Bad Faith 1In New York, the bad faith defense in dissolution proceedings traces its lineage to Matter of Kemp & Beatley, 64 NY2d 63 [1984], a landmark ruling by the state’s highest court that set the standard for minority shareholder oppression under § 1104-a of the Business Corporation Law, where the court wrote in dicta that “the minority shareholder whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression should be given no quarter in the statutory protection.”

Several years ago, I gave headline treatment to Justice Vito DeStefano’s decision in Feinberg v Silverberg recognizing the bad faith defense as applicable also in deadlock dissolution cases between 50/50 shareholders under BCL § 1104 notwithstanding a line of appellate rulings indicating that the underlying reasons for dissension and deadlock are not relevant. In reconciling those seemingly contradictory cases, Justice DeStefano wrote that the “manufactured creation of the dissension . . . is the sine qua non of bad faith” which “would belie a finding that the shareholders’ dissension poses an irreconcilable barrier to the continued functioning and prosperity of the corporation.”

Has the bad faith defense similarly osmosed to LLC dissolution? While I’m not aware of any New York cases directly addressing the issue, a recent decision by Chancellor Ellen Hobbs Lyle of the Tennessee Business Court in Wilford v Coltea, Case No. 15-856-BC [Tenn. Ch. Ct. 20th Dist. May 16, 2016], echoes Justice DeStefano’s rationale in upholding a bad faith defense in a dissolution case involving a Delaware LLC whose two 50/50 members seemingly were at an alleged managerial impasse with no way out. Continue Reading Bad Faith Defense Gets Boost in LLC Dissolution Case

Ben Means

Business divorce on steroids. That’s how I describe the tenor of litigation that can erupt when members of a family-owned business have a falling out.

No one has devoted more scholarship to the challenging intersection of law and conflict in the family-owned business than Benjamin Means, Associate Professor of Law at the University of South Carolina School of Law.

Longtime readers of this blog may recall a two-part online interview of Ben that I posted a few years ago (read here and here), in which he answered a series of questions about his groundbreaking law review article entitled Non-Market Values in the Family Business. The article uses social science and expansive notions of contractual relations in advocating for courts to give greater weight to what he calls “family values” in adjudicating corporate dissolution and other disputes among shareholder-members of the same family. Continue Reading Conflict in the Family-Owned Business: Interview With Professor Benjamin Means

spaceballs

To Mel Brooks’ collection of hit films, Oscars, and countless other comedic works and awards can now be added the distinction of having his 1987 Star Wars parody, Spaceballs, cited by the decidedly non-comedic Delaware Court of Chancery in support of its construction of an LLC agreement’s provision for advancement and indemnification in a lawsuit arising from a soured business relationship between the majority and minority members of a Delaware company formed in 2007 called Quivus Systems, LLC.

The transcript decision by Vice Chancellor Tamika Montgomery-Reeves in Harrison v Quivus Systems, LLC, C.A. No. 12084-VCMR [Del Ch Aug. 5, 2016], granted summary judgment on a claim for advancement of legal expenses in favor of the plaintiff Harrison, a principal of Quivus’s 45% member and its former CEO who was terminated in 2014 and then sued the following year in Washington D.C. Superior Court by the 55% member, Soroof International Corp., allegedly for mismanagement, incompetence, and looting.

Harrison filed his Chancery Court action after Soroof rejected his demand for advancement for all expenses, including legal fees, he incurred and would continue to incur in defending against all but one count in the D.C. action, as well as in prosecuting his counterclaims in the D.C. action. Continue Reading When Will Then Be Now? Court Construes LLC Agreement’s Advancement Provision With An Assist From Spaceballs

shorts

It’s late August, when the lure of the seashore and vacation plans push aside all but the most serious work-related endeavors, and when I share with my readers a few short summaries of recent decisions of interest in business divorce cases.

