purpose4Judicial dissolution statutes for limited liability companies in New York, Delaware, and many other states use the contract-centric language drawn from limited partnership law, namely, whether it is reasonably practicable to carry on the business in conformity with the articles of organization and operating agreement.

Court decisions in both Delaware and New York have construed their respective LLC statutes as authorizing judicial dissolution when the purpose of the entity, as defined in the operating agreement, can no longer be achieved. For instance, former Vice Chancellor Chandler of the Delaware Chancery Court in his 2008 Seneca Investments decision, and then-Vice Chancellor Strine in his 2009 Arrow Investment Advisors decision, both used language suggestive of the LLC agreement as the sole source to which a court should look in determining the LLC’s purpose. In New York, Justice Austin, writing for the Appellate Division, Second Department, in the seminal 1545 Ocean Avenue decision, similarly crafted a dissolution standard keyed to the frustration of the LLC’s “stated purpose” in the context of its operating agreement.

Does that mean courts never look outside the LLC agreement when determining if its purpose no longer is achievable? And how should a court determine purpose when the LLC has no written agreement? Recent decisions from Delaware and New York provide some clues to the answers.

Delaware Court Looks “Beyond the Purpose Clause”

Just last week, in Meyer Natural Foods LLC v Duff, C.A. No. 9703-VCN [Del. Ch. June 4, 2015], Vice Chancellor Noble summarily dissolved a Delaware LLC at the behest of its 51% managing member, notwithstanding the absence of operational deadlock or any genuine dispute that the LLC’s business could carry on profitably in conformity with the LLC agreement’s broadly defined purpose to engage in the business of marketing, distributing, and selling natural beef products.

So why dissolution? Because the business effectively was formed to operate as a joint venture with a beef products supplier owned and operated by the LLC’s 49% owners, who later terminated an exclusive supply agreement entered into by the supplier and the LLC concurrently with the LLC agreement. Prior to the dissolution proceeding, in separate litigation, the minority owners obtained a court order upholding their contention that, upon termination of the supply agreement, they were contractually free to compete against the LLC. Although the LLC agreement made no mention of the supply agreement and contained an integration clause, the supply agreement stated that it was a “condition to” the LLC agreement, and the LLC agreement referenced non-compete covenants that, as Vice Chancellor Noble found, “underscored the importance of the parties’ supply arrangement” which no longer existed.

The court’s opinion noted, on the one hand, the minority owners’ argument for a “broad characterization” of the LLC’s purpose consistent with the “plain language” of the LLC agreement’s purpose clause and, on the other hand, the petitioner’s “contextual interpretation” of the purpose clause “based on the various non-compete and mutual obligations” in the several agreements entered into when the venture was organized.

After noting that the Arrow and Seneca decisions seemingly confine the analysis to the language of the purpose clause, Vice Chancellor Noble nonetheless found more “persuasive” the petitioner’s contextual interpretation that looked “beyond the purpose clause of the LLC Agreement,” explaining as follows:

Despite the integration clause in the LLC Agreement, the entirety of the parties’ agreement . . . demonstrated that [the LLC] was not intended to be a business where [the petitioner] ran all of the operations and distributed profits to Respondents as passive members with an incidental supply contract. . . . Limiting the analysis to the purpose clause of the LLC Agreement would resolve the dispute on a technicality. . . . Fundamentally, the Court looks to the match between the company’s purpose and its reasonable current and future activities. . . . Given that the purpose of [the LLC] was to market and sell natural beef supplied by [the Respondents] according to [petitioner’s] specifications, the Court concludes that it is no longer reasonably practicable to operate [the LLC] in line with this vision. . . . [The LLC] cannot achieve its purpose when Respondents do not believe restrictive covenants apply to them and the Output and Supply Agreement has been terminated. The Court has determined that the purpose of [the LLC] was to operate a “joint venture business” based on a supply and distribution arrangement, but Respondents’ entities no longer provide [the LLC] with cattle.

In case you’re wondering why the 51% managing member had to seek judicial and not voluntary dissolution of the LLC, the LLC agreement expressly provided that the managing member could not cause the LLC “to undertake or engage in . . . the dissolution of the Company.” Another section of the agreement provided that dissolution is mandatory upon “the entry of a decree of judicial dissolution” under the LLC Act. The respondents in Meyer argued that the former provision trumped the latter, but the court disagreed, eschewing what it described as a “strict interpretation of an LLC agreement where the result would be inequitable.”

New York Cases

A pair of New York cases merits attention on the subject of ascertaining the LLC’s purpose.

