In New York, the bad faith defense in dissolution proceedings traces its lineage to Matter of Kemp & Beatley, 64 NY2d 63 , a landmark ruling by the state’s highest court that set the standard for minority shareholder oppression under § 1104-a of the Business Corporation Law, where the court wrote in dicta that “the minority shareholder whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression should be given no quarter in the statutory protection.”
Several years ago, I gave headline treatment to Justice Vito DeStefano’s decision in Feinberg v Silverberg recognizing the bad faith defense as applicable also in deadlock dissolution cases between 50/50 shareholders under BCL § 1104 notwithstanding a line of appellate rulings indicating that the underlying reasons for dissension and deadlock are not relevant. In reconciling those seemingly contradictory cases, Justice DeStefano wrote that the “manufactured creation of the dissension . . . is the sine qua non of bad faith” which “would belie a finding that the shareholders’ dissension poses an irreconcilable barrier to the continued functioning and prosperity of the corporation.”
Has the bad faith defense similarly osmosed to LLC dissolution? While I’m not aware of any New York cases directly addressing the issue, a recent decision by Chancellor Ellen Hobbs Lyle of the Tennessee Business Court in Wilford v Coltea, Case No. 15-856-BC [Tenn. Ch. Ct. 20th Dist. May 16, 2016], echoes Justice DeStefano’s rationale in upholding a bad faith defense in a dissolution case involving a Delaware LLC whose two 50/50 members seemingly were at an alleged managerial impasse with no way out.
Plaintiff Wilford and defendant Coltea formed Rubicon Equities LLC in 2012 as a realty investment firm. Rubicon got off to a harmonious and profitable start in 2013 with its initial equity investment in a commercial building which also generated significant management fees for Rubicon. Thereafter the parties’ stories diverge, with Coltea claiming their working relationship badly deteriorated leading him to offer to buy out Wilford’s interest in Rubicon, and Wilford claiming that Coltea’s proposed buy-out, together with Coltea’s setting up a separate Rubicon bank account to which he refused to provide Wilford access, were part and parcel of Coltea’s scheme to usurp an opportunity to invest in another real estate project known as the Public Square Garage.
Wilford filed suit against Coltea in 2015, asserting direct and derivative claims for breach of fiduciary duty, fraud, and tortious interference. Coltea counterclaimed for judicial dissolution of Rubicon pursuant to § 802 of the Delaware LLC Act. Coltea’s subsequent summary judgment motion on his dissolution counterclaim included a tape recorded conversation in which Wilford admitted to Coltea, among other statements deprecating their relationship, that “You and I have no ability to get along in business” and that their business relationship was “a failed marriage”.
Chancellor Lyle’s analysis initially found that Coltea’s allegations, including Wilford’s recorded comments of “dysfunctional management,” support “a reasonable inference that the dysfunctional business relationship of the members thwarts and makes it impossible for the members to accomplish the [LLC’s] business purpose” in satisfaction of the LLC Act’s requirements for judicial dissolution. Chancellor Lyle also noted that Rubicon’s operating agreement contains no mechanism to resolve the co-equal members’ deadlock. “Yet,” she continued:
even where the Operating Agreement provides no dispute resolution mechanism, judicial dissolution is not automatic. There is the additional requirement that the impasse be bona fide and genuine. If the impasse is manufactured by the party seeking dissolution or is being used to defraud or accomplish a result inimical to the LLC entity, Delaware law says judicial dissolution is inappropriate.
Chancellor Lyle’s decision features a lengthy discussion of Delaware case authorities in support of her conclusion that bad faith is a cognizable defense to a claim for LLC dissolution. I won’t replicate here her discussion other than to note that it weaves together Delaware case law involving both LLC dissolution under LLC Act § 802 and close corporation dissolution based on shareholder deadlock under § 273 of the Delaware General Corporation Law (the analog to New York’s BCL § 1104 applied by Justice DeStefano in the Feinberg case mentioned above).
Having found that the defense is available, Chancellor Lyle then identified facts presented by Wilford in support of the defense, in addition to the above-mentioned separate bank account:
- At his deposition, Coltea was unable to cite a specific dispute with Wilford that motivated him to propose a buy-out of Wilford’s interest.
- Coltea provided Wilford with misleading information about the Public Square Garage investment opportunity while pursuing measures to take the opportunity for himself.
- Wilford’s tape recorded comments were “seeded, stoked and provoked” by Coltea’s “attitudes and actions” toward Wilford while Coltea was making plans to take the Public Square Garage opportunity for himself.
- Dissolution would terminate the lucrative management fees being paid to Rubicon for its initial, successful investment project and would trigger a buy-out of Rubicon’s interest in the project thereby forfeiting future equity appreciation.
Based on the record before her, including the parties’ conflicting factual allegations, Chancellor Lyle concluded that summary judgment was inappropriate because
a fact finder could reasonably infer that in seeking to dissolve the LLC, Defendant Coltea intended to create a roadblock to prevent the LLC from capitalizing on the Public Square Garage opportunity. While these facts and inferences are relevant to Plaintiffs’ claims of breach of fiduciary duty, fraud, and tortious interference, the Court concludes the facts and inferences are also relevant on summary judgment as indicia of bad faith dissolution. . . . The facts and inferences supplied by the Plaintiff fit within the description in Delaware law of the narrow bad faith defense that dissolution is being used, not because there is a genuine impasse, but to manipulate an outcome in bad faith.
The court’s decision ordered the parties to complete discovery to be followed by court-ordered mediation.
As a Tennessee case applying Delaware law, Wilford’s influence on a New York court’s consideration of the bad faith defense to LLC dissolution under New York’s LLC Law § 702 is only as great as its core rationale which, as it happens, aligns with the seed of the rationale planted by the New York Court of Appeals in Matter of Kemp & Beatley and the more fully developed articulation of the rationale in Justice DeStefano’s Feinberg decision mentioned above.
A hat tip to attorney William O’Bryan, Jr. of Butler Snow in Nashville, whose blog post brought the Wilford case to my attention.