Want To Ditch Your Business Partner In Your LLC? It’s Not Always So Easy…4 Tips for Gaining Your Freedom — PODCAST!
September 2, 2013
TRANSCRIPT
Host = H
Michelle Maratto = M
Michelle Maratto = M
The material in purple is extra text that compliments the transcript of the podcast and provides more detailed information.
Host: Welcome to the Itkowitz PLLC Podcast Network in New York City. I’m your host, Tahlia Michelle. Today I am speaking with Itkowitz PLLC partner, Michelle Maratto, about Limited Liability Companies that own real estate, and what happens when one partner wants to break up the LLC and sell the property, and when another doesn’t. Hi, Michelle.
Michelle: Hi Tahlia.
H: OK, first give us some perspective, Michelle. Why are we even talking about this? I know that it is a frequent thing that people own real estate in Limited Liability Companies, but it a frequent thing that people want to break them up?
M: Well, Tahlia, we all make mistakes. Sometimes we hook up with people in business because it seems like a good idea at the time. Sometimes we have a need that we can’t figure out how to fill and we think that a certain person solves our problems for us. Maybe they have some money or some expertise. Maybe you are friends or relatives. Maybe you were at a stage where you lacked the confidence to try a new venture on your own.
Then time goes by. And you find out that going into business with that person was one of the worst mistakes that you ever made. Your partner is – fill in the blank: lazy, incompetent, dishonest. Maybe he marries someone you hate who interferes. Or maybe you just have different visions.
You want to break up the LLC, sell the property, divide up everything and move on. But true to your diverging ideas about the future, your partner wants to keep things the way they are.
H: So what’s the problem? Why can’t you just sue to partition the property?
M: If real property is owned by an LLC, a plaintiff cannot maintain a cause of action for partition in his individual capacity.
So if you can’t force partition, you need to next look at unraveling the LLC.
H: If you don’t want an LLC that you are a member of to exist anymore, can’t you just force a break up?
M: A lot of times the answer is — No — Not if your LLC partner doesn’t agree.
H: Why?
M: First, let’s talk about people who created an LLC, bought a building with it, started doing business under it, and just never bothered to make an operating agreement.
H: What’s an operating agreement?
M: An “operating agreement” is any written agreement of the members of an LLC concerning the business of an LLC and the conduct of its affairs.
H: Why wouldn’t the members of an LLC have one of those? That sounds good to me.
M: They didn’t think they needed one. They were relatives, spouses, friends. Or they thought they needed one but never got around to it.
H: So why do you need an operating agreement to dissolve an LLC?
M: Without an operating agreement that gives you a way out, you can’t break up an LLC if your LLC partners do not agree to, UNLESS – the court finds that it is not reasonably practicable to carry on the business.
And courts take that standard very seriously. So even if the partners hate each other and are torturing each other on a person level, if a business is still being carried on, the court will not force dissolution of an LLC.
Limited Liability Company Law § 701 states that:
On application by or for a member, the Supreme Court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.
The problem here is the lack of an operating agreement to provide some guidance on the standard for forcing dissolution. Thus we are at the mercy of the statute, as interpreted by case law.
Troubling and particularly instructive is Horning v. Horning Const., LLC, 12 Misc.3d 402 (Supreme Court, Monroe County, 2006). In this case a guy named Horning originally formed Horning Construction Company, Inc., in 1984. The company grew. In 2001 Horning took on two partners, employees of his company, to deal with his heavy work load. The oral agreement between the three was that the two new partners would take over some of the day-to-day responsibilities of the business in return for a one-third interest each in the LLC. There was never an operating agreement.
Horning alleged that the partners never assumed their anticipated duties to relieve him of his workload, but they did realize substantial financial gain because Horning nevertheless treated them as partners. The relationship between the three people deteriorated. Horning claimed that the company was unable to do business anymore because things between them were so bad. The partners opposed Horning’s petition to dissolve the LLC.
It would be almost funny, if it were not so sad, but the court in Horning noted that:
“At bottom, [Horning] requests dissolution on the ground that [his partner] despises him, [his other partner] resents him, neither of them trust [him], and that it is [their] intention to defeat an involuntary dissolution and make Horning’s remaining time with Horning, LLC so unbearable that he will relent and give him for a pittance the remainder of the company for which they have paid nothing to date.”
