LLC Member Costs in Defending Dissolution Proceeding Not Payable With LLC Funds

On March 23, 2016, the Second Department issued three decisions in Matter of Kassab v Kasab: 2016 NY Slip Op. 02089, 02090 and 02091, discussing LLC dissolution, including whether an LLC member can use LLC funds to defend a dissolution action.

In 2016 NY Slip Op. 02089 and 02090, the Second Department affirmed the dismissal of certain claims relating to a dispute between LLC members. In 2016 NY Slip Op. 02089, the Second Department held:

[T]he petitioner failed to state a cause of action for judicial dissolution of the LLC pursuant to Limited Liability Company Law § 702 based on his allegations of oppressive conduct and the respondent's efforts to exclude him from the management of the LLC. The petitioner's allegations, if true, would not establish that 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 that continuing the entity is financially unfeasible.

(Internal quotations and citations omitted) (emphasis added). Similarly, in 2016 NY Slip Op. 02090, the Second Department held that the petitioner could not seek an equitable buyout or obtain rescission of the LLC's operating agreement, explaining:

[T]he petitioner failed to state a cause of action for an "equitable buyout" of his interest in the LLC. While the Limited Liability Company Law does not expressly authorize a buyout in a dissolution proceeding, in certain circumstances, a buyout may be an appropriate equitable remedy upon the dissolution of an LLC. Here, since this Court has determined, in a companion appeal, that the petitioner failed to state a cause of action for the judicial dissolution of the LLC pursuant to Limited Liability Company Law § 702, there is no basis to invoke the equitable remedy of a buyout. . . . .

Additionally, the Supreme Court properly determined that the petitioner failed to state a cause of action for rescission of the LLC's operating agreement. As a general rule, rescission of a contract is permitted for such a breach as substantially defeats its purpose. It is not permitted for a slight, casual, or technical breach, but only for such as are material and willful, or, if not willful, so substantial and fundamental as to strongly tend to defeat the object of the parties in making the contract. Here, the petitioner failed to allege facts which, if true, would show that the respondent's alleged breach of the operating agreement substantially defeated the purpose of the agreement.

(Internal quotations and citations omitted).

However, in 2016 NY Slip Op. 02091, the Second Department affirmed the judgment of contempt against the respondent for using LLC funds to pay for his defense of the dissolution, explaining:

Here, the petitioner established, by clear and convincing evidence, that the respondent disobeyed a lawful order of the Supreme Court, clearly expressing an unequivocal mandate, with knowledge of its terms, by using funds belonging to [the LLC] to pay his legal fees in this hybrid proceeding and action, and that the petitioner was prejudiced by the offending conduct. Further, contrary to the appellants' contention, legal fees incurred by a shareholder in defending a dissolution proceeding are not payable with corporate funds as expenses incurred in the ordinary course of business.

(Internal quotations and citations omitted).

NOTE: Schlam Stone & Dolan is counsel for petitioner in this proceeding.