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NY Business Divorce

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

Can’t Get Rid of Those Nooks and Crannies: Delaware Supreme Court Clarifies Implied Covenant of Good Faith and Fair Dealing

By Peter Mahler on Posted in Delaware

The implied covenant of good faith and fair dealing, at least in the realm of shareholder and partnership disputes, may be one of the least understood and most misused legal doctrines.

I suspect the reason is, it’s not quite what it sounds like, and what it sounds like is an all-purpose, “lite” version of some quasi-fiduciary duty. I wish I had a dollar for every complaint I’ve seen in litigation between business co-owners in which, bringing up the rear in a parade of causes of action, the pleader alleges something like, “By reason of the foregoing, defendants breached their duty of good faith and fair dealing.” I wish I had another dollar for every court decision I’ve read dismissing such a claim on the ground it duplicates another cause of action for breach of contract.

Alright, you ask, so what is the implied covenant of good faith and fair dealing? Fundamentally it is a contract-centric doctrine whereby a court fills the “gaps” in the parties’ express agreement by discerning, under a reasonable expectations standard, what the parties would have agreed themselves had they considered the issue.  The doctrine is anchored in Judge Benjamin Cardozo’s 1917 opinion for the New York Court of Appeals in the Lady Duff-Gordon case (222 NY 88), where he famously wrote: Continue Reading

Trouble Looms When Clients Negotiate Their Own Shareholder Buy-Out Settlement Agreements

By Peter Mahler on Posted in Buyout, Settlement

In many if not most lawsuits between discordant business partners there comes a time when they launch settlement negotiations for a buy-out of one partner by the other. Sometimes this occurs early in the lawsuit and sometimes later, after one or more rounds of inconclusive motion practice and discovery proceedings.

The parties’ lawyers normally orchestrate and conduct settlement negotiations and are at their clients’ side at any face-to-face settlement meetings. Lawyers also are trained to ensure that any binding and enforceable settlement agreement entered into is fully baked, that is, it contains all the material terms and conditions necessary to effectuate the struck bargain, including appropriate representations and warranties, security and tax-related provisions, releases, and other necessary “boilerplate.” By the same token, lawyers are trained to flag any term sheet or other preliminary accord, that is, one that requires further fleshing out and negotiation, with an appropriate written acknowledgement that the stated terms are non-binding unless and until formalized in a future, comprehensive, signed agreement.

Sometimes, however, clients engage in direct settlement discussions without the lawyers. This can happen for many different reasons, with or without the lawyers’ approval and guidance. Clients have been known to initiate or take over settlement discussions directly with the other side when they feel lawyer ego or clash of personality are impeding the process. It also can happen when one or both clients believe their settlement demands and sentiments have been distorted or otherwise not communicated effectively by the other side’s lawyer to his or her client.  Continue Reading

What Law Applies When Internal Affairs Doctrine Clashes With Choice-of-Law Clause?

By Peter Mahler on Posted in Corporate Governance, Delaware, Foreign Business Entities, Interim Remedies, LLCs, Operating Agreement, Receivership

The internal affairs doctrine is a choice of law rule under which a court will apply the law of the state of the subject entity’s formation (lex incorporationis) rather than the law of the jurisdiction where suit is brought (lex fori) to governance disputes and other internal conflicts concerning rights and duties among the entity, its owners and managers. So, for instance, when a shareholder or member of a New York based Delaware corporation or LLC brings suit in a New York court against an officer or manager for breach of fiduciary duty, the New York judge ordinarily will adjudicate the claim under Delaware law, which may differ materially from the analogous New York common or statutory law.

The internal affairs doctrine in theory acknowledges the superior interest of the state of formation in the application of its laws to the entity’s internal governance, even when the entity is based outside the state and has no connection with the state other than its formation. The doctrine also serves to avoid the uncertainty and high transactional costs that would occur if a business entity operating in multiple states was subject to different rules of governance in each state. Finally, it reflects a strong presumption that those who chose to form their entity in a particular state desire to have their legal relations governed by the laws of that state.

