A Manhattan appellate panel’s unanimous decision last week in Brummer v Red Rabbit, LLC, 2015 NY Slip Op 02912 [1st Dept April 7, 2015], affirmed the dismissal of an LLC member’s claims for fraud and fiduciary breach based on the controller’s alleged concealment of impending equity investments by a pair of venture capital firms while the member was negotiating a partial buy-out of his membership interest.
The court held that the controller’s allegedly false representations regarding the company’s value and non-disclosure of investor interest “were neither relied upon nor material to plaintiff’s decision to sell.”
It’s an interesting contrast, to put it mildly, with the PF2 Securities case that I wrote about last week, in which a trial court refused to dismiss a minority shareholder’s fiduciary breach claim also based on an allegedly under-valued buy-out and the controller’s alleged withholding of financial information. In that case, the court held that the shareholder was “entitled to receive a fair market value for his stock after fair and complete disclosure and valuation.”
The complaint in Brummer (read here) alleged that around 2005 the plaintiff invested $25,000 in consideration of a 7% membership interest in a start-up venture called Red Rabbit that delivers “healthy” meals and snacks to New York metro area schools. After a period of modest growth, in 2010, the controlling member offered to buy back 6% for $28,500 using a percentage-of-revenue formula based on 2010 annual revenue of $475,000. He subsequently raised the offer to $40,000 which the plaintiff accepted, leaving plaintiff with a 1% membership interest. Continue Reading
Do controlling shareholders of a close corporation have an affirmative duty of financial disclosure when negotiating a buy-out of a minority shareholder? If so, what’s the source of the duty? Is it part of, or appurtenant to, a common-law fiduciary duty of loyalty or care? Or might it derive from the statutory right to seek judicial dissolution for the controllers’ oppressive acts?
Those weighty questions are prompted by a decision last month in which the court denied a motion to dismiss a minority shareholder’s counterclaim against the majority shareholders for breach of fiduciary duty in connection with a disputed buy-out agreement. The court’s decision in PF2 Securities Evaluations, Inc. v Fillebeen, 2015 NY Slip Op 30436(U) [Sup Ct NY County Mar. 26, 2015], invoked in tandem the majority shareholders’ fiduciary duty and the minority shareholder’s rights to be “free of oppressive conduct” and “in the event of a consensual buy-out . . . to receive a fair market value for his stock after fair and complete disclosure and valuation.”
The case involves a financial consulting firm called PF2 that uses mathematical models to evaluate collateralized debt obligations (CDOs). The defendant co-founded the company in 2007 and held a one-third stock interest. According to PF2’s complaint (read here), the defendant was responsible for developing the mathematical models and collecting data to evaluate CDOs. The complaint alleges that in 2012, as a result of the defendant “failing to fulfill his role as a director/partner of PF2,” the company negotiated “a generous buyout and employment contract” with the defendant “through various conversations and emails.” The complaint’s gravamen is that the defendant wrongfully competed with PF2 and misappropriated its proprietary information both before the buy-out when he was still a shareholder and afterward while he was in PF2’s employ. Continue Reading
Chris Mercer (photo right) is a name familiar to regular readers of this blog. I’ve written a number of posts about major valuation cases in which Chris testified as an expert business appraiser, including AriZona Iced Tea, Chiu, and Giaimo, and about his writings on the subject of statutory fair value and in particular the marketability discount. I’ve also had the pleasure of sharing the stage with Chris at continuing education programs including one upcoming on May 18 for the New York State Society of CPAs.
Chris has distinguished himself not only in the field of business appraisal, but as a deep thinker about how business owners, and especially the current wave of retiring baby boomers, can successfully reap the benefits of their ownership through diversification and careful transition planning. To that end Chris has published a number of books on buy-sell agreements and, most recently, a terrific book called Unlocking Private Company Wealth (Peabody Publishing 2014), subtitled “Proven Strategies and Tools for Managing Wealth in Your Private Business.” The book is a wake-up call for owners of closely held businesses who, caught up in the day-to-day operation and growth of their firms, pay little or no attention to managing and extracting the personal wealth tied up in their businesses and fail to devise rational exit and succession strategies.
