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NY Business Divorce

Information on Dissolution and Other Disputes Among Owners of New York Corporations, LLCs and Partnerships

Zelouf (Part Two): Fair Value Ruling Addresses Range of Issues

Posted in Buyout, Derivative Actions, Valuation, Valuation Discounts

Last week’s post gave the factual and procedural background of the Zelouf case, summarized Justice Kornreich’s decision awarding the 25% dissenting minority shareholder $2.2 million for the fair value of her shares and another $2.2 million damages for her “quasi-derivative” claims, and then focused on the court’s rejection of a discount for lack of marketability. If you haven’t already read last week’s post, I recommend you do so before continuing with this one.

In this Part Two, I’ll highlight a number of other, interesting issues addressed in Zelouf of importance both to business divorce lawyers and business appraisers.

Court Adopts ”No-Burden” Approach

Justice Kornreich’s decision at pages 6-9 offers a useful summary of the legal standard for determining fair value in a dissenting shareholder appraisal proceeding under Section 623 (h) of the Business Corporation Law, including a brief discussion of burden of proof. Noting that New York’s highest court never has addressed the issue, the court adopted the “no-burden” approach proposed by the parties and supported by former Justice Stephen Crane’s analysis in Matter of Cohen, 168 Misc 2d 91 [Sup Ct, NY County 1995], aff’d, 240 AD2d 225 [1st Dept 1997], under which, as Justice Kornreich put it, “the court will consider the parties’ expert testimony as persuasive evidence of fair value, but, at the end of the day, and even if the court finds neither expert to be persuasive, it is the court’s burden to make a fair value determination.” As to the quasi-derivative claims for corporate looting and waste, however, Justice Kornreich stated that the dissenting shareholder, Nahal, “still has the burden of proof . . . but the impact of such claims on the value of the company, if proven, will be decided by the court under the no-burden approach.” Continue Reading

Zelouf (Part One): Marketability Discount Rejected in Fair Value Proceeding

Posted in Dissenting Shareholder Appraisal, Family-Owned Businesses, Freeze-Out Merger, Valuation, Valuation Discounts

A year ago I wrote about a novel ruling by Manhattan Commercial Division Justice Shirley Werner Kornreich permitting the majority owners of a family-owned textile business to proceed with a freeze-out merger on the eve of trial of a 25% shareholder’s derivative lawsuit, where the avowed purpose of the merger was to strip the minority shareholder of standing to pursue her derivative claims. Key to the ruling were (1) the parties’ stipulation that, in any subsequent dissenting shareholder appraisal proceeding, the minority shareholder’s multi-million dollar claims of corporate waste and self-dealing by the controlling shareholders could be factored into the court’s appraisal, and (2) the inclusion in such appraisal of the minority shareholder’s legal fees in the terminated derivative action, assuming she prevailed in establishing her claims of waste and self-dealing.

The contemplated appraisal proceeding materialized after the minority shareholder rejected the corporation’s offer of $1.5 million for the statutory “fair value” of her 25% stake. A bench trial was held before Justice Kornreich over 11 days between March and July 2014. Last week, Justice Kornreich released her 32-page decision in Zelouf International Corp. v Zelouf, 2014 NY Slip Op 51462(U) [Sup Ct, NY County Oct. 6, 2014], fixing the fair value of the 25% stock interest at $2.2 million and awarding additional “damages” of another $2.2 million on the “quasi-derivative” claims for waste and self-dealing. The court also awarded the former minority shareholder her attorney’s and expert’s fees in both the appraisal proceeding and the prior derivative action, the calculation of which Justice Kornreich referred to a Special Referee to hear and report. The anticipated fee award plus pre-judgment interest likely will add millions more to the ultimate judgment against the company.

Zelouf tells a fascinating if not atypical tale of a highly profitable family-owned business run by second-generation owners whose internecine warfare and financial abuses led to years of bitter litigation. It also raises a number of interesting issues surrounding appraisal proceedings, including burden of proof, tax affecting, the discount for lack of marketability (DLOM), control premiums, and the inclusion of “quasi-derivative claims.” In this post, I’ll give the factual and procedural background of the case, followed by discussion of the opinion’s headline-grabbing issue, namely, Justice Kornreich’s rejection of any DLOM. Next week I’ll highlight the remaining issues of interest. Continue Reading

Understanding Standing in Corporate Dissolution Cases

Posted in Standing

The rules of standing to seek judicial dissolution of closely held New York business corporations can be confusing. Correction: they are confusing.

