Over 100 years ago, in Lord v Hull, 178 NY 9 , the New York Court of Appeals — the state’s highest court — drew upon English common law to establish what has become a bedrock principle of American partnership law, that courts generally will not entertain lawsuits between partners except in the setting of a dissolution or final accounting. As the court wrote:
If the members of a firm cannot agree as to the method of conducting their business, the courts will not attempt to conduct it for them. Aside from the inconvenience of constant interference, as litigation is apt to breed hard feelings, easy appeals to the courts to settle the differences of a going concern would tend to do away with mutual forbearance, foment discord and lead to dissolution. It is to the interest of the law of partnership that frequent resort to the courts by copartners should not be encouraged and they should realize that, as a rule, they must settle their own differences or go out of business. [Emphasis added.]
Many decades later, in another partnership case called Gramercy Equities Corp. v Dumont, 72 NY2d 560 , the same court expressed the same sentiment thusly:
[C]ourts are generally loath to intercede in squabbles between partners that result in piecemeal adjudications, preferring that partners either settle their own differences amicably or dissolve and finally conclude their affairs by a full accounting.
In the modern era, partnerships have been eclipsed by other forms of business associations including close corporations and, more recently, limited liability companies. Each form has fundamentally different characteristics and is governed by a fundamentally different statutory scheme. Yet, if we focus on the internal dynamics and turmoil that can afflict shareholders of a close corporation or members of an LLC – especially the smaller, owner-operated firms — the above-quoted partnership rationale, expressed so long ago in Lord v Hull and more recently in Gramercy Equities, seems equally apropos of these modern forms.
One judge who both has made that connection and put it into practice is Nassau County Commercial Division Justice Stephen A. Bucaria (pictured). Over the years this blog has featured many decisions by Justice Bucaria demonstrating, as described here, his willingness to think outside the box when it comes to devising practical and sometimes novel solutions to intractable problems in business divorce cases. Continue Reading
When not tightly drafted, expulsion provisions in shareholder or LLC operating agreements can cause a lot more trouble than they’re worth. Case in point: Harker v Guyther, 2014 NY Slip Op 07403 [3d Dept Oct. 30, 2014], decided last month by the Appellate Division, Third Department, in which the court resorted to dictionary definitions of the term “misappropriation” in denying summary judgment to a 50% LLC member who sought to expel the other 50% member in a fight ostensibly over health insurance coverage, of all things.
The case involves a Delaware limited liability company known as 3H Corporate Services, LLC based in Saratoga Springs, New York. The company, formed in 2003, bills itself as specializing in the provision of corporate and insurance licensing services to the insurance community. 3H’s two members, each holding a 50% interest, are Gary Harker and Joan Guyther.
In 2008, Harker and Guyther agreed to have 3H pay for their health insurance as an employment benefit. They later disagreed over various business issues, including Guyther’s contention that she deserved extra compensation for the disparity between the higher cost of Harker’s family health insurance plan and her individual coverage. The lid blew off after Guyther withdrew over $3,000 from the company’s operating account to true up the discrepant insurance premiums over the prior six months, and announced to Harker her intention to continue doing so. Continue Reading
The under-reporting of cash receipts a/k/a skimming by restaurant owners and other cash-intensive businesses costs many billions of dollars in lost tax revenues each year and, when detected by audit, can lead to stiff penalties and even criminal prosecution. When the business has multiple owners, not all of whom are in on the skimming, it also can constitute grounds for judicial dissolution, as illustrated in a fascinating post-trial decision last week by Brooklyn Commercial Division Presiding Justice Carolyn E. Demarest in Cortes v 3A N. Park Ave. Rest Corp., 2014 NY Slip Op 24329 [Sup Ct, Kings County Oct. 28, 2014].