One of the them, Vella v JP&F Realty Holding, LLC, Short Form Order, Index No. 5545/12 (Sup Ct Nassau County Sept. 28, 2012), which I previously highlighted here, involved an LLC whose operating agreement contained a narrow purpose clause expressly for the acquisition of a specific parcel of realty to house the members’ separate business. The contemplated purchase of the specified realty fell through, after which the LLC acquired a different property to house the separate business without any amendment of the LLC agreement. In the subsequent dissolution proceeding, the petitioner alleged that the stated purpose of the LLC could not be achieved, in response to which the respondents offered a series of documents allegedly authorized by the petitioner in furtherance of the acquisition of the replacement property. The court concluded that discovery and a hearing were required to determine whether it was reasonably practicable to carry on the LLC’s business in conformity with its purpose, i.e., the court did not confine itself to the express terms of the operating agreement’s purpose clause.

The second case, Matter of Natanel, 43 Misc 3d 1217(A) [Sup Ct Kings County 2014], is one I litigated on behalf of a 50% member who petitioned for dissolution of an LLC that, like the one in Vella, was formed by its two members to acquire a building to house their separate operating business. Unlike Vella, the realty LLC had no written operating agreement. After the members’ separate business closed shop, my client petitioned for dissolution of the realty LLC on the ground, among others, that it was no longer serving its specifically intended purpose to house the operating business. The other member contended the realty was acquired not for that specific purpose, but as an investment. Justice Carolyn Demarest’s post-trial decision credited my client’s testimony as to the LLC’s limited purpose and granted dissolution, explaining:

Respondent relies upon his contention that the purpose of [the LLC]   was to provide a vehicle for real estate investment. The statute mandates an examination of the operating agreement or the articles of organization defining the purposes of the LLC to determine whether it is reasonably practicable to continue the business. As noted, however, no operating agreement was ever signed here and the articles of organization fail to recite the purpose of the LLC. While generally, under such circumstances, the LLCL will prescribe the default rules, the statute cannot define the purely contractual basis for forming the LLC so as to permit a determination of whether its purpose is being thwarted by the conflict between the members.

. . . [T]he controlling statute provides for dissolution of the LLC, in the discretion of the court, where the purpose of the LLC can no longer be achieved. The credible, competent evidence is that petitioner and respondent formed [the LLC] exclusively in order to continue to house [the separate operating business]. There is no dispute that [the separate operating business] no longer functions as a business and, indeed, both partners have formed separate businesses in competition with . . . each other. In such circumstances, [the LLC’s] purpose no longer exists and dissolution is appropriate.

There is no single rule to govern the myriad fact patterns in cases such as Meyer, Vella, and Natanel where no operating agreement exists or where post-formation events either bring about a material change in the adverse members’ business relationship or materially deviate from the LLC agreement’s stated purpose. In other words, determining the LLC’s purpose for dissolution purposes, whether stated broadly or narrowly in the LLC agreement or not at all, is highly fact specific, and ultimately the question of dissolution based on inability to achieve the LLC’s purpose is vested in the sound discretion of the court exercising its equitable powers.

  • “In case you’re wondering why the 51% managing member had to seek judicial and not voluntary dissolution of the LLC, the LLC agreement expressly provided that the managing member could not cause the LLC ‘to undertake or engage in . . . the dissolution of the Company.’ Another section of the agreement provided that dissolution is mandatory upon ‘the entry of a decree of judicial dissolution’ under the LLC Act. The respondents in Meyer argued that the former provision trumped the latter, but the court disagreed, eschewing what it described as a “strict interpretation of an LLC agreement where the result would be inequitable.'”

    Interesting. It seems that the first provision is tantamount to a waiver of the right to judicial dissolution by the managing member, not inconsistent with the second provision which would still be relevant to a demand for judicial dissolution by the minority member. In a memorandum decision, the Delaware Chancery Court held that, when the operating agreement contains a waiver of the right to judicial dissolution, the court will not dissolve the LLC “even where it appears manifest that equity requires so.” Huatoco v. Satellite Healthcare, n. 2, available at http://llclawmonitor.wp.lexblogs.com/wp-content/uploads/sites/451/2013/12/601_2013120915128465VCG.pdf. But in Huatoco the waiver applied to all members. Maybe a waiver of the right to seek judicial solution is unenforceable if it applies to only some members but may be enforceable it it applies to everyone?

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    Peter A. Mahler | Farrell Fritz, P.C.
    (212) 687-1230, ext. 150 l pmahler@farrellfritz.com Visit New York Business Divorce Blog http://www.nybusinessdivorce.com Twitter @PeterMahlerEsq PLEASE TAKE NOTICE: The information transmitted is intended only for the person or entity to which it is addressed and may contain confidential and/or privileged material. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information by persons or entities other than the intended recipient is prohibited. If you receive this transmission in error, please contact the sender immediately and delete the material from your computer.