To the extent that, at law or in equity, a member or manager has

duties (including fiduciary duties) and liability relating thereto to a limited liability

company or to another member or manager, any such member or manager acting under

a limited liability company agreement shall not be liable to the limited liability company

or to any such other member or manager for the member’s or manager’s good faith

reliance on the provisions of the limited liability company agreement.

The duty of good faith derives from more of a contractual obligation than an actual

fiduciary duty separate from the contractual relationship found in the LLC Agreement.

Ribstein and Keating on Limited Liability Companies, Sec. 9.7 (2009). It relates to a

general obligation of conducting one’s duties, including the fiduciary duties of loyalty

and care, with good faith and fair dealing.

Drawing on how this duty is treated under UPA, courts have generally held that a partner

has a duty to act in good faith with respect to the partnership and other partners. RUPA

and ULLCA also impose an obligation of good faith and fair dealing on partners and

members and managers of an LLC. The obligation of good faith and fair dealing applies

to the discharge of all duties, including the fiduciary duties of care and loyalty or duties

outlined in the LLC Agreement. Thus, the duty of good faith and fair dealing is an

overarching requirement for members and managers in an LLC in how they carry out

their duties and obligations related to the company.

Although there is no specific and separate codification of a duty of good faith and fair

dealing for Washington LLCs apart from the above provision, it is still present as an

implied covenant and general obligation of contracting parties. As such, the contractual

duty of good faith and fair dealing may be modified in the LLC Agreement by

prescribing reasonable standards by which the obligation is to be measured, but the duty

cannot be wholly eliminated.

D. MODIFICATION OF DUTIES

RCW 25.15.155 provides that the LLC statutory provisions apply “unless otherwise

provided in the limited liability agreement.” Additionally, RCW 25.15.040(2)(b) provides

that the member’s or manager’s duties (including fiduciary duties) and liabilities “may be

expanded or restricted by provisions in a limited liability company agreement” as long as

not inconsistent with law. Thus, the LLC Agreement can modify the default duties

outlined in the statute, either by expanding the duty, restricting it, or setting out specific

actions to satisfy its compliance. However, these duties cannot be completely eliminated

altogether.

As discussed above, the modification of each duty includes certain restrictions. For

example, the duty of care cannot be reduced beyond avoiding intentional misconduct or a

knowing violation of the law; the duty of loyalty cannot be completely eliminated, even if

provided for in the LLC Agreement; and modification of the duty of good faith and fair

dealing seems to be restricted to prescribing standards of performance that are not

manifestly unreasonable.

E. SAMPLE LLC AGREEMENT PROVISIONS

Notwithstanding the above conclusion that we cannot be sure how Washington

courts will treat limitations on member and manager duties and liabilities, we believe that

it is still better to address any specific issues the members or managers may have with

respect to the duties of care or loyalty. In particular, the members should consider

highlighting or defining specific, agreed upon duties (e.g., time commitments, periodic

reporting, preparation of budgets and reports, disclosing opportunities, etc.) and specific

permissible activities (e.g., related party agreements, competing with the LLC, taking into

account a member’s or manager’s self interest when making decisions affecting the LLC,

etc.). Below are two sample provisions that define duties and/or expressly authorize

certain activities.

SAMPLE 1:

“(a) Members. The Members agree that (i) to the extent that, at law or in

equity, a Member has duties (including fiduciary duties) to the Company, any

other Member, any Assignee, any manager or any officer, all such duties of such

Member (including any fiduciary duties) are hereby limited to those duties

expressly described in this Agreement; (ii) each Member may engage or invest in

any other activity or venture or possess any interest therein independently or with

others, including any activity or venture that competes with or has interests

similar to the Company; and (iii) each Member shall not have any duty or

obligation to disclose or offer to the Company, or any other Member, or obtain

for the benefit of the Company, or any other Member, any other activity or

venture or interest therein. Notwithstanding anything to the contrary contained in

this Section, nothing contained herein shall (x) eliminate any Member’s implied

contractual covenant of good faith and fair dealing or (y) eliminate, limit or

otherwise modify a Member’s duties and obligations under a separate agreement

with the Company.

(b) Each manager shall discharge such manager’s duties in good faith, with

the care an ordinarily prudent person in a like position would exercise under

similar circumstances and in a manner such manager reasonably believes to be in

the best interests of the Company. To the fullest extent permitted by law, each

manager shall not be not liable to the Company or any Member for any action

taken as a manager, or any failure to take any action as a manager, unless such

manager has breached or failed to perform his or her duties and the breach or

failure to perform constitutes gross negligence, willful misconduct or

recklessness; provided, however, that nothing contained in this Section shall limit

or eliminate any liability for any act or omission by a manager that constitutes a

bad faith violation of the implied contractual covenant of good faith and fair

dealing.”

