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NY Business Divorce

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

Father’s Dead-Hand Control of LLCs Frustrates Sons’ Takeover of Realty Empire

Posted in LLCs

I recently wrote about the Kensington Publishing case in which the two children of the deceased business founder’s first marriage took control of a successful publishing house — to the consternation of the founder’s surviving second wife who inherited a majority of the company’s voting shares — by means of a voting agreement signed by the father without his wife’s knowledge several years before he died. In that case, the second wife, who was stymied in her effort to sell her majority stake on a control basis to a major publishing house, failed to convince the court to invalidate the voting agreement which port-mortem left board control in her stepchildren’s hands even upon a sale of the shares to an outside buyer.

The tables are turned in a new decision by Manhattan Commercial Division Justice Charles E. Ramos, in Serota v Scimone, 2014 NY Slip Op 30924(U) [Sup Ct, NY County Apr. 8, 2014], where it’s the second wife who prevails over the sons of her deceased husband’s first marriage by means of a different kind of dead-hand control mechanism involving a blanket delegation of LLC management authority to an outside contractor allied with the second wife and her son from her own prior marriage.

The Management Agreement in question, made by the ailing patriarch and business founder less than a month before his death, left his sons with ownership of a realty empire but with virtually no power to control it even though they automatically became the LLCs’ designated managers after their father died. Continue Reading

Legal Battle Over Board Seats Splits Neighbors in Manhattan Co-op

Posted in Advancement and Indemnification, Co-op Corporations, Corporate Governance

Housing cooperatives, or “co-ops” as they’re commonly known, occupy an unusual niche among forms of joint stock enterprises. Like any corporation, the tenant-shareholders have a common interest in maximizing for everyone’s benefit the value of the co-op’s assets, i.e., the apartment building and its common elements, but being neighbors who live above, below and beside one another, the tenant-shareholders also have intrinsically competitive interests regarding rights of access, use, development, transferability, etc., that can have a direct, disparate impact on quality of life and the resale value of their individual apartment units.

In large co-ops, where no single tenant-shareholder has a significant percentage of voting power, the centralized management authority of a democratically elected board of directors, exercised pursuant to the co-op’s by-laws, can regulate and mute any divergence between common and individual stockholder interests. Such centralized management, as in any corporation with widely dispersed ownership, effectively compartmentalizes decision-making at the board and shareholder levels.

But not all co-ops are large. In Manhattan and other parts of New York City there are many small co-op properties, including converted walk-up tenements and industrial loft buildings, with as few as four, five or six units where each tenant-shareholder may have a seat on the co-op’s board of directors and material voting power, thereby melding into one the theoretically distinct realms of director and shareholder authority and likewise conflating common and individual concerns.

Which also means that relations between tenant-shareholders in small co-ops can fall victim to the same kinds of infighting and dissension that afflict any small, closely held, owner-operated business enterprise. Some years ago I wrote about a Brooklyn co-op shareholder who petitioned for judicial dissolution of a five-unit co-op on grounds of oppressive conduct by the majority shareholders, which led to a statutory buy-out and contested valuation proceeding (read here and here). A Manhattan appellate panel’s decision last month in Akasa Holdings, LLC v Sweet, 2014 NY Slip Op 01822 [1st Dept Mar. 20, 2014], illustrates another kind of co-op shareholder dispute involving a battle for board control of a four-unit co-op, pitting one tenant-shareholder owning a majority of the voting shares against the other three tenant-shareholders. Continue Reading

Novel Ruling on Advancement in LLC Dissolution Case “Levels the Playing Field”

Posted in Advancement and Indemnification, Attorney's Fees, Interim Remedies, LLCs

Section 420 of New York’s LLC Law authorizes an LLC, “subject to the standards and restrictions, if any, set forth in its operating agreement,” to indemnify and hold harmless, and advance expenses to, any member, manager or other person ”against any and all claims and demands whatsoever.” The statute goes on to prohibit indemnification if a “judgment or other final adjudication adverse to such member, manager or other person” establishes that his or her acts were committed in bad faith or resulted from deliberate dishonesty, or that he or she gained a wrongful financial advantage.

In plain English, (1) if an LLC member, manager or other agent is successfully sued for actions relating to the LLC’s business and is hit with a damages award, so long as that person didn’t act in bad faith, dishonestly or profit illegally, when it’s all over the LLC can pay the award and reimburse the person’s legal expenses, and (2) the LLC also can fund (“advance”) the person’s legal expenses during the lawsuit, but the funds will have to be repaid if ultimately there’s a final judgment against the person and his or her conduct fails the bad-faith test.

There are few reported decisions by New York courts addressing claims for advancement in internecine lawsuits among LLC members. Best known is the 2009 Ficus decision in which the Appellate Division, First Department followed Delaware law to enforce advancement rights in litigation among members of a Florida LLC, emphasizing that rights of advancement and indemnification are “independent of one another” and that a court’s finding of misconduct for purposes of interim relief does not defeat advancement rights granted under the company’s operating agreement (read here). And then there’s the Borriello case, about which I wrote here, in which Justice Demarest enjoined an LLC from advancing the controlling members’ legal expenses in the face of the operating agreement’s provision which authorized indemnification only.

