A Few Dissolution Case Tidbits
This being the last, lazy week of August, I thought I'd offer something lighter than my usual fare for those sitting beachside with one eye on the kids and the other on their iPad. So without further ado, here are some short summaries of miscellaneous cases of interest involving shareholder disputes:
Court grants interim injunction restraining directors of Delaware corporation from committing acts that constitute grounds for dissolution under BCL 1104-a. In Ziglin v. Hommel, 2009 NY Slip Op 32636(U) (Sup Ct NY County Oct. 9, 2009), Manhattan Supreme Court Justice Debra A. James granted an unusual preliminary injunction in a dispute between two shareholders of a New York based Delaware corporation, requiring that the directors "not commit acts that constitute grounds for dissolution contained in BCL 1104-a(a)(1) and (2) , and that corporate records be made available pursuant to BCL 1104-a(c)." Why unusual? (a) The plaintiff filed a summons with notice, i.e., did not file a complaint. (b) The notice did not include a request for dissolution. (c) Case precedent seems to foreclose dissolution of a Delaware corporation by a New York court. (d) How does a director comply with an injunction against "oppression" of a minority shareholder?
Court denies dissolution petition but authorizes petitioner to seek fair value award under BCL 910 arising from sale of business assets. In Matter of Banani (New Millenium Pawnbrokers, Inc.), Short Form Order, Index No. 007728/10 (Sup Ct Nassau County Aug. 16, 2010), Nassau County Commercial Division Justice Stephen A. Bucaria ruled that the administrator of a deceased shareholder's estate failed to establish grounds for judicial dissolution under BCL 1104-a but granted her leave to serve an amended petition seeking payment of fair value for the shares under BCL 910. The latter statute authorizes a shareholder to initiate a dissenting shareholder appraisal proceeding upon the happening of certain events including, as occurred in Banani, the sale of all of the corporation's assets.
Court rules that shareholder of Corporation A cannot utilize de facto merger doctrine to seek dissolution of Corporation B. In Matter of Akcan (Vita Ristorante 58, Inc.), 2010 NY Slip Op 32195(U) (Sup Ct NY County Aug. 16, 2010), the petitioner sought to dissolve a corporation of which, admittedly, he was not a shareholder on the theory that it had entered into a de facto merger with another corporation in which he held a 25% stock interest. Manhattan Supreme Court Justice Jane S. Solomon dismissed the petition, noting that the petitioner cited "no authority that would allow a court to utilize the doctrine of de facto merger to shift his shareholder interest in one corporation to another corporation for the purpose of forced dissolution of the new corporation."
Court Addresses Necessary Party, Res Judicata Issues in Shareholder Oppression Case Pitting Uncle Against Nephews
It's a Vlasic classic story of a second-generation family business dispute. Over four decades ago, the three Adelstein brothers started a pickle distribution business in Brooklyn. The brothers jointly made all business decisions including salary, hiring and firing of employees. In 1995, brothers Sydney and Jack brought their sons Steven and Larry, respectively, into the business.
In 2006, the business was incorporated as Finest Food Distributing Co. Sydney and Jack transferred their one-third stakes to their sons, leaving brother Joel co-owning the business with his two nephews. In 2007, Joel was sidelined by health problems leaving his nephews in charge of all operations. According to Joel, when he later returned to work, and after he turned down the nephews' buyout offer, they initiated a squeeze-out by excluding him from company decision-making and withholding distributions.
In February 2009, the nephews terminated Joel's employment prompting Joel to file a lawsuit against them for breach of contract, breach of fiduciary duty and unjust enrichment. In January 2010, Nassau County Commercial Division Justice Timothy S. Driscoll granted the nephews' motion to dismiss the complaint, holding that Joel's employment was terminable at will, that they owed him no fiduciary duty as an employee, and that his remaining claims of malfeasance must be brought derivatively on the corporation's behalf. Adelstein v. Finest Food Distributing Co. N.Y. Inc., 2010 NY Slip Op 30149(U) (Sup Ct Nassau County Jan. 13, 2010).