I don’t think I’m going out on a limb stating that the overwhelming majority of partnership agreements, shareholder agreements and LLC agreements that contain an express choice of law provision select the law of the state of formation, i.e., there is no inconsistency between the parties’ contractually stated preference and the internal affairs doctrine. But once in a while I come across an exceptional case. Those of you who followed the Pappas v. Tzolis saga may recall that the New York-based Delaware LLC involved in that case had an operating agreement with a New York choice of law clause. As I noted in one of my several posts about the case (read here), the trial judge side-stepped the conflicts of law issue by finding the result the same under either state’s law, and the issue unfortunately was not addressed in the subsequent appellate rulings deciding the case under New York law.

Another exceptional case recently came to my attention. Gelman v. Gelman, Index No. 12664/10 (read here), is an unreported decision dated April 3, 2013, by Nassau County Supreme Court Justice Daniel Palmieri involving a dispute between two siblings who co-own a Delaware LLC. The court enforced a New York choice of law provision in the operating agreement in deciding the right to appointment of a receiver. As in Pappas, however, the court opined that the result would be the same under either state’s law. Continue Reading

Business Divorce Cases in the Suffolk County Commercial Division

By Peter Mahler on Posted in Attorney's Fees, Bankruptcy, Interim Remedies, Standing

Since the Second World War New York’s Suffolk County, occupying almost two-thirds of Long Island’s land mass, has experienced tremendous changes in population, demographics and in its economy.

In 1960, Suffolk’s population was half of its much smaller western neighbor Nassau County. By 1990 Suffolk’s population surpassed Nassau’s. According to 2012 census data Suffolk County has about 1.5 million residents compared to Nassau’s 1.3 million. Suffolk’s economy likewise evolved from mainly agriculture to a highly diverse base of manufacturing, construction, finance, farming, wholesale and retail business establishments, the total number of which surpassed Nassau County’s over the last fifteen years. The Hauppauge Industrial Park in western Suffolk, with over 1,300 companies employing over 55,000 Long Islanders, is the second largest industrial park in the country.

No wonder, then, that in 2002 court administrators added Suffolk to the growing list of counties in New York State with a specialized Commercial Division to handle increasingly complex business-related litigation. Starting with a single judge, today the Suffolk County Commercial Division, operating at the Supreme Court complex in Riverhead, has three judges including Presiding Justice Elizabeth H. Emerson, who has served in the Commercial Division from its inception; Justice Emily Pines, who joined the Commercial Division in 2007; and the Commercial Division’s most recent member, Justice Thomas F. Whelan. Continue Reading

Form K-1s Do Not Always a Shareholder Make

By Peter Mahler on Posted in Dissolution Defenses, Standing

One of my all-time favorite quotes is from a 2009 decision in a case called Matter of Pappas in which the court had to sift through a pile of contradictory, ambiguous and incomplete documents and testimony to determine the ownership of several closely held corporations. Justice Jack Battaglia hit the nail on the head when he wrote in that case:

In the real world, particularly that in which close corporations operate, clear evidence of share ownership is often not found in the corporate books and records, for any number of reasons.

In the “real world,” inattention to, misunderstanding of, or, in some cases, the deliberate falsification of share ownership records explains why there are so many corporate dissolution cases in which the threshold issue is the petitioner’s standing to seek dissolution. The petitioner who lacks a stock certificate, stock ledger or written shareholders’ agreement conclusively memorializing stock ownership, may be forced to rely on other evidence of ownership to refute the respondent shareholder’s contention that petitioner is a pretender.

In such cases corporate tax returns can play a critical role, particularly with subchapter “S” corporations that file partnership tax returns including form K-1s that identify each shareholder and state his or her ownership percentage. A dissolution petitioner who never received K-1s, but who knows or ought to know that the corporation filed partnership returns, may have great difficulty overcoming a defense of lack of standing. Likewise, a respondent shareholder who signed a corporate return that included a K-1 reporting the petitioner’s share ownership may find it impossible to establish a standing defense.

