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ARFA v. ZAMIR, 0603602/2005 (4-29-2008)

Supreme Court of the State of New York, New York County.

Apr 29, 2008

Judgment

CaseIQ

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Factual and Procedural Background

The underlying action was commenced by Rachel Arfa and Alexander Shpigel against their former business partner, Gadi Zamir. The three partners had formed Harlem Holdings to hold membership interests in various limited liability companies (LLC Intervenors) that own and manage residential properties in Manhattan, New York. Arfa and Shpigel collectively owned 60% of Harlem Holdings, while Zamir owned 40%. Until November 2005, Harlem Holdings co-managed the LLC Intervenors; since August 2006, Zamir has been the sole manager. The LLC Intervenors were permitted to intervene as defendants for the purpose of filing counterclaims against Arfa, Shpigel, and Harlem Holdings, and cross-claims against Zamir.

In motion sequence 027, plaintiff Alexander Shpigel moved to dismiss the intervenor-defendants' fourth counterclaim pursuant to CPLR 3211 (a)(3) and (a)(7). In motion sequence 028, Harlem Holdings LLC joined in that motion to dismiss.

Legal Issues Presented

Whether the LLC Intervenors have standing to assert a cause of action for breach of the Operating Agreements despite being non-signatories to those agreements.
Whether the intervenor-defendants' fourth counterclaim sufficiently pleads a cause of action for breach of contract against Harlem Holdings and the Managers.

Arguments of the Parties

Managers' Arguments (Plaintiff Alexander Shpigel and Harlem Holdings LLC)

The LLC Intervenors lack standing to assert breach of contract claims because they are non-signatories to the Operating Agreements.
They analogize the Operating Agreements to corporate shareholder agreements, enforceable only by parties who executed them.

LLC Intervenors' Arguments

An LLC may assert a breach of its operating agreement even if it did not execute the agreement.
They analogize LLC Operating Agreements to corporate bylaws, which constitute contracts between members and among themselves.
The Managers are effectively seeking to enforce the Operating Agreements against the LLCs, so the LLCs should be able to enforce those agreements in return.
They claim standing based on direct injury from the alleged breaches, supported by principles found in the Revised Uniform Limited Liability Company Act (RULLCA), which states an LLC is bound by and may enforce its operating agreement regardless of its manifestation of assent.
Alternatively, the LLCs may enforce the Operating Agreements as intended third-party beneficiaries.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Allianz Underwriters Ins. Co. v Landmark Ins. Co., 13 AD3d 172, 174 (1st Dept 2004)	Standard for motion to dismiss: liberal construction, accepting facts as true, and giving benefit of favorable inferences to pleader.	Applied to determine that the LLC Intervenors have standing and sufficiently pled breach of contract.
Hoffman v Finger Lakes Instrumentation, LLC, 7 Misc 3d 179, 185-86 (Sup Ct, Monroe County 2005)	An LLC, though a non-signatory, may enforce an operating agreement under principles of equitable estoppel.	Used to support the proposition that an LLC can enforce its operating agreement despite non-signatory status.
Elf Atochem North America, Inc. v Jaffari, 727 A2d 286 (Del 1999)	Equitable estoppel prevents parties from enforcing agreements selectively to their advantage.	Supported the reasoning that Managers cannot enforce the Operating Agreements against LLCs while denying LLCs the right to enforce the same agreements.
State of California Public Employees Retirement Sys. v Sherman Sterling, 95 NY2d 427, 434-35	Corporate bylaws constitute contracts between members and among themselves.	Used by analogy to support that LLC Operating Agreements govern relationships and benefit the LLCs.

Court's Reasoning and Analysis

The court began by applying the standard for motions to dismiss, construing the counterclaim liberally and accepting all factual allegations as true. It recognized that an LLC is a hybrid entity governed by its operating agreement, which is the controlling document for the LLC's business and member relations pursuant to New York's Limited Liability Company Law (LLCL).

