You know something’s seriously wrong with an LLC when the members can’t even agree on its name.
In a decision earlier this month by Suffolk County Commercial Division Justice Thomas F. Whelan, in Flax v Shirian, 2014 NY Slip Op 51229(U) [Sup Ct, Suffolk County Aug. 15, 2014], the court mercifully decreed death for a hopelessly dysfunctional, multi-member real estate holding company identified by one side as 27th Street Associates, LLC, by the other side as 27th Street, LLC, and in the property deeds and records of the New York Department of State, as 27 Street LLC.
But the name was the least of it. The LLC, formed in 2005, the following year invested over $4 million to acquire a tract of real property in Long Island City for the purpose of developing it with condominium housing. Eight years later, amidst a red-hot real estate market, nothing’s been built, there are two pending lawsuits among the members, one of the two, defined membership groups in the LLC itself has fallen into disarray, and all attempts at buy-out have failed.
You might think such are the ingredients for a successful petition for judicial dissolution of the LLC under Section 702 of the LLC Law, which authorizes the court to compel dissolution “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” But, although requested in Flax, Justice Whelan determined that court-ordained dissolution under § 702 was unnecessary because the circumstances triggered a contractually-required dissolution under the provisions of the operating agreement.
The Operating Agreement
The LLC’s operating agreement created two membership groups, denominated the Shirian Group and the Emmy Group, with each group consisting of multiple individuals. Collectively each group held a 50% membership interest. The Shirian Group was charged with responsibility for development and construction of the condominium project, and the Emmy Group with business and financial matters.
The operating agreement addressed events of dissolution in Sections 7 and 13. Section 7 (a) of the operating agreement vested management of the LLC “in its Members acting as Managers” and provided that all decisions require “the unanimous consent of the Managers.” Section 7 (b) provided that any dispute between “Members acting as Managers” which “prohibits the proper continuation of the Company’s business” shall result in “the Company being dissolved and its assets sold in bulk liquidation” unless the two membership groups are able to agree upon a buy-out or a sale of the LLC’s assets to a third party.
Section 13 listed a series of other dissolution events including death, expulsion or bankruptcy of a member of any group, unless the members of the other group vote to continue the business. It also provided for dissolution of the LLC upon a sale of all of the company’s assets, the cessation of its business operations, or a default by either of the member groups and the election of the other group to dissolve, where default was defined in Section 6 (d) as a default in the performance of the duties and obligations of either group that is “substantial and material.”
The plaintiff in Flax held a 21.25% membership interest as part of the Emmy Group. His complaint generally alleged that, beginning in 2012, serious disputes arose between the plaintiff and the Shirian Group members, as well as between plaintiff and the other Emmy Group members, resulting in management deadlock that precluded the LLC from achieving its real estate development purpose. The plaintiff also accused the Shirian Group members of instituting in bad faith a separate lawsuit against plaintiff claiming breach of fiduciary duty, and wrongfully refusing to negotiate a buy-out. The other members of the Emmy Group were likewise charged with such wrongful refusals and with breaching their obligations to make capital contributions and with dereliction of their duties.
The complaint asserted causes of action seeking a judicial declaration and specific performance dissolving the LLC pursuant to Sections 7 and/or 13 of the operating agreement and liquidating the LLC’s real property; judicial dissolution pursuant to LLC Law § 702; and for damages for breaches of the operating agreement.
Plaintiff’s Summary Judgment Motion
The plaintiff moved for partial summary judgment on his claim for judicial dissolution under § 702, however, as Justice Whelan noted in his ruling, plaintiff’s supporting papers also relied on the trigger events specified in Sections 7 and 13 of the operating agreement as grounds for dissolution. The plaintiff contended that because his Emmy Group co-members were siding with the Shirian Group against him, the Emmy Group had become incapable of making business decisions and that the Emmy Group itself had suffered a dissolution warranting a dissolution of the LLC under Section 13 of the operating agreement. The plaintiff also contended that the unanimous decision making required under Section 7 (a) of the operating agreement was impossible thereby warranting dissolution under Section 7 (b).
The defendants opposed the motion on the merits, and argued that the motion was premature due, among other things, to the absence of depositions.
The Court’s Decision
Justice Whelan launches his legal analysis with a highly useful summary of statutory and case authorities describing the interplay between the LLC Law’s default provisions and operating agreements, and explaining the judicial and non-judicial pathways to dissolution under Article 7 of the LLC Law. (If you’ll permit me to toot my own horn, Justice Whelan’s discussion of the latter point cites three case authorities, in two of which I was counsel for the prevailing party and in the third, the court’s decision cited one of my articles.)
The dissolution framework, Justice Whelan observes, makes “alternatively available” to the plaintiff judicial dissolution under § 702 and contractual dissolution under the operating agreement, the latter conforming to LLC Law § 701 (a) (2) stating that an LLC is dissolved upon “the happening of events specified in the operating agreement.” He then finds that the contractual basis for dissolution deserves priority, writing as follows:
It is clear, however, that the contractual claim for dissolution, which is properly advanced herein as a First cause of action, plenary claim for declaratory relief, enjoys priority over the statutory claim provided by LLCL §701. If successfully prosecuted, this contractual dissolution claim will extinguish the statutory claim under LLCL § 702 that initially co-existed with the contractual claim albeit, in the alternative, in view of the priorities dictated by LLCL § 701. Consequently, the court will first consider the plaintiffs’ entitlement to a declaration that dissolution has occurred under the terms of the operating agreement as demanded in the First cause of action advanced in the complaint.
