A Two-Act Play of LLC Default Rules and Manager Removal
January 24, 2022
“Except as provided in the operating agreement. . . ”
By my count, this phrase and its close relative, “unless otherwise provided in the operating agreement,” appear 59 times in New York’s LLC Law, most often to qualify a rule on LLC governance. This substantial deference to the members’ freedom of contract is a hallmark of LLCs, and it is often said that the LLC law contains default rules, or “gap fillers,” subject to the members’ rights to modify the rules as they see fit.
The interplay between the default rules and the members’ agreement sometimes gets complicated. For instance, when an operating agreement is completely silent on a right set forth in the LLC law, that silence can be ambiguous. Were the parties silent about that right in their operating agreement because they agreed to forgo it? Or does their silence in the operating agreement mean that the members wished to apply the default rules?
This difficult question took center-stage in a duo of recent decisions from Manhattan Commercial Division Justice Joel M. Cohen, in McCormack v Kuras, Index No. 656434/2021 [Sup Ct, New York County] and its related case, Triboss Brooklyn LLC v Kuras, Index No. 654282/2021 [Sup Ct, New York County]).
In these decisions, Justice Cohen rejects the majority members’ attempts to remove a managing member from management. In so doing, Justice Cohen recognizes the appeal of both sides’ arguments and takes the relatively rare step of expressly inviting appellate guidance on issues surrounding the applicability of the LLC law’s default rules.
The Operating Agreement
Triboss Brooklyn, LLC (“Triboss”), owned equally by McCormack, Kuras, and Ghorayeb, holds rental property in Brooklyn. Despite its name, Triboss has one boss: the Operating Agreement names McCormack as the sole Managing Member, providing him with exclusive authority to manage the company’s affairs, enter contracts, hire employees, and—notably here—sell or dispose of the LLC’s sole asset.
While silent on the removal of McCormack as Managing Member, the Operating Agreement provides that it can only be amended by the unanimous written consent of the members, McCormack included.
In 2021, McCormack decided to sell Triboss’ property. He requested that Kuras and Ghorayeb cooperate in his efforts to market and sell the property by turning over leases for units that Kuras had negotiated and by making the space in which Kuras and Ghorayeb were living available for showings. Kuras and Ghorayeb refused.
Act One: Majority Consent to Remove McCormack as Manager
When McCormack continued to explore the sale of the property, Kuras and Ghorayeb (collectively, the “Majority”)—together holding two-thirds of the outstanding membership interests—executed a written consent purporting to remove McCormack as Managing Member under LLCL 414.
LLCL 414, titled Removal or Replacement of Managers, states that:
Except as provided in the operating agreement, any or all managers of a limited liability company may be removed or replaced with or without cause by a vote of a majority in interest of the members entitled to vote thereon.
When the dispute over the validity of the Majority’s written consent reached the court, the Majority insisted that because the Operating Agreement was silent on removal of the Managing Member, the default rule in LLCL 414 must apply to “fill the gap.” They relied on Ross v. Nelson, 54 AD3d 258, 2008 NY Slip Op 06504 (1st Dept 2008) (covered in this post). In Ross, a divided First Department held that the members could vote to remove the managing member under LLCL 414 despite the operating agreement’s requirement of unanimous consent to amend.
McCormack argued that LLCL 414 did not apply because removing him as Managing Member would require amending the Operating Agreement, and any amendment required his consent. He distinguished Ross on the ground that the operating agreement there, albeit in an unrelated section, “opened the door” to manager expulsion. Specifically, the section dealing with dissolution provided:
This Company shall be dissolved and its affairs wound [sic] upon the first to occur of the following: . . . (c) The bankruptcy, death, expulsion, incapacity or withdrawal of any manager . . . (Emphasis added.)
This, argued McCormack, was the critical distinction. Section 414 applied in Ross because the operating agreement contemplated expulsion of the manager, but it did not set forth a framework for that expulsion. Here, by contrast, Triboss’ Operating Agreement did not contemplate expulsion at all, so Section 414 did not apply.
In a ruling from the bench on October 6, 2021, Justice Cohen denied the Majority’s request for a preliminary injunction enjoining McCormack from acting as Managing Member. Justice Cohen stated:
[W]hile the [Majority] offer[s] a construction of the statute that is not unreasonable and that construction is that the statute should supply the default rule of majority of members can replace the managing member, that is not the way currently it has been interpreted, at least by the cases that have addressed it.