As those two cases illustrate, sometimes it’s the non-controlling member trying to use advancement to shift his or her defense costs indirectly to the controlling members, and sometimes it’s the other way around. Such cost-shifting can give one side or the other a huge and sometimes decisive litigation advantage. In a recent, novel ruling by Nassau Commercial Division Justice Stephen A. Bucaria, the court decided to “level the playing field” by ordering the LLC to advance legal expenses of both sides. PFT Technology LLC v Wieser, Short Form Order, Index No. 8679/12 [Sup Ct Nassau County Feb. 20, 2014]. Continue Reading

Court Enforces “Quick Draw” Buy-Sell Agreement in Suit Between 50/50 Shareholders

Posted in Buyout, Deadlock, Family-Owned Businesses

You’ve heard of a Shotgun buy-sell agreement? Let me introduce you to the Quick Draw.

I’ve named it after Quick Draw McGraw, one of my favorite, classic Saturday morning TV cartoons, and because it so nicely describes the unusual buy-sell mechanism enforced by Brooklyn Commercial Division Justice David Schmidt in his fascinating decision earlier this month in Mintz v Pazer, Decision and Order, Index No. 502127/13 [Sup Ct, Kings County Mar. 12, 2014].

What’s the difference between a Quick Draw and a Shotgun? With a Shotgun, the offeror names a price at which the offeree has the option either to buy the offeror’s shares or sell the offeree’s shares to the offeror. In most instances, the precise timing of the trigger-pull by the offeror is not critical because the offeree has the choice to buy or sell, which if anything creates a disincentive to be the trigger-pulling offeror.

With a Quick Draw, upon the occurrence of a contractually defined trigger event, either side can give a notice to purchase the other’s shares at a price to be determined subsequently by an appraisal process. Unlike the Shotgun, however, the timing of the trigger-pull is everything. The designation of buyer and seller is determined instantly by whichever side first serves its written notice to purchase. When each side wants to buy out the other, as occurred in Mintz, a difference of minutes in the delivery of the purchase notice will determine which side gets to buy and which side must sell.

If you think that sounds a little meshuggeh, you’re not alone. But that’s the agreement the parties made in Mintz, and that’s what the judge enforced.  Continue Reading

Is Denial of Shareholder Status Shareholder Oppression?

Posted in Grounds for Dissolution, Standing

 

Thirty years ago, in Matter of Kemp & Beatley, Inc., New York’s highest court defined minority shareholder oppression as “majority conduct [that] substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decision to join the venture.” For example, the court wrote,

A shareholder who reasonably expected that ownership in the corporation would entitle him or her to a job, a share of corporate earnings, a place in corporate management, or some other form of security, would be oppressed in a very real sense when others in the corporation seek to defeat those expectations and there exists no effective means of salvaging the investment. [64 NY2d 63, 73]

One of the rarer applications of the reasonable-expectations test in corporate dissolution proceedings occurs when the controlling shareholder denies outright the petitioner’s status as a shareholder. The few such reported cases usually feature corporations that never followed corporate formalities, never issued stock certificates, and have no written shareholders’ agreement. The Pappas case, about which I wrote here and here, is a good example of a case in which the respondent’s repudiation of the petitioner’s stock interest was the primary factor supporting the court’s finding of oppressive conduct. As the court in Pappas wrote, it is “difficult to recognize a more reasonable shareholder expectation than that its interest will not be repudiated in its entirety, and that legal action would be required to compel its acknowledgment.”

The complaining shareholders in Pappas had been employed by, and actively involved in the management of, the subject businesses, hence they offered a multi-faceted picture of oppressive conduct by the controller. But what about a putative minority shareholder who has no involvement in the business other than as a passive investor or donee of shares? Such a shareholder cannot allege loss of employment or exclusion from a role in managing the corporation’s affairs. Is the controller’s denial of the petitioner’s shareholder status, by itself, enough to establish oppressive conduct under Kemp‘s reasonable-expectations standard?  Continue Reading

Stock Redemption Agreement Forecloses Seller’s Suit for Tax Liability on Phantom Income

Posted in Buyout

I’ve written before (here and here) about the need to address potential tax liability of the selling shareholder on ”phantom” income, i.e., undistributed net income allocated to the shareholder on his or her Form K-1, when entering into a buy-out agreement. The issue commonly arises when the buy-out occurs mid-tax year or at any time before the corporation’s books are closed and returns completed for the tax year in which the buy-out occurs and for any prior tax year. The seller, no longer in a position to review or influence the post-transaction tax returns, effectively may end up underwriting the taxes on retained earnings for the benefit of the remaining owners. (It’s a different story if the corporation is reporting and allocating losses on the K-1′s which, ordinarily, the selling shareholder is quite content to receive.)

