First Impression Decision Recognizes Cause of Action for Dissolution of Common Law LLC | Farrell Fritz, PC


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Five years ago we written about an important decision of the Delaware Chancery Court, In re Carlisle Etcetera, LLC, 114 A3d 592 [2015], in which a court first recognized the existence under Delaware law of a viable cause of action for the “equitable dissolution” of an LLC based on the fairness powers of the court , despite the existence of a law explicitly stating the grounds for judicial dissolution.

In our article on Carlisle, we noted that creative litigators in New York might “analogize Carlisle ‘s the recognition of the equitable dissolution of the LLC to the recognition by the State of New York of the common law dissolution for private companies. We concluded our article by noting that we knew, at that time, that there was “no case in New York regarding” whether there is a viable claim in New York for “the common law dissolution of ‘an LLC’.

Five years later, we’re delighted to write about a first-impression ruling last week by Brooklyn Commercial Division Judge Leon Ruchelsman in which a creative litigator persuaded the court to become the first in New York to recognize the existence of a viable cause. of action for the common law dissolution of an LLC, notwithstanding the existence of the LLC legal dissolution standard found in Article 702 of the Law on Limited Liability Companies (the “LLC Act”).

The doctrine of common law dissolution

The doctrine of common law dissolution dates back to a series of opinions from lower courts which resulted in the decision of the Court of Appeal in Liebert vs. Clapp, 13 NY 2d 313 [1963]). In Leibert, the Court held that dissolution is appropriate under the common law where the shareholder or directors of the corporation “have so manifestly breached the fiduciary duty which they owe to the minority shareholders as they are. disqualified from exercising the exclusive discretion and the power of dissolution conferred on them by law. “

Sixteen years later Liébert, the legislature enacted the New York State Dissolution Act for “oppressive conduct” against a minority shareholder, Section 1104-a of the Joint Stock Companies Act (the “BCL”). The enactment of BCL 1104-a could have sounded the death knell for a viable demand for the dissolution of a company based on common law principles. But in a handful of decisions Over the decades, appellate courts have continued to hold that common law dissolution remains a viable cause of action for the dissolution of a corporation, although it remains rare and requires, in the words of Lemle vs. Lemle, 92 AD3d 494 [1st Dept 2012], “evidence of odious conduct.”

In the most recent New York Court of Appeal ruling granting a motion to dismiss an application for common law dissolution, Ferolito vs. Vultaggio, 99 AD3d 19 [1st Dept 2012], the Court explained:

A common law dissolution request is properly formulated when it is alleged with sufficient factual detail that the controlling shareholders plundered the assets of the company at the expense of the minority shareholders, continuing the existence of the company for the sole purpose of profiting. to those who control it. , and sought to force and coerce minority shareholders to sell and sacrifice their stakes to those in control.

In practice, most common law applicants for dissolution choose this route because, like the applicant in Feldmeier v Feldmeier Equip., Inc., 164 AD3d 1093 [4th Dept 2018], “he could not apply for judicial dissolution under the Commercial Companies Act § 1104-a because he owned less than 20% of all the outstanding shares of the company.”

The Pachter Case

With all this law in the background, in Pachter vs. Winiarsky, Decision and Order [Sup Ct, Kings County Index No. 502779/2020], the Court examined two new questions: (i) does the doctrine of common law dissolution apply to SARLs; and (ii) is the dissolution of the common law LLC potentially available to a 50% member.

Pachter involved four LLCs owning real estate, two with written operating agreements, two without, owning multi-family properties in Brooklyn. Linderberg was a 50% member of each of the LLCs. After Lindenberg’s death, Pachter was appointed estate trustee. Two months after his appointment, Pachter sued the other 50% of LLC members, alleging in his petition a scheme of “embezzlement, self-operation, forgery, perjury, fraud, extortion and Theft of records, ”claiming they“ have embezzled over $ 6 million in company assets. Pachter alleged nine causes of action, including one count of common law dissolution and one count of legal dissolution under the LLC Act 702.

