Rosalyn H. Richter - Assocaite Justice, Appellate Division, First Department 042809

For more than 20 years, there’s been a split among New York’s several intermediate appellate courts on the question whether the state’s courts have subject matter jurisdiction in proceedings seeking judicial dissolution of foreign business entities.

No more. Last week, in a signed opinion by Associate Justice Rosalyn H. Richter (photo right), writing for a unanimous panel of the Manhattan-based Appellate Division, First Department, in Matter of Raharney Capital, LLC v Capital Stack LLC, 2016 NY Slip Op 01425 [1st Dept Feb. 25, 2016], the court abandoned its contrary 1994 ruling in Matter of Hospital Diagnostic Equipment Corp. and, realigning itself with decisions by the Brooklyn-based Second Department and Albany-based Third Department, held that New York courts lack subject matter jurisdiction over foreign company dissolution proceedings.

The Raharney case involves a petition filed in October 2014 in Manhattan Supreme Court by a 50% member of a two-member Delaware LLC with no written operating agreement, seeking judicial dissolution under § 18-802 of the Delaware LLC Act based on intractable deadlock (read petition here). The petition alleges that both members are New York residents, that the Delaware LLC’s place of business is New York, and that the LLC’s only connection to Delaware is its state of formation. The petitioner’s supporting memorandum of law predicated the court’s subject matter jurisdiction on Hospital Diagnostic in which the First Department found “without merit” the State Attorney General’s argument that the courts of New York lack subject matter jurisdiction to dissolve a foreign corporation.

The respondent member nonetheless moved to dismiss the petition, relying on a series of Second and Third Department decisions dismissing for lack of jurisdiction petitions seeking to dissolve foreign business entities, including Matter of Warde-McCann (2d Dept 1987) involving a Delaware corporation, Matter of Porciello (2d Dept 1998) involving a Florida corporation, Matter of MHS Venture Management Corp. (2d Dept 2009) involving a Delaware LLC, and Rimawi v Atkins (3d Dept 2007) also involving a Delaware LLC.

The dismissal motion came before Justice Alice Schlesinger who granted it from the bench (read transcript here), voicing agreement with the “more recent” Second and Third Department decisions and characterizing Hospital Diagnostic‘s contrary view of the jurisdictional question as “not terribly persuasive” and as “dicta.” She also distinguished Hospital Diagnostic on the basis that it involved a corporation rather than an LLC. The petitioner appealed.

In her opinion upholding the dismissal order, Justice Richter’s opening paragraph framed the issue and summarized the court’s ruling thusly:

In this appeal, we are asked to determine whether a New York court has the power to order the dissolution of a limited liability company that operates in this state, but was formed under the laws of another state. We conclude, consistent with decisions from the Court of Appeals, this Court, and our sister departments of the Appellate Division, that the courts of this state do not have subject matter jurisdiction to judicially dissolve a foreign business entity. Instead, the decision as to whether dissolution is appropriate lies with the courts of the state in which the entity was created.

The opinion reaches back to one 19th century and several early 20th century New York appellate decisions expressing the “view that a corporation could only be dissolved by the state that created it” before citing with approval the more recent Second and Third Department decisions mentioned above. Justice Richter also cited a number of decisions by appellate courts in other states holding that the courts in those states lack jurisdiction over dissolution of foreign business entities.

“We agree with the near-universal view,” Justice Richter wrote, “that the courts of one state do not have the power to dissolve a business entity formed under another state’s laws,” adding in a footnote that “although this proceeding involves a limited liability company, we perceive no reason why the rule should be different for corporations, partnerships and other business entities.”

Exercising her greater appellate prerogative, Justice Richter did not merely downgrade as dicta (as did Justice Schlesinger) the First Department’s acceptance of jurisdiction in Hospital Diagnostic, but confronted it head-on as inconsistent with prior decisional law and no longer to be followed, stating that Hospital Diagnostic “cannot be reconciled with the rulings of the other departments of the Appellate Division and the overwhelming weight of authority from other jurisdictions.” Her further explanation highlighted the fundamental issue of sovereign authority:

The short decision in Hospital Diagnostic relies solely on a citation to Broida v Bancroft (103 AD2d 88 [2d Dept 1984]), a shareholder derivative action that did not involve a request for corporate dissolution. In Broida, the court concluded that jurisdiction could be exercised over an action involving the internal affairs of a foreign corporation doing business in New York, unless New York was an inappropriate or inconvenient forum (id. at 91-92; see Hart v General Motors Corp., 129 AD2d 179, 185-186 [1st Dept 1987], lv denied 70 NY2d 608 [1987]). Although we do not quarrel with that proposition, we believe that judicially dissolving a foreign business entity is entirely distinct from resolving a dispute over its internal affairs (see Rimawi v Atkins, 42 AD3d at 801 [distinguishing between derivative claims involving internal affairs of a foreign corporation, for which there is subject matter jurisdiction, and a dissolution claim, for which there is not]). An order of dissolution from a New York court would infringe on the sovereign authority of another state by, in effect, forcing that state to extinguish an entity formed under its own laws. * * * * * [W]e disagree with petitioner that Delaware has only a minimal interest in the question of whether a business entity created in that state should be dissolved. Indeed, Delaware has a strong interest in determining whether business entities formed under its own laws continue to exist at all, and we should refrain from telling Delaware whether or not it should dissolve business entities formed in that state.

I’m guessing these are the same principles of state sovereignty unsuccessfully argued by the Attorney General in Hospital Diagnostic, likely born of the New York State government’s equal concern that other states might claim a reciprocal power to dissolve New York business entities operating in their states.

Justice Richter’s opinion for the court was careful to limit its holding to dissolution cases, mindful that New York courts routinely are called upon to resolve other kinds of disputes involving the internal affairs of foreign business entities, observing as follows:

We recognize that New York State courts play a critical role in resolving disputes involving business entities, and our limited holding here is only that New York courts lack subject matter jurisdiction to dissolve a business entity created under another state’s laws, an extremely narrow subset of cases. This case does not involve the authority of our courts to adjudicate the myriad disputes involving foreign entities doing business in this state, or to grant provisional relief in the course of hearing such controversies. The only relief sought here is the judicial dissolution of a foreign limited liability company, which can only be granted by the state that created it.

Closing Thoughts:  The Raharney decision is a long-overdue, welcome end to the uncertainty caused by the inter-departmental rift, although I have to add, having written half a dozen or more posts on the topic, as a blogger I’ll miss the controversy. It’s also important to remember that parties cannot contractually impose subject matter jurisdiction on a court. Therefore, business lawyers who draft shareholder and operating agreements for New York-based companies formed in other states — most often Delaware — need to give even more careful consideration to including in such agreements a provision mandating arbitration proceedings in New York. The state-specific enforceability of such a provision must be ascertained, but note that Section 18-109 (d) of the Delaware LLC Act expressly authorizes members and managers to include in the operating agreement a provision consenting to “the exclusivity of arbitration in a specified jurisdiction.” Further consideration should be given to including in the arbitration clause express reference to the arbitration award’s enforceability under the Delaware Uniform Arbitration Act (or equivalent act for entities formed in other states) to facilitate judicial confirmation of an award binding upon the Delaware (or other applicable state) Secretary of State who wields the executioner’s ax in the dissolution process.