Much digital ink has been spilled on this blog (here, here, here, and here) and elsewhere (Tom Rutledge’s terrific article can be read here) concerning the ability of LLC controllers to adopt or amend an operating agreement without the consent of all members.

In New York, Shapiro v Ettenson kicked things off, holding that the majority members of an LLC validly adopted a post-formation operating agreement without the minority member’s consent. The agreement in that case eliminated the minority member’s salary, authorized dilution of a member interest for failing to make mandatory capital contributions (the majority members issued a capital call promptly after the amendment), and member expulsion (the majority members expelled the minority member soon after the court upheld the LLC agreement).

Next came Ho v Yen where the court denied interim injunctive relief to a minority member who challenged the majority members’ adoption of a post-formation LLC agreement that authorized member expulsion and buy-out at book value (the majority members expelled the minority member within days after the amendment).

The appellate panel in Shapiro rested its holding on LLC Law § 402 (c) (3) which speaks to the majority’s right not only to adopt an operating agreement but also to amend it subject, of course, to any contrary provision in the operating agreement and certain statutory carve-outs in LLC Law § 417 (b). But since the vast majority of operating agreements that I’ve seen expressly require the consent of all members to amend, I figured I’d have a long wait before seeing a case that tests the limits of the non-unanimous amendment power.

My wait wasn’t nearly as long as I expected. Last month, in Yu v Guard Hill Estates, LLC, 2018 NY Slip Op 32466(U) [Sup Ct NY County Sept 28, 2018], Manhattan Commercial Division Justice Saliann Scarpulla denied a motion to dismiss a minority LLC member’s claims against the majority members for breaching their fiduciary duty by adopting, without the minority member’s consent, amendments authorizing mandatory capital calls and foreclosing upon the interest of a member who fails to contribute. What makes the case even more interesting is that the pre-existing operating agreement signed by all the members included a provision generally authorizing amendment by vote of members holding 51% of the member interests.  Continue Reading Does This Decision Put the Brakes on Non-Unanimous Amendments to Operating Agreements?

What’s a weaponized LLC? It’s one whose operating agreement gives the controlling majority members the authority to dilute, remove from management, or expel a non-controlling minority member, typically for failing to satisfy a mandatory capital call or engaging in conduct the majority determines to be a breach of specified standards of conduct.

Weaponization can occur openly or stealthily. Openly, the dilution, removal, or expulsion powers are spelled out explicitly in the operating agreement signed by all the members. Stealthily, the operating agreement authorizes amendment of the operating agreement by the majority, i.e., without minority consent, effectively allowing such powers to be added at a later time of the majority’s choosing.

Few tears normally are shed when a minority member is diluted, removed from management, or expelled under the express provisions of an operating agreement to which the minority member knowingly subscribed. As the saying goes, you made your bed, now lie in it.

Does the minority member hit with the stealth variety via an amendment to which he or she never consented deserve any greater sympathy? More importantly for litigators, does the majority’s adoption and implementation of such measures for the purpose of squeezing out the minority member, or otherwise gaining leverage in a dispute not necessarily related to the LLC’s governance and business affairs, provide the minority member with grounds to seek judicial dissolution of the LLC? Continue Reading Judicial Dissolution and the Weaponized LLC

C’mon, New York lawyers, do you really want to spend your time, your client’s money, and bother the court litigating a dead-end claim that your client rightfully expelled his or her LLC co-member for alleged misconduct, however egregious, when you don’t have an operating agreement that says your client can do it?

Despite clear law on the subject, some have not gotten the word as made evident by Justice O. Peter Sherwood’s ruling last month in Matter of Goyal (Vintage India NYC, LLC), 2018 NY Slip Op 31926(U) [Sup Ct NY County Aug. 7, 2018].