First, we’ll look at a decision in a dispute among former law firm partners in which the court upheld a partnership agreement amendment by the defendant majority partners, reducing the plaintiff’s percentage interest after he announced his intention to withdraw but before the actual withdrawal became effective. Next up is a relatively rare decision in an LLC dissolution case granting a motion to disqualify defense counsel under the advocate-witness rule of professional conduct. In the third case highlighted below, the Delaware Chancery Court dismissed a books-and-records action for lack of standing where the shares issued to the plaintiff never existed.

Court Enforces Eve-of-Withdrawal Reduction of Partnership Interest

Zohar v LaRock, Short Form Order, Index No. 14826/10 [Sup Ct Nassau County July 25, 2016]Article 8-B of New York’s Partnership Law authorizes regulated professional practices to organize as registered limited liability partnerships. The LLP form is highly popular with law firms because it offers the same limited liability protection afforded corporation shareholders and LLC members, except for their own professional negligence or malpractice. The LLP otherwise is subject to the same statutes and common-law rules governing general partnerships, which give partners great leeway in ordering their own affairs in their partnership agreement. Continue Reading Summer Shorts: Partnership Interest Reduction and Other Recent Decisions of Interest

RutledgeThe business community’s growing preference for the LLC entity form over the traditional corporation and partnership forms has introduced a whole new set of planning issues for lawyers who counsel clients at the formation stage in preparing the new LLC’s constitutional documents, including most importantly the operating agreement.

Tom Rutledge (photo right), one of the nation’s leading experts on LLCs and a principal drafter of his home state of Kentucky’s LLC Act among his many other accomplishments and leadership roles in the field of business organizations, recently published an article in the Journal of Passthrough Entities on the hot-button topic of LLC member expulsion with the provocative thesis that counsel need to actively consider and draft operating agreements that authorize forced expulsion of a member under specified circumstances in order to protect the venture’s ongoing activities and viability. The article is entitled “It’s Not Me, It’s You: Planning for Expulsion of LLC Members” and you owe it to yourself to read it here.

The article addresses the statutory backdrop for member expulsion; the grounds for expulsion to consider including in the operating agreement; the voting prerequisites and procedure for effectuating expulsion; the effect of expulsion including buy-out; and judicial review of expulsion decisions.

After reading the article, I asked Tom if he would discuss LLC member expulsion on my Business Divorce Roundtable podcast. I’m happy to report that Tom obliged, and you can hear my interview of Tom by clicking on the link at the bottom of this post.

The interview covers not only LLC member expulsion pursuant to the operating agreement which is the subject of Tom’s article, but also judicial expulsion of LLC members, a topic that recently generated headlines (and a post on this blog) when the New Jersey Supreme Court earlier this month issued its decision in IE Test v Carroll reversing an order of judicial expulsion under that state’s LLC Act. Judicial expulsion is destined to take on greater importance and controversy as more states adopt the Revised Uniform LLC Act which authorizes courts to expel an LLC member at the behest of the company or the other members on grounds involving breach of the operating agreement or other misconduct, or because it’s not reasonably practicable to carry on the business of the LLC with the member whose expulsion is sought.

There’s much more food for thought in Tom’s article and the podcast interview. I urge you to read and listen to both.

Good faithIf, as appears likely, the drafters of the LLC membership interest repurchase provisions at issue in Saleeby v Remco Maintenance, LLC, 2016 NY Slip Op 31447(U) [Sup Ct NY County July 25, 2016], thought they were helping the company avoid the possibility of litigation over the value assigned to the outgoing member’s interest, as it turns out they were sorely mistaken.

Poorly drafted or not, the LLC’s managers also likely did themselves and the company no favor by assigning a zero-dollar value to the membership interest of the terminated member in the Saleeby case, and by muddling the timing of the company’s exercise of its repurchase option.

