“What were they thinking?”

It’s a rhetorical question lawyers in my field reflexively ask themselves with a sideways shake of the head when a new client in a shareholder dispute involving a closely held business walks in with a poorly drafted shareholders’ agreement that, rather than serving its expected purpose to cement relations and avoid strife, is now the cause of expensive litigation due to some language ambiguity, vagueness, omission or other absurdity.  

Judges deciding the dispute have to pose and answer the same question, albeit framed a bit more soberly:  Based on the language used in the provision at issue, interpreted in the context of the entire agreement, is enforcement of the rights, obligations and remedy identified by the complainant consistent with the discernable intent of the parties to the contract?

So what were the members of Emmy Kodiak Developers of Woodbury, LLC thinking when they made the operating agreement at issue in Matter of Fassa Corp., Short Form Order, Index No. 018824/10 (Sup Ct Nassau County Feb. 1, 2011)?  The case stems from a petition to wind up the company’s affairs under Section 703 of the LLC Law.  The agreement contained a provision, the likes of which I’ve never seen, that gives any member the unqualified option at any time to terminate the operating agreement upon 60-days notice to the other members.  Stranger yet, the provision does not address the effect of the agreement’s termination on the status of the LLC, i.e., whether it is supposed to continue or dissolve. 

According to the decision by Nassau County Commercial Division Justice Stephen A. Bucaria, in 2008 the three co-equal members of the LLC agreed to invest $600,000 each to acquire and develop a particular parcel of residential real property in Woodbury, New York.  The president of the petitioning member, Fassa Corp., who also was a lawyer, prepared the operating agreement by adapting a form used in prior real estate deals between the other two members.

Fassa alleged that, after contributing its $600,000 capital, the other members acquired title to the Woodbury parcel in the name of a different entity in which Fassa had no interest.  Fassa also alleged that one of the respondent members deliberately delayed the project until after he sold another property in the same area owned by him.

In July 2010, Fassa served the other members with 60-days written notice, purporting to terminate the LLC’s operating agreement and to dissolve the company.  In September 2010, Fassa filed articles of dissolution with the New York Department of State.  Soon afterward, Fassa filed a lawsuit seeking judicial winding up of the “dissolved” LLC under Section 703.

The respondents argued that, in accordance with the termination clause’s express language, the notice to terminate only terminated the operating agreement and did not result in dissolution of the LLC.  In support they cited LLCL Section 701(a)(2), which provides that the company is dissolved upon the “happening of events specified in the operating agreement.”  Therefore, they concluded, Fassa must proceed by way of a petition for judicial dissolution of the company under LLCL Section 702.

In his decision, Justice Bucaria states that “an operating agreement is essential to determining whether judicial dissolution should be granted.”  This imperative, he explains, arises from LLCL Section 417(a), providing that “the members of a limited liability company shall adopt a written operating agreement,” and from LLCL Section 702, providing that a court may decree dissolution whenever it it not reasonably practicable to carry on the business “in conformity with the . . . operating agreement.” 

Justice Bucaria then turns to the critical question presented, namely, whether the LLC can continue after termination of its operating agreement.  He concludes not, in the following passage from the decision:

Where the operating agreement is silent as to the events which will trigger dissolution, the court must look to Limited Liability Company Law §702 ([Matter of 1545 Ocean Avenue, 72 AD3d 121, 124]). However, if the operating agreement is terminated, there is no basis for the court to determine whether “in the context of the operating agreement,” the stated purpose of the company may be realized or is financially unfeasible (Id. at 131). Since the parties could not have intended for Emmy Kodiak to continue without an operating agreement, the court interprets the 60 day notice provision as providing for dissolution of the company. Thus, the court determines that Emmy Kodiak Developers of Woodbury, LLC was dissolved as of September 18, 2010.

Alternatively, even if the termination notice did not effect a dissolution, Justice Bucaria finds dissolution warranted under LLCL Section 702 based on “‘fundamental and intractable'” conflict among the members “‘regarding the means, methods, or finances of the company’s operations'” thereby making it “‘unfeasible for the company to carry on its business as originally intended'” (quoting the late Justice Steven Fisher’s partially concurring opinion in 1545 Ocean Avenue). 

As a practical matter it’s hard to quarrel with Justice Bucaria’s pivotal finding that “the parties could not have intended for [the LLC] to continue without an operating agreement.”  What’s the alternative?  Could the members have intended to continue their business relationship in the absence of the agreement, governed by the LLC Law’s default rules?  After all, notwithstanding LLCL Section 417(a)’s mandate that every LLC have an operating agreement, there are plenty of LLCs that operate under the default rules because the members never get around to making a written agreement.  But still, why would business partners, each of whom obligated themselves to contribute $600,000 for a multi-year real estate development project, and who went to the trouble of making an operating agreement at the outset of their venture, contract to continue without one?  And why would they opt to allow termination of their operating agreement only so that, going forward, the applicable default rules arguably would make it harder to dissolve the company?  And if that was their intent, odd as it would have been, wouldn’t you expect them to say so in black and white?