Any publicly aired business divorce involving allegations of looting can be a nasty affair. Throw into the litigation mix the specter of under-reported taxes and it becomes positively toxic, which is the flavor I got from reading Justice Demarest’s detailed findings of fact and conclusions of law in her 24-page ruling which, ultimately, found that the controlling shareholders skimmed about $3.7 million and conditionally ordered dissolution of the corporation, contingent upon the controllers’ buy-out of the plaintiff’s shares for over $1.2 million.
The Cortes case involves a 150-table Mexican restaurant, bar, and nightclub called Cabo, located in Rockville Center on Long Island. In 2003, the plaintiff, Porfirio Cortes, acquired for $50,000 a 16.67% stock interest in the restaurant’s operating company, in which the remaining shares were owned equally by defendants Angelo Ramunni and Domenick DeSimone. The purchase agreement gave the corporation the right to repurchase Cortes’s shares in the event he resigned his designated position as managing partner though, oddly, it did not specify a price or a pricing mechanism. Continue Reading
The first and last time I wrote about the AriZona Iced Tea dissolution case — likely the biggest ever of its kind in New York – was four years ago, when 50% owner and co-founder John Ferolito filed his petition under Section 1104-a of the Business Corporation Law for judicial dissolution of the collection of companies that produce beverages and food products under the popular AriZona Iced Tea brand.
Since then, there’s been a multitude of trial and appellate decisions in that and several related lawsuits between Ferolito and the other co-founder and 50% shareholder, Domenick Vultaggio, all of which eventually were consolidated for trial starting last May before Nassau County Commercial Division Justice Timothy S. Driscoll, to whom the task fell of determining the fair value of the Ferolito shares pursuant to AriZona’s BCL Section 1118 buyout.
As you might expect, this was no ordinary valuation trial. Ferolito valued AriZona at $3.2 billion versus Vultaggio’s $426 million. For over a month, Justice Driscoll heard the testimony of 34 lay and expert witnesses, many of whom supplemented their in-court testimony with affidavits totaling about 1,000 pages, in addition to tens of thousands of pages of exhibits introduced into evidence. The parties filed post-trial memoranda last August, followed by oral summations in September, followed by more post-trial memoranda.
The wait is over. In a 42-page decision dated October 14, 2014 (2014 NY Slip Op 32830(U)), relying solely on the Discounted Cash Flow method, Justice Driscoll valued the entire enterprise somewhere around $1.4 to $1.5 billion after applying a 25% marketability discount. The number’s fuzziness reflects post-decision adjustments that will have to be calculated based on certain findings made by Justice Driscoll that departed from some of the assumptions made by the parties’ experts. According to Justice Driscoll’s self-described “back-of-the-envelope” calculations, the value of Ferolito’s 50% stock interest currently “approaches” $1 billion when pre-judgment interest is added at the rate of 9%. Justice Driscoll also left to future proceedings the critical question of AriZona’s ability to pay the fair value award, and its impact on the terms and conditions of any payout. Continue Reading
Last week’s post gave the factual and procedural background of the Zelouf case, summarized Justice Kornreich’s decision awarding the 25% dissenting minority shareholder $2.2 million for the fair value of her shares and another $2.2 million damages for her “quasi-derivative” claims, and then focused on the court’s rejection of a discount for lack of marketability. If you haven’t already read last week’s post, I recommend you do so before continuing with this one.
In this Part Two, I’ll highlight a number of other, interesting issues addressed in Zelouf of importance both to business divorce lawyers and business appraisers.