Continue Reading...Decision Breaks New Ground in Dispute Over Enforcement of Stock Buyback Triggered by Filing of Dissolution Petition
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Does the mere filing of a petition for corporate dissolution bring about "a succession to a third person by operation of law or court order" or the transfer of the right to "control or vote" the petitioner's shares? The question, upon which turns the non-petitioning shareholders' right to enforce a book-value buyout provision in the shareholders' agreement, lies at the heart of a multi-faceted ruling earlier this month in Matter of Piekos (Home Studios Inc.), 2010 NY Slip Op 51408(U) (Sup Ct Westchester County Aug. 3, 2010).
In his 23-page decision, Westchester Commercial Division Justice Alan D. Scheinkman undertakes a thorough review of the case law before concluding (a) the filing of the dissolution petition triggers the buyout clause, but (b) an evidentiary hearing is required to determine whether the petitioner had a "meaningful choice as to whether to sign the [shareholders'] agreement" and whether it would be "unconscionable" to enforce the buyout against an oppressed minority shareholder.
There are at least two reasons you'll want to read the Piekos decision. First, it collects and dissects the relevant case law to date on this important and recurring issue on which I have written numerous times, including an article in the New York Law Journal which Justice Scheinkman cites (read here) and several posts on this blog (read here, here and here). Second, wholly apart from the legal issues, the decision's detailed recital of the factual background tells a gripping story of broken relationships, bruised egos and sharp tactics amidst a fight for economic primacy and survival among business partners.
Continue Reading...Sassower Case Illustrates Anew the Price of Poorly Drafted Buy-Sell Agreement
The case of Sassower v. 975 Stewart Avenue Associates, LLC is fast approaching poster-child status as an illustration of the headaches that can follow from poorly drafted valuation criteria in the buy-sell provision of a shareholders' or operating agreement.
The case involves a medical practice known as Cardiovascular Medical Associates, P.C. ("CMA"), whose seven doctors also owned the building housing the practice through a separate limited liability company named 975 Stewart Avenue Associates, LLC ("975 Stewart"). Dr. Sassower resigned from CMA in late 2007, triggering his obligation to offer his interest in 975 Stewart to the remaining doctors.
The CMA shareholders' agreement set forth an appraisal procedure for fixing the purchase price, whereby the exiting member and the company each hire an appraiser followed by an exchange of appraisal reports within 30 days. If the appraisals fall within 10% of each other, the purchase price is the average of the two; if more than 10%, the two appraisers select a third appraiser whose valuation opinion determines the price.
Nothing unusual about this arrangement. Rather, the problem is seeded in the provision's vague and inarticulate language purporting to establish either a standard or method of valuation. Specifically, the operative Section 8.5(c) of the agreement states that the two, party-appointed appraisers must use "the market value approach appraisal methodology" while further providing that the opinion of the third, neutral appraiser "shall establish the fair market value" of the offered interest.
Continue Reading...Final Round of Corfian Case Features Diverse Dissolution Issues
Once in a while there comes along a corporate dissolution case fraught with so many interesting and challenging issues of fact and law that, as the saying goes, a student of business divorce could "go to school on it." Of course, it also helps to have an engaged judge willing to serve as "teacher", i.e., a judge who carefully parses the issues and writes a thoughtful, well-reasoned decision that sets forth the competing factual narratives and operative legal principles.
A protracted dissolution battle in Brooklyn Supreme Court called Matter of Pappas (Corfian Enterprises, Ltd.), presided over by Justice Jack M. Battaglia (pictured), is just such a case.
Pappas began in 2004, when the widow of Eleftherios Pappas embarked on what became a 6-year trek through the legal system trying to establish and get paid for her late husband's ownership interest in commercial realty and two closely held corporations which, she alleged, were co-owned with two other individuals, Theodoros Kalogiannis and Paul Fotinos. There was no direct evidence, by way of shareholder agreement or other reliable records, establishing ownership of the corporations, of which Mr. Fotinos claimed to be 100% shareholder.
