Header graphic for print

NY Business Divorce

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

Take the 50% Shareholder/Dissolution Pop Quiz!

Posted in Common Law Dissolution, Deadlock, Dissolution Basics, Standing

Ready to take a pop quiz? Here we go:

  1. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under the deadlock statute, Business Corporation Law § 1104?  __ Yes  __ No
  2. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under the oppressed shareholder statute, Business Corporation Law § 1104-a?  __ Yes  __ No
  3. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under common law?  __ Yes  __ No
  4. Can a 50% shareholder of Company A, who also is a director of Company B in which Company A holds a majority interest, petition for judicial dissolution of Company B under common law?  __ Yes  __ No

Let’s see how you did. If you answered “Yes” to #1, you’re right. But that was easy. Without even looking at the statute, BCL § 1104, logic tells you that a shareholder who possesses half the available voting power — that is, not enough to secure majority approval for shareholder or board action but enough to block the other 50% shareholder from doing the same — should be able to seek dissolution where deadlock results from disagreement with the other 50% shareholder. Continue Reading

“Jerk Insurance” Takes on New Meaning in Buyout Dispute

Posted in Accountants/Experts, Advancement and Indemnification, Buyout

Despite its pejorative-sounding name, “jerk insurance” — it’s more vulgar name is “schmuck insurance” — can serve a useful purpose in addressing a business owner’s concern about looking, well, like a jerk by selling his or her equity stake to a co-owner who then turns around and sells the company or its assets to an outside buyer at a much higher value. Basically it works by guaranteeing the seller additional monies in the event of a company sale within a defined post-buyout period, usually computed as a percentage of the net sale proceeds above a threshold value specified in the buyout agreement.

It’s a type of deal protection, for example, that would have avoided the seller’s remorse suffered by the unsuccessful plaintiffs in the well-known New York case, Pappas v Tzolis, who sold their majority stake for $1.5 million to the minority owner who, within months, sold the company’s sole asset to a third party for $17.5 million.

I can’t cite statistics, but I’d venture to say the great majority of buyers who are willing to give jerk insurance do so because they have no intention of selling the company within the defined post-buyout period. In that sense it’s giving away ice in winter, but it nonetheless can facilitate the buyout agreement by giving additional comfort to the seller that he or she is not losing out on a better deal the buyer may already have lined up to sell the company.

All of which makes all the more unusual and instructive the recently decided case of Charron v Sallyport Global Holdings, Inc., Opinion and Order, 12-cv-06837 [SDNY Dec. 10, 2014], in which one 50% shareholder bought out the other 50% shareholder for almost $41 million pursuant to a buyout agreement with a jerk insurance provision setting a $65 million threshold and, in the event of a company sale within the following year, giving the seller 20% of the entire proceeds of the sale rather than 20% of the difference between the threshold and the sale price. Continue Reading

Court Declines Jurisdiction Over Claim for Common-Law Dissolution of Delaware Corporation

Posted in Common Law Dissolution, Delaware, Foreign Business Entities

“[T]he Court concludes that it lacks subject-matter jurisdiction to dissolve a Delaware corporation, and thus dismisses the First Cause of Action.”

Sounds familiar? It should. The above ruling, found in Nassau County Commercial Division Justice Timothy S. Driscoll’s decision last month in Bonavita v Savenergy Holdings, Inc., Short Form Order, Index No. 603891-13 [Sup Ct Nassau County Dec. 8, 2014], adds to the growing list of cases in New York’s Second and Third Departments in which courts have declined subject-matter jurisdiction over claims for judicial dissolution of a foreign business entity. It also accentuates the schism, about which I’ve previously written, between decisions in those Departments and a smaller number of First Department rulings upholding jurisdiction in similar cases.

The plaintiffs in Bonavita, likely aware of the Second Department precedent stacked against them, took a somewhat different tack by asserting in their complaint’s First Cause of Action (read here) a claim for common-law dissolution of the subject Delaware corporation rather than a statutory claim for judicial dissolution under Article 11 of the Business Corporation Law. (Delaware has no statute authorizing judicial dissolution at the behest of a minority shareholder.) Continue Reading

Court’s Rejection of Marketability Discount in Zelouf Case Guided by Fairness, Not “Formalistic and Buzzwordy Principles”

Posted in Family-Owned Businesses, Valuation Discounts

The question is, will the Zelouf case prove to be an outlier or the beginning of a sea change in the way New York courts view the marketability discount in fair value proceedings?