In his book’s introduction, Chris nicely captures the credo of the quiescent business owner: Either I own the business or I don’t and there’s no in between. I’ll just keep things as they are until I sell the business or die. An owner such as this, who typically lacks an adequate shareholders or buy-sell agreement, and has no succession plan, is destined to become a client of a business divorce lawyer like me! To that owner, Chris says: “This book is written to help you understand the importance of your illiquid wealth — or the wealth locked in your private company — and present alternatives for helping you manage and eventually realize that wealth.” Continue Reading
The road to a business divorce can be a long and litigious one, strewn with obstacles big and small, limited only by the cleverness of the business owners and their counsel as each side strives to gain superior bargaining leverage against the other in anticipation of the inevitable buyout or other separation agreement.
The jousting can be especially intense in a business divorce between family members. The cost/benefit calculus that normally moderates tactics in and out of court is often warped by the intense emotions characteristic of a litigation pitting parent against child, sibling against sibling, cousin against cousin, and so on.
There’s a case pending in the Suffolk County Commercial Division, Margiotta v Tantillo, Index No. 62839-2013, that exemplifies the extraordinary demands upon the court’s resources as it’s called upon repeatedly to grant various forms of interim relief to one side or the other in a hotly contested family business divorce. A pair of recent decisions in the case by Justice Emily Pines also highlights the limitations upon the court’s power to grant interim relief when it comes to requests for mandatory injunctive relief, that is, requiring a party to perform some positive act as opposed to restraining them from doing something.
The stakes in Margiotta include a number of auto dealerships and the real properties on which they operate. The business was founded and controlled by the family patriarch, Anthony Tantillo, who died in 2013 at the age of 82. During his lifetime Mr. Tantillo brought into the business and gave minority interests to two children from his first marriage. He also brought into the business a stepson from his third marriage. His will left most of his estate to his two natural children and appointed one of them his executor. Possibly unknown to his two natural children until after his death, he also executed documents or entered into transactions that gifted company shares or otherwise gave majority ownership of several of the operating and realty companies to his stepson. Continue Reading
It’s not that I get nostalgic about derivative lawsuits (or Oldsmobiles), it’s just that it feels like we’re in a brave new world when it comes to adapting hoary corporate doctrine to that unincorporated upstart known as the limited liability company.
The clash between old and new looms in a derivative action concerning an LLC pending before Erie County Commercial Division Presiding Justice Timothy J. Walker called Univest I Corp. v Skydeck Corp., Index No. 2014-811644. The case stems from a dispute between the 50% managing member (BDC) and 50% non-managing member (Univest) of 470 Pearl Street, LLC, which was formed in 2004 for the purpose of acquiring for future development a parking lot in Buffalo, New York. Pending the development, BDC and Univest agreed to lease the parking lot to a BDC affiliate known as Skydeck Corp. The lease granted 470 Pearl the right to terminate the lease on 60-days notice.
In 2014, Univest, acting in 470 Pearl’s name, issued a termination notice to Skydeck under authority of an unusual provision in 470 Pearl’s operating agreement that gave either member the unilateral right “to cause 470 Pearl to terminate” the Skydeck lease. Two lawsuits followed Skydeck’s refusal to vacate. In the first, Justice Walker granted Univest a declaratory judgment upholding its termination notice and ordering Skydeck, pending further order, to pay an increased monthly rent (read amended complaint here and the court’s order here).
Shortly afterward, Univest commenced a derivative summary eviction proceeding on behalf of 470 Pearl, naming both Skydeck and BDC as respondents (read petition here). Now, let me pause the story for a moment. I’m not a landlord-tenant lawyer. If you’d asked me, before I looked into the Univest case, whether a non-controlling, non-managing corporation shareholder or LLC member could bring an eviction proceeding against the corporation’s or LLC’s tenant, I’m sure I would have guessed “no” for at least two reasons. First, I would have assumed the governing statute in Article 7 of the Real Property Actions and Proceedings Law somehow limits standing to seek relief to the owner or its authorized agent. Second, evicting a third-party tenant strikes me as quintessential management action. Imagine the chaos if any minority owner of a real estate operating company could take it upon themselves to launch eviction proceedings. But I would have guessed wrong. Gorbrook Associates, Inc. v Silverstein, 40 Misc 3d 425 [Dist. Ct. Nassau County 2013], a case of apparent first impression, held that a non-controlling, minority shareholder may bring derivatively an eviction proceeding. Continue Reading
If familiarity breeds contempt, does family breed contempt of court? Apparently so, at least in the recent case of Kassab v Kasab involving a corporate dissolution battle between two brothers, one of whom was held in contempt of court for using company funds to pay legal fees in violation of the court’s prior order prohibiting transactions “except in the ordinary course of business.”
