New York Business LLC’s Can Benefit from a Mandatory Member Buyout Clause—But This New York Case Shows Pitfalls
Sometimes members either want to leave or are forced out of an LLC, so including a buyout provision can prove to be useful. However, the provisions are often poorly drafted, leading to unforeseen complications.
This is well illustrated in Sassower v. 975 Stewart Avenue Associates, LLC[i]. Michael Sassower was a partner in an incorporated cardiologist practice.[ii] He was also a member of a real estate holding company, an LLC that actually owned the premises of the cardiology practice. Sassower sought to leave the practice, and pursuant to the operating agreement he was required to offer his 12.5% interest for sale to the LLC and members.
The operating agreement provided how the interest would be appraised: the LLC and the offering member were each to appoint a qualified appraiser, who would appraise according to the “market value approach appraisal methodology”. If the two resulting appraisals were within ten percent of each other, the average of the two would be the agreed upon value. Otherwise, a third appraiser would be appointed by the other two to determine the fair market value.
Sassower’s appraiser valued his interest at $962,500, while the LLC’s appraiser arrived at a value of $850,000. The LLC’s appraisal was subsequently amended due to an outstanding mortgage of $2.7M. The LLC informed Sassower that it was reducing its equity by the amount of the mortgage, which reduced Sassower’s valued interest to $350,000.
Greatly displeased, Sassower filed for declaratory relief (essentially asking the court to state what the value should be), stating that the mortgage should not be included in the appraisal. The LLC made a motion to dismiss the claim, and, after the court denied the motion, the LLC moved for dissolution. The court also denied that motion, noting that the LLC cannot move for dissolution as a result of the adverse outcome. The court granted Sassower’s motion to continue with the third appraisal.
The lesson is that in a buyout provision, the appraisal method should be clearly set forth. The point of the provision, i.e., efficiency and economy, was severely frustrated in this case, because certain key discounting factors (i.e. a mortgage) were not addressed in the agreement. In fact, all such buyout provisions should pay close attention to unique factors that may affect valuation and specifically highlight those for consideration (e.g., poor market for shares, family held business, major market features that impact this particular business, etc.)
[i]2009 NY Slip Op 31901(U) (Sup Ct Nassau County Aug. 14, 2009)
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