When drafting limited liability company operating agreements, some variation of the words “The LLC is formed to conduct any lawful business activity” is used to describe the purpose of the entity. The wisdom of this approach was called into question in a recent judicial dissolution proceeding that came before the New York County Commercial Division (Masley, J.). Across the East River, on the very same date, the Commercial Division in Queens also issued a decision in a judicial dissolution proceeding (Livote, J.), involving shareholder oppression in a corporation. These recent decisions serve as a reminder to corporate shareholders and LLC members – and their attorneys – that dissolving a business entity is far more difficult than creating it.
Broad Purpose Clause: Lazar v. Attena LLC[1]
Petitioners Lazar and Sheinbaum commenced a special proceeding pursuant to LLC Law § 702 to dissolve three LLCs: Attena LLC, Hemera LLC, and Nessa LLC, all of which had been formed during the early 2010s. They also sought the appointment of a receiver to wind up the LLCs’ affairs as well as to restrain respondents Mor and Zichron from filing tax returns on the LLCs’ behalf without prior express written consent of the petitioners or the receiver.
In their petition, Lazar and Sheinbaum contended that the sole purpose of the LLCs was to acquire, own, and operate five multi-family properties in Manhattan. All the associated properties were sold by December 2015, rendering the intended purpose of the LLCs moot. Asserting that the LLCs had therefore “run their course,” the petitioners sought judicial dissolution.
LLC Law § 702 provides that “‘[o]n application by or for a member, the supreme court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is [n]ot reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.’ Thus, the court must determine whether it is ‘reasonably practicable to carry on the business’” of the LLC (citing Matter of 1545 Ocean Ave., LLC, 72 A.D.3d 121 (2d Dep’t 2010). To succeed, the petitioner must establish 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.’” Id. at 131.
Upon the Court’s examination, contrary to the petitioners’ assertions, the operating agreements of the LLCs all defined each entity’s purpose as “any lawful business purpose” – not to acquire, own, and operate the properties. The Court noted that the petitioners offered no evidence to support the claim that this general purpose of the LLCs to engage in “any lawful activity” was no longer occurring. The court found that the respective operating agreements did not limit the business purpose of the LLCs and that the petitioners provided no evidence that the LLCs were in “financial turmoil, insolvent, or otherwise cannot meet their debts and obligations” (a second potential basis for dissolution). The Court therefore dismissed the petition, pointing out that “Oppressive conduct is not sufficient.”
Lazar is a sharp reminder that when petitioning for judicial dissolution under LLC Law § 702, a broad purpose clause in an operating agreement will be a potential hurdle that must be overcome. When forming a new company, the last thing business partners want to think about it is dissolving it based on a future disagreement. But the LLC members and attorney should discuss this clause upon the LLC formation, and not treat it as an afterthought.
Shareholder Oppression: Hammad v. Jamal Kamal Corp.[2]
Petitioner Nedal Hammad was the 25% owner (as well as the president) of respondent corporations Maysa Realty Corp. and Jamal Realty Corp. (“Jamal Kamal”), both real estate holding companies. Nedal’s brothers (Jamal, Kamal, Omar, and Samir) owned the remaining 75% of the corporations.
In February 2017, the brothers made fourteen demands to Nedal regarding company operations. One demand was to stop making payments to Highcrest, another company owned by the brothers, because they thought Nedal was using Highcrest to drain money from the companies to enrich himself. Nedal continued to make payments to Highcrest, making payments for $29,850 from Maysa and $29,975 from Jamal Kamal in March 2017. Later that year, Nedal made distributions of $150,000 from Maysa and $160,000 from Jamal Kamal to himself and the brothers, including Jamal, without their approval. The brothers did not cash the distribution checks. Thereafter, the brothers elected Jamal president. Jamal, as president, retroactively changed the 2017 distributions made to Nedal. Following his removal as president, Nedal filed a petition for judicial dissolution of the companies under BCL § 1104-a.
Additionally, in late 2018, Maysa and Jamal Kamal made distributions of $509,400 and $499,900, respectively. Nedal’s share of these distributions were applied to his outstanding loans that were created by the re-classifications. These distributions were calculated to reduce the balance of Nedal’s loans to zero. Nedal was not notified of the distributions.
Pursuant to Business Corporation Law (BCL) 1104-a, a holder of 20% or more of the shares of a business corporation (which Nedal held) may seek dissolution if “the directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders.” Dissolution also is warranted if “the property or assets of the corporation are being looted, wasted or diverted.”
In determining whether to proceed with involuntary dissolution, the court must take into account (1) “Whether liquidation of the corporation is the only feasible means whereby the petitioners may reasonably expect to obtain a fair return on their investment; and (2) Whether liquidation of the corporation is reasonably necessary for the protection of the rights and interests of any substantial number of shareholders or of the petitioners.”
Here, the Court held that judicial dissolution was not warranted. The removal of Nedal as president did not constitute oppressive conduct. However, no acceptable justification was offered for the reclassification of the payments to Highcrest; although the brothers alleged that Nedal was self-dealing through Highcrest, they did not prove the allegations.
The Court also noted that Nedal’s reasonable expectations as a shareholder were to receive a dividend in proportion to his ownership. The oppressive conduct against Nedal was to remedy what the brothers viewed as his unauthorized and oppressive conduct. After the 2018 distributions were made to “equalize” the distributions among all the shareholders, the Court did not find that any “future oppressive conduct” was intended by the brothers, and Nedal will share in future distributions. Therefore, dissolution would not be an appropriate remedy. Instead, the appropriate remedy was to pay to Nedal the amounts paid to Highcrest that the brothers improperly reclassified as loans.
Hammad is a reminder that courts have a great deal of discretion when determining petitions for judicial dissolution in shareholder oppression suits. Specifically, when majority shareholders are able to continue company operations, judicial dissolution may not be the appropriate remedy; monetary damages for past wrongdoings may be more appropriate. Like Lazar, Hammad reminds us that breaking up can be hard to do.
[1] 2020 WL 5439528 (NY County Sup. Ct., Sept. 9, 2020)
[2]2020 WL 5755548 (Queens County Sup. Ct., Sept. 9, 2020)