Mizrahi v Cohen

[*1] Mizrahi v Cohen 2013 NY Slip Op 50092(U) Decided on January 15, 2013 Supreme Court, Kings County Demarest, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on January 15, 2013
Supreme Court, Kings County

Ronald Mizrahi, individually and as a 50% member of and in the right of 372-376 Avenue U Realty LLC, a New York limited liability company, Plaintiffs,

against

Ezra Cohen, Defendant



3865/10



Attorney for Plaintiff:

Edward B. Safran

88 Pine Street

New York, NY 10038

Attorney for Defendant:

Solomon E. Antar

42 Falmouth Street

Brooklyn, NY 11235

Carolyn E. Demarest, J.

As a sequel to this Court's decision of January 12, 2012, granting plaintiff Mizrahi's petition for dissolution of 372-376 Avenue U Realty LLC (the LLC) and reserving any further action relating to the winding-up of the LLC pending an appraisal of the real property by an appraiser to be selected and agreed between the parties, and a full accounting by the LLC's accountant, defendant has moved for the appointment of a receiver. Because Mizrahi clearly held a substantially greater interest in the equity of the LLC, and defendant Cohen had ceased making any contributions to the LLC, failing even to pay his rent, the Court directed Mizrahi to manage the affairs of the LLC until further order of the Court. The Court is now in possession of the appraisal prepared by Davis R. Maltz & Co., Inc, in which the market value of the real property, as of February 12, 2012, is stated to be $4,550,000, with caveats regarding the volatility of capital markets going forward. Since the appraiser was jointly selected by the parties, and is recognized by this Court to be a competent authority in the field of real estate appraisal, the Court deems this sum to be the actual agreed value of the real estate for the purposes of this decision. The Court is also in receipt of the report (Accountant's Report) prepared by Joshua Silberberg of Zell & Ettinger, who has served as the accountant for the LLC since its inception and for both parties personally. The Court accepts as reliable this unchallenged report of the financial posture [*2]of the LLC, as of March 31, 2012, though defendant insists there is a monthly "net operating income of $4,000".

The Accountant's Report concludes that Mizrahi's capital account is $1,206,087, inclusive of his contributions to the date of the report, in contrast to Cohen's capital account of $295,500, after deduction of his $230,000 unauthorized withdrawal of capital which he owes to the LLC, with interest in excess of $100,000. Cohen also owed outstanding rent of $7,500 at the time of the Accountant's Report, which has since increased to $52,500 for the months of May through November 2012, according to the affidavit of Mizrahi submitted in support of his order to show cause seeking a direction to Cohen to pay such "use and occupancy" or vacate the premises, returnable on December 19, 2012, and now adjourned to January 30, 2013. The total assets of the LLC on March 31, 2012 were $4,654,252, inclusive of the fair market value of the real property as appraised at $4,550,000, cash of $96,752 and Cohen's overdue rent of $7,500. Accounts payable totaled $65,439, plus a mortgage balance of $4,387,382. Thus, assuming a liquidation of the assets of the LLC upon the sale of the real property at its appraised value, a loss to the LLC of over $1,000,000 would result, taking into account the capital debt owed to Mizrahi. As noted by Mr. Silberberg, a sale at auction would incur additional costs, resulting in an even greater loss. Both members of the LLC would lose their entire investment.

As he did at trial, plaintiff Mizrahi continues to request that the Court permit him to buy out Cohen's interest in the LLC, based upon the appraised value of the real property, in proportion to Cohen's capital account. Cohen objects, insisting upon a sale at public auction, which would be prohibitively costly in light of the LLC's outstanding debts and would exhaust all assets of the LLC without actually paying off its debts. It is noted that CPLR §8004 would render Cohen, as the movant for the appointment of a receiver, liable for any shortfall in funds available to compensate the receiver. In light of Cohen's prior defaults in rent and his unauthorized withdrawal of capital, for which he remains liable to the LLC, it is unlikely that Mr. Cohen would make good on such obligation. Moreover, there is no evidence that plaintiff is dissipating the assets of the LLC, as required for the appointment of a temporary receiver (see Quick v Quick, 69 AD3d 828, 829 [2d Dept 2010]; Vardaris Tech, Inc v Paleros, Inc, 49 AD3d 631, 632 [2d Dept 2008]). As this Court has already determined, Mizrahi, as the holder of four times the equity in the LLC as possessed by Cohen, has the greatest interest in preserving the assets of the LLC. Both parties remain personally liable on the mortgage, which has repeatedly been covered by Mizrahi's advancements of capital. To further dissipate the resources of the LLC by appointing a temporary receiver pursuant to CPLR Article 64, as defendant requests, when plaintiff is adequately managing and protecting the assets of the LLC, makes no sense. That application is denied.

