What are the warning signs that a partnership or LLC dispute is headed to court?

This page explains New York law for partnerships, LLCs and closely held corporations. It draws on the Partnership Law, the Limited Liability Company Law and the Business Corporation Law (BCL). KOR Law LLP's business divorce practice acts for founders, managing partners, minority members and shareholders in partnership disputes, shareholder litigation, ownership dilution claims, fiduciary duty claims, and contested buyouts and exits.

One point runs through all of it. Many of the statutes below set default rules that apply "subject to any agreement" between the owners (Partnership Law 40, 41). Your partnership agreement, operating agreement or shareholders' agreement is the first document to read, because it can change the answer.

Warning sign 1: why does refused access to the books matter so much?

When the person running the business stops sending statements or answering questions about the bank accounts, the other owners can no longer see what is happening to their money. New York gives each type of owner a records right, though the scope differs. In a partnership, the books are kept at the principal place of business, subject to any agreement, and "every partner shall at all times have access to and may inspect and copy any of them" (Partnership Law 41). Partners must also give "true and full information of all things affecting the partnership" to any partner on demand (Partnership Law 42).

An LLC member may inspect and copy, at the member's own expense, the company's required records, its financial statements for the three most recent fiscal years, and other information about the company's affairs "as is just and reasonable," for any purpose reasonably related to the member's interest. The operating agreement can set reasonable standards for that inspection (LLC Law 1102(b)), and it can let certain members or managers keep trade secrets and similar information confidential (LLC Law 1102(c)). The required records include each member's contribution and share of profits and losses, the operating agreement and its amendments, and the last three years of tax returns (LLC Law 1102(a)).

A shareholder of record of a corporation may examine the minutes of shareholder meetings and the record of shareholders on at least five days' written demand, for a purpose reasonably related to the shareholder's interest (BCL 624(b)). On written request, the corporation must also provide an annual balance sheet and profit and loss statement (BCL 624(e)). If the corporation refuses the inspection, the shareholder may apply to the Supreme Court in the judicial district where the corporation's office is located for an order to show cause, and the court hears the application summarily (BCL 624(d)). The full process, including the broader common-law right for shareholders, is covered in how to get access to company books and records in New York.

Warning sign 2: what makes a capital call a red flag?

A capital call becomes a warning sign when the amount, the deadline or the penalty for not paying looks designed to shrink one owner's share, such as a large call with a short deadline and automatic dilution.

For LLCs, the statute protects members against one-sided changes. Unless the operating agreement or the articles of organization provide otherwise, an amendment that increases a member's obligation to make contributions, or that alters how a member's distributions are computed, cannot be made without the written consent of each member adversely affected (LLC Law 417(b)). In a partnership, no one can become a partner without the consent of all the partners, and no act that contravenes the partners' agreement can rightfully be done without the consent of all of them (Partnership Law 40(7), 40(8)). Whether a particular call is valid therefore turns on what the agreement allows and how the call was approved.

Warning sign 3: what if distributions suddenly stop?

Owners expect to share in profits. When distributions dry up while the business appears to be doing well, or while the controlling owner's salary, fees or expense account grows, the other owners should ask why. Subject to any agreement, each partner shares equally in the profits and surplus remaining after liabilities are paid (Partnership Law 40(1)), and no partner is entitled to pay for acting in the partnership business (Partnership Law 40(6)). In an LLC, unless the operating agreement says otherwise, the managers fix the compensation of managers (LLC Law 411(e)), which is one reason a sudden pay increase deserves a close look.

A partner also has the right to a formal account of partnership affairs, including when the partner is wrongfully excluded from the business or its property, when the partnership agreement gives that right, and whenever other circumstances make it just and reasonable (Partnership Law 44).

Warning sign 4: when does disagreement become deadlock?

Deadlock means the votes needed to act cannot be obtained, so decisions the business needs do not get made. In a partnership, all partners have equal rights in management, and ordinary matters may be decided by a majority of the partners (Partnership Law 40(5), 40(8)), which leaves two equal partners with no tie-breaker unless their agreement supplies one. A partner may ask the court to dissolve the partnership, for example when another partner's conduct makes it not reasonably practicable to carry on the business with that partner (Partnership Law 63(1)(d)).

Deadlock is also where the exit rules start to matter. A New York LLC can be dissolved by the court when it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement, explained in how to dissolve a New York LLC when the members cannot agree. For corporations, holders of half the votes may petition for dissolution on grounds of deadlock (BCL 1104), and holders of 20% or more of the votes have a separate petition, covered in whether a minority shareholder can force a buyout or dissolution in New York.

Warning sign 5: what counts as self-dealing?

The typical pattern is the controlling owner doing business with the company on the side: hiring a company the owner also controls, leasing the owner's own property to the business, or taking an opportunity that belonged to the business. Every partner must account to the partnership for any benefit, and hold as trustee for it any profits, derived without the other partners' consent from any transaction connected with the partnership or from any use of its property (Partnership Law 43). How these duties differ for partners, managers, directors and officers is explained in what duties business partners and LLC managers owe each other in New York.

An LLC manager must perform the manager's duties in good faith and with the care that an ordinarily prudent person in a like position would use under similar circumstances (LLC Law 409(a)). A transaction between the LLC and a manager, or a business in which the manager has a substantial financial interest, is protected if the material facts were disclosed in good faith and the disinterested managers or the members approved it. Without that disclosure or approval, the company may avoid the transaction unless the parties to it establish that it was fair and reasonable to the company when it was approved (LLC Law 411(a), 411(b)). When the conduct also involved false statements, the separate elements of fraud may come into play; see what you have to prove to win a fraud claim in a New York business case. Because the loss usually falls on the company, the claim is often brought in its name, as described in when a shareholder or member can sue on the company's behalf in New York.

