Matter of Youngwall debuted on this blog last April (read here) when I wrote about a March 2008 decision (read here) by Nassau County Commercial Division Justice Stephen A. Bucaria, dissolving and appointing a receiver for a manager-managed LLC owned by two brothers. The court premised dissolution primarily on its finding that the LLC was not currently profitable.
Perry Youngwall, who opposed the dissolution petition brought by his brother, Nils, subsequently moved for reconsideration and to vacate the decision on various grounds. The headline grabber from Justice Bucaria’s July 2008 decision denying the motion, which I wrote about last week (read here), was his ruling that the operating agreement’s waiver of a member’s right to seek judicial dissolution was unenforceable as against public policy.
This week, I want to re-examine the court’s justification for dissolving the LLC, this time with the benefit of some additional facts brought out in the July 2008 decision.
By way of brief background, the LLC’s sole asset is a commercial building profitably leased for many years by a company, Transaero, originally owned by the brothers’ deceased father and currently controlled by Perry. Perry inherited all of his father’s Transaero shares after the father disinherited Nils who is contesting the father’s will in Surrogate Court. Transaero vacated the building on November 30, 2007, upon the expiration of its lease with the LLC. About two weeks later, Nils petitioned for dissolution of the LLC, contending that Perry rejected his requests to sell or re-let the building. Nils also claimed that the LLC’s non-member manager, Thomas Megale, was allied with Perry and that deadlock existed because the approval of a lease requires both brothers’ consent. Perry opposed dissolution on various grounds including the LLC’s long track record of profitable leasing, the existence of a separate management agreement governing re-letting, and because the LLC continued to operate under the management of Megale who was pursuing the LLC’s best interests.
In its initial decision, the court explained the factual basis for dissolving the LLC as follows:
Transaero was the only tenant, and there is no dispute that the LLC is not a profit-making entity at this time. Nor is there any admissible documentary proof that either the manager or the members are actively pursuing a future/current replacement for Transaero, notwithstanding the self-serving statements of the respondent [Perry] and the manager, whose motives are questionable, given the concurrent litigation in Surrogate Court and the latter’s employment. The respondent’s submission of an "agreement" purportedly dated October 8, 2001 does not qualify as documentary proof, inasmuch as there are numerous cross-outs and changes with no signature by either Nils Youngwall or Perry Youngwall.
In his subsequent motion to reconsider and vacate the court’s decision, Perry claimed to have subsequently discovered a fully-executed copy of the October 2001 management agreement. He further asserted that in the prior proceedings Nils "defrauded the Court" by misrepresenting that he did not recall the document. Perry argued that the management agreement demonstrates that the LLC has procedures in place to go forward with re-letting the building. Perry also submitted an affidavit from a real estate broker showing that the LLC’s building has substantial value as a rental property. Finally, Perry contended that retaining the property for rental will provide the LLC’s members with a substantial annual profit.
In opposition, Nils denied any fraud or deception in regard to the October 2001 management agreement and pointed out that neither side had a signed copy on the original submission. Nils also contended that Perry and Megale had prior knowledge for over four months of Transaero’s impending departure without taking any steps to market or rent the property and that there was no proof that anyone did so. He also argued that Perry’s "belated" attempts to evaluate and propose to rent the property were irrelevant and improper on a motion for reconsideration.
Justice Bucaria’s July 2008 decision rejected each of Perry’s arguments. The October 2001 management agreement, which the court disregarded in its prior decision,
did not take the form of any contract with a real estate agent or broker to rent or lease the subject property. Taking note that the respondent [Perry] had given notice prior to September 2007 that Transaero would not be renewing the lease, the respondent and the manager [Megale] had not demonstrated any desire to rent or lease the subject premises for a period in excess of three months. That is the lack of demonstrable proof that formed the basis of this Court’s ruling that the historical profit stream of the LLC was and had been effectively severed.
After noting that Perry did not proffer a reasonable excuse for his belated discovery of the executed management agreement, Justice Bucaria dismissed Perry’s reliance on the agreement, writing:
[T]he management agreement does not prove that the LLC was an ongoing viable entity, only that the LLC was "prepared to deal with the re-letting of the [subject premises] . . .", not that it had done so. In fact, as provided in Section II, "The principal objective of the Managing Agent will be to operate the Property in such a manner as will maximize the financial return to the Company, with an emphasis on current income" (emphasis supplied). That mandate was not fulfilled. Nor is there any evidence that the manager had complied with Section IV of the management agreement, i.e., "Managing Agent shall advertise vacancies by all reasonable and proper means; provided, Managing Agent shall not incur expenses for advertising in excess of $500.00 during any calendar quarter without the prior written consent of the Company."