SAMPLE 2:

“(a) The Members and their respective officers, directors, shareholders,

partners, members, managing members, agents, employees and Affiliates may

engage or invest in any business activity of any type or description (including,

without limitation, those that might be the same as or similar to the Company's or

any of its Subsidiaries, and that might be direct or indirect competition with the

Company or any of the Subsidiaries). Neither the Company nor any Member

shall have any right in or to such other activities or to the income or proceeds

derived therefrom. Except for the Capital Contributions required by Section 3.1,

no Member shall be obligated to (but in any event may in such Member's sole

discretion) present any investment opportunity or prospective economic

advantage to the Company and/or any of the Subsidiaries, even if the opportunity

is of the character that, if presented to the Company and/or the Subsidiaries,

could be invested in by the Company and/or Subsidiaries. Each Member shall

have the right to hold any investment opportunity or prospective economic

advantage for its own account or to recommend such opportunity to Persons

other than the Company and/or Subsidiaries. The Members acknowledge that

each Board Member and the Development Manager and its Affiliates own and/or

manage other businesses, including businesses that may compete for such

Person's time, as set forth in Section 7.6(b). Subject to Section 7.6(c), the

Members hereby waive any and all rights and claims that they may otherwise

have against the Board Members and the Development Manager and their

respective officers, directors, shareholders, partners, members, managing

members, agents, employees and Affiliates as a result of any such permissible

competitive activities.

(b) The Members hereby acknowledge that, throughout the term of this

Agreement, the following conflicts of interest will exist:

(i) Member A owns, and intends to develop and sell, the land

adjoining the Land, which comprises the Member A employment-based planned

unit development (the "Member A Project"), which actions may be taken by

Member A alone or in concert with others;

(ii) On the property within the Member A Project, Member A intends

to develop one or more competing golf courses and a number of single-family and

multi-family tracts, consisting of either improved lots or finished homes for sale to

the public, all of which are activities that will compete with the activities of the

Company;

(iii) Member A will construct, or cause to be constructed, within the

Member A Project a number of improvements, including but not limited to roads,

storm drainage systems, utility lines and connections, trail systems, common area

improvements, parks, communications systems, internet connections, etc; the

timing and sequencing of such activities may affect the value and marketing of the

improved lots to be developed by the Company;

(iv) Member A, in undertaking all such off-site activities, will take into

account its own economic interests (as well as those of its partners, if any), and

will not be required to account to the Company or Member B for any profits,

economic benefits, or other benefits derived from such activities; moreover, by so

doing, Member A will not be deemed to breach any fiduciary duty owed by it to

the Company or Member B under this Agreement; taking into account such

interests will not constitute a breach of Member A's good faith obligations to the

Company;

(v) The Company's Land will be subject to CC&Rs prepared and

recorded by Member A for the overall development of the Member A Project.

(c) Notwithstanding anything to the contrary contained in this Section 7.6,

nothing contained herein shall (i) eliminate any Member's, any Board Member's,

or the Development Manager's implied contractual covenant of good faith and

fair dealing subject to the acknowledged conflicts of interest set forth in this

Section 7.6 or (ii) eliminate, limit or otherwise modify any Member's, any Board

Member's, or the Development Manager's express duties and obligations under

this Agreement or a separate agreement with the Company or any Member

(including, without limitation, the Development Manager's duties and obligations

under Section 6.6(c) and the Development Management Agreement).”

F. DE FACTO PARTNERSHIPS

One often overlooked issue related to fiduciary duties arises with de facto partnerships.

RCW 25.05.005(6) defines a partnership as “an association of two or more persons to

carry on as co-owners a business for profit formed under RCW 25.05.055.” Because

actual intent to form a partnership is not required, an association within the definition,

even if lacking the specific intent, may result in a de facto partnership. See e.g., Simpson

v. Thorslund, 151 Wash. App. 276, 282, 211 P.3d 469 (2009) (de facto partnership

formed when attempt to form a corporation failed). The law of partnerships will then

apply to these de facto partnerships, including the imposition of fiduciary duties. As such,

failure to comply with LLC formation requirements could lead to the formation of a de

facto partnership instead.

Because a partnership can therefore be formed without the actual intent to do so, it is

important to be aware of the fiduciary duties and liabilities that attach to de facto

partnerships. Within a partnership, each partner owes the partnership and the other

partners the duty of loyalty and the duty of care, as set out in RCW 25.05.165. See also

Bishop of Victoria Corp. Sole v. Corp. Business Park, LLC, 138 Wash.App. 443, 456-57,

158 P.3d 1183 (2007). Partners are obligated to deal with each other with candor and the

utmost good faith and have a duty of loyalty to avoid secret profits, self-dealing, and

conflicts of interest. Id. A partner owes a duty of care to refrain from engaging in grossly

negligent conduct, intentional misconduct, and knowing violations of law. Id. The statute

also provides that a partner must comply with these duties, and any others under the

partnership agreement, with good faith and fair dealing. Thus, even if there was no actual

intent to form a partnership, one who engages with others in carrying on a business for

profit may be held to specific fiduciary duties and may be liable to the partnership for a

violation of those duties.

