The Purposeless Purpose Clause Makes a Comeback — Or Does It?
February 05, 2018
The test for judicial dissolution of LLCs under LLC Law § 702, as laid down in 1545 Ocean Avenue, initially asks whether the managers are unable or unwilling to reasonably permit or promote realization of the LLC’s “stated purpose” as found in its operating agreement.
I would venture to say that the overwhelming majority of operating agreements, in their purpose clauses, use the phrase “any lawful business” which, not coincidentally, mirrors the enabling language found in LLC Law § 201, authorizing LLCs to be formed for “any lawful business purpose.” Boiler-plate or not, using “any lawful business” in the purpose clause can be a prudent drafting technique to avoid future conflict or need to amend the operating agreement should the LLC’s business model change in response to future events. Of course, there are some circumstances, often involving single asset real estate holding companies, when stating a specific purpose is the more prudent technique.
Which is why last summer’s decision by the Appellate Division, Second Department in Mace v Tunick was such an eye opener. In Mace, the court held that the “any lawful business” purpose clause in the operating agreement at issue did not state any purpose, and on the basis that the lower court had engaged in impermissible fact-finding on a pre-answer dismissal motion, reversed the lower court’s summary dismissal of the minority member’s dissolution suit and remanded the case for further proceedings.
If “any lawful business” states no purpose, I queried in my prior post on the case, does “the primary focus of the judicial dissolution standard under 1545 Ocean Avenue — whether the LLC’s managers are willing or able to achieve its stated purpose under the operating agreement — merely becomes a waystation on the road to more protracted litigation proceedings requiring discovery and evidentiary hearings”?
I still don’t have the definitive answer to that question, but I can tell you what happened in Mace on remand to the lower court, and after the lower court conducted a trial.
Background
As described in greater detail in my prior post, Mace involves a recurrent fact pattern in which the owners of an operating business form a separate entity — in this case, an LLC known as Pedani Realty — to acquire a building to house the operating entity. The 20% member of Pedani sued for its dissolution when, about seven years after it purchased the property, and after the minority member retired and sold his interest in the operating company, the controlling owner relocated the operating company to another state and leased the building to a third-party at a drastically lower rent than was previously being paid by the operating company.
The minority member argued that once the operating company departed, Pedani no longer was serving its intended purpose and therefore deserved dissolution under the 1545 Ocean Avenue formulation. The majority member countered that, because Pedani’s stated purpose in its integrated operating agreement was “any lawful business,” and because Pedani was engaged in “lawful business” as a lessor of the property, the plaintiff cannot possibly show failure of purpose.
Westchester Commercial Division Justice Alan D. Scheinkman, who last month was elevated to Presiding Justice of the Appellate Division, Second Department, in May 2016 dismissed the dissolution claim on a pre-answer motion to dismiss. In his decision, Justice Scheinkman agreed with the plaintiff that the operating agreement’s purpose clause was not dispositive of the issue — indeed, that the clause contains “no stated purpose” — but nonetheless granted the defendant’s motion based on evidence that Pedani’s ongoing and viable purpose was to acquire title to, and manage, the property. On appeal, the Second Department likewise concluded that the purpose clause stated no purpose, but nonetheless vacated the order of dismissal on the ground that Justice Scheinkman’s conclusion as to Pedani’s purpose was an “impermissible factual finding” at the pre-answer stage of the case.
Justice Scheinkman’s Post-Trial Decision Dismissing the Case — Again
Within three months of the Second Department’s ruling, during which the parties engaged in discovery, the case went to trial before Justice Scheinkman who, following post-trial briefing, issued his decision on December 28, 2017, dismissing anew the plaintiff’s dissolution claim. You can read the decision here.
The plaintiff and defendant were the sole witnesses at trial. The plaintiff testified that he initiated the idea to buy a building to save on rent being paid to third-party landlords by the operating company, and that the majority owner had set the above-market rent that was paid by the operating company after it moved into Pedani’s building. Both parties testified about unsuccessful attempts to rent out a separate “barn” located on the property during the period the operating company occupied the main building.
In his findings of fact and conclusions of law, Justice Scheinkman initially noted that “the real nature of the dispute” between the parties was the plaintiff’s desire, unshared by the defendant, either to sell Pedani’s realty or to be bought out by the defendant, and the defendant’s insistence that the operating agreement negated any member’s right to require partition of company property or to compel any sale of company assets.
