Judicial dissolution of a business entity, whether pursuant to statute or common law, is an equitable remedy subject to equitable defenses, including the doctrine of “unclean hands.”
As described a few years ago by Justice Emily Pines in the Kimelstein dissolution case, the unclean hands doctrine “bars the grant of equitable relief to a party who is guilty of immoral, unconscionable conduct when the conduct relied on is directly related to the subject matter in litigation and the party seeking to invoke the doctrine was injured by such conduct.”
The doctrine has been employed in dissolution cases in two ways. First, it can defeat a petitioner’s standing to seek dissolution, as in Kimelstein where Justice Pines held that the petitioner’s admitted concealment from his ex-wives, creditors and federal government of his alleged, undocumented 50% equity interest in two corporations owned by his brother barred him from asserting the requisite stock holdings to seek statutory dissolution. Second, even when the petitioner’s stock ownership is conceded, the doctrine can bar the petitioner’s dissolution claim on the merits.
The doctrine’s latter use rarely has been successful. A recent exception is Sansum v Fioratti, 128 AD3d 420 [1st Dept 2015], in which the Appellate Division, First Department, ordered the dismissal of a common-law dissolution claim brought by a 6% shareholder in an art gallery based on the plaintiff’s “embezzlement” of company funds for which he pled guilty to larceny and related charges. The decision packs an even more powerful punch by virtue of the court’s summary disposition of the claim, disagreeing with the lower court that a hearing was required and invoking the doctrine of in pari delicto (Latin for “in equal fault”) to reject the plaintiff’s counter-argument, that the defendant stockholders themselves conducted illegal business operations. Continue Reading
Partnership dissolution cases have an especial poignancy, more so than cases involving other forms of business entities.
I think it’s because general partnerships are a dying breed of business association, supplanted in our litigious society by limited liability entities such as S corporations and LLCs.
The occasional partnership dissolution cases that land in court these days tend to involve family or multi-family real estate partnerships formed decades ago, in which one or more of the original partners have passed away or are approaching retirement and looking either to exit or to transfer their partnership interest and/or management role to their children. Fittingly, along with elderly parties the statutes governing the disputes are found in the superannuated New York Partnership Law, essentially unchanged since its adoption in 1919.
Such was the case in Breidbart v Olshan, Decision and Order, Index No. 003610/12 [Sup Ct Nassau County May 27, 2015], involving a realty partnership formed in 1977 to acquire and develop under a long-term lease a commercial office building in Lake Success on Long Island. The partnership, known as Boundary Realty Associates, consisted of three partners: Olshan (50%), Rosenberg (25%), and Breidbart (25%). The written partnership agreement provided that the partnership would employ as managing agent for the first three years a firm owned and operated by Olshan at a fixed commission of 4% of gross rental income. The agreement also provided for termination of the partnership in 2020 or sooner upon the consent of a majority in interest of the partners. Continue Reading
If you’ve studied New York dissolution law, you know that, unlike proceedings involving close corporations, there’s no statutory authority for a court-ordered buy-out when a member of a limited liability company petitions for judicial dissolution under LLC Law § 702.
You also know, especially if you follow this blog, that notwithstanding the absence of such authority, on a few occasions New York courts have invoked their common-law powers of equity to compel buy-outs in LLC dissolution cases, or have reached the same result by characterizing the buy-out as a form of liquidation.
The selected valuation date can make a critical difference in determining the value of an equity interest in the business. In dissolution proceedings involving close corporations, the statute authorizing a buy-out election, Business Corporation Law § 1118, stipulates valuation as of the day before the filing of the petition. We don’t have similarly definitive guidance on the LLC side because there’s no enabling statute, but the few LLC cases decided so far suggest some answers. Continue Reading
Several years ago I had my first encounter as a business divorce lawyer with an LLC agreement purchased from the online legal forms provider, LegalZoom.
The case involved a two-member New York LLC that, in the four or five years it operated, achieved enviable growth and profits. The two members were highly educated individuals with ample business experience.
Apparently for reasons of speed and convenience — they had the financial wherewithal to hire a lawyer, but chose not to — they used LegalZoom to form the LLC including the articles of organization and operating agreement. The latter document reflected a 70/30 ownership split.
