OppressionFor the second time, a unanimous panel of the Manhattan-based Appellate Division, First Department, has upheld the pretrial dismissal of an action for judicial dissolution of a limited liability company under Section 702 of the LLC Law where the petitioning minority member based the claim solely on allegations of “oppressive” conduct by the majority member.

The first time was about two years ago, in Doyle v Icon, LLC (103 AD3d 440), in which the First Department reversed a lower court’s denial of a motion to dismiss a § 702 petition alleging that the controlling members had “systematically excluded” the minority member from the LLC’s business operations and profits. The court held that such allegations “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.”

In so ruling the Doyle court adopted the standard for dissolution formulated in the Brooklyn-based Second Department’s landmark decision in the 1545 Ocean Avenue case, requiring a showing that, in the context of its operating agreement, the LLC’s stated purpose can no longer be achieved or that it is financially unfeasible. Justice Austin’s opinion in that case carefully differentiated the grounds for dissolution under LLC Law § 702 from those under Article 11 of the Business Corporation Law including the latter’s statute authorizing dissolution for “oppressive” conduct by the controlling shareholders and directors.

The First Department did it again last week in a case called Barone v Sowers, 2015 NY Slip Op 04195 [1st Dept May 14, 2015], involving a complaint brought by a 20% member of a single-asset realty holding LLC against the 80% member, alleging a series of derivative claims alongside a claim for dissolution under § 702. The unanimous appellate panel affirmed the lower court’s decision by Justice Eileen Rakower dismissing the dissolution claim and also dismissing the derivative claims for failure to adequately allege that pre-suit demand was excused. 

According to the complaint (read here), in 2002 plaintiff Barone as 20% member and defendant Sowers as 80% member formed 899 Fulton LLC to hold title to a two story, commercial building in Brooklyn with a current market value of at least $3 million. The LLC’s operating agreement named Sowers as sole manager with broad powers to control the LLC’s business affairs including discretionary authority to make distributions and to “purchase, lease or otherwise acquire from, or sell, lease or otherwise dispose of, to any Person any property.”

The Oppression Claim

Barone’s complaint included a cause of action labeled “Oppression” seeking dissolution under § 702. The claim alleged that Sowers engaged in “illegal, fraudulent and oppressive conduct” (terms lifted straight out of the oppressed minority shareholder statute, BCL § 1104-a) by his “failure to sell the Premises and/or provide access to Barone of [the LLC’s] books, records and/or documents.” The claim also incorporated factual allegations that Sowers gave his own law firm a sweetheart lease for the building’s second floor offices, and that he refused to account for the proceeds from a series of refinanced mortgages.

Paying at least lip service to § 702, the complaint alleged that Sowers’ conduct made it “not reasonably practical [sic] to carry on the business of [the LLC] in conformity with the [operating] Agreement.” The only specific provision of the operating agreement cited for that proposition, Section 5.5, governs the members’ right to inspect the LLC’s books and records.

Sowers moved in the lower court to dismiss the complaint on various grounds including failure to state a valid claim, which Justice Rakower orally granted in a ruling from the bench, the transcript of which unfortunately has not been posted to the court’s website. Barone appealed, contending in his pre-argument statement (read here) that Sowers “acted contrary to the expressed purpose and business of [the LLC] by failing to realize on the value of the Premises by selling or disposing of the Premises and has caused the Premises to remain as a rental so as to benefit Sowers personally, as he wishes to maintain his status as a tenant” for his sole benefit.

Last week’s affirmance by the First Department wasted few words in rejecting Barone’s argument for reinstatement of his oppression-based dissolution claim, writing as follows:

[P]laintiff was not entitled to dissolution of the LLC, pursuant to New York Limited Liability Company Law § 702, since the stated purpose and business of the LLC was to “acquire, improve, own, manage, sell, dispose of, and otherwise realize on the value of” the premises, and the allegations in the complaint do not show that Sowers 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” (Doyle v Icon, LLC, 103 AD3d 440, 440 [1st Dept 2013]; Matter of 1545 Ocean Ave., LLC, 72 AD3d 121, 131 [2d Dept 2010]).

Notice the court’s reference to, and quotation of, the LLC’s “stated purpose” contained in Section 3.1 of the operating agreement, which corresponds to the first prong of 1545 Ocean Avenue‘s standard for dissolution. As I’ve pointed out before, the more broadly stated the LLC’s purpose clause, the more difficult it is for a non-controlling member to state a claim for dissolution under the first prong. That leaves the second prong — financial unfeasibility — which can be difficult to establish for a single-asset real estate holding company such as the one in Barone, where the property apparently generates rental income sufficient to pay operating expenses and debt service.

The problems encountered by the plaintiff in Barone — his inability to force a sale of the LLC’s realty asset, and the divergence of economic interests where the majority member also leases a portion of the property — are not uncommon for holders of non-controlling interests who fail to bargain for and secure adequate safeguards and exit rights in the operating agreement.

Pleading Demand Futility

The other, important lesson to be learned from Barone concerns pleading standards for derivative claims by LLC members. Borrowed from BCL § 626, the standard requires the plaintiff to allege with particularity either the making of a pre-suit demand upon the controllers, or that such demand would have been futile.

The Barone complaint alleged that since Sowers owns 80% of the LLC, it would be futile for Barone to make a demand upon him to consent to the filing of an action on the LLC’s behalf. The First Department held this allegation insufficient and dismissed the complaint’s remaining claims, explaining that

this Court has made clear that Business Corporation Law § 626(c) “does not differentiate between minority and majority shareholders for demand purposes” (see Ocelot Capital Mgt., LLC v Hershkovitz, 90 AD3d 464, 466 [1st Dept 2011]). We note that Sowers’ alleged concealment of financial information does not warrant a finding that demand was futile, since “[a] corporation’s refusal to provide information to its shareholders is not on the [] list of circumstances where demand is excused” (Wyatt v Inner City Broadcasting Corp., 118 AD3d 517, 517 [1st Dept 2014]).

Update May 29, 2015:  Over at the New Jersey Business Dissolution Journal, Jay McDaniel compares and contrasts New York’s § 702 and Barone with the more oppression-friendly standards under New Jersey’s LLC dissolution statute and case law.