As to the operating agreement’s purpose clause, Justice Scheinkman reaffirmed the conclusion in his pre-trial decision, and in the Second Department’s decision, that “any lawful business” is “boiler-plate language” that “has no particular stated purpose.” He then rejected defendant’s argument, that parol (extrinsic) evidence is admissible “to either identify the real purpose of Pedani or clarify the ambiguity in the Operating Agreement as to the purpose of Pedani,” based on the absence of any ambiguity in the purpose clause and on the agreement’s merger clause, writing as follows:
In this case, the Operating Agreement of Pedani is a complete, integrated writing that expresses the parties’ entire agreement and intentions. Section 2.1, in stating the purpose of Pedani, is not ambiguous. It is crystal clear. Pedani “is to conduct any lawful business for which limited liability companies may be organized and to do all things necessary or useful in connection with the foregoing.” While this language defines the corporate purpose to be as broad as is lawful, it is not ambiguous. It plainly means exactly what it says: Pedani’s purpose is to conduct any lawful business that may be conducted by a limited liability company. Any testimony by [plaintiff], or any one else, to the effect that the “real” purpose of Pedani was limited to buying real estate and only holding it for so long as [the commonly-owned operating company] is in occupancy would be contradictory to the expressed written statement of purpose in the Operating Agreement that all parties, including [plaintiff], freely signed.
Then came the coup de grâce, denying dissolution:
Since it is lawful for a limited liability company to own and lease out property, and the Property is in fact owned by Pedani and is currently leased out, it cannot be said that [defendant], as the manager of Pedani, is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved.
The final three pages of Justice Scheinkman’s decision took a different tack, looking outside the confines of the purpose clause to arrive at the same conclusion, including the following points:
- LLC members are free to provide in the operating agreement specific events triggering dissolution, and may also do so indirectly by defining the LLC’s specific stated purpose “with management’s refusal to promote that purpose being a ground for [judicial] dissolution.” Pedani’s operating agreement included specific dissolution trigger events such as member expulsion, hence “it would scarcely make sense for the parties to have intended to state a specific purpose for Pedani, such that failure to promote it would lead to dissolution for a ground other than the ones the parties agreed to.”
- Even if it was proper “to read the purpose clause more narrowly than it is written,” the evidence at trial did not support a narrower reading, including proof that only one of the two buildings on the acquired property was leased to the operating company, and that the parties unsuccessfully attempted to lease the second building to a third party. “Since the parties intended to lease out a portion of the property,” Justice Scheinkman observed, “it cannot be said that they intended that the entire Property would be used exclusively as [the operating company’s] headquarters.”
- The majority member leased the entire property to an unrelated third party in June 2015, about four months before the plaintiff filed his lawsuit. The plaintiff was aware of the new lease but never objected before the suit and never claimed that the giving of the lease was unauthorized or that the controller failed to take reasonable steps to seek a replacement tenant. “Pedani could and did continue to manage the Property” after the operating company vacated, the court wrote.
As of this writing, the plaintiff has not filed a notice of appeal from the judgment dismissing the case, although his time to do so has not yet expired.
Where Does That Leave the Purposeless Purpose Clause?
Now that the dust in Mace has settled (assuming no further appeal), the question is, does the ubiquitous “any lawful business” purpose clause, in the face of the appellate and lower courts’ conclusions that it states no specific purpose, have any probative value in LLC dissolution contests?
There are two ways to read the decisions. The weaker reading of the clause as divined in Justice Scheinkman’s post-trial decision suggests that, standing alone, it lacks dispositive power, at least at the pleadings stage, in the face of conflicting allegations concerning the LLC’s purpose. Under this reading the clause’s probative value draws upon the operating agreement’s other provisions governing events of dissolution and the parties’ conduct of the business over a significant period of time prior to the dispute. Examination in that context, of course, lends itself to a greater likelihood of trial to resolve disputed factual issues.
The stronger reading focuses on Justice Scheinkman’s construction of the “unambiguous” purpose clause as meaning “exactly what it says” in the presence of a merger clause that precludes extrinsic evidence of some other, narrower purpose. This suggests that the “any lawful business” purpose clause could still play a potentially dispositive role in achieving pretrial, summary dismissal of an LLC dissolution claim alleging an unauthorized change of intended purpose.
Finally, don’t let my enthusiasm for the topic’s academic potential overstate Mace’s practical import. The vast majority of “failed purpose” LLC dissolution cases do not involve, as in Mace, a claim that the purpose of the LLC as presently being pursued is not the purpose as originally intended. Rather, they involve claims that the unchanged, original purpose of the LLC can no longer be achieved due to managerial dysfunction. In those cases, an “any lawful business” purpose clause generally is not an influential factor in the outcome.