Appellate Court Affirms Caplash Ruling Rejecting Authority of 50% LLC Member to Hire Company Counsel in Proceedings Against Other 50% Member
The fascinating case of Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC, involving a multi-faceted litigation between 50-50 members of a dental surgery practice, was fodder last year for several appellate and trial court decisions which in turn were fodder for several posts on this blog (see here, here and here). In what likely is the case's last hurrah, the Appellate Division, Fourth Department, earlier this month affirmed a series of trial court rulings by Monroe County Commercial Division Justice Kenneth R. Fisher including orders upholding the plaintiff's standing to seek dissolution and granting dissolution based on deadlock.
The threshold issue in the case was whether an attorney hired by the defendant 50% member, Dr. Mohammed Salahuddin, had authority under the operating agreement (a) to accept on the company's behalf a letter of resignation from the plaintiff Dr. Jolly Caplash, and (b) to assert counterclaims in the LLC's name against Dr. Caplash. If the attorney had authority to accept the resignation letter, which in turn depended on which of the two doctors held the office of President in the aftermath of a June 2007 member meeting, Dr. Caplash's membership was terminated and he lacked standing to seek dissolution.
In February 2008, the Fourth Department ruled that the issue could not be resolved without a trial of disputed factual issues. In a May 2008 mid-trial decision, Justice Fisher dismissed the counterclaims brought against Dr. Caplash in the LLC's name, concluding that even if Dr. Salahuddin was President of the LLC with general authority to hire company counsel, he had no authority to hire company counsel to prosecute an action against a co-equal 50% member. Justice Fisher's June 2008 post-trial decision found that Dr. Caplash held the President's office and, therefore, the attorney hired by Dr. Salahuddin had no authority to accept Dr. Caplash's resignation letter on the company's behalf which left intact the latter's entitlement to judicial dissolution of the deadlocked company.
Continue Reading...Appellate Ruling in Stock Valuation Case Further Muddies the Marketability Discount Waters
In determining the fair value of corporate shares, should the discount for lack of marketability (DLOM) apply only to the company's good will value, or to the entire enterprise value including tangible assets? Court decisions in New York tend to apply DLOM in the 25% range, so the answer can make a big difference in the ultimate award, particularly when the business is asset-heavy.
I've written before (read here) about conflicting case precedents in the Manhattan-based First Department (DLOM applies to enterprise value) and the Brooklyn-based Second Department (DLOM applies to good will value). Permit me to quote from that prior post, where I wrote:
With locked horns in the two downstate appellate departments, and no decisions on the subject from the two upstate appellate departments, it'll likely take some yet-to-be-born big-money valuation case to wend its way up to New York's highest court, the Court of Appeals, before we get a definitive answer.
Well, we still don't have a definitive answer from the Court of Appeals, but we do have a new decision on the subject from one of the upstate departments. The result aligns the Rochester-based Fourth Department with the First Department (DLOM applies to enterprise value), but the decision offers no analysis and, if anything, further muddies the DLOM waters.
Continue Reading...Appellate Rulings Clash Over Subject Matter Jurisdiction to Dissolve Foreign Business Entities
The Appellate Division, Second Department, last week issued a decision in a dissolution proceeding involving a New York-based Delaware limited liability company (LLC) in which it broadly pronounced that New York courts lack subject matter jurisdiction in such cases. The decision in Matter of HMS Venture Management Corp. (UtiliSave, LLC), 2009 NY Slip Op 04906 (2d Dept June 9, 2009), agrees with an appellate ruling two years earlier by the Third Department, also involving the requested dissolution of a Delaware LLC, in Rimawi v. Atkins, 42 AD2d 799, 840 NYS2d 217 (3d Dept 2007).
HMS and Rimawi both rely on precedents in which New York courts dismissed petitions seeking dissolution of foreign business corporations based on the hoary internal affairs doctrine under which courts traditionally declined to exercise jurisdiction where the determination of the rights of the litigants involves regulation and management of the internal affairs of a foreign corporation. What makes things particularly interesting, however, is a 1994 appellate decision by the Manhattan-based First Department, in Matter of Hospital Diagnostic Equipment Corp., 205 AD2d 459, 613 NYS2d 884 (1st Dept 1994), where that court expressly rejected the argument, made by no less a personage than the state Attorney General, that New York courts lack subject matter jurisdiction to dissolve foreign corporations.
