Purpose Clause

Subscribe to Purpose Clause

After two years, 300+ docket entries, and 12 motions, a lawsuit among members of a Delaware LLC that owned a 5-story apartment building on Manhattan’s Upper East Side (the “UES Building”) acquired to provide short-term rentals for international leisure and corporate travelers, and whose business was decimated by anti-Airbnb legislation, is barely past the pleadings stage and likely can look forward to years more litigation.

Manhattan Commercial Division Justice Jennifer G. Schechter’s recent decision in Favourite Ltd. v Cico, 2018 NY Slip Op 32781(U) [Sup Ct NY County Oct. 30, 2018], permitting the LLC and some of its members to file an amended pleading against the LLC’s former managing members, addresses several issues of interest including whether the legislature’s action automatically triggered dissolution under the operating agreement’s arguably conflicting provisions, and whether the former managers’ attempted reinvestment of proceeds from the UES Building’s sale in another property violated the operating agreement’s purpose clause.

According to the Second Amended Complaint ultimately allowed by the court, the two defendants as sole managing members of Upper East Side Suites, LLC, formed in Delaware in 2007, solicited investors from Italy’s business community who contributed $4.75 million to buy the UES Building to operate a short-term rental business. What allegedly followed is a scheme by the defendants of “self-dealing, mismanagement, waste of assets, fraud, and forgery that resulted in the loss of every cent of the $4.75 million invested.” Continue Reading Outlawing of LLC’s Short-Term Rental Business Brings Long-Term Litigation

The test for judicial dissolution of LLCs under LLC Law § 702, as laid down in 1545 Ocean Avenue, initially asks whether the managers are unable or unwilling to reasonably permit or promote realization of the LLC’s “stated purpose” as found in its operating agreement.

I would venture to say that the overwhelming majority of operating agreements, in their purpose clauses, use the phrase “any lawful business” which, not coincidentally, mirrors the enabling language found in LLC Law § 201, authorizing LLCs to be formed for “any lawful business purpose.” Boiler-plate or not, using “any lawful business” in the purpose clause can be a prudent drafting technique to avoid future conflict or need to amend the operating agreement should the LLC’s business model change in response to future events. Of course, there are some circumstances, often involving single asset real estate holding companies, when stating a specific purpose is the more prudent technique.

Which is why last summer’s decision by the Appellate Division, Second Department in Mace v Tunick was such an eye opener. In Mace, the court held that the “any lawful business” purpose clause in the operating agreement at issue did not state any purpose, and on the basis that the lower court had engaged in impermissible fact-finding on a pre-answer dismissal motion, reversed the lower court’s summary dismissal of the minority member’s dissolution suit and remanded the case for further proceedings.

If “any lawful business” states no purpose, I queried in my prior post on the case, does “the primary focus of the judicial dissolution standard under 1545 Ocean Avenue — whether the LLC’s managers are willing or able to achieve its stated purpose under the operating agreement — merely becomes a waystation on the road to more protracted litigation proceedings requiring discovery and evidentiary hearings”?

I still don’t have the definitive answer to that question, but I can tell you what happened in Mace on remand to the lower court, and after the lower court conducted a trial. Continue Reading The Purposeless Purpose Clause Makes a Comeback — Or Does It?

A dissolution petitioner received the judicial equivalent of the old quip “Where’s the beef?” in a Brooklyn appeals court decision last week reversing an order dissolving a limited liability company under Section 702 of the Limited Liability Company Law. In Matter of FR Holdings, FLP v Homapour, 2017 NY Slip Op 07439 (2d Dept Oct. 25, 2017), the Appellate Division, Second Department, sent the case back to the drawing board, despite the LLC having been in receivership for more than two years, because the petitioner “offered no competent evidentiary proof” in support of his petition for dissolution.

A Common Fact Pattern

FR Holdings involved a common fact pattern. 3 Covert LLC (“Covert”) was formed to own and operate a mixed-use apartment and commercial building in Brooklyn.  Under the operating agreement, the purpose of the member-managed LLC was “to purchase and sell residential and commercial real estate and to engage in all transactions reasonably necessary or incidental to the foregoing.” Section 6.01 (a) of the operating agreement permitted most actions by “the vote or consents of holders of a majority of the Membership Interests.” As alleged in the petition, the LLC had five members, four of whom each held 12.5% interests. The fifth member, FR Holdings, owned a 50% interest. Continue Reading “Where’s the Beef?” Says Appeals Court, Reversing LLC Dissolution

New York’s LLC judicial dissolution statute, Section 702 of the Limited Liability Company Law, provides far more limited grounds to dissolve a business than the Business Corporation Law – a harsh reality for allegedly mistreated minority members highlighted by a recent decision by Manhattan Supreme Court Justice David B. Cohen.

