In New York, Limited Liability Corporations (“LLC[s]”) are governed under the Limited Liability Company Law. LLCs have “perpetual existence” but may dissolve without judicial intervention as otherwise provided for in Limited Liability Company Law, §701. Nevertheless, upon the petition of a member, or someone acting on behalf of a member, a court may order a judicial dissolution of the LLC, but only “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement,” as prescribed in Limited Liability Company Law §702. (Emphasis added).

Nevertheless, even where dissolution is permitted, the Limited Liability Company Law, unlike the Business Corporation Law (BCL) and the Partnership Law (PL), does not explicitly prescribe how LLC assets consisting in real property are to be distributed.

This article discusses the judicial hurdles which must first be overcome to achieve an LLC dissolution and how New York courts, in such cases, have determined the rules for distribution of the LLC’s assets. We have found scant appellate case law on the subject; so attorneys need to note how appellate courts may continue to develop the law in this area.

The Dissolution Hurdle

As held in In re 1545 Ocean Ave., LLC, 72 AD3d 121, 131, 893 NYS2d 590 (2d Dept. 2010), the seminal New York decision construing Limited Liability Company Law §702, an LLC member seeking dissolution of an LLC must first 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.

The first step in conducting a judicial inquiry into the dissolution of an LLC is to conduct an initial contract-based analysis. The court must examine the LLC’s operating agreement to determine whether on the facts presented, it would be reasonably practicable for the LLC to carry on its business as set forth in the operating agreement. See 1545 Ocean Ave., supra, 72 AD3d at 128.

Unlike Business Corporation Law §1001 (which provides for dissolution upon either a majority or two-thirds vote of all outstanding shares) and Partnership Law §§60 and 63 (which respectively provide for dissolution “upon a change in the relation of the partners” or where “circumstances render a dissolution equitable,” Limited Liability Company Law 702 has been construed by New York Courts to preclude dissolution even where circumstances demonstrate that dissolution would otherwise serve the LLC members’ best interests. See. e.g., Matter of Horning v. Horning Const., LLC, 12 Misc 3d 402, 413, 816 NYS2d 877(Sup Ct., Monroe Co., 2006).

Absent an operating agreement, a court may hold a hearing where evidence is proffered in order for the court to ascertain the primary purpose of the LLC and whether the LLC remains able to conduct a financially viable business operation. See Matter of In re Eight of Swords, LLC, 96 AD3d 839, 840 (2d Dept. 2012).

The Arbitration Hurdle

Moreover, an LLC member, who is dissatisfied with decisions made by the managing member, can be frustrated in seeking dissolution where the LLC’s operating agreement mandates arbitration to settle all disputes between the LLC’s members. In such cases, the member seeking dissolution foregoes the right to seek judicial intervention. See Matter of Cusimano v. Berita Realty, LLC, 103 AD3d 720, 721 (2d Dept. 2013).

However, where the parties are deadlocked on how to operate the LLC, and even where an arbitrator issues an adverse ruling against the party seeking dissolution, the losing member may still seek judicial relief, where there are “allegations [of breach of fiduciary duty] from which damages attributable to [defendant’s conduct] might be reasonably inferred.” See Korangy v. Malone, 161 AD3d 645, 78 NYS3d 303 (1^st Dept. 2018).

Distribution of LLC Real Property Assets

Upon the grant of judicial dissolution under Limited Liability Company Law Section 702, the dissolved LLC must begin the process of winding up and file articles of dissolution under LLCL Section 705. See Matter of Spires v. Lighthouse Solutions, LLC, 4 Misc 3d 428, 438-39 (Sup Ct 2004). Following the grant of judicial dissolution, the court that issued the order must direct the winding up of the LLC’s affairs. See LLCL §703. The issuing court has discretion to decide whether the members of the LLC will conduct the winding up, or, if the court deems necessary, to appoint a receiver or liquidating trustee. Id.
Section 703(b) of the Limited Liability Company Law prescribes the following steps in conducting the winding up:

Upon dissolution of a limited liability company, the persons winding up the limited liability company’s affairs may, in the name of and for and on behalf of the limited liability company, prosecute and defend suits, whether civil, criminal or administrative, settle and close the limited liability company’s business, dispose of and convey the limited liability company’s property, discharge the limited liability company’s liabilities and distribute to the members any remaining assets of the limited liability company, all without affecting the liability of members including members participating in the winding up of the limited liability company’s affairs. (Emphasis added).

Following the winding up of an LLC, the liquidated assets must be distributed. Section 704 of the Limited Liability Company Law sets forth a specific “pecking order” in which the proceeds of the liquidated assets are to be distributed.

First, the proceeds of the liquidation must be used to satisfy any liabilities to creditors of the LLC.

Second, unless stated otherwise in the operating agreement, liabilities for distributions by member or former members are satisfied.

Finally, unless stated otherwise in the operating agreement, the members first receive the return of their capital contributions and secondly, whatever surplus is left, is distributed to the members proportionate to their membership interest.

