The leading New York case on the standard for judicial dissolution of limited liability companies, Matter of 1545 Ocean Avenue, LLC, held that the proponent of dissolution must show, in the context of the terms of the operating agreement or articles of organization, that:
(1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible.
Note that the first prong of the standard uses the words “stated purpose” which usually is expressed in the so-called “purpose clause” of the LLC’s operating agreement. Often the purpose clause is drafted broadly, authorizing the LLC to engage in “any lawful business purpose” or using similarly expansive language which can make it more difficult to establish grounds for dissolution under the 1545 Ocean standard.
Sometimes operating agreements define the LLC’s purpose more narrowly, authorizing the company to engage in a particular business pursuit. Frequently a narrow clause is used for limited purpose real estate companies, i.e., the clause will identify the specific investment property to be owned and operated by the LLC, which, in tandem with other provisions limiting fiduciary duties, can serve to clarify the members’ freedom to invest in other real estate ventures without breach.
It stands to reason that the narrower the purpose clause, the easier it should be to satisfy the first prong of the 1545 Ocean standard. But what happens when the operating agreement’s purpose clause sets forth one specific business pursuit but the LLC profitably is put to a different purpose? Can a member who, at least for a time, goes along with the different pursuit seek dissolution claiming that the LLC’s “stated purpose” is unachievable?
The Vella Case
That’s the question addressed in Vella v. JP&F Realty Holding, LLC, Short Form Order, Index No. 5545/12 (Sup Ct Nassau County Sept. 28, 2012), an unpublished decision recently handed down by Nassau County Acting Supreme Court Justice Denise L. Sher.
Vella involves the three owners of a Long Island-based commercial HVAC company called Performance Mechanical Corp. In 2007, as equal one-third members, they formed a separate company called JP&F Realty Holdings, LLC, to acquire a building to house the HVAC business. Initially the three members contracted individually to acquire a building in Maspeth, Queens, with the intent to later assign the contract to the LLC.
Prior to closing they entered into an operating agreement whose purpose clause stated that “[t]he purposes of the [LLC] are to acquire, own, hold, improve, manage and operate the real property known as 56-30 60th Street, in Maspeth, New York” and to engage in various activities incidental to the acquisition. The operating agreement included a provision requiring that any amendments be in writing. They also filed articles of organization stating that the LLC’s office is located in Queens County.
Subsequently the purchase of the Maspeth building fell through, so in 2008 the three owners found and purchased, through the LLC, another building located in New Hyde Park in Nassau County. The purchase was financed by two low interest mortgage loans totaling $738,000 facilitated by the Small Business Administration and the Empire State Certified Development Corp.
In 2012, after a falling out that pitted the petitioner Vella against his two co-owners, Vella filed two lawsuits, one concerning the ownership and operation of the HVAC business and another for dissolution of the realty LLC under Section 702 of the LLC Law. Vella contended that, because the LLC never acquired the Maspeth property, and because the operating agreement’s purpose clause was never amended in writing to authorize the purchase and operation of any other property, the LLC’s stated purpose cannot be realized and therefore dissolution is warranted notwithstanding Vella’s admitted agreement to purchase the New Hyde Park property. Vella also argued that the LLC was not in conformance with its articles of organization which were never amended to change its office location as required by Section 211(a) of the LLC Law. Vella made no allegation that the LLC was financially failing.
The respondents countered that Vella signed a variety of documents in furtherance of the mortgage financing of the 2008 acquisition of the New Hyde Park building, including a resolution stating that the LLC is duly authorized, validly exists and it is in the best interest of the LLC to enter into the loan transaction; a loan agreement stating that there is no legal bar to the loan in the LLC’s operating agreement; a mortgage agreement stating that the LLC has as its principal place of business the building being acquired; and a lease document in which it was agreed that the HVAC company would pay rent to the LLC in an amount limited to monies to pay the mortgage and taxes. The respondents argued that the documents demonstrate that the LLC “is operating and doing exactly what its Members and the Mortgage/Loan documents intended” and that the LLC “has been reasonably operating and conducting its business with the knowledge and consent of Petitioner.”
The Court’s Ruling
Justice Sher begins her analysis with a summary of governing legal principles, including:
- Judicial dissolution of an LLC is an “extreme measure” not to be undertaken merely because the LLC “has not experienced a smooth guide to profitability or because events have not turned out exactly as the LLC’s owners originally envisioned.”
- Dissolution is “reserved for situations in which the LLC’s management has become so dysfunctional or its business purpose thwarted that it is no longer practicable to operate the business, such as in the case of a voting deadlock or where the defined purpose of the entity has become impossible to fulfill.”
- “The test for whether dissolution of an LLC is warranted is whether it is reasonably practicable to carry on the business of the LLC, not whether it is impossible.”
Applying these principles and the standard enunciated in 1545 Ocean, Justice Sher finds that, “based on the papers alone,” Vella “has failed to submit the requisite evidentiary proof that it is reasonably impractical to carry on the business of the LLC” or that “the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved or that continuing the entity is financially unfeasible.”
While denying dissolution at the earliest stage of the case, Justice Sher nonetheless stops short of dismissing Vella’s petition, stating that the court “agrees with petitioner’s assertion that there is need for further discovery and a hearing of this matter on its merits.” Justice Sher in like manner denies the respondents’ motion to dismiss the petition, stating that respondents’ reliance on “unsigned copies of documents that they purport petitioner executed” does not “conclusively establish a complete defense to petitioner’s cause of action.”
Although the Vella decision does not shed much light on the court’s rationale, it nonetheless leaves us with two lessons, one substantive and one procedural. First, pay attention to the operating agreement not only when the LLC is formed, but also during the life of the LLC with an eye to any amendments that may be necessary or appropriate as circumstances change. Second, when opposing and/or moving to dismiss a petition for dissolution brought as a special proceeding under Article 4 of the Civil Practice Law and Rules, treat it as a summary judgment motion designed to show the non-existence of factual issues based on properly authenticated documents in admissible form.