IV. PLANNING AHEAD IN THE LLC AGREEMENT

A. IN GENERAL. The following is a summary of some possible solutions

should the members of the LLC encounter a governance or management stalemate (a

“Stalemate”). For purposes of this Part V, we will pretend that the LLC has two

members: “Member A” and “Member B”. Please note that the following is no intended

to be an exhaustive list of all solutions for a Stalemate, nor does the following set forth all

the pros and cons of each identified solution.

B. AVOIDING STALEMENTS. The best way to resolve management

disputes is to avoid situations that may give rise to the same. Ways to minimize the

likelihood that a Stalemate occurs include (i) avoiding approval thresholds that may

trigger Stalemate (e.g., supermajority or unanimous approvals), (ii) limiting the number

of possible Stalemate triggers (e.g., have a limited number of matters that require

supermajority or unanimous approvals), (iii) having an odd number of managers, (iv)

limiting the restrictions on fiduciary duties to avoid situations where a member’s or

manager’s interests are in conflict with the LLC yet such member or manager does not

have to abstain from participating in decision making and (v) avoiding approval

processes that interfere with the LLC’s operations.

C. WAIT IT OUT & OPERATE UNDER PRIOR APPROVALS;

DISPUTE RESOLUTION.

(i) Waiting it Out and Operating Under Prior Approvals. The LLC

Agreement could simply be silent with respect to resolving Stalemates. Such silence

would require that the members and managers find a way to continue operating the

LLC’s business without resolution of the Stalemate, which would likely mean that the

members and/or managers are operating under previously approved actions. After a

period of time, cooler heads may prevail and a resolution of the Stalemate could be

negotiated or the issues underlying the Stalemate could simply pass over time.

(ii) Mandatory Dispute Resolution. As an alternative to all of the

below described solutions or as an interim step before a Stalemate triggers any of the

below described solutions, the members could agree to mandatory alternative dispute

resolution (i.e., negotiation, mediation and binding arbitration) as a mechanism to resolve

Stalemates. Such a requirement may help the parties resolve any Stalemates and help

avoid a forced sale or dissolution. The following is a sample provision that contains

mandatory negotiations, followed by mandatory mediation, followed by binding

arbitration.

“(a) Negotiations. The Members, promptly and in good faith, shall attempt to

resolve any dispute arising under this Agreement by negotiation between the chief

executive officers of the Members. Either Member may give to the other Member

written notice of any dispute and, within ten (10) days after the giving of such

notice, the recipient of such notice shall give a written response to the other

Member. Each notice of a dispute and each response to any such notice shall

include a statement of the position of the party giving such notice or response in

respect of such dispute and a summary of arguments supporting such position.

Within fifteen (15) days after the giving of a notice of a dispute under this

subsection, the chief executive officers of the Members shall meet at a mutually

acceptable time and place, and thereafter as often as either of them reasonably

deem necessary, to attempt to resolve such dispute. All reasonable requests for

information made by any Member to the other shall be honored. If any dispute

has not been resolved by negotiation pursuant to this subsection within thirty (30)

days after the giving of the notice of such dispute, then the other Member may

initiate mediation of such dispute pursuant to Section 12.11(b). All negotiations

pursuant to this subsection shall be confidential and shall be treated as

compromise and settlement negotiations. Nothing said or disclosed, and no

document produced, in the course of such negotiations which is not independently

discoverable shall be offered, or received as evidence, or used for impeachment

or for any other purpose in any arbitration or litigation.

(b) Mediation. All disputes arising out of this Agreement not resolved

pursuant to Section 12.11(a), shall first be submitted to mediation, which shall

focus on the needs of everyone concerned and seek to solve problems

cooperatively with an emphasis on dialogue and accommodation. The goal of the

mediation shall be to preserve and enhance relationships by developing a

mutually acceptable resolution that will fulfill the needs of everyone concerned.

Any Member desiring mediation may begin the process by giving the other

Members a written request to mediate (a “Request to Mediate”), describing the

issues involved and inviting the other Members to join with the requesting

Member to name a mutually agreeable mediator (“Mediator”) and a time frame

for the mediation meeting. The Members and the Mediator may adopt any

procedural format that seems appropriate for the particular dispute. The contents

of all discussion during the mediation shall be confidential and nondiscoverable

in subsequent arbitration or litigation, if any. If the Members can agree upon a

mutually acceptable resolution with respect to the dispute, it shall be reduced to

writing, signed by all Members, and the dispute shall be at an end. If the result of

the mediation is a recognition that the dispute cannot be successfully mediated, or

if a Member refuses to mediate or to name a mutually acceptable Mediator within

a period of time that is reasonable considering the urgency of the disputed matter,

then any Member who desires dispute resolution shall seek arbitration.

