“It all started when the distributions stopped.”  In my travels as a business divorce litigator, I’ve seen many disputes between LLC co-owners that begin with that message.  A minority owner is content to remain a “silent partner”—letting the majority run the business—for as long as the checks keep coming.  Once the distributions stop, the minority partner begins to distrust, investigate, and second-guess, and the embryo of a business divorce takes shape.

But unless they find evidence of the majority’s self-dealing or other affirmative misconduct, minority owners seeking to restart a dried-up distribution tap find themselves at the bottom of a very steep climb.  Absent some provision in the operating agreement saying otherwise, the decision to distribute profits lies in the discretion of those in control.  That reality can lead to frustration and financial strain, particularly when the minority owner relies on the distributions as a return on their investment.

So, under what circumstances can a minority LLC owner compel the majority to issue distributions?  That question, and a recent decision from New York County Justice Reed, Schneider v Pine Mgt., Inc., 2024 NY Slip Op 51030(U) [NY County Aug. 8, 2024], inspires today’s discussion. 

Schneider vs. Pine Management

The dispute in Schneider centers on ten New York limited liability companies, which in turn own twelve different residential income-producing properties in the New York City area.  Acquired in the 1950s by Jerome Schneider and Harold Pine, the LLCs are now owned by various descendants of each patriarch. 

In 1979, Schneider moved to Paris, leaving Pine to manage the properties on his own.  When he did so, Schneider and Pine agreed that Pine would be paid a management fee for his stewardship of the properties.

Over time, the composition of the properties (and the manager) shifted.  Membership in the LLCs passed from the patriarchs to their descendants; for our purposes, it’s safe to assume that the LLCs are now owned 50% by members of the Schneider family and 50% by members of the Pine family, and each faction is united against the other.  And the Pines formalized their property management business.  They formed “Pine Management, Inc.” which managed the properties and other income producing properties in the Pine portfolio. 

All of the LLCs adopted operating agreements specifying that they were member-managed LLCs, but which also authorized the three Pine Management shareholders to “act as authorized persons on behalf of the Company.”  Later, eight of the ten LLCs—no one is quite sure why two were left behind—adopted new operating agreements stating that “Pine Management Inc. may be paid for services rendered in its role as property manager pursuant to a separate agreement with the Company.”

The Distribution Dispute

According to the Schneiders, beginning around 2010, the Pines—acting through Pine Management—“dramatically altered the LLCs’ operations: Pine slashed distributions to the LLCs’ members, instead using the LLCs’ money to fund over $12 million in construction and to hoard ‘cash reserves’ for no specific reason.”

The Pines responded that its “cash reserves” system was prudent management.  Substantial cash reserves allowed the LLCs to renovate rent stabilized units as soon as they become vacant, which renovations deregulate the units and ultimately increase the revenue that the properties can produce.  And maintenance of the century-old buildings is expensive: substantial cash reserves alleviate the LLCs’ need to finance (or make capital calls for) major repairs or improvements.

Schneiders’ Claims, Motion for Summary Judgment

The dispute about Pine’s alleged cash hoarding boiled over in 2019 when the Schneiders filed a 427-paragraph complaint against the Pines alleging all sorts of mismanagement, self-dealing, breaches of fiduciary duty, and breaches of the LLCs’ operating agreements.  While the claims originally asserted were varied and many, at least one of the Schneiders quickly acknowledged that the “linchpin of the litigation” was “absolutely” the Pines’ decision to withhold or dramatically decrease distributions from the LLCs.

Following discovery, the Schneiders moved for summary judgment on two of their theories.  First, they sought disgorgement of the management fee that the LLCs paid to Pine Management.  Although the LLCs’ operating agreements allowed Pine Management to be paid a fee “pursuant to a separate agreement,” said the Schneiders, no such “separate agreement” existed.  Second, the Schneiders argued that as to the two LLCs without amended operating agreements, Pine’s management of those Companies to their exclusion ran afoul of their operating agreements’ requirement that “the business and affairs of the Company shall be managed by the members.”

The Pines’ opposition dismissed the motion as a “leverage play to rewrite the Companies’ operating agreements and compel Pine . . . to make distributions to Members against Pine’s business judgment.”  The Pines insisted that—separate agreement or not—the 75-year history of Pines’ managing the properties for a fee is proof positive of an implied-in-fact contract between the LLCs and Pine Management.  And, the Pines argued, Pine Management’s status as an “authorized person” allowed it to make decisions concerning distributions and management of the LLCs without input from the Schneiders.    

