Judicial Dissolution of the Unprofitable LLC
This is a tale of two cases, decided five years apart, involving my all-time favorite business divorce topic: judicial dissolution of the limited liability company (LLC). The cases raise the interesting question whether a member may seek dissolution on the ground that the LLC is not profitable.
First, a bit of background for the uninitiated. The LLC is an unincorporated business entity that combines the limited liability benefits of the corporation with the favorable pass-through tax treatment of partnerships. Compared to the highly structured, mandatory provisions of the business corporation laws, the LLC laws offer far more flexibility and freedom of contract among the LLC members to order their ownership, economic and managerial relations as they see fit. LLCs are fast on the way to becoming the preferred form of closely held business organization. Already, in a number of states including Delaware, new LLC filings outnumber new corporation filings.
The New York LLC Law's sparsely worded provision for judicial dissolution, codified in Section 702 of the LLC Law, borrowed its language from the limited partnership law. Section 702 provides in relevant part:
Continue Reading...On application by or for a member, the supreme court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.
50% Shareholder May Not Sue Other 50% Shareholder in Company's Name
The concept of the corporation as a separate "person", with a legal identity distinct from its shareholders and the ability to sue and be sued in its own name, is the cornerstone of the corporate form of business organization. The essential corporate attribute of limited liability and the attendant imposition of fiduciary duties of loyalty and care on those entrusted to manage the corporation's affairs, could not comfortably exist without corporate separateness.
Okay, I admit that's a highfalutin way to introduce the discussion that follows, of a trite lawsuit between shareholders of a two-bit sports memorabilia business, but that's the beautiful thing about the law, its noblest notions inform even the most mundane of disputes.
The dispute in question is the subject of a decision last month by New York County Supreme Court Justice Joan Madden in a case called Sports Legends, Inc. v. Carberry, 2008 NY Slip Op 30718(U) (Sup Ct NY County Mar. 10, 2008) (read decision here). The case arose when one of two 50% shareholders of a sports memorabilia business caused a suit to be filed in the name of the corporation against the other shareholder, asserting claims to recover company merchandise allegedly taken by the defendant and not returned. The primary issue in the court's decision, of no interest here, was whether the action was barred by the statute of limitations (the court found that it was). Secondarily, and the reason I'm discussing the case, the court addressed the issue whether the shareholder who brought the suit in the company's name had the authority to do so.
Continue Reading...Appellate Court Enforces Stock Buyback Triggered by Dissolution Petition
One of my pet issues, on which I've written a number of times (see here, here and here), is whether the filing of a dissolution petition triggers a mandatory stock buyback under a shareholders' agreement that provides a right of first refusal (RFR). The cases raising the issue have all been deadlock dissolution petitions brought by 50% shareholders under Business Corporation Law Section 1104(a). That statute, unlike Section 1104-a governing minority shareholder oppression, does not give the respondent shareholders the right to purchase the petitioner's shares under Section 1118.
If the shareholders' agreement expressly provides that the filing of a dissolution petition triggers the RFR, unquestionably it should be enforced. The problem arises with the more typical RFR that does not contain such express language, but instead contains what most would consider boilerplate reference to stock transfers. Is enforcement by reason of such general language consistent with a shareholder's reasonable expectations, and with the statutory right to seek dissolution? The issue has very serious ramifications for the petitioner (and for petitioner's lawyer who may be unwary of the trap) because the RFR typically provides a below-market price for the buyback with a long-term payout.
A 2006 appellate decision in a case called Matter of Johnsen (ACP Distribution, Inc.) ruled that a dissolution petition triggered an RFR containing the operative terms, "donate, hypothecate, pledge, transfer or otherwise dispose of his Stock in any manner whatsoever." A September 2007 trial court decision in Matter of Schneck (R&J Components Corp.) (previously blogged here) went the other way where the operative terms were "sell, assign, mortgage, hypothecate, transfer, pledge, create a security interest or lien, encumber, give or otherwise dispose of any of the shares."
Continue Reading...High Court Restricts Remedies of Limited Partner Alleging Fraud by General Partner in Merger Transaction
On March 18, 2008, the New York Court of Appeals, which is New York's highest court, decided Appleton Acquisition, LLC v. National Housing Partnership (read decision here). The decision holds that a limited partner may not bring an action seeking damages or rescission based on allegations of fraud by the general partner in connection with a merger transaction, and that the statutory appraisal proceeding is the exclusive remedy for such claims. As a result, the plaintiff in Appleton, which acquired partnership interests post-merger from limited partners who did not exercise appraisal rights, was out of court and out of luck.
The limited partnership known as Beautiful Village ("BV") owned and managed a New York City apartment complex which received federal financing under HUD's Section 8 affordable housing program. By 2002, BV owed over $1.5 million to the corporate General Partner's parent company. Rather than foreclosing, the General Partner proposed that BV merge into a new limited partnership owned by the parent company, with each limited partner receiving $100 or 2.5 common units of the parent company for their BV shares. The limited partners received proxy statements disclosing the conflict of interest between the General Partner and its parent company, and advising that rejection of the merger would likely lead to foreclosure resulting in adverse tax consequences for the limited partners. The proxy also notified the limited partners of their alternative right to institute a judicial appraisal proceeding to receive the fair value of their partnership interests. None of the limited partners exercised their appraisal rights. In September 2002, the merger was approved and the limited partners' interests in BV were extinguished.
Three years later, plaintiff Appleton Acquisitions, LLC ("Appleton"), which had no prior involvement with BV, purchased from the former BV limited partners their equitable or partnership shares together with any legal claims they had against BV, the General Partner and its parent company. Appleton then filed a lawsuit against the latter entities asserting three causes of action for rescission of the merger and ancillary money damages on the grounds of fraud, breach of fiduciary duty and negligent misrepresentation. Appleton alleged that the proxy statement contained false and misleading statements and that the General Partner had depressed the value of the BV partnership interests by failing to enroll in a certain HUD program that would have provided BV with additional Section 8 rent subsidies. These allegations were also used to support two additional claims seeking monetary damages for breach of contract and aiding and abetting breach of fiduciary duty.
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