In Matter of Felzen v PEI Mussel Kitchen, LLC, 2017 NY Slip Op 31831(U) [Sup Ct, NY County Sept. 1, 2017], Felzen sued to dissolve the company that operates a pair of Manhattan seafood restaurants named Flex Mussels, based upon allegations of breach of fiduciary duty, looting and oppression – frequent grounds for dissolution under Section 1104-a of the Business Corporation Law.  In Matter of Zafar, an earlier decision written about on this blog, comparable allegations – i.e., “persistent self-dealing and dishonest conduct” – sufficed to dissolve an LLC.  Let’s see how things turned out here. Continue Reading LLC’s Purpose Being Achieved? Business Doing Fine? Good Luck Getting Judicial Dissolution

WARNING: Contractarians may find the following post disturbing. Reader discretion is advised.

Now that I’ve got your attention, consider this:

  • Under the standard for judicial dissolution of a New York LLC prescribed in the landmark 1545 Ocean Avenue case, the primary, contract-based inquiry is whether the LLC’s managers are unable or unwilling to permit or promote the stated purpose of the entity, as found in the LLC’s operating agreement or articles of formation, to be realized or achieved.
  • The typical, broad purpose clause found in untold thousands of standardized and customized LLC agreements provides that the LLC’s purpose is “any lawful business,” mirroring Section 201 of the LLC Law (“A limited liability company may be formed under this chapter for any lawful business purpose or purposes”).
  • When a fully integrated operating agreement states that the LLC’s purpose is “any lawful business,” may a minority member of an LLC nonetheless seek judicial dissolution based on extrinsic (parol) evidence that those in control of the LLC are operating it for a lawful business purpose that departs from the LLC’s alleged original lawful business purpose?

Until last week’s decision by the Brooklyn-based Appellate Division, Second Department — the same court that gave us 1545 Ocean Avenue — in Mace v Tunick, 2017 NY Slip Op 06170 [2d Dept Aug. 16, 2017], I would have answered that question “no” with support from a number of case precedents in New York and other jurisdictions including that hotbed of contractarian jurisprudence known as Delaware. After Mace, it appears that the “any lawful business” purpose clause may be as good as no purpose clause. Continue Reading Does Your LLC Agreement Have a Purposeless Purpose Clause?

LLCIf there’s a common theme to the trio of LLC cases highlighted in this post, it’s that having a well-crafted written operating agreement is no guarantee there won’t be a litigation dust-up, while not having a written operating agreement greatly enhances the odds of a legal dispute among members at some point down the road.

Let’s start with the well-crafted operating agreement in Estate of Calderwood v Ace Group International LLC, 2016 NY Slip Op 30591(U) [Sup Ct NY County Feb. 29, 2016], in which Manhattan Commercial Division Justice Shirley Werner Kornreich ruled that upon the death of the subject Delaware LLC’s majority member, under the express terms of Sections 9.7 and 7.1 of the LLC Agreement (read here), his estate was deemed a “Withdrawing Member” with no management rights and retaining solely the right to receive distributions. Continue Reading LLC Case Notes: Member Expulsion, Withdrawal, and LLC Purpose

got purposeUnder the LLC Law’s provision authorizing judicial dissolution and its interpretive case law, determining an LLC’s purpose can be essential to adjudicating whether it no longer is reasonably practicable to carry on its business in conformity with the operating agreement — in other words, whether its purpose has failed.

Failed purpose cases generally fall into one of two categories: those with written operating agreements containing express purpose clauses, and those without. In the latter category, where the LLC either has no written operating agreement or has one lacking a purpose clause, the member seeking dissolution may succeed through testimony and circumstantial evidence showing the failure of the LLC’s intended purpose. The Natanel case, which I litigated and wrote about here, was such a case resulting in judicial dissolution of a single asset, realty-owning LLC purchased to house the co-owners’ separate moving and storage business which eventually went out of business leaving the building largely vacant.

