Common-Law and Equitable LLC Dissolution: Going, Going, . . .
July 19, 2021
Recently, we’ve written two articles focusing on the brewing dispute over whether New York law recognizes a viable cause of action for “common-law” or “equitable” dissolution of a limited liability company.
In October 2020, I blogged about a pre-answer dismissal decision in Pachter v Winiarsky, in which a New York court for the first time upheld a claim for common-law LLC dissolution, even where the court in the same decision held that the petition failed to state a claim for statutory dissolution under Section 702 of the Limited Liability Company Law.
In May 2021, Peter Mahler blogged about a second pre-answer dismissal decision in the Pachter case, in which the court considered the sufficiency of an amended petition / complaint filed after issuance of the original dismissal decision. In the second Pachter decision, the court essentially reversed itself, dismissed the common-law / equitable dissolution claim, but reinstated the Section 702 dissolution claim.
On July 12, 2021, Brooklyn Commercial Division Justice Leon Ruchelsman issued the third decision in the knock-down-drag-out Pachter litigation addressing whether common-law / equitable dissolution of an LLC exists as a viable cause of action in New York. This decision came via a motion by Pachter for leave to reargue the prior dismissal.
Arguments in Support
The legal arguments the parties made are interesting, so I’ll devote some time to the briefs, which you can read here, here, and here.
In her moving papers, Pachter argued:
Equitable dissolution, also known as common law dissolution, is a well-settled doctrine entitling members of LLCs to dissolution when the LLC’s management has engaged in certain ‘egregious conduct’ towards the LLC or other members. See Lemle v. Lemle, 92 A.D.3d 494, 500 (1st Dep’t 2012).
I would best describe this argument as a “stretch.” Lemle was not an LLC dissolution case. The appeals decision in Lemle involved several corporations, but no LLCs. Lemle certainly did not address common-law LLC dissolution, a subject no New York appeals court has addressed directly (but more on this later). In fact, in another section of her brief, Pachter acknowledged the lack of appeals court guidance:
Plaintiff recognizes that the novelty and complexity of issues here will almost certainly necessitate appellate review [but] rather than await the appellate endorsement of equitable dissolution—in which case the parties would have to repeat discovery and trial—the best course of action would be to reinstate the claim and allow discovery and trial to go forward in the meantime on all issues asserted in the Amended Complaint.
On the ultimate merits of whether New York law would recognize common-law LLC dissolution, Pachter analogized to other areas of LLC jurisprudence where courts recognized common-law remedies not found in the written text of the LLC Law, arguing:
Equitable dissolution applies to LLCs. In Tzolis v. Wolff, 10 N.Y.3d 100 (2008), the Court of Appeals held that all well-established equitable doctrines for redressing harms by corporate fiduciaries are available in the LLC context in the absence of a ‘clear legislative mandate to the contrary.’
This is another “stretch.” We’ve written about Tzolis v Wolff many times. Though it may be the most important LLC case so far to reach the Court of Appeals, establishing the general principle that some “equitable” / “common-law” doctrines apply to LLCs, it certainly did not go so far as to hold that “all well-established equitable doctrines for redressing harms by corporate fiduciaries are available in the LLC context” unless prohibited by the LLC Law.
Rather, as Pachter pointed out in other sections of her brief, there are three leading strands of case law importing equitable concepts applicable to other entity forms to LLCs:
The gist of Pachter’s argument was that the court should take inspiration from these three strands of case law and import into the LLC law a fourth: equitable / common law dissolution, which originates from the law of corporations.
Arguments in Opposition
In their opposition brief, the respondents argued that New York’s leading LLC dissolution case, Matter of 1545 Ocean Ave, LLC, 72 AD3d 121 (2d Dept 2010), flatly prohibited any notion that New York courts may apply to LLCs the standards for common-law dissolution of corporations:
In . . . LLCL 702, the Legislature can only have intended the dissolution standard therein provided to remain the sole basis for judicial dissolution of a limited liability company. Phrased differently, since the Legislature, in determining the criteria for dissolution of various business entities in New York, did not cross-reference such grounds from one type of entity to another, it would be inappropriate for this Court to import dissolution grounds from the Business Corporation Law or Partnership Law to the LLCL.
