Is it time for New York to follow Delaware and officially declare deadlock as a reason for dissolving LLC? | Farrell Fritz, PC

Since its inception in New York in 1994, the limited liability company has been the preferred choice of corporations in New York and across the country. For the next 15 years, New York’s lower courts struggled to arrive at a consistent interpretation of the enigmatic provision of Section 702 of the LLC Act, modeled on that of New York’s Revised Limited Partnership Act, which mandated the court’s dissolution of LLCs “if this is not reasonable is practicable to continue as a going concern in accordance with the articles of incorporation or operating agreement.”

As I wrote in a Article in NYSBA Journal Many years ago, in those early days, some courts without meaningful appellate guidelines, express or implied, treated LLCs as commercial corporations subject to the same judicial resolution standards and remedies set forth in Section 11 of the Corporations Act.

A unified standard under Section 702 did not appear until 2010, when the Appellate Division, Second Division, issued its landmark decision, authored by former Associate Justice Leonard B. Austin Matter of 1545 Ocean Avenue, LLC.

In the court’s detailed opinion, Judge Austin articulated a contract-centric approach that requires a Section 702 applicant to demonstrate, “in connection with the terms of the operating agreement or articles of incorporation, that (1) the management of the corporation may or may not be able to.” is willing to reasonably permit or promote the stated purpose of the business to be realized or achieved, or (2) going concern is not financially feasible.”

1545 Ocean Ave concerned an LLC owned by two 50/50 co-directors. The petitioner claimed that the commercial deadlock between the two owners and managers was the only basis for the dissolution, the deadlock being a long-recognized ground enshrined in the Companies Act Section 1104 for the involuntary dissolution of closely held companies, owned by the disputed 50/50 shareholders.

By dismissing the deadlock-based petition, Judge Austin refused to import, as he put it, “business corporation law grounds for dissolution” into the LLC statute. As he further explained:

“Deadlock” is in and of itself a basis for judicial dissolution under Section 1104 of the Companies Act. However, such an independent ground for dissolution is not available under section 702 of the limited liability company law. Instead, the court must consider the directors’ disagreement given the operating agreement and 1545 LLC’s continued ability to function in this context.

Since then there have been a number of lower court decisions 1545 Ocean Ave in 50/50 LLC termination cases reflecting Justice Austin’s analytical framework and rejecting deadlock as an “independent ground for termination”. Examples featured in this blog include the decision of Judge Saliann Scarpulla (then Manhattan Commercial Division judge, later appealed). Advanced 23, LLC v Chamber House Partners, LLC and the decision of retired Judge Charles Ramos in Goldstein versus Pikus. In both cases, the courts were willing to consider the non-cooperation between peer managers only to the extent that it affected the LLC’s ability to function within the context of the operating agreement and its stated purpose.

Too close reading of Section 702?

The above question came to mind when I read the interesting Opinion Letter last week Regarding: Dissolution of T&S Hardwoods KD, LLC, another in a very long line of Delaware Chancery Court decisions in judicial dissolution cases involving Delaware LLCs co-managed by 50/50 members. In all of these cases, go back at least to the 2004 statement by former Vice-Chancellor (and later Chancellor) Strine Haley vs TalcottBy analogy, the Chancery Court expressly incorporated into its construction of Section 18-802 of the Delaware LLC Act, authorizing the court dissolution of LLCs, the corporate deadlock doctrine established for 50/50 closed corporations under Section 273 of the Delaware General Corporation Law.

Five years later Haleynamed in another 50/50 LLC dissolution case Regarding: Arrow Investment Advisors, LLCVice-Chancellor Strine clearly identified the deadlock as a basis for a judicial dissolution when he wrote: “Dissolution is reserved for situations where the LLC’s management has become so dysfunctional or its business purpose has become so frustrated that it is no longer practicable to do so to conduct business, such as in the event of a deadlock or when the stated purpose of the corporation has become impossible.”

My above references to Delaware LLC Act Section 18-802 and Arrow investor carry an ironic element to the question I raise in this post about New York’s conceptually narrower approach to deadlock and LLC resolution. Section 702 of the New York LLC Act is an almost exact replica of Section 802 of the Delaware LLC Act, in which neither mentions the word deadlock. Justice Austin in his 1545 Ocean Ave Opinion not just quoted Arrow investor As a mainstay of his analysis of Section 702, he quoted extensively from it, including the passage cited above that specifically identified “vote blocking” as a reasonable ground for a judicial resolution.

In short, there is no material difference in the text of the Delaware and New York LLC dissolution statutes, nor a less strong analogy to their respective corporate law cousins ​​governing shareholder deadlock, which logically explains why, on the one hand, the Delaware case law is explicit recognizes standstill as a ground for judicial dissolution of LLCs, while on the other hand New York law does not recognize standstill as an “independent ground” for dissolution of LLCs.

Semantics or substance?

Is it possible that the difference in the legal approaches of Delaware and New York is just a matter of semantics, with no practical implications for real cases?

Certainly there are instances when a standstill in important decisions jeopardizes the company’s ability to continue to achieve its purpose, eg., halting the renewal of a critical line of credit that requires personal guarantees, or relocating the business as the office lease nears an expiration date. The failed purpose pin of 1545 Ocean AveThe wording of the § 702 Standard, which rejects deadlock as an independent basis for resolution, would still accommodate such deadlock-based fact patterns.

But I have also seen and can imagine many circumstances in which the two approaches might well yield different results. Here I am thinking primarily (but not exclusively) of cases involving 50/50 commercial real estate holding LLCs that continue to operate the property, collect rent, pay bills and remain financially viable while the two owners engage in serious personal animosity and feud with management , maintenance, finances, distributions and long term goals including holding or selling the property.

About five years ago, when Professor Douglas Moll published his Nationwide survey on GmbH dissolution statutesfive states – Arizona, California, Florida, Kansas and New Hampshire – expressly include deadlock in their involuntary dissolution laws as a ground for judicial dissolution, separately and apart from the prevailing statutory standard. ie., it is no longer practical for the LLC to continue in business.

Nothing I have said above is intended to suggest that New York courts should abandon the contract-centric approach that underpins both Delaware’s and New York’s approach to court dissolution of LLCs. The company agreement should always have top priority. But in so many cases involving two-member 50/50 LLCs, we see companies with no operating agreement or with poorly drafted operating agreements that lack a deadlock breaking mechanism. In these cases, the appropriate powers of the New York courts in dissolution cases may be hampered 1545 Ocean Ave‘s restrictive reading of deadlocks.

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