Referencing Goldstein v Pikus, 2015 NY Slip Op 31483[U] [Sup Ct, New York County 2015] (covered in this post) and Friedman v Bridge Capital Corp., [Sup Ct, New York County 2010], Justice Cohen continued:
Two of my colleagues . . . determined that the reference to expulsion in the agreement at issue in Ross was critical to the result and that what the statute really means is that if the agreement can be read reasonably to provide for removal, that’s fine, but if there is no reference to removal . . . in that situation the default rule is the other way, because if the contract names a specific person, doesn’t talk about forcibly removing them against their will, then that’s it.
Inviting the First Department to weigh in, Justice Cohen concluded:
And, you know, I think it would be helpful to have, perhaps, appellate guidance on this, but, as I read the law as it is right now, I cannot conclude that the third-party plaintiff has shown a likelihood of success on that issue.
Thus, the Court denied the Majority’s request for an injunction barring McCormack from acting as Managing Member.
Act Two: Amendment to the Articles of Organization
After Justice Cohen ruled on their request for a preliminary injunction enforcing their written consent, the Majority again tried to remove McCormack as manager, this time by voting to amend Triboss’ Articles of Organization.
The Operating Agreement only required unanimous consent to amend the Operating Agreement; it did not discuss amendments to the Articles of Organization. Therefore, argued the Majority, the default rule in LLCL 213 applied: “an amendment to the articles of organization shall be authorized by at least a majority in interest.” Moreover, LLCL 211 provides that an amendment to the articles of organization can change its management structure, and when there is a conflict between the articles of organization and the operating agreement, the articles of organization control.
In a January 11, 2022, written decision, Justice Cohen rejected the Majority’s bid to amend Triboss’ Articles of Organization to remove McCormack as manager:
The attempt by Respondents Kuras and Ghorayeb to evade the terms of the Operating Agreement by seeking to amend the Articles of Organization – without Petitioner’s consent and in violation of the Operating Agreement to which all parties agreed – is similarly unavailing. As stated in Nathanson v Nathanson, 20 AD3d 403, 403-04 [2d Dept 2005], even if the articles of organization vest management of the company in its members generally, “such vesting of authority is ‘subject to any provisions in . . . the operating agreement . . . granting or withholding the management powers or responsibilities of one or more members”’ (quoting LLCL § 401[a]).
Based on that reasoning, the Court declared that McCormack “is, has been, continues to be, and remains the Managing Member of Triboss.”
Triboss completes a trio of cases holding that LLCL 414’s manager removal rights do not apply unless the operating agreement somehow opens the door to involuntary manager removal. LLC members and counsel must be aware of any operating agreement that appoints a managing member but remains silent on removal. In those circumstances—particularly if amending the operating agreement requires unanimous consent—ousting the managing member against his or her will may prove impossible.
Act One of Triboss raises complex and important questions concerning the interplay between the default rules of the LLC law and the “gaps” left by an operating agreement that fails to address certain rights and remedies in those default rules. We’ll wait to see if an appeal by the Majority gives the First Department cause to take Justice Cohen up on his invitation to provide clarification.
I’m also curious about Act Two.
Nathanson, the case cited by the Court, holds that the management powers established in the articles of organization are subject to the limitations imposed on those powers by the operating agreement. An operating agreement can limit—but not be inconsistent with (see LLCL 417)—the management powers established by the articles of organization. Act Two of Triboss takes Nathanson a step further, holding that the operating agreement can limit the members’ rights to determine what management powers the articles of organization establish (or in this case, change) in the first place.
Consider whether that can be reconciled with LLCL 203(7). While not cited by the parties, LLCL 203(7) provides that the members may include in the articles of organization “any other provisions, not inconsistent with law, that the members elect to include in the articles or organization for the regulation of the internal affairs of the limited liability company, including, . . . (B) a statement of whether there are limitations on the authority of members or managers or a class or classes thereof to bind the limited liability company.” Notice a significant omission: Section 203 contains no carve out such as, “except as otherwise provided in the operating agreement.” Arguably, under LLCL 203(7), the members’ rights to establish the management powers in the articles of organization are not subject to any limitations of the operating agreement.