Summer Shorts: For-Cause Termination of LLC Member and Other Decisions of Interest

August 17, 2020

Usually I open my annual Summer Shorts post with some breezy comment about summer vacations, travel, or poolside reading. But this shelter-at-home year we find ourselves living and working in profoundly different circumstances, so I’ll skip the usual pleasantries and get straight to the subject matter consisting of short summaries of five recent decisions of interest involving disputes between business co-owners, four by New York courts and one from Mississippi.

This year’s summaries include:

• a decision upholding the termination for cause of an LLC member based on a felony conviction that preceded his membership;
• a decision denying a motion to dismiss a statutory counterclaim for deadlock dissolution which the  plaintiff unsuccessfully argued was foreclosed because of the plaintiff’s own request for dissolution;
• a decision refusing to limit the plaintiff limited partners’ access to books and records under the normal rules governing discovery in plenary actions based on provisions in the partnership agreement giving the general partner discretion to withhold certain information;
• a decision denying defense motions to dismiss a statutory dissolution action on procedural grounds and based on issue or claim preclusion;
• and finally, an unusual decision by the Mississippi Supreme Court in an oppression case brought by a 49% shareholder against the other 51% shareholder, affirming the trial judge’s remedial order for the transfer of a 1% interest thereby equalizing the two shareholders at 50/50, in lieu of dissolution.

Court Upholds LLC Member’s For-Cause Expulsion

In Tradesman Program Managers, LLC v Doyle, 2020 NY Slip Op 32452(U) [July 24, 2020], the plaintiff LLC, which serves as a managing general agent for domestic insurance carriers, sought a declaratory judgment validating its for-cause expulsion of the defendant member pursuant to provision in the operating agreement defining “cause” to include a felony conviction. The LLC also sought to invalidate the defendant’s purported transfer of his interest to an entity presumably under his control and presumably designed to avoid expulsion and mandatory redemption of defendant’s interest.

Manhattan Commercial Division Justice Andrea Masley granted summary judgment for the plaintiff LLC. The defendant’s felony conviction not only was a matter of undisputed public record, but under federal law the conviction barred defendant from engaging in the insurance business without the written consent of regulatory officials. Justice Masley also found that the expulsion provision, being “silent on the time frame for conviction,” applied even though the conviction pre-dated the defendant’s acquisition of his interest. Finally, Justice Masley agreed with the LLC that defendant’s assignment of his interest was “null and void” because of non-compliance with the operating agreement and because the transferee entity did not exist at the time of the purported transfer.

Court Permits Statutory — But Not Common Law — Dissolution Counterclaim

Office Group, Inc. v Sinesio, 2020 NY Slip Op 32527(U) [Sup Ct NY County July 31, 2020], involves claims and counterclaims between the two, 50% shareholders of a company formed in 1998 to provide design and marketing services. Each accused the other of various breaches of fiduciary duty including use of company funds for non-business purposes. The plaintiff also accused the defendant of using company resources to create a competing business. The defendant’s counterclaims included applications for both statutory dissolution based on deadlock under BCL section 1104 (a) (1) and under common law.

On a motion to dismiss defendant’s counterclaims, the plaintiff argued that the dissolution counterclaims were barred because the plaintiff’s own complaint sought dissolution. The argument fell flat with Manhattan Commercial Division Justice Andrew Borrok who pointed out that the complaint “simply does not state a proper cause of action for dissolution” which was only mentioned cursorily in the prayer for relief. Justice Borrok nonetheless dismissed the common-law dissolution claim which “is available only to minority shareholders that accuse majority shareholders of looting the corporation.”

Partnership Agreement’s Restrictions on Access to Books and Records is No Bar to Discovery Rights in Plenary Action

The question presented in a second case before Justice Borrok, Younker v GPB Capital Holdings, LLC, 2020 NY Slip Op 32121(U) [Sup Ct NY County July 1, 2020], was the extent to which the partnership agreement’s provisions governing access to books and records either augmented or restricted the plaintiff limited partners’ right to discovery, under generally applicable rules of civil procedure, of partnership information relevant to the complaint’s claims of malfeasance by the general partner and others.