But not always, as evidenced by an appellate ruling earlier this month in Matter of Sunburst Associates, Inc., 2013 NY Slip Op 03368 (3d Dept May 9, 2013). Continue Reading

Whose Lawsuit Is It Anyway?

By Peter Mahler on Posted in Corporate Governance, Interim Remedies, LLCs

The title of this post is a riff on English playwright Brian Clark’s play Whose Life Is It Anyway? set in the hospital room of a car accident victim rendered quadriplegic, who must overcome opposition to his determination to end his life by euthanasia.

The play came to mind when I read the recent decision by Westchester Commercial Division Justice Alan D. Scheinkman in Briarcliff Solutions Holdings, LLC v. Fifth Third Bank (Chicago), Decision and Order, Index No. 70431/2012 (Sup Ct Westchester County Apr. 25, 2013), in which opposing stakeholders in a paralyzed, defunct limited liability company are fighting over who has the right to control and potentially terminate a lawsuit brought in the name and right of the LLC against one of the factions. The court’s ruling, in the procedural setting of a preliminary injunction motion, is notable primarily for its novel application of the irreparable injury requirement to a threatened board takeover designed to thwart prosecution of claims against the very same putative board members.

The lawsuit concerns a company known as Briarcliff Solutions Group, LLC (“BSG”) that, prior to its cessation of business in March 2011, owned operating subsidiaries that provided enterprise software solutions to leading retailers and wholesale distributors. At the risk of oversimplification, Faction #1 led by Paul Lightfoot held a majority equity stake in BSG while Faction #2 (a small group of private institutional and individual lenders) financed the company with rights to obtain majority control of the company’s managing Board of Directors in the event of loan default.       Continue Reading

Who Wants to Be a Minority Shareholder of a Delaware Closely-Held Corporation?

By Peter Mahler on Posted in Buyout, Compulsory Buyout, Delaware, Grounds for Dissolution, LLCs

State laws give voting power and, hence, management control, to majority shareholders in closely-held corporations. The minority shareholder can thus find herself without an effective voice in setting corporate policies for officer and employee compensation, finance, accounting, shareholder distributions, and a host of other decisions affecting the business. When this happens, the minority shareholder who feels she is being treated unfairly may desire to cash out her shares–for which no market likely exists–whether or not she has an available mechanism to do so, such as put rights or a buy-sell agreement.

Most states, including New York, long ago enacted judicial remedies for minority shareholders in cases of “oppressive” conduct by controlling shareholders. The New York statutory scheme, codified in §§ 1104-a and 1118 of the Business Corporation Law, authorizes the court to dissolve a closely-held corporation while giving the controlling shareholders the option to avoid dissolution by purchasing the petitioning owner’s shares for “fair value” which the court will determine if the parties cannot agree on a price. Many states including New York, by statute or common law, empower the court to compel a buy-out of the petitioner’s shares even if the controlling shareholder does not elect to purchase.

Delaware–which ranks 45th among the states in population but #1 in the incorporation of out-of-state entities–is not one of those states. Delaware, known for its management-friendly business laws, does not have a statute protecting oppressed minority shareholders of closely-held corporations. Except in cases of deadlock between two 50/50 shareholders, Delaware does not have a statute authorizing judicial dissolution of a closely-held corporation at the behest of a shareholder. Neither Delaware statute nor case law recognizes an oppressed minority shareholder’s right to be bought out.

The disadvantage of being a minority shareholder in a Delaware closely-held corporation came to the fore last week in Blaustein v. Lord Baltimore Capital Corp., C.A. No. 6685-VCN (Del Ch Apr. 30, 2013), in which Vice Chancellor Noble of the Delaware Chancery Court issued a 49-page opinion holding:

  • the alleged failure by the controlling directors and shareholders to “negotiate in good faith toward a reasonable purchase price” did not breach any implied covenant of good faith and fair dealing arising from a provision in the shareholders’ agreement fixing minimum voting thresholds for board and shareholder approval for discretionary stock redemption, and
  • the defendant controlling directors and shareholders owed no fiduciary duty to the plaintiff as a minority shareholder to accept her “reasonable” repurchase proposal.  Continue Reading