Here I’m not referring to disputes over whether someone is a shareholder at all, or holds a specific percentage. I’ve posted many an article on this blog about dissolution cases in which the petitioner’s stock ownership was challenged for lack of documentation and/or as inconsistent with the entity’s organic instruments, tax returns and other business records.

Rather, I’m referring to the statutory criteria for standing and the judicial application of those criteria to situations in which a challenge is raised concerning whether a particular, otherwise-uncontested ownership interest confers eligible holder status as to the entity whose dissolution is sought.

Let’s start with the statutes.

Section 1104 of the Business Corporation Law.  This statute authorizes a petition for judicial dissolution based on director or shareholder deadlock and internal dissension brought by “the holders of shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors.” Note that the statute requires the petitioner to own voting shares, and that it specifies a 50% voting interest — no more, no less. Continue Reading

You’re Fired! No, I’m Oppressed!

Posted in Grounds for Dissolution

Tom Rutledge (pictured) is an extraordinary combination of practicing lawyer, scholar, bar leader, lecturer, and prolific writer on business organizations. He’s a member of Stoll Keenon Ogden PLLC resident in its Louisville, Kentucky office and, among his many extra-curricular activities, is chair of the ABA Business Law Section’s Committee on LLCs, Partnerships and Unincorporated Entities. When Tom questions engrained notions about shareholder oppression in closely held businesses, people take notice.

I, for one, took notice of Tom’s thought-provoking article in the July-August 2014 issue of the Journal of Passthrough Entities entitled “Minority Shareholder Oppression? — The Problem is Not With the Answer But Rather With the Question.” Targeting legal doctrine that, Tom contends, improperly treats the majority’s termination of a minority shareholder’s at-will employment as an act of oppression, the article takes issue with what Tom calls the “classic prevailing analysis of shareholder oppression” under which courts are expected

to modify the contractual terms of the corporate form to create and enforce rights not afforded by the statute and not, as to the venture at hand, negotiated for and incorporated into the agreements comprising the venture.

In other words, the “classic formula under which the ‘oppression’ of minority shareholders and members is framed,” as Tom puts it, in the case of the terminated minority shareholder places the remedial cart before the rights-and-obligations horse. It does so, first, by failing to acknowledge the “separate and distinct” legal relationships that arise from the “corporate contract” as opposed to the “employment relationship” and, second, by encouraging ex-post judicial modification of the former by deeming oppressive conduct (i.e., termination of an at-will employee) that is fully sanctioned by the latter’s governing principles.  Continue Reading

Choose the Right Dissolution Statute for the Right Remedy

Posted in Buyout, Deadlock, Dissolution Basics, Grounds for Dissolution

Your client, a 50% shareholder of a New York close corporation, tells you that the business is in complete disarray due to irreconcilable disputes with the other 50% shareholder and that he believes the other shareholder has misappropriated the corporation’s assets and diverted business opportunities.

The client accepts your recommendation to bring a judicial dissolution proceeding. You review Article 11 of the Business Corporation Law before drafting the dissolution petition. You come across two dissolution statutes denominated § 1104 and § 1104-a. Section 1104, called ”Petition in case of deadlock among directors or shareholders,” confers standing on a 50% shareholder and, as the name straightforwardly suggests, authorizes a court to dissolve based on deadlock precluding board action or election of directors, or other “internal dissension” warranting dissolution.

Section 1104-a, with the more cryptic name, ”Petition for judicial dissolution under special circumstances,” confers standing on a shareholder with 20% or more of the corporation’s voting shares, and authorizes dissolution when the controlling shareholders or directors engage in “illegal, fraudulent or oppressive actions” against the petitioning shareholder, or have ”looted, wasted, or diverted” the corporation’s property.

You quickly realize that your 50% shareholder-client has standing to seek dissolution under both statutes. Which one should you choose? If you believe you have facts sufficient to obtain dissolution under one of them, is there any reason to consider the other? Can you choose both? Does it really matter?

