Court Enjoins Dilution of Brewing Company LLC Membership Interest
September 11, 2021
Most folks associate beer with pleasure. Beer brings the happy, and many craft brewers will tell you they went into business for that very reason. But an investor in a Bushwick, Brooklyn beer brewing company and taproom startup was anything but happy after his co-members began taking steps to dilute his membership interest in the limited liability company, resulting in fast and furious litigation and an immediate injunction motion to halt the alleged “freeze out.”
According to his complaint, Peter Lengyel-Fushimi (“Peter”) was a molecular biologist by training who decided to pursue his passion for craft beer making and “dedicate his life to beer.” Peter “committed himself to his new goal of opening a brewery,” took a series of apprenticeships in local breweries to learn the trade, and ultimately partnered with Anthony Bellis (“Anthony”) and Zachary Kinney (“Zachary”) to form Kings County Brewers Collective, LLC (the “Brewery”).
In 2014, Peter, Anthony, and Zachary entered into an Operating and Subscription Agreement, according to which each became a manager and 25.33% “Class A” membership interest holder, collectively owning 76% of the Brewery. The remaining 24% membership interests were sold to investors denominated “Class B” and “Class C” interests, the Class B member having limited voting rights, the Class C members no voting rights only an economic interest. Peter held the title of Head of Beer Production / Operating Manager.
Important for his later injunction application, a standard merger and no-oral-modification provision in Section 10.1 of the Operating Agreement provided, “This agreement constitutes the whole and entire agreement of the parties with respect to the subject matter of this agreement, and it shall not be modified or amended in any respect except by a written instrument executed by all of the Members.”
In 2016, the Brewery opened for business. The next year, according to the complaint, New York magazine nominated it one of the five “absolutely best brewery taprooms” in New York City. By 2020, the Brewery generated close to $4 million in revenue, employed over 20 workers, and remained successful even through the pandemic.
Behind the scenes, though, beer wasn’t the only thing brewing. “[P]ersonality and philosophical differences plagued relations between the three Class A members,” disputes often arising over their approach to expanding the business, creating an “unpleasant working environment for the three partners, who were no longer on friendly terms.”
By the end of 2020, the Class A members were at “loggerheads” and “began discussing ways of engineering a business divorce,” including a potential sale of the business, opening a new location where the feuding founders could work apart from one another, a paid departure of Peter from the Brewery to start a new brewing company, or Peter selling a portion of his interest to the Class B member.
In early 2021, according to the complaint, Anthony and Zachary began to take steps to expel or dilute Peter’s interest, culminating in an announcement that they planned to amend the Operating Agreement to convert his Class A membership interest into a new “Class D” interest with no management rights, terminate him as officer of the Brewery, remove him from management, and cease his compensation. Anthony and Zachary circulated proposed amendments to the operating agreement (read here and here), which they claimed to be empowered to adopt by mere majority vote of the Class A members.
The Complaint and Injunction Motion
Ostensibly forced out of the business he helped found, Peter sued Anthony and Zachary in Brooklyn Supreme Court alleging five claims: (i) a declaratory judgment that Section 10.1 of the Operating Agreement prohibited amendment without unanimity of the Class A members, (ii) breach of the Operating Agreement, (iii) breach of the implied covenant of good faith and fair dealing, (iv) violation of Section 409 of the Limited Liability Company Law requiring LLC managers to act “in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances,” and (v) breach of fiduciary duty.
The same day he sued, Peter moved by Order to Show Cause to enjoin his co-members from “removing or attempting to remove [him] as a Class A member” and from “removing or attempting to remove or terminate [him] as an officer” of the Brewery. In his memorandum of law, Peter argued that he would be irreparably harmed by termination of his management and control rights, and that Section 10.1 of the Operating Agreement barred his co-members from acting without his consent.
Anthony and Zachary each filed an affidavit in opposition (read here and here) and made a cross-motion to dismiss the complaint, taking the position that the Operating Agreement could be amended by simple majority vote. In the words of Anthony, “It the belief of [the defendants] that no approvals or signatures beyond a majority of the Class ‘A’ are required under . . . the operating agreement, and since [Zachary] and I make up 50.66% . . . of the Class ‘A’ equity, any action taken is appropriate when approved by both of us.”
