LAW: Has the Time Come for New York to Follow Delaware and Officially Pronounce Deadlock as Ground for LLC Dissolution?

LAW: Has the Time Come for New York to Follow Delaware and Officially Pronounce Deadlock as Ground for LLC Dissolution?

Since its legislative birthing in New York in 1994, the limited liability company has become the preferred choice of entity New York and across the country. Over the ensuing 15 years or so, New York’s lower courts struggled to arrive at a consistent interpretation of LLC Law § 702’s enigmatic provision, patterned on that found in New York’s Revised Limited Partnership Act, authoring judicial dissolution of LLCs “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.”

As I wrote in a NYSBA Journal article many years ago, in those early days, with no meaningful appellate guidance, some courts explicitly or implicitly treated LLCs as business corporations subject to the same judicial dissolution standards and remedies specified in Business Corporation Law Article 11.

A uniform standard under § 702 didn’t appear until 2010, when the Appellate Division, Second Department, issued its landmark decision authored by former Associate Justice Leonard B. Austin in Matter of 1545 Ocean Avenue, LLC.

In the court’s lengthy opinion, Justice Austin articulated a contract-centric approach under which a § 702 petitioner must establish, “in the context of the terms of the operating agreement or articles of incorporation, 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.”

1545 Ocean Avenue involved an LLC owned by two 50/50 co-managing members. The petitioner claimed managerial deadlock between the two owner-managers as the sole basis for dissolution, deadlock being a long-recognized basis, statutorily ensconced in Business Corporation Law § 1104, for involuntary dissolution of closely held corporations owned by dissension-riddled 50/50 shareholders.

In dismissing the deadlock-based petition, Justice Austin’s opinion, as he put it, refused to “import dissolution grounds from the Business Corporation Law” into the LLC Law. As he further explained:

“Deadlock” is a basis, in and of itself, for judicial dissolution under Business Corporation Law § 1104. However, no such independent ground for dissolution is available under Limited Liability Company Law § 702. Instead, the court must consider the managers’ disagreement in light of the operating agreement and the continued ability of 1545 LLC to function in that context.

There have been a number of lower court decisions since 1545 Ocean Avenue in 50/50 LLC dissolution cases echoing Justice Austin’s analytic framework, rejecting deadlock as an “independent ground for dissolution.” Examples featured on this blog include the decision by Justice Saliann Scarpulla (then a Manhattan Commercial Division judge, later elevated to the appellate bench) in Advanced 23, LLC v Chamber House Partners, LLC and retired Justice Charles Ramos’s decision in Goldstein v Pikus. In both those cases, the courts were willing to consider non-cooperation between co-equal managers only insofar as it impacted the LLC’s ability to function in the context of the operating agreement and its stated purpose.

Too Cramped a Reading of Section 702?

The above question came to mind as I was reading last week’s interesting letter opinion in In re: Dissolution of T&S Hardwoods KD, LLCyet another in a very long line of Delaware Chancery Court rulings in judicial dissolution cases involving Delaware LLCs co-managed by 50/50 members. In all those cases, going back as least as far as former Vice Chancellor (and later Chancellor) Strine’s 2004 opinion in Haley v Talcottthe Chancery Court has expressly incorporated by analogy into its construction of § 18-802 of the Delaware LLC Act, authorizing judicial dissolution of LLCs, the doctrine of corporate deadlock established for 50/50 close corporations under Delaware General Corporation Law § 273.

Five years after Haleyin another 50/50 LLC dissolution case named In re: Arrow Investment Advisors, LLCVice Chancellor Strine clearly identified deadlock as a basis for judicial dissolution when he wrote, “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.”

My above references to Delaware LLC Act § 18-802 and Arrow Investor carry an ironic element central to the question I raise in this post about New York’s conceptually narrower approach to deadlock and LLC dissolution. New York’s LLC Law § 702 is an almost exact replica of Delaware’s LLC Act § 802, neither of which mentions the word deadlock. Justice Austin in his 1545 Ocean Avenue opinion not only cited Arrow Investor as a mainstay of his analysis of § 702, he quoted from it at length, including the above-quoted passage specifically identifying “voting deadlock” as adequate cause for judicial dissolution.

In short, there is neither any material difference in the text of Delaware’s and New York’s LLC dissolution statutes, nor any less powerful an analogy to their respective corporation law cousins governing shareholder deadlock, that logically explains why, on the one hand, Delaware jurisprudence explicitly recognizes deadlock as ground for judicial dissolution of LLCs while, on the other hand, New York jurisprudence declares deadlock as not an “independent ground” for LLC dissolution.

Semantics or Substance?

Is it possible the difference in jurisprudential approaches of Delaware and New York is merely a matter of semantics, with no practical effect in real-life cases?

Certainly there are cases when a deadlock over major decisions threatens the ability of the firm to continue achieving its purpose, e.g., deadlock over renewing a critical line of credit requiring personal guarantees or relocating the business as its office lease approaches an expiration date. The failed-purpose prong of 1545 Ocean Avenue‘s formulation of the § 702 standard, rejecting deadlock as an independent basis for dissolution, nonetheless would accommodate such deadlock-based fact patterns.

But I have also seen and can imagine many circumstances where arguably the two approaches could lead to different outcomes. Here I’m thinking mainly (but not exclusively) of cases involving 50/50 commercial realty holding LLCs which continue to operate the property, collect rent, pay bills, and remain financially feasible while the two owners engage in serious personal hostility and clash over management, maintenance, finance, distributions, and long-term objectives including holding or selling the realty.

Nothing I’ve said above is to suggest that New York courts should jettison the contract-centric approach which undergirds both Delaware’s and New York’s approach to judicial dissolution of LLCs. The operating agreement should always reign supreme. But in so many instances involving two-member, 50/50 LLCs, we see companies with no operating agreement or with poorly crafted operating agreements that lack any deadlock-breaking mechanism. It’s in those cases where the equitable powers of New York courts in dissolution cases arguably are hobbled by 1545 Ocean Avenue‘s restrictive reading of deadlock.

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