The Purposeless Purpose Clause Rides Again
September 28, 2020
“The Company is formed for any valid business purpose”
Nine seemingly benign words in the garden-variety operating agreement of a realty holding LLC. Nine words that, as one judge opined under similar circumstances some years ago, are tantamount to “no stated purpose.” Yet, in a case decided earlier this month called Lazar v Attena LLC, 2020 NY Slip Op 33003(U) [Sup Ct NY County Sept. 9, 2020], those nine innocuous words produced a first-round knockout of a dissolution petition brought by members of three affiliated LLCs that had sold off their realty assets and essentially had already wound up their business. Let me explain.
Under section 702 of the New York LLC Law, as construed by the courts, an LLC member may apply for judicial dissolution if either (1) management is unable or unwilling to permit or promote the LLC’s “stated purpose” as expressed in the operating agreement or articles of organization, or (2) continuing the LLC is financially unfeasible. The vast majority of LLC dissolution cases fit within the first, failed-purpose category.
The failed-purpose test’s focus on the LLC’s “stated purpose” has generated controversy and litigation, especially in dissolution cases involving realty holding LLCs. For instance, in 2015, in the Ross case that I wrote about here, Justice Timothy Driscoll cited the operating agreement’s broad purpose clause (“any lawful act or activities for which limited liability companies may be formed under the [NY LLC Law]”) in dismissing a dissolution petition brought after the LLC’s sole realty asset was sold and the controlling members decided to reinvest the sale proceeds in a new property rather than distributing them. The court rejected the petitioner’s contention that the LLC’s no-longer-achievable, unwritten, sole purpose was to acquire and operate the original property.
Mace v Tunick
The analysis got more complicated in the wake of the Appellate Division, Second Department’s 2017 decision in the Mace v Tunick case that I wrote about here and here.
In Mace, the minority member of two LLCs with common ownership — one an operating business; the other the owner of the realty that housed the operating business — after being bought out of his interest in the operating company, sued to dissolve the realty LLC when the remaining owners of the operating business decided to relocate the business out-of-state, leaving the property empty or partially rented. The minority member contended that the LLC no longer served its intended purpose to house the operating business. The lower court, in an opinion by Justice Alan D. Scheinkman (since promoted to Presiding Justice of the Appellate Division, Second Department), granted the defendants’ pre-answer dismissal motion.
En route to dismissal, however, Justice Scheinkman found that the operating agreement’s purpose clause (“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”) “contains no stated purpose.” Treating it as dispositive, Justice Scheinkman added, “would preclude judicial dissolution on every occasion in which such common, boiler-plate purpose language is used in an Operating Agreement.”
He nonetheless went on to dismiss the complaint based on the plaintiff’s failure to allege facts showing that the LLC’s purpose had changed or that the LLC’s management was unable or unwilling to reasonably permit or promote the LLC’s achievement of its purpose to acquire and maintain the property.
On appeal by the minority member, the Second Department agreed with the lower court that the broad purpose clause neither “set forth any particular purpose” nor “utterly refuted the plaintiff’s allegation as to [the LLC’s] purpose so as to conclusively establish a defense as a matter of law to the plaintiff’s dissolution cause of action.”
The appellate panel nonetheless reversed the order of dismissal and remanded the case for further proceedings. The panel concluded that the lower court made an “impermissible factual finding” based on disputed extrinsic evidence that the LLC’s purpose “was simply to acquire and manage property.” After remand, discovery, and trial, Justice Scheinkman dismissed the action on the merits in a written opinion that, as I commented here, relied not only on the “unambiguous” purpose clause but also on the operating agreement’s other provisions governing events of dissolution and on the parties’ conduct of the business over a significant period of time prior to the dispute.
Lazar v Attena LLC
The Lazar case, decided earlier this month by Manhattan Commercial Division Justice Andrea Masley, is a dissolution case involving three, member-managed LLCs owned by the two individual petitioners and the two individual respondents. According to the petition, the LLCs were formed between 2011 to 2013 for the purpose of acquiring and operating a number of multifamily properties located in Manhattan. All of the properties were sold in late 2015. As far as I’ve been able to tell from reviewing some of the court filings, all of the sale proceeds were disbursed, presumably to mortgage lenders, other creditors, and ultimately the members. At the oral argument of the respondent’s dismissal motion, the respondent’s attorney stated that he did not know if any of the LLC bank accounts had any remaining funds.
So if all the assets were sold and the proceeds distributed, you ask, why a dissolution lawsuit? The gravamen of the case, as well as that of a companion plenary action brought by the same petitioners against the same respondents asserting a variety of business tort claims, has to do with hundreds of thousands of dollars of supposed “debts” owed to the LLCs by the respondents that were reflected in the LLCs’ tax returns through the 2014 tax year. Allegedly, the debts “disappeared without explanation” in the 2015 returns that the respondents caused to be filed on behalf of the LLCs.
