New York Business Divorce : New York Business Dissolution Lawyer & Attorney : Farrell Fritz Law Firm : Buy-outs, Shareholder Disputes : New York, NY

In April 2008, Westchester County Commercial Division Justice Kenneth W. Rudolph  sua sponte issued an order dismissing the dissolution petition for failure to demonstrate prima facie that UtiliSave is unable to function as intended or failing financially.  Then something unusual happened, as described in the Second Department's decision:

MHS then moved to vacate the order entered April 21, 2008, asserting that, subsequent to the court's denial of the petition for failure to make a prima facie case, it learned that the court lacked subject matter jurisdiction over a proceeding to dissolve a foreign limited liability company.  Desirous of bringing a dissolution proceeding in Delaware, but concerned that it would be bound by the order denying the petition for failure to make a prima facie case, MHS moved to vacate the order entered April 21, 2008, and requested that the proceeding instead be dismissed for lack of subject matter jurisdiction. 

In other words, after losing the case, the petitioner challenged the court's jurisdictional basis to hear its own petition!  Justice Rudolph denied MHS's motion in an August 2008 order, writing as follows:

Having filed an admittedly sparse and factually incorrect pleading, and having filed the petition upon a good faith belief that this Court had subject matter jurisdiction, petitioner's attorneys now contend that this Court has no jurisdiction to dissolve a Delaware limited liability company.  The Court notes that its [prior] decision did not dissolve UtiliSave but dismissed the petition for its failure, prima facie, to demonstrate that UtiliSave was unable to function as intended or failing financially or unable to reasonably operate as a going concern.

MHS's appeal from the two orders contended that, under the Third Department's Rimawi decision and Second Department case law dismissing petitions to dissolve foreign corporations, the court lacked subject matter jurisdiction to entertain a petition to dissolve a foreign LLC.  The respondent countered that any possible limitation on the court's subject matter jurisdiction was never implicated because the court did not actually dissolve the LLC, and that the court's power to dismiss the petition for failure to state a valid claim was within permissible bounds of the internal affairs doctrine.

The Second Department's decision accepted MHS's argument without elaboration and vacated the order dismissing the petition, writing as follows:

A claim for dissolution of a foreign limited liability company is one over which the New York courts lack subject matter jurisdiction (see Rimawi v Atkins, 42 AD3d 799; Matter of Porciello v Sound Moves, 253 AD2d 467; Matter of Warde-McCann v Commex, Ltd., 135 AD2d 541). "[A] court's lack of subject matter jurisdiction is not waivable, but may be [raised] at any stage of the action, and the court may, ex mero motu [on its own motion], at any time, when attention is called to the facts, refuse to proceed further and dismiss the action'" (Matter of Fry v Village of Tarrytown, 89 NY2d 714, 718, quoting Robinson v Oceanic Steam Nav. Co., 112 NY 315, 324).

"A judgment or order issued without subject matter jurisdiction is void, and that defect may be raised at any time and may not be waived" (Editorial Photocolor Archives v Granger Collection, 61 NY2d 517, 523). As such, the order entered April 21, 2008, which denied the petition on the merits is void, the motion to vacate that order should have been granted, and the proceeding must instead be dismissed for lack of subject matter jurisdiction. 

The court's citations to Warde-McCann and Porciello are Second Department rulings from 1987 and 1998, respectively, dismissing dissolution petitions involving New York-based foreign corporations.  Neither one expressly refers to the court's subject matter jurisdiction.  Indeed, Warde-McCann seems to predicate its holding on the internal affairs doctrine which assumes jurisdiction but declines to exercise it in the interests of interstate comity.  The Third Department's Rimawi decision, also cited in the above passage, does state explicitly that New York courts lack subject matter jurisdiction to dissolve foreign LLCs, however, Rimawi's support for the statement consists of citations to Warde-McCann and Porciello.  In addition, Rimawi (but not the MHS decision) expressly acknowledges the First Department's contrary ruling in the Hospital case.

Hospital involved a petition for dissolution of a Delaware corporation based on shareholder dissension under BCL Section 1104(a)(3).  The respondent shareholders successfully moved in the trial court to dismiss the case on the ground of forum non conveniens, based on the corporation's lack of substantial contacts with New York.  The New York Attorney General, undoubtedly sensitive to how courts in sister states might treat dissolution disputes involving New York corporations, also had moved for dismissal of the petition insofar as it sought dissolution, but on the different ground that the court lacked subject matter jurisdiction to dissolve a foreign corporation.  The losing petitioner appealed to the Manhattan-based Appellate Division, First Department.  The Attorney General filed a brief in which it argued that the trial court should have dismissed the dissolution claim based on lack of jurisdiction rather than on forum non conveniens grounds, since the latter assumes the court's subject matter jurisdiction in the first instance.  The First Department's decision upheld the dismissal based on forum non conveniens, adding that the Attorney General's position, "that the courts of New York  lack subject matter jurisdiction to dissolve a foreign corporation" is "without merit."