It most certainly does matter, for a couple of reasons mainly having to do with the different remedies offered by the two statutes. Continue Reading

A Boost for Books-and-Records Proceedings

Posted in Access to Books and Records, Derivative Actions

Pity the poor books-and-records proceeding. Misunderstood. Neglected. Widely viewed among New York practitioners as an ineffective use of time and resources. Jealous cousin to its wildly popular Delaware counterpart.

That perception could start to change thanks to a decision last week by a Manhattan appellate panel in a shareholder books-and-records proceeding. Although the court’s ruling involves a public company, its liberalizing influence is bound to effect books-and-records proceedings involving closely-held business entities as well.

There are two sources of a shareholder’s right to gain access to corporate information: statute and common law. The New York statute, Business Corporation Law § 624, is nothing if not miserly. Under § 624 (b) and (e), a shareholder has the right upon written demand to examine minutes of shareholder meetings, the shareholder list, and the most recent annual and interim financial statements. That’s it. Not very useful if the shareholder wants detailed knowledge of the corporation’s decision-making, communications and financial transactions.

Then there’s the common-law right to inspect a corporation’s books and records, which is broader than the statutory right and can extend to all of the relevant corporation books and records. While it can be argued that the burden of pleading and proof differs depending upon whether the right to inspect is sought under the statute or common law, in either event, if the shareholder presents in good faith and shows a “proper purpose” for seeking the corporate records, the corporation resisting inspection must show the shareholder’s purpose is improper or is otherwise proceeding in bad faith. Continue Reading

Buy-Out Interruptus: Court Okays New Suit Five Years After Unconsummated Election to Purchase in Prior Dissolution Case

Posted in Access to Books and Records, Buyout, Derivative Actions, Dissolution Procedure, Standing

Minority Shareholder alleging oppressive acts by Majority Shareholder sues for judicial dissolution of ABC Co. under § 1104-a of the Business Corporation Law. Majority Shareholder elects to purchase Minority Shareholder’s shares under BCL § 1118, thereby converting the case to a valuation proceeding. After numerous adjournments, Minority Shareholder discharges his counsel and fails to appear at court conferences. The court marks the proceeding “off calendar” without prejudice to restore it by motion. Minority Shareholder never moves to restore. The buy-out never takes place.

Several years later, during which Minority Shareholder has had no involvement in ABC Co.’s business, up pops a new lawsuit by Minority Shareholder, not for dissolution but, rather, asserting individual and derivative claims against Majority Shareholder for taking excessive compensation and seeking damages for breach of shareholders’ agreement and to recover Minority Shareholders’ ongoing percentage of profits. Majority Shareholder opposes the new lawsuit, contending that Minority Shareholder ceased being a shareholder of ABC Co. upon the Majority Shareholder’s election to purchase years earlier in the dissolution case, and that Minority Shareholder’s sole remedy is to pursue the buy-out in that prior proceeding.

Is Minority Shareholder still a shareholder of ABC Co. with the right to assert shareholder claims in the new action, or is he limited to a buy-out remedy in the prior dissolution proceeding? Should the court grant Majority Shareholder’s dismissal motion based on the pendency of the prior dissolution proceeding? Continue Reading

Hot Topics in Business Divorce

Posted in Compulsory Buyout, Corporate Governance, Deadlock, Foreign Business Entities, Freeze-Out Merger, LLCs, Valuation Discounts

What are the current, hot topics in the law of business divorce? I’ve been thinking about this in preparation for a speaking engagement later this month, and thought I’d preview my choices for the hot-topic list in the hope that some interested readers might offer their own ideas about unsettled areas of the law governing dissolution cases and other types of disputes among co-owners of closely held business entities.

Not surprisingly, a majority of the topics I’ve come up with concern limited liability companies, which first came into being in New York in 1994. Case law applying the LLC Law got off to a tepid start — it wasn’t until 2010 that an appellate court authoritatively construed LLC Law § 702 governing judicial dissolution — but the pace of court decisions concerning LLCs has quickened in recent years as the LLC slowly but surely has supplanted the traditional business corporation as the preferred form of entity for privately-owned companies.

