gas pumpA gas station in Poughkeepsie, New York, is the prosaic setting for a noteworthy decision last month by Dutchess County Supreme Court Justice Christine A. Sproat judicially dissolving a limited liability company owned equally by two brothers.

The court’s unpublished decision in Matter of Zafar (M&D of Dutchess, LLC), Index No. 3123/15 [Sup Ct Dutchess County Dec. 4, 2015], is one of the few LLC dissolution cases I’ve seen centered on allegations of looting and diversion. While looting and diversion are expressly made grounds for dissolution under the statute governing close corporations, they are not mentioned in the LLC dissolution statute. Nonetheless, the court in Zafar found that the nature and extent of the managing member’s “persistent self-dealing and dishonest conduct” — I’m quoting from the court’s decision — made it, in the language of LLC Law § 702, “not reasonably practicable to carry on the business . . . in conformity with the articles of organization.”

The case pits petitioner Mobashar Zafar against his younger brother Dawood Ahmed as 50/50 members of M&D of Dutchess, LLC. According to Zafar’s petition (read here), the brothers owned the gas station as tenants in common from 1986 until they conveyed it to their newly formed LLC in 1999 at which time the station was under lease to a third-party operator. The brothers never had a written operating agreement but in practice agreed that the younger brother, Ahmed, who lived in the area, would alone manage the LLC’s business affairs.

Zafar received from Ahmed what he (Zafar) thought was his 50% split of the net rental proceeds through 2014 when, according to the petition, Zafar discovered that Ahmed was collecting and keeping for himself additional rents from the station tenant. Zafar subsequently obtained a copy of the tenant’s 2011 lease which, lo and behold, identified the landlord not as M&D of Dutchess, LLC, but a company with a similar name, M&D Dutchess Property, LLC. In fact, no such entity was ever legally formed but Ahmed did form in 2006 another similarly named company, M&D Dutchess Properties, LLC.

To Zafar’s further dismay, as an express condition of entering into the 10-year lease, the 2011 lease required the tenant to pay upfront to Ahmed, personally, what is commonly known as “key money” in the sum of $100,000, which Ahmed never disclosed to, or shared with, his brother. Even worse, Zafar subsequently learned of another $46,000 key money payment to Ahmed by the same tenant for a prior lease term which, likewise, Ahmed neither disclosed to, nor shared with, Zafar.

In support of his showing that the purpose of the LLC, to own and lease the gas station, no longer can be achieved, Zafar alleged, apparently without contradiction by Ahmed, that due to Ahmed’s actions the LLC (i) holds no lease in its own name, (ii) collects no rents, (iii) has no bank account, (iv) files no tax returns, and (v) does no business. Zafar argued that Ahmed’s personal “usurpation” of the business warranted judicial dissolution under LLC Law § 702 or, alternatively, a compulsory “equitable” buy-out of one member by the other at fair market value.

In his answer and affidavit opposing the petition, Ahmed claimed that all funds in his possession relating to the gas station “are held solely for the benefit of M&D Dutchess” which is “alive and well and is operating as contemplated by the members when the Company was formed and as provided in the Articles of Organization.”

Ahmed contended that Zafar knew all along and never objected to his handling of the company finances and the absence of a company bank account; that Zafar received half of all net rental proceeds; and that over the 25 years since they bought the property, Ahmed alone put in substantial, uncompensated “sweat equity” and incurred unreimbursed legal and other expenses developing, maintaining, improving, and operating the property.

Ahmed also argued that Zafar’s allegations failed to demonstrate that the LLC could not continue its business in conformity with its Articles of Organization (which contained the minimal, statutorily required statements) and that Zafar’s appropriate recourse, if any, for Ahmed’s alleged financial misconduct was by way of an action asserting derivative claims, not a dissolution proceeding.

Justice Sproat in her decision bought none of that, essentially agreeing with Zafar that Ahmed’s diversion to other entities and himself of the gas station leases and income warranted dissolution. Here’s what she wrote:

The petitioner has submitted uncontroverted evidence of respondent Ahmed’s personal exploitation of  the LLC’s sole asset. The evidence reveals that respondent Ahmed has ceased operation of the respondent LLC in favor of his own competing interests. Specifically, respondent Ahmed has formed “his own corporate entities and sole proprietorships to exploit the [respondent LLC’s] Premises for his own use and benefit while diverting leases, business opportunity, money and control away from the [respondent LLC] and the petitioner, its 50% member.” (Verified Petition, paragraph 24.) Based upon respondent Ahmed’s persistent self-dealing and dishonest conduct, together with the 50-50 member deadlock between petitioner and respondent Ahmed, this Court determines that “it is not reasonably practicable to carry on the business [of the LLC] in conformity with [its] articles of organization (LLCL § 702.) The “disagreement or conflict among the members regarding the means, methods, or finances of the company’s operations is so fundamental and intractable as to make it infeasible for the company to carry on its business as originally intended.” (Matter of Fassa Corp., 31 Misc.3d 782 (2011) quoting Matter of 1545 Ocean Ave., LLC, 72 AD3d 121, 133 [Fisher, J., concurring in part and dissenting in part].) Accordingly, the petitioner’s application for dissolution of M&D of Dutchess, LLC must be granted.

Finally, explicitly adopting Justice Demarest’s technique in the Natanel case, Justice Sproat encouraged the brothers to work out the terms of their business divorce by delaying her appointment of a liquidating trustee under LLC Law § 703 to give them the opportunity to “agree upon a more appropriate course of action, such as an agreed buyout or a mutually-agreeable broker to market the property.” Ultimately it didn’t work in Natanel, which also involved a single asset realty company. We’ll just have to wait and see if the parties in Zafar can do better.

My thanks to Darren Fairlie, the attorney for Mr. Zafar, for sharing the court’s decision.