Is an LLC dissolution petition brought eight years after an alleged freeze-out barred by the statute of limitations? Is the limitations period relevant if the controlling member continued to carry on the business during the freeze-out period? Does the death of the controlling member trigger dissolution?
These and other questions are addressed in a recent decision of interest by the Brooklyn Surrogate’s Court in Sealy v. Clinton LLC, 2011 NY Slip Op 21375 (Sur Ct Kings County June 13, 2011). The court in Sealy followed the Appellate Division, Second Department’s landmark decision last year in the 1545 Ocean Avenue case in finding no ground for judicial dissolution under §702 of the LLC Law — and therefore no need to analyze the statute of limitations defense — where the controlling member continued to operate the subject real estate holding company during the alleged freeze-out period. The court nonetheless granted relief based on the controlling member’s death as one of the dissolution trigger events defined in the parties’ operating agreement.
In 1997, Charlie Alston and Daryl Sealy formed Clifton LLC to invest in real estate. Each held a 50% interest in the member-managed LLC. In 1999, the LLC bought two units in a Brooklyn commercial condominium. Alston rented one unit and used the other for his business office. Alston apparently attended to the LLC’s business affairs without Sealy’s involvement in the following years.
Alston died in late 2006, shortly after which Sealy withdrew half of the $356,000 in the LLC’s bank account. Alston’s administrator, Gloria Alston, brought a turnover proceeding in Surrogate’s Court demanding return of the funds. Gloria alleged that Sealy had ceased doing business with Alston after the LLC’s formation in 1997 and that Alston “inadvertently” left Sealy’s name on the LLC’s bank account. Gloria also alleged that Alston “inexplicably” deposited $350,000 into the LLC account that Alston received upon the sale of other real property owned in his own name.
Sealy countered that, shortly before his death, Alston agreed to deposit funds into the LLC account to pay for the rentals Alston received from the leased condominium unit and for the rental value of the unit used by Alston. Sealy asserted his right to withdraw half the funds as a 50% member.
While the turnover proceeding was still pending, in May 2008, Sealy filed a partition action in Supreme Court seeking a sale of the condominium units and the division of the sale proceeds. Sealy subsequently amended his complaint seeking judicial dissolution and winding up of the LLC. Sealy alleged that Alston froze him out of the business in late 2000 and refused his demands for an accounting and distributions. Sealy also claimed that dissolution of the LLC was required under a provision of the operating agreement mandating dissolution upon the death of a member unless the surviving member opts within 90 days to continue the business, which Sealy did not do. Gloria’s answer to the dissolution claim denied that Sealy was a member of the LLC.
In late 2008, Supreme Court transferred the dissolution action to Surrogate’s Court to be heard in conjunction with the turnover proceeding. Sealy thereafter moved for an order winding up the LLC and for an accounting, which the Surrogate’s Court treated as a motion for summary judgment on Sealy’s claim for dissolution.
Gloria raised three independent grounds in opposition. First, she argued that Sealy was not a member of the LLC. Specifically, she contended that Sealy repudiated the operating agreement when he opposed the purchase of the condominiums and, after Alston bought them over Sealy’s objection, “quit” the LLC and never again participated or contributed in any way to the LLC’s activities.
The decision, by Kings County Surrogate Anthony J. Cutrona, rejects that argument. The LLC’s operating agreement incorporates LLC Law §606’s default rule for member withdrawal as it existed in 1997, when a member could withdraw as of right on six-months notice. There was no evidence that Sealy withdrew.
Gloria secondly argued that, even if Sealy was a member, his dissolution claim was asserted more than six years after Alston allegedly froze Sealy out of the business in 2000, and thus was barred by the statute of limitations. In reply, Sealy denied that he was frozen out in 2000, and he downplayed his petition’s freeze-out allegation as merely a “term of art.”
Here’s where the decision gets interesting. Surrogate Cutrona concludes that he need not address the statute of limitations issue “because, under the LLCL, even if [Sealy] was frozen or cut out of [the LLC’s] management in 2000, this would not give him a cause of action for dissolution.” Gloria’s argument, the Surrogate explains, relies on cases under the Business Corporation Law and Partnership Law for her assertion that Sealy had the right to seek dissolution when Alston froze Sealy out of the LLC’s management. The LLC Law, however, “does not provide an equivalent right for members of a limited liability company.” Instead, he continues, “LLCL §702 authorizes judicial dissolution only upon a showing that it is not reasonably practicable to carry on the business in accordance with the operating agreement.”
Surrogate Cutrona buttresses his conclusion with a discussion of Justice Leonard Austin’s important opinion in Matter of 1545 Ocean Avenue, LLC, 72 AD3d 121 (2d Dept 2010), where the court, in defining the standard for LLC dissolution under §702, made it clear that claims of oppression and deadlock, while sufficient under the dissolution statutes governing closely held corporations, do not suffice under the LLC Law. Section 702 instead requires a showing that, in the context of the operating agreement, the LLC’s management is unable or unwilling to permit or promote the stated purpose of the entity to be achieved, or continuing the entity is financially unfeasible. (Read here and here my prior posts on the 1545 Ocean Avenue case and its subsequent impact on LLC dissolution jurisprudence.)
In Sealy, Surrogate Cutrona finds, the evidence showed that Alston “carried on the business of [the LLC] until the day he died.” As further explained by the Surrogate:
The Limited Liability Company Law provides that, unless provided otherwise in the operating agreement, management of the company is vested in its members. LLCL § 401. In such cases, “any such member exercising such management powers or responsibility shall be deemed to be a manager” and “shall have and be subject to all of the duties and liabilities of a manager”. LLCL § 402. Therefore, Sealy had no cause of action to seek the dissolution of [the LLC] prior to Alston’s death in 2006. Based on the above, Sealy’s cause of action for dissolution is not barred by the Statute of Limitations.
Gloria’s third argument was that Sealy’s “delay” in seeking dissolution until after Alston’s death warranted denial of the “extreme” remedy of dissolution based on the equitable doctrine of laches. Surrogate Cutrona rejects this argument as well, noting that “it was only on Alston’s death that Sealy had a basis to seek dissolution” of the LLC. In addition, even though there was evidence that Alston paid off the mortgage on the condominium units with non-LLC funds, it was not inequitable to hold that the LLC is the owner of the units bought in its name with funds drawn from the LLC’s bank account. Whether Gloria can recoup monies contributed by Alston to purchase the condominium units and to pay off the mortgage, the Surrogate notes, “may be determined in the dissolution and accounting proceeding.”
There being no viable defenses, Surrogate Cutrona grants Sealy’s motion for summary judgment of dissolution based on the operating agreement’s provision stating that the LLC is to be dissolved upon the death of a member unless within 90 days thereafter the remaining member elects to continue the business, which election Sealy never made.
It’s interesting to speculate what would have happened if Alston had not died, and if Sealy had brought a dissolution claim in 2007 based on deadlock going back to 2000 or upon the earlier acquisition of the condominium units. In the 1545 Ocean Avenue case, which also involved a two-member LLC owned 50-50, a major factor in the court’s denial of dissolution was the peculiar provision in the operating agreement authorizing either member-manager to act unilaterally. The court’s opinion in Sealy does not disclose whether the operating agreement had such a provision or a more typical provision effectively requiring unanimous agreement. Assuming the latter, perhaps the statute of limitations argument would have stood a better chance of success.
Update May 23, 2013: By decision and order dated May 22, 2013 (read here), the Appellate Division, Second Department, affirmed Surrogate Cutrona’s order dissolving the LLC.