For years I’ve been carping about the substantive and procedural inadequacies of New York’s LLC judicial dissolution statute. LLC Law Section 702, which was modeled after the rarely utilized limited partnership dissolution statute, consists in its entirety of the following two sentences:
On application by or for a member, the supreme court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement. A certified copy of the order of dissolution shall be filed by the applicant with the department of state within thirty days of its issuance.
At the time of the LLC Law’s adoption in 1994, the legislature’s minimalist approach made some sense because of tax considerations requiring avoidance of certain corporate characteristics including continuity of life. The IRS’s subsequent implementation of check-the-box regulations freely permitting partnership tax treatment of LLCs, and the 1999 LLC Law amendments restricting member withdrawal from LLCs, largely eliminated the legislative rationale for Section 702 as enacted, leaving the statute, in my view, not up to the complex task of adjudicating LLC breakups (hence the title of my June 2002 article published in the New York State Bar Journal, Vol. 74, No. 5, "When Limited Liability Companies Seek Judicial Dissolution, Will the Statute Be Up to the Task?").
These observations are prompted by a recent decision by New York County Commercial Division Justice Bernard J. Fried in a case I’ve previously written about called Ficus Investments, Inc. v. Private Capital Management, LLC. Ficus is a highly contentious dispute between LLC members involving accusations that the managing members misappropriated over $20 million. Last January, an appellate ruling enforced the lead defendant’s right to advancement of his legal defense costs as provided by the operating agreement (see my earlier post here).
In a follow-up ruling dated February 23, 2009, Justice Fried granted a motion by the LLC’s 20% member, Private Capital Management, LLC ("PCM"), also enforcing its advancement rights. According to Justice Fried’s April 2008 decision, PCM is owned 50-50 by defendant Thomas Donovan and Lawrence Cline. In an apparent effort to lessen or avoid PCM’s advancement rights, the plaintiff (or more likely Cline, who earlier settled with the plaintiff under a cooperation agreement) made a cross motion to dissolve PCM. This required Justice Fried to determine whether, absent a pleading containing a claim for dissolution, the court can decree dissolution on application by motion. As far as I know, this is the first decision to address the issue.
Justice Fried notes that the operative language in Section 702 (court may decree dissolution "on application by or for a member . . .") does not expressly deny the right to seek dissolution by way of motion. He also contrasts Section 702 with the detailed procedural provisions in Article 11 of the Business Corporation Law requiring the commencement of a special proceeding for judicial dissolution of closely held business corporations by way of verified petition and order to show cause. Notwithstanding the legislative omission in the LLC Law, Justice Fried concludes that
the better practice is to apply for judicial dissolution by way of a plenary action. This would provide [the dissolution proponent] the opportunity to plead a cause of action for judicial dissolution, and it would enable [the dissolution opponent] to answer this claim, rather than merely oppose the [motion]. . . . Moreover, the vast majority of the cases applying Section 702 involve an application for dissolution that is made by way of cause of action contained in the complaint, counterclaim, or plenary petition [citations omitted]. . . . Here, Plaintiffs have not sought summary judgment on a claim or counterclaim for judicial dissolution, but rather, have merely cross-moved for the relief sought. Defendant PCM has neither interposed a counterclaim for dissolution nor indicated in any way that it would favor such relief. As stated above, I believe the preferable way to proceed with this application for judicial dissolution is by way of petition, and, exercising my discretion, I therefore deny Plaintiffs’ cross-motion without prejudice.
There’s no question that Justice Fried’s conclusion reflects the practical reality. I have brought, defended and otherwise seen any number of LLC dissolution cases commenced by summons and complaint in a plenary action, as well as by order to show cause and verified petition in a special proceeding whose accelerated procedures are governed by CPLR Article 4.
Curiously, the courts routinely accept petitions for LLC dissolution by way of special proceeding notwithstanding the absence of statutory authority for doing so, as seemingly required by CPLR 103(b) ("All civil judicial proceedings shall be prosecuted in the form of an action, except where prosecution in the form of a special proceeding is authorized.").