Divorcing an LLC – or – Why an Operating Agreement can be Priceless
Divorcing from your business partners in a limited liability company can be just as nerve-racking, costly and life/business interrupting as divorcing your spouse. What is worse, if you failed to plan for an exit strategy in an operating agreement, you could be unsuccessful and be stuck with the LLC for good.
Peter Mahler, a partner at Farrel Fritz, published an article in the New York Law Journal which reports on business divorce cases in 2006. One of the cases mentioned in the article is Horning v. Horning Construction LLC.
Horning had a successful construction business, but felt overwhelmed by the workload. To ease his plight, he gave two of his employees, Klimowski and Holdsworth, a one-third interest each in a new company named Horning Construction, LLC. Then Horning contributed the construction business to the LLC. Even though the new LLC members tried to agree on the terms of an operating agreement, they never succeeded. Eventually, Horning offered to sell his part of the LLC to Klimowsky and Holdsworth for, what he thought was, a fair price.
Klimowsky and Holdsworth declined. Things got ugly and Horning wanted out, no matter what.
Horning went to court and demanded that the LLC be dissolved.
Klimowsky and Holdsworth objected and pointed out that the LLC continued to employ
more than 40 people, that it met all of its financial obligations, and that it was fully solvent. They claimed that it would be unnecessary and unjust to dissolve
the LLC which would place in jeopardy the livelihood of more than
Guess what……the court decided that the three of them have to make it work. No dissolution. Horning is stuck with two business partners who can overrule him on everything.
The court stated that dissolution of an LLC in the absence of an
operating agreement can only be had, if the standard
of Section 702 of the New York Limited Liability Company Law is met, i.e., "whenever it is not reasonably practicable to
carry on the business in conformity with the articles of organization or operating agreement."
The court decided that there weren’t sufficient facts to justify a dissolution of the LLC. In its reasoning, the court stated (emphasis added):
One certainly can sympathize with petitioner’s plight. In 2001, he had
a thriving corporation and wished to reduce his work schedule. Whether
for estate and gift tax reasons, or otherwise, he brought in two
trusted men and gave them each one-third ownership of a new venture set
up as a LLC. But he did this without prior or contemporaneous execution
of an operating agreement giving him fair exit rights in the event of
future disharmony. Moreover, during the next few years, despite having
failed to secure an operating agreement to protect him, he transferred
the business of his corporation to the LLC (something he did not have
to do if he was dissatisfied with the parties’ arrangements), and the
LLC grew substantially, even in relation to the corporation’s previous
level of business. Despite petitioner’s stated frustration with the
failure of the members to reach terms on an operating agreement, he was
happy to keep doing business through the LLC until he unsuccessfully
proposed a buyout to respondents in 2005, the company’s most successful
year. Only then did he seek dissolution.