“Finally, while this court is the only court with jurisdiction to dissolve the Company, the parties are advised that further attempts to collaterally evade the lawful orders of the New Jersey court may result in sanctions.”
Strong words, indeed, at the conclusion of a Decision and Order earlier this month by Manhattan Commercial Division Justice Shirley Werner Kornreich in a multi-jurisdictional fight for control of a data marketing company organized as a New York LLC owned by two deeply divided, 50-50 members.
Justice Kornreich’s ruling in Matter of Belardi-Ostroy, Ltd. v American List Counsel, Inc., 2016 NY Slip Op 30727(U) [Sup Ct NY County Apr. 14, 2016], denied injunctive relief and dismissed a dissolution petition which asked her effectively to override an order issued last December by a New Jersey judge appointing a fifth Board member to fill a vacancy on the LLC’s otherwise deadlocked five-member Board of Directors.
The LLC, headquartered in Manhattan and operating under the trade name Belardi/Ostroy, was formed in 1997 as a 50-50 joint venture between an established marketing company known as American List Counsel (ALC) and two individuals — Ms. Belardi and Mr. Ostroy — who were then employed by a competitor. Although set up as a distinct legal entity, the LLC operationally functioned as a division of ALC which provided essential back-office and financial support in exchange for receiving 15% of the LLC’s commission income.
At inception the parties entered into an Operating Agreement and a Member Agreement. Both appear to be the product of careful forethought and custom tailoring. The agreements established a corporate-style management structure in which Belardi and Ostroy held the offices of CEO and President under the supervision of a five-member Board of Directors consisting of two Belardi-Ostroy appointees, two ALC appointees, and a jointly-selected fifth Director identified by name in the Operating Agreement.
In 2011, the fifth Director resigned due to illness. As Justice Kornreich’s decision states, since then “Belardi-Ostroy has controlled the Company and refused to hold Board meetings or agree on a fifth Director.” Based on my own perusal of some of the documents filed in the New York action, it appears that trouble between the two sides had been brewing for some time before 2011, such that when the fifth Director resigned resulting in a deadlocked Board with executive control in the hands of Belardi and Ostroy, those two pushed to terminate ALC’s support services and to negotiate a buy-out of ALC’s membership interest.
The New Jersey Lawsuit
When the negotiations failed, in 2012, Belardi-Ostroy filed a lawsuit in New Jersey state court — as required by the forum selection provisions in the agreements — seeking a declaratory judgment invalidating the support services provision in the Member Agreement.
After about three years of litigation taken up largely by procedural jousting, in December 2015, upon the application of ALC and over Belardi-Ostroy’s objection, in order to break the Board deadlock the New Jersey court appointed a fifth Director chosen from names submitted by both sides. The judge selected ALC’s nominee as the “strongest” candidate and because giving ALC “their choice seems to have a good deal of fairness associated with it” in light of Belardi-Ostroy having “essentially run the company themselves” since 2011. For those interested, you can read here the fascinating transcript of the December hearing at which the judge repeatedly voiced his view that a properly constituted Board — and not the court — is the legally required and appropriate forum for resolution of the company’s management issues.
The New York Dissolution Proceeding
About three weeks later, Belardi-Ostroy filed a petition in the New York court under LLC Law § 702 to dissolve the LLC. Their petition (read here) alleges that the New Jersey court, in violation of the Operating Agreement and Member Agreement requiring a mutually acceptable choice, appointed as the fifth Director “ALC’s hand-picked nominee” who will “rubber-stamp” ALC’s plans to oust Belardi and Ostroy from their management roles and continue the support services arrangement. Along with dissolution, the petition includes a claim to compel an “equitable” buy-out of ALC’s membership interest.
On the heels of their petition, and also following a motion for reconsideration in the New Jersey case (which was later denied), Belardi-Ostroy moved in the New York case for a preliminary injunction to prevent any meeting of the Board of Directors that would include the fifth Director appointed by the New Jersey court.
ALC opposed the dissolution petition and the injunction motion. Both came on for hearing before Justice Kornreich on March 4, 2016, the transcript of which is available here. It’s an interesting read, and although Justice Kornreich reserved her ruling on dissolution pending a written decision, her skepticism is undisguised as when she repeatedly characterized the petition and the injunction motion (which she denied from the bench) as an effort to use the New York court to “trump the New Jersey Court’s ruling.”
