LLC’s Post-Dissolution Receivership is On, is Off, is On
July 22, 2019
Last week’s post examined an unusual case in which the court appointed a temporary receiver of an LLC pending the adjudication of the minority members’ petition for judicial dissolution. But what about the court’s power to appoint a receiver a/k/a liquidating trustee following the court’s involuntary dissolution of an LLC?
There’s a statute for that, namely, section 703 of New York’s LLC Law. The statute authorizes a member “upon cause shown” to apply to the court for appointment of a receiver to wind up the affairs of an LLC that has been dissolved voluntarily or involuntarily. What “cause” suffices? The statute doesn’t say, leaving it entirely to the court’s discretion.
Appointing a post-dissolution receiver sometimes can seem like a no brainer, as when the LLC is owned and managed by two, co-equal managing members whose inability to co-manage precipitated the dissolution. In such cases, and depending on the nature of the business, a court may condition appointment of a receiver on the members’ ability to agree to a winding up plan by a specified date, or appoint a receiver from names supplied by the parties, or appoint one of the members as receiver, or appoint an outside receiver of its own choosing.
A recent decision by Manhattan Commercial Division Justice Andrew Borrok in Tufenkian v Tirakian, 2019 NY Slip Op 31052(U) [Sup Ct NY County Apr. 19, 2019], adds to the handful of reported LLC cases in which courts address post-dissolution receivership. Like the Cangro case examined in last week’s post, it stems from an unusual set of facts leading to appointment of a receiver, but there the similarity ends.
The Court Orders Dissolution
Tufenkian involves a dispute between the two 50/50 members of Harvest Song Ventures, LLC, formed in 2005 to produce and sell specialty jams and preserves. In 2015, the petitioner Tufenkian petitioned to dissolve the LLC based on deadlock and the company’s alleged insolvency. In October 2016, Justice Charles Ramos (since retired) granted the petition, quipping at the conclusion of oral argument in his patented, colorful style, “I don’t want to be too flip about this, but you can stick a fork in this company. It’s done.”
The Court Orders, Then Un-Orders, Receivership
Justice Ramos’s subsequent dissolution order appointed a receiver to be selected by the court from names to be submitted by the parties. Before the deadline for submitting names, however, Tufenkian requested leave to withdraw his claim for appointment of a receiver. He represented that the company had ceased operations, had minimal cash, inventory and receivables, and that there were insufficient assets to pay receiver fees. In March 2017, Justice Ramos agreed and vacated as moot the portion of his order appointing a receiver.
Two Years Later, Respondent Requests a Receiver
Post-dissolution the case trudged forward as the parties litigated various other claims and counterclaims against each other. Then, in early 2019, the respondent Tirakian filed her own motion to appoint a receiver under LLC Law § 703.
In her motion, Tirakian accused Tufenkian of making false representations to Justice Ramos in his petition and request to withdraw his receivership application. According to Tirakian, Tufenkian continued to operate the business and to sell its product under a purported license agreement with his separately owned company.
Tufenkian opposed the motion. He admitted the ongoing business activity but contended that the product sales to his separate company were de minimis; that they were designed to maintain product “shelf space” at retailers so as to preserve the brand’s value for sale in liquidation; and that Tirakian had been kept informed all along.
Justice Borrok Re-Orders Receivership
Justice Borrok’s brief analysis, and his decision to grant Tirakian’s request for a receiver, latched onto Tufenkian’s admission that he had continued to produce and market the LLC’s products under its brand name for an extended period post-dissolution. Here’s what he wrote:
Although the appointment of a temporary receiver is a “an extreme remedy resulting in the taking and withholding of possession of property from a party without an adjudication on the merits,” which “should be granted only where the moving party has made a clear evidentiary showing of the necessity for the conservation of the property at issue and the need to protect the moving party’s interests,” here, the appointment of a receiver is necessary to wind up the affairs of Harvest Song and provide a proper accounting (Meagher v Doscher, 157 AD3d 880, 883-84 [2d Dept 2018] [quotation and citation omitted]). In the three years since the Dissolution Order was issued, Mr. Tufenkian has not wound up Harvest Song’s affairs in any way and, in fact, has continued to pursue consignment and licensing arrangements on its behalf (Jacobson Aff., 3-5, NYCSEF Doc. No. 184). Under these circumstances, Ms. Tirakian has met her burden of establishing that a temporary receiver is appropriate and necessary to protect the parties’ interests.
