Does Your LLC Agreement Have a Purposeless Purpose Clause?
August 21, 2017
WARNING: Contractarians may find the following post disturbing. Reader discretion is advised.
Now that I’ve got your attention, consider this:
- Under the standard for judicial dissolution of a New York LLC prescribed in the landmark 1545 Ocean Avenue case, the primary, contract-based inquiry is whether the LLC’s managers are unable or unwilling to permit or promote the stated purpose of the entity, as found in the LLC’s operating agreement or articles of formation, to be realized or achieved.
- The typical, broad purpose clause found in untold thousands of standardized and customized LLC agreements provides that the LLC’s purpose is “any lawful business,” mirroring Section 201 of the LLC Law (“A limited liability company may be formed under this chapter for any lawful business purpose or purposes”).
- When a fully integrated operating agreement states that the LLC’s purpose is “any lawful business,” may a minority member of an LLC nonetheless seek judicial dissolution based on extrinsic (parol) evidence that those in control of the LLC are operating it for a lawful business purpose that departs from the LLC’s alleged original lawful business purpose?
Until last week’s decision by the Brooklyn-based Appellate Division, Second Department — the same court that gave us 1545 Ocean Avenue — in Mace v Tunick, 2017 NY Slip Op 06170 [2d Dept Aug. 16, 2017], I would have answered that question “no” with support from a number of case precedents in New York and other jurisdictions including that hotbed of contractarian jurisprudence known as Delaware. After Mace, it appears that the “any lawful business” purpose clause may be as good as no purpose clause.
Mace fits within a recurrent fact pattern in which the owners of an operating business form a separate entity — in this case, an LLC — to acquire real property to house the operating business. In 2007, the owners of Ceres Chemical Co., in which the plaintiff had a 20% interest, formed Pedani Realty Services, LLC to acquire for $1.25 million a building in Westchester, New York, to serve as headquarters for Ceres. The plaintiff contributed 20% of the purchase price and received a 20% membership interest in Pedani.
At the time of its formation, Pedani’s members filled in the blanks and executed what appears to be an off-the-shelf, pre-printed form of operating agreement with the following purpose clause:
The purpose of the Company is to conduct any lawful business for which limited liability companies may be organized and to do all things necessary or useful in connection with the foregoing.
The agreement also has an integration clause disavowing all “representations, agreements, arrangements or understandings, oral or written, between or among the parties relating to the subject matter of this Agreement which are not fully expressed in this Agreement.”
Ceres occupied the building for the next 6 or 7 years, paying rent to Pedani at the monthly rate of $13,000. In 2013, the plaintiff retired and sold his 20% interest in Ceres to the defendant 80% shareholder, allegedly with the understanding that Ceres would continue paying rent to Pendani in which the plaintiff continued to hold a 20% interest and defendant the remaining 80%.
In 2014, the defendant moved Ceres’s operations to South Carolina, vacated Pedani’s building, and stopped paying rent to Pedani. The defendant subsequently made himself Pedani’s managing member and issued a capital call over plaintiff’s objection. In 2015, the defendant leased Pedani’s building to an unrelated third party at a monthly rent of about $3,600 which plaintiff alleged was below fair market value.
The Dissolution Complaint
The plaintiff filed suit in October 2015. The first cause of action in his amended complaint (read here) sought judicial dissolution of Pedani under LLC Law § 702, alleging that upon Ceres’s departure from the property “the purpose for which Pedani was formed had ceased,” and that the defendant had rejected plaintiff’s request to sell the property and dissolve the LLC.
The plaintiff alleged as additional cause for dissolution defendant’s breach of fiduciary duty and breach of the operating agreement in connection with leasing the property at less than fair market rent and making an unauthorized capital call, all of which created “fundamental and intractable” disagreement between the LLC’s two members “as to make it unfeasible for Pedani to carry on its business as originally intended.”
The Trial Court’s Decision
The defendant filed a motion to dismiss the complaint, contending that Pedani continued to carry on its business consistent with the operating agreement’s broad purpose clause (“any lawful business”) and that the plaintiff as 20% member had no right under the agreement to force a sale of the property.
