Statute Constrains Commissions for Court-Appointed Receivers in Corporate Dissolution Proceedings
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A decision this month by the Albany-based Appellate Division, Third Department, in Matter of Eklund Farm Machinery, Inc., 2010 NY Slip Op 04097 (3d Dept May 13, 2010), spotlights anew the inadequate statutory compensation scheme governing court-appointed receivers in corporate dissolution proceedings.
Section 1113 of the Business Corporation Law (BCL) authorizes the court to appoint a receiver at any stage of a dissolution proceeding. When appointed prior to an order of dissolution, the receiver's role is to preserve corporate assets and to rescue the business from a controlling shareholder's mismanagement or from the paralysis of deadlock between two 50% owners. If the court orders dissolution, the receiver is charged with winding up the business, liquidating its assets, discharging its liabilities, and distributing the remainder to the shareholders.
BCL Article 12 lays out a comprehensive scheme governing the powers and duties of corporation receivers. Section 1217 specifies the receiver's entitlement to commissions for his or her services using a sliding scale of percentages of "the sums received and disbursed." The scale is 5% on the first $20,000; 2.5% on the next $80,000; and 1% on the remainder. Note how stingy the rate is compared to the straight 5% commission authorized by § 8004(a) of the Civil Practice Law and Rules (CPLR) which applies to receivers appointed under CPLR Article 64 including, for example, receivers appointed in mortgage foreclosure proceedings.
The Eklund case involved a protracted corporate dissolution of a family-owned business for which the trial court appointed a receiver. In 2007, the trial court's order granting dissolution was affirmed on appeal. The dissolution proceeding then settled, making a sale of the corporation's assets unnecessary. The receiver had made two prior, interim applications for commissions which were awarded without opposition, in which his commissions were calculated by applying § 1217's percentage scale twice, to both the sums received and again to those disbursed by the receiver.
Following settlement the receiver submitted a final application for commissions based upon transactions that occurred after his prior applications, using the same calculation method. This time the parties objected, arguing that the receiver used an incorrect calculation method and seeking to recalculate and modify the prior, interim commission awards. The trial court refused to modify the prior awards based on the parties' failure to object timely, but it agreed that the final commissions must be computed by applying the statutory percentages only once to the sums that passed through the receiver's hands since the interim awards.
On the receiver's appeal to the Appellate Division, Third Department, the court confronted the issue whether § 1217's reference to commissions on "sums received and disbursed" (emphasis added) permits an aggregate award of commissions on sums received plus commissions on sums disbursed, or requires the court to apply the percentage only once to the sums that pass through the receiver's hands. The court agreed with the trial court's single-calculation interpretation, commenting as follows:
Although we have not previously considered this specific question of whether Business Corporation Law § 1217(a) authorizes awards of commissions calculated upon both the "sums received and disbursed," we note the interpretations given by other courts to the similar language in CPLR 8004 (see Eastrich Multiple Inv. Fund v Citiwide Dev. Assoc., 218 AD2d 43, 44 [1996]; Coronet Capital Co. v Spodek, 202 AD2d 20, 26-27 [1994]; People v Abbott Manor Nursing Home, 112 AD2d 40, 41 [1985]), and we read the statute here as contemplating that the commission paid to a receiver will be the statutory percentage of the amount that has been both collected and disbursed. That is, "a commission is due upon the total amount which passes through the receiver's hands" (Matter of Jakubowicz v A.C. Green Elec. Contrs., Inc., 25 AD3d 146, 150 [2005] [internal quotation marks and citation omitted]). Accordingly, we conclude that Supreme Court did not err in . . . granting commissions based upon the total amount that passed through the receiver's hands.
The decision does not describe the receiver's services, the hours he devoted, or the amounts collected and disbursed, so it's hard to know whether or to what extent the receiver's award -- before or after it's halving by the court -- constitutes reasonable compensation. What is known is that, had the case not settled, and had the receiver gone forward with liquidation, the sums upon which his commissions would have been computed would have included substantial proceeds from the sale of assets. Considering that the receiver's temporary stewardship of the corporation likely contributed to its preservation and to the ultimate settlement that permitted the parties to avoid liquidation, it certainly can be argued that the receiver effectively was penalized financially for doing a good job.