Years later the members’ relationship turned bitter, which is when I first got involved in what became a court case and eventually the liquidation and dissolution of what had been a successful business. As in every business divorce, the reasons for the demise of the business were complex and unique but shortcomings in the operating agreement also contributed significantly to the parties’ legal postures and willingness to risk litigation. Continue Reading
Judicial dissolution statutes for limited liability companies in New York, Delaware, and many other states use the contract-centric language drawn from limited partnership law, namely, whether it is reasonably practicable to carry on the business in conformity with the articles of organization and operating agreement.
Court decisions in both Delaware and New York have construed their respective LLC statutes as authorizing judicial dissolution when the purpose of the entity, as defined in the operating agreement, can no longer be achieved. For instance, former Vice Chancellor Chandler of the Delaware Chancery Court in his 2008 Seneca Investments decision, and then-Vice Chancellor Strine in his 2009 Arrow Investment Advisors decision, both used language suggestive of the LLC agreement as the sole source to which a court should look in determining the LLC’s purpose. In New York, Justice Austin, writing for the Appellate Division, Second Department, in the seminal 1545 Ocean Avenue decision, similarly crafted a dissolution standard keyed to the frustration of the LLC’s “stated purpose” in the context of its operating agreement.
Does that mean courts never look outside the LLC agreement when determining if its purpose no longer is achievable? And how should a court determine purpose when the LLC has no written agreement? Recent decisions from Delaware and New York provide some clues to the answers. Continue Reading
Rare is the petition for LLC dissolution not immediately greeted by a motion to dismiss by the non-petitioning members.
Don’t get me wrong. Pre-answer motions to dismiss are a staple of all kinds of litigation including business disputes. It’s just that, in my experience, as compared to more pedestrian matters such as contract disputes based on nonpayment or delivery of defective goods, the open-endedness of the standard for judicial dissolution of LLCs gives the non-petitioning member greater room and incentive to argue that the petition does not adequately allege grounds for relief and therefore should be dismissed out of the gate.
The member seeking dissolution and his or her counsel have choices to make that can affect the odds of surviving an early dismissal motion:
- File for dissolution by summons and complaint in a plenary action, or by petition in a special proceeding?
- If utilizing a special proceeding, commence it by order to show cause or by notice of petition?
- Whether using a complaint or petition, allege the bare minimum facts or lay out detailed testimonial and documentary evidence as if it were a summary judgment motion?
Business divorce and business valuation are inseparable. By that I mean, in almost every business divorce matter where the co-owners are beyond reconciliation, determining the value of the business is essential to any resolution, whether by settlement or court verdict, whereby one owner usually buys out the other or they divide the business assets.
Valuing a closely held business for which no active market exists is no simple thing. Sure, for certain industries there are rules of thumb that can give a very rough indication of value, e.g., EBITDA multiples, but the specific and often unique attributes of every business, including customer relationships, dependency on key personnel, accounting practices, and owner discretionary spending, make reliance on such simplistic formulas an unsatisfactory proposition in the super-charged, high stakes atmosphere of a contested separation of business partners.
So what valuation options does the business owner have? Sometimes the only feasible option is to engage an accredited business appraiser to prepare a comprehensive, detailed report setting forth the appraiser’s conclusion of value in a form admissible at trial, such as in dissolution proceedings when one side elects to buy out the other and the case is headed to a judicial hearing to determine the fair value of the seller’s shares. Such appraisals can take a significant amount of time to complete, depending in large part on the ease or difficulty of the appraiser’s access to company information, and can cost tens of thousands of dollars (or even six figures) depending on the size and complexity of the business (and the sophistication and billing rates of the appraisal firm, which can vary widely).
In most instances, when the parties to an incipient business divorce “lawyer up,” the need for a full-blown appraisal can be too remote to justify the effort and expense. The dispute may settle without litigation or in the early stages of a litigation. Or sometimes the parties litigate the grounds for dissolution over a period of months or even years before a buyout remedy is ordered.
It’s in the initial stages of a business divorce that a “quick-and-dirty” appraisal can be most useful and cost effective. Continue Reading
For the second time, a unanimous panel of the Manhattan-based Appellate Division, First Department, has upheld the pretrial dismissal of an action for judicial dissolution of a limited liability company under Section 702 of the LLC Law where the petitioning minority member based the claim solely on allegations of “oppressive” conduct by the majority member.
