New York Supreme Court Addresses LLC Agreement Interpretation, Indemnification and Dissolution

This case summary was prepared by Megan Gehret.

In Warner v. Heath, the New York Supreme Court addressed several issues of interpretation of an LLC’s operating agreement, as well as legal issues relating to its dissolution.  In October of 2012, Warner formed a New York limited liability company called Mile High Run Club, LLC (hereafter, “the Company”).  Warner and the Co-Founding Members – Mr. Heath, Ms. Tabet, Mr. Nuell and Mr. Robinson – made up the five member board.  On July 3, 2018, after a supermajority vote, Warner was removed as the CEO of the Company and replaced by Heath.  On December 21, 2018, Warner was notified that the Co-Founding Members voted to remove her from the board and that it would be determined whether her removal was “for Cause” at a later date.  After initiating litigation in Fall of 2018, Warner filed a second amended complaint on January 25, 2019 seeking individual relief rooted in twelve different causes of action.  Defendants Heath, Kuzmanich, Tabet, Nuell and Robinson moved to dismiss.

Warner’s first cause of action sought dissolution of the Company pursuant to LLC Law § 702 and Enforcement of Warner’s Right to Reversion of Mile High’s IP. Warner argued that dissolution of the Company was necessary because the Company was insolvent and continuation without her presence was unfeasible.  The Court stated the law regarding dissolution as follows, “an LLC may be dissolved ‘whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.’”  In the state of New York, common law has established that dissolution is permitted only when: “(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.”  Warner failed to present evidence to support her claim that the Company was financially unfeasible and could not fulfill its stated purpose without her. Rather, the Company continued to own and operate studios, and even opened a third studio during the pendency of this litigation.  The Court dismissed this cause of action. 

The complaint further alleged aiding and abetting breach of fiduciary duty against all defendants. Warner claimed that Heath and Kuzmanich presented a fake investment proposal to the board in order to “dissuade the other Managers from accepting a real offer.”  She further contends that the other board members knew or should have known that the proposal was deceptive. The Court dismissed this cause of action as duplicative against defendants Heath, Tabet, Nuell and Robinson, who were already subject to the direct breach of fiduciary duty claim as members of the board.  Though, the Court found sufficient facts pleaded as to actual knowledge and substantial assistance on the part of Kuzmanich in stymying the sale of the Company.  Thus, this cause of action survived as it pertains to defendant Kuzmanich.

Warner additionally alleged a breach of the Operating Agreement’s prohibition on removing plaintiff from the board without Cause and operation of the Company with a four-member board.  When the Co-Founding Members removed Warner from the board, they informed her that they would determine whether there was Cause for such removal at a later date. The Court allowed this claim to survive, citing to section 3(b) of the Operating Agreement which states that the board members may only remove a Founding Member from the board, “if such member meets any of the conditions for removal for Cause.”  Thus, removal of Warner without a stated cause breached the Operating Agreement. This cause of action survived.

The Court dismissed four causes of action stated in Warner’s complaint as derivative claims: (i) all breach of fiduciary duty claims – with the exception of an alleged sale-related fiduciary breach; (ii) breach of the Operating Agreement’s confidentiality requirements; (iii) breach of the Operating Agreement’s undertaking requirements; and, (iv) tortious interference with business relations. A derivative claim may only be brought on behalf of a corporation, not by an individual seeking relief on her own behalf, as Warner is here.

The Court dismissed three additional causes of action reasoning that Warner failed to put forth sufficient evidence to satisfy the elements of each claim. Particularly, Warner failed to provide sufficient evidence to support cause for: (1) rescission of the Operating Agreement and the IP Agreement; (2) rescission of the Contribution Agreement; and, (3) defamation.

The Court also dismissed Warner’s eleventh cause of action – breach of indemnification and advancement rights – reasoning that the Operating Agreement only provided former Managers with indemnification rights for costs incurred in connection with the defense of any actual or threatened lawsuit.  Warner was not entitled to indemnification for affirmative claims in this action. Finally, Warner’s twelfth cause of action alleged a breach of books and records rights under the Operating Agreement and LLC Law § 1102. The Court upheld this claim having already determined that Warner has the right to inspect the Company’s books and records.

In brief, the Court ordered defendants’ motion to dismiss granted in part, denied in part. Judge Schecter left Warner with three surviving causes of action and a chance to dispute the potential for punitive damages.