In her April 14 written decision, Justice Kornreich quoted at length from the New Jersey judge’s bench decision denying Belardi-Ostroy’s reconsideration motion, and she acerbically described their New York injunction motion as a “collateral attack on the New Jersey court’s ruling,” adding that “principles of comity and judicial efficiency militate heavily against countenancing such a tactic.”
On the merits of the petition, Justice Kornreich set forth the familiar standard for dissolution of an LLC under § 702: either management is unable or unwilling to achieve the LLC’s stated purpose, or continuing the LLC is financially unfeasible. The latter ground, she observed in a footnote, is inapplicable as both sides agreed the company is profitable. Belardi-Ostroy’s reliance on the former ground centered on their claim of deadlock, prompting Justice Kornreich’s comparison to the Second Department’s landmark ruling in 1545 Ocean Avenue where that court dismissed a dissolution petition brought by a 50% member claiming deadlock because the operating agreement “provided for a means to avoid deadlock” by permitting unilateral decision-making by either of the two managers. “Here,” she wrote,
the Company’s LLC agreement does so as well, and the New Jersey court’s recent appointment of a fifth, tie-breaking Director provides a path for management to reasonably permit or promote the stated purpose of the Company to be realized or achieved and for the Company to proceed profitably.
So long as Belardi-Ostroy does not violate the orders of this court and New Jersey court, a board meeting can take place and deadlock can be resolved by the newly appointed fifth Director. Deadlock, therefore, is not grounds for dissolution. Indeed, deadlock does not appear to be a ground the parties intended to result in dissolution because the Operating Agreement provides a straightforward means of avoiding deadlock — having a tie-breaking fifth member on the Board.
Justice Kornreich’s decision also emphasized the difference between non-actionable disagreement over business strategy and the dissolution-triggering inability to achieve the LLC’s intended purpose:
Most importantly, there is no basis to believe, even assuming the allegations in the petition to be true, that the stated purpose of the Company cannot be achieved or that the Company cannot feasibly turn a profit. Rather, Belardi-Ostroy takes issue with ALC’s business strategy which, in Belardi-Ostroy’s view, should be more internet driven. The court expresses no opinion on the matter, nor should it. The management decisions of a New York LLC made in good faith and with the proper exercise of business judgment cannot be second guessed by the court. There is no authority that permits a non-controlling member to seek dissolution of an LLC on the ground that a disagreement over strategy exists (unless, of course, the operating agreement provides otherwise, which it does not in this case). [Citations and footnotes omitted.]
Justice Kornreich also emphasized the New Jersey court’s primary jurisdiction over the parties’ dispute:
There are no grounds justifying dissolution of the Company at this juncture. On the contrary, a Board meeting with the newly appointed fifth Director must be held and the parties must make good faith efforts to seek a viable path forward. To the extent the parties behave improperly — that is, if they breach the governing contracts or their fiduciary obligations — redress should be sought in the New Jersey court, not in this court. The judge in that case clearly understands the issues underlying the parties’ disputes, and it is that judge the parties shall be accountable to. That said, as the New Jersey court itself recognized, the term of the fifth Director is only for one year [see Dkt. 76 at 27 (12/2/15 Tr. at 54)], and, hence, it is necessary to chart a more permanent, stable course forward. Uncertainty over the Company’s future, however, does not mean it is not reasonably practicable to carry on the business.
Even the most sophisticated, carefully drawn agreement among business owners is no guarantee of a successful, long-term relationship. The sophisticated agreements in this case involving 50-50 owners foresaw and dealt with the possibility of deadlock by providing for a jointly-chosen, fifth member on the Board of Directors. Could the agreements’ drafters have foreseen the inability to agree on a replacement for the fifth member upon his resignation, death, or disability? I suppose so. Could they also have foreseen such inability at a time when the interests and goals of the 50-50 owners had diverged to the point where one of them wanted to go it alone? I suppose so.
But even given such foresight, what could they have drafted differently to avoid painful litigation? If the parties cannot amicably agree on the fifth Director, necessarily any drafting solution will involve some form of third-party compulsory or arbitrary appointment process almost guaranteed to leave one faction feeling at a disadvantage. Alternatively, the agreement could include a provision triggering a buy-sell process upon the failure to appoint a fifth Director, but doing so could itself create incentives for internal dissension and disagreement over the appointment and replacement of the fifth Director.
If someone knows a better solution, I’d like to hear about it.