Repeat After Me: You May Not Expel a Member of a New York LLC Unless the Operating Agreement Says So

September 17, 2018

C’mon, New York lawyers, do you really want to spend your time, your client’s money, and bother the court litigating a dead-end claim that your client rightfully expelled his or her LLC co-member for alleged misconduct, however egregious, when you don’t have an operating agreement that says your client can do it?

Despite clear law on the subject, some have not gotten the word as made evident by Justice O. Peter Sherwood’s ruling last month in Matter of Goyal (Vintage India NYC, LLC), 2018 NY Slip Op 31926(U) [Sup Ct NY County Aug. 7, 2018].

First, some background: Over ten years ago, in one of my earliest posts on this blog, I observed that, in contrast to states whose LLC statutes authorize judicial expulsion a/k/a dissociation of a misbehaving member, New York’s LLC Law does not authorize a judicial expulsion remedy, and that non-judicial member expulsion can only occur if and under the circumstances specified in the operating agreement.

Two years later, a far more consequential observer, namely, the Appellate Division, Second Department, in Chiu v Chiu specifically held that courts lack authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy.

In the years since Chiu, I’ve seen no cases deviating from its holding. On the contrary, lower courts consistently have applied Chiu to reject what I’ll call self-help member expulsion in the absence of authorization by the operating agreement, e.g., Justice Whelan’s 2013 decision in the Sieni case in which I represented a minority LLC member whom purportedly was expelled by the majority member without operating agreement authorization, and Justice DeStefano’s 2016 decision in the Genovese case to similar effect. For an example of a case in which the court upheld the right to expel a member based on authorizing language in the operating agreement, see Garcia v Garcia, 2011 NY Slip Op 52261(U) [Sup Ct Kings County Dec. 6, 2011] .

The Goyal Case

Justice Sherwood’s decision last month in Goyal unsurprisingly follows the same path to the same end.

The petitioner, alleging that he and the respondent each held 50% membership interests, sought judicial dissolution under LLC Law § 702 of a company called Vintage India NYC, LLC formed in 2014 to operate a clothing store in Manhattan’s “Little India” neighborhood. They had no written operating agreement.

By the end of 2016 the business was ailing financially. The petitioner accused respondent starting in 2017 of physically threatening him, barring him from the business premises, taking him off the bank account, and otherwise freezing him out of the business. The respondent fired back with accusations of embezzlement and other financial improprieties by petitioner.

After Justice Sherwood denied the petitioner’s initial application for preliminary injunctive relief, the respondent moved to dismiss the petition on the sole ground she had expelled the petitioner from the LLC who therefore lacked standing to seek judicial dissolution.

Respondent’s argument was awkward if not schizophrenic. On the one hand, she claimed that, at inception, she and the petitioner orally agreed to 50/50 membership but that petitioner’s interest wouldn’t “vest” until he matched her $200,000 capital contribution which, she alleged, he never did. On the other hand, she didn’t dispute that the company filed tax returns with Form K-1s reporting petitioner’s 50% membership. Also left unexplained was why she needed to expel petitioner if he wasn’t a member in the first place, his interest never having vested.

The formal process by which the respondent purported to expel the petitioner struck the same discordant note. First, she sent the petitioner a notice of member meeting, in which she identified herself as a 50% member, to vote on a resolution “to remove [petitioner] as a member of the LLC for cause.”

The petitioner boycotted the recorded meeting which was carefully choreographed by respondent’s lawyer and a transcript of which was filed with the court. Following a lengthy, one-sided presentation by her lawyer of the petitioner’s alleged misconduct, including a statement that the petitioner held a “contingent unvested interest,” the respondent cast her sole vote “to remove and/or expel [petitioner] from Vintage India NYC, LLC,” after which her lawyer pronounced, “The vote carries.”

Ask yourself, how could respondent’s vote as a 50% member carry when, under LLC Law § 402’s and § 404’s applicable default rules, a majority in interest is required for a meeting quorum and to approve any action?

Also at the meeting was the company’s “interim” counsel — hired by  the respondent — who offered the comment, “I think it’s clear that it would have been better if there was an operating agreement but the law doesn’t require that and the law was not silent when people form an LLC and don’t have an operating agreement, there are other rules that govern.”

How right and how wrong counsel was: right that it would be better — essential, really — if there was an operating agreement authorizing expulsion, wrong that “the law doesn’t require that.”

Oddly, neither side’s court filings acknowledged much less argued the leading Chiu case, but Justice Sherwood certainly did in explaining his denial of the respondent’s motion to dismiss for lack of standing:

Vintage India argues the Petitioner has failed to state a claim because he is not a member of Vintage India NYC, LLC. [Petitioner] was, according to respondent, “removed for cause” at the March 2017 meeting. [Respondent] claims [Petitioner] was removed as a member and expelled from the LLC, and that his interest in Vintage India, which was unvested at that time, was revoked at that meeting. Vintage India cites a handful of cases as part of this section of its memo, but fails to explain how the cases support its position. The Annotations to the Limited Liability Company Law, however, state that “neither the LLC nor the other members have the statutory right to expel a member from the LLC. . . . The right to expel a member must be expressly set forth in the operating agreement” (NY Limit Liab Co Ch. 34, Refs & Annos, 6.12.2 Expulsion, see also Man Choi Chiu v Chiu, 71 AD3d 646, 647 [2d Dept 2010] [“Although Limited Liability Company Law § 701 mentions expulsion of members, there is no statutory provision authorizing the courts to impose such a remedy. Rather, the reference to expulsion of members contemplates the inclusion of such a provision in an operating agreement”]) Man Choi Chiu v Chiu, 71 AD3d 646, 647 [2d Dept 2010]). Further, while the Limited Liability Company Law provides that a manager of an LLC may be removed, that requires a majority vote, which [Respondent] lacks as [Petitioner] owns half of the interest in Vintage India (see LLCL § 414).

Respondent provides no law to support its argument that [Petitioner’s] shares had not vested. While there is a dispute as to whether [Petitioner] paid money into the LLC and the amount, it is undisputed that he put in “sweat equity” and held a 50% interest in the firm. At most, there is a dispute as to whether his shares had vested. The defense that [Petitioner’s] interest is unvested is unexplained and is unsupported by citation to either caselaw or statute. [Citations to record omitted.]

So there you have it: no operating agreement authorizing expulsion means no expulsion, either judicially or non-judicially. It’s that simple in New York.