Rare is the petition for LLC dissolution not immediately greeted by a motion to dismiss by the non-petitioning members.
Don’t get me wrong. Pre-answer motions to dismiss are a staple of all kinds of litigation including business disputes. It’s just that, in my experience, as compared to more pedestrian matters such as contract disputes based on nonpayment or delivery of defective goods, the open-endedness of the standard for judicial dissolution of LLCs gives the non-petitioning member greater room and incentive to argue that the petition does not adequately allege grounds for relief and therefore should be dismissed out of the gate.
The member seeking dissolution and his or her counsel have choices to make that can affect the odds of surviving an early dismissal motion:
- File for dissolution by summons and complaint in a plenary action, or by petition in a special proceeding?
- If utilizing a special proceeding, commence it by order to show cause or by notice of petition?
- Whether using a complaint or petition, allege the bare minimum facts or lay out detailed testimonial and documentary evidence as if it were a summary judgment motion?
Plenary Action vs. Special Proceeding. New York’s rules of civil procedure distinguish between an action initiated by traditional summons and complaint and a special proceeding initiated by a petition and either order to show cause or notice of petition. As I’ve written previously, a member may seek judicial dissolution of an LLC using either form, unlike dissolution of a close corporation which by statute must be sought by petition and order to show cause in a special proceeding. On a motion to dismiss, the procedural choice of a special proceeding to seek LLC dissolution simultaneously tees up for the court’s determination at the initial, combined hearing of the petition and motion to dismiss the sufficiency of the evidence supporting grounds for dissolution and whether there exist factual disputes necessitating an evidentiary hearing. If brought as a plenary action, the court’s inquiry on the pre-answer dismissal motion is limited to the narrower, non-merits based grounds, such as failure to state a valid claim, lack of standing, statute of limitations, etc., spelled out in Section 3211(a) of the Civil Practice Law and Rules, as this case held. The CPLR’s more restrictive approach to discovery in special proceedings also can influence the choice of form when anticipating a motion to dismiss.
Order to Show Cause vs. Notice of Petition. If the member seeking dissolution opts to bring a special proceeding, the rules permit the petition to be brought on either by order to show cause or by notice of petition. With the show cause order, there’s no guarantee the petitioner will be permitted to file reply papers; it’s up to the judge’s discretion. If the respondent files a separate dismissal motion, as a practical matter the petitioner’s opposition to the motion will double as reply papers in further support of the petition, so this choice is not as potentially important as the others. Rather, the main differences are timing (the order to show cause usually gets before the judge for an initial hearing quicker than if a notice of petition is used) and whether the petitioner wants interim relief such as a temporary restraining order, in which case the order to show cause method is required.
Notice Pleading vs. Detailed and Documented Facts. I’ve preached numerous times (e.g., here) that a petition in a special proceeding seeking judicial dissolution should allege and document in as great detail as possible all the facts and circumstances demonstrating grounds for dissolution, as if it were a motion for summary judgment. I state this as a general rule, recognizing that there may be circumstances when holding back certain information until a later, more propitious time may be to the advantage of the member seeking dissolution. But any decision to hold back evidence must bear in mind the court’s function and authority at the initial hearing of the petition to make a summary determination on the merits to the extent no triable issues of fact are raised. The potential for a motion to dismiss does not alter this. The analysis is more nuanced when dissolution is sought by ordinary summons and complaint, where the purpose of the relaxed pleading standards is simply to provide adequate notice of the claim. Still, in my view, it’s a mistake to limit the complaint’s allegations to a bare recital of the elements of a claim for LLC dissolution, i.e., that it is no longer reasonably practicable for the LLC to carry out its stated purpose under the operating agreement or that it has become financially unfeasible. Failure to include evidentiary facts supporting those allegations enhances the likelihood of a successful motion to dismiss by the opposing members.
The Koch Case
Let’s see how these concepts played out in an LLC dissolution case decided a couple of weeks ago by a Manhattan judge, in Koch v HC Hospitality Partners, LLC, 2015 NY Slip Op 30828(U) [Sup Ct NY County May 18, 2015].