The Ruling

New York County Justice Robert Reed denied the Schneiders’ motion for summary judgment.  Justice Reed found that an “implied in fact” contract exists between Pine Management and the LLCs covering Pine Management’s retention of a management fee.  Nobody thought Pine Management was working for free; the Court found that Plaintiffs for years had received financial statements showing payment of the management fee, and that “silent acquiesce” in the face of those statements was critical evidence of an agreement for payment of the management fee to Pine Management.

As to the Schneiders’ bid to be restored to management roles, the Court held that the LLCs’ operating agreement designated Pine Management as an “authorized person” under LLC law 102(c), and that Plaintiffs failed to demonstrate that Pine Management’s actions with respect to distributions was outside of the authority given to it as such. 

Distributions and the Business Judgment Rule

Despite the “linchpin of the litigation” being the allegedly withheld distributions, Plaintiffs’ motion and the Court’s decision in Schneider v Pine say very little about whether and when a minority owner of an LLC can compel those in control to make distributions.  And that silence says everything about how difficult if not impossible it can be. 

New York caselaw is of course rife with cases finding that an LLC manager breached his or her fiduciary duties by making distributions to one member and not another. 

But in cases of equal treatment—the manager deciding against distributions to any member—the courts generally defer to the business judgment of the manager (see, e.g., Simon v Moskowitz, 193 AD3d 520 [1st Dept 2021] [discussed in this post]; Estate of Alexander Calderwood v Ace Group Intern. LLC, 2016 NY Slip Op. 30591[U], 12 [NY County 2016] [“Failure to make distributions . . . is a business judgment of management and, in and of itself, insufficient to allege a breach of fiduciary duty.”]; In re O’Neil v Axon [NY County 2013] [“Thus the alleged failure to make distributions . . . cannot support the claim for breach of fiduciary duty.”]; Zuckerbrod v 355 Co. LLC, 2011 NY Slip Op. 34199[U] [Nassau County 2011] [dismissing action because the decision to withhold distributions was “appropriate under the Business Judgment Rule, and there is no admissible evidence to the contrary.”]).   

In some circumstances, litigants can avoid application of the deferential business judgment standard by offering evidence to show that the decision-maker was self-interested or stood to profit personally at the expense of the LLC.  In the case of a failure to make distributions, however, those facts are hard to come by, since the only real consequence of the failure is increased cash for the LLC. 

There also seems to be some recent confusion as to whether a claim for withheld distributions is direct or derivative.  While I see it as a direct claim—it is difficult to imagine an injury to the LLC arising from accumulation of cash via nonpayment of distributions—at least one Court has held that “The decision to pay distributions . . . make[s] out a claim of a derivative nature which belongs to the corporation” (see Mandour v Rafalsky, 2024 NY Slip Op. 31086[U], at 15 [NY County 2024]).

Against that legal backdrop, I can only assume that rather than put themselves up against the deferential business judgment standard, the Schneiders chose to collaterally attack the Pines on issues not directly related to the withheld distributions. 

Other Angles to Compel Distributions

Up against the deferential business judgment rule, a minority owner seeking to restart the distribution tap might consider other well-worn business divorce theories:

Shareholder oppression.  Unlike minority members of a New York LLC, minority shareholders of a closely held New York corporation may have a cause of action for dissolution based on “shareholder oppression” (BCL 1104-a).  And Courts have defined “oppressive conduct” as “majority conduct [that] substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decision to join the venture.”  With that definition in mind, it’s relatively easy to imagine a circumstance where the majority’s failure to make distributions/dividends defeats the “reasonable expectations” of the minority shareholder (yet another reason as a minority interest owner to prefer the corporation over the LLC).

Implied covenant of good faith and fair dealing.  Where a member-managed LLC’s operating agreement is completely silent on the issue of distributions, consider whether that silence leaves room for a claim of breach of the implied covenant of good faith and fair dealing based on the majority’s failure to approve distributions.  As far as I can tell, the Schneiders still have a live (very general) claim for breach of the LLCs’ operating agreements; perhaps they will try that route at trial.

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