So, without further ado, here’s my list of hot topics in business divorce:

Equitable Buy-Out in LLC Dissolution Cases.  In contrast to oppressed minority shareholder dissolution petitions involving closely-held corporations (see Business Corporation Law § 1118), the LLC Law has no provision authorizing courts to compel a buy-out of the complaining or respondent LLC members as a remedy in judicial dissolution cases brought under LLC Law § 702. There nonetheless have been several appellate decisions affirming or ordering a compulsory buyout as an “equitable” remedy, of which the most notable is the Second Department’s 2013 ruling in Mizrahi v. Cohen where the court compelled a buy-out requested by the petitioner of the respondent member’s 50% interest. These few cases, each involving their own, peculiar set of facts, provide little guidance as to the circumstances under which courts will or won’t grant an equitable buy-out, or as to the interplay between equitable buy-out and LLC agreements that may limit dissolution remedies. It also remains to be seen whether buy-out awards in LLC cases will be based on the fair value standard used in statutory buy-outs of oppressed minority shareholders. Continue Reading

Court Puts LLC Out of Its Misery, Contractually

Posted in Dissolution Basics, Grounds for Dissolution, LLCs, Operating Agreement

You know something’s seriously wrong with an LLC when the members can’t even agree on its name.

In a decision earlier this month by Suffolk County Commercial Division Justice Thomas F. Whelan, in Flax v Shirian, 2014 NY Slip Op 51229(U) [Sup Ct, Suffolk County Aug. 15, 2014], the court mercifully decreed death for a hopelessly dysfunctional, multi-member real estate holding company identified by one side as 27th Street Associates, LLC, by the other side as 27th Street, LLC, and in the property deeds and records of the New York Department of State, as 27 Street LLC.

But the name was the least of it. The LLC, formed in 2005, the following year invested over $4 million to acquire a tract of real property in Long Island City for the purpose of developing it with condominium housing. Eight years later, amidst a red-hot real estate market, nothing’s been built, there are two pending lawsuits among the members, one of the two, defined membership groups in the LLC itself has fallen into disarray, and all attempts at buy-out have failed.

You might think such are the ingredients for a successful petition for judicial dissolution of the LLC under Section 702 of the LLC Law, which authorizes the court to compel dissolution “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” But, although requested in Flax, Justice Whelan determined that court-ordained dissolution under § 702 was unnecessary because the circumstances triggered a contractually-required dissolution under the provisions of the operating agreement. Continue Reading

Summer Shorts: Director Removal and Other Recent Decisions of Interest

Posted in Arbitration and Mediation, Corporate Governance, Dissolution Defenses, Dissolution Procedure, Expulsion and Removal, Standing

They say this summer has been unusually cool in the Northeast, but it’s been a hot one for business divorce litigation, judging from the number of recent court decisions involving various and sundry disputes among co-owners of closely held businesses. So, once again, it’s time for my annual summertime post featuring a few, short summaries of recent decisions of interest in business divorce cases.

First, we’ll look at a decision by Justice Melvin Schweitzer in a battle between 50/50 ownership factions over control of an international translation services company with over 3,000 employees. Next up is Justice Carolyn Demarest’s ruling denying a change of venue in a corporate dissolution case. Last is a decision by Justice Marcy Friedman in which she addressed an interesting statute of limitations defense in a drawn-out dissolution case.

Shareholder of Parent Corporation Has Standing to Sue Derivatively to Remove Subsidiary’s Director But Not for Dissolution

Elting v Shawe, 2014 NY Slip Op 32126(U) [Sup Ct, NY County July 24, 2014]. It’s not everyday you encounter business divorce litigation on the scale of this case, involving a firm with over 3,000 employees and revenues over $350 million. The subject company is a closely held Delaware holding corporation owned 50/50 by two individuals who also comprise its two-director board, and its wholly owned New York subsidiary providing international translation services. One owner-director sued the other for alleged financial and management abuses, asserting direct and derivative claims seeking the defendant’s removal as an officer and director of the subsidiary under BCL §§ 706 (d) and 716 (c), and also seeking deadlock dissolution of the subsidiary under BCL § 1104 (a). Continue Reading