Let's first look at HMS. The subject Delaware LLC, called UtiliSave, operates in New Rochelle, New York, where it audits utility bills and usage of corporate clients. Its only connection to Delaware is its legal formation there. In 2007, 40% member and co-manager MHS Venture filed a petition to dissolve UtiliSave in Westchester County Supreme Court. Its petition sought dissolution under the terms of the operating agreement, allegedly based on the company's failure to make certain distributions, and on the statutory ground that it was no longer reasonably practicable to carry on the business in conformity with the operating agreement. It's unclear whether the petition invoked statutory dissolution under Section 702 of the New York LLC Law or under Section 18-802 of the Delaware LLC Act or both.
Continue Reading...Court Grants 50% LLC Member's Petition for Judicial Dissolution of Passive Holding Company
A recent decision by New York County Commercial Division Justice Bernard J. Fried addresses issues of interest concerning (a) the standing of an assignee of a member's economic interest to seek judicial dissolution of an LLC, and (b) grounds for dissolution of a two-member, 50-50 LLC that functioned as a holding company for a non-managing minority interest in another company.
The memorandum decision in Matter of Cline (Private Capital Management, LLC), Index No. 650117/09 (Sup Ct NY County May 29, 2009), grows out of a mega-lawsuit started by Ficus Investments, Inc. (Ficus) against Thomas Donovan, Lawrence Cline and Private Capital Management, LLC (PCM). PCM, a New York LLC co-owned 50-50 by Donovan and Cline, was the managing 20% member of a Florida LLC called Private Capital Group, LLC (PCG) that purchased, managed and sold non-performing mortgages. Ficus, which invested $300 million in the venture, held the remaining 80% interest. In 2007, Ficus terminated PCM as PCG's manager and brought suit against it along with Donovan and Cline allegedly for misappropriating over $20 million.
Early on Cline settled with Ficus and entered into a cooperation agreement as part of which he conveyed to a Ficus-owned entity called PCM Interest Holding, LLC (Holding) all of Cline's economic interest in PCM and his irrevocable voting proxy. Meanwhile, amidst burgeoning litigation proceedings between Donovan and Ficus, in April 2008 Justice Fried ruled that Donovan was entitled to advancement of his legal expenses under PCG's operating agreement. Ficus's appeal from that ruling was rejected in January 2009 (read here my post on the appellate ruling). In February 2009, Justice Fried also granted PCM's motion for advancement of its legal expenses. As part of the same ruling, Justice Fried denied without prejudice a procedurally defective cross-motion by Ficus and nominal defendant Cline seeking judicial dissolution of PCM (read here my post on that ruling).
Continue Reading...Can Corporate Dissolution Proceedings Be Brought in Federal Court?
This month's Business Valuation Update includes a lengthy analysis of a recent stock valuation decision in a high-stakes corporate dissolution case, Kaplan v. First Hartford Corp., 2009 WL 737681 (D. Me. Mar. 20, 2009), brought by an oppressed minority shareholder of a Maine corporation that developed, owned and operated strip malls. The court, which had to contend with three different expert appraisals that came in $9 million at bottom and $48 million at top, valued the entire enterprise at $15 million based on "Pink Sheets" market trades adjusted -- as required by Maine's buyout statute -- to exclude any minority and marketability discounts. The decision is well worth the read for students of the art of stock valuation, but that's not what I want to address here. Rather, what I find most interesting about the case is who decided it: a federal judge.
Why is that interesting? The federal courts have two basic sources of subject matter jurisidiction: (1) the case involves a federal question, meaning the complaint asserts claims arising under federal statute or the U.S. Constitution, and (2) diversity of citizenship, meaning in most cases that the plaintiffs and defendants are citizens of different states. The typical case seeking judicial dissolution of a state-chartered corporation seeks state law remedies solely, which leaves diversity of citizenship as the only possible avenue to bring a corporate dissolution case in federal court.
Fiduciary Breach Can Result in Shareholder Oppression, But Is Shareholder Oppression a Breach of Fiduciary Duty?
A recent Northern District New York federal court decision (HT Eric Fryar) caught my eye when I read a passage explaining the court's reasons for denying a motion to dismiss a plaintiff's claim against fellow shareholders for breach of fiduciary duty. The court in Rusyniak v. Gensisi, 2009 WL 1269911 at *14 (NDNY May 5, 2009), starts off simply enough, with the observation that the relationship between shareholders in closely held corporations is a fiduciary one. In the next sentence, the court writes:
More specifically, it "is the fiduciary duty owed by . . . majority shareholder[s] in a closely held corporation to a minority shareholder, not to engage in oppressive actions toward minority shareholders." (Italics added.)