The partnership agreement generally granted partners broad rights of access to books and records, subject to use limitations (“not to use Partnership Information other than for purposes of evaluating, monitoring, or protecting its investment in the Partnership”) and also giving the General Partner the right to withhold information “for such period of time as the General Partner in good faith determines to be advisable” if the General Partner “in good faith” believes disclosure is not in the partnership’s best interests.

Justice Borrok granted the plaintiffs’ motion to compel access to partnership books and records, holding that the plaintiff partners “are contractually entitled to access the books and records” and that the agreement “does not provide a valid basis for denying access.” He further commented that “nothing in the LPA prevents a Limited Partner from accessing the books and records if the Limited Partner has filed a lawsuit on behalf of or against” the partnership. Finally, Justice Borrok found that “irrespective of the Limited Partners’ contractual rights to access the books and records,” the same materials were discoverable as relevant to the complaint’s allegations of wrongdoing.

Court Throws Lifeline to Procedurally Defective Dissolution Action

Lamorena v Malloy, 2020 NY Slip Op 31927(U) [Sup Ct NY County May 22, 2020, involves a dispute between 50/50 shareholders of a corporation that operates a pharmacy. The plaintiff, Lamorena, filed a suit for statutory judicial dissolution styled not as a special proceeding commenced by petition and order to show cause, as required by BCL Article 11, but as an ordinary action commenced by summons and complaint.

The defendant, Malloy, moved for summary judgment dismissing the action as procedurally defective and as barred by issue and/or claim preclusion arising from a prior action by Malloy against Lamorena in which Lamorena failed to appear and suffered a default.

In her decision, Manhattan Supreme Court Justice Nancy Bannon denied both prongs of Malloy‘s motion. First, she found that Lamorena’s failure to seek dissolution by petition “is not fatal to that relief” and that the “case law allows the court to grant the plaintiff the right to amend his pleadings to convert this action for statutory dissolution into a petition for common-law dissolution.” (Apparently, no one advised the court that a 50% shareholder lacks standing to sue for common-law dissolution, as the court ruled in the Office Group case highlighted above.)

As to Malloy’s preclusion argument, Justice Bannon noted that the prior action in which Lamorena defaulted remained pending without entry of judgment and that there was no identity of issues in the two actions, the prior one involving Lamorena’s alleged wrongdoing and the present one Malloy’s alleged wrongdoing.

Court Orders 50/50 Ownership in Lieu of Dissolution

The Mississippi Supreme Court’s opinion in Boatright v A&H Technologies, Inc., No. 2019-CA-00229-SCT [Sup. Ct. Miss. June 4, 2020], tells a woeful saga of a successful business venture and partnership that, over a period of years, deteriorated to bitter, litigious warfare between the two shareholders. The plaintiff 49% shareholder sued for corporate freeze-out among other claims, seeking the 51% shareholder‘s removal as officer and director and, as an alternative to dissolution, that he be made majority shareholder.

The trial judge agreed with the freeze-out claim but found that dissolution was not feasible because the company’s main asset was its long-term contract with its sole customer. The judge declined to remove the defendant as officer and director and instead ordered a stock transfer making the two shareholders 50/50, required the company to hire corporate counsel and an accountant, and directed the now 50/50 shareholders to make all hiring and firing decisions together.

On appeal, the Supreme Court upheld the trial court’s principal rulings including the stock transfer which, to say the least, is an unusual and, I imagine, rarely granted remedy. To the defendant’s argument that compelling equal ownership and control will only lead to deadlock, the court responded that the only alternative defendant proposed, to retain his 51% ownership and management control, was “untenable” due to his “oppressive conduct.”