The case involves a dispute between two 50% factions of an LLC formed in 2012 to own and operate certain restaurants, bars and other venues in New York City. The LLC’s operating agreement vested sole management rights in the designees of the respondent members, subject to member approval for specified major decisions. The petitioners, two brothers, simultaneously entered into consulting agreements with the LLC giving them certain operational, oversight and marketing responsibilities.
In early 2014, the petitioners sued to dissolve the LLC. They did so by commencing a special proceeding by petition and notice of petition. The 7-page verified petition (read here) consists of 24 paragraphs, all but 2 or 3 of which consist of party identification and background, references to the operating agreement, and boilerplate claims for relief under the dissolution statutes, LLC Law sections 702 and 703.
The only arguably substantive allegations of grounds for dissolution are found in paragraphs 15-16, mentioning in summary fashion that the respondents previously brought suit in the company’s name against the petitioners for alleged violation of a non-compete agreement without getting member consent for the suit, and paragraph 17 stating as follows:
Upon information and belief, Respondents continue to operate the business of the Company without the involvement or participation of Petitioners, have used the income of the Company to pay personal obligations, have intentionally failed to pay debts owed by the Company (currently amounting to approx [sic] $182,000, if not more) including to former employees, consultants and vendors of the Company on the pretext that the Company has no readily available cash. The Company’s 2012 Partnership Return reflects total assets consisting of only $8,320 in cash. The former employees and vendors of the Company have repeatedly contacted Petitioners begging for payment of their respective invoices and/or unpaid salaries/commissions.
Under LLC Law § 702’s standard for dissolution as pronounced by the Second Department in the 1545 Ocean Avenue case, and under First Department case law (Doyle v Icon and more recently, Barone v Sowers) holding that a non-controlling member’s exclusion from management by itself does not constitute a valid claim for LLC dissolution, it’s difficult to see how the sparse allegations in the Koch petition could survive a motion to dismiss.
Which also is how the Koch respondents saw it, as evidenced by their promptly-filed motion to dismiss based on failure to state a valid claim for dissolution. Their memorandum of law (read here) predictably argued that the petition failed to present any factual evidence and failed to meet the standard for judicial dissolution.
The petitioners opposed the dismissal motion with a detailed, 21-page affidavit (read here) attaching numerous exhibits showing (or so they alleged) the LLC’s dire financial circumstances, the irreconcilable breakdown of relations between the 50/50 owners, and the respondents’ mismanagement of the company’s business operations. Their memorandum of law (read here) argued that “lack of evidence” was not a proper ground for dismissal on a pre-answer motion under CPLR 3211(a) for failure to state a claim, and that the petition’s allegations, as supplemented by their opposing affidavit, adequately alleged grounds for judicial dissolution.
The court’s decision by Justice Ellen Coin, after summarizing the parties’ contentions, denied the motion to dismiss, directed the respondents to file an answer, and stayed the proceeding pending the completion of discovery in the related non-compete litigation, writing as follows:
[D]issolution of a limited liability company is a drastic remedy. At this point, neither side has adequately demonstrated whether the management of [the LLC] is unable or unwilling to reasonably permit its stated purpose to be realized or whether continuing to operate [the LLC] is financially feasible.
The parties sharply dispute whether the company is being operated according to the terms of the Operating Agreement. They also dispute the financial viability of the company including, among other things, the amount of its debts and whether such debts are being paid.
In light of such factors, and as there has been no discovery as yet in the proceeding, the court finds it premature to determine whether dissolution is appropriate.
Earlier in this post I noted that a pre-answer motion to dismiss in a dissolution case brought as a special proceeding simultaneously tees up for the court its merits-based determination as to the sufficiency of the evidence supporting grounds for dissolution and whether there exist factual disputes necessitating an evidentiary hearing. The court’s decision in Koch is a perfect example of this, and shows how the petitioners’ evidentiary showing in opposition to the dismissal motion effectively salvaged the perfunctory allegations in their petition subject, of course, to any appeal the respondents may pursue in the Appellate Division.