In Mizrahi v. Cohen, a dentist and an optometrist formed a limited liability company for the purpose of the construction and operation of a mixed-use building in which they intended to set up their respective offices. The two did not have an LLC agreement at the time they formed the LLC; it was executed a few months later when they purchased the land. The lender required an LLC agreement and the attorney who represented both members at the closing drafted an LLC agreement. The agreement provided, among other things, that:
- Each member owned a 50% membership interest in the company;
- After the initial capital contributions, the amount of which was not set forth, no member would be required to contribute additional capital, unless required by a vote of all members;
- No member had the right to receive any return of any capital contribution; and
- Upon dissolution, the LLC assets were to be distributed first to creditors of the company, and then to the members, in proportion of their respective ownership shares.
The two members contributed approximately the same amount toward the down payment and made approximately equal capital contributions to the LLC for about three years thereafter. At some point, however, their respective contributions started to differ. Over time, the dentist contributed approximately $1.4 million in capital to the company, while the optometrist contributed approximately $317,000. According to the accountant for the LLC, the LLC experienced net operating losses in each year and it would have failed without the use of proceeds of the mortgage loan and capital infusions by the dentist, which were used to cover its operating expenses. Not surprisingly, the dentist was not happy. He filed a suit, seeking judicial dissolution of the LLC and an order authorizing him to purchase the optometrist’s membership interest upon dissolution, among other things.
On appeal, the court determined that the trial court correctly ordered the judicial dissolution of the LLC on grounds that it was not reasonably practicable for the LLC to continue to operate under the circumstances, as it was financially unfeasible. As for the dentist’s excess capital contributions, the court found that the LLC agreement was silent as to the issue of equalization of capital contributions. And because the written agreement was ambiguous in this respect, the lower court considered an affidavit submitted by the optometrist, which showed that the excess contributions were to be treated as loans to the LLC. Thus, the court determined that the excess capital contributions were loans to the LLC that could be repaid upon the dissolution of the LLC, and the appeals court agreed. Finally, while New York law does not expressly authorize a buyout in a dissolution proceeding, the court said it might be an appropriate remedy in a situation like this.
Again, the two business partners here would have benefited from a more carefully drafted LLC agreement tailored to their specific needs, clearly setting forth their respective capital obligations and buyout provisions. The importance of a well-written operating agreement can never be emphasized too much.
This post was the fourth part of our multi-part series on business partnership, disagreement, and dissolution. You can find the other posts by searching our blogs at www.mcbrideattorneys.com. If you have any questions about the content of this blog or any business law issues not discussed here, please contact us.
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This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
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 Mizrahi v. Cohen, 961 N.Y.S.2d 538 (App. Div. 2nd Dept. 2013). Unless otherwise noted, all references to the case are to this citation.