We all know that, when it comes to the litigation of disputes between co-owners of a closely held business, the ability of one side to use company funds to pay their legal fees — in effect requiring the other side, which is paying its own legal fees out of pocket, to subsidize their opponent’s litigation expenses — can provide a critical financial and psychological advantage as the case slowly and expensively wends its way through the judicial process.
The issue usually surfaces in one of two ways: (1) the majority owners named as defendants use their voting control to approve the company’s advancement and indemnification of their legal expenses or (2) when the company also is named as a respondent or defendant, even if only nominally, they use their control of the company checkbook to pay whatever portion of defense costs they decide to allocate to the company, which may be 100%. The PFT Technology and Borriello cases, which I wrote about here and here, are examples of the former. An example of the latter, featuring an appellate decision in which the court explained the general parameters of when corporate funds can and cannot be used in a dissolution proceeding, is Matter of Levitt (read here). Continue Reading
How many law professors do you know whose bibliography includes titles like, “Agents of the Good, Servants of Evil: Harry Potter and the Law of Agency,” or “Eliminating Fiduciary Duty within Closely Held Businesses — Cardozo is Dead: We Have Killed Him”? I only know of one, and that’s Daniel S. Kleinberger (pictured), Emeritus Professor of Law at William Mitchell College of Law in St. Paul, Minnesota.
Amidst a spectacular career as teacher, prolific author and business law scholar, Professor Kleinberger also has played a leading role in state and national legislative drafting projects, writing the statutes that govern unincorporated business entities, including his service as co-reporter for and a principal drafter of the Revised Uniform Limited Liability Company Act (“ULLCA (2006)”) which has been enacted in ten states and currently is pending in the legislatures of four others.
In 1994, Professor Kleinberger and co-author Carter G. Bishop published their treatise, Limited Liability Companies: Tax and Business Law (Warren, Gorham & Lamont) which has become one of the bibles of LLC law. Among the many developing areas of the law of LLCs addressed in the treatise is the application of “veil piercing” principles, originally developed as part of the common law of business corporations, to enable creditors of LLCs, under certain circumstances involving abuse of the LLC form, to satisfy LLC obligations with the personal assets of the LLC owners.
According to Professor Kleinberger, a number of LLC statutes have eliminated disregarding “corporate” formalities as a ground for piercing the LLC veil, and some courts applying the law of other jurisdictions have discarded or at least discounted formalities. In an excerpt, printed below, from the forthcoming supplement to the Bishop & Kleinberger LLC treatise, Professor Kleinberger writes about the types of formalities that still matter even in jurisdictions that by statute or case law have done away with governance formalities as a piercing factor.
Formalities that Matter [new section to Chapter 6] copyright 2015 Carter G. Bishop and Daniel S. Kleinberger
In a February, 2015 post to LNET-LLC,1 a leading creditor-debtor litigator wrote:
So, yes, [under statutes that eliminate governance formalities] the [limited liability] company is not required to comply with corporate formalities, but that doesn’t mean that the company’s books can be in such a state of intentional or negligent disarray that legal ownership of its assets and basic financial operations cannot be clearly established. I think that some planners are mistaking “non-compliance with corporate formalities is not a grounds for veil piercing” with “there is no need for an LLC to keep basic records like any other similar business would”, and that is quite wrong.2
When it comes to fair-value jurisprudence, the Brooklyn-based Appellate Division, Second Department, works in mysterious ways.
Take, for instance, its 2010 Murphy decision, in which it noted without elaboration that the application of a discount for lack of marketability (DLOM) is not in all cases limited to the enterprise’s goodwill without so much as acknowledging 25 years of its own contrary precedent.