Justice Whelan ultimately decides that contractual dissolution is warranted under Section 7 of the operating agreement, but before getting there he rejects a number of the plaintiff’s arguments for dissolution under Section 13:
- Plaintiff’s claim, that dissolution was triggered under Section 13 (a) by “dissolution” of the Emmy Group, fails because the provision refers to dissolution of the members, not the member groups.
- Plaintiff’s alternative claim, that dissolution was triggered under Section 13 (f) due to the other Emmy Group members’ non-payment of their share of the Emmy Group’s capital contributions, fails because the plaintiff made up the deficit, thus there was no performance default by the Emmy Group under Section 6 (d), and no consequent election to dissolve by the Shirian Group.
- Plaintiff’s remaining arguments for dissolution under Section 13, based on the alleged scheme by the other members to expel or marginalize him as a member, and the purported cessation of the LLC’s business operations, Justice Whelan wrote, “have no evidentiary support in the record nor are the plaintiff’s conclusions with respect thereto rooted in controlling statutory or case authorities.”
Turning to Section 7, Justice Whelan finds that the plaintiff successfully established grounds for dissolution based on the provision’s unanimous consent requirement. The following explanatory quote from the decision is lengthy but worth reading:
The record reflects by proof in admissible form that this failure arose in 2012 from the various disputes between plaintiff Flax and the other members of the company, including the deep discord over Flax’s proposal to sell the premises at a profit without development rather than to develop them with condominium housing as now advocated by the other member/managers. The unanimous consent provision of ¶ 7(b) requires that the dispute causing the absence of unanimous consent of all member/managers be of such magnitude that it “prohibits the proper continuation of the Company’s business”.
A review of the record adduced on this motion reveals that there is ample proof that these disputes are of a sufficient magnitude to have caused a prohibition of the proper continuation of the company’s business. Not contested is that the Shirian defendants and plaintiff, Edward Flax, are at war with each other in various courts in this state in which both sides outline disputes which render unanimous consent by the two separate member groups, impossible. There is also ample evidence in the record demonstrating that disputes between the plaintiff and his fellow EMMY defendants are of a sufficient magnitude to render the EMMY group members incapable of acting together and in concert as member/managers of their group and of the company. The record also contains sufficient evidence that the result of these disputes, all of which rest upon a failure of unanimous consent, prohibit the proper continuation of the company’s business as evidenced by the minimal progress that has been made towards accomplishing stated purposes of the company, namely, the development of company owned premises with condominium units and the sale thereof for the benefit of company members.
Had there been no unanimous consent provision in the Operating Agreement, the company may have continued to pursue its business objectives (see e.g., In re 1545 Ocean Ave., LLC, 72 AD3d 121, supra). There is, however, such a provision and the suggested buy-out remedy provided therein failed, as engagement in such remedy is not mandatory, but instead, left to the election of each group with its members acting in concert. The record is replete with evidence that only the members of the Shirian group is capable of acting in concert thus putting the voluntary, contractual, buy-out remedy beyond the reach of the parties who have been unable to agree buy-out offers previously proposed. The court thus finds that the contractual dissolution mandated upon a failure of unanimous consent as provided in ¶ 7(a) and ¶ 7(b) of the Operating Agreement has was triggered in 2012 and that plaintiff Flax has established a prima facie entitlement to a judicial declaration to that effect.
Justice Whelan next analyzes the defendants’ various opposing contentions, none of which, he concludes, raises a genuine issue precluding summary judgment in plaintiff’s favor directing contractual dissolution.
The decision raises two other points of interest. First, Justice Whelan rejects plaintiff’s request for authority to “liquidate/sell” the LLC’s real property, since the operating agreement does not authorize any one member to do so. Instead, the decision schedules a conference at which “the court shall hear input from the parties as to the formulation of the particulars of the sale of the company’s assets in bulk liquidation as set forth in ¶ 7 of the Operating Agreement.”
Second, Justice Whelan rejects the defendants’ request to be afforded the opportunity to buy out the plaintiff’s membership interest under court supervision, in lieu of the LLC’s dissolution and the sale of its assets. “While that remedy is indeed available to litigants in a statutory dissolution proceeding brought pursuant to LLCL § 702 because the statutory remedy is equitable,” Justice Whelan notes, it is not available “where the dissolution occurs under the terms of an operating agreement as contemplated by LLCL § 701(a)(2).”
One final observation: The LLC in Flax had six managing members. It’s highly unusual, and in my view ill-advised, for a significantly capitalized real estate development company with a half dozen managing members to include in its operating agreement a unanimous consent requirement for all business decisions, particularly when paired with a vaguely-defined provision for dissolution automatically triggered by “any dispute” that “prohibits the proper continuation” of the LLC’s business. With that kind of provision, the only thing that surprises me about Flax is that it took so long for the LLC to implode.