This point was driven home even more forcefully in the Jakubowicz case cited in the above-quoted passage. Jakubowicz also involved a protracted dissolution proceeding which was settled shortly before the judicial sale of the corporation's properties including realty valued between $12 million and $20 million. The court-appointed receiver, who was an attorney, devoted 300 hours over an 11-month period including conducting the mediation that resulted in the settlement. The amount received and disbursed by him totaled about $380,000 which, applying § 1217's percentages, resulted in commissions less than $5,800, or about $19 per hour.
The receiver unsuccessfully asked the trial court to award him an additional $150,000 based on 1% of the value of the corporation's real properties which he valued at $15 million. On the receiver's subsequent appeal, the Manhattan appeals court reluctantly agreed with the lower court, stating that § 1217 is subject to "strict construction," that the statute does not authorize commissions on the value of property owned but not sold by the corporation, and that the payment of commissions in excess of the statutory rate is "contrary to its plain meaning." The court's opinion commends the receiver's successful mediation efforts and notes that § 1217 discourages a receiver from assisting with settlement by tying commissions solely to sums received and disbursed. In the court's own words:
Although we are required to give literal application to the provisions of Business Corporation Law § 1217, we cannot detract from the value of the services rendered by the receiver, which were applauded by Supreme Court and acknowledged, albeit reluctantly, by the parties. The statutory reimbursement scheme contemplates the actual dissolution of the corporation and the distribution of corporate assets by the receiver; it does not address the situation where dissolution is avoided. In this case, the receiver was able to extract a negotiated settlement and so preserve, more effectively than by means of a judicial sale, the value of the corporate assets for the share owners. This outcome is favorable both to the parties and to the court. As a matter of policy, settlement is favored as a means of facilitating the resolution of disputes and preserving judicial resources (see Mitchell v New York Hosp., 61 NY2d 208, 214 [1984]; Matter of Hofmann, 287 AD2d 119 [2001]). These salutary purposes will not be promoted by a compensation provision that dissuades a receiver from attempting to settle a dispute between share owners in order to preserve his entitlement to an adequate commission for the services he has rendered.
In sum, the remedy lies not with the courts but with the Legislature. We strongly urge that consideration be given to amending Business Corporation Law § 1217 to afford a court discretion to fix a receiver's commission based upon the value of the services rendered in those cases where, as here, dissolution and the consequent disposition of corporate property are not effectuated (particularly as the result of a negotiated settlement), subject to limitation by reference to a percentage of the total assets administered.
I know first hand the importance of finding an experienced, qualified receiver to take charge of a dysfunctional business in the throes of dissolution litigation. I also know that most of these cases -- at least the ones involving businesses with going concern value -- eventually result in a buyout settlement which, as in Eklund and Jakubowicz, can substantially reduce the prospects for receiver compensation. This undoubtedly deters many qualified attorneys and other professionals from taking on receivership assignments. It is unfortunate that the Jakubowicz court's plea for legislative amendment seems to have fallen on deaf ears in our state capitol.
Appellate Rulings Clash Over Subject Matter Jurisdiction to Dissolve Foreign Business Entities
The Appellate Division, Second Department, last week issued a decision in a dissolution proceeding involving a New York-based Delaware limited liability company (LLC) in which it broadly pronounced that New York courts lack subject matter jurisdiction in such cases. The decision in Matter of HMS Venture Management Corp. (UtiliSave, LLC), 2009 NY Slip Op 04906 (2d Dept June 9, 2009), agrees with an appellate ruling two years earlier by the Third Department, also involving the requested dissolution of a Delaware LLC, in Rimawi v. Atkins, 42 AD2d 799, 840 NYS2d 217 (3d Dept 2007).
HMS and Rimawi both rely on precedents in which New York courts dismissed petitions seeking dissolution of foreign business corporations based on the hoary internal affairs doctrine under which courts traditionally declined to exercise jurisdiction where the determination of the rights of the litigants involves regulation and management of the internal affairs of a foreign corporation. What makes things particularly interesting, however, is a 1994 appellate decision by the Manhattan-based First Department, in Matter of Hospital Diagnostic Equipment Corp., 205 AD2d 459, 613 NYS2d 884 (1st Dept 1994), where that court expressly rejected the argument, made by no less a personage than the state Attorney General, that New York courts lack subject matter jurisdiction to dissolve foreign corporations.
