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

Novel Ruling in Lawsuit Over Capital Call Prods Parties to Equitable Buy-Out

Posted in Buyout, Capital Call, Compulsory Buyout, Interim Remedies, LLCs

Lawsuits among partners in closely held businesses present infinite variations on claims for breach of contractual, statutory and common law duties. Depending on many factors — the size of the business and number of partners; their individual roles in the business and relative voting power; the degree of personal animosity; whether the firm is family-owned; the nature, profitability and prospects of the business, etc. — the partners and their lawyers usually know early on if the severe rupture in relations symbolized by the outbreak of litigation is reconcilable or not. This is true even when no one in the lawsuit is asking the court to dissolve the entity and end the partnership.

Experienced judges know it too. They’ve seen these intensely personal and bitterly fought cases linger for years, generating one pre-trial motion after another along with appeals, as the sides jostle for position and superior leverage for what all concerned know is most likely to happen in the end anyway: a settlement involving either a buy-out of one side by the other or, if the business assets lend themselves to it, a division of assets.

But judges don’t have the power to order dissolution of the business and thereby hasten the inevitable buy-out or division of assets unless someone asks for it by way of petition brought under the applicable dissolution statute, which, for various reasons beyond the scope of this post, they may never do.

So how can a judge prod the parties toward a business divorce when no one has petitioned for dissolution? One of our most experienced judges in this field, Nassau County Commercial Division Justice Stephen A. Bucaria, recently devised a novel solution in Digirolomo v. Sugar LI, LLC, Short Form Order, Index No. 008756 (Sup Ct Nassau County Nov. 20, 2013), by granting a preliminary injunction in favor of an LLC’s minority members, preventing the controlling member from enforcing capital call provisions in the operating agreement, conditioned on the plaintiffs’ filing within 30 days an amended complaint seeking judicial dissolution of the LLC

Background

Digirolomo involves a four-member LLC formed to operate a night club. The two, plaintiff minority members, holding a combined 34% interest, were each credited with a $100,000 capital contribution in consideration of their assignment of a lease covering the premises. The defendant controlling member, who held a 56% interest and was sole manager, contributed $665,000 cash. The LLC’s operating agreement required the members to make pro rata additional capital contributions if alteration expenses exceeded $750,000, and also authorized the managing member to make additional capital calls for ordinary business expenses. In the event a member failed to make a required capital contribution, under the agreement the other members could purchase the defaulting member’s interest at a nominal price of $7.50 per unit.

After the night club opened, the defendant managing member sent a notice of mandatory capital contribution to the minority members in which he claimed to have made an additional capital contribution over $100,000 to cover rent, liquor and sales tax payments. The notice demanded that the other members contribute their respective shares and offered to purchase their interests at the nominal price of $7.50 per unit if they were not able to make the required contribution.

The Capital-Call Lawsuit and Interim Injunction

In July 2013, the two, plaintiff minority members filed suit against the managing member for breach of fiduciary duty, conversion and other claims, alleging he took $200,000 in unauthorized cash withdrawals, caused the company to incur a sales tax lien, and denied them access to company records. The suit did not seek judicial dissolution of the LLC.

The plaintiffs also moved for a preliminary injunction and obtained a temporary restraining order, preventing the managing member from disposing of the plaintiffs’ membership units or purchasing them in accordance with the capital call provisions of the operating agreement. The managing member opposed the motion, contending that the night club was operating at a loss and needed additional capital to fund operating expenses.

In August 2013, Justice Bucaria issued a decision granting the requested preliminary injunction (read order here). The court found that the plaintiffs showed a likelihood of success on the merits of their claim that the managing member breached the operating agreement by failing to call for additional capital “in good faith” and that plaintiffs would suffer irreparable injury unless the managing member was restrained from purchasing their membership interests for nominal value.

Justice Bucaria’s Novel Ruling on Reargument

The managing member then moved to reargue the motion for preliminary injunction, arguing that his ”good faith” was not at issue because the operating agreement expressly permitted a capital call for the expenses at issue.

In his decision last month, Justice Bucaria conspicuously omits any discussion of the standards governing, or merits of, or opposition to, the reargument motion. Instead, he launches his analysis with a telling observation about the limits of the judicial role in managing the business affairs of an entity akin to a partnership :

“[C]ourts are generally loath to intercede in squabbles between partners that result in piece-meal adjudications, preferring that partners either settle their own differences amicably or dissolve and finally conclude their affairs by a full accounting” (Grammercy Equities Corp. v. Dumont, 72 NY2d 560, 564-65 [1988]). Since a limited liability company is operated with the flexibility of a partnership, a court is similarly reluctant to intercede in a dispute between the members, absent dissolution of the company (See Limited Liability Company Law, McKinney’s Practice Commentary at p. 251).

My translation of the above: C’mon guys, either settle or shut it down, but don’t ask the court to spend its precious time arbitrating every little thing.

But how to get to the separation involving an LLC when the parties haven’t requested dissolution and the LLC statute, unlike its counterpart statute governing dissolution of corporations, has no buy-out provision?  Justice Bucaria’s answer highlights what appears to be the courts’ growing acceptance of compulsory buy-out as an appropriate, “equitable” remedy in LLC dissolution cases. Here’s what he says:

The Limited Liability Company Law does not expressly authorize a buyout in a dissolution proceeding (Mizrahi v Cohen, 104 AD3d 917, 920 [2d Dept 2013]). Nonetheless, in certain circumstances, a buyout may be an appropriate equitable remedy upon the dissolution of an LLC (id). While the price agreed upon in the operating agreement is generally enforceable, the court may impose a surcharge or adjustment, if the majority member has dissipated assets or engaged in other oppressive conduct toward the rninority members (Business Corporation Law § 1104-a(d)).

Since the court may adjust the buyout price based upon a dissipation of assets, it may temporarily restrain the repurchase of a minority member’s interest, pending determination of the appropriate adjustment. 

If, as Justice Bucaria writes, a court may order a buy-out in an LLC dissolution case as an equitable remedy, how does it get there if no one has petitioned for dissolution? The novel solution devised by Justice Bucaria in Digirolomo is to condition the injunctive relief sought by the plaintiff, preventing the managing member from acquiring their membership units at a nominal price, on their filing an amended complaint adding a claim for LLC dissolution under LLC Law § 702. The decision thus provides:

Accordingly, defendants’ motion for leave to reargue plaintiffs’ motion for a preliminary injunction is granted. Upon reargument, plaintiffs’ motion for a preliminary injunction, restraining defendants from repurchasing plaintiffs’ interests in Sugar LI, LLC, is granted to the extent that defendants are restrained from purchasing plaintiffs’ interest pending a hearing upon whether defendant Narod has dissipated company assets or otherwise engaged in oppressive conduct toward the minority members. The preliminary injunction will terminate 30 days from the date of this order if plaintiffs have not served amended complaints seeking judicial dissolution of Sugar LI, LLC. [Emphasis added.]

Mind you, the court is not compelling the plaintiffs to do anything. Rather than following the course suggested by Justice Bucaria, they can decide not to file an amended complaint for dissolution and continue to contest the validity of the capital call, if that’s what they believe is in their best interests. I’d be surprised if that’s what they do, but only time – 30 days from November 20, 2013, to be precise — will tell.