Last October I wrote about Zelouf Int’l Corp. v Zelouf, an important post-trial decision in which, among other significant rulings, Manhattan Commercial Division Justice Shirley Werner Kornreich refused to apply a discount for lack of marketability (DLOM) in a statutory fair value proceeding triggered by a freeze-out merger of a family-owned business.

Justice Kornreich found the risk of illiquidity associated with the company ”more theoretical than real,” explaining there was little or no likelihood the controlling shareholders would sell the company, i.e, themselves would incur illiquidity risk upon sale. Imposing DLOM in valuing the dissenting shareholder’s stake, therefore, would be tantamount to levying a prohibited discount for lack of control a/k/a minority discount.

Within weeks of the decision, both sides filed motions for reargument seeking to vacate or modify various aspects of the court’s rulings. In a decision dated December 22, 2014 (read here), Justice Kornreich adhered to her prior rulings in all respects save one concerning the limitations period for the minority shareholder’s derivative claims.

Happily for us sideline observers, Justice Kornreich saw fit to revisit and expand upon her reasons for rejecting a DLOM given what she described as “New York’s contentious DLOM jurisprudence and the persuasive opinions of the academic community and non-New York courts.” Continue Reading

Top Ten Business Divorce Cases of 2014

Posted in Access to Books and Records, Annual Top 10 Cases, Buyout, Dissenting Shareholder Appraisal, Freeze-Out Merger, LLCs, Operating Agreement, Valuation, Valuation Discounts

I’m pleased to present my seventh annual list of the past year’s ten most significant business divorce cases. This year’s crop includes noteworthy rulings on a variety of issues in dissolution, appraisal, books-and-records, and other cases involving closely held corporations and limited liability companies. All ten were featured on this blog previously; click on the case name to read the full treatment. And the winners are:

  1. Zacharius v Kensington Publishing Corp., 42 Misc 3d 1208, 2014 NY Slip Op 50011(U) [Sup Ct, NY County Jan. 6, 2014], a lawsuit involving a family-owned publishing business in which Justice Eileen Bransten upheld a stock voting agreement that gave board control to the minority shareholders/step-children of the majority shareholder, although she allowed the majority owner’s suit to proceed on a claim challenging the authenticity of her late husband’s signature on the voting agreement.
  2. Pokoik v Pokoik, 115 AD3d 428, 2014 NY Slip Op 01502 [1st Dept Mar. 6, 2014], a first impression ruling in which the Appellate Division, First Department, in granting summary judgment against an LLC manager for breach of fiduciary duty, rejected the manager’s reliance on the safe-harbor provisions of LLC Law § 409.
  3. Mintz v Pazer, Decision and Order, Index No. 502127/13 [Sup Ct, Kings County Mar. 12, 2014], in which Justice David Schmidt enforced an unusual, “quick draw” buy-sell provision in the shareholders’ agreement of a real estate holding company owned 50/50 by two families, compelling a sale to the family that gave the first notice of purchase following unsuccessful mediation of a deadlock.
  4. JPS Partners v Binn, 2014 NY Slip Op 31204 [Sup Ct, NY County May 6, 2014], in which Justice Melvin Schweitzer held that the restructuring of an LLC, in which substantially all of its assets were transferred to a subsidiary, unintentionally triggered the LLC’s dissolution under a provision in the operating agreement.
  5. Budis v Skoutelas, Short Form Order, Index No. 702060/13 [Sup Ct, Queens County July 16, 2014], in which Justice Orin Kitzes held that the estate of a deceased LLC member had no standing to assert derivative claims on the LLC’s behalf.
  6. Retirement Plan for General Employees v McGraw-Hill Cos., 120 AD3d 1052, 2014 NY Slip Op 06154 [1st Dept Sept. 11, 2014], in which the Appellate Division, First Department, reversed the trial court’s ruling dismissing a books-and-records proceeding brought against McGraw-Hill, and held that the petitioning pension fund’s stated purpose of the requested inspection, to investigate the board’s oversight of McGraw-Hill’s subsidiary, Standard & Poor’s, was a proper purpose even if the inspection ultimately establishes that the board engaged in no wrongdoing.
  7. Zelouf International Corp. v Zelouf, 45 Misc 3d 1205(A), 2014 NY Slip Op 51462(U) [Sup Ct, NY County Oct. 6, 2014] [click here for Part 2], a post-trial ruling in a dissenting shareholder appraisal case in which, among other significant rulings, Justice Shirley Kornreich rejected a discount for lack of marketability and granted the petitioner a separate award on her quasi-derivative claims against the controlling shareholders.
  8. Ferolito v AriZona Beverages USA, LLC, 2014 NY Slip Op 32830(U) [Sup Ct, Nassau County Oct. 14, 2014], in which Justice Timothy Driscoll awarded close to $1 billion (that’s not a typo) to the 50% owner of the AriZona Iced Tea business in a fair value buy-out proceeding under BCL § 1118. The court’s many significant rulings included its sole reliance on the DCF method and its rejection of potential acquirers’ expressions of interest.
  9. Cortes v 3A N. Park Ave. Rest Corp., 2014 NY Slip Op 24329 [Sup Ct, Kings County Oct. 28, 2014], in which Justice Carolyn Demarest conditionally ordered the dissolution of a restaurant business from which the controlling shareholders were found to have skimmed about $3.7 million cash, unless they purchased the minority owner’s shares for about $1.2 million.
  10. Slayton v Highline Stages, LLC, 2014 NY Slip Op 24333 [Sup Ct, NY County Oct. 30, 2014], in which Justice Shirley Kornreich ruled that LLC Law § 407′s default rule, permitting members to act by written consents without a meeting, trumped the meeting requirement in LLC Law § 1002(c) governing member approval of mergers.