Let's first look at HMS. The subject Delaware LLC, called UtiliSave, operates in New Rochelle, New York, where it audits utility bills and usage of corporate clients. Its only connection to Delaware is its legal formation there. In 2007, 40% member and co-manager MHS Venture filed a petition to dissolve UtiliSave in Westchester County Supreme Court. Its petition sought dissolution under the terms of the operating agreement, allegedly based on the company's failure to make certain distributions, and on the statutory ground that it was no longer reasonably practicable to carry on the business in conformity with the operating agreement. It's unclear whether the petition invoked statutory dissolution under Section 702 of the New York LLC Law or under Section 18-802 of the Delaware LLC Act or both.
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.
Court Enjoins "Squeeze-Out" Capital Call by Controlling Members of LLC
Baseball has the squeeze play. Majority owners of closely held companies have the squeeze out. It's only fitting, then, that I refer to what happened in the recently decided case, Cooperstown Capital, LLC v. Patton, 2009 NY Slip Op 02277 (3d Dept Mar. 26, 2009), involving a dispute between majority and minority owners of a baseball camp, as the "squeeze-out play."
Martin and Brenda Patton owned land in upstate New York about 20 miles from the Baseball Hall of Fame in Cooperstown. In 2004, they entered into agreements with Cooperstown Capital, LLC to build and operate a baseball camp and hotel on the Patton land. The Pattons contributed the land to Abner Doubleday, LLC ("Abner") in exchange for 35% membership interests in Abner and a second company formed to operate the baseball camp, called Cooperstown All Star Village, LLC ("CASV"). Cooperstown Capital paid $400,000 and gave a $1 million promissory note for 35% interests in the two companies. A third investor, Marco Lionetti, acquired the remaining 30% interests.
The $1 million promissory note was made payable to the Pattons, but the operating agreements designated the payments as operating expenses of the companies and treated Cooperstown Capital's additional capital contributions as credits against the Patton note.
The baseball camp opened under the name Cooperstown All Star Village, but relations among the owners soon deteriorated over various financial disputes which erupted in a pair of lawsuits centering on Cooperstown Capital's obligations for capital contributions and payments on the Patton note. In December 2007, in a suit commenced by the Pattons against Cooperstown Capital demanding payment of the note, the Appellate Division, Third Department, upheld the denial of the Pattons' summary judgment motion, stating that "[b]ecause the note requires defendants to pay, but the operating agreements include payments under the note as operating expenses of Abner and CASV, questions of fact exist concerning the breach of the agreements and the amount, if any, due under the note." (Read decision here.)
Now comes the "squeeze-out play." Apparently not content to await trial, in February 2008, the Pattons with the support of the other 30% member, Lionetti, called a meeting of Abner's members to vote upon and approve a capital call upon Cooperstown Capital alone, demanding that it contribute over $450,000 for operating expenses consisting of amounts allegedly due under the Patton note. Under Abner's operating agreement, the other members may make a capital contribution if a requested party fails to do so, and such action is treated as a loan for a period of 90 days. Thereafter, if the loan is not repaid, the defaulting member's interest may be decreased and the contributing member's interest increased accordingly.
Cooperstown Capital quickly sought to enjoin implementation of the February 2008 capital call, contending that when it refused to make the demanded contribution, the Pattons purported to loan Abner the funds (to pay themselves) and were threatening to dilute Cooperstown Capital's membership interest so as to give the Pattons absolute control of the business.
LLC member disputes usually turn on the express provisions of the operating agreement, and Cooperstown is no exception. Section 5.2 of Abner's operating agreement governing additional capital contributions provides:
The Members shall contribute such additional capital on a pro rata basis in proportion to their respective "Membership Interests", as hereinafter set forth in Section 6 hereof, as such amount is determined in good faith by the consent of Members holding a majority in interest.
In support of its injunction application, Cooperstown Capital argued that Section 5.2 does not authorize a selective capital call upon one member, and that by diluting its membership interest the Pattons effectively would wrest over two-thirds control of the LLC giving them the unchecked power to sell major LLC assets and dissolve the LLC. In a Memorandum Decision and Order dated April 21, 2008, Oneonta County Supreme Court Justice Kevin M. Dowd agreed with Cooperstown Capital and granted the injunction, stating:
Plaintiff has shown a probability of success on the merits. The operating agreement for Abner states in Section 5.2, "The Members shall contribute such additional capital on a pro rata basis in proportion to their respective 'Membership Interest,'…" Section 5.8 further states that in determining the amount of any additional capital contribution the members shall consider all the operating expenses. Operating expenses are defined by Section 13.13 of the Operating Agreement to include payments of principal and interest due under the Patton notes. Based upon these sections, there appears to be no basis to make a capital call on Plaintiff alone.
