Think Twice Before Putting 100% Quorum Requirement in By-Laws or LLC Agreement

November 12, 2018

It’s no surprise that the quorum requirements found in close corporation by-laws and LLC operating agreements rarely step into the limelight in business divorce disputes. After all, the typical quorum provision for meetings of shareholders, directors, and LLC members and managers requires attendance by a bare majority of voting shares or membership interests or, at the board or managerial level, a bare majority of the board of directors or managers. In other words, it’s usually not the holding of the meeting that generates the dispute, it’s the action taken at the meeting by the control faction that generates the dispute.

In the case of closely held entities with two owners having equal interests and control, a quorum provision requiring majority attendance effectively requires attendance by both owners. If owner #1 doesn’t attend the meeting, not because of some benign reason but due to a disagreement with owner #2 over the action proposed by the latter to be voted upon at the meeting, that produces a deadlock the same as if both owners attended the meeting and cast conflicting votes. Deadlock is deadlock, meeting or no.

Now imagine a closely held entity that has three or more voting shareholders or members, or three or more members of the board of directors or managers, with a quorum provision requiring the presence at a meeting of all the shareholders or members, or of all the directors or managers. With such an entity, a dissenter with minority voting power who couldn’t otherwise defeat a proposed action requiring majority approval, nonetheless can block the action simply by not showing up at the meeting. So much for majority rule.

Actually, we don’t have to imagine the scenario because that’s what happened in Casilli v Natan, 2018 NY Slip Op 32621(U) [Sup Ct NY County Oct. 12, 2018], recently decided by Manhattan Commercial Division Justice Andrea Masley. In her decision, Justice Masley was invited to substitute the statutory default rule under LLC Law § 404, requiring the presence at meetings of a majority in interest of the members, for an “unworkable” quorum provision in the LLC’s operating agreement requiring the presence of all. Not surprisingly, at least to this writer, Justice Masley declined the invitation.

Casilli involves a multi-member LLC that operates a bar and restaurant in lower Manhattan. The LLC has three managing members: Messrs. Casilli, Natan, and Cohen. Section 3.1 (g) of the Operating Agreement, entitled “Quorum and Voting,” provides as follows with respect to action by the Board:

The presence of all of the appointed Managers shall constitute a quorum for the transaction of business at a meeting of the Board. All action by the Board must be authorized by a majority of the Managers, provided, however, that Managers may grant proxies to the other Managers to vote on their behalf.

Member voting and quorum provisions are contained in Section 8.2 which incorporates a Schedule 8.2 listing actions that require member approval by majority vote, but only after being recommended by the Board of Managers. One of the specified actions is filing for bankruptcy protection.

In May 2017, Casilli filed suit against Natan and Cohen accusing them of breaching fiduciary duty and requesting their removal from the Board of Managers.

Natan and Cohen quickly responded by noticing a meeting of the Board of Managers to remove Casilli as president and director of operations. Casilli, who did not attend the meeting, sought an interim injunction preventing them from carrying out their plan. In a June 2017 order, the court granted the injunction, citing Section 3.1 (g) of the Operating Agreement requiring the presence of all three managing members to constitute a quorum for the transaction of business. “In the absence of a quorum,” the court wrote, “no transaction can occur.”

In April 2018, rather than calling for a meeting of the managers as they unsuccessfully attempted the year before, this time Natan and Cohen noticed a meeting of the members, ostensibly pursuant to Section 8.2 of the Operating Agreement, to “recommend” that they authorize the retention of counsel to file a Chapter 11 petition. Casilli promptly moved to enjoin the meeting.

At the conclusion of oral argument on Casilli’s motion (read the transcript here), Justice Masley issued an order staying the member meeting pending her decision. She also directed counsel to submit supplemental briefs addressing the interplay of Sections 3.1 (g) and 8.2 of the Operating Agreement as bearing upon the validity of the meeting notice and its proposed member vote to approve a bankruptcy filing, and on whether the LLC Law’s default rules supply an alternative remedy.

Casilli’s brief focused on Section 8.2’s requirement that any member vote on the actions listed in Schedule 8.2, including a bankruptcy filing, must be preceded by a Board recommendation to do so. The only way to get a Board recommendation, Casilli argued, is to have a Board meeting, and the only way to have a Board meeting under Section 3.1 (g) is if all three managers attend the Board meeting, which never happened. “There is nothing in the Operating Agreement that can force either a Manager or a Member to attend any meeting,” Casilli argued, and there is “nothing in the [LLC Law that] speaks on what happens if there is never a quorum of the Board of Managers present.”

Natan’s and Cohen’s brief framed the issue as whether the “inability to convene a quorum renders the Operating Agreement a functional nullity since [it] contains no provision by which this type of stalemate can be broken.” Asserting that Casilli has a fiduciary duty to attend Board meetings, and pointing out that the LLC Law has no quorum provision for meetings of managers of manager-managed LLCs, Natan and Cohen concluded that the court should impose LLC Law § 404’s default rule, requiring a majority in interest be present for meetings of the members, to the subject LLC’s Board meetings.

The Court’s Decision

In her decision last month, after summarizing the relevant provisions of the Operating Agreement, Justice Masley found that, under its “plain, unambiguous language,” the meeting notice was “defective” in that it was “issued to address matters contemplated in Schedule 8.2 without first holding an authorized Board Meeting: if the full Board was not present at a Board Meeting regarding those matters, the requisite quorum was lacking.” Further, “[n]one of the sections [of the LLC Law] identified by the parties address resolution of a stalemate amongst board members, or an inability to reach a quorum to take action.”

Justice Masley thus ruled in Casilli’s favor:

There are no mechanisms for forcing a Manager to appear for a Board meeting, or for circumventing an inability to obtain a quorum. . . . The court declines to adopt defendants’ reasoning and apply default LLC Law provisions where, as here, the Operating Agreement is plain and unambiguous in spite of its lack of certain contingency procedures, especially where defendants have not established that a Board Meeting was noticed, let alone convened, but the necessary quorum was not attained due to one Managing Member’s refusal to attend.

Justice Masley accordingly granted Casilli’s motion to the extent of prohibiting Natan and Cohen from holding a general membership meeting “until such time as such meeting is properly noticed under the Operating Agreement.”

The Takeaway. There may be peculiar circumstances warranting a 100% quorum requirement in by-laws or an operating agreement, with no contingency provision for a no-show shareholder, director, member, or manager. But unless the by-laws or operating agreement require unanimous approval of the proposed action — and even then, it’s difficult to understand why you’d want one holdout to be able to scuttle a meeting, assuming the purpose of the meeting is to debate proposed actions and persuade others — it’s hard to imagine why you’d want to go that route.