Under the LLC Law’s provision authorizing judicial dissolution and its interpretive case law, determining an LLC’s purpose can be essential to adjudicating whether it no longer is reasonably practicable to carry on its business in conformity with the operating agreement — in other words, whether its purpose has failed.
Failed purpose cases generally fall into one of two categories: those with written operating agreements containing express purpose clauses, and those without. In the latter category, where the LLC either has no written operating agreement or has one lacking a purpose clause, the member seeking dissolution may succeed through testimony and circumstantial evidence showing the failure of the LLC’s intended purpose. The Natanel case, which I litigated and wrote about here, was such a case resulting in judicial dissolution of a single asset, realty-owning LLC purchased to house the co-owners’ separate moving and storage business which eventually went out of business leaving the building largely vacant.
In the former category, the petitioner may face a more daunting if not impossible path to dissolution when an otherwise financially viable LLC’s written agreement contains a typical, broad purpose clause permitting any lawful business activity, such that the termination of the LLC’s initial business, e.g., owning a certain property or holding a certain investment portfolio, may transmute into something entirely different without running afoul of the dissolution statute.
Matter of Ross
The petitioner in Matter of Ross (427 Old Country Road, LLC), Short Form Order, Index No. 605338/15 [Sup Ct Nassau County Dec. 10, 2015], decided earlier this month by Nassau County Commercial Division Justice Timothy S. Driscoll, apparently thought his case, like Natanel, was unbound by any operating agreement when, as one of three brothers each holding a one-third membership interest, he filed for dissolution of a realty owning LLC after its sole commercial property was sold, generating a multi-million dollar profit that his brothers refused to distribute in order to invest in other property, or so they claimed.
The dissident brother’s petition (read here) made no mention of an operating agreement. It alleged that the LLC was formed “as a single purpose entity for the primary purpose of acquiring, owning and operating commercial real property . . . for which to house, under lease, a ‘patio.com’ retail store operated by a related entity,” and that following the property’s sale to an unrelated buyer for over $6.6 million, the LLC “no longer conducts business, nor has any plans to operate any other business.”
When the respondent brothers answered and moved to dismiss the petition, however, they produced an operating agreement dated and signed by all three brothers just a few days before the closing of the sale of the property. According to the respondents, the operating agreement was prepared “as part of the paperwork needed to consummate” the property’s sale, at the request of the buyer’s title company.
The agreement’s broad purpose clause, in Section 1.3, provided that “[t]he purposes of the Company are to engage in any lawful act or activities for which limited liability companies may be formed under the New York Limited Liability Company Act . . ..” Section 5.1, titled “Management,” among other sweeping powers authorized the LLC’s managers to acquire, finance, develop, and operate “any property the Company comes to own in the future.” Section 8.1 provided for the LLC’s “perpetual” duration.
Based largely on the operating agreement, the respondent brothers argued that the highly profitable LLC was fully able to achieve its stated purpose by reinvesting the sale proceeds in other investment opportunities related to their operating business. The petitioner’s response was fourfold:
- Without denying his signature on the operating agreement, he alleged he was unaware the agreement had been fully executed until disclosed by respondents in the litigation.
- Based on the operating agreement’s provision for arbitration of all disputes, he promptly served an arbitration demand (which Justice Driscoll temporarily stayed at respondents’ request) and filed a motion in court to compel arbitration and for leave to discontinue the dissolution petition without prejudice.
- He opposed his brothers’ motion to dismiss the dissolution petition, arguing there was no evidence of a bona fide intent to use the sale proceeds to acquire a new property.
- He argued that the court alternatively should order an equitable buyout by his brothers of his membership interest.
Justice Driscoll’s decision scored an unqualified victory for the respondents by dismissing the dissolution petition based on the LLC agreement’s broad purpose clause, and denying the petitioner’s application to compel arbitration based on waiver. From the decision:
Petitioner has failed to demonstrate grounds for dissolution of the Company pursuant to LLCL § 702. The Operating Agreement, which Petitioner concededly signed and whose contents Petitioner is presumed to know and assent to, provides that the Company is authorized to engage in a broad spectrum of activities and does not support Petitioner’s contention that it existed solely to own the Property. Moreover, the Company is indisputably profitable. Under these circumstances, Petitioner has not adequately alleged that 1) the management of the Company is unable or unwilling to reasonably permit or promote the stated purpose of the Company to be realized or achieved; or 2) continuing the Company is financially unfeasible. Under these circumstances, dismissal of the Petition and the Instant Action, is appropriate. The court also concludes that Petitioner waived his right to arbitrate this dispute by filing the Petition, thereby seeking the benefits of litigation.
There’s nothing unusual about a buyer’s title company requiring the seller of realty owned by a multi-member LLC to provide a valid written operating agreement in support of the seller’s authority to convey the property. If a non-controlling member of the LLC wants assurance that the LLC will be wound up and dissolved, and the net sale proceeds distributed to the members, and if the LLC doesn’t already have an operating agreement dictating that result upon the sale of the LLC’s sole asset, the wisest course is to negotiate and get it in writing before a contract of sale and last minute, LLC agreement of convenience is entered into.