Poorly Drafted Disability Clause in Operating Agreement Provides Novel Defense to LLC Dissolution Proceeding
"You can't dissolve the company, you're crazy!"
That more or less sums up one of the most novel defenses I've ever come across in a dissolution proceeding, in which the respondent 50% member of an LLC argued that the petitioning 50% member could not dissolve the company because he was under a mental disability as defined in the parties' operating agreement. Although the defense ultimately failed in this case, there's a lesson to be learned about the proper drafting of disability clauses in shareholder and operating agreements.
The case is Matter of Swett (Factors Walk, LLC) decided several years ago by Monroe County Commercial Division Justice Kenneth R. Fisher. In 2002, Bradford Swett and W. Curtis Barnes as 50/50 members formed a limited liability company known as Factors Walk, LLC to develop and sell real estate consisting of a 75-acre subdivided tract. The operating agreement vested management in the two members equally. It also appears to have included a provision, not fully described in the court's decision, authorizing a member to precipitate voluntary dissolution simply by giving notice to the other member.
In 2005, Swett gave Barnes the prescribed notice following which he commenced a proceeding for judicial supervision of the winding up of the LLC pursuant to LLC Law Section 703(a). The statute authorizes a member to seek such relief for an LLC that has been dissolved either voluntarily or by judicial decree under LLC Section 702.
Continue Reading...De Facto Dissolution of LLC Does Not Terminate Members' Fiduciary Duty or Avoid Accounting for Subsequent Profits
An important appellate decision handed down earlier this month holds that LLC members' fiduciary duties to each other do not expire upon the de facto termination of the members' business relationship, but, rather, continue until formal voluntary or involuntary dissolution. As a result, members who continue to do business through the old LLC, or who start up a new competing company prior to formal dissolution of the old LLC, must account to the excluded members for pre-dissolution profits.
The case, Matter of Beverwyck Abstract, LLC, 2008 NY Slip Op 06337 (3d Dept July 17, 2008), has its genesis in a business arrangement between the two individual owners of real estate and mortgage brokerage firms (I'll refer to them as the Brokers) and an Attorney who owned a title abstract firm called Gateway Title Agency, LLC. Previously, the Brokers had teamed up with a different attorney to form Beverwyck Abstract, LLC to perform title work, however that attorney soon withdrew from the firm. In September 2001, the Brokers assigned a 49% membership interest in Beverwyck to Gateway, with the understanding that the Brokers' mortgage company would refer title work to Gateway. Beverwyck had no assets at the time and Gateway made no capital contribution. The fees generated by Gateway's title work would belong to Beverwyck and would then be distributed 1/2 to the Brokers and 1/2 to Gateway. At the same time, the Brokers would arrange for the Attorney to act as the bank closing attorney for the Brokers' mortgage company, with those fees being retained by the Attorney.
Court Orders Return of Investment as Equitable Remedy in LLC Dissolution Proceeding
It would be hard to find a business dissolution case with messier facts and thornier legal issues than Tal v. Superior Vending, LLC, 2008 NY Slip Op 51205(U) (June 6, 2008). The 28-page decision by Justice Alan D. Scheinkman of the Westchester County Supreme Court's Commercial Division describes a business relationship between two individuals that arose from friendship and degenerated in bitter acrimony and litigation over the dissolution of a limited liability company that supplied and maintained vending machines. The decision also grapples with a novel remedial problem: After Partner A freezes out Partner B, how does a court equitably liquidate a company whose assets and business have been transferred to another company controlled by Partner A which thereafter acquires additional assets that are commingled with the original assets, thus making it impossible to determine the assets and value of the company being dissolved? Justice Scheinkman's solution -- a money judgment in favor of the frozen-out partner equal to his capital investment plus interest -- is equally novel.
Peter Plotkin started a vending machine business in 1997 called Superior Vending Corp. ("SV Corp.") that reached almost $1 million in gross revenues by 2000 when Arik Tal became his business partner. Tal and his wife had become friends with Plotkin and his wife, and had rented a summer house together. In exchange for a 50% interest in SV Corp., in August 2000 Tal invested $170,000 which was used to acquire the assets of another vending company called Vernon Vending Corp. Tal also guaranteed payment of the $150,000 purchase price balance. In October 2000, Plotkin and Tal formed a new LLC called Superior Vending, LLC ("SV LLC") to which they informally transferred all the assets of SV Corp. Plotkin and Tal both were active in the business. They had no shareholders agreement for SV Corp. and no operating agreement for SV LLC.
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