It’s the perfect LLC storm: Accusations by the minority member of overreaching and breach of fiduciary duty by the controlling members, no operating agreement, and an LLC statute that affords neither party a judicial means of achieving the separation they each want.
The case, Matter of Koutelos (Mouhlas Realty, LLC), was decided last month by Queens County Supreme Court Justice Patricia P. Satterfield (read decision here). The petitioner, Mary Koutelos, holds approximately 15% membership interest in Mouhlas Realty, LLC which was formed in 2000 as a member-managed LLC. The decision doesn’t describe the LLC’s business or tell us if Koutelos is actively involved in running it. All we can glean is that Koutelos filed a petition under LLC Law Section 702 for judicial dissolution of the LLC based on allegations of overreaching and breach of fiduciary duty by two of the other three members, apparently involving a capital call and/or loan to be used for compensation of one or more member-managers; the members have no operating agreement; and the other members refused Koutelos’s request to adjourn a meeting.
The decision also tells us that the "respondent" — we don’t find out if this refers to the LLC or one of the other members individually — filed an answer with a counterclaim for an "equitable buyout" conditioned on the court applying a 30% discount for lack of marketability in valuing the petitioner’s interest.
Addressing Koutelos’s dissolution claim first, Justice Satterfield notes that, in typical fashion, the LLC’s articles of organization "contain no provision relating to the operation of the business other than the paragraph stating that the limited liability company is to be managed by 1 or more members." In the absence of an operating agreement, Koutelos must demonstrate that the LLC cannot function in accordance with the LLC Law’s default provisions. (For more on dissolution and the "statutory operating agreement," see Matter of Spires (Lighthouse Solutions, LLC), 4 Misc3d 428 (Sup Ct Monroe County 2004).)
Koutelos is unable to convince the court of the LLC’s impairment. First, the management scheme to which she objected — I’m guessing that the other members reduced or eliminated her duties — is permissible under LLC Law Section 401 which, absent contrary provision in the articles of organization or operating agreement, vests management in all the members.
Second, in regard to alleged improper compensation, LLC Law Section 411 gives the managers authority to fix the compensation of managers for services in any capacity and, under Section 402(c)(2), a majority in interest of the members may approve incurring indebtedness other than in the ordinary course of business.
Third, while the LLC Law contains no specific provision to compel additional capital contributions, "neither is there statutory prohibition against the practice, and the payment of an additional capital contribution properly voted for by the members has been approved judicially" (citing Van Der Lande v. Stout, 13 AD3d 261 (1st Dept 2004)).
Fourth, the court faults Koutelos for failing to verify personally the petition or to submit her own affidavit in support. The verification of the petition by counsel, who lacks personal knowledge of the facts, does not constitute evidence in admissible form.
Justice Satterfield accordingly holds that the petition does not plead the requisite grounds for dissolution under Section 702 based on the absence of facts showing that the LLC is "unable to function in accordance with its articles of organization or [statutory] operating agreement, or that the business is failing financially."
The court next addresses the counterclaim for equitable buyout. Why "equitable"? Because Article 7 of the LLC Law governing judicial dissolution has no provision for buyout, in contrast to Section 1118 of the Business Corporation Law which gives the respondent shareholders the right to purchase the shares of a minority shareholder who seeks dissolution under BCL Section 1104-a.
The respondent argued that a right to an equitable buyout was recognized in Lyons v. Salamone, 32 AD3d 757 (1st Dept 2006). In Lyons, upon granting the minority member’s petition for judicial dissolution of an LLC based on the majority member’s financial improprieties, the trial court ordered a "mutual buyout" or closed auction whereby each member would bid for the other’s interest. The Appellate Division, First Department, upheld the order over the petitioner’s objection that a buyout remedy is not authorized by the LLC Law. (Lyons is discussed in detail in my annual review of business divorce cases of 2006 published in the New York Law Journal, read here.)
In Koutelos, Justice Satterfield rules that, to the extent the counterclaim was asserted only as an alternative to dissolution, it is rendered moot by dismissal of the petition. In any event, according to Justice Satterfield, Lyons did not recognize a right to an equitable buyout. Rather, she concludes, Lyons "merely approved a liquidation method fashioned by the [lower] court in connection with the dissolution and sale of a business."
On top of that, Justice Satterfield continues, "even if respondent did have a right to buy out petitioner’s interest, it would not be entitled to condition such buyout on a perceived right to a 30% unmarketability discount in the valuation of the interest."
So there you have it. Ms. Koutelos wants out but has no right to withdraw or dissolve. The other members want her out but have no right to expel her or to compel her to sell her interest. It’s easy to say that the parties have only themselves to blame for failing to enter into an operating agreement with buy-sell provisions, but that doesn’t solve the problem. What would solve the problem is an amendment to the LLC Law authorizing an election to purchase and a valuation procedure as provided in BCL 1118.