Are claims for judicial dissolution of business entities arbitrable?
It’s a question I’m occasionally asked by business owners and, surprisingly, by lawyers. I say surprisingly because here in New York, the courts long ago settled the question in favor of arbitrability. But there are some nuances when it comes to judicial dissolution and arbitration, and the arbitrability of dissolution claims is not a given in all states.
What follows is a very basic explanation of the rules and some issues surrounding arbitration of judicial dissolution claims. Bear in mind, however, that the governing rules, whether statutory or judge-made, can vary significantly from state to state, so whether you’re a business owner or a lawyer representing one, be sure to consult the rules in your jurisdiction.
How Do Business Entities Get Dissolved?
It may not be obvious why I pose this question first. Let me explain.
Corporations, limited liability companies, and limited partnerships — I’m purposely omitting general partnerships — are state-enabled creatures that draw their first breath only upon meeting statutory filing requirements with the Secretary of State. They likewise draw their last breath upon filing the statutorily specified documentation requiring the Secretary of State to dissolve the entity.
Business entity dissolution is governed by statute and comes in two flavors: voluntary (i.e., non-judicial) and involuntary (i.e., judicial). In the case of voluntary dissolution, the statutorily required filing consists of an authorized certificate of dissolution. Involuntary dissolution requires the filing of a court order directing the Secretary of State to dissolve the entity.
We know that arbitrators cannot give birth to business entities, but can they kill them off? It’s really a two-part question:
- whether courts have exclusive jurisdiction to grant the statutory remedy of involuntary dissolution such that even the broadest arbitration clause cannot empower an arbitrator to do so, and
- whether an arbitrator’s award granting dissolution can, without more, trigger dissolution by filing it with the Secretary of State.
Taking those in reverse order, I doubt anyone seriously argues that an arbitrator’s award on its own can trigger involuntary dissolution by the Secretary of State. The statutes clearly require a judicial order of dissolution. But I also doubt anyone seriously argues that the requirement of a judicial order affects arbitrability, given the procedure that, as far as I know, exists in every state for judicial confirmation of arbitration awards. After all, that’s the process by which any arbitration award, for money damages or any other remedy, translates to a legally enforceable judgment.
As we’ll see below, it’s the first part of the question that has prompted at least some courts to hold that claims for involuntary dissolution of business entities are non-arbitrable.
Arbitration of Dissolution Claims in New York
New York is not one of those states. Every reported case I’ve seen, at least over the last 40 years or so, has upheld the arbitrability of dissolution claims involving closely held business entities. All of those decisions address the issue no differently that they would any challenge to the arbitrability of a claim, simply by asking whether the subject arbitration clause is broad enough to encompass a dissolution dispute. Here’s a sampling of the decisions:
- Matter of Levy (Joyce Morris, Inc.), a 1980 decision in which the Appellate Division, Second Department, affirmed an order compelling arbitration of a claim for judicial dissolution based on shareholder oppression, including an attempted squeeze-out at a discounted price fixed in the shareholders’ agreement, under the agreement’s provision requiring arbitration of “any questions, differences or controversies with respect to this Agreement, or other breach thereof.”
- Ehrlich v Stein, another Second Department decision from 1988 in which the court reversed the lower court’s order denying a motion to compel arbitration and directed the parties to arbitration of the 50% shareholders’ dissolution claim based on deadlock. The arbitration clause in the shareholders’ agreement covered “any disputes or controversies of whatever kind or nature which may arise in connection with, for breach or on account of the performance or nonperformance of this agreement.” The lower court denied the motion because the arbitration clause in the shareholders’ agreement did not specify either internal dissension or corporate dissolution. The appellate court disagreed, finding that “the general subject matter of the dispute, i.e., whether and if so, on what terms, the shareholders should sever their corporate ties, is more than reasonably related to the general subject matter of the agreement establishing those ties. The fact that the dispute might otherwise serve as a predicate for judicial dissolution does not narrow the scope of the arbitration clause.”
- Matter of Herrero (Tenth Ave. Fine Foods, Inc.), a 1990 decision in which the Appellate Division, First Department, upheld the lower court’s order compelling arbitration of the petitioning minority shareholder’s oppression-based dissolution claim under a classically broad arbitration clause extending to “any and all controversies in connection with or arising out of this Agreement.”
- Spatz v Ridge Lea Associates, LLC, a 2003 decision by the Appellate Division, Fourth Department, in which it reversed the lower court’s order denying a motion to compel arbitration in an action for judicial dissolution of an LLC. The appellate panel disagreed with the lower court’s finding that the defendants had waived their right to arbitrate by delay in filing the motion to compel arbitration and by their participation in the litigation, adding that “the subject matter of plaintiffs’ amended complaint, including the request for dissolution of the [LLC}, is encompassed by the broad arbitration agreement.”
- Cusimano v Berita Realty LLC, a 2011 trial court ruling by the Nassau County Commercial Division compelling arbitration of a 50% member’s claim for judicial dissolution of an LLC whose operating agreement included a broad arbitration clause encompassing “any dispute, controversy or claim arising out of or in connection with this Agreement or any breach or alleged breach hereof.” The court found that the petition’s allegations of financial impropriety by the LLC’s other 50% member “are directly related to the operation and management of [the LLC], and are appropriately governed by the Arbitration Clause in the Operating Agreement.”
