Last week, in Matter of Superior Vending, LLC, 2010 NY Slip Op 02801 (2d Dept Mar. 30, 2010), the Brooklyn-based Appellate Division, Second Department, affirmed a trial court decision in an LLC dissolution case previously reported in this blog here.  The order at issue awarded as an “equitable” remedy the return of the petitioner’s capital contribution in exchange for his membership interest in a vending machine business, notwithstanding the court’s acknowledgment that there is no buyout remedy in the LLC Law.  Instead, the court referred to it as “equitable method of liquidation.”

Hmmm, let me get this straight.  Petitioner transfers membership interest to respondent.  Respondent pays money to petitioner.  LLC remains up and running.  And that’s a liquidation, not a buyout?

Is this another case in which New York courts undermine the contract-based LLC form by super-imposing equitable remedies that only add to the uncertainty surrounding adjudication of LLC disputes and thereby discourage use of the LLC form?  Or is it simply a court doing its best to craft a just resolution for the litigants before it based on the peculiar facts presented by the case?  Or is it both?

In my prior post I laid out the facts in Superior Vending in abundant detail, so I won’t do it again.  Here’s the summary from the appellate decision, though I warn you it does not nearly do justice to the story:

In 1997 Peter Plotkin incorporated a vending machine company that distributed beverages and snacks to businesses, schools, and hospitals throughout the New York City metropolitan area. In 2000 Arik Tal helped Plotkin to acquire a second vending machine company. Specifically, Tal paid a down payment in the sum of $170,000 and executed a promissory note pursuant to which he agreed to pay the remaining balance of the purchase price in monthly installments. Although Plotkin and Tal formed a limited liability company known as Superior Vending, LLC (hereinafter Superior), to operate the business, they never executed an operating agreement.

Plotkin and Tal, in effect, terminated their business relationship in November 2002. Although Tal initially commenced an action in March 2003, inter alia, to dissolve Superior, he failed to pursue the dissolution claim. That action was marked off the trial calendar in May 2004, and dismissed in May 2005. Meanwhile, Plotkin continued to operate and expand the vending machine business. In June 2007 Tal commenced the instant proceeding pursuant to Limited Liability Company Law § 702, inter alia, to dissolve Superior and recover his share of Superior’s assets and interim distributions.

In the lower court proceedings Plotkin consented to the dissolution but contended that Tal was entitled only to half its remaining assets consisting of some old equipment worth a little over $30,000.  Tal brought in a business appraiser who testified that the value of Tal’s 50% interest ranged up to $700,000 including assets acquired by Plotkin after Tal left the business.  Westchester County Commercial Division Justice Alan D. Sheinkman found neither side’s position reasonable, and instead ordered that Tal transfer his membership interest to Plotkin in exchange for about $256,000 representing Tal’s initial capital contribution plus subsequent note payments with certain offsets.  The order further provided for liquidation of the combined businesses in the event Plotkin did not comply.  Justice Sheinkman anchored his ruling in § 704(c) of the LLC Law which dictates priority of LLC asset distribution in liquidation.

The Second Department’s affirmance devoted all of two sentences to its explanation for upholding the lower court’s order, neither of which adds anything significant to the analysis.  Here they are:

Although the Limited Liability Company Law does not expressly authorize a buyout in a dissolution proceeding, the Supreme Court properly determined that the most equitable method of liquidation in this case was to provide Plotkin a period of 45 days within which to purchase all of Tal’s right, title, and interest in Superior for the principal sum of $256,549.43, plus 9% interest from November 22, 2002 (see Lyons v Salamone, 32 AD3d 757, 758). This approach, which excluded an award of interim distributions made by Superior after November 2002, allowed Tal to recover his investment plus a reasonable return on that investment with respect to his membership interest in Superior, which terminated in November 2002.

The Lyons decision cited in the above passage is another instance in which an appellate court — in that case, the Manhattan-based First Department — upheld a somewhat different form of equitable buyout remedy in an LLC dissolution.  In Lyons the court granted a contested LLC dissolution petition, after which, over petitioner’s objection, it required the two parties to bid against each other to purchase the other’s interest.  Here’s how the court there explained it using the same “liquidation” nomenclature used in Superior Vending:

We reject plaintiff’s argument that the absence of a provision in the Limited Liability Company Law expressly authorizing a buyout in a dissolution proceeding rendered the IAS court without authority to grant the parties mutual buyout rights, and find that it is an equitable method of liquidation to allow either party to bid the fair market value of the other party’s interest in the business, with the receiver directed to accept the highest legitimate bid.

From a policy standpoint, LLC cases granting equitable remedies as in Superior Vending and Lyons (and let’s not forget Tzolis v. Wolff and Gottlieb v. Northriver Trading) should give us pause, however right they may seem as a just disposition of the particular case.  A statistical survey recently published by Professor Rodney Chrisman in the Fordham Journal of Corporate & Financial Law shows New York lagging far behind the rest of the country in the rate of new LLC filings compared to the traditional business corporation.  The most commonly-cited reason, unique to New York, is the high cost of the legally required public advertisement of the filing of the articles of organization.  Many interested observers, including myself, believe that another significant factor is the discomfort level due to the relative unpredictability of outcomes when LLC internal disputes land in court, especially given the large number of LLCs that are formed without written operating agreements.  When courts, particularly at the appellate level, resort to uncodified, implied duties and equitable remedies designed to bypass statutory omissions, the uncertainty factor takes on added weight.

At least for involuntary dissolution, the solution is simple.  As I proposed some years ago in a NY State Bar Journal article, the LLC Law should be amended to add a buyout election in dissolution cases comparable to § 1118 of the Business Corporation Law.  Other states have this feature.  It should be made a default rule, subject to any overriding terms of the operating agreement.  In other words, the LLC members in the operating agreement would be free to eliminate the right of election upon the filing of a dissolution petition, or to specify the amount or manner of computation of the buyout amount, and the terms of payment.

For those entrepreneurs and investors who would enter into a written operating agreement in any event, the presence of the buyout default rule would further encourage LLC members at the outset to negotiate and draft exit provisions that suit their specific needs and circumstances.  For the many LLC start-ups that never get around to making an operating agreement, a statutory default rule granting the right to purchase the dissolution petitioner’s membership interest would provide greater certainty, would encourage out-of-court buyout negotiations and, for those disputes that can’t be resolved amicably, would reduce the scope of litigation and its attendant costs.

Any legislators out there listening?

Ribstein on Superior Vending:    Read here Professor Larry Ribstein’s take on Superior Vending.