Here, in a nutshell, is what happened in Saleeby as described in Manhattan Commercial Division Justice Anil C. Singh’s decision: In 2005, the defendant company Remco Maintenance, a New York based Delaware LLC, hired plaintiff Saleeby as its President and CEO. Saleeby’s employment agreement granted him a 7.5% Class B membership interest which fully vested by the time he was terminated without cause in February 2012. Over the next two years, Saleeby and the company attempted without success to negotiate their dispute over his termination, severance, vacation pay, and rights to unemployment insurance. In 2014, the company informed Saleeby that in 2013 it had exercised its option under the LLC Agreement to repurchase his membership units at a “fair market value” of zero dollars. Saleeby subsequently filed suit against the LLC for breach of contract and conversion. Continue Reading Good Faith Trumps Sole Discretion in LLC Agreement’s Repurchase Provision

ExpulsionThere are arguments pro and con when it comes to the power to expel a/k/a dissociate an LLC member. On the one hand, expulsion can be viewed as a necessary measure to preserve the LLC as a going concern when faced with persistent misconduct or failure to perform by one of its members. On the other hand, depending how broadly or narrowly the expulsion criteria are drawn, the power to expel can be a tool of oppression and abuse by those wielding it for their self-advantage.

Expulsion can occur in one of two ways. First, the operating agreement can authorize member expulsion under specified circumstances by self-executing action of the other members or managers. This is not a feature I regularly come across in operating agreements of LLCs, especially those whose membership consists of founding owners actively involved in the business.

Second, in states that have adopted the Revised Uniform LLC Act — to date numbering 16 plus the District of Columbia; New York is not one of them — courts are authorized to expel an LLC member on application by the company or a member on three specified grounds, two of which entail fault-based standards based on intentionally wrongful conduct or material breach, and the third of which dispenses with the notion of wrongful conduct by authorizing judicial expulsion of a member who

has engaged or is engaging in conduct relating to the company’s activities and affairs which makes it not reasonably practicable to carry on the activities and affairs with the person as a member.

Not surprisingly, the open-endedness of the above provision when utilized in LLC disputes has generated litigation, with New Jersey courts taking the lead. Last week, in IE Test, LLC v Carroll, 2016 WL 4086260 [NJ Sup Ct Aug. 2, 2016], that state’s Supreme Court handed down a major decision in which it reversed the lower courts’ summary judgment order expelling an LLC member and adopted a series of factors to assist trial courts in determining whether it is not reasonably practicable to operate an LLC in light of a subject member’s conduct. Continue Reading New Jersey Supreme Court Raises the Bar for Judicial Expulsion of LLC Members

consentThe pick-your-partner principle is universally embedded in the default rules of limited liability company enabling acts, including Sections 601 through 604 of the New York LLC Law which permit free assignment of distributional and other economic rights appurtenant to a membership interest but require the other members’ consent before an assignee is granted full member status with voting and other rights associated with membership in an LLC.

The distinction between a “mere” assignee versus a transferee with member status can become a battle ground when a putative LLC member who received his, her or its interest by assignment brings legal action against the LLC’s managers for dissolution, access to books and records, or asserting derivative claims on behalf of the LLC. That’s because by statute and/or common law, the suing party’s requisite legal standing to assert such claims depends on having member status.

A recent decision by Manhattan Commercial Division Justice Saliann Scarpulla in MFB Realty LLC v Eichner, 2016 NY Slip Op 31242(U) [Sup Ct NY County June 24, 2016], in which she dismissed derivative claims by a mere assignee of LLC interests, starkly illustrates the distinction and the importance of compliance with the LLC agreement’s provisions for bestowing member status on assignees. Continue Reading Operating Agreement’s Two-Step Consent Provision Foils Assignment of LLC Member Interest

The tiny state of Delaware plays an enormous role in this country’s corporate life. Delaware has long been the overwhelmingly preferred state of incorporation for publicly owned companies, and its cutting-edge (many would also say pro-management) enabling acts for closely held business entities have made it an exporter to the other 49 states of countless privately owned corporations, limited partnerships, and limited liability companies that have no connection to Delaware other than their state of formation.

The Delaware judicial system serves an integral role in maintaining the state’s corporate hegemony. The Delaware Court of Chancery is widely viewed as the country’s preeminent business-law trial court by virtue of its broad jurisdiction over Delaware business entities both public and private, and thanks to a judicial selection process that promotes the best and brightest candidates for the court’s judgeships including one Chancellor and four Vice-Chancellors whose typically thorough and scholarly written opinions are closely followed by lawyers and judges throughout the country.