In the former category, the petitioner may face a more daunting if not impossible path to dissolution when an otherwise financially viable LLC’s written agreement contains a typical, broad purpose clause permitting any lawful business activity, such that the termination of the LLC’s initial business, e.g., owning a certain property or holding a certain investment portfolio, may transmute into something entirely different without running afoul of the dissolution statute. Continue Reading LLC Agreement’s All-Purpose Purpose Clause Defeats Dissolution Petition

deadlockTwo major themes are at work in a noteworthy decision last month by Manhattan Commercial Division Justice Charles E. Ramos in Goldstein v Pikus, 2015 NY Slip Op 31455(U) [Sup Ct NY County July 20, 2015], dismissing a petition for judicial dissolution of a New York limited liability company.

First, a petition asserting hostility-infused deadlock between co-managers of a New York LLC will be dismissed summarily absent allegations that the deadlock defeats the LLC’s purposes as defined in the operating agreement, or is causing the LLC to fail financially. Deadlock, per se, doesn’t cut it.

Second, single-asset real estate holding companies present a greater challenge for the dissolution petitioner alleging a dysfunctional relationship between co-managers. No matter the level of discord between co-managers, tenants must continue paying rent and the landlord must continue providing building services, maintenance and financial upkeep. In other words, compared to the operational mayhem and business impairment often caused by warring co-owners of a sales or service business, the realty firm’s purpose and finances tend to remain intact, making it harder to satisfy the dissolution standard for LLCs.

Background

Goldstein stems from a fight for control of Ten Sheridan Associates, LLC, which was formed in 1996 to acquire a 14-story, mixed-use rental building with 73 residential apartments located in Manhattan’s West Village. All of the apartments are rent regulated. Continue Reading Deadlock Hits Dead End in LLC Dissolution Case

purpose4Judicial dissolution statutes for limited liability companies in New York, Delaware, and many other states use the contract-centric language drawn from limited partnership law, namely, whether it is reasonably practicable to carry on the business in conformity with the articles of organization and operating agreement.

Court decisions in both Delaware and New York have construed their respective LLC statutes as authorizing judicial dissolution when the purpose of the entity, as defined in the operating agreement, can no longer be achieved. For instance, former Vice Chancellor Chandler of the Delaware Chancery Court in his 2008 Seneca Investments decision, and then-Vice Chancellor Strine in his 2009 Arrow Investment Advisors decision, both used language suggestive of the LLC agreement as the sole source to which a court should look in determining the LLC’s purpose. In New York, Justice Austin, writing for the Appellate Division, Second Department, in the seminal 1545 Ocean Avenue decision, similarly crafted a dissolution standard keyed to the frustration of the LLC’s “stated purpose” in the context of its operating agreement.

Does that mean courts never look outside the LLC agreement when determining if its purpose no longer is achievable? And how should a court determine purpose when the LLC has no written agreement? Recent decisions from Delaware and New York provide some clues to the answers. Continue Reading Finding Purpose Outside the LLC Agreement

The leading New York case on the standard for judicial dissolution of limited liability companies, Matter of 1545 Ocean Avenue, LLC, held that the proponent of dissolution must show, in the context of the terms of the operating agreement or articles of organization, that:

(1) 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 (2) continuing the entity is financially unfeasible.

Note that the first prong of the standard uses the words “stated purpose” which usually is expressed in the so-called “purpose clause” of the LLC’s operating agreement. Often the purpose clause is drafted broadly, authorizing the LLC to engage in “any lawful business purpose” or using similarly expansive language which can make it more difficult to establish grounds for dissolution under the 1545 Ocean standard.

Sometimes operating agreements define the LLC’s purpose more narrowly, authorizing the company to engage in a particular business pursuit. Frequently a narrow clause is used for limited purpose real estate companies, i.e., the clause will identify the specific investment property to be owned and operated by the LLC, which, in tandem with other provisions limiting fiduciary duties, can serve to clarify the members’ freedom to invest in other real estate ventures without breach.

It stands to reason that the narrower the purpose clause, the easier it should be to satisfy the first prong of the 1545 Ocean standard. But what happens when the operating agreement’s purpose clause sets forth one specific business pursuit but the LLC profitably is put to a different purpose? Can a member who, at least for a time, goes along with the different pursuit seek dissolution claiming that the LLC’s “stated purpose” is unachievable? Continue Reading LLC Dissolution Case Tests Limits of Operating Agreement’s Purpose Clause