The respondents moved to dismiss the case on several grounds, including their argument that the petition’s allegations satisfied neither the failed-purpose nor the financial-failure prong of the test for judicial dissolution under LLC Law § 702. The petitioners argued, among other contentions, that dissolution was warranted because the LLCs ceased to serve their sole, intended purpose to acquire and operate the five multifamily properties that had been purchased and later sold. In reply, the respondents pointed to the purpose clauses in the LLCs’ essentially identical operating agreements, each stating that the LLC “is formed for any lawful business purpose.”
Justice Masley agreed with the respondents, writing in no uncertain terms:
The purpose of the LLCs here is “any lawful business purpose”. Nowhere in the operating agreements does it state, as petitioners allege, that the “sole purpose of the LLCs was to acquire, own and operate five separate multifamily properties located in Manhattan.” Nowhere do petitioners claim respondents have failed to promote or permit the LLCs’ stated purposes. [Record references omitted.]
Justice Masley’s opinion distinguished case precedents relied on by the petitioners. In support of dissolution, she cited Justice Saliann Scarpulla’s decision dismissing a § 702 petition in the Yu v Guard Hill Estates, LLC case which I wrote about here. In that case, Justice Scarpulla held, the petition failed to allege facts demonstrating the controlling members’ failure to permit or promote the achievement of the LLC’s purpose as stated in its operating agreement. The purpose clause in Yu, however, was not of the any-lawful-purpose variety. Rather, it was limited to the realty still owned and maintained by the LLC.
Justice Masley’s opinion further concluded that the petitioners failed to satisfy the financial-failure prong of the test, finding “no evidence that the LLCs are in financial turmoil, insolvent or otherwise cannot meet their debts and obligations.” She also found that petitioners’ additional allegations of “oppressive conduct,” even if assumed true, did not constitute ground for dissolution under § 702 as construed in Doyle v Icon and other cases.
Are Mace and Lazar Reconcilable?
The answer to the question is elusive and made all the more difficult because neither side in Lazar cited Mace in their memoranda of law nor mentioned Mace at oral argument — a strange omission, particularly on the part of the petitioners. Perhaps that explains why Mace is not mentioned in the Lazar decision.
The answer is made even more difficult by the different procedural postures of the two cases. Mace was a plenary action decided by the lower court on a pre-answer motion to dismiss where the court must assume the truthfulness of the complaint’s well-pleaded factual allegations. The appellate panel held that under the applicable standard of review, the operating agreement’s any-lawful-business purpose clause did not “conclusively establish a defense as a matter of law to the plaintiff’s dissolution cause of action.”
In contrast, Lazar was brought as a special proceeding in which the litigants must proffer testimonial and documentary evidence in admissible form and in which the court must make a summary determination on the merits unless it finds disputed issues of fact requiring a hearing. Thus, even had petitioner in Lazar relied on Mace, it is far from clear that the outcome would have been any different, i.e., that the court would have found sufficient evidence that the members agreed to limit the LLCs’ purpose or that, even if they had, that the limited purpose of the LLCs in their winding up mode was not being met.
If my answer sounds like a punt, it is. This is one of those issues that’ll just have to await further case law development.
“You All Can’t Get Along, So Why Not Just Dissolve and Move On?”
I read the transcript of oral argument in the Lazar case. You can too. It was conducted on Skype. I don’t know if any of the clients were watching or listening in. If they did, they heard Justice Masley, who has decades of experience as court attorney and judge, strongly recommend that the parties resolve their differences by hiring a neutral accountant to perform an accounting. They also would have heard Justice Masley express frustration (or, at least, that’s how it reads to me) with their multiple lawsuits concerning a defunct business operation and business partners in need of a divorce, to wit:
I can hear the motions, and I will hear them, it’s fine; but, you know, at the end of the day your clients don’t want to work together anymore so they are going to split up, and the only way they can do that is with an accounting. [Tr. 5]
I just don’t know why your clients — you all can’t get along, so why not just dissolve them and move on? . . . Do the accounting and go your separate ways. [Tr. 47-48]
Let’s just say I grant these motions. You are stuck with each other. Like, you have to find a way to help your clients get away from each other. They don’t want to do business. You know, we can get rid of the lawsuits, but at the end of the day they are still stuck together. So I will do my job and resolve these motions; but you are the attorneys for your clients, and, you know, they don’t want to do business together so we are all going to be back together again. Well, maybe you will — maybe you will get a new case and get a different judge. You started with [Justice] Sherwood, now you have me. What is the next lawsuit going to be? [Tr. 53]
Having since granted the motion to dismiss the dissolution petition, as the good judge said, the clients are stuck with each other that much longer.