Court Adopts ”No-Burden” Approach
Justice Kornreich’s decision at pages 6-9 offers a useful summary of the legal standard for determining fair value in a dissenting shareholder appraisal proceeding under Section 623 (h) of the Business Corporation Law, including a brief discussion of burden of proof. Noting that New York’s highest court never has addressed the issue, the court adopted the “no-burden” approach proposed by the parties and supported by former Justice Stephen Crane’s analysis in Matter of Cohen, 168 Misc 2d 91 [Sup Ct, NY County 1995], aff’d, 240 AD2d 225 [1st Dept 1997], under which, as Justice Kornreich put it, “the court will consider the parties’ expert testimony as persuasive evidence of fair value, but, at the end of the day, and even if the court finds neither expert to be persuasive, it is the court’s burden to make a fair value determination.” As to the quasi-derivative claims for corporate looting and waste, however, Justice Kornreich stated that the dissenting shareholder, Nahal, “still has the burden of proof . . . but the impact of such claims on the value of the company, if proven, will be decided by the court under the no-burden approach.” Continue Reading
A year ago I wrote about a novel ruling by Manhattan Commercial Division Justice Shirley Werner Kornreich permitting the majority owners of a family-owned textile business to proceed with a freeze-out merger on the eve of trial of a 25% shareholder’s derivative lawsuit, where the avowed purpose of the merger was to strip the minority shareholder of standing to pursue her derivative claims. Key to the ruling were (1) the parties’ stipulation that, in any subsequent dissenting shareholder appraisal proceeding, the minority shareholder’s multi-million dollar claims of corporate waste and self-dealing by the controlling shareholders could be factored into the court’s appraisal, and (2) the inclusion in such appraisal of the minority shareholder’s legal fees in the terminated derivative action, assuming she prevailed in establishing her claims of waste and self-dealing.
The contemplated appraisal proceeding materialized after the minority shareholder rejected the corporation’s offer of $1.5 million for the statutory “fair value” of her 25% stake. A bench trial was held before Justice Kornreich over 11 days between March and July 2014. Last week, Justice Kornreich released her 32-page decision in Zelouf International Corp. v Zelouf, 2014 NY Slip Op 51462(U) [Sup Ct, NY County Oct. 6, 2014], fixing the fair value of the 25% stock interest at $2.2 million and awarding additional “damages” of another $2.2 million on the “quasi-derivative” claims for waste and self-dealing. The court also awarded the former minority shareholder her attorney’s and expert’s fees in both the appraisal proceeding and the prior derivative action, the calculation of which Justice Kornreich referred to a Special Referee to hear and report. The anticipated fee award plus pre-judgment interest likely will add millions more to the ultimate judgment against the company.
Zelouf tells a fascinating if not atypical tale of a highly profitable family-owned business run by second-generation owners whose internecine warfare and financial abuses led to years of bitter litigation. It also raises a number of interesting issues surrounding appraisal proceedings, including burden of proof, tax affecting, the discount for lack of marketability (DLOM), control premiums, and the inclusion of “quasi-derivative claims.” In this post, I’ll give the factual and procedural background of the case, followed by discussion of the opinion’s headline-grabbing issue, namely, Justice Kornreich’s rejection of any DLOM. Next week I’ll highlight the remaining issues of interest. Continue Reading
The rules of standing to seek judicial dissolution of closely held New York business corporations can be confusing. Correction: they are confusing.
Here I’m not referring to disputes over whether someone is a shareholder at all, or holds a specific percentage. I’ve posted many an article on this blog about dissolution cases in which the petitioner’s stock ownership was challenged for lack of documentation and/or as inconsistent with the entity’s organic instruments, tax returns and other business records.
Rather, I’m referring to the statutory criteria for standing and the judicial application of those criteria to situations in which a challenge is raised concerning whether a particular, otherwise-uncontested ownership interest confers eligible holder status as to the entity whose dissolution is sought.
Let’s start with the statutes.
Section 1104 of the Business Corporation Law. This statute authorizes a petition for judicial dissolution based on director or shareholder deadlock and internal dissension brought by “the holders of shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors.” Note that the statute requires the petitioner to own voting shares, and that it specifies a 50% voting interest — no more, no less. Continue Reading
Tom Rutledge (pictured) is an extraordinary combination of practicing lawyer, scholar, bar leader, lecturer, and prolific writer on business organizations. He’s a member of Stoll Keenon Ogden PLLC resident in its Louisville, Kentucky office and, among his many extra-curricular activities, is chair of the ABA Business Law Section’s Committee on LLCs, Partnerships and Unincorporated Entities. When Tom questions engrained notions about shareholder oppression in closely held businesses, people take notice.
