Here we go again.
My last outing on this blog analyzed a dispute over the consequences of a limited partner’s failure to meet a mandatory capital call. There, the Manhattan-based Appellate Division, First Department, held that under the Delaware limited partnership agreement’s terms featuring dueling “notwithstanding anything herein to the contrary” clauses, the limited partner lost its right to vote on defined Major Decisions.
This time around, involving a Delaware LLC member’s failure to meet mandatory capital calls, in a decision issued last week in DTI-DSIC, LLC v 930-DSIC, LLC, the First Department adopted the managing member’s interpretation of the LLC agreement by upholding the forced sale of the defaulting member’s interest to the managing member. Nothing unique about that. But consider this: the sole consideration given for the interest was the managing member’s non-recourse promissory note for approximately $1.7 million with no maturity date under which no payments are due except to the extent of any after-tax distributions received by the managing member — of which there has been none — in respect of the defaulting member’s former interest.
In both cases involving governance agreements prepared by sophisticated counsel at BigLaw firms, the First Department reversed rulings by esteemed Manhattan Commercial Division judges in favor of the defaulting parties, which only goes to show how even the most carefully drafted agreements are no guarantee against plausible disputes over their construction and application.
The Parties
In 2010-11, DTI-DSIC, LLC (DTI) invested $1.85 million for an 11.22% membership interest in 930-DISC, LLC (the Company) a Delaware holding company that in turn invested in Decision Sciences, a security technology company specializing in inspection systems for detecting radiological, nuclear, and other contraband threats in shipping containers. The Company’s Managing Member is 930-DSIC Partner LLC, also a Delaware company. DISC and its members are governed by a 2010 Amended and Restated Operating Agreement.
The Capital Call Provisions
The Managing Member shall have full power, in its discretion, to require the Defaulting Member to sell its Interest to the Managing Member, one or more other Members and/or one or more third parties designated by the Managing Member (which third party or third parties may be Affiliates of the Managing Member or any other Member), at a purchase price equal to the lesser of (x) the cost of such Defaulting Member’s Interest or (y) such price as the Managing Member determines in good faith is fair and reasonable under the circumstances.
Section 4.2(f) gives the Company “the right to set-off any or all amounts owing by a Defaulting Member to the Company against all distributions and other amounts from time to time payable by the Company hereunder to such Defaulting Member.”
DTI’s Default and the Forced Sale
Beginning in late 2012, DTI failed to make its required capital contributions. In 2014, the Managing Member issued a Notice of Default to the tune of about $42,000. The Notice stated that DTI was a Defaulting Member and that DISC and the Managing Member reserve all rights and remedies under the LLC Agreement including the forced sale of DTI’s interest.
Fast forward to 2021, when the Company notified DTI that a portion of its membership interest was sold via tender offer. The notice advised that, after deductions for part of DTI’s overdue share of management fees and expenses, the remaining sale proceeds of slightly more than $1.1 million were placed in escrow.
Fast forward to 2024, when the Managing Member notified DTI that it was forcing a sale of DTI’s remaining membership interest to the Managing Member. In exchange, the Managing Member issued DTI a non-recourse promissory note in the stated sum of $1,677,382.95 and providing that “[a]ny payments on this promissory note shall be made solely from and to the extent of the amount of after-tax distributions actually received by [Managing Member] from [the Company] in respect of the DTI Interest.” In an accompanying Membership Interest Transfer Instrument, the Managing Member stated that the sale price represented a “fair and reasonable price for the DTI Interest . . . as determined by the Managing Member in good faith” less the Managing Member’s legal expenses associated with DTI’s default and the forced sale.
DTI Sues; the Motion Court’s Decision
In early 2025, DTI brought suit against the Company, the Managing Member, and the latter’s Manager. DTI’s complaint, which challenged neither its status as a Defaulting Member nor the fact of the forced sale, sought recovery from the Company and Managing Member of about $3.25 million — the alleged tender offer proceeds from the 2021 partial sale of DTI’s membership interest — plus not less than $1.85 million from all three defendants equal to its original investment. The six-count complaint asserted claims for breach of the LLC Agreement — the primary focus in what follows — plus breach of fiduciary duty, conversion, unjust enrichment, accounting, and fraud.
The defendants moved to dismiss the complaint, essentially arguing that DTI’s contract claim contesting the pricing and pay-out terms of the forced sale, is negated by Sections 4.2(e) and (f) of the LLC Agreement and that DTI’s remaining claims either are duplicative of the contract claim, or displaced by the LLC Agreement, or fail to state a valid claim.
DTI’s three-prong defense of its contract claim argued (1) that defendants breached the LLC Agreement by failing to distribute the proceeds of the sale of DTI’s interest to DTI in a reasonable time, (2) that the sale proceeds are not “distributions” as that term is used in Section 4.2(f), and (3) that the complaint adequately pleads defendants’ breach by failing to properly value DTI’s interest.