In the 15 years since Hospital was decided, I'm aware of only one case in which a lower court within the First Department  issued a ruling refusing to dismiss a petition for dissolution of a foreign entity.   So, is there any practical significance here, or is it just an academic exercise to determine the borderline between subject matter jurisdiction and the internal affairs doctrine, where the application of either generally will result in the dismissal of a petition to dissolve a foreign business entity?

It's hard to say.  There are a number of New York cases holding that the court can adjudicate a dissolution dispute involving a foreign entity insofar as it can grant remedies short of dissolution, e.g., a compelled buy-out of a minority shareholder.  Matter of Dohring (CVC Products, Inc.), 142 Misc 2d 429, 537 NYS2d 767 (Monroe County 1989), and Sokol v. Ventures Education Systems Corp., 10 Misc 3d 1055(A) (Sup Ct NY County 2005), are the best known of these cases.  A court that deems itself without subject matter jurisdiction is unlikely to keep the case to consider lesser remedies.

Finally, last March I wrote about a recent New Jersey state court decision in which the court asserted its jurisdiction not only to hear a dissolution petition involving a New Jersey-based Delaware corporation, but also to apply New Jersey's dissolution statute to the Delaware entity.  The contrast in judicial philosophy between that case and HMS could not be starker.

The operating agreements contained no provision for the expulsion or removal of a member-manager.  Ross's claim rested on Article II, Section 7 of the operating agreements providing:

Eric Nelson, Gary Podell and Dean Ross have been elected member managers and shall continue to serve as member managers in accordance with provisions of this Agreement.  In case of any vote for the election of managers all members agree to vote for Eric Nelson, Gary Podell and Dean Ross only.

Section 8 of the same Article provided for election of a new manager by majority vote of the members should there be less than three managers due to "the death, retirement, resignation, or insanity of a manager."  (Note the omission of any forced removal.)

Podell and Nelson argued, and the trial court agreed, that notwithstanding Article II, Section 7, a voting majority of the members could remove a manager under Section 414 of the New York Limited Liability Company Law, entitled "Removal or Replacement of Managers," which states:

Except as provided in the operating agreement, any or all managers of a limited liability  company may be removed or replaced with or without cause by a vote of a majority in interest of the members entitled to vote thereon.

The trial court's decision did not comment directly on the interplay between Article II, Section 7 of the operating agreement and Section 414's default proviso ("Except as otherwise provided in the operating agreement, . . .").  Rather, it held that, in the absence of a specific expulsion provision in the operating agreement, Section 414 authorizes a majority of the members to remove a manager.  The trial court also found that the removal right was "implicit" in the provisions of the operating agreement, specifically, Section 1 of Article VI dealing with dissolution and providing as follows:

This Company shall be dissolved and its affairs wound [sic] upon the first to occur of the following: . . . (c) The bankruptcy, death, expulsion, incapacity or withdrawal of any manager, unless within six months after such an event, this Company is continued and a new manager elected to replace said manager either by vote or written consent of a majority interest of all remaining members.  (Emphasis added.)

Ross appealed.  The three-judge majority wrote a very brief decision in which it disposed of Ross's argument in one paragraph:

The operating agreement under which the parties worked was, by its terms, guided by the Limited Liability Company Law.  Even though the agreement lacked a specific provision for removal of a member-manager, it clearly and unambiguously allowed for same by the language of Article VI, which called for the dissolution of the LLC and its reorganization upon, among other events, the "expulsion" of a member-manager. Lacking a specific mechanism in the operating agreement for such expulsion, the parties relied on § 414 of the Limited Liability Company Law, which allows for removal of a manager by majority vote of the other members.

The dissenters also wrote one, albeit longer paragraph on the issue, in which they concluded that Article II, Section 7 of the operating agreement trumped Section 414 of the LLC Law: 

Limited Liability Company Law § 414 provides for the removal or replacement of any or all managers with or without cause by a vote of a majority in interest of the members entitled to vote thereon, "[e]xcept as provided in the operating agreement." Although the operating agreements in issue do not have a specific expulsion provision, Article III (MEMBERS/MANAGERS) of both agreements sets forth the companies' ownership and management structure and provides, in paragraph 7, that "Eric Nelson, Gary Podell and Dean Ross have been elected member managers and shall continue to serve as member managers in accordance with the provisions of this Agreement. In case of any vote for the election of managers all members agree to vote for Eric Nelson, Gary Podell and Dean Ross only." There is no claim of fraud or mistake in the wording or adoption of the operating agreements, and "[a]bsent some indicia of fraud or other circumstance warranting equitable intervention, it is the duty of a court to enforce rather than reform the bargain struck" (Grace v Nappa, 46 NY2d 560, 565 [1979]). Thus, regardless of the provision in paragraph 1 of Article VI (DISSOLUTION) that the companies would be dissolved upon, inter alia, the "bankruptcy, death, expulsion, incapacity or withdrawal of any manager," since the members were obliged to vote for the three named persons in "any" election of managers, their vote to expel plaintiff from both companies and replace him with his brother was contrary to the plain and unambiguous language of the agreements. Therefore, plaintiff is entitled to a declaration that his removal from office was invalid, and to reinstatement of his second cause of action for breach of the operating agreements.

