“Where’s the Beef?” Says Appeals Court, Reversing LLC Dissolution
October 30, 2017
A dissolution petitioner received the judicial equivalent of the old quip “Where’s the beef?” in a Brooklyn appeals court decision last week reversing an order dissolving a limited liability company under Section 702 of the Limited Liability Company Law. In Matter of FR Holdings, FLP v Homapour, 2017 NY Slip Op 07439 (2d Dept Oct. 25, 2017), the Appellate Division, Second Department, sent the case back to the drawing board, despite the LLC having been in receivership for more than two years, because the petitioner “offered no competent evidentiary proof” in support of his petition for dissolution.
A Common Fact Pattern
FR Holdings involved a common fact pattern. 3 Covert LLC (“Covert”) was formed to own and operate a mixed-use apartment and commercial building in Brooklyn. Under the operating agreement, the purpose of the member-managed LLC was “to purchase and sell residential and commercial real estate and to engage in all transactions reasonably necessary or incidental to the foregoing.” Section 6.01 (a) of the operating agreement permitted most actions by “the vote or consents of holders of a majority of the Membership Interests.” As alleged in the petition, the LLC had five members, four of whom each held 12.5% interests. The fifth member, FR Holdings, owned a 50% interest.
In November 2014, FR Holdings and Piroozian, owners of 62.5% of the LLC, sued the minority — Homapour and two relatives, collective owners of 37.5% of the business — alleging that the members were “deadlocked in their disagreement” over how to manage the property, such as whether to “put more money into it to improve its condition” or to sell it. The petitioners alleged that Homapour, owner of 12.5% of the business, “assumed more and more control over the property and began to operate unilaterally,” eventually “shutting out” the petitioners, opening up new bank accounts and diverting rents to the accounts, and intentionally scuttling a potential sale of the property to a third party.
FR Holdings and Piroozian claimed that because of Homapour’s “unilateral usurpation of powers,” the “stated purpose of the Company cannot be realized” and the LLC is “unable to carry on its business in accordance with the Operating Agreement.” Aside from the petition itself, the papers in support of dissolution consisted of just an attorney affirmation and five exhibits.
Homapour opposed dissolution, arguing that the petition’s allegations largely fell under the heading of “oppression,” which did not justify dissolution. Homapour also submitted an affidavit and tax return showing that the LLC was a profitable business.
On reply, the petitioners submitted an email chain over the course of a single day in December 2014, in which Homapour slurred Piroozian several times, as proof that it was “not reasonably practicable” to carry on the business.
The Dissolution Order
In March 2015, Nassau County Supreme Court Justice Thomas A. Adams issued an order granting the petition and dissolving the company. The Court held:
[T]he record, including, but not limited to, the parties’ December 2, 2014 e-mails, confirm that it is not ‘reasonably practicable’ for 3 Covert LLC to continue to operate as intended, i.e. , ‘the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized
The Receivership Order
In a post-dissolution order, the Court appointed a receiver — despite the petition containing just a single paragraph concerning the appointment of a receiver, and despite not explaining at all why one was needed except to “supervise and monitor the collections of rents.” The receiver was empowered to take immediate possession of all property of the LLC and to sell its realty.
Respondents appealed. While the appeal was pending, they filed a motion in the lower court to reargue, which the court denied. After that, respondents filed a motion to stay enforcement of the dissolution and receivership orders. Justice Adams issued an order granting a stay of enforcement of the dissolution and receivership orders pending respondents’ appeal of the orders, but only “to the limited extent” of staying “the winding up of the LLC’s affairs” and “the sale or auction” of its real property.
The Appellate Decision
The Appellate Division’s decision recited the familiar rule, laid down in the landmark 1545 Ocean Avenue case, that to be entitled to dissolution under the LLC Law, the petitioner “must establish, in the context of the terms of the operating agreement or articles of incorporation, that (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible.”
Applying that principle, the court held:
the petitioners failed to establish their entitlement to a summary determination of the proceeding because they offered no competent evidentiary proof to support their assertions that Homapour unilaterally usurped management and control over the LLC in alleged violation of the operating agreement, and thwarted an alleged agreement for the sale of the building.”
Harkening back to the same court’s holding two months earlier in Mace v Tunick, 153 AD 689, 2017 NY Slip Op 06170 (2d Dept Aug. 16, 2017), written about here, the court noted that the stated purpose of the LLC was “to purchase and sell residential and commercial real estate,” yet there was no allegation in the petition that the management of the LLC was unwilling or unable to achieve this purpose. The Court also noted that “the LLC had been operated in a profitable manner as evidenced by its 2013 tax returns.”
As a result of petitioners’ insufficient evidentiary showing, the court held:
Supreme Court should not have summarily determined that dissolution was warranted on the ground that the management of the LLC was unable or unwilling to reasonably permit or promote the stated purpose of the LLC to be realized or achieved. We therefore remit the matter to the Supreme Court, Nassau County, for an evidentiary hearing in connection with this issue, and for a new determination of the petition thereafter.”
A Few Observations
First, as noted on this blog many times, New York’s rules of civil procedure require a petitioner in summary proceedings for dissolution to make a strong evidentiary showing equivalent to that required for summary judgment. Unlike in a typical lawsuit, the petitioner cannot simply allege facts. In a dissolution proceeding, he or she must prove those facts with competent, admissible evidence. Failure to do so will require, at a minimum, an evidentiary hearing as in FR Holdings, or worse, summary denial of the petition.
Second, as also noted on this blog as recently as just a few weeks ago, allegations of oppression, breach of the operating agreement, or breach of fiduciary duty — all of which were present in the petition in FR Holdings — typically are not enough to justify dissolution under the LLC Law. The focus is on the operating agreement, and whether the company can function as intended in accordance with the LLC’s stated purpose.
Third, FR Holding is one of those highly unusual cases in which members holding a majority interest seek judicial dissolution, raising the obvious question, what stopped them from filing a certificate of voluntary dissolution and then, if necessary, petition the court to appoint a liquidating trustee under LLC Law 703? Section 6.01 (a) of Covert’s operating agreement provided that all member actions required majority approval except where expressly provided otherwise in the agreement. Section 6.01 (b) enumerated actions requiring the members’ unanimous approval, not including dissolution. Possibly counsel for the majority petitioners concluded — rightly or wrongly — that Section 12.01 (d), authorizing dissolution upon “[t]he Members’ written consent,” required unanimous written consent.
Fourth, despite being sent back to the lower court for a new decision on the petition, it appears that the first round of litigation in the lower court was not a total waste for the petitioners. Filings in the lower court show that while the appeal was pending, the court-appointed receiver collected rents from the LLC’s tenants and made substantial interim distributions to the members in accordance with their pro rata interests. Given the petition’s allegations of Homapour’s “unilateral usurpation of powers,” petitioners presumably would not have received those distributions without the dissolution and receivership orders.
Finally, the lower court’s stay pending the appeal in FR Holdings turned out to be particularly important for respondents. Had the court not issued the stay, and if the building had been sold in the meantime, respondents’ win on appeal would have been a pyrrhic victory.