(c) Arbitration. Any dispute, controversy or claim among the Members

arising out of or relating to this Agreement, which has not been settled by

mediation will be settled by arbitration in accordance with the commercial rules

of the American Arbitration Association as then in effect. In any arbitration

hereunder, each Member will select one arbitrator and the two arbitrators so-

selected shall select a third. The three arbitrators selected will each have one

vote, and a majority vote of the arbitrators will be binding. The arbitration will

take place in Seattle, Washington. The arbitrators will apply the law of the State

of California without regard to its choice of law principles. Judgment upon the

award rendered by the arbitrators may be entered in any court for a judicial

acceptance of the award and an order of enforcement. As part of the arbitrators’

award, the arbitrators will, subject to Section 12.08, allocate the fees and costs of

the arbitration (including the arbitrators’ fees and costs and each parties’

reasonable attorneys’ fees, expenses and costs incurred preparing for and

participating in the arbitration) between the parties participating in the

arbitration as such arbitrators deem appropriate.”

D. BUY-SELL RIGHTS, CONVERSION OR DISSOLUTION. If the

members are unable to resolve a Stalemate, the LLC Agreement could include one or

more of the following purchase and sale rights, conversion right or dissolution process,

the basic structure of which is set forth below. The following also highlights certain pros

and cons of each solution.

(i) Member A Call Right at Fixed Price.

(a) Basic Structure. Upon the occurrence of a Stalemate,

Member A would have the option (but not the obligation) to purchase Member B’s

interest in the LLC for a purchase price equal to Member B’s capital contributions, plus

interest per annum at an agreed upon coupon rate, or a purchase price based on some

other formula.

(b) Certain Pros.

Fixed price should make the transaction faster and more

efficient than other solutions.

Guaranteed, fixed rate of return on investment if

formula is based on a coupon rate.

If the coupon rate is sufficiently high, loss of potential

upside on investment may be adequately offset by

protection from potential downside.

(c) Certain Cons.

Member A controls whether or not transaction occurs.

As a result, Member B may have to sell its LLC interest

at a time when it would prefer to remain a member or

be forced to stay when Member B would rather sell.

Fixed price means Member B may miss the opportunity

to see significant appreciation in value. Member B

would only receive a fixed rate of return on its

investment, which rate of return may be significantly

less than 50% of the then enterprise value of the LLC.

If Member A has the ability to trigger a Stalemate

without violating its obligations to Member B, Member

A will be able to purchase Member B’s interest at any

time that Member A desires.

If a more complex formula is used, it may be very

difficult to select an appropriate formula and/or create a

fair formula that cannot be manipulated by those

running the LLC.

(ii) Member A Call Right at Appraised Price.

(a) Basic Structure. Upon the occurrence of a Stalemate,

Member A would have the option (but not the obligation) to purchase Member B’s

interest in the LLC for a purchase price determined by one or more appraisers. The

parties would establish parameters for the appraiser to consider when appraising the LLC.

(b) Certain Pros.

Appraised value may be more fair for Member B.

Enables Member B to benefit from any significant

increase in the enterprise value of the LLC.

(c) Certain Cons.

As with the other call right, Member A controls

whether or not transaction occurs. As a result, Member

B may have to sell its LLC interest at a time when it

would prefer to remain a member or be forced to stay

when Member B would rather sell.

As compared with a coupon rate formula, Member B

would lose the protection against a devaluation of the

LLC.

If Member A has the ability to trigger a Stalemate

without violating its obligations to Member B, Member

A will be able to purchase Member B’s interest at any

time that it desires.

Using appraisers will take more time.

(iii) Put or Call Right at Fixed Price.

(a) Basic Structure. Upon the occurrence of a Stalemate,

Member A would have the option (but not the obligation) to purchase Member B’s

interest in the LLC or Member B would have the option (but not the obligation) to sell its

interest in the LLC to Member A, in either case for a purchase price equal to Member B’s

capital contributions, plus interest per annum at an agreed upon coupon rate, or a

purchase price based on some other formula.

(b) Certain Pros.

Same as above under Section 1(b) above.

If Member A doesn’t exercise its option, Member B can

exercise its option and force a sale.

(c) Certain Cons.

Each party can trigger the transaction but never party

can stop the other from triggering the transaction. As a

result, Member B may have to sell its LLC interest at a

time when it would prefer to remain a member.

Fixed price means Member B may miss the opportunity

to see significant appreciation in value. Member B

would only receive a fixed rate of return on its

investment, which rate of return may be significantly

less than 50% of the then enterprise value of the LLC.

If either party has the ability to trigger a Stalemate

without violating its obligations to the other party,

either party will be able to control when a transaction

occurs.

