Count ’em: At the time A sued B for judicial dissolution of one of their several jointly owned companies, there are not one, not two, not three, but eight pending lawsuits between the two 50/50 business partners who first teamed up over 20 years ago.
I would guess most people hearing that would think a judge hearing the dissolution case wouldn’t hesitate to grant the petition and appoint a receiver to wind down and liquidate the business. I also would guess a great many lawyers hearing that would think the same, reasoning that a practical-minded judge would find no good reason to perpetuate a badly fractured relationship between two deadlocked, hostile, highly litigious business owners who no longer communicate except through their lawyers.
As evidenced by Manhattan Commercial Division Justice Andrew Borrok’s ruling last month in Matter of Ruham dismissing a petition for judicial dissolution, those guesses would be wrong if the entity is a functioning, viable, single-asset real estate holding company organized as a New York LLC governed by boilerplate articles of organization and without a written operating agreement.
A Decades-Long Business Relationship Goes Kablooey
The antagonists in Ruham went into business together in the mid-1990’s. Their co-owned ventures include a high-end flooring business and restaurants. In 2000, they formed a company called Hoham 932 Grand Street LLC to purchase the property at that Brooklyn address, initially used for the flooring business and later for a restaurant.
The LLC’s sole governing document is its bare-bones Articles of Organization. As we often see in LLC disputes that land in court, the members never had an operating agreement. The boilerplate Articles give the LLC’s name, the county in which its office is located, provide for its perpetual existence, appoint the Secretary of State for service of process and, in what 24 years later became significant in Justice Borrok’s ruling, provide “[t]he limited liability company is to be managed by 1 or more members.”
The relationship appears to have soured by 2019 with the filing of the first three lawsuits between the members, followed over the next five years by another eight or so in New York and other states involving multiple companies including Hoham 932 Grand Street LLC.
The Dissolution Petition
The petition to judicially dissolve Hoham under Section 702 of the LLC Law filed in 2023 launches with a laundry list of his partner’s alleged misconduct “in connection with the various business enterprises” they were engaged in, leading to their falling out and multiple litigations. Turning to Hoham, the petition’s material allegations include:
- Petitioner and Respondent are “equal managing members of the LLC” of which the building is its sole asset.
- In 2015 the building was leased to a third-party commercial tenant under a net lease.
- Since 2020, Petitioner has received no income from the LLC and Respondent “has completely frozen Petitioner out of the operation of the LLC” by denying Petitioner access to the LLC’s books and records.
- Respondent “began treating the LLC funds as his own” by transferring funds out of the LLC’s security and operating accounts to accounts controlled solely by Respondent and “fully excluded Petitioner from the governance of the LLC.”
- Respondent commenced a nonpayment proceeding against the building’s tenant “without Petitioner’s knowledge or consent.”
The petition also alleges that it is “financially unfeasible to continue the LLC’s existence” due to the alleged diversion of rents and real estate tax arrears over $115,000 “which may lead to the foreclosure of the Building, the LLC’s sole asset and the ownership of which is the LLC’s sole purpose of existence.”
The Dismissal Motion
In support of its motion to dismiss the petition, the Respondent contended that:
- Respondent is the “sole managing member” of the LLC under the Articles’ provision stating that the LLC “is to be managed by 1 or more members.”
- Petitioner “walked away” from the LLC and “left the management of the LLC to [Respondent] focusing his time and efforts on his other companies instead.”
- Respondent protectively transferred LLC funds to accounts controlled by Respondent after Petitioner transferred $20,000 to himself.
- Petitioner “harassed” and “threatened” the tenant.
- Respondent commenced a nonpayment proceeding against the tenant after it stopped payment of rent and real estate taxes during the COVID lockdown.
- Respondent also filed suit against the co-guarantors of the lease.
- Since then the tenant has made some payments and there is a pending settlement with the tenant and guarantors that will pay all the unpaid taxes and most of the unpaid rent.
- The LLC is seeking a new tenant and Respondent is “optimistic that it will find one.”