The case law generally views the issue through a contract lens. In other words, absent provision in the buy-out agreement for reimbursement of tax liability on phantom income, there’s no inherent, common-law right to a tax distribution to a former shareholder after the buy-out’s consummation.

The general rule takes on even greater potency when the buy-out agreement contains provisions effectively waiving the shareholder’s rights to seek additional monies coupled with a merger clause, which is what happened in a case decided last month by the Manhattan-based Appellate Division, First Department, called Jia v Intelli-Tec Security Services, Inc., 2014 NY Slip Op 01384 [1st Dept Feb. 27, 2014]. Continue Reading

Court Limits Scope of Release, Denies Advancement of Defense Costs in Sibling “Food Fight”

Posted in Advancement and Indemnification, Derivative Actions, Family-Owned Businesses, Interim Remedies, LLCs, Operating Agreement

According to its website, Brooklyn-based wholesale food distributor Jersey Lynne Farms traces its roots to the 1940′s when Vito Loconte began a door-to-door business selling loose eggs in mushroom baskets. Seventy years later, Jersey Lynne Farms is a major, full line food distributor selling to supermarkets, institutions, convenience and bagel stores, delicatessens, diners and restaurants throughout the metropolitan New York area.

In the 1990′s, a few years before he died, Loconte transferred stock ownership and management of Jersey Lynne Farms to his son Michael and daughters Dorine, Diane and Maria, some of whose spouses also took jobs in the family business. In 1999, the four siblings transferred ownership of the building that houses the distribution business to a newly formed limited liability company, named Caterina Realty, LLC, of which each sibling is a 25% member-manager. Since then Caterina Realty leases the property to Jersey Lynne Farms as sole tenant.

The Falling Out

Family unity fractured in 2011 when Michael, Diane and Maria banded together to oust Dorine as an officer, director and employee of Jersey Lynne Farms. They also fired Dorine’s husband from his position in charge of purchasing. That same year, a dispute erupted over the terms of a new lease between Jersey Lynne Farms and Caterina Realty. Relying on widely disparate appraisals, Dorine argued for an annual base rent of $600,000 compared with the $342,000 annual base rent adopted in the lease ultimately approved by her three siblings in late 2011.    Continue Reading

The Dissolution Court’s Broad Powers to Void Post-Filing Conveyances

Posted in Interim Remedies

The statutory scheme governing judicial dissolution of closely held New York business corporations resides in Article 11 of the Business Corporation Law. Article 11 includes several provisions empowering the courts to preserve corporate assets while the case is being litigated. The best known and most frequently invoked provisions are BCL § 1113, authorizing a court-appointed receiver, and BCL § 1115, granting the court broad authority to issue injunctions restraining the corporation’s shareholders, directors, officers and creditors from imperiling the corporation’s assets.

Wedged between those two provisions is a lesser known and rarely used statute, BCL § 1114, that gives the courts powers akin to those exercised by bankruptcy judges, to void any post-filing sale, transfer or encumbrance of corporate property made without the court’s prior approval. Here’s the full text of the statute:

A sale, mortgage, conveyance or other transfer of, or the creation of a security interest in, any property of a corporation made, without prior approval of the court, after service upon the corporation of a summons in an action, or of an order to show cause in a special proceeding, under this article in payment of or as security for an existing or prior debt or for any other or for no consideration, or a judgment thereafter rendered against the corporation by confession or upon the acceptance of any offer, shall be void as against such persons and to such extent, if any, as the court shall determine. Continue Reading

The High Price of Bungled Expert Disclosure in Valuation Cases

Posted in Accountants/Experts, Arbitration and Mediation, Discovery, Valuation

Courts determine the value of equity interests in closely held firms in a variety of settings, including (among others) dissenting shareholder proceedings triggered by mergers; elective stock buy-outs triggered by minority shareholder dissolution petitions; partnership buy-outs triggered by death or dissolution; disputes over contractual buy-outs contained in agreements among the co-owners; and damages claims arising from buy-outs tainted by fraud or wrongful nondisclosure.

The central feature of a valuation contest is the battle of the opposing appraisal experts. Nothing is more critical to the success of a litigant’s valuation case than putting on the testimony of a qualified, independent, experienced, credible, well-prepared, articulate appraiser who, using his or her written appraisal report as a springboard, can both educate and persuade the judge (or jury in certain types of cases) who has ultimate responsibility for  determining the value of the equity interest under the applicable standard of value.

In most valuation proceedings, the parties either are required to, or voluntarily agree to, disclose certain information concerning their intended expert witnesses in advance of the valuation hearing. I say in most cases because the governing rules can vary depending whether the case is brought in court or as an arbitration and, if in court, as a plenary action versus a special proceeding, or in the court’s Commercial Division versus in a general civil part. Disclosure practices also can vary from judge to judge. Continue Reading