The Pattons appealed, arguing that the injunction was inconsistent with the Third Department's December 2007 decision in which it found questions of fact concerning whether Abner and CASV or Cooperstown Capital was obligated to pay the Patton note. In its March 26, 2009 opinion, the appellate court rejected this argument and upheld the injunction, writing:
While both Supreme Court and this Court previously determined that questions of fact preclude summary judgment in the parties' related case (Patton v Ferrara, 46 AD3d at 1205), plaintiff has still established a likelihood of success here. Abner's operating agreement permits capital calls, but specifies that the "[m]embers shall contribute such additional capital on a pro rata basis in proportion to their respective '[m]embership [i]nterests.'" Under the operating agreement and the promissory notes, the Patton notes are payable as operating expenses of Abner and CASV rather than the individual members, and capital calls "shall" be shared pro rata by the "members" plural. Hence, despite questions of fact, it is at least likely that plaintiff will succeed in proving the impropriety of Abner's notice requiring a capital contribution only from plaintiff to pay the Patton note.
An opportunity for defendants to shift the balance of power and wrest complete control over the company can constitute irreparable injury (see Vanderminden v Vanderminden, 226 AD2d 1037, 1041 [1996]; Casita, LP v Maplewood Equity Partners [Offshore] Ltd., 17 Misc 3d 1137A, *8 [2007]; see also Matter of Brenner v Hart Sys., 114 AD2d 363, 366 [1985]). If plaintiff does not pay the capital contribution, the operating agreement permits the remaining members to meet the capital contribution on plaintiff's behalf as a loan, then repay the loan with plaintiff's equity interests in Abner. In that scenario, plaintiff would lose not only its shares of Abner, but also its ability to block certain actions which require a two-thirds vote. Those actions include selling major LLC assets and dissolving the LLC. The possibility of plaintiff losing any real say in Abner, as opposed to maintaining the status quo where defendants suffer no actual harm, suggests that the equities balance in plaintiff's favor. Thus, Supreme Court did not abuse its discretion in granting the preliminary injunction (see Matter of Kalichman, 31 AD3d 1066, 1067 [2006]).
The occasional need for additional capital contributions is a fact of life for many closely held businesses. A business organized as a New York limited liability company must pay attention to Section 502 of the LLC Law which sets forth certain default rules surrounding member liability for contributions. Section 502 does not, however, mandate any consequences to the membership interest of the defaulting member, leaving this entirely to the operating agreement. Here's what it says in Section 502(c):
The operating agreement may provide that the membership interest of any member who fails to make any required contribution shall be subject to specified consequences of such failure. Such consequences may include, but are not limited to, reduction or elimination of the defaulting member's interest, subordination of the defaulting member's interest to that of nondefaulting members, a forced sale of the defaulting member's interest, forfeiture of the defaulting member's interest, the lending by the other members of the amount necessary to meet the defaulting member's commitment, a fixing of the value of the defaulting member's interest by appraisal or by formula and redemption or sale of such member's interest at such value, or other consequences
In other words, if the operating agreement does not expressly authorize dilution, forfeiture, or other adverse consequences to the non-contributing member's interest, the LLC has no immediate recourse beyond seeking to enforce the payment obligation. This was not the problem for the Pattons in Cooperstown. Rather, their problem was adopting a selective capital call designed to bring down the operating agreement's "hammer" provisions upon only one member, contrary to the operating agreement's pro rata formula for additional member contributions.
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, 53 AD3d 903 (3d Dept 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.
This arrangement worked for nearly two years until a flood of mortgage refinancings referred by the mortgage company exceeded Gateway's capacity, at which point the mortgage company stopped assigning mortgage closing work to the Attorney. The tensions grew, culminating in a February 17, 2003 meeting of the Brokers and the Attorney at which they orally agreed that Gateway and the Attorney would no longer perform title work for Beverwyck. The Brokers sent the Attorney draft forms for her to execute assigning Gateway's interest in Beverwyck back to the Brokers effective April 1, 2003, but she never signed them. For the balance of 2003, the Brokers continued to operate Beverwyck without Gateway, employing the title services of the same attorney who had been one of Beverwyck's original members before dropping out. In early 2004, the Brokers and this other attorney formed a new company under the name Beverwyck Abstract & Settlement Co., LLC, to perform title work referred by the Brokers' mortgage company.