- Matter of Parness v Saul, a 2011 trial court ruling by a New York County judge compelling arbitration of claims arising out of an LLC operating agreement, including dissolution, where the agreement’s broad arbitration clause included “any controversy or claim arising out of or relating to this Agreement, or the breach thereof.”
Arbitration of Dissolution Claims in Other States
The picture gets fuzzier outside New York.
I’ve not done anything close to a 50-state survey. What I can report based on a some casual research is that there is some number of states that align with New York’s pro-arbitrability stance in dissolution cases, and there is some number of states that take the opposing view.
Assuming the following decisions are representative of the jurisprudence in their respective states, courts in Utah, Arizona, and Ohio, like those in New York, will compel arbitration of dissolution claims under a broad arbitration clause:
- HITORQ LLLC v TCC Veterinary Services Inc., a 2020 decision by the Utah Court of Appeals involving an LLC whose operating agreement required arbitration of any “dispute regarding the enforcement or interpretation of this Agreement,” arguably not the broadest of arbitration clauses but, the court concluded, broad enough to affirm the lower court’s order compelling arbitration of the plaintiffs’ dissolution claim based on allegations tied to violation and interpretation of the operating agreement. The court rejected the plaintiffs’ contention that the dissolution claim is non-arbitrable because “the right to dissolve a Utah LLC is based exclusively on statutory grounds” and “seeks a specific remedy authorized by statute . . . and does not seek to enforce any specific term of the Operating Agreement.”
- Sun Valley Ranch 308 L.P. v Robson, a 2012 decision by the Arizona Court of Appeals affirming an order compelling arbitration of a statutory claim for dissolution of a limited partnership whose partnership agreement’s arbitration clause, described by the court as “the paradigm of a broad clause,” encompassed “any” controversies or disputes “arising out of or relating to” the agreement. The court rejected the plaintiffs’ argument that the dissolution claim is non-arbitrable because under the dissolution statute “only the superior court may grant such relief,” adding that nothing in the statute suggests the power to dissolve lies exclusively with the courts “or that parties may not agree to submit partnership dissolution and accounting disputes to arbitration.”
- Meyers v Marks, a 2011 decision by the Ohio Court of Appeals affirming an order compelling arbitration of a claim for dissolution of an LLC involving a dispute concerning membership and management rights where the operating agreement required arbitration of “any controversy or claim arising under or by reason of this Agreement or the breach of it.” As in the Arizona case, the court rejected the plaintiff’s argument that judicial dissolution of an LLC is not arbitrable because the dissolution statute limits authority to dissolve an LLC to the court of common pleas.
And then there’s this pair of recent decisions by South Carolina and California courts taking the opposite view:
- Palmetto Wildlife Extractors, LLC v Ludy, a decision earlier this month by the South Carolina Court of Appeals affirming the denial of the respondents’ motion to compel arbitration of an LLC dissolution claim where the operating agreement mandated arbitration of “any controversy or claim arising out of or related to this Agreement or the breach thereof . . . except as may otherwise be provided herein,” holding that the claim “can only be resolved by the circuit court.” The court reasoned: “In that claim, Respondents sought the dissolution of the LLC pursuant to section 33-44-801 of the Act. Section 33-44-801(4) provides for dissolution ‘on application by a member or a dissociated member, upon entry of a `judicial decree” if certain events occur. See Judicial, Black’s Law Dictionary (11th ed. 2019) (‘Of, relating to, or by the court or a judge.’).”
- Chappellet v 4614 Hawley Boulevard LLC, a 2021 decision by the San Diego Superior Court that, as described in California lawyer Dan Robinson’s blog post, denied a motion to compel arbitration of a lawsuit seeking to dissolve an LLC whose operating agreement provided that all actions arising from or related to the operating agreement have to be resolved through binding arbitration. According to Dan, the judge cited no case precedent and instead based the ruling on the LLC statute’s provision that an operating agreement may not “vary the power of a court to decree dissolution in the circumstances specified in subdivision (a) of Section 17707.03.” Dan quotes the decision’s statement that “an agreement compelling arbitration of a dissolution action would take this ‘power’ away from the Court and instead vest it with a private arbitrator in violation of the referenced code section. As a result, the arbitration agreement within the subject operating agreement cannot, as a matter of law, compel arbitration of the dissolution action and no waiver has occurred.”
Be Aware of Narrow Arbitration Clauses
I’ll close out this post with one other noteworthy wrinkle, namely, even in states such as New York that recognize the arbitrability of dissolution claims, attention must be paid to arbitration clauses not of the broad type.
An example is JC Aviation Investments, LLC v HyTech Power, LLC, a 2021 decision by the Washington Court of Appeals that opens with the line, “Parties can be compelled to arbitrate only the matters they agreed to arbitrate.” The case involves a petition seeking dissolution of an LLC. The operating agreement’s arbitration clause covered “any dispute hereunder” which the court found was not equivalent to the typical broad clause requiring arbitration of any dispute “arising out of” and “relating to” the agreement. Instead, the court held that the “narrowly drafted” arbitration clause did not encompass the petitioner’s dissolution claim because the petition invoked only the section of the operating agreement’s dissolution provision specifically referring to judicial dissolution under Washington’s LLC Act authorizing a party to “seek a decree of dissolution in superior court, as contemplated by the statute.” The court further commented that “this determination does not require resolving a dispute under the LLC agreement,” only whether “under these circumstances, it is’ reasonably practicable’ for [the LLC] to continue operating in the manner required in its LLC agreement.”