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.
Roundup of 2007 Business Divorce Cases
The New York Law Journal recently published, for the 9th consecutive year, my annual review of business divorce cases (read it here). Most of the cases discussed in the article have been mentioned in previous postings.
Here's a rundown of the article's choices for 2007's most interesting business divorce cases, with links provided to the cases and to previous postings:
- Dissolution and Right of First Refusal: Matter of Schneck (R&J Components Corp.) (discussed here) and Matter of Schwimmer (El-Roh Realty Corp.), where two judges reached opposite results on the issue of whether the petitioner's filing of a dissolution petition triggered a right of first refusal and mandatory buyback under the shareholders' agreement.
- LLCs and Temporary Receivers: At the Airport, LLC v. Isata, LLC (discussed here) in which the court held that the LLC Law does not authorize the court to appoint a temporary receiver until after dissolution is ordered.
- Grounds for Dissolution: Matter of Cheung (Ho Foong Shiu Realty Corp.) and Matter of Livolsi (111 Glen Street Corp.) (discussed here) in both of which the courts denied dissolution petitions brought by 50% shareholders claiming oppression by the other shareholder.
- Restrictive Covenants: Matter of Autz (Ronald C. Fagan, M.D. and Arthur Lutz, M.D., P.C.) (discussed here) where the court ruled that the sale in liquidation of the company's good will is a sale "under compulsion" and therefore does not trigger an implied covenant not to solicit customers.
- Pre-Conversion Agreements: Matter of Hochberg (Manhattan Pediatric Dental Group, P.C.) (discussed here) in which the court compelled arbitration of a dissolution case under an arbitration clause in a partnership agreement that pre-dated the conversion of the business to a professional corporation.
- Partner Limited Liability Shield: Ederer v. Gursky (discussed here) where New York's top court interpreted Section 26(b) of the Partnership Law as not shielding partners in limited liability partnerships from personal liability against claims for breach of the partnership's or partners' obligations to each other.
If you'd like to read some of my previously published annual reviews, look under Links on the right sidebar of this blog's home page where you'll find links to my articles covering the years 2003 through 2006.
Next week, New York Business Divorce returns to Anatomy of a Dissolution Slugfest, Part III.
Anatomy of a Dissolution Slugfest: Part II
This is the second in a series of postings on a multi-faceted corporate dissolution battle waged in Nassau County Supreme Court called Matter of Marciano (Champion Motor Group, Inc.) involving three partners and a luxury automobile dealership.
Part I of the series (read it here) summarized the basic facts and discussed the defendants’ initial challenge to the plaintiff Marciano’s standing to seek dissolution. The court’s decision identified evidence suggesting that, as the defendants’ argued, the plaintiff deliberately elected not to have his alleged 38% ownership interest reflected in the corporate records or in tax filings. Ultimately, however, the court refused to dismiss the case because of the disputed facts surrounding the issue of plaintiff’s share ownership.
In this Part II, we examine the several other issues of interest addressed by Justice Ira Warshawsky in his initial decision in the case dated September 5, 2006.
1. Defendants’ argument that their exclusion of plaintiff from the business was reasonable following his indictment for stock fraud.
The majority owner defendants contended that, even assuming plaintiff Marciano could establish his ownership percentage in Champion above the minimum 20% required by the dissolution statute (BCL § 1104-a), their decision to exclude him from any involvement in the business, following his criminal indictment for stock fraud in December 2004, was reasonable as a matter of law.
As with the issue of stock ownership, Justice Warshawsky concluded that the reasonableness of defendants’ exclusionary actions "must await further factual development through discovery in the underlying action". The defendants’ evidence of damaging repercussions and concrete economic injury to the business from Marciano’s indictment, the court found, was "anecdotal" and lacked "determinative foundational support in the record".
Continue Reading...Dissolution and the 50% Shareholder
In the judicial dissolution arena, one of the trickiest decisions faced by counsel representing a 50% shareholder of a closely held New York corporation is whether to ask for dissolution based on deadlock under Section 1104 of the Business Corporation Law (BCL), or based on allegations that the other 50% shareholder is guilty of illegal, fraudulent or oppressive conduct or has looted, wasted or diverted corporate assets under BCL Section 1104-a, or under both statutes.
