The limited liability company did not exist as a legally recognized business entity in New York when I first began handling business divorce cases in the 1980s. Decades later, the LLC is “King of the Hill,” having displaced closely held business corporations and partnerships as the entity of choice for newly formed businesses in New York and across the nation.
The legislative premise of LLC enabling statutes is freedom of contract. The statutes establish default rules that, with few mandatory exceptions, can be modified or even eliminated by the members in their operating agreement so as to order their internal affairs as they see fit to optimize management, operating, and economic efficiencies.
The default rules comprising New York’s LLC Law contain necessarily broad and undefined terms in identifying and enforcing the rights and responsibilities of LLC members and managers. As with other enabling statutes, by and large the legislature left it to the courts to construe, define, and refine the LLC Law’s provisions on a case-by-case basis. Over time, and through the doctrine of precedent known as stare decisis, the courts collectively fashion a common-law quilt that provides guidance for lawyers and other business advisors and, in turn, transactional certainty to the business community.
Matter of Cangro
These ruminations meet their antithesis in a recent decision in a case called Matter of Cangro, 2019 NY Slip Op 31846(U) [Sup Ct Richmond County May 16, 2019], in which two non-managing members together holding 25% of a family-owned, single-asset realty LLC petitioned for judicial dissolution under LLC Law § 702 based on allegations that they were being excluded from management and deprived of access to banking, insurance, and other granular business records.
In its decision, the court granted the petitioner’s motion to appoint a temporary receiver to take away control of the LLC from the managing member notwithstanding:
- the LLC’s operating agreement — an off-the-shelf, outdated “Blumberg” form agreement in which most of the blanks supposed to be filled in were left blank — expressly and exclusively delegates all management authority to the respondent sole managing member;
- the operating agreement severely limits the manager’s duty to report to the non-managing members;
- the petitioner was provided with company records in discovery, and
- the petitioner’s allegations, that the LLC’s assets were being “lost, hidden, or destroyed” were bereft of specifics, speculative by their very terms, and denied by the respondent.
The court’s decision mentions the existence of the operating agreement and acknowledges respondent’s status as sole managing member, but seemingly attributes significance to neither. Even more puzzling, it cites the petitioner’s allegation that the respondent “assumed total control of the business operations” — yes, that’s what he’s supposed to do as sole managing member.
Basically, in support of appointment of a receiver under Section 6401 of the Civil Practice Law and Rules — the LLC Law, unlike the Business Corporation Law, has no provision for appointment of an interim receiver pending the dissolution proceeding — the court relies on petitioner’s allegations of oppressive conduct by the respondent, and lack of access to the LLC’s books and records, even though case precedent uniformly holds that neither is ground for dissolution (read here and here).
Speaking of Section 6401, the court’s decision does mention appropriately the heavy burden on the proponent of a temporary receivership, requiring “a clear evidentiary showing of the necessity for the conservation of the property at issue.” But then, effectively, it shifts the burden to the respondent by finding that his “general averments concerning the financial status of the LLC are of no avail.”
I’d understand that statement better if the petitioners’ supporting affidavits included specific allegations of ongoing or impending, serious harm to the LLC’s property. But close inspection of the affidavits reveals nothing of the kind.
And That’s Not All
There’s more where that comes from. For instance, I was puzzled to read in the background section of the court’s decision the statement that the subject LLC was “formed pursuant to Section 702” of the LLC Law. Section 702, of course, is the statute authorizing a petition to dissolve an LLC; it has nothing to do with formation. Before blaming the court for that misstatement, I checked the parties’ papers filed for and against the receivership application and, lo and behold, both sides made the same misstatement.
No harm done I suppose but, still, if the parties and the court get wrong something as basic as that, how much confidence can we have in the outcome? Judging by the fact that the respective counsels’ legal arguments hardly cited any relevant LLC case law in favor of citations to cases involving close corporations, I’m tempted to say not much.
Appointing a temporary receiver to take control of the subject business is a drastic and expensive remedy — potentially a real game changer — not to be lightly granted before a determination on the merits of the petitioner’s claims.
Is There an Explanation?
So what’s going on here? The best clue I found lies in a decision by the court a week later, in which it denies “without prejudice” the petitioners’ application to dissolve the LLC, stating as its reason that the court “prefers to see if the parties can reach a non-judicial resolution of the matter with the appointment of the temporary receiver.”
Another clue of uncertain impact is the existence of two other, concurrent lawsuits with the same line-up of antagonists involving petitions to dissolve two other realty holding companies with the same percentage ownership and management. In other words, forcing a settlement in one is more likely to lead to a global settlement of all three cases.
Whatever the shortcomings in the parties’ papers, and however thin the court’s stated reasoning for appointing a receiver, I have to assume the judge had good reasons even if not apparent in the record. I know how difficult and intractable business divorce cases can be when the antagonists are family members. I’ve had cases in which judges have raised the specter of receivership as motivation for settlement discussions and mediation. But I’ve not had cases in which judges actually appointed a receiver as a settlement motivator — particularly for an LLC outside of a 50/50 deadlock situation — absent satisfaction of the high standard for doing so under the statute.
This year is the 25th anniversary of New York’s LLC Law. Case law development has been slow, as evidenced by the 16 years it took before an appellate court in the 1545 Ocean Avenue case construed the standard for judicial dissolution of LLCs under Section 702. There have not been all that many decisions involving interim receivership applications, and even fewer involving a sole managing member as in Cangro.
The paucity of precedent makes it all the more important that the bar and the bench pay close attention to the nuances of the LLC Law, the critical role of the operating agreement, and how LLC jurisprudence in the business divorce arena differs in important respects from close corporation and partnership jurisprudence governing internal affairs.