Justice Borrok Dismisses the Petition
In his decision, while noting the plethora of lawsuits between the parties, Justice Borrok recites and characterizes the facts of the case as “relatively straightforward.” He then sets forth the standard for obtaining the “drastic remedy” of dissolution under Section 702 as quoted from the seminal 1545 Ocean Avenue case:
the petitioning member must establish, in the context of the terms of the operating agreement or articles of incorporation [sic], that (i) 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 (ii) that continuing the entity is financially unfeasible
Justice Borrok then finds that the petition does not satisfy either prong of the standard for dissolution.
First, Justice Borrok construes the Articles’ provision that the LLC “is to be managed by 1 or more members” as “not address[ing] which member would manage it” and “not requir[ing] majority vote to effectuate the purpose of the LLC.” In other words, even though he rejects Respondent’s reading of that same provision as making Respondent the sole managing member, by reading it to authorize any one member alone to make management decisions, as in the 1545 Ocean Avenue case, Justice Borrok finds “no risk of deadlock.”
Second, Justice Borrok concludes that the petition does not
set forth another statutory basis for dissolution — the dispute at present between the members is not inimicable to achieving the purpose of the LLC and there is no threatened foreclosure or other financial malady that threatens the viability of the LLC or its purpose.
“Thus,” Justice Borrok concludes, “to the extent the Petition seeks dissolution, an injunction, and a receiver in support of such dissolution, it must be denied and dismissed without prejudice.”
Not the End of the Story
In addition to dissolution, the petition also included a claim to compel Petitioner’s access to the LLC’s books and records. The decision notes that the Respondent did not dispute his refusal to provide access to the books and records and comments that, “[n]othing in the record establishes that either the Petitioner or the Respondent is the manager, and the Respondent cannot cherry-pick that which he shares with his 50% partner.” Justice Borrok accordingly decrees that the Respondent “must make the books and records available to the Petitioner.”
Of greater consequence in the long run, the decision makes explicit that the denial of Petitioner’s request for dissolution does not foreclose other forms of relief including a derivative action. Here’s what Justice Borrok wrote on that score:
[T]he facts of this case may present a cause of action sounding in breach of fiduciary duty of care and loyalty which may potentially be asserted in a derivative action based on the allegations that Respondent has failed to provide access to the books and records of the LLC, entry into transactions not in the best interests of the LLC and/or against the express interests of Petitioner, a 50% owner of the LLC, and alleged misappropriation of assets. Nothing in this Decision and Order should be read to prevent the viability of the assertion of such claim.
Petitioner wasted little time exploiting the judge’s observation. Less than two weeks later, the Petitioner filed a new complaint concerning the subject LLC based on essentially the same allegations in the dismissed dissolution petition, in which he asserts four derivative claims and six direct claims against the Respondent.
A Higher Hurdle for Dissolution of Realty-Holding LLCs
In cases of this sort, the takeaway that always screams out and that I preach with mind-numbing regularity is: don’t embark on any multi-investor venture to be organized as an LLC without first negotiating and entering into a forward-looking operating agreement that also addresses break-up scenarios. And don’t do it without the assistance of competent legal counsel!
That advice applies to any business organized as an LLC, but perhaps with even greater necessity when it comes to realty-holding LLCs.
Some nine years ago I wrote about an LLC dissolution case titled Goldstein v Pikus decided by former Manhattan Commercial Division Justice Charles Ramos which also involved a bitter dispute between two estranged co-managing members of a realty-holding LLC. As in Rahum, Justice Ramos dismissed the petition because there was insufficient evidence that the property’s management was dysfunctional or that financial failure was looming.
What I wrote then about the relatively high hurdle for gaining judicial dissolution of a functioning, financially viable realty-holding LLC, notwithstanding an overtly hostile relationship between co-managing members, is no less apropos of the Rahum case:
First, a petition asserting hostility-infused deadlock between co-managers of a New York LLC will be dismissed summarily absent allegations that the deadlock defeats the LLC’s purposes as defined in the operating agreement, or is causing the LLC to fail financially. Deadlock, per se, doesn’t cut it.
Second, single-asset real estate holding companies present a greater challenge for the dissolution petitioner alleging a dysfunctional relationship between co-managers. No matter the level of discord between co-managers, tenants must continue paying rent and the landlord must continue providing building services, maintenance and financial upkeep. In other words, compared to the operational mayhem and business impairment often caused by warring co-owners of a sales or service business, the realty firm’s purpose and finances tend to remain intact, making it harder to satisfy the dissolution standard for LLCs.
[View source.]
