In a 3-2 decision, a panel of Appellate Division, First Department judges last week upheld the removal of an LLC member-manager by majority vote of the members, notwithstanding provision in the operating agreement requiring all members to vote for the ousted member-manager in any election for managers. The case is Ross v. Nelson, 54 AD3d 258, 2008 NY Slip Op 06504 (1st Dept 2008).
The underlying facts in Ross are described in the trial court’s decision dated October 12, 2006, written by New York County Commercial Division Justice Helen E. Freedman. Since 1996, Dean Ross owned minority membership interests in two New York limited liability companies, each of which owned rental properties in Manhattan. The LLCs had substantially identical operating agreements naming Ross, Eric Nelson and Gary Podell as the member-managers. Each LLC also had a number of non-manager members. Things went smoothly until 2001, when severe strains developed in the relationship between Podell and Nelson on the one hand and Ross on the other. Podell and Nelson called meetings of the LLCs’ members to vote on the removal of Ross as a member-manager, and to replace him with Ross’s brother who also was a member of both LLCs. The resolutions passed. Ross brought suit seeking to invalidate the vote and to declare that he continued to be a member-manager of the LLCs. He also sought to recover one-third of property management fees that were paid to a separate company owned by Podell and Nelson.
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 underSection 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 ). 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.