Stringent Requirements for Dissolution of LLCs Survive Yet Another Year, Westchester Women’s Bar Association Newsletter, December, 2011

By: Virginia K. Trunkes While New York may have recently eased restrictions in procuring a divorce from a spouse via last year’s no-fault legislation, the parameters for dissolution of limited liability companies (“LLCs”) have remained intact during 2011.

In this past year, a few key decisions highlighted the burdens of obtaining – or preventing – dissolution of an LLC which are unique to this business entity.  After all, the hybrid nature of an LLC – mixing elements of a corporation with those of a partnership – often results in outcomes different from those in other types of business disputes.  As is the usual case in LLC litigation, the key component in analyzing such issues is the operating agreement.

There is a rational reason for focusing on the operating agreement: the policy underlying New York’s limited liability company law (“LLCL”) is that the members are permitted broad flexibility in structuring the LLC by use of the operating agreement.  The LLCL does provide default procedures, but they apply only if the operating agreement’s terms do not address the issue.  See Spires v. Casterline, 4 Misc.3d 428, 433, 778 N.Y.S.2d 259 (Sup. Ct. Monroe Co. 2004) .

In one of this year’s cases, Sealy v. Clifton L.L.C., — N.Y.S.2d —-, 2011 WL 5084659 (Surr. Ct. Kings Co. 2011 [Cutrona, J.]), the 50% owner of an LLC sought, in pertinent part, a declaration that the LLC had recently dissolved due to the other 50% partner’s death and an accounting.  In seeking the accounting, plaintiff asserted that he had been frozen out of the business eight years earlier, and was refused information about the LLC’s funds.  That notwithstanding, the LLC’s business was not affected.

Defendant, via the administrator of the estate, argued, inter alia, that plaintiff lacked standing to seek relief as an LLC member on the ground that his claims were barred by the statute of limitations.  Defendant contended that the LLC had dissolved when plaintiff was shut out of the LLC’s affairs, at which time his entitlement to seek dissolution and concomitant membership rights began accruing.

The court disagreed, noting that while the Business Corporation Law (“BCL”) and Partnership Law (“PL”) authorizes dissolution when a member is frozen out of the entity’s management (BCL §§ 1104, 1104-a; PL § 62), the same does not apply to LLCs.  Instead, the LLCL allows automatic dissolution only upon the occurrence of an event as stated in the operating agreement or other very limited circumstances, like if there are no members. LLCL § 701.  The LLCL permits judicial dissolution when it is not reasonably practicable to carry on the business in accordance with the operating agreement (or articles of organization). LLCL § 702.  The court noted that here, it was undisputed that defendant continued carrying on the business until the day he died.

In that regard, the court held that dissolution was warranted in light of the operating agreement’s provision that the LLC would dissolve upon, inter alia, the death of a member unless the remaining members elected to continue the company’s business.  Obviously plaintiff did not consent to continue the LLC’s activities after defendant’s death, and defendant did not otherwise refute that dissolution was merited.  The court added that whatever monies defendant infused into the LLC when plaintiff no longer participated in the business could be recouped in the accounting proceeding.

In another of this year’s cases addressing one member’s request for dissolution, again the operating agreement was dispositive, although its terms were less obvious to the members protesting dissolution.  In Matter of Fassa Corp., 31 Misc.3d 782, 924 N.Y.S.2d 736 (Sup. Ct. Nassau Co. 2011 [Bucaria, J.]), the petitioner, an LLC member, sought a judicial winding up of the LLC’s affairs.  Petitioner argued that he was entitled to dissolution after he served a 60-day written notice terminating the operating agreement, as its terms permitted.

The other-members-respondents objected and asserted that it was reasonably practicable to carry on the LLC’s business without petitioner’s participation.  The respondents urged that LLCL § 701(a)(2), which allows for dissolution upon the “happening of events specified in the operating agreement,” was not applicable because petitioner’s notice was not an “event” specified in the operating agreement as triggering dissolution of the company.

The court determined that it did not have to decide what was not reasonably practicable, since this was not a matter where the operating agreement’s terms were silent as to the events which will trigger dissolution.  Rather, the court found that the LLC’s operating agreement allowed for its termination upon a member’s 60-day exercise of that option.  Without an operating agreement, there was no basis for the court to determine whether “in the context of the operating agreement,” the stated purpose of the company may be realized or is financially unfeasible as LLCL § 702 mandates.  Further, the court reasoned that where the LLCL requires that every LLC have an operating agreement (LLC § 417(a)), this LLC could not continue upon petitioner’s exercise of the option because the parties could not have intended for the LLC to continue without an operating agreement.  In any event, the court added that dissolution was appropriate because the dispute between the members was so fundamental and intractable that it was not feasible for the company to continue its business.

At first glance, Matter of Fassa conflicts with Spires, supra, insofar as the latter indicated that an LLC can operate without an operating agreement, but will simply be subject to the LLCL’s default provisions. Id, at 436.  Upon closer inspection, the result in Matter of Fassa stemmed from, among other things, the choice of specific language in the operating agreement which seemed to discuss the termination of the LLC, versus a ministerial operating agreement.  Regardless, where “[t]he appropriateness of an order of dissolution of a limited liability company is vested in the sound discretion of the court hearing the petition” (Matter of Extreme Wireless, 299 A.D.2d 549, 550, 750 N.Y.S.2d 520 (2d Dep’t 2002)), both of the aforementioned 2011 cases serve as yet additional reminders that an LLC’s operating agreement is precious and its terms should be drafted with forethought and precision.