I, for one, took notice of Tom’s thought-provoking article in the July-August 2014 issue of the Journal of Passthrough Entities entitled “Minority Shareholder Oppression? — The Problem is Not With the Answer But Rather With the Question.” Targeting legal doctrine that, Tom contends, improperly treats the majority’s termination of a minority shareholder’s at-will employment as an act of oppression, the article takes issue with what Tom calls the “classic prevailing analysis of shareholder oppression” under which courts are expected
to modify the contractual terms of the corporate form to create and enforce rights not afforded by the statute and not, as to the venture at hand, negotiated for and incorporated into the agreements comprising the venture.
In other words, the “classic formula under which the ‘oppression’ of minority shareholders and members is framed,” as Tom puts it, in the case of the terminated minority shareholder places the remedial cart before the rights-and-obligations horse. It does so, first, by failing to acknowledge the “separate and distinct” legal relationships that arise from the “corporate contract” as opposed to the “employment relationship” and, second, by encouraging ex-post judicial modification of the former by deeming oppressive conduct (i.e., termination of an at-will employee) that is fully sanctioned by the latter’s governing principles. Continue Reading
Your client, a 50% shareholder of a New York close corporation, tells you that the business is in complete disarray due to irreconcilable disputes with the other 50% shareholder and that he believes the other shareholder has misappropriated the corporation’s assets and diverted business opportunities.
The client accepts your recommendation to bring a judicial dissolution proceeding. You review Article 11 of the Business Corporation Law before drafting the dissolution petition. You come across two dissolution statutes denominated § 1104 and § 1104-a. Section 1104, called ”Petition in case of deadlock among directors or shareholders,” confers standing on a 50% shareholder and, as the name straightforwardly suggests, authorizes a court to dissolve based on deadlock precluding board action or election of directors, or other “internal dissension” warranting dissolution.
Section 1104-a, with the more cryptic name, ”Petition for judicial dissolution under special circumstances,” confers standing on a shareholder with 20% or more of the corporation’s voting shares, and authorizes dissolution when the controlling shareholders or directors engage in “illegal, fraudulent or oppressive actions” against the petitioning shareholder, or have ”looted, wasted, or diverted” the corporation’s property.
You quickly realize that your 50% shareholder-client has standing to seek dissolution under both statutes. Which one should you choose? If you believe you have facts sufficient to obtain dissolution under one of them, is there any reason to consider the other? Can you choose both? Does it really matter?
It most certainly does matter, for a couple of reasons mainly having to do with the different remedies offered by the two statutes. Continue Reading
Pity the poor books-and-records proceeding. Misunderstood. Neglected. Widely viewed among New York practitioners as an ineffective use of time and resources. Jealous cousin to its wildly popular Delaware counterpart.
That perception could start to change thanks to a decision last week by a Manhattan appellate panel in a shareholder books-and-records proceeding. Although the court’s ruling involves a public company, its liberalizing influence is bound to effect books-and-records proceedings involving closely-held business entities as well.
There are two sources of a shareholder’s right to gain access to corporate information: statute and common law. The New York statute, Business Corporation Law § 624, is nothing if not miserly. Under § 624 (b) and (e), a shareholder has the right upon written demand to examine minutes of shareholder meetings, the shareholder list, and the most recent annual and interim financial statements. That’s it. Not very useful if the shareholder wants detailed knowledge of the corporation’s decision-making, communications and financial transactions.
Then there’s the common-law right to inspect a corporation’s books and records, which is broader than the statutory right and can extend to all of the relevant corporation books and records. While it can be argued that the burden of pleading and proof differs depending upon whether the right to inspect is sought under the statute or common law, in either event, if the shareholder presents in good faith and shows a “proper purpose” for seeking the corporate records, the corporation resisting inspection must show the shareholder’s purpose is improper or is otherwise proceeding in bad faith. Continue Reading