The internal quote is from McCagg v. Schulte Roth & Zabel LLP, 20 Misc 3d 1139(A) (Sup Ct NY County Aug. 1, 2008). Both Rusyniak and McCagg cite the New York Court of Appeals' seminal decision in Matter of Kemp & Beatley, 64 NY2d 63, 73 (1984), construing the term "oppressive action" as used in the judicial dissolution statute, Section 1104-a of the Business Corporation Law, to mean "majority conduct [that] substantially defeats expectations [of the minority shareholder] that, objectively viewed, were reasonable under the circumstances and were central to the petitioner's decision to join the venture."
There are many cases in which courts have found that majority shareholder conduct constituting breach of fiduciary duty -- be it self dealing or theft of corporate opportunity or other "classic" violations of the duties of loyalty and care meant to squeeze out the minority shareholder -- satisfies the reasonable-expectations test of oppression. But, is the opposite true? Does proof of oppression constitute breach of fiduciary duty, as Rusyniak suggests?
Continue Reading...Court Orders Hearing On Minority Shareholder's Petition for Common Law Dissolution
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UPCOMING CLE PROGRAM ON LIMITED LIABILITY COMPANIES On Thursday, May 21, 2009, I'll be speaking about LLC dissolution at a CLE program sponsored by the Queens County Bar Association. I'll be joined by attorney and author Michele Santucci who'll speak on LLC origins, choice of entity and organizational issues. It's a two-hour evening program (6 p.m. to 8 p.m.) with light dinner available starting at 5 p.m. For more details and registration, click here. Hope to see you there! |
Minority shareholders in closely held New York corporations, unlike many other states, must hold at least 20% of the corporation’s voting shares to petition for judicial dissolution on grounds of oppression under Section 1104-a of the Business Corporation Law. There’s little if any legislative history to explain the arbitrary 20% threshold. I imagine it was included as a compromise to satisfy legislators opposed to judicial interference with traditional corporate majority rule.
Shareholders with less than 20%, and without any claim for breach of shareholders' agreement, have limited options to right perceived wrongs by the controlling shareholders. They may bring a derivative action under BCL Section 626 for corporate waste, diversion of assets or other wrongs causing injury to the corporation, but first they either must make proper demand upon the board of directors or demonstrate demand futility. BCL Section 627 also requires a derivative plaintiff-shareholder with less than a 5% interest to give security for the corporation's costs including legal expenses. Furthermore, depending on the circumstances, commencing a plenary action for breach of shareholders' agreement or asserting derivative claims for recovery on the corporation's behalf may not provide sufficient leverage to induce a buy-out of the plaintiff's shares, assuming the plaintiff is pursuing an exit strategy.
The below-20% shareholder has one other option: common law dissolution. It carries no minimum ownership percentage. It's harder to establish than statutory oppression under BCL 1104-a, and rarely successful, but under the right circumstances it may give such a shareholder at least a toe-hold toward dissolution, which also may be enough to induce serious buy-out negotiations.
A recent decision by Queens County Commercial Division Justice Orin R. Kitzes presents one of the relatively rare instances in which a claim for common law dissolution successfully advances past the pleading stage. The case, Matter of Mouzakitis (Pearl Nightlife, Inc.), Index No. 28420/08 (Sup Ct Queens County Feb. 24, 2009), was previously featured on this blog when the court initially dismissed without prejudice a common law dissolution petition because the plaintiff's husband, who co-owned the shares as tenants by the entirety, was not a party to the action. Husband and wife thereafter filed a new action as co-plaintiffs, again suing for common law dissolution.
Continue Reading...Mediation and Business Divorce: Interview with Mediator Leona Beane
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UPCOMING CLE PROGRAM ON LIMITED LIABILITY COMPANIES On Thursday, May 21, 2009, I'll be speaking about LLC dissolution at a CLE program sponsored by the Queens County Bar Association. I'll be joined by attorney and author Michele Santucci who'll speak on LLC origins, choice of entity and organizational issues. It's a two-hour evening program (6 p.m. to 8 p.m.) with light dinner available starting at 5 p.m. For more details and registration, click here. Hope to see you there! |
In last week's post, entitled "Winning the Dissolution Battle, Losing the War," I wrote about two cases in which business partners remained locked in protracted litigation even after one side's gambit for dissolution failed. I was very pleased to get an email from Leona Beane who read the post and commented, "Your ending statements refer to both situations with utter gloom and despair. It's a perfect segue-way into describing the benefits of mediation as an alternative."
Leona Beane, you see, is a former law professor turned full-time mediator/arbitrator based in New York City. I first met her when she was assigned by the court as mediator in a difficult business divorce case of mine pitting sibling against sibling. Much to my surprise, the case settled after a long day of candid dialog led by Leona.
