The title of this week’s post is inspired by two recent decisions in LLC dissolution cases in which courts crafted remedial measures that appear to venture into new territory in an effort to achieve efficient and equitable resolution of the parties’ dispute.
In one case, the court ordered an appraisal proceeding for a buyout of the petitioning member’s interest after denying his request to dissolve the LLC. In the other, involving a dispute between 50/50 managing members, the court appointed a temporary receiver with limited powers to monitor the LLC’s financial activity.
The appraisal remedy was ordered by Commercial Division Justice Stephen A. Bucaria in Matter of Gold (Cosmo Holdings LLC), Short Form Order, Index No. 6722/11 (Sup Ct Nassau County Oct. 26, 2011). The petitioner in Gold is a 25% member and the respondent Kanter is a 75% member of a member managed LLC called Cosmo Holdings LLC formed in 2007 to invest in other companies. Each member made an initial capital contribution over one-half million dollars. The operating agreement provides that a member who wishes to sell his or her interest must first make an offer to the other member to sell at a mutually agreed upon price.
In 2009, Kanter removed Gold as a signatory on Cosmo’s bank account. In May 2011, Gold petitioned to dissolve Cosmo based upon deadlock between the managing members. Gold also alleged that Kanter withheld financial information and refused to make distributions to Gold.
Justice Bucaria’s decision first summarizes the standard for judicial dissolution of LLCs under §702 of the LLC Law, as construed by the Appellate Division, Second Department, in the 1545 Ocean Avenue case:
[LLC Law] §702 provides that a court may decree judicial 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 the operating agreement. Dissolution is a drastic remedy, which is not to be granted unless management is unwilling or unable to promote the company’s stated purpose or continuing the company is financially unfeasible.
Justice Bucaria then turns to Cosmo’s operating agreement, which in critical part provides that members holding a majority of the capital interests shall elect the managers. “As the holder of a majority membership interest,” Justice Bucaria writes, “respondent [Kanter] has the authority to exclude petitioner [Gold] from the management of Cosmo.” He then finds that Gold has not established that Kanter as managing member “is unable or unwilling to promote Cosmo’s purpose of investment” and has not shown that “the continuation of Cosmo is financially unfeasible.” Justice Bucaria accordingly denies Gold’s application for judicial dissolution.
Does Gold go home empty handed, relegated to a passive-investor role for the life of the LLC? Not quite. Justice Bucaria’s decision orders a buyout appraisal of Gold’s membership interest in the LLC, stating as follows:
However, absent agreement between the parties as to buyout price, petitioner has the common law right to an appraisal proceeding for the purpose of determining the fair market value of her membership interest in the limited liability company (Appleton Acquisition, LLC v. National Housing Partnership, 10 NY3d 250, 256 ). The parties shall conduct discovery as to the fair market value of petitioner’s interest in Cosmo Holdings as of the date of the filing of the dissolution petition, May 5, 2011.
In the cited Appleton case, New York’s highest court held that under the Revised Limited Partnership Law, a limited partner could not bring a plenary action under common law to seek rescission of a merger and, instead, was restricted to his or her statutory appraisal remedy.
Other New York courts have enforced an equitable buyout of an LLC membership, albeit under special circumstances where the courts characterized the relief as a species of “liquidation” based on a finding of grounds for dissolution, such as in Lyons v. Salamone, 32 AD3d 757 (1st Dept 2006), and Matter of Superior Vending, LLC, 71 AD3d 1153 (2d Dept 2010). As far as I know, the decision in Gold is the first instance in which a court granted a straight buyout remedy for an LLC member without there being a basis for dissolution. It will be interesting to see if other courts follow Gold‘s lead.
The second case, involving a less momentous but still novel remedy in an LLC dissolution proceeding, is Scomello v. Pascarella, 2011 NY Slip Op 51965(U) (Sup Ct Suffolk County Nov. 2, 2011). The LLC in Scomello operates a non-medical clinic offering various skin care and “appearance enhancement” treatments. The plaintiff and defendant, each owning a 50% interest in the member-managed LLC, filed suit and counter-suit accusing each other of various financial and management irregularities. The defendant’s counter-suit included a claim for dissolution under LLC Law §702 and a request for appointment of a temporary receiver to manage the business pending the litigation. Both parties also moved for preliminary injunctive relief of various sorts.
The decision by Commercial Division Justice Emily Pines comments that the two members present “diametrically opposed allegations of what has occurred in their business relationship,” and that “the continued operation of the LLC may depend on an equitable accounting in accordance with the [Operating] Agreement’s provisions.” To maintain the status quo and preserve the LLC’s assets, Justice Pines permits the plaintiff member to continue managing the LLC but under a preliminary injunction that restrains either member from withdrawing LLC funds for himself without the other’s consent, or otherwise transferring funds except in the ordinary course of business.
The novelty in Scomello is Justice Pine’s appointment of a temporary receiver, not to manage the business, but simply to monitor its financial activities. Here’s how she describes the scope of the receiver’s duties:
Thus a limited preliminary injunction should remain in effect along with the appointment of a temporary receiver with limited powers to receive monthly statements and back up documents, setting forth all income received and expenses paid by the LLC as well as all member withdrawals and payments of any kind.
Why is this novel? As explained in a decision some years ago by Justice Leonard Austin before his elevation to the Appellate Division, the LLC Law’s provisions governing judicial dissolution have no provision for appointment of a receiver until after dissolution is decreed. This omission stands in contrast to §1113 of the Business Corporation Law, which expressly authorizes a court in dissolution cases involving close corporations to appoint a temporary receiver with broad powers to preserve company assets while the dissolution case is pending. An alternative path to receivership for any type of business entity is provided in Article 64 of the Civil Practice Law and Rules, but the courts apply a much more rigorous showing of imminent harm to the business before acting under that Article — a showing that does not appear to have been made in Scomello.
The monitoring powers granted by Justice Pines in Scomello effectively address a recurring problem in many dissolution proceedings — not just LLCs — where one side has little or no access to real-time financial information while the case goes on. Courts often will direct the controlling side to make ongoing disclosure but, almost invariably, new disputes will arise over the adequacy or timeliness of the disclosure. An independent receiver serving only as monitor, acting with the imprimatur of the court, is in a far superior position to enforce disclosure obligations and to convey information the non-controlling side as needed.
Update August 26, 2015: The court-ordered buy-out remedy in Matter of Gold appears not to have been consummated, as indicated in a decision and order by Justice Bucaria dated August 11, 2015 (read here) granting the petitioner’s unopposed motion for a default judgment of dissolution of the LLC. Why it took almost four years is a mystery to me.