Over the past decade, the Limited Liability Company ("LLC") has become one of the most favored forms of a closely held business organization in New York. As an unincorporated business entity, the LLC is favored because of its pass-through tax treatment coupled with maximum operating flexibility. However, an LLC also demands a well-written and comprehensive operation agreement - especially with regard to withdrawal and dissolution - because it may create the only chance for a member to exit the company.
Under Limited Liability Company Law ("LLCL") §606, for example, unless the operating agreement specifically provides for the right of withdrawal, a member is not allowed to withdraw prior to dissolution of the LLC. Thus, where there is no such provision, if a member wants to withdraw, he must try to force a dissolution under LLCL §702, which provides:
On application by or for a member, the Supreme Court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.
This provision is particularly ambiguous because there is no definition of "not reasonably practicable" in the LLCL. However, the recent decision of In the Matter of 1545 Ocean Ave., LLC and Crown Royal Ventures, LLC, 2010 N.Y Slip Op. 688 (2nd Dep’t Jan. 26, 2010), shows just how hard it can be to meet that standard, because of its narrow interpretation.
The 1545 Ocean Ave case exemplifies a common scenario: An LLC was formed to invest in real estate, and it was owned by two members, Crown Royal Ventures, LLC ("Crown Royal") and Ocean Suffolk Properties, LLC ("Ocean Suffolk"), and managed by a representative from each member company. It was not long before tensions between the managers escalated. There was disagreement as to which contractors would be used for the project, among other things, and work was allegedly done and paid for without the consent of one or the other manager. In the end, Crown Royal announced that it wanted to withdraw its investment from the LLC, but though there were discussions regarding one member or the other being bought out, no resolution was ever realized.
Crown Royal then sought dissolution of the LLC on the basis of "deadlock," which the Supreme Court granted. On appeal by Ocean Suffolk, the Appellate Division was asked to determine if the Supreme Court had properly granted the petition of Crown Royal to dissolve 1545 Ocean Ave., upon the showing of management "deadlock."
The Appellate Division’s Analysis
In deciding this question, the Appellate Division began with a concise history of the LLCL, noting the amendments of 1999. The Appellate Division found that since there had been no amended of LLCL §702 in 1999, and the Legislature did not cross-reference dissolution criteria from one type of business entity to another, it would be inappropriate to import dissolution grounds from the Business Corporation Law ("BCL") or Partnership Law ("PL") to the LLCL.
In granting the dissolution, the Supreme Court had done precisely what the Appellate Division found was prohibited: it had imported “deadlock” as a basis for dissolution from BCL §1104. The Appellate Division found that since no such independent ground for dissolution exists under the LLCL, it would not be read into it. LLCL §702 is the sole basis for judicial dissolution for an LLC.
Unlike the BCL or PL, the Court noted that an analysis of dissolution under LLCL §702 begins with the LLC’s operating agreement, making it initially a contract-based analysis. In the 1545 Ocean Ave. case, the Appellate Division found it of note that the 1545 Ocean Ave. operating agreement did not require both managers agree on a proposed action, and did not require a quorum. In addition, as the operating agreement was silent on the topic of dissolution, the LLC was bound by the requirements of LLCL §702. It was in the context of the operating agreement, then, that the Appellate Division considered the ability of the LLC to function.
The Appellate Division noted a few other decisions, from various jurisdictions, holding that “serious difference of opinion among the managers” and commingling of funds did not meet the high standard of "not reasonably feasible."
In light of dissolution being a drastic remedy, the Court held:
"After careful examination of the various factors considered in applying the “not reasonably practicable” standard, we hold that for dissolution of a limited liability company pursuant to LLCL 702, the petitioning member must establish, in the context of the terms of the operating agreement or articles of incorporation, 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."
In 1545 Ocean Ave, where the allegations were that the parties failed to hold regular meeting, failed to achieve quorums, and were otherwise in "deadlock," judicial dissolution pursuant to LLCL §702 was not warranted according to the Appellate Division. Much of the Court’s reasoning was based on the fact that under the 1545 Ocean Ave. operating agreement, none of the acted alleged to have been committed (or omissions) were prohibited, or otherwise required. And none of the alleged acts were contrary to the purpose, or were prohibiting the entity from pursuing its purpose. Furthermore, the Appellate Division acknowledged that if the members were truly aggrieved by the manger’s actions, a derivative claim would be available to them.
As clearly exemplified in 1545 Ocean Ave., achieving an exit from an LLC can be a nearly impossible task if there is no provision in the operating agreement allowing for withdrawal or governing the dissolution of the company. It also makes clear that provisions of an operating agreement will be a controlling part of a New York court's analysis in deciding whether an exit from the LLC will be granted. Thus, without an operating agreement governing these eventualities, a member can be helpless in trying to withdraw his investment from an LLC.