The choice can have a dramatic effect on the outcome of the proceedings, not just because of the different proofs required, but because only one of the statutes – BCL Section 1104-a – triggers the other shareholder’s right to avoid dissolution by electing to purchase for “fair value” the shares of the petitioning shareholder. (See previous post on the subject.)
In many business divorce cases involving two 50% shareholders there nonetheless is one natural buyer and one natural seller. Sometimes it’s because one of the two controls more of the client relationships. Sometimes it’s because one of the two personally or through a separate company owns the realty leased by the co-owned company. Sometimes it’s because one of the two has far deeper pockets. In these situations, the 50% shareholder who wants out and his or her counsel must think long and hard about whether they gain or lose bargaining leverage by handing the opposing shareholder the right to force a buyout. In my experience, a deadlock petition under BCL Section 1104 usually packs a bigger wallop than an 1104-a petition by denying the automatic buyout and thereby putting added pressure on the shareholder who may be more motivated to keep the company as a going concern.
Here’s a recent case where things took a different and unhappier direction for the petitioning 50% Shareholder A who sought dissolution under BCL Section 1104-a alleging that he was frozen out by 50% Shareholder B. The case involved a real estate holding company that leased the property to a separate business solely owned by Shareholder B. The troubles started when Shareholder A’s employment with the tenant business terminated. The court denied Shareholder A’s application to dissolve upon finding no evidence of oppression, looting or other misconduct by Shareholder B.
Would Shareholder A have done better seeking deadlock dissolution under Section 1104? It’s hard to say without knowing more facts. Establishing deadlock in a relatively passive real estate holding company can pose a challenge. The fact that he did proceed under Section 1104-a suggests that he made a losing bet that Shareholder B would elect to purchase his shares. One also can speculate that the lease held by Shareholder B’s separate company was of the sweetheart variety, thereby taking away some measure of Shareholder B’s incentive to opt for a buyout.
The case, Matter of Livolsi (111 Glen Street Corp.), 2007 NY Slip Op 32911 (U) (Sup Ct Nassau County Sept. 13, 2007), was decided by Justice Stephen A. Bucaria of the Nassau County Supreme Court, Commercial Division.
Be Aware of Differences Between LLC and Corporation Dissolution
Judicial dissolution of a New York limited liability company (LLC) is governed by Section 702 of the LLC Law (LLCL), whereas judicial dissolution of a closely held business corporation is governed by Article 11 of the Business Corporation Law (BCL). Under Section 702, a court may order LLC dissolution “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” That’s it. No more.
Article 11 of the BCL is more expansive. Section 1104(a) authorizes a petition for judicial dissolution by a 50% shareholder based on various deadlock scenarios. Section 1104-a permits judicial dissolution at the behest of an “oppressed” minority shareholder or where the controlling shareholders divert or waste company assets or otherwise are guilty of illegal or fraudulent actions toward the other shareholders.
Depending on the provisions of the LLC operating agreement, conduct that would constitute grounds for dissolution under Article 11 of the BCL also may constitute grounds under LLCL Section 702. But not always, as one minority member of an LLC recently found out when the court dismissed his request for judicial dissolution. According to the court’s decision, the minority member alleged that the majority members engaged in “illegal, fraudulent and oppressive conduct” – terms that are lifted right out of BCL Section 1104-a. The court ruled that “[w]hile such allegations are grounds for dissolution under [BCL] § 1104-a, they are not grounds for dissolution of a limited liability company”. The case, Bonanni v. Horizons Investors Corp., was decided by Justice Elizabeth Hazlitt Emerson of the Suffolk County Supreme Court, Commercial Division.
The lesson is clear: A complaint or petition for dissolution of an LLC should reflect Section 702’s provisions by alleging a genuine conflict between, on the one hand, the adverse member’s alleged misconduct or other conditions warranting dissolution and, on the other hand, the terms of the operating agreement or articles of organization.