The majority responds to the dissent in a footnote, stating that the dissent's argument, "that Article III controls would compel us to view that Article in a vacuum, dismissing the significance, if not the actual presence, of Article VI and thereby ignoring the need to read the agreement as a whole."  (Don't be confused by the appellate court's reference to Article III, Section 7; it's the same provision referred to as Article II, Section 7 in the trial court's decision.)

The good news for LLC governance aficionados is that, under New York rules of appellate procedure, the 3-2 vote gives Ross an appeal as of right to New York's highest court, the New York Court of Appeals.  Let's hope Ross takes the trip to Albany.

Whether he does or not, and though I'm attracted to the logic of the dissent, it's not clear to me that Ross v. Nelson will have much practical impact:

• Ross gives rise to no broad pronouncements of law.  At bottom it is an ordinary contract construction case involving a peculiar operating agreement, with one side (the majority) giving force to the word "expulsion" in the dissolution article and the other side (the dissenters) discounting it.
• In my experience, most operating agreements for LLCs with active member-managers include super-majority or unanimity or stiff for-cause requirements that protect member-managers from removal at will by a majority in interest of the members.
• The operating agreements in Ross were written before the 1999 amendment to Section 701(b) of the LLC Law, which reversed the prior default rule under which an LLC would dissolve automatically upon the death, retirement, resignation, expulsion, bankruptcy  or  dissolution of a member unless the remaining members opted to continue it.  Article VI, Section 1 of the operating agreements in Ross appears to have been patterned on the language of pre-amendment Section 701(b) except for the substitution of the word "manager" for "member."  I'd be surprised if many post-amendment operating agreements use such language.
• Finally, the removal of Ross as a manager did not affect his status and rights as a member of the LLCs.

The death of a partner in a general partnership triggers rights and obligations spelled out in the New York Partnership Law.  Under Partnership Law Section 62, absent an agreement to the contrary, the death of a partner is an event of dissolution of the partnership.  Under Partnership Law Section 73, when a partner dies (or retires) and the remaining partner or partners opt to continue the business rather than dissolve the partnership and settle the partner accounts, the deceased partner's legal representative is entitled to be paid "as an ordinary creditor an amount equal to the value of his interest in the dissolved partnership" to be ascertained as of the date of dissolution.

In other words, when the uncle and the other remaining partners continued the real estate businesses after Susan Vick's death without winding up and settling accounts, they became obligated to pay her estate the "value" of her partnership interest plus, at the estate's option, interest on that amount or the interim profits attributable to the use of Susan Vick's rights to the use of the property of the dissolved partnership.

The appeal in Vick followed a nonjury trial at which the judge valued Vick's interests in two of the partnerships.  Her 20% interest in one of the partnerships was valued around $1.2 million.  Her 9% interest in the other was valued around $170,000.

A number of issues were raised by both sides on the appeal.  The one of interest here is the uncle's contention that the trial court improperly refused to discount the values of Susan Vick's partnership interests for lack of control and for lack of marketability.

The discount for lack of control ("DLOC"), also referred to as the minority discount, is an amount or percentage deducted from the pro rata share of value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control.  The discount for lack of marketability ("DLOM") is an amount or percentage deducted from the value of an ownership interest to reflect the absence of marketability compared to publicly traded investments.  Depending on the business and assets involved, combined reductions for DLOC and DLOM can top 50% of the pro rata value of the enterprise, hence at trial they are often the subject of high stakes duels between the opposing appraisal experts whose opinions require significant judgment calls a/k/a art.  (For those who want to learn more about the basics of valuation discounts, a good resource is the IRS's Valuation Training for Appeals Officers Coursebook.  The section on DLOC and DLOM is on pages 94-99.)

The trial court in Vick ruled that DLOC and DLOM are barred by Section 73's requirement for payment of the value of the deceased partner's interest to the estate "as an ordinary creditor".  The appellate court sided with the uncle and disagreed with the trial court, holding that this language does not address valuation but, rather, "the method of collecting the value of the deceased partner's interest vis-a-vis creditors of the partnership and of the individual partners". 