In a pair of Decisions and Orders available here and here, Kings County Commercial Division Justice Leon Ruchelsman granted Peter a broad preliminary injunction, then narrowed the scope of the injunction.
In the first decision, Justice Ruchelsman ruled that Peter demonstrated a “likelihood of success” that Anthony and Zachary “breached the agreement” because Section 10.1 of the Operating Agreement prohibited amendment without unanimity, so “there was no basis to exclude [Peter] without a vote of all members,” and “the entire action taken by the defendants as Class A members was without authority.”
On the issue of irreparable harm, the Court concluded, “The harm the plaintiff asserts is not about money damages per se but about the management and participation in a business he started which cannot be quantified in any dollar amount.”
Lastly, the Court ruled, “Based upon the above analysis there are surely questions of fact regarding the activities of the defendants. Therefore, the motion seeking to dismiss the lawsuit is denied.”
Anthony and Zachary moved for leave to reargue, asking the Court, in effect, to disregard Section 10.1 of the Operating Agreement because the parties in the past often made modifications without unanimous written consent, arguing that strict enforcement of Section 10.1 “destroys the company while a modification to it allowing for a vote [of the majority] maintains the status quo and allows the LLC to continue in operation.” Anthony and Zachary further argued that enjoining them from removing Peter as officer contravened Section 4.3 of the Operating Agreement providing that “an officer shall serve at the pleasure of the Class A members.”
In the second decision, Justice Ruchelsman ruled that the parties’ alleged failure to adhere at times to Section 10.1 of the Operating Agreement did not negate its enforceability, writing:
That provision necessarily and clearly requires a unanimous consent to amend the agreement. That provision . . . should be ignored because it is inconvenient to the parties or because it was not honored by the [Class A members] in the past. The fact the parties conducted their business without adherence to that clause . . . does not mean the court should likewise ignore the clause. The clause is not confusing or complicated or indecipherable nor is it contradicted by any other provision[s] in the operating agreement. . . . While the court is sympathetic to the parties’ plight, which they caused themselves, they fail to explain how a modification of that clause, allowing a vote without unanimity, is even possible.
But the court modified its prior injunction order slightly, concluding that under Section 4.3, “unanimity is not required” to remove a Class A member as officer of the Brewery, ruling that the Court’s prior injunction order “cannot cover the plaintiff’s status as an officer or employee.”
Injunctions in Business Divorce Cases
Fortunately for Peter, his facts fell comfortably within a well-developed body of case law holding that loss of management rights in a closely-held business venture can constitute “irreparable harm” for which money damages are inadequate, including in beer company litigations (see e.g. Wisdom Import Sales Co., L.L.C. v Labatt Brewing Co., Ltd., 339 F3d 101 [2d Cir 2003] [“bargained-for minority right to participate in corporate management has value in and of itself and a denial of that right, without more, can give rise to irreparable harm”]; Louis Foodservice Corp. v Vouyiouklis, 2002 NY Slip Op 50448 [U] [Sup Ct, Kings County 2002] [“It is well-settled that plaintiffs’ alleged harm, an opportunity for defendants to shift the balance of power and assume management and control of the corporation, may properly be viewed as irreparable injury”]).
We’re written previously about how injunction motions can be particularly effective when deployed tactically in business divorce cases. Lengyel-Fushimi is a perfect example of a plaintiff using an injunction motion at the commencement of the lawsuit to maximum effect, achieving a critical early win and setting the stage for the rest of the litigation.
For Peter, he was simultaneously able to persuade the court to embrace the merits of his complaint within two months of the case’s commencement, and to stop dead in its tracks his co-members’ attempt to impair his ownership and control rights in the Brewery. One suspects Peter may attempt to parlay his early injunction victory into a quick settlement via a negotiated buy out or sale of his interest. We’ll keep an eye on the docket and let our regular readers know if future blog-worthy events arise in the case.