The court in Horning ultimately held that dissolution in the absence of an operating agreement can only be had upon satisfaction of the standard of § 702, i.e., “whenever it is not reasonably practicable to carry on the business.”
H: How can a court find that it is practice to carry on a business if the partners are torturing each other?
M: If the business is paying its employees, paying its debts, completing the work it undertook, if it’s a development project and the building is getting built, then the court doesn’t care if the partners are personally unhappy. In other words, LLC members are often left at one another’s mercy.
The partners in Horning pointed out that the LLC continued to employ more than 40 people, that it was meeting all of its financial obligations, and that it was fully solvent. The partners contended that there was no reason to believe that the LLC could no longer function. The partners asserted that the company was not deadlocked, that it was simply run by a majority rule, and that under the circumstances, it was unnecessary and unjust to dissolve the LLC which would place in jeopardy the livelihood of the 40 employees, and that there was no impediment to the LLC s continuation because all bids only required the approval of two of the members.
H: That’s a harsh result.
M: Dissolution of an LLC has been purposefully made more difficult than dissolution under the Business Corporations Law. Also, there is no buy out provision built into the statute. Thus, a member of an LLC without an operating agreement has no right to withdraw and no right to receive fair value for his or her interest.
Here’s a solid real estate example – a development project.
Dissolution was similarly denied in In re 1545 Ocean Ave., LLC, 72 A.D.3d 121 (2nd Dept. 2010). There the appellate court held that dissolution of an LLC was not warranted, though managers disagreed about construction work performed on the LLC property and the hiring of a construction business to perform the work, and they did not hold regular meetings or achieve quorums. The court found that the operating agreement did not require regular meetings or quorums, managers communicated with each other on a regular basis, and disputes between managers was not inimitable to development of the property, which was the purpose of the LLC. The court ratified this language from another case:
“The 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 hair-trigger 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.”
And don’t forget that even if you have an operating agreement, it might not speak to forced dissolution of any kind.
H: I need some solutions here, now Michelle! So what do you, as a litigator who sees these problems every day, suggest.
M: These situations are often complex, and very fact specific, and every situation is different – but I can tell you some of the solutions that I have come up with in these situations.
H: Go for it.
M: The person who wants to get out may very well have other leverage points. For example, in one case my guy who was being held captive was the only guy developing and managing the property over the years. So we sued his LLC partners, for the value of his management services for several years. That got their attention.
H: Interesting.
M: Another idea would be to simply file the lawsuit for dissolution and go in as prepared as possible to make a case that the purposes of the LLC have been frustrated. If employees and debts are being paid, and if a building’s development is proceeding, the court is unlikely to find in your favor. But maybe things are not going well. Maybe there isn’t enough money to meet the LLC’s obligations. Again, every situation is different, your lawyer has to take a really good long hard look at the facts in these cases, and you, as the client have to be cooperative with that.
H: So difficult, doesn’t mean impossible?
M: Right. And the lawsuit might not be a sure winner, but the fact of it might create a pressure all its own.
Of course, a totally different option is, not to pay the lawyers anything for a fight, but to pay your enemy for certainty. Buy your partners out if possible.
H: Money makes the world go round.
M: Then again, sometimes you need to take a step back and think. The lack of an operating agreement and an exit pathway is certainly a bad thing, but with every downside comes an upside. There is nothing in the agreement, because there is no agreement, which says that you can’t market your share of the LLC to someone else. Maybe someone who speculates in these kinds of things, maybe someone who your partners wouldn’t have nearly as much fun pushing around.
H: Wow, those are some great ideas, and all very different. How do you know what to advise a client in these situations, Michelle?
M: In my firm we have a unique way of practicing law, a protocol called Legal Project Management. Long story short, after carefully ascertaining the client’s real goals, we do a great deal of upfront analysis – of both the facts and the law. Then we give the client a clear written outline of their options, and for each option we present the pros, the cons, the costs, the time frame, the risks, and the options likelihood of advancing the client’s goals. Together, we figure out the right approach.
H: Well, Michelle, thank you so much for this information. I look forward to speaking with you in the future.
M: My pleasure. Thank you.
H: A transcript of today’s podcast is available on Itkowitz.com, right there on the teaching and publishing blog, just search for “Limited Liability Company” and it will pop right up with some other good stuff as well! Thanks for listening.
