Scrivener’s Error Keeps Sailboat-Owning LLC Afloat
December 27, 2022
Pictured right is the Nite Cap, a 42’ sailboat known to cruise the New York area waters. As we return to our desks after the coldest Christmas in recent memory, it’s tempting to daydream about a summer day on her deck: drink in hand, wind filling the sails, and an easy heel giving way to weary legs and sea-tossed hair….
The members of Nite Cap’s owner, Bull-Poet, LLC, recently traded the full sheets and gentle seas of the Hudson for the strum and drang of litigation in New York’s Supreme Court. But the squall has passed; thanks to New York County Justice Gerald Lebovits’ conclusion that Bull-Poet’s operating agreement contains a scrivener’s error, Nite Cap will sail again under Bull-Poet’s ownership.
In 2014, Avram Ludwig, Will Sahlman, and Doug Liman, three friends who shared a love for sailing, decided to purchase Nite Cap. To do so, they formed Bull-Poet, a New York LLC, with each of the friends owning a one-third membership interest in the LLC. With equal contributions from each, Bull-Poet purchased Nite Cap.
Bull-Poet’s Operating Agreement
Upon the formation of Bull-Poet, the members entered into a mostly standard Operating Agreement. It names Sahlman as the Manager, responsible for the day-to-day affairs of the Company, and it sets forth modest record-keeping requirements. The Operating Agreement requires Bull-Poet to maintain: (i) a current list of the members, (ii) the LLC’s certificate of formation and Operating Agreement, (iii) the LLC’s tax returns, “if any, for the three (3) most recent years,” and (iv) “any financial statements for the three (3) most recent years.”
Article VII of the Operating Agreement allows for the voluntary withdrawal of a member upon six-months’ notice to the remaining members, and it provides that a withdrawn member is not entitled to liquidation of his interest until the LLC dissolves; until then, the withdrawn member becomes an economic interest holder.
The Operating Agreement also addresses the dissolution of Bull-Poet. Article VIII provides:
1. The Company shall be dissolved and wound up upon the first to occur of the following events:
a. The written consent of a majority of the Members in interest;
b. The retirement, expulsion, death, bankruptcy or insanity of a Member;
c. The sale of all or substantially all of the business; or
d. A judicial decree of dissolution.
2. The events specified in Article 7 paragraph 1 shall not result in the dissolution, winding up and termination of the Company unless within ninety (90) days of the occurrence of an event, a majority in Capital Interests of the remaining Members elect to discontinue the business of the Company.
Did you spot the potential error? Section 2 of Article VIII provides that the events specified in “Article 7 paragraph 1” do not require the dissolution of the Company. But what about the events specified in Article VIII, Section 1? If Section 2 applies only to “Article 7” (which relates to voluntary withdrawal) then dissolution of Bull Poet is required upon any of the events set forth in Article VIII, Section 1, such as the death of a member.
Ludwig’s Successor Attempts to Run Bull-Poet Aground
From 2014 to 2019, Bull-Poet saw little activity. It owned Nite Cap, which the members used recreationally, often sailing it together. Bull-Poet’s only income was transfers from the members, and its expenses were ones incidental to the ownership of Nite Cap.
Upon Ludwig’s death in March 2019, his membership interest in Bull-Poet passed to his sister, Antonia. When she was provided with copies of Bull-Poet’s financial statements demonstrating the de minimis activity, Antonia commenced suit, citing the record-keeping requirements set forth in the Operating Agreement. Among other claims, Antonia alleged that the remaining members of Bull-Poet breached their fiduciary duty to the Company by failing to cause Bull-Poet to file tax returns and maintain sufficient records. She also sought dissolution of the Company pursuant to Article VIII of the Operating Agreement and an accounting of Bull-Poet’s income and expenses.
Bull-Poet and the remaining members (collectively, “Defendants”), moved to dismiss Antonia’s action, and they pulled no punches in accusing Antonia of a cash-grab—seeking to “parlay [her inherited stake in Bull-Poet] into an exorbitant payout for herself, out of the pockets of the two surviving members.”
The Scrivener’s Error
Antonia hinged her dissolution claim on Article VIII, Section 1(b) of the Operating Agreement, which requires the dissolution of Bull-Poet upon the death of a member. By its terms, the limitation on dissolution set forth in Article VIII, Section 2, Antonia argued, applied to events of voluntary withdrawal set forth in “Article 7 paragraph 1,” but not to the events requiring dissolution listed in Article VIII.