However, the Limited Liability Company Law provides no statutory asset distribution mechanism for liquidation of the assets when dissolution of an LLC is permitted. Accordingly, where the judicial dissolution of an LLC is ordered, the court must “provide a mechanism for the liquidation and distribution of its assets[.]” Mizrahi v. Cohen, 38 Misc 3d 1213(A), 966 NYS2d 347 (Sup. Ct., Kings Co., 2013) (internal citations omitted).

Accordingly, courts have adopted various methods of liquidation to suit the facts and circumstances before them on a case by case basis.
In PFT Tech., LLC v. Wieser, 181 AD3d 836, 839 (2d Dept. 2020), the Court adopted a method it deemed “equitable,” holding that “Under the circumstances of this case, … the most equitable method of resolving the dispute among the principals of [the LLC] was to permit the majority members to buy out [the defendant’s] interest and to set the valuation date for that interest as…the day prior to the commencement of the action.”

Another method courts have employed during the winding up of an LLC is to order the public sale of real property. See In re 47^th Road LLC, 54 Misc.3d 1217(A), 54 NYS3d 610 (Sup. Ct., Queens Co., 2017), where the court authorized the receiver to take possession of the apartment building and pay all debts, liabilities and expenses after the sale of the apartment building.

Mizrah, supra, illustrates another way in which a court used its discretion to exercise and apply principals of equity. In Mizrahi, the two LLC members initially made equal capital contributions into the LLC. Eventually, the contributions made by the plaintiff began to and continued to greatly exceed the contributions of the defendant.

The trial court determined that the capital contributions of the plaintiff, which were in excess of those of the defendant, were to be treated as loans by the plaintiff to the LLC. The operating agreement of the LLC provided that a member did not have a right upon dissolution to receive repayment of capital contributions.

On appeal the Second Department affirmed the finding of the lower court, but held that the lower court should have granted the plaintiff’s request allowing him to purchase the defendant’s interest in the LLC upon the dissolution.

The trial court had originally devised a plan whereby the members would submit a bid to the appointed trustee for the property, giving credit to each bidder of the amount owed by the LLC to him in outstanding loans. If no bids were received by a specified date, the trustee was to report the need for a public auction sale of property to the court and advertise the auction.

The Second Department noted that, although the Limited Liability Company Law does not authorize a buyout in dissolution, nevertheless, under certain circumstances, as in Mizrahi, a buyout is an appropriate equitable remedy upon dissolution. See also Lyons v. Salamone, 32 AD3d 757, 758 (1st Dept. 2006), where the court found “that it is an equitable method of liquidation to allow either party to bid the fair market value of the other party’s interest in the business, with the receiver directed to accept the highest legitimate bid.”

Conclusion

In sum, following a judicial dissolution of an LLC, courts have discretion in directing the winding up of the LLC and may opt to employ the use of an equitable remedy such as the private sale amongst the members of the dissolved LLC. PFT Tech, Lyons, and Misrahi, supra. Courts may also opt to allow an appointed receiver or trustee to execute the sale via a public auction or sale at fair market value. 47^th Road, supra.

It is important, therefore, for attorneys to be familiar with all of the available ways in which courts are likely to order the winding up and distribution of an LLC’s real property assets upon dissolution.

In doing so, the attorney, whose client is most interested in either preserving an ownership interest in the LLC’s real property or in obtaining the maximum buyout recovery from the sale of the property, can plan how to best achieve the client’s objectives.

However, the more important lesson to be learned from this discussion is to be attentive to the “hurdle” issues noted above when drafting or negotiating LLC operating agreements.

1545 Ocean Ave., LLC, supra, makes it clear that the parties forming an LLC can avoid those “hurdles” when negotiating “the context of the terms of the operating agreement,” Id. In doing so, the parties can adopt terms similar to those prescribed in Business Corporation Law §1001 (which provides for dissolution upon either a majority or two-thirds vote of all outstanding shares) or in Partnership Law §§60 and 63 (which respectively provide for dissolution “upon a change in the relation of the partners” or where “circumstances render a dissolution equitable.”

Accordingly, whether or not the business of the LLC remains financially viable, or whether or not there is otherwise a “deadlock” between or among the LLC members, this need not preclude the dissolution and distribution of LLC assets; particularly the distribution ofthe LLC’s real estate assets.

In this way, where LLC assets consist of real property, the members of the LLC can adopt terms and conditions in their operating agreements which enable them, when irreconcilable differences emerge, to avoid mandatory arbitration, dissolve the LLC and, under RPAPL(1), partition ownership of the real estate. See Bailey and Desiderio, Rules on Partitioning Ownership Property Rights, New York Law Journal (April 16, 2022).

Attorneys on both sides of the negotiating table should want to seek the flexibility such terms would provide; because one cannot ever know, at the beginning of the business relationship, which of the parties will be most interested in having such flexibility available when the business relationship starts to sour and becomes intolerable.

Adam Leitman Bailey is the founding partner of Adam Leitman Bailey, P.C., and John M. Desiderio is partner and Chair of the firm’s Real Estate Litigation Group. Richard Trabosh, a second-year litigation extern attending the Maurice A. Deane School of Law at Hofstra University, assisted in the preparation of this article.