If a more complex formula is used, it may be very

difficult to select an appropriate formula and/or create a

fair formula that cannot be manipulated by those

running the LLC.

(iv) Put or Call right at Appraised Price.

(a) Basic Structure. Upon the occurrence of a Stalemate,

Member A would have the option (but not the obligation) to purchase Member B’s

interest in the LLC or Member B would have the option (but not the obligation) to sell its

interest in the LLC to Member A, in either case for a purchase price determined by one or

more appraisers. The parties would establish parameters for the appraiser to consider

when appraising the LLC.

(b) Certain Pros.

Same as above under Section 2(b) above.

If Member A doesn’t exercise its option, Member B can

exercise its option and force a sale.

(c) Certain Cons.

Each party can trigger the transaction but never party

can stop the other from triggering the transaction. As a

result, Member B may have to sell its LLC interest at a

time when it would prefer to remain a member.

As compared with a coupon rate formula, Member B

would lose the protection against a devaluation of the

LLC.

If either party has the ability to trigger a Stalemate

without violating its obligations to the other party,

either party will be able to control when a transaction

occurs.

Using appraisers will take more time.

(v) Shotgun Purchase and Sale.

(a) Basic Structure. Upon the occurrence of a Stalemate, either

party (the “First Party”) has the option (but not the obligation) to offer to buy the other

party’s (the “Second Party’) interest in the LLC at a price set by the First Party (the

“Purchase Price”). The Second Party then has the option to either sell its LLC interest

to the First Party in exchange for the Purchase Price or to acquire the First Party’s LLC

interest in exchange for the Purchase Price.

(b) Certain Pros.

The Purchase Price will generally be a fair price

because the First Party won’t want to pay too much or

be forced to sell for too little.

Enabling one party to fix the Purchase Price should

make the transaction faster and more efficient than

other solutions.

Neither party has clear control over the process.

(c) Certain Cons.

If Member B is not willing to be a buyer, Member A, if

it is the First Party, can set a lower Purchase Price

because it won’t have to worry about Member B being

a buyer.

If Member B is not a willing to be a buyer, this solution

may not provide any meaningful relief and may only

benefit Member A.

It can be very difficult to pick a Purchase Price.

(vi) Equity Conversion.

(a) Basic Structure. Upon the occurrence of a Stalemate,

Member B has the option, but not the obligation, to either (i) sell its interest in the LLC to

Member A at either a fixed price (see Section 3 above) or an appraised price (see Section

4 above) or (ii) have its interest in the LLC converted into a non-voting, preferred

security with a fixed and capped rate of return, anti-dilution protections and information

rights (the “New Security”).

(b) Certain Pros.

Member B controls whether a transaction occurs and

the structure for that transaction.

If Member B elects to receive a New Security, Member

B will receive its preferred return before Member A

receives its return and Member B will retain its right

and ability to learn more about the business.

(c) Certain Cons.

By giving up its management/voting rights, Member B

will not be able to participate in any decisions regarding

the LLC. Thus, Member B’s investment will be at risk

to the extent Member A fails to properly manage the

business.

A fixed return means Member B may miss the

opportunity to see significant appreciation in value.

Member B would only receive a fixed rate of return on

its investment, which rate of return may be significantly

less than 50% of the then enterprise value of the LLC.

Member B would not receive an immediate payment on

its investment.

Certain bankruptcy issues may arise.

(vii) Dissolution.

(a) Basic Structure. Upon the occurrence of a Stalemate, either

party may cause the dissolution of the LLC. The assets of the LLC would be collected

and liquidated to payoff debts and any remaining assets would be distributed to the

members pro rata based on their capital account balances.

(b) Certain Pros.

Provides significant motivation to avoid a Stalemate.

Liquidation of the assets may be the most equitable

remedy for the parties since third party negotiations will

dictate the purchase price for the assets.

(c) Certain Cons.

Precludes either party from continuing the business

even if such party would like to continue the business.

Liquidating the assets as part of a dissolution may not

result in payment of the highest purchase price as

buyers may successfully negotiate lower prices when

they know that the sale arises out of a dissolution.

(viii) Additional Issues with Such Solutions. In the event any member

attempts to exercise or successfully exercises any of the above described solutions, the

members and the LLC may encounter the following issues:

(a) the transaction may constitute a breach under agreements

binding on the members or the LLC;

(b) third party approvals may be required to properly

implement one or more of these solutions;

(c) the other member may be unable or unwilling to perform

(e.g., lack of financing to fund purchase price, lack of appropriate corporate approval,

etc.); and

(d) members may not be able to specifically enforce rights

under the LLC Agreement for any number of reasons, including the issues listed in

clauses (a), (b) and (c) above.

