Court Enjoins Dilution of Membership Interest Despite Past Practice

On August 25, 2021, in Lengyel-Fushimi v. Bellis, et al., Kings Supt. Ct. Index No. 512764/2021, Justice Ruchelsman denied leave to reargue its prior decision granting plaintiff a preliminary injunction enjoining the other members from diluting his membership interest by majority vote where the operating agreement required unanimous approval regardless of past practice, explaining:

As noted, Article 10.1 of the operating agreement states that the agreement “shall not be modified or amended in any respect except by a written instrument executed by all of the Members” (id). That provision necessarily and clearly requires a unanimous consent to amend the agreement. That provision is not an “odd-duck of a clause” (citation omitted) that should be ignored because it is inconvenient to the parties or because it was not honored by the corporation in the past. The fact the parties conducted their business without adherence to that clause and calls into question the behavior of the parties and the tax consequences that may flow from such behavior, does not mean the court should likewise ignore the clause. The clause is not confusing or complicated or indecipherable nor is it contradicted by any other provision in the operating agreement. The defendants argue that adopting this interpretation “causes serious harm as the LLC has to refund the investments of these non-members it has held for years, likely with interest, or face litigation as a result of the failure to take these actions. The Court surely did not intend these outcomes and must reconsider its Decision, since 10.1 destroys the company while a modification to it allowing for a vote maintains the status quo and allows the LLC to continue in operation” (citation omitted). While the court is sympathetic to the parties’ plight, which they caused themselves, they fail to explain how a modification of that clause, allowing a vote without unanimity, is even possible.

The Court further rejected defendants' argument that because the operating agreement allows them to remove plaintiff as an officer of the company by majority vote they could also reclassify him as a non-managing member by majority vote. The Court held that diluting plaintiff's ownership interest requires an amendment to the agreement which could only be done by unanimous approval.

The attorneys at Schlam Stone & Dolan LLP frequently advise on how to seek or defend against injunctive relief in business divorce cases. Contact the Commercial Division Blog Committee at commercialdivisionblog@schlamstone.com if you or a client have questions concerning a business divorce matter or drafting an operating agreement.