Forensic Accounting Helps Wins the Day in Oppressed Shareholder Stock Valuation Proceeding
A company's financial statements constitute the core data used by business appraisers to value shareholder equity in statutory appraisal proceedings triggered by dissolution petitions brought by oppressed minority shareholders.
In my experience, most small and medium sized closely held businesses do not have audited financial statements but instead rely on their outside accountant to prepare either a compilation or review report which merely compiles management's financial reports without any probing whatsoever (compilation) or employs a limited analysis of the company's accounting practices and other factors but without any data testing as would be done in an audit (review).
When using the income and market approaches to value a business, appraisers engaged as expert trial witnesses routinely make "normalizing" adjustments to the income statement (a/k/a Profit & Loss statement or "P&L") before applying a capitalization rate or market value ratios. For instance, the appraiser will eliminate extraordinary gains or losses, or may adjust officer/owner compensation to reflect reasonable compensation rates based on generally accepted industry surveys.
But beyond standard normalization, an expert appraiser using non-audited statements must determine whether the underlying income, expense, asset and liability data provided by management are reliable to a reasonable degree. Otherwise it's GIGO -- garbage in, garbage out.
That's where forensic accounting comes in, as nicely illustrated in a recent case decided by Queens County Commercial Division Justice Orin R. Kitzes in Matter of Adelstein (Finest Food Distributing Co. N.Y., Inc., 2011 NY Slip Op 33256(U) (Sup Ct Queens County Nov. 3, 2011).
Continue Reading...Court Orders Dissolution of Unprofitable Real Estate LLC
Back in 2008, I wrote a couple of posts about the Youngwall case in which the court ordered involuntary dissolution of a commercial real estate limited liability company (LLC) owned 50/50 by two brothers who also were involved in a bitter dispute over their father's will, based on the personal animosity between the brothers and because the vacant building was losing money (read here and here).
Youngwall foreshadowed the landmark decision in 2010 by the Appellate Division, Second Department, in the 1545 Ocean Avenue case, which redefined the standard for judicial dissolution of LLCs under §702 of the LLC Law as requiring the petitioner to show "in the context of the terms of the operating agreement or articles of incorporation, that (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible."
I emphasize the disjunctive "or" in the quoted passage because the cases involving judicial dissolution petitions based solely on financially failing LLCs are few and far between, as opposed to the more common scenarios involving management and/or money disputes between members of otherwise profitable ventures. The explanation may well be that most business people don't like to pay lawyer's fees fighting over a corpse.
LLCs being the entity of choice for real estate holding companies, and the real estate market having remained in a slump the last four years, it was only a matter of time before another Youngwall case appeared. And so it has, in the form of Mizrahi v. Cohen, 2012 NY Slip Op 50030(U) (Sup Ct Kings County Jan. 12, 2012), decided last week by Brooklyn Commercial Division Justice Carolyn E. Demarest.
Continue Reading...An Ill-Fated Solution to an Ill-Fated Buy-Sell Agreement
Let's face it: If you have a close corporation shareholders' agreement or LLC operating agreement including a buy-sell provision with a fixed share price that's supposed to be updated periodically, there's a good chance you (or your estate) are in for a nasty fight when the buy-out is triggered by the death, disability or retirement of one of the owners. Why so? Because more often than not the owners never update the agreed share price, so that when a buy-out is triggered many years later, the last agreed value no longer reflects a fair value for the ownership interest due to the growth (or decline) of the business in the interim, e.g., the Nimkoff case about which I wrote here.
Many such buy-sell agreements include an alternative valuation method when the agreed price -- often memorialized in a so-called Certificate of Value appended to the shareholders' agreement -- is not updated within a stated number of years before the trigger event, such as using an appraiser to perform a current evaluation. Such alternatives are no panacea, however, especially when the agreement fails to specify valuation parameters including the standard of value (e.g., fair market value, fair value, book value) and level of value (e.g., controlling, marketable minority, nonmarketable minority). The Sassower case, about which I wrote here and here, is a textbook illustration of the litigation woes that can follow when the buy-sell fails to articulate relevant valuation parameters.
If there's anything worse than failing to specify standards for the alternative valuation, it's providing no alternative, as when the buy-sell mandates use of the stale fixed price, which brings us to this week's featured case, DeMatteo v. DeMatteo Salvage Co., 2011 NY Slip Op 09586 (2d Dept Dec. 27, 2011).