First, some background: Over ten years ago, in one of my earliest posts on this blog, I observed that, in contrast to states whose LLC statutes authorize judicial expulsion a/k/a dissociation of a misbehaving member, New York’s LLC Law does not authorize a judicial expulsion remedy, and that non-judicial member expulsion can only occur if and under the circumstances specified in the operating agreement.

Two years later, a far more consequential observer, namely, the Appellate Division, Second Department, in Chiu v Chiu specifically held that courts lack authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy. Continue Reading Repeat After Me: You May Not Expel a Member of a New York LLC Unless the Operating Agreement Says So

How can majority business owners legally rid themselves of a problematic minority owner? Not by transferring the business’s assets to another entity for no consideration. That was the conclusion of Manhattan Commercial Division Justice Shirley Werner Kornreich last month in a lawsuit over a minority shareholder’s stake in Bareburger, Inc., owner of its namesake restaurant chain.

The Bareburger Litigation

In Stavroulakis v Pelakanos, 2018 NY Slip Op 50180(U) [Sup Ct NY County Feb 13, 2018], Bareburger had no written shareholders agreement. Stavroulakis owned 16% of the corporation. He and his co-owners were friends before founding the business. After Bareburger took off, Stavroulakis’ co-owners complained that he was not involved enough to justify his ownership so, as related by Justice Kornreich, they did something rather drastic:

Unbeknownst to him and without his consent, after plaintiff moved to Greece, the defendants, who collectively owned the rest of the Company, transferred all of the Company’s assets to other entities in which defendants (but not plaintiff) have an interest. They did so for no consideration either to plaintiff or the Company, rendering the Company an empty shell.

Continue Reading The Cash-Out Merger Solution to the Problem Minority Owner

Unlike the LLC statutes in many other states, New York’s LLC Law does not authorize the LLC or any of its members to seek judicial expulsion of another member, no matter how egregious the member’s behavior. As the Appellate Division ruled in Chiu v Chiu, the only way to expel (a/k/a dissociate) a member of a New York LLC is if the operating agreement so provides.

A carefully tailored expulsion provision in an operating agreement, paired with a reasonably fair buyout, can provide a salutary mechanism for protecting the LLC against a member who engages in wrongful or illegal conduct, jeopardizes the LLC’s licensing or legal status, or consistently fails to perform his or her delegated responsibilities. On the other hand, an expulsion provision that uses subjective or overly broad criteria to define expulsion trigger events can encourage opportunistic behavior by the control faction against the minority, especially if expulsion is accompanied by a forced buyout of the expelled member on unfair financial terms. LLC guru Tom Rutledge wrote a very informative article on the topic, about which I interviewed him for my podcast, in which he gives a roadmap of the various considerations involved in designing and implementing an effective expulsion provision in an LLC agreement.

It’s one thing when all of the LLC’s members consent to an operating agreement authorizing member expulsion. However well or poorly drawn, however fair or unfair its terms, that’s called freedom of contract. You made your bed, now lie in it. But what about an operating agreement adopted by a control faction, without the consent of the minority, authorizing member expulsion at the control faction’s behest? Or how about an operating agreement with expulsion and lopsided buyout provisions adopted without minority consent, after the breakout of hostilities with the minority?

Which points back to Shapiro v Ettenson, a case I’ve written about several times before (here, here, and here). For those unfamiliar with the case, in Shapiro the lower and appellate courts construed LLC Law § 402 (c) (3) (“Voting Rights of Members”) as permitting holders of a majority interest in the LLC to adopt an initial, binding operating agreement long after the LLC was formed and commenced business, without the consent of the minority member. The operating agreement adopted in that case, among other things, converted the LLC from member-managed to manager-managed, authorized additional capital calls, the dilution of the membership interest of a non-contributing member, and member expulsion for cause. Continue Reading LLC Member Expulsion: What Hath Shapiro Wrought?

