Thursday, February 9, 2012

New York Court Addresses “Not Reasonably Practicable" Standard for LLC Dissolution

New York Court Addresses “Not Reasonably Practicable”
Standard for LLC Judicial Dissolution

      Under Kentucky law, an LLC may be judicially dissolved upon a showing that it is not reasonably practicable to operate the LLC in accordance with its operating agreement. KRS § 275.290(i). This standard was adopted from Section 902 of the Prototype LLC Act, the primary model for the original Kentucky Act. To date no Kentucky court, in a published decision, has interpreted this language. However, a recent decision of the New York Supreme Court (the trial court under the New York system) provides useful guidance both as to the interpretation of this language as well as addressing perceived inequities in dissolution. Mizrahi v. Cohen, 2012 WL 104775 (N.Y. Sup. Ct. Jan. 12, 2012).

       Mizrahi and Cohen were equal owners in an LLC that owned a commercial office building. A portion of the building was leased to Cohen's professional practice, while another floor was rented to Mizrahi’s professional practice. The LLC was never able to satisfy its obligations from cash flow, and from the first year of operations additional capital was required from the members in order to keep the LLC current on its obligations. Initially Mizrahi and Cohen contributed equally, but after some period of time Cohen failed to keep up, and Mizrahi made disproportionate contributions. Ultimately, Mizrahi contributed some $900,000 to the LLC more than had Cohen. Ultimately, Mizrahi sued for judicial dissolution of the LLC.

       As to the standard to be employed in interpreting the “not reasonably practicable” threshold, in reliance upon In Re 1545 Ocean Ave., LLC, 893 N.Y.S. 2d 590 (N.Y. 2010), the Mizrahi court found that dissolution would be appropriate upon the petitioner’s demonstration that:

In the context of the terms of the operating agreement or articles of incorporation [sic-organization], 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.
      In light of the LLC’s inability to support its operations from its own income, Cohen’s failure to contribute towards the satisfaction of those obligations and the acknowledgement that the LLC would entirely fail should Mizrahi cease making capital contributions, the Court determined that the operation of the LLC was not financially feasible. 2012 WL 104775, *8.

      Having determined that the LLC would be dissolved, the court turned to the mechanisms to be employed. The operating agreement at issue provided that upon liquidation and after satisfaction of creditor liabilities, the remaining assets would be distributed 50% to each member. The operating agreement did not require, as an intermediate step, the return of contributed capital to each of the members. The dissolution had been sought, at least partially, based upon the fact that Mizrahi had contributed $900,000 more to the LLC than had Cohen. Applying the operating agreement as written, Cohen would have received a windfall. For that reason, the court recharacterized Mizrahi’s additional $900,000 not as a capital contribution but rather as a loan to be satisfied before net assets were distributed amongst the members in accordance with the agreed 50%/50% sharing ratios.

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