Continue Reading...Top 10 Business Divorce Cases of 2011
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I'm pleased to present my fourth annual list of picks for the past year's ten most significant business divorce cases. This year's crop includes rulings on substantive and procedural issues involving dissolution, buy-out, appraisal and fiduciary breach involving closely held corporations, limited liability companies, and professional corporations. All ten were featured in this blog previously; click on the case name to read the full treatment. And the winners are:
- Matter of Supplier Distribution Concepts, Inc., 80 AD3d 869, 2011 NY Slip Op 00084 (3d Dept Jan. 6, 2011), presenting a fight over the proper venue for a corporate dissolution proceeding, in which the appellate court reversed an order departing from the statutory mandate requiring commencement of the proceeding in the judicial district correlating to the county in which the business is located as stated in its certificate of incorporation.
- Matter of Darvish (Haslacha, Inc.), 2011 NY Slip Op 30134(U) (Sup Ct NY County Jan. 19, 2011), involving the liquidation and winding up of a real estate holding company by a receiver, in which the court rejected a shareholder's contention that the property must be sold at public auction rather than by private sale.
- Matter of Giaimo (EGA Associates, Inc.), 31 Misc 3d 1217(A), 2011 NY Slip Op 50714(U) (Sup Ct NY County Apr. 25, 2011), a valuation proceeding involving a large portfolio of Manhattan apartment buildings, where the court applied a discount for built-in capital gains but refused to apply a marketability discount.
- Centro Empresarial Cempresa S.A. v. America Movil, S.A.B. de C.V., 17 NY3d 269, 2011 NY Slip Op 04720 (Ct App June 7, 2011) and Arfa v. Zamir, 17 NY3d 737, 2011 NY Slip Op 04719 (Ct App June 7, 2011), a pair of highly important decisions by the Court of Appeals dismissing fiduciary breach claims between shareholders based on written releases given as part of the challenged transactions.
With a Whimper, Not a Bang: New York's Top Court Rules on LLC Promoter Liability
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One of the benefits of writing a law blog is getting to know and exchange ideas, case notes and legal tidbits with other lawyers and academics. I am grateful that in this fashion I got to know Professor Larry Ribstein, who passed away unexpectedly last weekend at the peak of his prolific, dazzling career as a leading academic voice and mentor to many in diverse fields of business law and particularly in the area of unincorporated business entities. He had a giant intellect and a forceful style that pulled no punches. He was, as I described him to others, scary smart. Two years ago, on the occasion of the publication of his brilliant book, The Rise of the Uncorporation, he graciously agreed to be interviewed for this blog (read here). His last message to me was an email forwarding a post he wrote about the New York Court of Appeals' decision last week in the Roni LLC v. Arfa case discussed below, in which with typical and well-earned bravado he credits his amicus brief filed in that case with influencing the outcome. Undoubtedly, his influence and legacy of provocative scholarship will be felt and carried forward by many for a long, long time. |
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Last week the judges of the New York Court of Appeals unanimously affirmed the Appellate Division, First Department's interlocutory order in Roni LLC v. Arfa denying a motion to dismiss investors' claim for breach of fiduciary duty against the organizers or "promoters" of a series of real estate holding limited liability companies allegedly for failing to disclose, prior to formation of the LLCs, millions of dollars in brokerage commissions to be paid to the promoters. Roni LLC v. Arfa, 2011 NY Slip Op 09163 (Ct App Dec. 20, 2011).
The First Department's controversial ruling held, by analogy to 19th century cases imposing fiduciary obligations on stock corporation promoters, that promoters of LLCs by virtue of their status as such also take on fiduciary duties of disclosure to prospective investors. Before reaching the issue, the court specifically found that the complaint failed to allege, as an alternative basis for finding a fiduciary duty, that the defendants possessed superior expertise or knowledge about the real estate transactions coupled with false representations concerning that subject, or that defendants' personal connections with the plaintiffs established a fiduciary relationship. (Read here my account of the First Department's decision.)
Continue Reading...The Case of the Dueling Dissolution Petitions: Who Can Buy Out Whom?
An appellate ruling in a case featuring dueling dissolution petitions popped up last week, reminding us of the important strategic differences vis-à-vis the buyout when considering whether to seek involuntary corporate dissolution under one or the other of New York's pair of asymmetric statutes governing shareholder oppression and deadlock.
The petitioning minority shareholder in Matter of Carson (Carrabasset Management Corp.), 2011 NY Slip Op 09063 (App. Div. 3rd Dept. Dec. 15, 2011), sought judicial dissolution of two corporations under Business Corporation Law §1104-a based on shareholder oppression by the majority shareholder who allegedly resigned and abandoned his corporate responsibilities.
A petition brought under §1104-a triggers the other shareholder's absolute right under BCL §1118 to elect to purchase the petitioner's shares for "fair value" to be agreed upon by the parties or, absent agreement, determined by the court. Quite often the minority shareholder will petition for dissolution under §1104-a hoping and expecting that the respondent majority shareholder will elect to purchase the petitioner's shares in lieu of dissolution.
