In the end, it wasn’t much of a fight.
The case of Huggins v Scott, decided last month by Justice W. Franc Perry of the Manhattan Supreme Court, illustrates anew the well-nigh insurmountable hurdle faced by a minority member seeking judicial dissolution of an economically viable LLC carrying on its business in conformity with its intended purpose.
The case tells the story of two longtime friends who became romantically involved and then became business partners before both relationships fizzled.
The Respondent is a female, registered amateur boxer and certified boxing coach who, in 2007, started a boxing club known as Women’s World of Boxing (WWB) to offer boxing workshops to teenage girls in under-served communities in Manhattan, Brooklyn, and the Bronx. Over the next decade, the unincorporated WWB had no permanent home and operated out of other boxing gyms.
Respondent organized WWB as a single-member New York limited liability company in 2014. In 2017, with financing help from Petitioner, who also personally co-guaranteed the lease, WWB constructed and opened its own boxing gym. Petitioner and Respondent entered into a written operating agreement under which they respectively held 40% and 60% membership interests.
The agreement vested decision-making authority in members holding a majority of WWB’s membership interests, i.e., Respondent, except for specified major decisions requiring unanimous approval. It also designated Respondent WWB’s CEO/COO and Petitioner its CFO, but did not otherwise delineate officer duties. It was undisputed that the Petitioner never was involved in WWB’s day-to-day operations or managed its finances.
The Relationship Deteriorates
The gym opened in early 2018 and in time gained over 100 clients. As the business grew, however, the two owners’ personal relationship deteriorated.
Later that same year, Petitioner wrote to Respondent declaring their relationship over and proposing a $75,000 buyout. The letter acknowledged that, “[s]ince the [gym’s] doors have opened, you’ve [Respondent] been successfully maintaining the business including paying the rent without my contribution” and “it’s only fair that you move forward without my attachment or any further involvement from me.”
Apparently the proposed buyout fell flat, at which point the Petitioner engaged counsel who began sending Respondent demands for the LLC’s financial documents and subsequently filed on Petitioner’s behalf a petition for judicial dissolution of WWB.
The petition sought dissolution of WWB pursuant to section 702 of the LLC Law based on “internal dissension among the members” and Respondent’s alleged “misappropriation” and “conversion” of WWB’s assets, allegedly rendering it “not reasonably practicable to carry on the business of [WWB] in conformity with the Operating Agreement.” It also alleged that Respondent “locked out” Petitioner from the business by failing to provide invoices and receipts for WWB expenses and by not allowing Petitioner to conduct bookkeeping and accounting.
The petition also included a series of direct and derivative claims seeking damages for breach of fiduciary duty and other alleged business torts. It also sought injunctive relief and appointment of a temporary receiver.
The Respondent opposed the petition, contending that the Petitioner was “trying to use this court to extract revenge” on a “former romantic partner”; that the lock-out allegations were belied by Petitioner’s pre-litigation letter admitting non-involvement in the business; that WWB was continuing to operate for its intended purpose as a boxing club; and that WWB was financially viable.
Justice Perry’s 7-page decision, after summarizing the parties’ factual allegations, sets forth a useful summary of basic principles governing judicial dissolution of LLCs under section 702:
In determining whether a limited liability company should be dissolved, pursuant to Section 702, “the court must first examine the limited liability company’s operating agreement to determine, in light of the circumstances presented, whether it is or is not `reasonably practicable’ for the limited liability company to continue to carry on its business in conformity with the operating agreement” (Matter of Kassab v. Kasab, 137 AD3d 1135, [2d Dept 2016]). To warrant judicial dissolution, the allegations must show that “the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or [that] continuing the entity is financially unfeasible” (Doyle v Icon, LLC, 103 AD3d 440, 440 [1st Dept 2013]).
“Disputes between members are not sufficient to warrant the exercise of judicial discretion to dissolve an LLC that is operated in a manner within the contemplation of it[s] purposes and objections as defined in its articles of organization and/or operating agreement” (Kassab v Kasab, 60 Misc 3d 1204[A] [Sup Ct Queens Cnty 2018]). Moreover, allegations that the movant has been systematically excluded from the operation and affairs of the subject company are insufficient to establish that it is no longer “reasonably practicable” for the company to carry on its business, as required for judicial dissolution under LLCL § 702 (Doyle, 103 AD3d at 440, quoting LLCL § 702).
The above quotation’s last sentence and citation to Doyle v Icon foretold the outcome. “Here,” Justice Perry wrote, “Petitioner has failed to establish a cause of action for judicial dissolution of the Company, pursuant to LLCL § 702, based on her allegation of mismanagement of the Company’s funds and Respondent’s efforts to exclude her from the management of the Company.” He explained:
The Operating Agreement states that the purpose of the Company is to conduct any lawful business whatsoever that may be conducted by limited liability companies pursuant to the LLCL in New York. The Petition and affirmation in support fail to establish that the Company is presently unable to fulfill its stated purpose by operating a gym at the Premises. The Company continues to possess a leasehold interest in the Premises, to finance its monthly operating costs of approximately $10,000.00, and to provide services to its client members. [Citations to record omitted.]
Petitioner’s pre-litigation letter also came back to haunt the claim for dissolution. As Justice Perry wrote:
In her Letter, Petitioner concedes that, despite the lack of her involvement in the operations and finances of the Company, the Company as led by Respondent has remained open for business and able to pay its expenses without additional capital contributions since Respondent began operating the gym in 2017. Petitioner’s allegations, thus, are insufficient to demonstrate that the management of the company is unable or unwilling to reasonably permit or promote the stated purpose of the Company to be realized or achieved or that continuing the Company is financially unfeasible.
Finding no basis for dissolution, Justice Perry likewise denied appointment of a receiver and, in the end, denied the Petition “in its entirety” other than directing that Respondent “provide Petitioner with the opportunity to inspect the books and records of the Company.”
Takeaways. The Huggins case reprises themes destined to be played out again and again in disputes between LLC members under the LLC Law’s sparse and, some would argue, inadequate statutory scheme:
- Section 702 as construed by the courts, unlike its counterpart statutes governing closely held corporations, does not recognize allegations of internal dissension, or oppression by controlling members, as grounds for judicial dissolution.
- Rather, the statute requires an evidentiary showing of the LLC’s financial infeasibility or that it is no longer capable of fulfilling its intended purpose. The standard inherently is a tough one to satisfy for non-controlling members of a viable business.
- The LLC agreement in Huggins included a “shotgun” style buy-sell provision triggered by a disagreement “on any matter” continuing for 30 days, allowing (but not requiring) either member to deliver a buy-sell notice giving the other member the choice to buy or sell her interest at the price given in the notice. Neither party in Huggins initiated the buy-sell, almost undoubtedly due to the glaring asymmetries between their roles, interests, and abilities in operating the business, not to mention any possible asymmetry in their ability to finance a buyout.
- The denial of the petition in Huggins puts the parties back in the unresolved 60/40 business partnership they had before the lawsuit, albeit with Respondent having the upper hand as majority member no longer under the cloud of possible dissolution. It’s now up to the parties to reach a settlement or continue their unhappy partnership.
- Huggins also illustrates the additional risk taken on when partners in a romantic relationship go into business together, and the potentially fatal spillover effect on the business when the relationship ends, making all the more important the need to anticipate and draft appropriate mechanisms in the operating agreement for a separation of business interests when the romance dies.