Arguments of the parties

The petitioner’s support memorandum of law discusses on pages 8-17 the history of common law dissolution and the factual circumstances in which it is potentially available. Pachter casually stated, “Common law dissolution is a well-established fair remedy available to members of the LLC, regardless of any law. The only case supporting this proposition? Nothing else than Carlisle himself. Rather than relying on the direct New York authority applying common law dissolution to LLCs, the petitioner drew an analogy with previous New York court instances applying the principles of equity / common law to find remedies that do not exist under the law:

The respondents requested that the petition be dismissed. In their dismissal memorandum of law (you can also read the opposition and reply comments here), the respondents argued that the existence of LLC 702 has supplanted any potential remedy for common law dissolution, relying on apparently strong language from In re 1545 Ocean Ave., LLC, 72 AD3d 121 [2d Dept 2010]:

[T]The legislator cannot have intended that the dissolution norm provided for therein to remain 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 dissolution of [corporate law] Where [partnership law] To [LLC law].

decision

In its decision, the Court dismissed the second cause of action for legal dissolution under LLC 702, finding that the petitioner’s “allegations of oppression and freezing” and “the crux of the petition” – that “the respondents, as managers of the company essentially stole over a million dollars by embezzling rental income and also committed other irregularities “-” while supporting the dissolution of the common law, does not support du all legal dissolution ”under the standard set out in In Ocean Avenue. Then, the Court, without recognizing that it applied corporate principles to SARLs, explained:

Regarding the first cause of action of the motion, first, common law dissolution remains a viable cause of action in New York. When statutory dissolution is not possible, shareholders in this situation have had and continue to have recourse in the form of ordinary law dissolution. Common law dissolution, prior to BCL 1104-a, is a fair cause of action that allows shareholders below the 20% ownership threshold to request the dissolution of a private company in certain circumstances of embezzlement. Although common law dissolution cases are relatively rare in New York City, case law has evolved (and continues to evolve) that sheds light on this cause of action, the burden of proof necessary to support such a cause of action. action, and remedy available if liability is established.

Rather than focusing on an explicit discussion of whether common law dissolution is available for LLCs, the Court focused its attention on a secondary legal issue: whether a 50% member of an LLC can make a viable claim. common law dissolution. In Sternberg v Osman case, 181 AD2d 897 [2d Dept 1992], the Court ruled that “the remedy in matters of common law dissolution is available alone minority shareholders who accuse majority shareholders and / or corporate officers or directors of plundering the company and of having failed in their fiduciary duty. Osman involved a 50/50 deadlock. The Court held that since “Osman and Sternberg are both 50% shareholders and constitute all of the officers and directors of Long Island Paneling Centers, Inc., so neither of them is qualified to claim a common law dissolution ”.

In Pachter, the Court distinguished Osman, explaining: “There are cases in other jurisdictions that hold ‘minority’ status can be obtained and dissolution pursued even from a fifty percent owner.” The Court concluded:

[A] narrow approach that excludes recourse because the petitioner happens to be a fifty percent owner fails to consider the individual facts of each dissolution petition on a case-by-case basis. . . He does not understand this either, since statutory dissolution is not possible. . . the petitioner will have no way to challenge the alleged irregularities, an untenable situation. Therefore, the petitioner should have the right to pursue the claims and allegations contained in the petition, notwithstanding the status of fifty percent owner. Therefore, the motion to dismiss the first count is dismissed.

Farewell thoughts

Why would an applicant choose to plead an application to dissolve the ordinary law LLC? As we noted Many times, the bar for the statutory dissolution of LLC is rather high. According to the New York precedent, the stalemate may not be enough to dissolve. Neither “oppression” in the classic sense which can justify the dissolution of companies. Pachter has now opened the door for aggrieved LLC owners to circumvent LLC Law 702, arguing for an LLC dissolution although he or she may be unable to argue a viable legal dissolution claim.

It is relatively easy to explain the doctrine of the dissolution of common law companies as a vestige of New York law prior to the enactment of BCL 1104-a. The same is not so easy to do for the dissolution of a common law LLC, where a judicial dissolution law with an applicable legal standard had existed for decades before the emergence of a dissolution remedy. common law. We express no opinion as to whether the decision of the Court in Pachter is consistent with the prior enactment of LLC Law 702 and the language of the Court in Ocean Avenue that the legislature wanted this provision to be “the sole basis for judicial dissolution” of an LLC. This question will be left to the courts of appeal in the years to come.

One final comment on Pachter. As we noted in previous articles, the death of an LLC member can cause permanent problems for the member or their estate when they attempt to bring an action for dissolution. The Pachter The Court did not consider this argument, presumably because the respondents did not raise it in their motion to dismiss, in fact referring in their dismissal brief to “the interest of the estate in all LLCs”, thus treating the interest of the estate as not being different from that of the deceased, potentially waiving a potential defense based on lack of status.

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