A Fresh Take on Partnership to LLC Conversions
August 08, 2022
A rarely litigated provision of the New York Limited Liability Company Law (the “LLC Law”), Section 1006, authorizes the conversion of a general or limited partnership to a New York LLC through a statutorily-prescribed process, similar in ways to a merger, including the partners’ adoption of an “agreement of conversion” and the filing of a “certificate of conversion” with the New York State Department of State.
LLC Law 1006 and Partnership Law 121-1102
Like a merger, LLC Law 1006 provides the option to limited partners – but not general partners – to opt out from the transaction (i.e., dissent) and seek “fair value” in an appraisal proceeding governed by the procedures set forth in Section 121-1102 of the Revised Limited Partnership Act, found in Article 8-a of the New York Partnership Law (the “Partnership Law”). The leading case on Partnership Law 121-1102 is the 2008 Court of Appeals decision in Appleton Acquisition.
LLC Law 1006’s heyday was in the late 1990s and early 2000s, following New York’s adoption of the LLC Law effective in 1994, when many owners of partnerships opted to convert to the LLC form to enjoy the combined benefits of limited personal liability, pass-through tax status, and the flexibility to organize LLCs in many different ways in the operating agreement.
The Dearth of Case Law
Until last month, there were exactly nine reported decisions on Westlaw addressing LLC Law 1006. Virtually none of them addressed the correct interpretation and applicability of the statute. Until three weeks ago, the leading case on LLC Law 1006 was Miller v Ross, a case which invalidated on technical grounds a partnership to LLC conversion, but which could hardly be described as a treatise on the subject given its brevity (i.e., one paragraph).
The Shalov Case
Last month, New York County Supreme Court Justice Nancy M. Bannon issued what instantly became the most scholarly decision in New York jurisprudence to consider LLC Law 1006 and its interplay with Partnership Law 121-1102. The irony: the Court concluded that because the conversion was structured as a multi-step process, not a classic, short-form, one-step conversion from partnership to LLC, the two statutes, including the right to dissent and seek fair value in a valuation proceeding, did not strictly apply to the transaction. Based on this conclusion, in Shalov v Brisbane Assocs. Ltd. Partnership (2022 NY Slip Op 32375(U) [Sup Ct, NY County Jul. 18, 2022]), the Court considered and rejected a 1% limited partner’s challenge to a partnership to LLC conversion – approved and adopted by the other 99% partnership interests – on both procedural and substantive grounds, upholding the entity’s conversion in all respects.
The Procedural Challenge
Procedurally, Shalov asked the Court to declare the transaction invalid, alleging in her first cause of action that the transaction was “null and void and of no force or effect whatsoever” because the partnership’s majority admittedly did not strictly follow the notice and meeting requirements of Partnership Law 121-1102, which Shalov argued was incorporated into LLC Law 1006. Alternatively, Shalov asked the Court in her second cause of action to provide her a fair value appraisal of her former 1% limited partnership interest under Partnership Law 121-1102.
The Court framed the question as “whether the Plan [of conversion] was a statutory conversion within the meaning of the LLC Law, as opposed to the utilization of a mechanism of conversion not governed by statute.” The Court explained:
Section 1006 of the LLC Law states that a limited partnership ‘may’ convert to a limited liability corporation, without any intermediate steps, if the partners approve an agreement of conversion, the limited partnership files Articles of Organization with the Secretary of State including a statement that the partnership was converted to a limited liability company, and the limited partnership cancels its certificate of limited partnership. Here, the Partnership reorganized in a different manner. The Partnership first transferred its assets to [Brisbane Associates, LLC, i.e.,] the Company and initially owned the Company. The partners voluntarily contributed their partnership interests to one of [four member LLCs, Seward Brisbane, LLC, Alice Brisbane, LLC, Elinor Brisbane, LLC, and Sarah Brisbane, LLC, i.e.,] the Family LLCs, each of which was then admitted as a substitute general partner owning the aggregate partnership interests of the participating family members. The last step in the conversion was the pro rata, in-kind distribution of the Partnership’s only remaining asset – its ownership interest in the Company – to each partner, whether a Family LLC or an individual. Upon completion of that step, pursuant to the Partnership Agreement, the Partnership no longer had any limited partners and therefore was dissolved by operation of law.
Thus, the Plan proceeded to effectuate the conversion of the Partnership to the Company not by means of a conversion agreement and the expedited statutory process authorized by the LLC Law but pursuant to a series of agreements and exercises of the power of the General Partners, as bestowed by the Partnership Agreement. Moreover, while the Plan ultimately resulted in former partners holding various membership interests in the Company, the Company was never considered to be the same entity as the Partnership and did not assume the Partnership’s obligations, (see LLC Law 1007). In light of the foregoing, the plaintiff’s invocation of the procedures permitted by the LLC Law and Article 8-a of the Partnership Law is misplaced.
The Substantive Challenge
Substantively, Shalov alleged causes of action for damages based upon the conversion for breach of fiduciary duty, fraud, negligent misrepresentation, “minority oppression,” unjust enrichment, and conversion. The Court dismissed each one, ruling that the transaction as structured applied equally to all partners and “while the plaintiff strains to construct a narrative of biased and unfair treatment towards her alone, her submissions establish that she had access to the very same documents as all other family members who were limited partners. . . . Thus, the business judgment rule protects the subject transaction from judicial scrutiny.”
Comments on Shalov
One of the lessons of Shalov: transactional lawyers who structure limited partnership to LLC conversions may be able to effectively avoid some of the procedural provisions of LLC Law 1006, particularly the dissenter’s right to seek fair value in an appraisal proceeding otherwise afforded limited partners under Partnership Law 121-1102, by structuring the transaction as a multi-step process, not as a straight partnership to LLC conversion.
One of the oddities of Shalov: the case involved conversion of a New York limited partnership to a Delaware LLC, yet the Court applied New York law. Why apply a New York statute to a transaction where the surviving entity was organized under Delaware law? The parties’ transaction documents assumed the applicability of LLC Law 1006, the plaintiff herself pled the applicability and violation of LLC Law 1006 in her own complaint, and the parties in their briefs (you can read them here, here, and here) all assumed the applicability of New York law. Because of the parties’ apparent agreement over New York law’s application, the Court apparently did not question the choice of law analysis.