Business divorce practice nationwide is no less susceptible to the influence of the Delaware legislative and judicial juggernaut. In New York, as in other states that are home to many Delaware-formed business entities, the internal affairs doctrine mandates application of Delaware law to disputes among entity co-owners, and jurisdictional constraints require owners seeking the ultimate remedy of judicial dissolution to do so in the Delaware Chancery Court. The Chancery Court’s interpretation of Delaware business entity statutes governing internal relations among co-owners of closely held business entities also has had significant influence over the interpretation of counterpart statutes in other states by their judiciaries. (A prominent example of this is the Second Department’s 2010 decision in the 1545 Ocean Avenue case which drew heavily upon Delaware Chancery Court precedent in setting the standard for judicial dissolution of LLCs under Section 702 of New York’s LLC Law.)

HeymanLadigAll of which is why I’m excited to invite readers to listen to my most recent podcast episode on the Business Divorce Roundtable entitled “Business Divorce, Delaware Style” featuring my interview of two leading Delaware litigators — Kurt Heyman (photo left) and Pete Ladig (photo right) — talking about what it’s like to litigate business divorce cases in the Chancery Court and current developments in Delaware law affecting such cases including important decisions I’ve written about on this blog in the TransPerfect, Carlisle, and Meyer cases.

Click on the link at the bottom of this post to hear the interview.

Kurt Heyman is a founding partner of Proctor Heyman Enerio LLP in Wilmington, Delaware, where he focuses his practice on corporate governance, partnership and limited liability company disputes in the Delaware Court of Chancery. Kurt lectures and writes extensively on business divorce and other corporate governance topics, he’s Co-Chair of the Business Divorce Subcommittee of the ABA Business Law Section, and he leads the Business Divorce and Private Company Disputes group on LinkedIn.

Pete Ladig is Vice Chair of the Corporate and Commercial Litigation Group at Morris James also in Wilmington. Pete concentrates his practice in the areas of corporate governance and commercial litigation, stockholder litigation, fiduciary duties, partnership and limited liability company disputes, and class action and derivative litigation. He’s also active in the ABA Business Divorce Subcommittee and has published articles on business divorce topics including a must-read post on his firm’s blog called What Is Business Divorce? Pete also co-hosts a podcast called CorpCast discussing corporate and commercial law in Delaware.

If you’re interested in business divorce, you’ll certainly enjoy listening to my interview of Kurt and Pete, both of whom speak on the subject with great authority, insight, and passion.

tie-breakerThe New York Business Corporation Law offers the 50% shareholder of a close corporation two avenues to judicial dissolution: deadlock at the board or shareholder level or internal dissension under BCL § 1104, and oppressive actions by the directors or those in control of the corporation under BCL § 1104-a.

The 50% petitioner faces an important strategic decision whether to invoke one or the other (or both) of the statutes. That’s because § 1104-a — but not § 1104 — triggers the respondent’s elective right under BCL § 1118 to acquire the petitioner’s shares for fair value. As I’ve written previously, often a 50% petitioner may gain greater negotiating leverage by proceeding solely under § 1104 based on deadlock, thereby depriving the other 50% faction of a statutory buy-out opportunity.

I can only speculate whether a strategic decision of that sort was at work in Matter of Hudson (Pure Lime USA, Inc.), Short Form Order, Index No. 600127/16 [Sup Ct Nassau County June 16, 2016], in which Nassau County Commercial Division Justice Stephen A. Bucaria dismissed the 50% shareholders’ § 1104 dissolution petition that superficially asserted director deadlock, but where the governing shareholders agreement authorized one of the respondent’s designees on the four-member board to cast the deciding vote in case of a tie vote. How can there be deadlock, the winning argument went, when the parties had a tie-break provision specifically designed to avoid deadlock? Continue Reading Tie-Breaker in Shareholders Agreement Defeats Deadlock Dissolution Petition