First-Impression Decision Recognizes a Cause of Action for Common-Law LLC Dissolution
October 19, 2020
Five years ago, we wrote about an important decision from the Delaware Chancery Court, In re Carlisle Etcetera, LLC, 114 A3d 592 , in which a court recognized for the first time the existence under Delaware law of a viable cause of action for “equitable dissolution” of an LLC based upon the court’s equity powers, notwithstanding the existence of a statute explicitly setting forth the grounds for judicial dissolution.
In our write up on Carlisle, we noted that creative litigants in New York might “analogize Carlisle’s recognition of equitable LLC dissolution to New York’s recognition of common-law dissolution for closely held corporations.” We concluded our article by commenting that we knew, at that time, of “no New York case addressing” whether there exists in New York a viable claim for “common-law dissolution of an LLC.”
Five years later, we’re pleased to write about a first-impression decision issued last week by Brooklyn Commercial Division Justice Leon Ruchelsman, in which a creative litigant persuaded the Court to become the first in New York to recognize the existence of a viable cause of action for common-law dissolution of an LLC, notwithstanding the existence of the LLC judicial dissolution standard found in Section 702 of the Limited Liability Company Law (the “LLC Law”).
The Doctrine of Common-Law Dissolution
The doctrine of common-law dissolution dates back to a series of lower court opinions culminating in the Court of Appeals’ decision in Liebert v Clapp, 13 NY 2d 313 ). In Leibert, the Court ruled that dissolution is appropriate under the common law where the corporation’s shareholder or directors “have so palpably breached the fiduciary duty they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by statute.”
Sixteen years after Liebert, the legislature enacted New York’s dissolution statute on the grounds of “oppressive conduct” against a minority shareholder, Section 1104-a of the Business Corporation Law (the “BCL”). The enactment of BCL 1104-a could have spelled the demise of a viable claim for corporate dissolution based upon common-law principles. But in a handful of decisions over the decades, appeals courts have continued to hold that common-law dissolution remains a viable cause of action for corporate dissolution, although it remains uncommon and requires, in the words of Lemle v Lemle, 92 AD3d 494 [1st Dept 2012], “evidence of egregious conduct.”
In the most recent New York appeals court decision sustaining against a dismissal motion a claim for common-law dissolution, Ferolito v Vultaggio, 99 AD3d 19 [1st Dept 2012], the Court explained:
A claim for common–law dissolution is properly stated where it is alleged with sufficient factual detail that the shareholders in control have been looting the company’s assets at the expense of the minority shareholders, continuing the corporation’s existence for the sole purpose of benefitting those in control, and have sought to force and coerce the minority shareholders to sell and sacrifice their holdings to those in control.
As a practical matter, most petitioners suing to dissolve under the common law choose that route because, like the petitioner in Feldmeier v Feldmeier Equip., Inc., 164 AD3d 1093 [4th Dept 2018], “he could not seek judicial dissolution under Business Corporation Law § 1104-a because he owned less than 20% of all outstanding shares of the Corporation.”
The Pachter Case
With all of this law as a backdrop, in Pachter v Winiarsky, Decision and Order [Sup Ct, Kings County Index No. 502779/2020], the Court considered two novel questions: (i) does the doctrine of common-law dissolution apply to LLCs; and (ii) is common-law LLC dissolution potentially available to a co-equal, 50% member.
Pachter involved four real property holding LLCs, two with written operating agreements, two without, owning multi-family properties in Brooklyn. Linderberg was a 50% member of each of the LLCs. After Lindenberg died, Pachter was appointed the estate’s fiduciary. Two months after her appointment, Pachter sued the other 50% members of the LLCs alleging in her petition a scheme of “embezzlement, self-dealing, forgery, perjury, fraud, extortion, and spoliation of records,” asserting that they “misappropriated over $6 million of the Companies’ assets.” Pachter alleged nine causes of action, including count one for common-law dissolution, and count two for statutory dissolution under LLC Law 702.
The Parties’ Arguments
The petitioner’s supporting memorandum of law discusses at pages 8-17 the history of common-law dissolution and factual circumstances in which it is potentially available. Pachter breezily argued, “Common law dissolution is a well-established equitable remedy available to LLC members irrespective of any statute.” The one case supporting this proposition? None other than Carlisle itself. Rather than rely upon direct New York authority applying common-law dissolution to LLCs, the petitioner analogized to prior instances of New York courts applying equitable / common-law principles to find remedies that do not exist as a matter of statute:
Respondents moved to dismiss the petition. In their dismissal memorandum of law (you can also read the opposition and reply submissions here), respondents argued that the existence of LLC Law 702 supplanted any potential common-law dissolution remedy, relying upon some seemingly strong language from In re 1545 Ocean Ave., LLC, 72 AD3d 121 [2d Dept 2010]:
[T]he 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 [corporate law] or [partnership law] to [LLC law].