The Intervening Kassab Decision
On June 22, 2021, the same day Pachter’s reargument motion was submitted for decision, the Appellate Division – Second Department issued a pair of important new decisions (available here and here) in the Kassab litigation. As I wrote a few weeks ago, one of the decisions contains the following language echoing Ocean Avenue: “Limited Liability Company Law 702 provides the sole basis for judicial dissolution of a limited liability company, and includes a ‘more stringent’ standard than that for dissolution of a corporation” (quotations omitted; emphasis added).
The Reargument Decision
In his decision, Justice Ruchelsman rejected for the second time Pachter’s request to recognize a viable cause of action for common-law dissolution, rendering two essential legal rulings.
First, the court ruled:
In Matter of 1545 Ocean Avenue . . . the court held that the sole basis for dissolution of a limited liability company were the grounds outlined in Limited Liability Company Law § 702, namely judicial dissolution and that it was improper ‘to import dissolution grounds from the Business Corporation Law or Partnership Law to the Limited Liability Company Law.’ Indeed, there are no cases that apply anything other than judicial dissolution to limited liability companies. The fact that other remedies are available to limited liability companies such as piercing the corporate veil or the business judgement rule does not mean other dissolution methods are possible. [Although] petitioner argues there is no reason why equitable dissolution should be barred when it is available for entities that are so similar to limited liability corporations . . . that is a policy argument which cannot override the clear directive of Matter of 1545 Ocean Avenue. Indeed, this court is bound by Matter of 1545 Ocean Avenue which interpreted Limited Liability Company Law 702 as foreclosing all other forms of dissolution.
Second, the court ruled:
The petitioner further argues ‘the law supports the viability of equitable dissolution.’ While that is surely true when dealing with ordinary corporations, and it may very well be the petitioner has demonstrated the sufficiency of evidence necessary to obtain equitable dissolution generally, it is not true at all when dealing with limited liability companies. The cases cited by petitioner do not endorse such equitable dissolution for limited liability companies. Tzolis v. Wolff . . . held that derivative actions were permissible in a limited liability company, however, that has nothing to do with whether other forms of dissolution are available. Further, in Mizrahi v. Cohen . . . the dissolution that occurred was ‘judicial’ pursuant to Limited Liability Company Law 702. . . Again, while arguments based upon logic or common sense might seem persuasive, at this time there is no basis for a dissolution of a limited liability company that is not judicial.
State of the Law After Pachter
In Pachter‘s trio of decisions, common-law LLC dissolution showed brief signs of promise as a new cause of action, but now seems of questionable provenance unless and until an appeals court or other trial level court finds such a claim viable under New York law.
For petitioners / plaintiffs, one can understand the appeal of a catch-all, non-statutory dissolution claim embracing “egregious” cases of breach of fiduciary duty as a means to dissolve an LLC. As our regular readers know, with some exceptions, breach of fiduciary duty, oppression, even exclusion from the LLC, often do not suffice to establish grounds to dissolve under the standards of Matter of 1545 Ocean Ave. There is a growing body of case law dismissing at the pre-answer stage Section 702 petitions alleging these dissolution grounds (you can read some of several recent examples we’ve blogged about here, here, here). There is also a growing body of appellate decisions affirming such grants of dismissal, even reversing denials of dismissal (the latest being Kassab from last month; two others can be found here and here).
All of this demonstrates that the ways for members to dissolve a New York LLC seem to be narrowing, not broadening, making the operating agreement all that much more important. If they wish, creative drafters of operating agreements, particularly those representing non-controlling members, might consider enumerating in the operating agreement those rights and duties the parties consider truly vital, contravention of which may provide grounds for dissolution under LLC Law 701 (2) permitting dissolution upon the “happening of events specified in the operating agreement.” Though this rarely occurs in practice, it may be one approach to try to anticipate and address the fact that, under New York’s judicial dissolution statute, breaking up can be hard to do .