The Brokers and Gateway ultimately could not reach agreement regarding the winding up of Beverwyck's business. In late 2003, the Brokers commenced a proceeding for judicial dissolution of Beverwyck. The court conducted a two-day bench trial in March 2005, and granted dissolution by order dated May 26, 2005. The court also ordered the parties to prepare final accountings. The two resulting accountings differed by approximately $155,000 based on the use of different accounting periods. The higher number in Gateway's accounting included the entire period following the February 17, 2003 meeting through the formal dissolution on May 26, 2005, whereas the Brokers' accounting stopped March 31, 2003 (the end of the quarter closest in time to the meeting).
The Brokers asked the trial court to determine the date of dissolution for accounting purposes. The Brokers contended that a de facto dissolution occurred at or shortly after the February 17, 2003 meeting by reason of the parties' agreement that Gateway would no longer provide title work for Beverwyck. They argued by analogy to partnership cases in which courts have found from circumstantial proof of the ending of a business relationship the termination of the partnership and concurrent cessation of the partners' fiduciary duties. In a decision dated July 11, 2007 (2007 NY Slip Op 52620[U]), Albany County Commercial Division Justice Richard M. Platkin ruled against the Brokers on the ground that "Beverwyck's operating agreement spells out unequivocally the circumstances under which the LLC will be dissolved," and that there had been no written agreement or vote taken to dissolve the company as the operating agreement required to effectuate voluntary dissolution. As Justice Platkin elaborated:
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Since the members had bound themselves by the terms of their operating agreement, the mere cessation of referrals from [the Broker's mortgage company] to Beverwyck or the bare assertion by [the Brokers] that the company was no longer in existence was insufficient to dissolve the LLC or to relieve [the Brokers] of their fiduciary duties to the organization, since such eventualities were not listed as terminating events in the parties' operating agreement.
The Brokers appealed the decision. Their appellate brief (read it here) pressed the argument for application to LLCs of partnership law principles whereby the partner relation and associated fiduciary duties terminate upon the declared intention of a partner to withdraw from the partnership. They argued that such intention to withdraw was further evidenced by the Attorney's e-mail sent to the Brokers after the February 17, 2003 meeting in which she referred to the parties' "decision to terminate our business relationship" and "our decision to go our separate ways." Gateway's opposing appellate brief (read it here) argued that partnership withdrawal and dissolution rules do not apply to LLCs, and that the trial court correctly applied contract principles in enforcing the provisions of Beverwyck's operating agreement. (My thanks to the attorneys in the case, Robert Ganz and Kevin Luibrand, for providing copies of their briefs.)
The July 17, 2008, decision by the Appellate Division, Third Department, affirmed the lower court's ruling in Gateway's favor, stating:
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We cannot agree with [the Brokers'] heavy reliance upon case law regarding the dissolution of at-will partnerships and joint ventures to support their contention that the parties' fiduciary duties to each other as members of a limited liability company ended when they met and decided on February 17, 2003 that Gateway would no longer provide title insurance services to Beverwyck. The pertinent provisions of the Limited Liability Company Law and Beverwyck's operating agreement provide sufficient guidance here. . . . [I]t is uncontroverted that there was no formal vote or written consent of the majority of the members to dissolve. Inasmuch as they failed to do so, [the Brokers'] argument that they could have unilaterally dissolved Beverwyck because they held a majority interest is unavailing. . . . Absent written consent or formal vote of a majority of the members, the only means of dissolution recognized by the operating agreement and applicable statute was by judicial dissolution.
The court's decision involves only the accounting for Beverwyck. Gateway brought a separate lawsuit against the Brokers and their new title company to recover a share of the latter's profits prior to the judicial dissolution of Beverwyck in May 2005.
The Beverwyck break-up scenario and ensuing litigation tell a cautionary tale of business expediency overtaking legal loose ends in the interregnum between the onset of hostilities and the final dissolution decree. The Brokers must be kicking themselves for not conducting a formal vote and using their 51% majority to dissolve the LLC voluntarily in February 2003. In many instances, however, there is no such easy out, e.g., because there's 50-50 ownership or the operating agreement requires an unattainable super-majority or unanimous consent for a voluntary dissolution. In those situations, short of settlement the best solution is prompt commencement of judicial dissolution and perhaps an interim application for authorization to do business for one's own account under a different company.