The plaintiff argued that Pedani’s purpose no longer existed following Ceres’s departure, and that the operating agreement’s “generic” purpose clause did not preclude a finding that Pedani was formed for the more limited purpose of purchasing and holding the property to serve as Ceres’s headquarters.
In a Decision and Order dated May 23, 2016 (read here), the presiding judge, Westchester Commercial Division Justice Alan D. Scheinkman, agreed with the plaintiff that the operating agreement’s purpose clause was not dispositive of the issue — indeed, that the clause contains “no stated purpose” — but nonetheless granted the defendant’s motion based on evidence that Pedani’s ongoing and viable purpose was to acquire title to, and manage, the property. Here’s how it played out, in the judge’s own words:
Here, Pedani has no stated purpose. Rather, Section 2.1 of the Operating Agreement contains broad, boiler-plate language that the purpose of the Company is to conduct any lawful business for which a limited liability company may be organized and to do all things necessary or useful in such regard. Defendants’ argument is, essentially, that because Pedani’s stated purpose is to do any lawful business, it is impossible to conclude that the management of the entity is unable or unwilling to permit or promote any lawful business from being achieved. This argument is far too facile as, if accepted, it would preclude judicial dissolution on every occasion in which such common, boiler-plate purpose language is used in an Operating Agreement. Indeed such broad language may be invoked, not because the company lacks a specific purpose but to avoid hamstringing company operations, or shifts in business, through more restrictive language.
More important, the Court cannot ignore the fact . . . that Pedani was formed on July 9, 2007 and, by deed dated September 26, 2007, Pedani took title to the Property. Hence, the contemporaneous real estate documents, read together with the Operating Agreement, indicate that the initial purpose of Pedani was to acquire title to, and manage, the Property. However, Plaintiff has failed to allege facts which, if proven true, would establish that the purpose of Pedani changed or that the management of Pedani is unable or unwilling to reasonably permit or promote Pedani’s achievement of its purpose to acquire and maintain the Property.
The Appellate Court’s Ruling
The plaintiff appealed from Justice Scheinkman’s dismissal of the dissolution claim. In its unsigned memorandum opinion last week, the Appellate Division agreed with Justice Scheinkman that the operating agreement’s purpose clause “did not set forth any particular purpose for Pedani,” but it then labeled as “an impermissible factual finding” Justice Schienkman’s conclusion that Pedani’s purpose “was simply to acquire and manage property.” The defendant was not entitled to dismissal of the dissolution claim, the court wrote, because:
Neither the operating agreement nor the leases of the property to Ceres and, upon Ceres’ relocation, a third party, utterly refuted the plaintiff’s allegation as to Pedani’s purpose so as to conclusively establish a defense as a matter of law to the plaintiff’s dissolution cause of action.
As I mentioned above, a number of prior court rulings have dismissed LLC dissolution claims based on alleged failure of purpose in the face of operating agreements with broad purpose clauses like the one in Mace. Examples include Justice Driscoll’s decision in Matter of Ross, which I wrote about here, and Delaware Chancery Court’s decision in In re Seneca Investments, LLC, which I wrote about here.
Is it necessarily so that “any lawful business” purpose is the equivalent of no stated purpose? Why must its “boiler-plate” character and its unlimited scope render it useless under the contract-centric approach endorsed in 1545 Ocean Avenue, especially when, as is usually the case, the operating agreement has a merger clause precluding reliance on any extrinsic representations and understandings of purpose or anything else outside the written agreement? Could not Justice Scheinkman’s astute observation, that a purpose clause more restrictive than “any lawful business” could “hamstring” company operations, equally serve a valid objective to make it harder for a member to seek judicial dissolution?
Unfortunately, the Appellate Division’s sparsely worded decision in Mace did not address any of these questions.
One thing’s for certain. There are countless operating agreements in existence with “any lawful business” purpose clauses. If “any lawful business” is a purposeless purpose clause, the primary focus of the judicial dissolution standard under 1545 Ocean Avenue — whether the LLC’s managers are willing or able to achieve its stated purpose under the operating agreement — merely becomes a waystation on the road to more protracted litigation proceedings requiring discovery and evidentiary hearings. Good for business divorce lawyers like me. Not so good for business owners.