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Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: June 9, 2020

Court Refuses to Dissolve LLC; High Burden for Dissolution Not Met

On May 1, 2020, Justice Schecter of the New York County Commercial Division issued a decision in Warner v Heath, 2020 NY Slip Op. 31447(U), holding that the high burden for dissolving an LLC had not been met, explaining:

The Operating Agreement provides that the Company may be dissolved pursuant to LLC Law § 702 and that, upon dissolution, plaintiff may reacquire the intellectual property she gave to the Company for $1. LLC Law § 702 states that an LLC may be dissolved whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement. While the LLC law is silent as to the meaning of not reasonably practicable, case law has established that dissolution is not permitted pursuant to the statute unless (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.

Indeed, judicial dissolution–an extreme remedy–must be granted sparingly.

[A] court will not dissolve an LLC merely because the LLC has not experienced a smooth glide to profitability or because events have not turned out exactly as the LLC’ s owners originally envisioned; such events are, of course, common in the risk-laden process of birthing new entities in the hope that they will become mature, profitable ventures. In part because a hairtrigger dissolution standard would ignore this market reality and thwart the expectations of reasonable investors that entities will not be judicially terminated simply because of some market turbulence, dissolution is reserved for situations in which the LLC’s management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business, such as in the case of a voting deadlock or where the defined purpose of the entity has become impossible to fulfill.

Even in the case of deadlock, dissolution is prohibited if the operating agreement provides a mechanism for resolving that deadlock.

There is no deadlock here. Even if plaintiff were still on the board, she would simply be outnumbered. Her alleged wrongful removal from the board did not fundamentally alter the governance of the Company as dictated by the Operating Agreement. To the extent plaintiff had an urgent desire to resume influencing the Company’s direction, she could have sought a preliminary injunction on her wrongful-removal claim. That she has not done so in the more than a year since her removal not only speaks volumes about the practical effect of her removal, but also shows that the Company is capable of fulfilling its stated purpose without her. After all, dissolution is a remedy of last resort. Wrongful removal should result in restoration of her position on the board, not dissolution of the LLC.

There is also no basis pleaded in the SAC to compel dissolution because continuation of Mile High is financially unfeasible. Plaintiff alleged in the SAC–more than a year ago–that the Company was about to financially implode. She was wrong. Plaintiff does not dispute that the Company continues to own and operate indoor treadmill studios and has opened a third studio during the pendency of this litigation. While the Company may well have long term financial concerns, plaintiff has not plausibly alleged that continuation of the business is truly financially unfeasible. Plaintiffs contention that the Company is insolvent under any definition of that term does not save her claim. Many newer companies will have a debt load far in excess of its assets. Indeed, it is not uncommon for businesses to survive long periods of unprofitability with the long-term goal of gaining significant market share, developing valuable technology or potential synergies with other companies to make it an attractive acquisition target. Selling the Company has, in fact, been a major focus for the last few years. It is not for the court to force closure of newer businesses simply because its principals don’t agree particularly, where, as here, there is an operating agreement that governs. So long as the Company appears to be able to run its business and there is no indication that rent, invoices, and salaries are systematically unpaid, the court will not shut it down.

Dissolution may well be required if the Company’s financial situation significantly worsens in the future. As pleaded in the SAC, however, this is simply a classic case where the Company has not experienced a smooth glide to profitability and where events have not turned out exactly as plaintiff originally envisioned. If the Company is truly worthless, the only real utility of dissolution for plaintiff is recoupment of her IP. While she indisputably has that bargained-for right, it is expressly conditioned on meeting the requirements of § 702. That she may well have been treated inequitably by the Co-Founding Members is no basis to loosen the standards of § 702.

(Internal quotations and citations omitted).

This decision relates to a significant part of our practice: business divorce (a break-up between the owners of a closely-held business). Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding a business divorce.

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