In August 2025, the motion court heard oral argument and issued a written decision denying dismissal of the contract claim. After noting that DTI no longer challenged the valuation, the court shared its rationale as follows:
[T]here remains a disputed issue of fact about whether defendants breached the contract when they failed to pay plaintiff the proceeds from the forced sale of its membership interest. As explained on the record, the Agreement, as onerous to plaintiff as it seems to be, does not define “distribution.” It is therefore not clear whether paying plaintiff the proceeds of the forced sale would qualify as a distribution, or whether the funds defendants are holding simply sale proceeds. . . . After the forced sale of plaintiff’s interest, defendants did not turn over the net proceeds of the sale. This left plaintiff without any membership interest and without any compensation, despite having made a substantial investment. Although the Agreement does not require defendants to pay the proceeds within any set time period, if defendants are supposed to turn over the proceeds, the law would imply a reasonable time.
The decision also denied dismissal of the fiduciary breach and accounting claims while dismissing the unjust enrichment, conversion, and fraud claims.
The Arguments on Appeal
The defendants appealed from those parts of the decision denying dismissal of the contract, fiduciary, and accounting claims. As for the contract claim, their appellate brief argued that paying DTI for its membership interest is a “distribution” within the plain meaning of the term as used in Section 4.2(f). It also cited DTI’s complaint’s allegation that defendants breached the LLC Agreement by “failing to distribute the proceeds due to Plaintiff.”
Defendants also relied on provisions in Article 6 of the LLC Agreement giving the Managing Member unqualified discretion to make or withhold distributions. They argued that the LLC Agreement was not silent as to the timing of distributions, including any payment due under the promissory note, but expressly leaves to the Managing Member’s discretion the determination when to make a distribution.
Their brief also described the note’s pay-out terms as “objectively reasonable,” such that:
The Managing Member should not have to come out of pocket to buy out a Defaulting Member. Nor should a Defaulting Member end up better off than non-defaulting Members by having its capital returned early and its risk eliminated because it defaulted.
DTI’s appellate brief naturally defended the motion court’s decision, labelling as “misguided” the defendants’ assertion that the sale “proceeds” are “distributions” as that term is used in the LLC Agreement. Rather, they argued, “a distribution is a payment to all owners out of current or past earnings, not a payment to a former member of the proceeds from the sale of its interest.”
DTI alternatively argued that, even if the sale proceeds are “distributions,” its contract claim withstands dismissal based on its allegations of Managing Member’s abuse of discretion by omitting from the promissory note a reasonable time for payment, and its “bad faith” failure to pay the sale proceeds to DTI. In response to defendants’ “objectively reasonable” assertion, DTI countered that, instead of expelling DTI, Managing Member “could just have easily sought to enforce [DTI’s] contribution obligations and kept it a member.” “At bottom,” DTI continued, “the reasonableness of Defendants’ actions, and whether [Managing Member] acted within its ‘discretion’ are issues of fact improper to resolve on a pre-answer motion to dismiss.”
The First Department’s Ruling
The First Department’s decision last week gutted most of the DTI claims left standing by the motion court, holding first that DTI’s contract claim should have been dismissed “because plaintiff did not allege that any conduct by the Managing Member violated the parties’ operating agreement.” As the court further explained:
The record demonstrates that plaintiff was in default, and that the Managing Member had the discretion under the operating agreement to force the sale of defaulting members’ interests, to determine the purchase price in a forced sale, and to determine the time and the size of any disbursement of the proceeds to the defaulting member. Further, the operating agreement provided that the Managing Member could not be held liable for matters left to its discretion unless it exercised its powers in bad faith. Plaintiff failed to allege that the Managing Member knew that its conduct contravened the terms of the operating agreement, and therefore did not plead that it exercised its contractual authority in bad faith. In addition, plaintiff makes only conclusory allegations that defendants “scheme[d] to defraud innocent investors.” [Citations omitted.]
The decision next held that “for similar reasons” the motion court also should have dismissed the fiduciary breach claim, finding that the Managing Member’s exercise of its contractual right to determine the forced-sale price and timing of any payment “cannot form the basis of a cause of action for breach of fiduciary duty.”
The decision’s only good news for DTI was (1) allowing its contract claim to proceed only as to the Company’s allegedly improper reduction of the sales proceeds above and beyond amounts owed by DTI as a Defaulting Member, and (2) upholding DTI’s accounting claim which the court held was not duplicative of the contract claim “because the two causes of action seek different remedies.”
I Would Have Liked . . .
The First Department’s decision says not a word about the central point of debate in the parties’ briefs, as the motion court put it, “whether paying plaintiff the proceeds of the forced sale would qualify as a distribution, or whether the funds the defendants are holding [are] simply sale proceeds.” I would have liked the court to address the issue.
The sparse record before the motion court and on appeal consisted only of DTI’s complaint, the LLC agreement, the 2014 default notice, the 2021 letter regarding the tender offer, and the few documents mentioned above concerning the 2024 forced sale. Not unusual for a pre-answer motion to dismiss. I would have liked to know more about the Company’s financial picture and cash flows to better understand the extent to which the risk of a quasi-forfeiture, forced sale reasonably rested upon the defaulting member.
Finally, the appellate ruling faulted DTI’s complaint for failing to allege that the Managing Member “knew that its conduct contravened the terms of the operating agreement, and therefore did not plead that it exercised its contractual authority in bad faith.” I would have liked to know whether, had the complaint contained a talismanic recitation of bad faith, it would have changed the outcome given the decision’s generous description of the Managing Member’s discretionary powers to determine if and when to cause a forced sale, the pricing, and the terms of payment.