This winter forever will be remembered in the Northeast as the winter of the “bomb cyclone,” which gets credit for the 6º temperature and bone-chilling winds howling outside as I write this. So in its honor, I’m accelerating my annual Winter Case Notes synopses of recent business divorce cases, which normally don’t appear until later in the season.

This year’s selections include a variety of interesting issues, including LLC dissolution based on deadlock; the survival of an LLC membership interest after bankruptcy; application of the entire-fairness test in a challenge to a cash-out merger; an interim request for reinstatement by an expelled LLC member; and a successful appeal from a fee award in a shareholder derivative action.

Deadlock Between LLC’s Co-Managers Requires Hearing in Dissolution Proceeding

Advanced 23, LLC v Chamber House Partners, LLC, 2017 NY Slip Op 32662(U) [Sup Ct NY County Dec. 15, 2017].  Deadlock is not an independent basis for judicial dissolution of New York LLC’s under the governing standard adopted in the 1545 Ocean Avenue case but, as Manhattan Commercial Division Justice Saliann Scarpulla explains in her decision, when two co-equal managers are unable to cooperate, the court “must consider the managers’ disagreement in light of the operating agreement and the continued ability of [the LLC] to function in that context.” In Advanced 23, the co-managers exchanged accusations of bad acts and omissions, e.g., one of them transferring LLC funds to an unauthorized bank account, raising material issues of fact as to the effectiveness of the LLC’s management and therefore requiring an evidentiary hearing, which is just what Justice Scarpulla ordered. Of further note, in a companion decision denying the respondent’s motion to dismiss the petition (read here), Justice Scarpulla rejected without discussion the respondent’s argument that judicial dissolution under LLC Law § 702 was unavailable based on a provision in the operating agreement stating that the LLC “will be dissolved only upon the unanimous determination of the Members to dissolve.” In that regard, the decision aligns with Justice Stephen Bucaria’s holding in Matter of Youngwall, that even an express waiver of the right to seek judicial dissolution of an LLC is void as against public policy. Continue Reading Winter Case Notes: LLC Deadlock and Other Recent Decisions of Interest

Wanted: Business Divorce Stories

Are you a business owner who’s been through a contentious break-up with your business partners and would like to share your experience with others? Are you a lawyer with a great war story to share about a business divorce case you handled? If so, and if you’re interested in telling your story for my Business Divorce Roundtable podcast, call me at 212-687-1230 or email me at pmahler@farrellfritz.com.


2of3A company has four founding shareholders each of whom is a director-employee. Their agreement provides that the votes of three out of four founders are required to terminate the employment of any founder or to approve a series of other major decisions such as making distributions, issuing or redeeming shares, amending the certificate of incorporation or bylaws, etc.

When one of the founders no longer is employed and thereby automatically loses his seat on the Board, under the same provision the number of votes required to approve termination of another founder or the other enumerated major decisions drops to two out of three.

Sounds simple so far, right?

Now let’s complicate things. Under another provision, any amendment of the agreement requires the approval of the company and of the founders holding at least 75% of the voting shares, which raises the following questions:

  • What happens when only three founders remain, two of them vote to terminate the third, and the remaining two hold less than 75% of the voting shares?
  • Can the business be managed with less than three founders who lack the voting power to amend the agreement to allow the them to make the enumerated major decisions?
  • Is the vote to terminate the third founder invalid absent a concurrent amendment of the agreement authorizing management of the company by only two founders?
  • If so, does that render the two-out-of-three voting authorization meaningless? Continue Reading Then There Were Two: Court Rejects Minority Shareholder’s Claim of Wrongful Termination Under Founders Agreement

powerlessAn appellate decision last week sounds alarm bells for minority members of New York LLCs that have no operating agreement and for anyone considering becoming a minority member of an LLC without first having in place an operating agreement.

By the same token, the decision provides opportunities for majority members of existing LLCs without operating agreements to cement and expand their control powers.