Two of the above cases — Ferolito and Zelouf — also made it onto the nationwide top-ten list published in the January 2015 issue of Business Valuation Update, the business valuation profession’s leading monthly newsletter.

Dissolution Battle Over Heavily Indebted Business Yields $1 Buy-Outs

Posted in Accountants/Experts, Buyout, Deadlock, Dissolution Basics, Valuation

I’ve often said that business owners don’t fight over corpses, meaning that no one in their right mind would incur the trouble and expense of bringing or contesting a judicial dissolution petition over a business that has no value.

Well, like most generalities, there are exceptions. Seven years ago, among this blog’s inaugural posts, I wrote about a Manhattan Supreme Court case called Matter of Giraud in which an allegedly oppressed minority shareholder petitioned under BCL § 1104-a for judicial dissolution of an art consignment business, the majority shareholder elected to buy him out under BCL § 1118, the majority shareholder’s unopposed appraisal expert testified that the indebted, money-losing business with a short remaining term on its lease had no positive value, and the court ordered the majority shareholder to tender a symbolic $1 to acquire the petitioner’s shares.

Now there’s another one. Earlier this month, in Matter of Markowitz, 2014 NY Slip Op 51739(U) [Sup Ct, Kings County Dec. 10, 2014], Brooklyn Commercial Division Presiding Justice Carolyn E. Demarest, citing the Giraud case, ordered the two respondent shareholders, who had elected to purchase the shares of the two petitioning shareholders, to pay the nominal sum of $1 to each of them. Easing the pain somewhat, Justice Demarest also ordered the purchasing shareholders to provide releases and an indemnification and hold harmless personal guarantee against any claims made against the petitioners relating to the business.   Continue Reading

LLC Subscription Agreement No Bar to Transfer of Membership Interest

Posted in Access to Books and Records, LLCs, Operating Agreement, Stock Transfer Restrictions

A Manhattan appellate panel’s two-page decision in Gartner v Cardio Ventures, LLC, 2014 NY Slip Op 07423 [1st Dept Oct. 30, 2014], offers a dry account of a disputed transfer of an LLC membership interest, in which the court held that the terms of an LLC subscription agreement did not bar the transfer otherwise permitted under the LLC Law’s default rules.

But the story behind the decision is anything but dry. As revealed in papers filed in the lower court proceedings, the suit was brought by the ex-husband of the transferee in an attempt to frustrate a Florida court’s final judgment of divorce, requiring him to transfer to his wife one half of his membership interest in a company that operates physical therapy offices at multiple New York locations. The judgment further provided that if the transfer couldn’t be done, the wife would receive the net economic benefits of the half-interest.

Soon after the divorce judgment was entered, the husband signed a court-approved transfer document instructing the LLC to transfer half his 4% interest to his wife. The other LLC members promptly executed a consent to the transfer, admitting the wife as a 2% member.

The now ex-husband, who had fiercely resisted the transfer in the Florida divorce proceedings and had signed the transfer directive under the court’s threat of contempt, subsequently filed suit in Manhattan Supreme Court against the LLC, its managers, and his ex-wife, claiming that the transfer was “unauthorized” and “illegal,” and should be rescinded, because of language in his LLC Subscription Agreement purportedly barring the transfer of membership interests. Continue Reading

Negotiating a Buyout? Don’t Overlook Taxes on Phantom Income

Posted in Attorney's Fees, Buyout, Phantom Income

Think of it this way: At every negotiation of a shareholder buyout involving an S corporation or other passthrough entity, there are three parties at the table — the seller, the buyer, and the IRS.