Continue Reading...Recent Appellate Rulings Clarify Standards for Challenging Releases Given to Fiduciaries of Closely Held Business Entities: Part 2
This is the second of two posts analyzing two recent decisions by the Manhattan-based Appellate Division, First Department, in which the court dismissed fraudulent inducement claims by LLC members against co-member fiduciaries arising from agreements that included broad general releases. Last week's post examined Centro Empresarial Cempresa S.A. v. America Movil S.A.B. de C.V., 2010 NY Slip Op 04719 (1st Dept June 3, 2010), which involved a dispute over a buyout between members of a Delaware LLC that owned an Ecuadorian mobile telephone company. The second case, discussed in this week's post, also concerns a dispute between co-members of a Delaware LLC, but this time the business operations are closer to home, involving a series of real estate acquisitions in New York City.
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The case of Arfa v. Zamir is one of those hydra-headed business partnership disputes that takes on a life of its own, generating multiple lawsuits and dozens of motions, decisions and appeals that take up years before anything seems to get resolved on the merits. I've written up decisions in the Arfa family of cases on several prior occasions, most recently on the issue whether LLC promoters are fiduciaries (see here), before that on indemnification rights of LLC managers (see here), and before that on whether a general release of a LLC fiduciary given as part of an inter-member transaction bars a subsequent action for fraudulent inducement (see here).
The last-mentioned post highlighted a December 2008 decision by Manhattan Commercial Division Justice Charles E. Ramos refusing to dismiss a fraudulent inducement claim by plaintiffs Rachel Arfa and her husband, Alexander Shpigel, as 60% members of the subject LLC, against defendant Gadi Zamir, who held the remaining 40% interest, relating to a real estate acquisition and development venture in upper Manhattan known as Academy Street. Here's a short summary of the factual background from my prior post:
Continue Reading...Recent Appellate Rulings Clarify Standards for Challenging Releases Given to Fiduciaries of Closely Held Business Entities: Part 1
Two years ago, in Littman v. Magee, 54 AD3d 14 (1st Dept 2008), the Manhattan-based Appellate Division, First Department, made waves with a decision in which it reinstated a complaint for breach of fiduciary duty and fraudulent inducement by an LLC member who sold his minority interest to the majority, gave them a comprehensive release and, over a year later, after the majority sold the company at a substantial premium, claimed he had been misled as to the true value of his interest. My write-up of the decision (read here) referred to Littman as "lowering the bar" for claims of this sort by making broad pronouncements that seemingly elevated beyond the power of release the purchaser-fiduciary's duty to disclose to the seller all material facts bearing on the transaction. At the time, with some degree of concern, I posed the question, "After Littman, can business owners pursue and exploit the profitable sale of their business or its assets without risk of liability to a former partner whose interest was acquired at a cheaper price?"
In a recent pair of decisions, the First Department effectively has enervated Littman's broad pronouncements regarding the inefficacy of releases vis-à-vis the fiduciary duty of disclosure. In Centro Empresarial Cempresa S.A. v. America Movil S.A.B. de C.V., 2010 NY Slip Op 04719 (1st Dept June 3, 2010) (hereafter "Centro"), and Arfa v. Zamir, 2010 NY Slip Op 06070 (1st Dept July 13, 2010) (hereafter "Arfa"), lower courts had denied motions to dismiss fraudulent inducement claims by LLC members who entered into transactions which included an exchange of general releases. In both cases, the plaintiffs argued, and the lower courts agreed, that under Littman a general release does not insulate a fiduciary from liability for failing to disclose the fiduciary's own wrongdoing. On appeal in both cases, the First Department reversed the lower courts' orders and directed dismissal of the claims, finding that the plaintiffs had failed to allege facts sufficient to set aside their releases. In both cases, the First Department expressly distinguished Littman by limiting it to its particular facts.
Interestingly, both appellate decisions were authored by Associate Justice David Friedman who was not on the panel that decided Littman as were none of the other Arfa panel members and only one of the Centro panel members. As related below, the one Centro panel member who also decided Littman -- Associate Justice Catterson -- was half of a two-judge dissent in Centro.
In this Part One of a two-part series, I report on the Centro decision. In next week's Part Two, I'll report on the Arfa decision.