The decision directs appointment of a neutral third party as receiver, to be selected from names provided by the parties, to wind up its affairs including “liquidating and marshalling its assets in an orderly and efficient manner and providing an accounting, with all the usual powers and duties according to the laws of this State.”
As of this writing, no order of appointment has been entered.
As I’ve said before, appointment of a neutral receiver either during the pendency of a dissolution proceeding or afterward is a real game changer. If the litigation is brought by a non-controlling minority owner, the majority faction instantly loses the considerable economic, informational, and other advantages of control. Even when ownership and control is 50/50, the transfer of control to the receiver inevitably accelerates case resolution one way or another.
The Cost of Receivership
Recall that Tufenkian’s withdrawal of his request for a receiver contended that the LLC had insufficient funds to pay a receiver. Whether or not the contention was true, the fact remains that receiver compensation can be a real problem when the subject company is cash starved.
The LLC Law, unlike the Business Corporation Law, does not specify receiver compensation rates. Courts therefore usually defer to the rate for receivers generally specified in section 8004 of the Civil Practice Law and Rules which is up to 5% of “the sums received and disbursed by him.”
The receiver’s task of winding up a company big or small can be a laborious, time-consuming affair. The receiver also may need to hire legal counsel and an accountant or other professional. None of those folks works for free.
If the company has illiquid assets such as intellectual property or realty that can generate at auction cash sufficient to fairly compensate the receiver and ancillary professionals at the end, the problem may be overcome.
If not, what happens? Vice Chancellor Travis Laster of the Delaware Court of Chancery recently had such a case before him in Longoria v Somers, C.A. No. 2018-0190-JTL [Del Ch May 28, 2019]. Here’s how he described and solved the problem:
The receiver for an insolvent corporation has incurred expenses and will need to incur additional expenses, but the corporation has no liquid assets, and it is unclear whether a sale of its other assets will generate enough funds to cover the costs of the receivership. The receiver has asked whether he can tax the interim expenses against the parties as costs and, if the winding up process fails to generate sufficient funds, tax any remaining expenses against the parties.
The petitioner owns fifty percent of the corporation’s shares, and the respondent owns the other fifty percent. The respondent has agreed to pay half of the costs of the receivership.
The question presented is whether the court can tax the remaining costs of the receivership against the petitioner. Under venerable and still-controlling Delaware Supreme Court authority, the answer is yes. The receiver is granted authority to tax the petitioner with half of the expenses that he has incurred and will incur.
The referenced “venerable and still-controlling” Delaware precedent is Brill v Southerland, 14 A.2d 408 [Del. 1940]. The court there stated the general rule that “a receiver’s compensation and expenses are payable from the funds in his hands, and no part is taxable against the party at whose instance the receiver was appointed.” It then acknowledged an exception:
Where there is no fund out of which expenses can be paid, or the fund is insufficient, the usual rule is that the party at whose instance the receiver was appointed should be required to provide the means of payment.
I haven’t researched whether any New York court has ruled similarly. Shoot me an email if you know.
Update July 22, 2019: Ask and ye shall receive. Attorney Donna-Marie Korth at the Certilman firm was kind enough to send me a copy of a 2010 decision by former Nassau County Commercial Division Justice Ira Warshawsky (read here) in which the court cited CPLR § 8004(b) in support of the court’s authority, as the statute expressly provides, to “direct the party who moved for the appointment of the receiver to pay” the receiver’s commission and expenses when the company’s funds are depleted at the termination of the receivership. In that case, the two sides stipulated to split the amount due the receiver.