V. DISSOLUTION STRATEGIES

A. DISSOLUTION GENERALLY

An LLC may dissolve and wind up affairs for the several reasons outlined in RCW

25.25.270, which includes:

1. According to a dissolution date specified in the certificate of formation.

2. The happening of an event specified in the LLC Agreement.

3. By written consent of all of the LLC members.

4. After the passage of 90 consecutive days during which the LLC has no members.

5. By judicial decree under RCW 25.15.275 in which dissolution will result if it is

not reasonably practicable to carry on the business in conformity with the LLC

Agreement or other circumstances render dissolution equitable. In the case of

judicial dissolution, a receiver may be appointed by the court under RCW

7.60.025(1)(t).

6. The expiration of 5 years after the effective date of dissolution under RCW

25.15.285 without reinstatement of the LLC.

The secretary of state may also administratively dissolve an LLC under RCW 25.15.285

if the company does not pay license fees or penalties when they come due; the LLC does

not deliver its completed initial or annual report to the secretary of state when it is due;

the LLC is without a registered agent or registered office in the state for 60 days or more;

or the LLC does not notify the secretary of state within 60 days that its registered agent or

office has changed, resigned, or discontinued. When an LLC is administratively

dissolved, the company can apply to the secretary of state for reinstatement within 5

years after the effective date of dissolution.

During dissolution, a winding up of the LLC’s affairs occurs where the LLC must

prosecute and defend suits, settle and close its business, dispose or and convey property,

discharge liabilities, and distribute to members any remaining assets. RCW 25.15.295(2).

During this period, the duty of care and duty of loyalty still apply as the LLC is still

considered a business entity, but these duties may be modified somewhat by agreement.

B. PROCESS

The dissolution process may best be handled by outlining a plan for liquidation for the

LLC (see sample “Greenacre, LLC Plan of Liquidation” in Part VI). After dissolution has

begun, the LLC shall pay or make reasonable provisions to pay all claims and obligations

known to the LLC, including contingent, condition, or unmatured claims. While the LLC

statutes do not outline how to dispose of the known claims, Washington’s corporate

statute, RCW 23B et seq., provides an outline related to known claims of a dissolved

corporation. This process may be used to help guide the disposition of known claims

against an LLC.

To determine the extent of liabilities against the LLC, the LLC should send a notice and

request to all holders of known claims against the LLC to make them aware of the

dissolution and to request information regarding any claims against the LLC. The scope

of known claims should include: any matured claims, even when the amount of the claim

is not known; any unmatured, conditional, or contingent claims that may arise under an

executory contract to which the LLC is a party; any claim that the LLC has knowledge of

the identity and mailing address of the holder and has actual knowledge of existing facts

that could give rise to or indicate an intention to assert a claim.

The notice and request should ask the holder for a description of facts related to matured

and legally assertable claims or for the holder to identify the executory contract related to

any unmatured, conditional, or contingent claims. The notice and request should also ask

for the mailing address of the holder of a claim where funds can be sent and provide a

deadline of 120 days by which a written claim of the notice must be delivered to the LLC.

Upon receipt of the claims, the priority of each should be determined and then the LLC

should distribute its liquidated assets to the creditors according to their priority. The

sample “Plan of Liquidation” contemplates an LLC that will not have enough assets to

satisfy all of its creditors. However, if assets remain after all creditors have been satisfied,

then the remaining assets are to be distributed to the members of the LLC.

After all claims have been received, the assets of the LLC should be distributed as such

(unless the LLC Agreement provides otherwise):

1. Creditors, including members and managers who are creditors, in satisfaction of

liabilities of the LLC;

2. Members and former members in satisfaction of liabilities for distributions;

3. Members for their capital contributions;

4. Members in proportionate share of their membership interest.

C. LIABILITY

Dissolution alone does not cause the LLC to cease as a legal entity separate from its

members or cause the members to be automatically personally liable for the LLC’s debts.

Instead, the LLC will continue to operate as a legal entity, but the purposes and activities

of the LLC have changed. RCW 25.15.303 provides for the remedies available to third

parties when an LLC is undergoing dissolution, stating: The dissolution of a limited

liability company does not take away or impair any remedy available against that limited

liability company, its managers, or its members for any right or claim existing, or any

liability incurred at any time, whether prior to or after dissolution, unless an action or

other proceeding thereon is not commenced within three years after the effective date of

dissolution. Such an action or proceeding against the limited liability company may be

defended by the limited liability company in its own name.

During the dissolution and winding up process, the LLC must pay or make reasonable

provisions to pay for all claims and obligations known to the LLC. This includes

contingent, conditional, or unmatured claims. Under Chadwick Farms, members of an

LLC who fraudulently attempt to use the LLC Act to avoid such liability expose

themselves to individual liability. A member may also be subject to personal liability if

he winds up an LLC improperly or does not comply with the provisions that govern the

distribution of the LLC’s assets, resulting in the possibility of a plaintiff piercing the veil

of the LLC form.

