Header graphic for print
NY Business Divorce Information on Dissolution and Other Disputes Among Owners of New York Corporations, LLCs and Partnerships

Appellate Court Orders Equitable Buy-Out in LLC Dissolution Case

Posted in Buyout, Compulsory Buyout, Deadlock, LLCs

The Mizrahi v. Cohen case, about which I’ve posted twice before, took a surprising turn last week when an appellate court granted the plaintiff’s request to compel a buy-out of the defendant’s interest as an equitable remedy in an LLC dissolution fight between 50/50 members.

Last week’s ruling by the Brooklyn-based Appellate Division, Second Department, in Mizrahi v. Cohen, 2013 NY Slip Op 02056 (2d Dept Mar. 27, 2013), resolved an appeal and cross-appeal from a January 2012 post-trial order by Brooklyn Commercial Division Justice Carolyn E. Demarest. The trial court’s order granted the plaintiff’s request to dissolve the subject LLC which owns a mixed-use, four-story building that houses Mizrahi’s dental office and Cohen’s optometry office along with other tenants. (Read here my post about the January 2012 decision.)

The Appellate Division affirmed Justice Demarest’s determination that dissolution under LLC Law § 702 was warranted based on the LLC’s financial infeasibility caused largely by the defendant 50% member’s refusal to make additional capital contributions. It also affirmed Justice Demarest’s rulings allowing parol evidence of the parties’ course of dealings to assist the interpretation of the LLC agreement, and dismissing plaintiff’s contract and fiduciary breach claims.

The Appellate Division disagreed with Justice Demarest on one issue only, albeit one with potentially great precedential importance in LLC dissolution cases: Did the plaintiff establish a right to compel a buy-out of the defendant’s membership interest as an equitable remedy in lieu of winding up the LLC and liquidating its realty asset?

I’ll briefly review the lower court proceedings before discussing the appellate court’s ruling.

The January 2012 Post-Trial Decision

In rejecting the plaintiff’s request for an equitable buy-out, Justice Demarest accepted the defendant’s contention that the LLC agreement’s express provisions for the winding up and distribution of assets to the members upon dissolution, which largely tracked the statutory default rules in LLC Law § 704, precluded a buy-out remedy. She also pointed to the members’ personal guarantees of the LLC’s $4.4 million mortgage loan, and to the bank’s entitlement to satisfaction of the mortgage debt upon the LLC’s dissolution, as further justification for rejecting the plaintiff’s proposed buy-out remedy.

Justice Demarest’s January 2012 order deferred the appointment of a receiver to wind up the LLC pending an accounting of the members’ vastly disproportionate financial contributions to the LLC and the appointment of an independent appraiser to assess the realty’s fair market value.

The January 2013 Post-Accounting Decision

Both sides filed appeals from the January 2012 order. The accounting and appraisal went forward pending the appellate proceedings, culminating with a second decision and order by Justice Demarest in January 2013 about which I wrote here, in which the plaintiff again requested, and the court again denied as unauthorized by the LLC agreement, the right to compel defendant to sell his membership interest to plaintiff in lieu of a winding-up and liquidation.

Instead, in recognition that a sale of the realty appraised at slightly over $4.5 million would (1) barely satisfy the mortgage debt, (2) wipe out plaintiff’s disproportionate $1.2 million contribution, and (3) likely dislocate both members’ professional practices, Justice Demarest ordered as an equitable remedy a mutual buy-out auction sale, such as approved in Lyons v. Salamone, 32 AD3d 757 (1st Dept 2006), in which each member could bid for the other’s 50% interest conditioned on plaintiff having a credit bid for the debt owed him by the LLC and the defendant being required to satisfy his debt in excess of $200,000 owed to the LLC.

Last Week’s Appellate Decision

At defendant Cohen’s request the Appellate Division stayed Justice Demarest’s January 2013 order pending the determination of the appeals from her January 2012 post-trial decision. As already noted, the appellate court’s decision handed down last week affirmed Justice Demarest’s rulings in all respects save her rejection of plaintiff’s request to compel a buy-out of defendant’s membership interest.