In its decision, the Court dismissed the second cause of action for statutory dissolution under LLC 702, holding that the petitioner’s “allegations of oppression and freezing out,” and the “crux of the petition” – that “respondents, as managers of the corporation essentially stole over a million dollars by diverting rental incomes and committed other improprieties as well” – “while supporting common law dissolution, do not support statutory dissolution at all” under the standard set forth in In re Ocean Avenue. Then the Court, without acknowledging that it was applying corporate principles to LLCs, explained:
Concerning the first cause of action of the petition, first, common-law dissolution remains a viable cause of action in New York. Where statutory dissolution is unavailable then shareholders in that situation have had, and continue to have, recourse in the form of common-law dissolution. Common-law dissolution, which predates BCL 1104-a, is an equitable cause of action which permits shareholders below the 20% ownership threshold to seek dissolution of a private corporation under certain circumstances of malfeasance. Although common-law dissolution cases are relatively rare in New York, a body of case law has evolved (and continues to evolve) that sheds light on this cause of action, the burden of proof necessary to sustain such a cause of action, and the available remedies if liability is found to exist.
Rather than focus on an explicit discussion of whether common-law dissolution is available to LLCs, however, the Court focused its attention on a secondary legal question: whether a 50% member of an LLC can state a viable claim for common-law dissolution. In Matter of Sternberg v Osman, 181 AD2d 897 [2d Dept 1992], the Court held that “the remedy of common-law dissolution is available only to minority shareholders who accuse the majority shareholders and/or the corporate officers or directors of looting the corporation and violating their fiduciary duty.” Osman involved a case of 50/50 deadlock. The Court ruled that since “both Osman and Sternberg are each 50% shareholders, and they constitute all of the officers and directors of Long Island Paneling Centers, Inc., with the result that neither is qualified to request common-law dissolution.”
In Pachter, the Court distinguished Osman, explaining, “There are cases in other jurisdictions that hold ‘minority’ status can be obtained and dissolution pursued even from a fifty percent owner.” The Court concluded:
[A] narrow approach which forecloses relief because the petitioner happens to be a fifty percent owner fails to consider the individual facts of each dissolution request on a case by case basis . . . It also fails to appreciate that since statutory dissolution is unavailable . . . the petitioner will have no avenue in which to challenge the improprieties alleged, an untenable situation. Therefore, the petitioner should be entitled to pursue the claims and allegations contained in the petition, notwithstanding the status as a fifty percent owner. Therefore, the motion seeking to dismiss the first count is denied.
Why would a petitioner choose to plead a claim for common-law LLC dissolution? As we have noted many times, the bar for statutory LLC dissolution is rather high. Under New York precedent, deadlock may not be enough to dissolve. Nor “oppression” in the classic sense that may justify dissolution of corporations. Pachter has now opened the door for aggrieved LLC owners to work around LLC Law 702, pleading a claim for LLC dissolution even though he or she may be unable to plead a viable statutory dissolution claim.
It’s relatively easy to explain the doctrine of common-law corporate dissolution as a vestigial remnant of New York law pre-dating enactment of BCL 1104-a. It’s not so easy to do the same for common-law LLC dissolution, where a judicial dissolution statute with a governing legal standard has existed for decades prior to emergence of a common-law dissolution remedy. We express no opinion on whether the Court’s holding in Pachter is consistent with prior enactment of LLC Law 702 and the Court’s language in Ocean Avenue that the Legislature intended that provision to be “the sole basis for judicial dissolution” of an LLC. That issue will be left to appeals courts in the years to come.
A final comment about Pachter. As we have noted in prior articles, the death of an LLC member can pose standing problems for the member, or her estate, when attempting to sue for dissolution. The Pachter Court did not consider this argument, presumably because the respondents did not raise it in their dismissal motion, in fact referring in their dismissal brief to “the Estate’s membership interest in all the LLCs,” thus treating the Estate’s interest as no different than the decedent’s, in effect potentially waiving a potential defense based upon lack of standing.