Continue Reading...Pizza Wars of the Shareholder Kind
Who doubts that pizza runs in the veins of New York City inhabitants? According to one recent study by the NYC Economic Development Corporation, the city's five boroughs have almost 1,300 pizzerias. Which neighborhoods have the most? An EDC survey published last week gives top honors to the East Village in Manhattan, Ridgewood in Queens, and Williamsburgh in Brooklyn. Highest per capita concentration? Manhattan's East Harlem and Lower East Side.
There have been many stories about the intense competition and even litigation among the city's warring pizza purveyors, such as the lengthy court battle between the owners of the names "Famous Ray's" and "Original Famous Ray's." With so many pizza businesses, it's inevitable that some of them also fall victim to disputes among co-owners resulting in petitions for judicial dissolution.
Such is the case in Matter of DiMaria (JJM Pizza Corp.), 2011 NY Slip Op 33151(U) (Sup Ct Nassau County Nov. 28, 2011), involving a dispute between minority and majority shareholders of a small pizzeria chain located in northeast Queens known as Cascarino's Brick Oven Pizza. In a decision last month by Nassau Commercial Division Justice Ira B. Warshawsky, the court ruled that the parties' conflicting allegations concerning petitioner's claim of oppression and respondents' "unclean hands" defense prevent a summary determination of the petition. Justice Warshawsky also denied the petitioner's request for appointment of a temporary receiver.
Continue Reading...Appellate Court Reinstates LLC Manager in Dispute with Investor in Vodka Venture
The highly competitive and lucrative market for premium vodka has spawned some of the most creative advertising and promotional campaigns known to consumers (think Absolut). A new market entrant offering vodka imported from Holland under the brand name Medea, sold in special bottles designed with an interactive LED ticker display, has spawned a different kind of competition, of the litigious sort, involving a fight for control between an angel investor and the managing member of the company.
An appellate court decision issued last week in Lehey v. Goldburt, 2011 NY Slip Op 08670 (1st Dept Dec. 1, 2011), reinstated the managing member whom the lower court had removed and replaced with the investor on the latter's application for interim relief. The decision reinforces the constraints lower courts face in granting provisional remedies without holding an evidentiary hearing to resolve conflicting allegations. The decision also addresses an interesting issue of contract construction arising from an arguable inconsistency between the operating agreement's provisions for the appointment and removal of managers.
Continue Reading...NY's Top Court Hears Argument on LLC Promoter Liability
On November 15, 2011, the spectacular Albany courtroom pictured at left was the setting for oral argument before the New York Court of Appeals in Roni LLC v. Arfa, No. 228, in which the court is poised to decide whether pre-formation limited liability company "promoters" have a fiduciary duty of disclosure to potential investors. The outcome could have a significant impact on investment structure and investor solicitation, especially in the real estate industry where the LLC, for tax and other reasons, is the preferred form of business organization.
The case involves claims by a group of Israeli real estate investors who purchased membership interests in a series of LLCs formed to acquire, renovate, manage and eventually re-sell multi-family residential properties in New York City. The complaint's gravamen is that the defendants, who identified the properties, solicited investors, organized the LLCs, negotiated the acquisitions and obtained mortgage financing, concealed from the plaintiffs certain "brokerage" fees of up to 15% that the defendants were to receive from the property sellers and mortgage brokers, eventually exceeding $6.5 million. The plaintiffs alleged that the defendants as "promoters" of the to-be-formed LLCs had a fiduciary duty to disclose the brokerage arrangement to the plaintiffs as prospective investors, and that the fees inflated the purchase prices paid for the properties to plaintiffs' financial detriment.
Continue Reading...Freeze-Out Merger and the Limited Liability Company
There are many reported decisions addressing the rights of dissenting minority shareholders in merged corporations to receive cash payment for the fair value of their shares pursuant to an appraisal proceeding (e.g., see last week's post on the Barasch case). Dissenters' rghts, embodied in statutes enacted over 100 years ago, protect minority shareholders from majority actions that fundamentally change the nature of their investment without their consent, while abrogating the ancient common-law rule that permitted a single shareholder to block a merger.
There's also ample statutory and case law addressing the rights of the controlling shareholders to compel the cashing out of a minority shareholder for fair value subject to appraisal, in what's known as a "freeze-out merger."
But what about that relatively recent invention, the limited liability company? Do minority members of LLCs have a statutory right to demand payment for their interest if the LLC is merged into another entity? Can the majority members force a minority member to cash out his or her interest in a freeze-out merger? Is there any case law on the subject?
Yes, the LLC laws in New York and some other states make provision for dissenters' rights.
Yes, the majority can effectuate a freeze-out merger.
Yes, there is decisional law but the cases are few and hard to find.
Continue Reading...