My first piece on the original Youngwall decision posed a series of questions roughly falling into two categories. First, is the decision consistent with the limited scope of Section 702 of New York’s LLC Law, authorizing judicial dissolution "whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement"? Second, as a policy matter do we want courts to decide dissolution contests based on the complex set of factors and management prerogatives that influence a company’s short and long term profitability?
I’ll address those in reverse order. The facts brought out in the July decision paint a much clearer picture of a deliberate plan by Perry, with Megale’s support, to let the LLC’s building lie fallow indefinitely to exert financial pressure on Nils concurrent with the battle over the father’s estate. Perry decided to relocate Transaero months before it happened, yet he and Megale took no steps whatsoever even to begin the process of re-letting. True, Nils filed for dissolution only two weeks after Transaero vacated the building at the end of November 2007. But even by the time the original court submissions were made in February 2008, there still was no sign of re-letting activity. That adds up to about 6 months of inactivity from the time Perry caused Transaero to give notice. The belated appearance of the signed management agreement, with its specific provisions for re-letting, only adds to the appearance of deliberate inaction. On these facts, it’s hard to quarrel with the court’s conclusion that Perry and Megale had no intention of re-letting the building, i.e., restoring the LLC to profitability.
The first question remains the harder one to answer. Nothing in the court’s July decision augments the first decision’s legal reasoning, namely, that because LLCs are formed to engage in business for pecuniary profit, an LLC whose operating agreement or articles of organization recite that is it formed for "any lawful business purpose" may be judicially dissolved on the ground that it is not making a profit. To be clear, the issue is not that an LLC’s financial condition and prospects are immaterial to the overall propriety of dissolution in any specific case, it’s whether the statute’s core requirement, of the inability to carry on the LLC’s business "in conformity with" the operating agreement or articles, should be predicated on frustration of an implied business purpose to make a profit.
If Youngwall involved a close corporation instead of an LLC, and the facts otherwise were the same, it would have the makings of a classic shareholder impasse and squeeze-out triggering a judicial dissolution remedy for deadlock and oppression under Section 1104 and 1104-a of the Business Corporation Law. I find Youngwall so fascinating precisely because it highlights Section 702’s shortcomings as a judicial tool for resolving the most common varieties of LLC breakups which, contrary to assumptions seemingly underlying Delaware’s "contractarian" school of LLC jurisprudence, do not involve LLCs with custom-tailored operating agreements carefully negotiated across the table with the assistance of highly sophisticated corporate counsel. More likely they involve an accountant’s recommended use of an LLC for tax reasons with nary a thought given to governance issues, followed by the use of a recycled, non-negotiated form LLC agreement slapped together by the financial partner’s lawyer without any other lawyer’s participation.
Speaking of Delaware, Chancellor Chandler’s R&R Capital opinion, discussed alongside Youngwall in last week’s post on judicial dissolution waivers, posits Delaware’s statutory covenant of good faith and fair dealing as a member’s judicial backstop against abusive conduct by a controlling member when dissolution is not available. Does this suggest that Youngwall could be a case of a member seeking an inappropriate remedy based on the wrong claim? What about a derivative action for injunctive relief (to compel re-letting the building) and damages (for lost rental income) against the LLC’s manager for breach of (1) New York’s implied duty of good faith and fair dealing that attaches to the operating agreement, and (2) the manager’s statutory duties of good faith and care under LLC Law Section 409? Section 1104-a(b)(1) of the BCL expressly requires the court to consider whether dissolution is the "only feasible means" for a shareholder to obtain a fair return on investment. Unfortunately, LLC Law Section 702 has no similar provision.
One final note. Justice Bucaria’s July 2008 decision mentions that the court-appointed receiver listed the LLC’s building with a broker for sale. Following the decision, Perry Youngwall filed a motion in the Appellate Division, Second Department, asking for a stay of sale pending his appeal from the March 2008 and July 2008 decisions. By order dated August 22, 2008, the appellate court denied the motion. In typical fashion the court’s order offers no reasons, so it can’t be read as an explicit approval of the underlying orders. I’m sure many lawyers nonetheless would opine that the denial of the stay motion, cognizant that an impending sale of the building likely will render moot Perry’s appeal from the order of dissolution, implicitly takes a dim view of the merits of his appeal. I, for one, will be disappointed if the appellate court does not decide the case, but what do you expect from a blogger?
Update February 15, 2009: In a decision dated January 29, 2009, Justice Bucaria approved the sale of the LLC’s building to an entity controlled by the respondent, Perry Youngwall, for $3.5 million, in preference to a proposed sale to an unrelated third-party buyer for $3.3 million.
Update July 14, 2010: The will contest between Nils and Perry has been decided. Nassau County Surrogate Riordan issued a ruling dated June 29, 2010, dismissing Nils’ objections and admitting to probate the father’s will which disinherited Nils.