Why the IRS? The commonly understood answer, even to those lacking tax expertise, is the seller’s liability for capital gains tax on buyout proceeds in excess of the seller’s basis in the shares.

Less appreciated, especially to those without tax expertise, but potentially of equal or even greater financial impact, is the seller’s liability for ordinary income taxes on undistributed a/k/a phantom income that may be reported on his or her Form K-1 issued by the passthrough entity after the buy-out closes for a tax period that preceded the buyout. For this type of tax liability, think of the IRS as a tax allocator which, at the direction of the remaining shareholders who control the company’s tax reporting, will reduce some portion of their personal income tax liability by allocating undistributed net income to the selling shareholder who will be forced to pay ordinary income taxes on phantom income. While this also should reduce the seller’s capital gain on the sale by increasing basis in the shares, overall the seller loses because of the significantly higher tax rates on ordinary income versus capital gains.

This is a topic I’ve written about several times before, featuring cases in which the seller’s release barred a post-buyout suit seeking reimbursement for taxes on phantom income (read here) or where the seller relied unsuccessfully on tax provisions in the buyout agreement that didn’t support indemnification of taxes on phantom income (read here and here). Add to this collection a case decided last month by the Appellate Division, First Department, which handed the selling shareholder a double defeat by finding that his release barred his claim to recover taxes on phantom income and also ordering him to pay attorneys’ fees incurred by the corporation and its majority shareholder defending the seller’s suit under the buyout agreement’s indemnification provision. Sina Drug Corp. v Mohyuddin, 2014 NY Slip Op 07757 [1st Dept Nov. 13, 2014]. Continue Reading

Minority Shareholder’s Investigation of Management Misconduct is Proper Purpose for Books & Records Demand

Posted in Access to Books and Records

Are books-and-records proceedings on a roll?

Last September I wrote about an important appellate ruling that month in a books-and-records proceeding against the McGraw-Hill publishing company, in which the court held that the petitioning shareholder’s allegations of mismanagement and breach of fiduciary duty by board members constituted a proper purpose for the inspection demand, regardless whether the inspection ultimately establishes that no wrongdoing occurred. I referred to the ruling as a boost for New York’s under-utilized books-and-records proceeding under Section 624 of the Business Corporation Law, especially for minority shareholders of closely held corporations who, unlike shareholders in public companies with reporting duties, are sometimes shut out completely from any information concerning the company’s business dealings and financial affairs.

Sure enough, less than two months after the McGraw-Hill decision, Brooklyn Commercial Division Presiding Justice Carolyn E. Demarest cited it as precedent for her ruling in Novikov v Oceana Holdings Corp., 2014 NY Slip Op 24332 [Sup Ct, Kings County Nov. 3, 2014], granting a close corporation minority shareholder’s petition to inspect an array of financial and corporate records to investigate possible wrongdoing by the controlling shareholders. Continue Reading

No Meeting, No Vote Required for LLC’s Freeze-Out Merger Approved by Majority’s Written Consents

Posted in Dissenting Shareholder Appraisal, Freeze-Out Merger, LLCs

There’s a wrinkle in New York’s LLC Law still being ironed out by the courts when it comes to the necessity for member meetings to approve certain actions such as mergers.

On the one hand, under LLC Law § 407(a)’s default rule, whenever LLC members “are required or permitted to take any action by vote,” such action may be taken ”without a meeting, without prior notice, and without a vote” so long as signed written consents are obtained from members holding the number of votes required to approve the action had there been ”a meeting at which all of the members entitled to vote therein were present and voted.” When consents in lieu of meeting are used, § 407(c) requires “prompt notice” thereafter be given to any members who did not execute consents. In other words, any excluded, non-consenting member is presented with a fait accompli.

On the other hand, LLC Law § 1002(c) provides that any proposed agreement of merger or consolidation “shall be submitted” to the members for a vote “at a meeting called on twenty days’ notice or such greater notice as the operating agreement may provide.” In addition, § 1002(e) echoes the meeting requirement by providing that any member entitled to vote on the proposed transaction ”may, prior to that time of the meeting at which such merger or consolidation is to be voted on, file . . . written notice of dissent from the proposed merger or consolidation.”

The question is, does § 407(a)’s written consent trump § 1002(c)’s meeting mandate, or the other way around? Continue Reading