Death of a General Partner, or How Not to Plan for Succession in a Limited Partnership

By Peter Mahler on Posted in Partnerships

When you come across a legal dispute among the partners of a New York limited partnership, the first thing you need to know is whether it’s an “old” or a “new” limited partnership, that is, whether it’s governed by the Limited Partnership Act adopted in 1922 (NYLPA) or the Revised Limited Partnership Act (NYRLPA) adopted in 1991 for partnerships formed after that date. Depending which law applies, the case will either be a mess or a bigger mess, which is one of the many reasons the limited partnership form has fallen into disfavor since New York’s adoption of the superior limited liability company form in 1994.

Manhattan Supreme Court Justice Saliann Scarpulla recently handed down a decision involving what I consider the messier category of limited partnership dispute governed by the old NYLPA. The court’s opinion in Poole v. West 111th Street Rehab Associates, 2013 NY Slip Op 30827(U) (Sup Ct NY County Apr. 19, 2013), addressed a particularly thorny issue whether and how the partnership could be continued and reconstituted with a new general partner following the death of the last remaining, original general partner. Upon examining the overlapping and arguably inconsistent, crazy-quilt provisions of the NYLPA, the partnership’s Certificate of Limited Partnership and its Limited Partnership Agreement, as well as the partners’ course of conduct, Justice Scarpulla held that the limited partner seeking a declaration of the partnership’s dissolution failed to establish his entitlement to relief as a matter of law, and that a trial was required to resolve disputed issues of fact. Continue Reading

The Accidental Pro Bono Business Divorce Lawyer

By Peter Mahler on Posted in Attorney's Fees, Deadlock

Matter of Boucher (Carriage House Realty Corp.), 2013 NY Slip Op 02571 (2d Dept Apr. 17, 2013), decided last week by a Brooklyn appellate panel, offers a routine narrative of a dysfunctional close corporation owned by two, 50/50 shareholders, one of whom sought and won an order granting judicial dissolution. What makes it noteworthy is the court’s handling of an issue that repeatedly crops up in 50/50 cases, namely, the engagement of counsel by the respondent shareholder to represent the corporation at the corporation’s expense in opposition to the dissolution petition. The lawyer who appeared for the corporation in Boucher learned the hard way that courts will not allow one 50% shareholder to use corporate funds to resist dissolution sought by the other 50% shareholder.

Last week’s decision caps a five-year litigation saga that started when Tracy Boucher, as 50% shareholder of a real estate brokerage named Carriage House Realty Corp., sued for judicial dissolution claiming deadlock under Business Corporation Law § 1104. The dissolution petition named the corporation as the sole respondent. The other 50% shareholder, Joan Gorta, engaged counsel who appeared and filed opposing papers on behalf of the corporation. Continue Reading

For Sale: Undocumented LLC Membership Interest. Cheap.

By Peter Mahler on Posted in Dissolution Basics, LLCs, Standing

This is an unusual story about an ultimately unsuccessful effort to dissolve a limited liability company (LLC) by someone who claimed to have acquired through judgment enforcement proceedings a debtor’s undocumented membership interest in the LLC.

Ibrahim Saleh is a real estate entrepreneur who was responsible for, among other building projects, the development and construction of the Flatiron Hotel located at Broadway and 26th Street in Manhattan. The hotel project, which began amidst the onset of recession in 2007-08, encountered severe financial and construction problems that generated work stoppages, foreclosure and lien enforcement proceedings. According to published reports, Saleh subsequently was indicted on federal charges and remains a fugitive from justice.

The hotel project’s general contractor, a firm with the felicitous name Born to Build, LLC (“BTB”), won a ruling in May 2011 granting a default judgment against Saleh individually for $2.7 million plus interest (read here). The following month BTB enlisted the City Marshal to advertise and conduct an execution sale against Saleh’s supposed membership interest in the limited liability company that owned the fee title to the hotel property, known as 1141 Realty, LLC (“1141″). BTB was declared the high bidder and purchased the garnished interest for $100,000. Presumably it was a credit bid against the judgment amount. Continue Reading