Last week’s unanimous decision by the Manhattan-based Appellate Division, First Department in Shapiro v Ettenson, 2017 NY Slip Op 00442 [1st Dept Jan. 24, 2017], affirmed the lower court’s order enforcing an operating agreement signed by two of the LLC’s three co-founding, co-equal members, adopted two years after the LLC’s formation without the signature or consent of the LLC’s third member. Among other features, the operating agreement departed from the statutory default rule by authorizing the reduction of the percentage interest of a member who fails to satisfy a capital call approved by the majority, which is exactly what the two majority members did following their adoption of the agreement, along with eliminating the minority member’s salary. Continue Reading Thinking About Becoming a Minority Member of a New York LLC Without an Operating Agreement? Think Again

SushiThe Japanese word “omakase” translates as “I’ll Ieave it up to you” and is used by patrons of sushi restaurants to leave the selection to the chef rather than ordering à la carte.

The minority member of an LLC that operates a high-end Japanese restaurant in Brooklyn featuring omakase service, and who sued for judicial dissolution, recently learned a different meaning of omakase, as in, don’t leave it up to the court to protect you from being frozen out by the majority member when you don’t have a written operating agreement, much less a written operating agreement containing minority-interest safeguards.

The hard lesson learned by the petitioner in Matter of Norvell v Guchi’s Idea LLC, 2016 NY Slip Op 32307(U) [Sup Ct Kings County Nov. 18, 2016], has been taught before, starting most prominently with the First Department’s 2013 decision in Doyle v Icon, LLC and reinforced by that court two years later in Barone v Sowers, holding that minority member claims of oppressive majority conduct including systematic exclusion from the LLC’s operations and profits, in the absence of a showing that the LLC is financially unfeasible or not carrying on its business in conformity with its operating agreement, do not constitute grounds for judicial dissolution under LLC Law § 702. Continue Reading Another Frozen-Out Minority LLC Member’s Petition for Dissolution Bites the . . . Sushi?

RutledgeThe business community’s growing preference for the LLC entity form over the traditional corporation and partnership forms has introduced a whole new set of planning issues for lawyers who counsel clients at the formation stage in preparing the new LLC’s constitutional documents, including most importantly the operating agreement.

Tom Rutledge (photo right), one of the nation’s leading experts on LLCs and a principal drafter of his home state of Kentucky’s LLC Act among his many other accomplishments and leadership roles in the field of business organizations, recently published an article in the Journal of Passthrough Entities on the hot-button topic of LLC member expulsion with the provocative thesis that counsel need to actively consider and draft operating agreements that authorize forced expulsion of a member under specified circumstances in order to protect the venture’s ongoing activities and viability. The article is entitled “It’s Not Me, It’s You: Planning for Expulsion of LLC Members” and you owe it to yourself to read it here.

The article addresses the statutory backdrop for member expulsion; the grounds for expulsion to consider including in the operating agreement; the voting prerequisites and procedure for effectuating expulsion; the effect of expulsion including buy-out; and judicial review of expulsion decisions.

After reading the article, I asked Tom if he would discuss LLC member expulsion on my Business Divorce Roundtable podcast. I’m happy to report that Tom obliged, and you can hear my interview of Tom by clicking on the link at the bottom of this post.

The interview covers not only LLC member expulsion pursuant to the operating agreement which is the subject of Tom’s article, but also judicial expulsion of LLC members, a topic that recently generated headlines (and a post on this blog) when the New Jersey Supreme Court earlier this month issued its decision in IE Test v Carroll reversing an order of judicial expulsion under that state’s LLC Act. Judicial expulsion is destined to take on greater importance and controversy as more states adopt the Revised Uniform LLC Act which authorizes courts to expel an LLC member at the behest of the company or the other members on grounds involving breach of the operating agreement or other misconduct, or because it’s not reasonably practicable to carry on the business of the LLC with the member whose expulsion is sought.

There’s much more food for thought in Tom’s article and the podcast interview. I urge you to read and listen to both.