VI. SAMPLE PLAN OF LIQUIDATION

GREENACRE, LLC

PLAN OF LIQUIDATION

The following is the proposed plan of liquidation (“Plan”) of Greenacre, LLC, a

Washington limited liability company (the “Company”). This Plan assumes that the

Company’s creditors will not be paid in full and that there will be no assets available for

distribution to members of the Company with respect to their ownership interests.

I. SUMMARY

The plan of dissolution (the “Plan”) can be summarized as follows:

A. Class A and Class B members consent to dissolution of the Company

B. Notice of the dissolution is given to all known creditors of the Company,

with a “claims bar date” established

C. 45 days prior to the claims bar date, submit a request for tax status

letter to the Washington Department of Revenue

D. Consider all claims and determine their relative priorities

E. Distribute assets to creditors according to the priorities; where assets

are insufficient to pay all claims of equal priority, distributions shall be

made ratably among such claims

F. Execute and file a Certificate of Cancellation with the Washington

Secretary of State to cancel the Company’s Certificate of Formation

II. PLAN OF LIQUIDATION OR “WINDING UP”

A. Consent to Dissolution

The Company’s Limited Liability Company Agreement (“Agreement”) provides

for dissolution upon the written consent of a Majority in Interest of the Members coupled

with a Special Consent to dissolve the Company. The term “Majority in Interest” is not

defined in the Agreement. However, the term “Majority in Voting Interest” is defined to

mean Class B members holding more than 66 2/3% of the Class B units held by all

members. The Agreement also provides that only Class B members are voting members

of the Company. Consequently, it appears that dissolution requires the approval of Class

B members holding more than 66 2/3% of the Class B units held by all members.

In addition, the Agreement requires a Special Consent to dissolve the Company.

“Special Consent” is defined in the Agreement to mean Class A members holding 51% or

more of the percentage interests of all Class A members excluding any Class A members

which are also Class B members or an equity owner or former equity owner of MTF

USA, Inc.

Consents will be submitted to the Class A members and the Class B members for

their approval of dissolution of the Company.

B. Notice to Known Creditors

The Washington LLC statute (RCW 25.15 et seq.) provides that a limited liability

company that has dissolved shall pay or make reasonable provision to pay all claims and

obligations, including all contingent, conditional, or unmatured claims and obligations,

known to the LLC and all claims and obligations which are known to the LLC but for

which the identity of the claimant is unknown. The statute does not address unknown

claims. The statute also does not provide a mechanism for disposing of the known

claims. However, the Washington corporate statute (RCW 23B et seq.) provides a

process for disposing of known claims against a dissolved corporation. Although the

dissolution process for a Washington corporation differs from the dissolution process for

a Washington LLC, the process for disposing of known claims against a corporation, with

some modification, appears reasonable for use by a dissolved LLC.

After the consents described in Section A above have been obtained, the

Company will send a written Notice of Dissolution and Request to File Claims to the

holders of known claims against the Company. For purposes of this notice, a “known

claim” will mean any claim or liability:

(i) that has matured sufficiently, either before or after the effective date of the

Consents described in Section A above, to be legally capable of assertion

against the Company, whether or not the amount of the claim or liability is

known or determinable; OR

(ii) is unmatured, conditional, or otherwise contingent, but may subsequently

arise under any executory contract to which the Company is a party, other

than under an implied or statutory warranty as to any product

manufactured, sold, distributed, or handled by the Company; AND

(iii) as to which the Company has knowledge of the identity and the mailing

address of the holder of the claim or liability and, in the case of a matured

and legally assertable claim or liability, actual knowledge of existing facts

that either could be asserted to give rise to, or indicate an intention by the

holder of the claim to assert, such a matured claim or liability.

The Notice of Dissolution and Request to File Claims will provide the following:

(a) A demand for the holder of the known claim to provide a description of

the facts specified in paragraph (iii) above relating to a matured and

legally assertable claim or liability, or an identification of the executory

contract with respect to which unmatured, conditional, or contingent

claims or liabilities are sought to be disposed of through this process;

(b) A demand for the holder of the claim to provide a mailing address where

any funds to be paid may be sent;

(c) the deadline, which will be 120 days from the effective date of the Notice

of Dissolution, by which a written notice of claim must be delivered to the

Company;

(d) state that the known claim will be barred if a written notice of claim

describing the known claim with reasonable particularity is not delivered

to the Company by the deadline; and

(e) state that the known claim or any executory contract on which the known

claim is based may be rejected by the Company, in which case the holder

of the known claim will have a limited period of 90 days from the

effective date of the rejection notice in which to commence a proceeding

to enforce the known claim.

The Company shall maintain a record of the date on which a written notice of

dissolution is sent to each holder of a known claim.