However, having determined that the LLC should be dissolved, it is the duty of the Court to provide a mechanism for the liquidation and distribution of its assets (see Limited Liability Company Law (LLCL) §703(a); Spires v Lighthouse Solutions, LLC, 4 Misc 3d 428, 439 [Sup Ct, Monroe County, 2004])).

As is apparent from my prior decision of January 12, 2012, in this matter (34 Misc 3d 1210[A], 2012 NY Slip Op 50030[U]), this case presents a cautionary tale regarding the drafting and execution of the operating agreement for an LLC, the adoption of which is statutorily mandated in LLCL §417 (see Rich, Practice Commentaries, McKinney's Cons Laws of NY, [*3]Book 32A, LLCL 5(A)). As noted in the earlier decision, the parties apparently summarily executed the Operating Agreement, without reviewing it, immediately prior to the closing on their purchase of the subject real property, in response to the demands of the mortgagee. The basis for the draft by counsel is not known, but it has been suggested that it was constructed by "cutting and pasting" portions of other operating agreements. (Compare Matter of Fassa Corp., 31 Misc 3d 782, 783 [Sup Ct, Nassau Co, 2011]). While the LLCL does provide the required terms of operation of an LLC upon default where there is a lack of direction in the operating agreement or no operating agreement has been executed (see Spires at 433, 435-436), where specific direction is provided within a duly-executed operating agreement, the statute will not supercede such express provisions, unless they are contrary to the law (cf. Matter of 1545 Ocean Ave., LLC, 72 AD3d 121, 128-130 [ 2d Dept 2010]). A limited liability company, though analogous to a corporation in some respects, is primarily a creature of contract. Thus, when provisions regarding management and operation are arbitrarily or carelessly adopted, without consideration to future potential problems, the parties may be forced to accept consequences that none of them wanted or intended. The Operating Agreement herein appears to contain inconsistent provisions relating to the "economic interest holder's" rights and obligations with respect to his capital account, although the Court recognizes some of the confusing language may be designed to meet tax requirements which have not been raised in the litigation. The Operating Agreement does not, however, expressly authorize the relief plaintiff seeks in the context of a judicial dissolution.

The reports and trial evidence before the Court establish beyond cavil that the LLC is essentially bankrupt in that its liabilities far exceed its assets. It is clear that neither member will be entitled to a "distribution" of assets upon liquidation after satisfaction of the mortgage and payment of other outstanding debts, although plaintiff Mizrahi will be entitled to the repayment of funds he has advanced as a loan if any assets remain after satisfaction of all other obligations. Upon sale of the building to a third party, neither member will be entitled to remain in his commercial unit unless a lease is negotiated with the new owner. Although the Court has hoped and believed that the parties would seek to avoid such Draconian consequences and work out a reasonable solution between themselves, and plaintiff has proposed to lease to defendant his existing premises upon his buyout of Cohen's interest, Cohen has declined and insists upon a public auction and sale.

Article VI, section 6.4 of the Operating Agreement provides for a "mandatory buy-out" of the interest of a member by the surviving members upon an "involuntary withdrawal"; however, as this Court previously noted, it is only the plaintiff who can be said to have involuntarily withdrawn by virtue of the filing of the petition for dissolution, and defendant has taken the position that there has been no involuntary withdrawal. Article VII concerns "Dissolution, Liquidation, and Termination of the Company", specifying that, upon dissolution, assets shall be first applied to the payment of creditors, "including Members and Economic Interest Holders who are creditors" in satisfaction of liabilities. There is no provision for a buyout of a member's interest by other members upon winding up following dissolution.

LLCL §502(c) states that the operating agreement may provide sanctions for the failure of a member to make a "required contribution", including "reduction or elimination of the [*4]defaulting member's interest, subordination of the defaulting member's interest to that of non-defaulting members, a forced sale of the defaulting member's interest, forfeiture of the defaulting member's interest," or lending by other members to cover the defaulting member's obligation, or, upon fixing the value of the interest, "redemption or sale of such member's interest at such value". This statutory authorization would appear to support plaintiff's request to buyout defendant's interest, however, such authorization is contingent on the language of the operating agreement and, as previously noted, the Operating Agreement herein expressly provides that no member may be required to contribute additional capital except upon the vote of 100% of the membership, of which there is no evidence, nor is any member obligated to restore a negative capital account (Operating Agreement §§3.2, 4.2.2). Thus, there exists no contractual predicate for the relief plaintiff seeks.