Then there’s last week’s decision in Chiu v Chiu, 2015 NY Slip Op 01427 [2d Dept Feb. 18, 2015], in which it upheld without comment a lower court’s decision to apply 0% DLOM in valuing a membership interest in a realty-holding LLC co-owned by two brothers. Considering the ongoing, vigorous debate in legal and valuation circles surrounding the existential propriety of DLOM under the statutory fair value standard, as recently played out in the Zelouf and Giaimo cases, it would have been extremely helpful to other litigants had the Second Department explained why it believed DLOM was inappropriate in Chiu. Oh well. Continue Reading
In the early 1990’s New York enacted its version of the Revised Uniform Limited Partnership Act (NYRULPA), codified in Article 8-A of the New York Partnership Law §§ 121-101 et seq. The law’s modernized features include in §§ 121-1101 through 1105 provisions for the merger and consolidation of limited partnerships along with the right of dissenting limited partners to be paid “fair value” for their partnership interests as determined in an appraisal proceeding.
You can count on one hand the number of published New York court decisions over the last 25 years dealing with dissenting limited partners. In fact, until this year, it’s possible you could count the number on one finger, that being the Court of Appeals’ 2008 ruling in the Appleton Acquisition case which I wrote about here. Appleton held that a limited partner may not bring an action seeking damages or rescission based on allegations of fraud by the general partner in connection with a merger transaction, and that the statutory appraisal proceeding is the exclusive remedy for such claims. Appleton never reached the issue of appraisal.
It therefore appears that last month’s decision by Manhattan Supreme Court Justice Geoffrey D. Wright in Levine v Seven Pines Associates L.P., 2015 NY Slip Op 30138(U) [Sup Ct NY County Jan. 28, 2015], may be the first published ruling that addresses issues attendant to a fair value determination in a dissenting limited partner case under NYRULPA.
Now, if you’re hoping for a meaty decision that delves into the fine points of appraisal methodology, Levine is not your case. Rather, Levine was decided on pre-trial motions to fix a date for an appraisal hearing and to compel the respondent limited partnership to provide certain pre-trial disclosure. In addition, the procedural aspects of the dissenting limited partner provisions in § 121-1105 expressly piggyback on the well-established procedures set forth in § 623 of the Business Corporation Law dealing with dissenting shareholders. Still, the issues decided in Levine serve up some useful pointers for practitioners. Continue Reading
The statutes and judge-made law governing dissolution and other claims among co-owners of closely held business entities can vary significantly from state to state. Depending on the states, there also can be much in common, which is why I like to keep an eye on developments outside New York, and not just Delaware which tends to have the most advanced business-law jurisprudence.
Below are five business divorce cases decided by appellate courts outside New York that made a splash in 2014. As you might expect, four of the five involve that relatively new business entity form, the limited liability company. The one involving a traditional business corporation, however, likely made the biggest splash.
Ritchie v Rupe, 2014 WL 2788335 [Tex. Sup Ct June 20, 2014]. The Lone Star State takes the prize for the most controversial business divorce decision in 2014, thanks to the Texas Supreme Court’s decision in Ritchie which, as one commentator put it, effectively “gutted the cause of action for shareholder oppression in Texas.” A Texas intermediate appellate court ruling in 1988, which had been followed ever since, recognized a compulsory buyout remedy for oppressed minority shareholders under a broad test for oppression mirroring New York’s reasonable-expectations standard. No more. The Ritchie court, in a 6-3 decision, narrowly defined oppressive conduct by majority shareholders as “when they abuse their authority over the corporation with the intent to harm the interests of one or more of the shareholders, in a manner that does not comport with the honest exercise of their business judgment, and by doing so create a serious risk of harm to the corporation.” The Ritchie majority then applied the coup de grâce by construing the applicable Texas statute as limiting the remedy for oppressive conduct to the appointment of a “rehabilitative receiver.” Bye bye buyout. For a more detailed analysis of Ritchie‘s impact on Texas business divorce litigation, check out my friend Ladd Hirsch’s posts here, here, and here on his Texas Business Divorce blog. Continue Reading