The court found that the LLC Intervenors have standing to enforce the Operating Agreements despite being non-signatories. It relied on the principle that an LLC can enforce its own operating agreement, as seen in Hoffman, where equitable estoppel allowed enforcement of arbitration provisions by a non-signatory LLC. The court noted that the Managers seek to enforce the Operating Agreements against the LLCs, so they cannot simultaneously deny the LLCs the right to enforce the same agreements.

The court also considered the logic that the LLCs suffered direct injury from the alleged breaches, supporting their standing to sue, analogous to principles in the Revised Uniform Limited Liability Company Act (RULLCA), which New York has not yet adopted but which recognizes an LLC's ability to enforce its operating agreement regardless of manifestation of assent.

Alternatively, the LLCs may enforce the Operating Agreements as intended third-party beneficiaries, given that the agreements were adopted unanimously and govern the parties' relationships for the LLCs' benefit.

Accordingly, the court concluded that the LLC Intervenors have standing and have adequately pled a breach of contract claim.

Holding and Implications

The court DENIED the motions by plaintiff Alexander Shpigel and counterclaim defendant Harlem Holdings LLC to dismiss the intervenor-defendants' fourth counterclaim.

The action will continue in all other respects. The decision directly allows the LLC Intervenors to pursue their breach of contract claims against the Managers. No new precedent was established beyond the application of established principles regarding LLC operating agreements and standing.

Show all summary ...

[EDITOR'S NOTE: This case is unpublished as indicated by the issuing court.] CHARLES EDWARD RAMOS, Judge.

Motion sequence numbers 027 and 028 are consolidated for disposition.

In motion sequence number 027 (formerly 016), plaintiff Alexander Shpigel moves to dismiss the intervenor-defendants' fourth counterclaim pursuant to CPLR 3211 (a) (3) and (a) (7).

In motion sequence number 028 (formerly 020), counterclaim defendant Harlem Holdings LLC (Harlem Holdings) joins in Shpigel's (together, the Managers) motion to dismiss the intervenor-defendant's fourth counterclaim.

Lawrence Mandelker, Esq. was appointed the temporary receiver of Harlem Holdings on February 22, 2006.

Background

The underlying action was commenced by Rachel Arfa and her husband, Alexander Shpigel, against their former business partner, defendant Gadi Zamir. The three partners had formed Harlem Holdings to hold the membership interests of the intervenor-defendants, that are comprised of various limited liability companies (LLC Intervenors), that, in turn, own and manage dwellings around Manhattan, New York. Arfa and Shpigel formerly owned 60% of the membership interests in Harlem Holdings, and Zamir owned the remaining 40% membership interest. Until November of 2005, Harlem Holdings served as the co-manager for each of the LLC Intervenors. As of August 2006, Zamir has served as the sole manager of each of the LLC Intervenors.

The LLC Intervenors were given leave to intervene in this action as defendants, for the purpose of filing counterclaims against Arfa, Shpigel and Harlem Holdings, and cross-claims against Zamir.

Discussion

The LLC Intervenors' fourth counterclaim alleges that Harlem Holdings, the managing member of the LLC Intervenors, breached each of the LLC Intervenors' operating agreements (Operating Agreements), by: (1) assigning its membership interests in each LLC without obtaining the requisite consent from the other members; (2) failing to fund certain approved capital calls made by Zamir; and (3) causing the LLC Intervenors to incur loans that were not approved by each of the LLC's members (LLC Intervenors Counterclaims and Cross-Claims, ¶¶ 27-35).

The Managers argue that the LLC Intervenors lack standing to assert a cause of action for breach of contract, because the LLC Intervenors are non-signatories to the Operating Agreements that were allegedly breached. They analogize the LLC operating agreement to a corporate shareholder agreement, that, like any agreement, can only be enforced by a party that executes it.

The LLC Intervenors contend that a cause of action for breach of an operating agreement can be asserted by an LLC, irrespective of whether the LLC actually executed it. They analogize an LLC's operating agreement that is adopted unanimously by shareholders to corporate bylaws, that have been held to constitute a contract between members of the corporation and the members among themselves.

