The multi-faceted Ficus Investments litigation juggernaut, of which I’ve written about numerous times before, took another twist last week with a ruling by the Appellate Division, First Department, reversing the lower court’s order dissolving the LLC that served as 20% managing-member of the mortgage business at the center of the dispute.  Matter of Cline (Private Capital Management, LLC), 2010 NY Slip Op 02862 (1st Dept Apr. 8, 2010)

The lower court cited the litigation-infused acrimony between former co-defendants and business partners Lawrence Cline (the petitioner) and Thomas Donovan (the respondent) as ground for dissolution.  The appellate court, however, agreed with Donovan that, following the lower court’s denial of his motion to dismiss the petition for lack of standing and failure to state a valid claim, rather than granting dissolution it should have granted Donovan leave to file an answer to the petition due to a factual dispute over the authenticity of the LLC’s operating agreement. 

The decision reminds practitioners that a favorable summary disposition, i.e., without holding an evidentiary hearing, of a dissolution petition can be a fleeting triumph.  The case books are heavily laden with appellate reversals of summary grants and denials of dissolution petitions involving close corporation and LLCs.  Beyond its procedural aspect, Cline also reaffirms the central importance to the court’s dissolution inquiry of determining the LLC’s business purpose.

The appellate decision lays out the basic facts as follows (more ambitious readers can get additional background from my prior post describing the lower court’s May 2009 ruling by clicking here):

The petition alleges that the two equal managing members of PCM, petitioner Cline and respondent Donovan, no longer speak to each other and have taken antagonistic positions in ongoing, intractable litigation, which has resulted in the deadlock of PCM.

There is a related action entitled Ficus Invs., Inc. v Private Capital Mgt. LLC (61 AD3d 1 [2009]).  Ficus, a Florida corporation, is the managing member and 80% owner of Private Capital Group, LLC (PCG), which is in the business of buying, managing and selling nonperforming real estate mortgages.  PCM is the minority member, holding 20% of PCG.  Ficus and PCG allege that respondent Donovan and petitioner Cline misappropriated and diverted over $50 million from PCG to PCM.

In July 2007, Cline entered into a settlement agreement with Ficus and PCG, pursuant to which he returned assets worth millions of dollars to PCG and agreed to cooperate with Ficus’s investigation. The settlement agreement is under seal, and it is characterized differently by Cline and Donovan, the former representing that he conveyed to PCM Interest Holding, LLC (PCMIH), an entity wholly owned by Ficus, his economic interest in PCM, and the latter explaining that Cline conveyed his ownership interest in PCM Corp., the entity that owns PCM, to an affiliate of PCG and resigned as a manager of PCM. 

Cline’s dissolution petition named both himself and his alleged assignee, PCMIH, as petitioners.  The petition alleged that PCM was formed merely to hold Cline’s and Donovan’s combined 20% interest in PCG.  Donovan responded with a motion to dismiss the petition on two, legal grounds.  First, he argued that PCMIH as non-member assignee lacked standing to seek dissolution.  The lower court agreed with this contention, which PCMIH did not challenge on appeal.

Second, he argued that, assuming the truth of the petition’s allegations of acrimony between himself and Cline, such allegations failed to establish that PCM could no longer fulfill its alleged business purpose as a passive holding company within the meaning of the dissolution statute, Section 702 of the New York LLC Law.  In support of the latter argument, both in his lower and appellate court briefs, Donovan relied primarily on In re Seneca Investments, LLC, 2008 WL 4329230 (Del. Ch. Sept. 23, 2008), where the Delaware Chancery Court dismissed a dissolution petition brought by a minority member of an LLC which had ceased active business operations.

Neither side submitted to the lower court any operating agreement for PCM, the reasons for which became apparent after the court on its own initiative requested copies of PCM’s organizational documents.  Donovan submitted an operating agreement, apparently co-signed by him and Cline, which identified another entity allegedly co-owned by the two called PCM Corp. as the LLC’s sole member, designated Donovan and Cline as co-Managers, and stated the LLC’s purpose to be “managing the purchase, and resolution of non-performing mortgage [sic] as agreed from time to time by the Managers”.  Cline denied his signature on the operating agreement which he labeled “fraudulent”.

Clearly, the operating agreement — if authentic — posed problems for both sides.  From Cline’s standpoint, it would mean that PCM Corp., over which he and Donovan share equal control, has the exclusive right to pursue dissolution of PCM, thereby requiring dismissal of the petition.  From Donovan’s standpoint, the operating agreement’s narrow purpose clause, expressly requiring joint decision making by the now bitter adversaries over a business whose function as manager of PCG was terminated, would almost certainly allow a finding of irreconcilable deadlock and frustration of business purpose.

The lower court resolved the authentication impasse by declaring that the dispute between Cline and Donovan over the operating agreement itself demonstrated the “litigious nature of their relationship” and warranted dissolution regardless of the operating agreement’s validity.

Not so fast, the Appellate Division said last week in reversing the order of dissolution.  Here’s the pertinent excerpt from the decision:

On the basis of this submission alone, Donovan should have been permitted to file an answer, because it raises a factual issue as to whether Cline is a member of PCM and thus has standing to maintain this proceeding.  The motion court acknowledged the factual dispute regarding the authenticity of the PCM operating agreement submitted by Donovan, noting that Cline’s assertion that the agreement is fraudulent “is indicative of the litigious nature of their relationship” and that the stated purpose of the agreement militates in favor of dissolution because it would “entail even more cooperation between the members” than would be the case if PCM was formed merely as a passive investment entity, as alleged by Cline. Significantly, the disputed operating agreement specifically addressed by the motion court was not a proper basis for summary adjudication of the petition, but instead, a sound reason to grant Donovan leave to serve an answer. Under such circumstances, where a “factual issue exists which may be raised by answer” (Matter of Lefkowitz v Therapeutic Hypnosis, 52 AD2d 1017, 1018 [1976]), it was improvident for the motion court to deny Donovan’s application for leave to serve an answer (compare Matter of Dodge, 25 NY2d 273, 286-287 [1969] and Matter of Cunningham & Kaming, 75 AD2d 521, 522 [1980] [where permitting respondent to file an answer would have served no useful purpose]).

Courts generally let litigants chart their own procedural course, and the litigants must abide the consequences of their chosen courses.  In Cline, there’s a fascinating interplay of chosen procedure and substance at work.  Donovan’s counsel appears to have made a calculated gamble on a first-round knockout by seizing upon Cline’s characterization of the LLC’s purpose as a passive holding company, while deliberately not challenging Cline’s individual standing to seek dissolution based on the (disputed) operating agreement.  The lower court upset the calculation when it asked to see the LLC’s operating agreement which, up to that point, neither party perceived as helping his own, immediate objective.  Donovan’s gambit backfired when the lower court granted dissolution, but his procedural victory on appeal may allow him to fight another day.