Defendants, backed by a high-powered litigation team at Paul, Weiss, responded with a two-pronged argument: First, they argued that dissolution of Bull-Poet was improper because Antonia could not satisfy the requirements of LLC Law 702 and Matter of 1545 Ocean Ave., LLC, 72 AD3d 121, 131 (2d Dept 2010) (discussed here) that it is not reasonably practicable to carry on the business of the LLC. Second, Defendants argued that “the only logical reading of Article VIII, Section 2, is that it is intended to carve out an exception to the directly preceding section—Article VIII, Section 1—and that the reference to ‘Article 7 paragraph 1’ is merely a scrivener’s error.”
Notably, the “only logical reading” offered by Defendants is not very logical. It makes no sense for Article VIII, Section 2’s requirement of member consent to dissolution to apply to dissolution under Article VIII, Section 1(a) (members’ consent), 1(c) (sale of the business), or 1(d) (judicial decree of dissolution).
Although courts have the equitable power to correct “a mistake solely in the reduction of an agreement to writing” (Stang LLC v Hudson Sq. Hotel, LLC, 2017 N.Y. Slip Op. 31243[U], 15 [N.Y. Sup Ct, New York County 2017]), a unilateral mistake of one party is “not enough to rewrite an agreement that is complete on its face” (Resort Sports Network Inc. v PH Ventures III, LLC, 67 AD3d 132, 136 [1st Dept 2009]). While simple to articulate, these principles require sometimes difficult judgment calls in circumstances like this one, where neither proposed interpretation is a perfect fit.
Justice Lebovits sided with Defendants, concluding that the limitation on dissolution in Article VIII, Section 2 applied to the events of dissolution set forth in Article VIII, Section 1 and not “Article 7.” The Court observed:
[T]here would be no reason for an exception to the provisions of Article VII, § 1, to be placed in Article VIII, rather than in Article VII. Article VIII, § 2, also refers to dissolution-triggering events, plural. Article VIII, § 1, has multiple possible triggering events; Article VII, § 1, only one.
Additionally, it would be odd to read Article VIII, § 2, as creating an exception to Article VII, § 1. That is, Article VIII, § 2, is phrased as limiting the effect of the operating-agreement provision to which it applies—it states that the events at issue “shall not result in the dissolution, winding up and termination of the company unless” a majority of the remaining members opts to discontinue the company. But Article VII does not, by its own terms, require dissolution/winding-up of the LLC upon a member’s withdrawal. There would thus be no reason for Article VIII, § 2, to be phrased in restrictive terms if it were tied to Article VII, as plaintiff’s position requires.”
The Court was, however, rightly skeptical of Defendants’ argument that a member seeking dissolution under the terms of the operating agreement must also satisfy the 1545 Ocean Avenue standard: “It is not entirely clear to the court whether plaintiff must (as defendants suggest) satisfy the requirements of LLC Law § 702 to obtain dissolution, should dissolution otherwise be required under the terms of the LLC’s operating agreement; and the authority provided by defendants does not directly address that question.”
But What of the Equitable Accounting?
Perhaps the most interesting part of the Court’s decision is its denial of Antonia’s claim for an accounting based solely on the Defendants’ unsworn assertions that there are no profits for which to account. The Court reasoned:
Plaintiff has not alleged an adequate basis to believe that the financial information she has received from defendants is incomplete, such that Bull-Poet earned revenue or profits not reflected in its brokerage statements that might be the proper subject of an accounting.”
Implicit in the Court’s decision here is a welcome bit of practical restraint: there simply is no need for a lengthy and expensive accounting when there is nothing for which to account. That restraint is consistent with cases like First Equity Realty v The Harmony Group II, 2022 NY Slip Op 30674(U) (Sup Ct, New York County Mar. 3, 2022) (discussed here), which declines to order an accounting on the basis that it would be a futile exercise.
But that line of cases sits in apparent tension with a separate line of cases holding that a minority member’s right to an accounting is “absolute,” such as the First Department’s relatively recent decision In re Grgurev v Licul et al., 203 AD3d 624 (1st Dept 2022) (a case also discussed here), which states that: “whenever there is a fiduciary relationship between the parties . . . there is an absolute right to an accounting.”
Last March, I made the not-so-bold prediction that given the ubiquity of accounting claims in business divorce cases, the “practical limitations” on an equitable accounting claim quickly would be tested by subsequent cases. While Bull-Poet may prove that prediction true, it also means that we have not seen the end of these uncertain waters.