I've long thought that mediation is under-utilized in business divorce matters. So inspired by Leona's email, I decided to ask her some questions about mediation in general, and about mediating business divorce cases in particular. I think you'll find her answers enlightening.
PM: I find that many people are unfamiliar with mediation. How do you describe it?
Continue Reading...Winning the Dissolution Battle, Losing the War
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UPCOMING CLE PROGRAM ON LIMITED LIABILITY COMPANIES On Thursday, May 21, 2009, I'll be speaking about LLC dissolution at a CLE program sponsored by the Queens County Bar Association. I'll be joined by attorney and author Michele Santucci who'll speak on LLC origins, choice of entity and organizational issues. It's a two-hour evening program (6 p.m. to 8 p.m.) with light dinner available starting at 5 p.m. For more details and registration, click here. Hope to see you there! |
Most business divorce litigation involving closely held companies results either in a buyout of one party by the other, or the two sides dividing the remaining assets and going their separate ways.
The biggest problem getting to the buyout is the absence of a public market to establish the value of the interest being acquired, particularly when dealing with a non-controlling interest in a sales or services-based operating company. The buyer and seller, even when advised by qualified business appraisers, can be light years apart on price due to different assumptions about a host of valuation inputs some of which necessarily require subjective analysis.
Splitting up the business can be very easy or very difficult, depending on the specifics of the business. It tends to be more difficult when there is value associated with the defunct company's name or other such intangible good will value at the enterprise level (as opposed to personal good will that follows the individual business partner wherever he or she goes).
Litigation means time, expense and uncertainty, all of which can jeopardize the potential benefits of an eventual buyout or business split-up. It is difficult for the controlling owner to invest and make business plans while under the cloud of a prospective buyout of uncertain magnitude. The risks can be even greater in a split-up scenario for business partners who, perhaps as a matter of business survival, begin taking unilateral and sometimes surreptitious steps at odds with each other, designed to retain for themselves the loyalty and business of key customers and vendors.
These ruminations, and the title of this post, are inspired by recent decisions in two cases in which business partners remain locked in protracted and undoubtedly expensive litigation even after one side's initial attempt to achieve judicial dissolution became moot.
Continue Reading...Pay Attention to the Latent Power of Corporate Bylaws
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UPCOMING CLE PROGRAM ON LIMITED LIABILITY COMPANIES On Thursday, May 21, 2009, I'll be speaking about LLC dissolution at a CLE program sponsored by the Queens County Bar Association. I'll be joined by attorney and author Michele Santucci who'll speak on LLC origins, choice of entity and organizational issues. It's a two-hour evening program (6 p.m. to 8 p.m.) with light dinner available starting at 5 p.m. For more details and registration, click here. Hope to see you there! |
The lead-up to business divorce litigation is a tense pas de deux in which, once the dispute reaches critical mass, the two sides "lawyer up" and begin tactical maneuvers to best position themselves for the coming court battle. Sometimes the maneuvering consists of a series of back-and-forth letters between the lawyers staking out their positions and attacking the other's. Especially when one faction owns a controlling interest in the company, the maneuvering also may include formal meetings of the shareholders or the corporation's board of directors (or members/managers in the case of an LLC) to authorize actions adverse to the non-controlling faction.
Never mind that the owners never once held a formal meeting or kept minutes or adopted written resolutions since the day the corporation was formed. Never mind that the corporate kit, containing the organizational documents, stock ledger and certificates, has been sitting untouched, gathering dust since day one.
Among the likely neglected documents in the corporate kit are the corporation's bylaws. Bylaws are to be distinguished from the shareholders' agreement. The latter typically sets forth the stock interests of the individual shareholders, designates directors and officers, and contains restrictions on the transfer of shares, among other provisions. In contrast, think of bylaws as the corporation's operating system, consisting of internal rules not specific to any named individuals, governing such matters as quorum and notice requirements for meetings of the shareholders and board of directors; procedures for the election and replacement of directors; the number and term of directors; and the titles and duties of the corporation's officers. Section 601 of the Business Corporation Law mandates the adoption of bylaws by the incorporators at the initial organization meeting required under BCL Section 404.
I can't say whether all the parties and counsel in Matter of McDaniel (162 Columbia Heights Housing Corp.), 2009 NY Slip Op 29047 (Sup Ct Kings County Feb. 3, 2009), were cognizant of the bylaws as they maneuvered prior to commencement of dissolution proceedings. I can say that the bylaws played a dispositive role in the court's determination of their preliminary dispute over a certain stock transfer involving shares of a residential co-operative corporation.
Continue Reading...