However, in fashioning an appropriate procedure for the winding up of a dissolved LLC, the Court is possessed of discretion to exercise principals of equity (see Rich, Supp Practice Commentaries, McKinney's Cons Laws of NY, Book 32A, Limited Liability Company Law 8.5, 2012 Pocket Part, at 78). In Lyons v Salamone (32 AD3d 757, 758 [1st Dept 2006]), the Appellate Court expressly rejected the argument that, in the absence of an express statutory provision authorizing a buyout, the Court was without authority to order mutual buyout rights permitting the members to bid the fair market value of the other member's interest, with a direction to the receiver to accept the highest legitimate bid. Further, as plaintiff has repeatedly pointed out, in Matter of Superior Vending LLC (71 AD3d 1153 [2d Dept 2010]), the Second Department approved a buyout of a member's interest, in the absence of an operating agreement, where the member had essentially abandoned any participation in the LLC for several years prior to pursuing the proceeding for dissolution. This Court has declined to award similar relief here because the provisions of the duly-executed Operating Agreement do not appear to authorize such relief. (See Man Choi Chiu v Chiu, 71 AD3d 646, 647 [2d Dept 2010], in which the Appellate Court affirmed the denial of the expulsion of a member where neither the articles of organization, nor the operating agreement, provided for expulsion, notwithstanding the reference to such possibility in LLCL §701, finding "no statutory provision authorizing the courts to impose such a remedy"). However, in light of defendant's continuing failure to pay even the use and occupancy which is due on his premises while continuing in occupancy, and the likelihood that plaintiff continues to cover all expenses of the building with infusions of additional contributions, thus unjustly enriching defendant, the inequity of the present situation is profound and warrants Court intervention.[FN1] Accordingly, this Court has fashioned the following relief in response to defendant's motion for the appointment of a receiver.

The Court hereby appoints Richard A. Klass, Esq. of 16 Court Street, 29th Floor, Brooklyn, New York 11241-0102, Telephone: 718-643-6063, as liquidation trustee of the subject LLC ("Trustee"). Upon his compliance with the requirements of Part 36 of the Rules of the Chief Judge, Mr. Klass is to obtain from the accountant for the LLC, Joshua Silberberg, an up-to-date accounting of the assets and liabilities of the LLC and the current status of the capital [*5]accounts of the two members, including any outstanding loans owed to the members by the LLC and all outstanding debts, together with accrued interest, owed to the LLC by such members. Such report shall be submitted by February 28, 2013. Plaintiff shall immediately turn over to the Trustee and Accountant Silberberg copies of all books and records, including bank statements and leases, relating to the management and operation of the subject Property and the LLC, copies of which shall also simultaneously be provided to defendant through counsel. The costs of such accounting shall be a charge to the LLC and take priority over any other debts except compensation of the appointed Liquidation Trustee who shall be compensated for his services at the rate of $300 an hour, plus any costs incurred.

Each member may submit to the Trustee a proposal for the purchase of the other member's interest ("bid"), including the satisfaction of the existing mortgage upon the Property, which may include, with the consent of the mortgagee, the assumption of the mortgage and release of the other member as guarantor. Each bidder must submit a 25% deposit with such bid; however, the member shall be given credit against such deposit for any debt owed to him personally by the LLC and any debt owed to the LLC by a member must be paid in full, in addition to the 25% deposit, before such bid may be accepted by the Trustee. The Trustee shall accept the highest qualifying bid. If no qualifying bids are received by March 22, 2013, the Trustee is directed to advertize the public auction sale of the Property, which shall be sold subject to any outstanding mortgage. The Trustee shall report to the Court the need for such public sale and submit the appropriate order authorizing such relief. Following the sale of the Property, the Trustee will be responsible for the collection and distribution of assets in satisfaction of the liabilities of the LLC and the distribution of any excess to the members in proportion to their economic interests, in conformity with section 7.2 of the Operating Agreement.

Plaintiff's counsel is directed to serve a copy of this Decision and Order upon the Trustee and the mortgagee of the Property within ten days of entry. Plaintiff shall continue to manage the day- to-day operation of the Property pending submission to, and acceptance of, bids by the Trustee. The report and recommendation of the Trustee, to be made on or before April 22, 2013, is subject to approval by this Court prior to closing of title between the members or public sale of the Property. The Trustee may request an extension of the dates set forth herein for good cause.

This constitutes the decision and order of the Court.

_________________________________________

CAROLYN E. DEMAREST

JUSTICE OF THE SUPREME COURT Footnotes

Footnote 1:This Court is aware that there is an appeal pending argument in the Appellate Division and the decision of that Court may impact the decision herein, however, no stay has been entered and the decision of the Appellate Court is likely to be delayed for some months.