How does a warning sign turn into a court case in New York?

1. Read the agreement. Find the clauses on records, capital calls, distributions, voting, transfers, buyouts and dispute resolution. The statutory defaults apply subject to them (Partnership Law 40; LLC Law 417(a)).
2. Make a written demand. Ask for the specific records and information, and state your purpose. For a corporation, a written demand at least five days ahead is required for the statutory inspection (BCL 624(b)).
3. Keep the response. A refusal, a partial production or silence can matter later. Once records are produced, a corporation's required books and records are prima facie evidence of the facts stated in them, in favor of the plaintiff, in an action against the corporation or its officers, directors or shareholders (BCL 624(g)).
4. Go to court if refused. A shareholder can seek an order compelling inspection by order to show cause (BCL 624(d)). A partner can seek a formal account (Partnership Law 44). The court's power to compel production of a corporation's books is otherwise preserved (BCL 624(f)).
5. The forum. Cases go to the state Supreme Court. Disputes over the internal affairs of business organizations can be heard in the Commercial Division if the county's monetary threshold is met, and dissolution cases without regard to the threshold (22 NYCRR 202.70(b)(7), (b)(11)); see whether your business dispute belongs in the New York Commercial Division.
6. Urgent harm. If money or property is about to be moved in a way that would make a later judgment ineffectual, a preliminary injunction or temporary restraining order may be sought (CPLR 6301); see how fast you can get a TRO or preliminary injunction in a New York business dispute.

Once a case is filed, document exchange follows the court's rules, and the Commercial Division has its own limits on interrogatories and depositions, described in what discovery limits apply in the New York Commercial Division.

What changes the answer?

• The type of entity. Partners, LLC members and shareholders have different records rights and different exit routes (Partnership Law 41; LLC Law 1102, 702; BCL 624, 1104).
• The agreement's terms. Partnership rights apply subject to the partners' agreement (Partnership Law 40), and an operating agreement can set reasonable standards for records access (LLC Law 1102(b)).
• Who approved the transaction. Good faith disclosure and approval by disinterested managers or members protects an interested-manager deal (LLC Law 411(a)).
• Whether the change needed your signature. Amendments that raise contribution obligations or change distribution formulas need each affected member's written consent, unless the agreement or articles provide otherwise (LLC Law 417(b)).
• The size of your stake. Corporate dissolution petitions require half the votes for deadlock or 20% for the separate petition (BCL 1104, 1104-a).
• The amount in dispute and the county. Commercial Division assignment for internal affairs disputes depends on the monetary threshold (22 NYCRR 202.70(a), (b)(7)).
• How much time has passed. Claims have filing deadlines; see how long you have to sue for breach of contract, fraud, or a sale of goods in New York.

For example: a three-member LLC that stops sharing information

Common mistakes

• Asking only by phone. An oral request is easy to deny later. Put records demands in writing; for a corporation, the statutory inspection right depends on written demand (BCL 624(b)).
• Paying the call before reading the agreement. Whether a capital call or dilution is valid depends on the operating agreement and on who consented (LLC Law 417(b)).
• Assuming the statute overrides the agreement. Many partnership rules apply "subject to any agreement" (Partnership Law 40, 41).
• Treating a 50/50 split as a stalemate with no exit. The law provides routes out for LLCs and corporations (LLC Law 702; BCL 1104).
• Waiting until the money is gone. Interim relief under CPLR 6301 is aimed at acts that would make a judgment ineffectual, which is easier to show before the transfer than after.

What to do this week

1. Find the signed partnership, operating or shareholders' agreement and every amendment.
2. Write down each warning sign you have seen, with dates, amounts and who was involved.
3. Send a written records demand that lists specific documents and states your purpose as an owner.
4. Collect your own copies of tax forms, statements and emails about distributions and capital calls.
5. Do not sign consents, amendments or capital call acknowledgments until you understand them.
6. Speak with business divorce counsel about deadlines and whether urgent relief is needed.

Frequently asked questions

Can an LLC refuse to show me records because it says my request is hostile?

The member's right covers inspection for any purpose reasonably related to the member's interest as a member, subject to reasonable standards set in or under the operating agreement (LLC Law 1102(b)). If the operating agreement provides for it, certain members or managers may keep trade secrets and similar information confidential for a reasonable time (LLC Law 1102(c)).

Can a corporation ask me to sign anything before I inspect?

Yes. A corporation may deny the statutory inspection if the shareholder refuses to provide an affidavit that the inspection is not wanted for a business other than the corporation's and that the shareholder has not, within five years, sold or offered for sale any list of shareholders (BCL 624(c)).

Is my partner allowed to be paid for running the business?

Under the default partnership rule, no partner is entitled to pay for acting in the partnership business, except a surviving partner winding up its affairs (Partnership Law 40(6)).

What can I recover if my partner took a side deal?

A partner must account to the partnership for any benefit, and holds as trustee for it any profits, derived without the other partners' consent from a transaction connected with the partnership or from use of its property (Partnership Law 43).

Does it matter whether the business is a corporation or an LLC?

Yes. A corporation's minority shareholders have a statutory dissolution petition with a buyout election (BCL 1104-a, 1118), while LLC members rely on the dissolution standard in LLC Law 702 and on the operating agreement. The records rights also differ (BCL 624; LLC Law 1102). How the exit price is set is covered in how a business is valued in a New York buyout or dissolution.