A known claim against the Company is barred if the holder of the known claim

who was given written notice of dissolution does not deliver the written notice of claim to

the Company by the deadline OR if a holder of a known claim that was rejected by the

Company does not commence a proceeding to enforce the known claim within 90 days

from the effective date of the rejection notice.

C. Tax Status Letter

Washington law does not provide for the issuance of a Department of Revenue

Clearance Certificate to an LLC. However, the Company may request a Tax Status

Letter from the Washington Department of Revenue. This request will be made 30-45

days prior to the deadline for known creditors to submit their claims to the Company. A

Tax Status Letter will advise you of whether or not the Department of Revenue contends

additional taxes remain owing to the State of Washington.

D. Claims and Priorities

As claims are received, they will be reviewed by one or more employees or agents

of the Company. This review will be to determine the claim’s validity, consistency with

the Company’s records, and order of priority for payment. Not later than 30 days after

the claims deadline set forth in the Company’s written notice of dissolution, the Company

shall complete its review of submitted notices of claim and shall notify the holder of each

such claim of the Company’s acceptance or rejection of the claim. An acceptance of a

claim shall specifically exclude a promise to pay such claim since payment, if any, will

be based on the relative priority of the claim and the amount of claims of similar or

higher priority to the accepted claim. The Company shall maintain a record of the date

on which it sends notice of acceptance or notice of rejection to the submitter of a notice

of claim.

E. Priority of Claims

The Washington LLC statute provides that, upon winding up of an LLC, the

assets shall be distributed as follows:

(i) to creditors, including members and managers who are creditors, to the

extent otherwise permitted by law, in satisfaction of liabilities of the

Company (whether by payment or the making of reasonable provision for

payment) other than liabilities for which reasonable provision for payment

has been made and liabilities for distributions to members of the

Company;

(ii) unless otherwise provided in the Agreement, to members and former

members in satisfaction of liabilities for distributions under RCW

25.15.215 or 25.15.230; and

(iii) unless otherwise provided in the Agreement, to members first for the

return of their contributions and second respecting their interests in the

Company, in the proportions in which the members share in distributions.

The Board of Directors does not anticipate that any assets will be distributable under

paragraphs (ii) and (iii) above. The Washington LLC statute does not provide the

priorities of the claims of creditors. However, the Washington receivership statute, RCW

7.60.230, and the federal bankruptcy statute, 11 U.S.C. §507, set forth priorities of claims

under their respective circumstances. A combination of these provisions appears to be

reasonable in the context of the winding up of the Company’s business. Claims shall

have priority in the following order:

(a) Holders of liens on Company property, which liens are properly perfected

under applicable law, shall receive proceeds from the disposition of their

collateral, provided that such claims shall be paid from the proceeds in

accordance with their respective priorities under otherwise applicable law;

(b) Actual, necessary costs and expenses incurred during the winding up

process, other than those claims allowable under paragraph (a) above.

Such costs and expenses shall include wages and salaries of employees of

the Company; commissions payable for services rendered during the

winding up process; taxes incurred by the Company on and after the

effective date of dissolution; and compensation for professional services

rendered by attorneys or accountants during the winding up process;

(c) Allowed unsecured claims, to the extent of $10,000.00 for each individual,

earned within 180 days before the effective date of dissolution of the

Company for wages, salaries, or commissions earned by such individual;

(d) Allowed unsecured claims for contributions to an employee benefit plan

arising from services rendered within 180 days before the effective date of

dissolution of the Company to the extent of the number of employees

covered by each such plan multiplied by $10,000, less the aggregate

amount paid to such employees under paragraph (c) above plus the

aggregate amount paid by the Company on behalf of such employees to

any other employee benefit plan;

(e) Allowed unsecured claims of individuals, to the extent of $1,800 for each

such individual, arising from the deposit, before the effective date of

dissolution, of money in connection with the purchase of property for the

personal, family, or household use of such individual that were not

delivered or provided;

(f) Unsecured claims of governmental units for taxes that accrued prior to the

effective date of dissolution;

(g) Other unsecured claims.

E. Distribution of Assets

As soon as practicable after all claims of a specific priority have been finally

determined and accepted and/or have been finally resolved by a proceeding commenced

after rejection of a notice of claim or by a failure to commence a proceeding within 90

days after the effective date of a rejection of a claim, the Company shall pay accepted and

finally resolved claims of such priority to the extent of assets available to pay claims of

such priority, PROVIDED, however, that no payments to holders of claims of a specific

priority shall be made until all claims of all higher priorities that have been accepted

and/or finally resolved have been paid in full. In the event all accepted and finally

resolved claims of a specific priority cannot be paid in full from the assets available for

payment of such claims, such claims shall be paid ratably. In the event an accepted or

finally resolved claim cannot be paid because the claimant is unknown, the Company

shall deliver the amount due on such claim to the Washington Department of Revenue as

unclaimed property.