The children also lost their argument based on provisions in the Business Corporation Law (BCL) including "fair value" buyouts under BCL Sections 623 and 1118.  Here's what the court said:

Nor, contrary to plaintiffs' contention, does the buyout of a deceased partner's interest implicate all of the factors that our courts have relied upon in denying discounts in the corporate minority or dissenting shareholder contexts (see Matter of Penepent Corp., 96 NY2d 186, 194 [2001]; Matter of Friedman v Beway Realty Corp., 87 NY2d 161, 167, 169-170 [1995]). A partnership minority discount would not contravene the distinctly corporate statutory proscription (Business Corporation Law § 501 [c]) against treating holders of the same class of stock differently, or undermine the remedial goal of the appraisal statutes to protect shareholders from being forced to sell at unfair values, or inevitably encourage oppressive majority conduct. Nor would a decreased marketability discount implicate these policy concerns, as it applies equally to all partnership interests, not those of the deceased partner only (see Matter of Blake v Blake Agency, 107 AD2d 139, 149 [1985], lv denied 65 NY2d 609 [1985];see also Matter of Fleischer, 107 AD2d 97, 101 [1985]; Hall v King, 177 Misc 2d 126, 134-135 [1998]).

The uncle's victories on these points proved Pyrrhic, however, because in the end the appellate court upheld the non-discounted award based on several other factors.  As I read the opinion, (1) the deceased partner's estate should not be financially penalized by the surviving partners' choice either to wind up the business or continue it; (2) real estate holding companies are poor candidates for discounts; and (3) you can't fault a partner for causing dissolution by dying.  Read it for yourself and decide:

[A]pplication of the discounts sought by defendants would deprive plaintiffs of the value of the decedent's proportionate interest in a going concern, since they would not receive what they would have received had the entire entity been sold on the open market unaffected by a diminution in value as a result of a forced sale (see East Park Ltd. Partnership v Larkin, 167 Md App 599, 619-620, 893 A2d 1219, 1231 [2006], cert denied 393 Md 243, 900 A2d 749 [2006]; Winn v Winn Enters., Ltd. Partnership, 100 Ark App 134, —, — SW3d —, —, 2007 Ark App LEXIS 693, *10-11 [Ct App 2007]). The unavailability of the discounts is particularly apt here, where the business consists of nothing more than ownership of real estate (see Cohen v Cohen, 279 AD2d 599 [2001]; Matter of Cinque v Largo Enters. of Suffolk County, 212 AD2d 608 [1995]; East Park, 167 Md App at 610, 893 A2d at 1226 [fair value of partnership interest equals amount partners would receive if property sold at arm's length]), and where the valuation ensues from the death of a partner and not as the result of any misconduct of a withdrawing partner in causing dissolution (cf. Anastos v Sable, 443 Mass 146, 150-151, 819 NE2d 587, 591 [2004]). In this regard, we note that Haymes v Haymes (298 AD2d 117, 119 [2002], lv denied 100 NY2d 509 [2003]), in which we applied minority interest and decreased marketability discounts to the valuation of partnership interests in an equitable distribution matter, should not be understood as an imprimatur on such discounts as a matter of law, but only as addressing the trial court's resolution of a conflict in expert testimony, and is therefore limited to its particular facts.

There's an awful lot going on in that one paragraph, enough to justify a separate article on each sentence.  For now, I'll sum up as follows:

• Vick neither requires nor forbids application of DLOC and DLOM in determining the "value" of partnership interests under Partnership Law Section 73.  Perhaps it can be said that Vick places the burden on the remaining partners to justify the discounts.  Compare this to "fair value" determinations under BCL Sections 623 and 1118 where the case law makes clear that DLOC is prohibited but DLOM is generally to be applied absent exceptional circumstances.  Also compare it to the valuation of business interests in equitable distribution proceedings under the Domestic Relations Law where the standard is "fair market value" and both DLOC and DLOM are generally to be applied absent exceptional circumstances.  Confused?  You should be.
• One of the factors the Vick court relies on is that the valuation ensued from the death of a partner and not because of wrongful misconduct by a withdrawing partner.  Remember, Section 73 also deals with a partner who retires, not just with deceased partners.  Vick therefore gives added incentive to the remaining partners to argue wrongful withdrawal in the case of a retired partner.
• The court's citation to Cinque v Largo Enterprises is curious considering that, in a case called Hall v. King decided in 1999, the First Department affirmed a valuation decision that explicitly refused to follow Cinque, which is a Second Department case holding that DLOM only applies to good will value.  Making matters more confounding, in the paragraph that precedes the citation to Cinque, the Vick court cites with approval -- you guessed it -- Hall v. King.  Oh well, as Ralph Waldo Emerson wrote in his essay, Self-Reliance, "A foolish consistency is the hobgoblin of little minds".