A Manhattan appellate panel’s two-page decision in Gartner v Cardio Ventures, LLC, 2014 NY Slip Op 07423 [1st Dept Oct. 30, 2014], offers a dry account of a disputed transfer of an LLC membership interest, in which the court held that the terms of an LLC subscription agreement did not bar the transfer otherwise permitted under the LLC Law’s default rules.
But the story behind the decision is anything but dry. As revealed in papers filed in the lower court proceedings, the suit was brought by the ex-husband of the transferee in an attempt to frustrate a Florida court’s final judgment of divorce, requiring him to transfer to his wife one half of his membership interest in a company that operates physical therapy offices at multiple New York locations. The judgment further provided that if the transfer couldn’t be done, the wife would receive the net economic benefits of the half-interest.
Soon after the divorce judgment was entered, the husband signed a court-approved transfer document instructing the LLC to transfer half his 4% interest to his wife. The other LLC members promptly executed a consent to the transfer, admitting the wife as a 2% member.
The now ex-husband, who had fiercely resisted the transfer in the Florida divorce proceedings and had signed the transfer directive under the court’s threat of contempt, subsequently filed suit in Manhattan Supreme Court against the LLC, its managers, and his ex-wife, claiming that the transfer was “unauthorized” and “illegal,” and should be rescinded, because of language in his LLC Subscription Agreement purportedly barring the transfer of membership interests.
The specific provision relied upon, found in Section 4 of the Subscription Agreement, reads as follows:
4. Transferability. I agree not to transfer or assign this Agreement, or any interest herein; and further agree that I will not sell, assign, transfer or otherwise dispose of or encumber the Membership acquired pursuant hereto without registration under the Securities Act of 1933, as amended, or exemption therefrom and without compliance with all applicable laws.
The husband alternatively contended that a provision in the LLC’s operating agreement (which he never signed) freely permitting transfers to a “spouse,” likewise barred the transfer made after the final judgment of divorce, i.e., after his marriage was legally dissolved.
The Lower Court’s Ruling
Following completion of discovery all parties moved for partial summary judgment primarily concerning the validity of the transfer. In a decision read into the record, Manhattan Commercial Division Justice Lawrence K. Marks held that Section 4 of the Subscription Agreement:
by its terms only prohibits [plaintiff’s] unilateral disposal of his interest in the subscription agreement itself which is not at issue here. It explicitly contemplates disposal of the membership interest which is at issue here as long as such disposal complies with applicable laws. Moreover, Section 7 (I) of the subscription agreement states that any document representing the membership interest must bear a legend stating that unauthorized transfers or assignments are void ab initio. Thus, the subscription agreement clearly contemplates the possible sale or transfers of membership interests and does not support [plaintiff’s] motion for summary judgment.
Justice Marks further held that the plaintiff’s non-execution of the LLC’s operating agreement made no difference to the outcome because of the other members’ signed consents to the transfer as authorized by Section 603 and Section 604 of the LLC Law. He also dismissed as moot the plaintiff’s separate claim for access to the LLC’s financial records, finding that “[a]ny information in these books or financial records could have been caught in the discovery process.”
The Appellate Court’s Ruling
On plaintiff’s appeal from Justice Marks’s decision, the Appellate Division, First Department, affirmed in all respects save the dismissal of the books-and-records claim, which was reinstated based on the plaintiff’s “independent statutory right to conduct an inspection” under LLC Law § 1102.
As to the disputed transfer, the appellate court fully endorsed Justice Marks’s analysis, writing as follows:
Under the terms of the operating agreement, the transfer to defendant [ex-wife], which was approved in writing by a majority of the members, is expressly authorized. Even assuming that the operating agreement is invalid, the majority’s written consent to transfer the interest would govern (see Matter of Spires v Lighthouse Solutions, LLC, 4 Misc 3d 428, 433 [Sup Ct, Monroe County 2004]).
Further, the subscription agreement governs the transfer, it does not bar it. Indeed, the subscription agreement does not enumerate any restrictions on transfer, other than compliance with the law. As such, were the subscription agreement to control, the issue of transfer would be governed by the Limited Liability Company Law pursuant to which the transfer was valid based on the written consent of the majority of the members (see Limited Liability Company Law §§ 603, 604).
The outcome in Gartner is hardly a surprise. Subscription agreements are often used for closely held business entities whose ownership includes numerous passive investors, certain types of professional practices, and in other special circumstances. Their main purposes are to secure the investor’s contractual obligation to acquire for specified consideration an interest in the entity, and to memorialize the investor’s representations and acknowledgements that he or she is a sophisticated and financially suitable investor with full awareness of the risks involved.
Typically the entity’s proposed shareholders’ agreement, limited partnership agreement, or LLC agreement is among the exhibits to the subscription agreement. It is in those documents, and not in the subscription agreement, that one expects to find any applicable restrictions on transfers of the interest being acquired. The subscription agreement in Gartner was no exception, stating in Section 6 the subscriber’s consent to execute the accompanying operating agreement which, among other provisions, contains “restrictions . . . upon the transferability of the Membership interest of the Company acquired pursuant hereto.”
Finally, the possibility that a member’s marriage may dissolve, and that as in Gartner his or her membership interest may be deemed a marital asset subject to equitable distribution, is often dealt with explicitly in the operating agreement by way of provision for redemption of the entire interest on specified terms, or by limiting the transfer to an assignment of an economic interest only. The consents to the transfer of membership interest with voting rights by all of the other members in Gartner, which apparently were readily given, is unusual, in my experience.