The first time was about two years ago, in Doyle v Icon, LLC (103 AD3d 440), in which the First Department reversed a lower court’s denial of a motion to dismiss a § 702 petition alleging that the controlling members had “systematically excluded” the minority member from the LLC’s business operations and profits. The court held that such allegations “are insufficient to establish that it is no longer ‘reasonably practicable’ for the company to carry on its business, as required for judicial dissolution under Limited Liability Company Law § 702.”
In so ruling the Doyle court adopted the standard for dissolution formulated in the Brooklyn-based Second Department’s landmark decision in the 1545 Ocean Avenue case, requiring a showing that, in the context of its operating agreement, the LLC’s stated purpose can no longer be achieved or that it is financially unfeasible. Justice Austin’s opinion in that case carefully differentiated the grounds for dissolution under LLC Law § 702 from those under Article 11 of the Business Corporation Law including the latter’s statute authorizing dissolution for “oppressive” conduct by the controlling shareholders and directors.
The First Department did it again last week in a case called Barone v Sowers, 2015 NY Slip Op 04195 [1st Dept May 14, 2015], involving a complaint brought by a 20% member of a single-asset realty holding LLC against the 80% member, alleging a series of derivative claims alongside a claim for dissolution under § 702. The unanimous appellate panel affirmed the lower court’s decision by Justice Eileen Rakower dismissing the dissolution claim and also dismissing the derivative claims for failure to adequately allege that pre-suit demand was excused. Continue Reading
I recently had a fair value appraisal hearing at which the opposing business valuation expert’s report and testimony in support of his proposed percentage discount for lack of marketability (DLOM) relied heavily on the percentages used in a number of reported court decisions in other cases. The reported cases were selected and supplied to the expert by the retaining counsel. The expert made no effort to draw meaningful comparison between the facts and circumstances concerning the subject company and the companies involved in the other cases. Indeed, some of the decisions in the other cases shed little if any light on the factors or methodology underlying the DLOM accepted by the court.
Should business appraisers rely on case precedent in determining discounts?
Not according to the IRS, one of whose many jobs is to review and sometimes challenge the marketability (and other) discounts reflected in estate and gift tax returns valuing interests in family limited partnerships and other closely held business entities.
In 2009, the IRS issued for its own internal use a 111-page paper called Discount for Lack of Marketability Job Aid for IRS Valuation Professionals (available online here). The DLOM Job Aid subsequently went public and serves as an important resource for business appraisers and lawyers involved in business valuation matters in which the applicable standard and level of value warrant consideration of a marketability discount. As regular readers of this blog know, DLOM often can be the single most contentious issue in fair value proceedings in the New York courts resulting from dissenting and oppressed minority shareholder lawsuits.
The DLOM Job Aid’s Executive Summary describes its overall purpose thusly: Continue Reading
Viewing the arc of Delaware Chancery Court jurisprudence over the last two decades implementing that state’s Limited Liability Company Act, and witnessing the Delaware legislature’s frequent amendments to the statute in reaction to judicial developments, you can’t help but detect a pattern of maintaining the unique attributes of the Delaware LLC, as compared to other forms of business entity, by:
- rigorously promoting freedom of contract (in the form of the LLC agreement) and its corollary, “you made your bed now lie in it”;
- deciding internal governance disputes within the bounds of the interplay of the Delaware LLC Act’s default rules and the LLC agreement; and
- strongly disfavoring judicial intervention based on open-ended notions of fairness (the main exception being when managers take on fiduciary duties by agreement or by default under the statute).
Stated simply, in Delaware certainty trumps indeterminacy.
Well, not always, as seen in a first-impression ruling last week by Vice Chancellor J. Travis Laster in In re Carlisle Etcetera LLC, C.A. No. 10280-VCL (read here), in which the court held that the assignee of an LLC membership interest, who as a non-member and non-manager lacked standing to seek involuntary dissolution under Section 18-802 of the Delaware LLC Act, nonetheless had standing to seek equitable dissolution under the Chancery Court’s common-law authority as a court of equity. Continue Reading