A one-third owner of a company sues for dissolution, alleging he has been systematically excluded from the operations and affairs of the business, and that his co-owners have refused to account for or pay him his share of the profits, all of which they have taken for themselves.
If this were a suit by the minority shareholder of a close corporation, claiming that the majority owners were guilty of oppressive conduct warranting judicial dissolution under §1104-a of the Business Corporation Law, chances are the complaint would easily withstand a pretrial defense motion for dismissal on the grounds of legal insufficiency.
Now take the same allegations, but this time assume the business is organized as a limited liability company (LLC) instead of a corporation, and that dissolution is sought by a minority member under §702 of the LLC Law. Would the complaint similarly withstand a motion to dismiss at the pleading stage?
Unfortunately for the complaining LLC member in Doyle v. Icon, LLC, 2013 NY Slip Op 00797 (1st Dept Feb. 7, 2013), decided earlier this month by a Manhattan appellate panel, the answer is “no”. The fact that the appellate decision reversed a lower court ruling that upheld the complaint further highlights the crucial, conceptual distinction between the bases for judicial dissolution of corporations and LLCs.
The setting for Doyle is a trendy nightspot in downtown Manhattan known as the R Bar. The R Bar is owned by Icon, LLC which was formed in 2001 by David Finnegan, Sean Cunningham and Keith Doyle as equal one-third members. The members never entered into a written operating agreement. According to the material allegations of Doyle’s complaint filed in September 2009 (read a copy here), starting in early 2007 Finnegan and Cunningham:
- “systematically excluded” Doyle “from the operations and affairs of the Company”;
- “failed and refused to account to [Doyle] in regard to the Company’s assets and affairs” or “as to the profits and losses of the Company”;
- “failed to hold annual and/or regular meetings of the members of the Company”;
- “disposed of the Company assets without [Doyle’s] knowledge or consent”;
- “failed and refused to pay [Doyle] his share of the profits and/or award distributions to [Doyle]”; and
- “converted [Doyle’s] share of Company distributions to their own benefit and use”.
Doyle’s complaint asserted a claim for judicial dissolution under LLC Law §702 which authorizes the court to “decree 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 operating agreement.”
Finnegan and Cunningham filed a motion to dismiss the complaint on the ground that its allegations failed to state a valid claim (read here their supporting memorandum of law). The trial court denied the defense motion in an unpublished memorandum decision dated April 4, 2011 (read here).
The court cited, among other cases, the Second Department’s opinion in 1545 Ocean Avenue — the leading New York appellate decision interpreting §702’s standard for dissolution — under which dissolution is appropriate when, in the context of the operating agreement, (1) the management of the LLC is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be achieved, or (2) continuing the LLC is financially unfeasible. The court held that Doyle’s allegations, “the gravamen [of which] is that [Doyle] was excluded from Icon’s managerial decisions and deprived of the rights ensuing from his one-third interest . . . are sufficient to state a claim for judicial dissolution pursuant to §702.”
Finnegan and Cunningham appealed the decision to the Appellate Division, First Department, which issued a short opinion reversing the lower court’s ruling and ordering dismissal of the dissolution claim on the ground that the complaint’s allegations fail to satisfy §702’s standard as construed in 1545 Ocean Avenue. Here’s what the court wrote:
Plaintiff’s allegations that he has been systematically excluded from the operation and affairs of the company by defendants are insufficient to establish that it is no longer “reasonably practicable” for the company to carry on its business, as required for judicial dissolution under Limited Liability Company Law § 702. The allegations do not show 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” (see Matter of 1545 Ocean Ave., LLC, 72 AD3d 121, 131 [2d Dept 2010]; Schindler v Niche Media Holdings, 1 Misc 3d 713, 716 [Sup Ct, New York County 2003]). Indeed, the allegations show that the company has been able to carry on its business since the alleged expulsion of plaintiff in 2007; the allegation that defendants failed to pay plaintiff his share of the profits and award him distributions shows that the company is financially feasible.
Doyle, as a one-third member of an LLC without an operating agreement, lacked a basis to allege that the LLC could not continue operating in conformity with the statutory default rules that give management control to Finnegan and Cunningham as the two-thirds majority. As the court also emphasized, his own allegation of withheld profits proved fatal to any contention that the LLC was financially failing. Whether Doyle possesses other viable claims against Finnegan and Cunningham, e.g., for failing to make profit distributions to him, was not before the appellate court.
In fairness to Doyle, his complaint preceded by about six months the 1545 Ocean Avenue decision, which dramatically shifted LLC dissolution jurisprudence away from the notion, accepted in a number of previous lower court decisions, that allegations of oppressive conduct by the majority against the minority sufficient to state a claim for dissolution under BCL §1104-a also suffice under LLC Law §702. Post-1545 Ocean Avenue, however, it is clear that the complaining member’s factual allegations in support of dissolution cannot focus solely on the impact of the alleged misconduct or other circumstances on his or her personal rights or expectations of participating in company management and profit sharing.
Doyle reinforces that the focus instead must be on the business of the LLC and whether it is failing financially or that the dispute among the members has made it no longer reasonably practicable to continue operations in conformity with the operating agreement or, where there’s no operating agreement, in conformity with the LLC Law’s default rules.
Update January 10, 2015: In a decision dated December 17, 2014 (read here), the trial court denied Doyle’s motion seeking summary judgment in his favor on his surviving claims for conversion of his LLC membership interest, unjust enrichment, and for an accounting. The court’s decision recites in detail the parties’ factual allegations that, if nothing else, underscore the perils of failing to document properly the members’ ownership rights and obligations as they evolve over time in response to business exigencies.