Common law and Equitable LLC dissolution: Going, Going,. . . | Farrell Fritz, PC
Recently, we wrote two articles focusing on the ongoing dispute over whether New York law recognizes a viable cause of action for the “ordinary” or “fair” dissolution of a limited liability company. .
In October 2020, I blogged on a dismissal decision prior to response in Pachter vs. Winiarsky, in which a New York court first upheld an application to dissolve a common law LLC, even when the court, in the same decision, held that the petition failed to apply for legal dissolution under Article 702 of the Law on Limited Liability Companies.
In May 2021, Pierre Mahler blogged on a second dismissal decision prior to response in the Pachter case, in which the court considered the sufficiency of a petition / complaint amended filed after the issuance of the initial dismissal decision. In the second Pachter decision, the court essentially reversed, dismissed the common law / equity application for dissolution, but reinstated the section 702 application for dissolution.
On July 12, 2021, Brooklyn Commercial Division Judge Leon Ruchelsman issued the third decision in the knock-down-drag-out Pachter litigation over whether the common law / equitable dissolution of an LLC exists as a viable cause of action in New York City. This decision was made through a petition from Pachter for leave to challenge the previous dismissal.
The legal arguments put forward by the parties are interesting, so I will devote some time to the briefs, which you can read here, here, and here.
In his moving papers, Pachter argued:
Equitable dissolution, also known as common law dissolution, is a well-established doctrine allowing members of LLCs to dissolve when the management of the LLC has engaged in certain “egregious conduct” towards the LLC or other members. See Lemle vs. Lemle, 92 AD3d 494, 500 (1st Dep’t 2012).
I would better describe this argument as a “stretch”. Lemlé was not an LLC dissolution case. The appeal decision in Lemlé involved multiple companies, but no LLCs. Lemlé certainly did not address the dissolution of the common law LLC, a topic that no New York appeals court has addressed directly (but we’ll get to that later). In fact, in another section of his brief, Pachter acknowledged the lack of guidance from the appeals court:
The Applicant acknowledges that the novelty and complexity of the issues in this case will almost certainly require appellate review. [but] rather than wait for approval by the appeal of the equitable dissolution — in which case the parties would have to repeat the discovery and trial — the best course of action would be to reinstate the claim and allow the discovery to be made. and the trial to move forward in the meantime on all of the issues raised in the amended complaint.
On the ultimate merits of whether New York law would recognize the dissolution of the common law LLC, Pachter drew an analogy with other areas of LLC case law where courts have recognized common law remedies not found in the written text of the LLC law, arguing:
Equitable dissolution applies to LLCs. In Tzolis vs. Wolff, 10 NY3d 100 (2008), the Court of Appeal held that all well-established equitable doctrines for the remedy of damages caused by trust companies are available in the context of the LLC in the absence of a “clear legislative mandate to the contrary “.
This is another “stretch”. We have written on Tzolis vs. Wolff Many times. While this may be the most important LLC case to date to reach the Court of Appeal, establishing the general principle that certain “fair” / “common law” doctrines apply to LLCs, it does not. She certainly did not go so far as to say that “” all well-established fair doctrines for redressing damages caused by trust companies are available in the LLC context, “unless prohibited by LLC law.
On the contrary, as Pachter pointed out in other sections of his brief, there are three main lines of case law important to equitable concepts applicable to other forms of LLC entity:
The gist of Pachter’s argument was that the court should draw inspiration from these three lines of authority and import a fourth into LLC law: equity / common law dissolution, which originates in corporate law. companies.
In their opposition brief, the respondents argued that the main LLC dissolution case in New York, Case of 1545 Ocean Ave, LLC, 72 AD3d 121 (2d Dept 2010), categorically prohibits any notion that the courts of New York could apply common corporate law dissolution standards to LLCs:
In . . . LLCL 702, the Legislature can only have wished that the standard of dissolution provided for therein remains the sole basis for the judicial dissolution of a limited liability company. In other words, since the legislature, in determining the criteria for the dissolution of various business entities in New York, did not intersect these grounds from one type of entity to another, it would be inappropriate for this Court to import the reasons for the dissolution of the Business Company Law or Company Law to the LLCL.