Continue Reading...Guest Post: Business Appraiser Jeff Risius on the Equity Risk Premium
I'm pleased to present a guest post on an important valuation topic by business appraiser Jeffrey M. Risius (jrisius@srr.com). Jeff is a Managing Director at Stout Risius Ross, Inc., a financial advisory firm specializing in valuation and financial opinions, investment banking, and dispute advisory and forensic services. Jeff specializes in valuation in a litigation setting including shareholder proceedings, bankruptcy matters and transaction disputes. Jeff's below post elegantly explains one of the fundamental aspects of business appraisal, namely, ascertaining the equity risk premium component of the capitalization rate used in the discounted cash flow ("DCF") method. As you'll read, this issue took front and center in a recent decision by the Delaware Chancery Court. I think you'll find it very informative. - P.A.M.
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One commonly applied methodology in the valuation of businesses is the Discounted Cash Flow (“DCF”) Method. The premise of this method is that a company’s value is equal to the present value of all future cash flows expected to be generated by that company using a rate of return that incorporates the time value of money and the business risk associated with the cash flows. The appropriate rate of return to utilize in the DCF Method is closely related to the perceived level of risk associated with the projected cash flows.
Continue Reading...Keeping the Gag on Ex-Business Partners: LLCs and Confidentiality Agreements
LLC Law section 409 and New York case law impose fiduciary duties of care and loyalty on member-managers of limited liability companies. Less clear are the duties of non-managing LLC members who fall outside the ambit of section 409.
The duty of loyalty encompasses an obligation to maintain the confidentiality of company trade secrets which are broadly defined as information not generally known or reasonably ascertainable by which a business can obtain an economic advantage over competitors or customers. Do non-managing LLC members have a duty not to disclose company trade secrets? How can an LLC protect itself against the risk of disclosure by LLC members?
Two recently decided cases provide some answers. The first, Kuroda v. SPJS Holdings, LLC, 2010 Del. Ch. LEXIS 57 (Del.Ch. Mar. 16, 2010), decided by the Delaware Chancery Court, held that the implied duty of good faith and fair dealing under Delaware law does not obligate LLC members to keep company information confidential. The second, Strix, LLC v. Buckley, 2010 NY Slip Op 30927(U) (Sup Ct Nassau County April 7, 2010), decided by a New York court but also involving a Delaware LLC, granted a preliminary injunction against LLC members under the confidentiality provisions contained in their employment agreements.
Continue Reading...Are LLC Organizers Fiduciaries?
Will there be a new wave of lawsuits by disappointed investors in business enterprises organized as limited liability companies, alleging that the investors were solicited to become members by slick, fast-talking promoters who concealed their own self-dealing in violation of a fiduciary duty of disclosure that existed even before the LLC was formed? A recent New York appellate ruling has opened the door to just such suits.
By the beginning of the 18th century, when Daniel Defoe wrote about the "Villainy of Stock-Jobbers", the public held a contemptuous view of those who traded in the proto stock markets of the time. In the late 19th century, the term "promoter", referring to those who organized companies and sold shares, likewise took on derogatory shades amidst an industrial boom that experienced no shortage of flim-flam artists exploiting an unprecedented wave of public investment in railroads, utilities, heavy industry and real estate development companies.
Common-law courts in the U.S. reacted by imposing fiduciary duties on corporate promoters, thereby providing some means of civil recourse for duped investors, and some incentive for greater disclosure by corporation organizers. For example, in Dickerman v. Northern Trust Co., 176 U.S. 181 (1900), the U.S. Supreme Court wrote that a corporate promoter, which it defined as one who "brings together the persons who become interested in the enterprise, aids in procuring subscriptions and sets in motion the machinery which leads to the formation of the corporation itself," must be "treated as standing in a confidential relation to the proposed company, and is bound to the exercise of the utmost good faith." The promoter, the Court went on, "is the agent of the corporation and subject to the disabilities of an ordinary agent. His acts are scrutinized carefully, and he is precluded from taking a secret advantage of the other stockholders. . . . [and] must faithfully disclose all facts relating to the property which would influence those who form the company in deciding upon the judiciousness of the purchase."
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