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LLC Operating Agreement Does Not Prevent Freeze-Out Merger

On October 24, 2016, Justice Charles E. Ramos of the New York Commercial Division denied a motion by minority members of a limited liability company (“LLC”) to enjoin a freeze-out merger that would cash out the minority members’ interests.  Huang v. N. Star Mgmt. LLC, 652357/2016, 2016 NY Slip Op 32194(U), at *4 (N.Y. Sup. Ct. Oct. 24, 2016).  The court rejected the minority members’ argument that the majority members had violated the LLC’s operating agreement by transferring their membership interests to another LLC to effect the merger.[1] 

The seven-member LLC at issue in Huang owned mixed-use real estate in Flushing, Queens.  Shortly after the members settled a dispute involving the refinancing of the property, the four majority members, who collectively owned 67% of the LLC, initiated a freeze-out merger to cash out the three minority members’ interests.[2] 

A freeze-out merger eliminates unwanted minority stakeholders by forcing them to sell their interests.  Here, each of the four majority members transferred his interest in the preexisting LLC to a new LLC, and the new LLC was to then merge into the preexisting LLC, which would buy out the minority members’ interests with cash.[3]

Two of the three minority members filed suit and sought a preliminary injunction to prevent the merger.  They claimed that the merger violated a clause in the preexisting LLC’s operating agreement governing the transfer of membership interests.  The clause provided that “[a] Member may freely transfer his interest in [the preexisting LLC] to another person or entity . . . only with the prior majority consent of other Members either in writing or at a meeting called for such purpose.”[4]

The plaintiffs argued that this clause required a majority of disinterested members to approve a transfer of a membership interest, and that the majority members violated the clause when they transferred their interests to the new LLC with only the consent of the other majority members, who were not disinterested.  Because the transfers to the new LLC were invalid, the plaintiffs argued, the new LLC did not have authority to execute the merger.[5]

Justice Ramos rejected this argument under the plain language of the operating agreement, which was “completely devoid of the term ‘disinterested’” and which “clearly permit[ted] a member to transfer their membership interest upon approval by a simple majority of members.”  The court found that, for each of the four transfers made to the new LLC, the transferring majority member obtained majority consent from the other three majority members.[6]

The plaintiffs have appealed.[7] 

Patterson Belknap’s NY Commercial Division Blog will monitor the case and report material developments.

 

[1] Huang v. N. Star Mgmt. LLC, 652357/2016, 2016 NY Slip Op 32194(U), at *3 (N.Y. Sup. Ct. Oct. 24, 2016).

[2] See id. at *1.

[3] See id. at *1-4.

[4] Id. at *1-2.

[5] See id. at *2; Transcript of Oral Argument at 3-7, Huang v. N. Star Mgmt. LLC, 652357/2016 (N.Y. Sup. Ct. July 8, 2016), NYSCEF Doc. No. 33.

[6] Huang, 2016 NY Slip Op 32194(U), at *3-4.

[7] Notice of Appeal at 1, Huang v. N. Star Mgmt. LLC, 652357/2016 (N.Y. Sup. Ct. Nov. 18, 2016), NYSCEF Doc. No. 38.