The speaker Kassab Decision
On June 22, 2021, the same day Pachter’s re-argumentation motion was submitted for decision, the Appeals Division – Department Two released two important new decisions (available here and here) in the Kassab litigation. Like I written a few weeks ago, one of the decisions contains the following language echoing Ocean Avenue: “The Limited Liability Company Law 702 provides the sole basis for the judicial dissolution of a limited liability company and includes a “stricter” standard than that for the dissolution of a company.”(Citations omitted; emphasis added).
The re-argumentation decision
In his decision, Ruchelsman J. rejected for the second time Pachter’s request to recognize a viable cause of action for the dissolution of the common law, rendering two essential legal decisions.
First, the court ruled:
In Case of 1545 Ocean Avenue . . . the court ruled that the only basis for the dissolution of a limited liability company was the grounds set out in the Law on Limited Liability Companies § 702, namely judicial dissolution and that it was inappropriate “to import the grounds for dissolving the Law on Commercial Companies or the Law on Limited Liability Companies. Liability company law. ‘ Indeed, there are no cases which apply anything other than judicial dissolution to limited liability companies. The fact that other remedies are available to limited liability companies, such as piercing the corporate veil or the business judgment rule, does not mean that other methods of dissolution are possible. [Although] The petitioner argues that there is no reason why equitable dissolution should be prohibited when it is available for entities which are so similar to limited liability companies. . . it is a political argument which cannot go beyond the clear directive of Case of 1545 Ocean Avenue. Indeed, this jurisdiction is bound by Case of 1545 Ocean Avenue which interpreted Law 702 on Limited Liability Companies as prohibiting any other form of dissolution.
Second, the court ruled:
The petitioner further claims that “the law supports the viability of an equitable dissolution”. While this is certainly true in the case of ordinary companies and it may well be that the applicant has demonstrated the sufficiency of proof necessary to obtain a fair dissolution in general, this is not at all true. when it comes to limited liability companies. The cases cited by the petitioner do not support such equitable dissolution for limited liability companies. Tzolis v. Wolff. . . ruled that derivative actions were permitted in a limited liability company, however, this has nothing to do with the possibility of other forms of dissolution. In addition, in Mizrahi v. Cohen. . . the dissolution that occurred was “judicial” in accordance with Law 702 on Limited Liability Companies. . Again, while arguments based on logic or common sense may seem compelling, at this time there is no basis for a dissolution of a limited liability company that is not judicial.
Rule of law after Pachter
In PachterIn the trio of common law decisions, the dissolution of the LLC has shown brief signs of promise as a new cause of action, but now appears to be of questionable origin unless an appeals court or another. trial court would not find such a claim viable under New York law.
For petitioners / complainants, one can understand the appeal of a catch-all and non-statutory dissolution request embracing “”flagrant breaches of fiduciary duty as a means of dissolving an LLC. As our regular readers know, with few exceptions, breach of fiduciary duty, oppression, or even exclusion from the LLC, is often not enough to establish grounds for dissolution under the standards of the LLC. Case of 1545 Ocean Ave. There is a growing body of case law rejecting at the pre-response stage petitions under Section 702 alleging these grounds for dissolution (you can read some of the recent examples we blogged about. here, here, here). There is also a growing number of appeal decisions affirming these revocation grants, even going so far as to overturn refusals of revocation (the most recent being Kassab last month; we find two others here and here).
All of this shows that the means for members to dissolve a New York LLC appears to be shrinking, not expanding, which makes the operating agreement all the more important. If desired, creative writers of operating agreements, especially those representing non-controlling members, might consider listing in the operating agreement the rights and obligations that the parties consider to be truly vital. , the violation of which may constitute grounds for dissolution under SARL Law 701 (2) allowing dissolution in the event of “the occurrence of events specified in the operating agreement”. While this rarely happens in practice, it can be an approach to try to anticipate and deal with the fact that under New York’s Judicial Dissolution Act breaking up may be difficult to do.