The plaintiff Mizrahi argued on appeal that the LLC agreement affirmatively contemplated the requested buy-out as reflected in its provision for in-kind distribution of assets at fair market value upon dissolution. He also argued that the buy-out was authorized by the Second Department’s decision in Matter of Superior Vending, LLC, 71 AD3d 1153 (2d Dept 2010), which upheld an order in an LLC dissolution case directing the controlling member to repay the non-controlling member his investment in the LLC in exchange for his membership interest as “the most equitable method of liquidation.” (Read here and here excerpts from Mizrahi’s main and reply briefs, and here and here my posts on the trial and appellate court rulings in Superior Vending.)

The defendant Cohen countered that a buy-out remedy was inconsistent with the LLC agreement’s express provision for distribution of assets upon dissolution. He also argued that the circumstances were distinguishable from those in Superior Vending because the LLC in that case lacked an operating agreement, and because the two members consented to dissolution and had severed their mutual operation of the business years before the litigation. (Read here excerpt from Cohen’s appellate brief.)

The Second Department set forth in one paragraph its determination of the issue in Mizrahi’s favor, and its agreement that Superior Vending provides authority for a buy-out. Here’s what it said:

The Supreme Court should have granted, in effect, the plaintiff’s application for an order authorizing him to purchase the defendant’s interest in the LLC upon its dissolution. The Limited Liability Company Law “does not expressly authorize a buyout in a dissolution proceeding ” (Matter of Superior Vending, LLC [Tal-Plotkin], 71 AD3d 1153, 1154). Nonetheless, in certain circumstances, a buyout may be an appropriate equitable remedy upon the dissolution of an LLC (see id.). Under the facts of this case, the remedy of a buyout by the plaintiff is appropriate (see id.). Contrary to the defendant’s contention, the provisions of the LLC agreement regarding dissolution of the LLC do not preclude an order authorizing a buyout upon the judicial dissolution of the LLC pursuant to Limited Liability Company Law § 702 (see Limited Liability Company Law § 702; see also Matter of Superior Vending, LLC [Tal-Plotkin], 71 AD3d at 1154). Accordingly, the matter must be remitted to the Supreme Court, Kings County, for further proceedings and for a determination thereafter as to the value of the defendant’s interest in the LLC.

What guiding principles can be drawn from the court’s meager analysis? Here are some suggestions:

  • Court-ordered buy-outs are here to stay in LLC dissolution cases, notwithstanding the absence of statutory authority as found in § 1118 of the Business Corporation Law applicable to dissolution cases involving closely held corporations. The buy-out ordered in Superior Vending was based on an extremely unusual fact pattern, whereas the one in Mizrahi is closer to mainstream. In the future I expect to see Mizrahi aggressively wielded by litigants in LLC dissolution cases as supporting authority to compel buy-outs where the operating agreement provides no exit mechanism. Litigants opposing buy-out will try to distinguish the defendant’s financial irresponsibility and the draconian consequences of liquidation in Mizrahi.
  • LLC agreement drafters, take note: The decision expressly rejects Cohen’s contention that the LLC agreement’s provisions preclude a court-ordered buy-out remedy, but makes no mention of Mizrahi’s contention that the LLC agreement affirmatively authorizes a buy-out remedy. Consequently it can be argued that members of an LLC whose operating agreement contains an express prohibition on court-ordered buy-out, or which mandates some other disposition of member interests upon dissolution inconsistent with buy-out, should not be able to obtain a Mizrahi buy-out remedy.
  • The Mizrahi decision offers no guideposts as to when an equitable buy-out is warranted, merely stating that buy-out is appropriate “under the facts of this case.” In other words, entitlement to an equitable buy-out is highly fact-specific and will be decided on a case-by-case basis.
  • The Mizrahi decision makes no mention of the defendant Cohen’s personal guarantee of the LLC’s $4.4 million mortgage debt, which Justice Demarest cited as a factor in denying a buy-out remedy. Mizrahi offered to have Cohen released from his liability on the mortgage debt as a condition of the buy-out, which strikes me not only as reasonable but essential to protect Cohen from future liability on the repayment of debt as to which he will have no financial interest and no control.

My thanks to Edward B. Safran, Esq., the attorney for the plaintiff in Mizrahi v. Cohen, for providing copies of the appellate briefs.