For the reasons set forth below, affording the counterclaim a liberal construction, accepting the facts alleged as true and according the LLC Intervenors the benefit of every favorable inference ( Allianz Underwriters Ins. Co. v Landmark Ins. Co., 13 AD3d 172, 174 [1^st Dept 2004]), the Court determines that the LLC Intervenors have standing to pursue the cause of action, and have sufficiently pled a cause of action for breach of contract.

An LLC is a hybrid entity, combining elements of the corporate and partnership form (Rich, Practice Commentaries, McKinney's Consolidated Laws of NY, Book 32A, Limited Liability Corporation Law at 175). The operating agreement is the governing instrument of the LLC. Section 417 (a) of the Limited Liability Corporation Law (LLCL) provides that the members of an LLC "shall adopt a written operating agreement . . . relating to (I) the business of the limited liability company, (ii) the conduct of its affairs, and (iii) the rights, powers, preferences, limitations or responsibilities of its members, managers, employees or agents." Further, the operating agreement is defined as "any written agreement of the members concerning the business of the LLC and the conduct of its affairs and complying with section 417" (LLCL section 102 [u]).

Recognizing that an LLC is bound by, and can enforce, its own operating agreement, is not a novel concept in the oft-times murky area of LLC law. For instance, in Hoffman v Finger Lakes Instrumentation, LLC ( 7 Misc 3d 179, 185-86 [Sup Ct, Monroe County 2005]), an LLC moved to compel arbitration based upon an arbitration provision contained in the operating agreement. Relying upon principles of equitable estoppel, the court determined that, although the LLC was a non-signatory to the operating agreement, it could enforce the arbitration clause contained therein because all persons that were concerned with the LLC had executed the operating agreement, and presumed that it was in effect ( id. at 185).

Hoffman ( 7 Misc 3d at 185-86), is narrowly distinguishable to the extent that it involves arbitrability. However, it is broadly applicable to the issue raised here. That court reasoned that the signatories to the operating agreement that were seeking to prevent the LLC from enforcing the arbitration clause cannot "have it both ways, by "seek[ing] to hold the non-signatory liable pursuant to duties imposed by the agreement . . ., but, on the other hand, deny[ing] the arbitration's applicability because the defendant is a non-signatory" ( id.; accord Elf Atochem North America, Inc. v Jaffari, 727 A2d 286 [Del 1999]).

The LLC Intervenors allege that the Managers are seeking to enforce the Operating Agreements against the LLCs by demanding the funding of loans in the Managers' favor, and the payment of fees for services that the Managers allegedly performed for the LLCs (Counterclaims and Cross-Claims of LLC Intervenors, ¶¶ 27-35, 38 [4-5]). Implicit in the Managers' claims is that the Operating Agreements govern the parties' relationship, and are binding upon them. The Managers cannot logically seek to enforce the Operating Agreements against the LLC Intervenors, while simultaneously seeking to deny the LLC Intervenors from enforcing the identical Operating Agreements against them.

Moreover, insofar as the LLC Intervenors allegedly bore the direct injury from the breach of the Operating Agreements, logic dictates that they would have standing to pursue redress for that injury, a principle that is recognized in the Revised Uniform Limited Liability Company Act (RULLCA), although not yet adopted by the New York Legislature. Section 111 (b) of the RULLCA states, "A limited liability company is bound by and may enforce the operating agreement, whether or not the company has itself manifested assent to the operating agreement."

Alternatively, the LLC may enforce the operating agreement as the intended third-party beneficiary of the Operating Agreements. There is no doubt that the LLC and the Managers regarded the Operating Agreements, adopted unanimously by members, as governing their relationship, and for the benefit of the LLCs ( compare State of California Public Employees Retirement Sys. v Sherman Sterling, 95 NY2d 427, 434-35).

For these reasons, the Court determines that the LLC Intervenors have standing to directly pursue a cause of action for breach of its own Operating Agreements against the Managers, and that they adequately pled the elements of a claim for breach of contract.

Accordingly, it is

ORDERED, that the motions to dismiss the fourth counterclaim by plaintiff Alexander Shpigel (027) and counterclaim defendant Harlem Holdings LLC (028) are denied; and it is further

ORDERED that the action in all other respects shall continue.