In Warner v. Heath, the New York Supreme Court addressed several issues of interpretation of an LLC’s operating agreement, as well as legal issues relating to its dissolution.[1] In October of 2012, Warner formed a New York limited liability company called Mile High Run Club, LLC (hereafter, “the Company”).[2] Warner and the Co-Founding Members – Mr. Heath, Ms. Tabet, Mr. Nuell and Mr. Robinson – made up the five member board.[3] On July 3, 2018, after a supermajority vote, Warner was removed as the CEO of the Company and replaced by Heath.[4] On December 21, 2018, Warner was notified that the Co-Founding Members voted to remove her from the board and that it would be determined whether her removal was “for Cause” at a later date.[5] After initiating litigation in Fall of 2018, Warner filed a second amended complaint on January 25, 2019 seeking individual relief rooted in twelve different causes of action.[6] Defendants Heath, Kuzmanich, Tabet, Nuell and Robinson moved to dismiss.
 
Warner’s first cause of action sought dissolution of the Company pursuant to LLC Law § 702 and Enforcement of Warner’s Right to Reversion of Mile High’s IP. Warner argued that dissolution of the Company was necessary because the Company was insolvent and continuation without her presence was unfeasible.[7] The Court stated the law regarding dissolution as follows, “an LLC may be dissolved ‘whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.’”[8] In the state of New York, common law has established that dissolution is permitted only when: “(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.”[9] Warner failed to present evidence to support her claim that the Company was financially unfeasible and could not fulfill its stated purpose without her. Rather, the Company continued to own and operate studios, and even opened a third studio during the pendency of this litigation.[10] The Court dismissed this cause of action.  
 
The complaint further alleged aiding and abetting breach of fiduciary duty against all defendants. Warner claimed that Heath and Kuzmanich presented a fake investment proposal to the board in order to “dissuade the other Managers from accepting a real offer.”[11] She further contends that the other board members knew or should have known that the proposal was deceptive. The Court dismissed this cause of action as duplicative against defendants Heath, Tabet, Nuell and Robinson, who were already subject to the direct breach of fiduciary duty claim as members of the board.[12] Though, the Court found sufficient facts pleaded as to actual knowledge and substantial assistance on the part of Kuzmanich in stymying the sale of the Company.[13] Thus, this cause of action survived as it pertains to defendant Kuzmanich. 
 
Warner additionally alleged a breach of the Operating Agreement’s prohibition on removing plaintiff from the board without Cause and operation of the Company with a four-member board.[14] When the Co-Founding Members removed Warner from the board, they informed her that they would determine whether there was Cause for such removal at a later date. The Court allowed this claim to survive, citing to section 3(b) of the Operating Agreement which states that the board members may only remove a Founding Member from the board, “if such member meets any of the conditions for removal for Cause.”[15] Thus, removal of Warner without a stated cause breached the Operating Agreement. This cause of action survived.
 
The Court dismissed four causes of action stated in Warner’s complaint as derivative claims: (i) all breach of fiduciary duty claims – with the exception of an alleged sale-related fiduciary breach; (ii) breach of the Operating Agreement’s confidentiality requirements; (iii) breach of the Operating Agreement’s undertaking requirements; and, (iv) tortious interference with business relations. A derivative claim may only be brought on behalf of a corporation, not by an individual seeking relief on her own behalf, as Warner is here.[16]
 
The Court dismissed three additional causes of action reasoning that Warner failed to put forth sufficient evidence to satisfy the elements of each claim. Particularly, Warner failed to provide sufficient evidence to support cause for: (1) rescission of the Operating Agreement and the IP Agreement; (2) rescission of the Contribution Agreement; and, (3) defamation.[17]
 
The Court also dismissed Warner’s eleventh cause of action – breach of indemnification and advancement rights – reasoning that the Operating Agreement only provided former Managers with indemnification rights for costs incurred in connection with the defense of any actual or threatened lawsuit.[18] Warner was not entitled to indemnification for affirmative claims in this action. Finally, Warner’s twelfth cause of action alleged a breach of books and records rights under the Operating Agreement and LLC Law § 1102. The Court upheld this claim having already determined that Warner has the right to inspect the Company’s books and records.[19]
 
In brief, the Court ordered defendants’ motion to dismiss granted in part, denied in part. Judge Schecter left Warner with three surviving causes of action and a chance to dispute the potential for punitive damages.



[1] Warner v. Heath, Index No. 654714/2018 at 1 (N.Y. Sup. May 1, 2020).
 
[2] Id. at 2.
 
[3] Id. at 3.
 
[4] Id. at 5.
 
[5] Id. at 5-6.
 
[6] Id. at 6.
 
[7] Id. at 11-12.
 
[8] Id. at 10, citing LLC Law § 702.
 
[9] Id. at 10, citing Matter of 1545 Ocean Ave., LLC, 72 AD3d 121,131 (2d Dept 2010).
 
[10] Id. at 12.
 
[11] Id. at 15.
 
[12] Id. at 18.
 
[13] Id. at 17.
 
[14] Id. at 20.
 
[15] Id.
 
[16] Id. at 14.
 
[17] Id. at 18-19, 21.
 
[18] Id. at 25.
 
[19] Id.

Category: 

Tag: 

By: