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

CunninghamNew Hampshire lawyer John Cunningham eats, sleeps and breathes limited liability companies.

Seriously, John has carved out for himself a niche practice as one of the foremost experts in the country on the formation of limited liability companies and the drafting of LLC operating agreements.

He shares his knowledge through his many lectures and publications, including his leading LLC formbook and practice manual, co-authored by Vernon Proctor, called Drafting Limited Liability Company Operating Agreements published by Wolters Kluwer, and his highly informative blog Cunningham on Operating Agreements. John also chaired the committee that wrote the New Hampshire Revised LLC Act enacted in 2013.

From a business divorce perspective, management deadlock is a recurrent problem and precipitator of litigation for LLCs with two equal members. I didn’t fully grasp the potential magnitude of the problem, however, until I read John’s recent article in the Wealth Counsel Quarterly called “Avoiding Deadlocks in LLC Operating Agreements” in which he cited an IRS statistic that 25% of all LLCs nationwide consist of two members. My own experience jibes with John’s article’s observation, that “the members of most two-member LLCs are equal in voting and profit shares,” and that

For all of these LLCs, the issue of deadlock is major. Even in the best two-member LLC, it is likely that deadlock issues will eventually arise, and can destroy an otherwise promising LLC.

Continue Reading John Cunningham on Avoiding Deadlock in Two-Member LLCs

Not VerifiedIn one of my first posts on this blog I warned about the dire consequences (i.e., dismissal) of bringing a summary proceeding for corporate dissolution under Article 11 of the Business Corporation Law by filing a petition verified by the petitioner’s attorney rather than by the petitioner, unaccompanied by the petitioner’s sworn affidavit attesting to the merits of the petition’s alleged grounds for dissolution.

What about the other way around, that is, when a respondent opposing a dissolution petition files an answer to the petition verified only by his or her attorney, also unaccompanied by a sworn affidavit of the respondent attesting to the facts offered in opposition to dissolution?

Not surprisingly, the consequences are equally dire — for the respondent, anyway — as illustrated by the court’s recent decision in Matter of Salcedo (Hispanos Car Service, Inc.), 2016 NY Slip Op 31143(U) [Sup Ct Richmond County May 11, 2016], granting a dissolution petition in the absence of “admissible evidence” contradicting the petition’s allegations. Continue Reading How Not to Oppose a Dissolution Petition

Molk_Peter

Peter Molk, an Assistant Professor of Law at Willamette University College of Law and a rising young star in legal academia, has written a groundbreaking article entitled How Do LLC Owners Contract Around Default Statutory Protections? slated for publication in the University of Iowa College of Law’s Journal of Corporation Law and currently available here on SSRN.

The article also is the subject of my podcast interview of Professor Molk embedded at the bottom of this post.

Professor Molk’s article deserves attention because it asks and attempts to answer based on empirical evidence a vital question: Is the freedom of contract promoted by the LLC statutes’ default rules being used as theory would predict, to promote economic efficiency and to craft more efficient owner protections? In fact, his study finds that LLCs with more vulnerable owners adopt fewer owner safeguards, suggesting that contractual freedom may be used by LLC controllers opportunistically rather than to achieve efficiencies.

Professor Molk’s first-of-its-kind study tests theory with the reality of what is actually happening in the world of LLC operating agreements. He does this by carefully examining almost 300 operating agreements of LLCs involved in litigated cases mostly in Delaware but also in New York, looking for provisions that either weaken or strengthen owner protections granted by the statutory default rules. The patterns his study finds have a direct impact on business divorce practitioners and also should influence choice of entity decisions and the drafting of agreements by practitioners involved in entity formation.

In his own words, here’s the abstract of Professor Molk’s article:

Limited liability companies are built on the idea of contractual freedom. Unlike other business organization forms, most owner protections apply only by default to LLCs, which are free to waive or modify them as desired. This freedom promises economic efficiency if parties are sophisticated but raises the potential for opportunism by relatively more sophisticated managers and majority owners. While companies ranging from small landscape firms to Chrysler and Fidelity organize as LLCs, remarkably little is known about whether or how LLCs use this contractual flexibility.

I analyze the operating agreements of 283 privately owned LLCs organized under Delaware and New York law to determine when and how parties alter default provisions. I find widespread use of LLC statutes’ flexibility to decrease default owner protections, as well as widespread adoption of substitute owner protections that do not apply by default. There is little evidence, however, that the contractual freedom is used to craft more efficient owner protections. Instead, using a proxy for owner vulnerability, I find that LLCs with more vulnerable owners adopt significantly fewer owner safeguards, suggesting that contractual freedom may be used more for opportunism, not efficiency.

Professor Molk has much, much more to say on the subject in my podcast interview which I hope you’ll listen to and enjoy.

 

WillThere’s been very little case law defining the powers of the executor of a deceased LLC member under New York LLC Law § 608, enabling the executor or other estate representative to “exercise all of the member’s rights for the purpose of settling his or her estate or administering his or her property, including any power under the operating agreement of an assignee to become a member.”

Perhaps the dearth of section 608 case law stems from the fact that even the most basic LLC operating agreements usually include provisions governing the disposition of a deceased member’s interest.

For example, the agreement may trigger mandatory redemption or buy-out of the deceased member’s interest. Or, as in the Budis case, it may track the default rules under sections 603 and 604 permitting the assignment of LLC interests to any person who, unless admitted as a member by the surviving members, obtains only an assignee’s right to receive the distributions and allocations of profits and losses the deceased would have received, i.e., receives no voting rights and therefore lacks member standing to participate in management, seek judicial dissolution, sue derivatively, demand access to books and records, etc.

A case from neighboring Connecticut may help to fill in at least some of the gaps in New York’s section 608 case law. A decision last month by the Appellate Court of Connecticut — that state’s intermediate appellate court — in Warren v Cuseo Family, LLC, AC 37239 [May 3, 2016], dealt with an interesting set of facts involving the estate of the majority owner of a family-owned LLC and produced an unusual but not surprising ruling giving the executor extraordinary power as temporary receiver to wind up the LLC’s affairs in order to settle the decedent’s estate. Continue Reading Executor of Deceased Majority Member Appointed Receiver to Wind Up LLC

Goodwill

This is a story about a recent case involving a fight over the inclusion or exclusion of goodwill in valuing the interest of a retired partner in a medical practice organized as a limited liability partnership, and how it easily could have been avoided. But first, it helps to understand the legal framework for valuing such an interest and the type of goodwill at issue.

The limited liability partnership or LLP is a highly popular form of business association for professional practices including law firms and medical groups. As its name suggests, the LLP combines the attributes of a partnership with the limited liability traditionally associated with corporations, except that professionals in LLPs generally remain personally liable for their own misconduct or negligence.

In New York, the formation and registration of LLPs is governed by Article 8-B of the Partnership Law. In all other respects, as to both their internal and external affairs, the New York LLP is governed by the same provisions governing general partnerships codified in Sections 1 through 82 of the Partnership Law based on the ancient Uniform Partnership Act promulgated in 1914. Continue Reading How to Avoid Bad Blood Over Goodwill in Professional Partnership Valuations

BDR

If you liked Part One of my Business Divorce Roundtable podcast interview of Chris Mercer on the subject of the marketability discount in statutory fair value appraisal proceedings, you’ll definitely enjoy Part Two which is now available on a bunch of podcast directories including iTunes, Stitcher, Soundcloud, or your favorite RSS reader. Better yet, you can listen to it by clicking here. And if you haven’t yet listened to Part One, click here.

The marketability discount has played an outsized role in New York fair value proceedings under Sections 623 and 1118 of the Business Corporation Law, and has taken on new shades of controversy in recent years as some judges and business appraisers have questioned its theoretical, empirical, and equitable foundations when valuing the shares of dissenting or oppressed minority stockholders in closely held companies.

It also has its defenders, but Chris Mercer is not one them. Chris has taken a very public and vocal stand against application of the marketability discount in fair value cases. In Part Two of my interview, Chris talks about cases in which he has served as expert witness at trial advocating a zero percent marketability discount, including the Giaimo, Chiu, and AriZona Iced Tea cases.

If you like the podcast, please don’t forget to subscribe on iTunes or your other podcast manager.

I’ve got exciting news for all you business divorce junkies: Now you can get your fix of the latest news in the world of business divorce via my new podcast. It’s called the Business Divorce Roundtable and it’s currently available on iTunes and Soundcloud.

Let me first tell you what the podcast is not. It’s not an audio rendition of this blog; you won’t hear me reading my weekly posts which will continue as they have for the last 8+ years analyzing the latest business divorce case law and statutory developments.

Rather, the podcast will feature in-depth interviews with top professionals in the field of business divorce from the legal, academic and business evaluation communities. Below you’ll find a link to a two-minute preview in which I describe my plans for the podcast. Please give it a listen!

Below you’ll also find a link to the podcast’s premiere episode, Part 1 of a 2-part interview with leading business appraiser Chris Mercer on the discount for lack of marketability in fair value proceedings, a topic that has generated much controversy of late in New York case law and business valuation circles, and concerning which Chris has been at the forefront as testifying expert in key appraisal contests including the AriZona Iced Tea case. It’s a highly informative interview on an issue of great importance to any business owner, expert, or advisor involved in a business valuation exercise in or out of court.

And don’t forget, if you like what you hear and don’t want to miss future episodes, please be sure to subscribe to Business Divorce Roundtable on iTunes, Soundcloud, or your favorite RSS reader. Also, your reviews and feedback are greatly appreciated.

Continue Reading Announcing the Business Divorce Roundtable Podcast

Who paysThere are two breeds of buy-outs in corporate dissolution proceedings: voluntary and involuntary.

When a minority shareholder petitions for judicial dissolution on grounds of oppression, New York’s statutory scheme gives respondents the option to avoid a dissolution contest voluntarily by electing within 90 days to purchase the petitioner’s shares for “fair value” in an amount either to be agreed upon by the parties or determined by the court in an appraisal proceeding.

The buy-out statute (Business Corporation Law § 1118) grants the right of election to “any other shareholder or shareholders or the corporation” which, as a practical matter, leaves it up to the controlling shareholders whether to purchase the shares individually or through the corporation. Not surprisingly, in my experience the election overwhelmingly is made by the corporation. After all, who wants to undertake personal liability voluntarily, especially before the court determines the value of the petitioner’s shares and the terms of payment? Continue Reading Who Pays When the Court Compels a Buy-Out?

66discountTalk about playing your cards wrong.

A partner with a 3.08% interest worth $4.85 million in a partnership that owns a major shopping mall likely will walk away with only a few hundred thousand dollars after a court decision finding that he wrongfully dissolved the partnership and deducting from the value of his interest the other partners’ damages including legal fees, a 15% discount for goodwill, a 35% marketability discount, and a whopping 66% minority discount.

Last week’s decision by the Brooklyn-based Appellate Division, Second Department, in Congel v Malfitano, 2016 NY Slip Op 03845 [2d Dept May 18, 2016], rejected the partner’s appeal from the trial court’s determination of wrongful dissolution and also upheld its valuation determination with one major exception: the appellate court held that the trial court erred by failing to apply a minority discount and that it should have applied a 66% minority discount based on the “credible” expert testimony “supported by the record.”

The defendant partner’s fateful decision took place in 2006, when he sent his fellow partners a written notice unilaterally electing to dissolve the partnership due to what he described as a “fundamental breakdown in the relationship between and among us as partners.” The other partners quickly responded with a damages lawsuit claiming that he had wrongfully dissolved in violation of the partnership agreement in an effort to force the partnership to buy out his interest at a steep premium. The defendant, arguing that the partnership was at-will and of indefinite duration, denied wrongful dissolution and counterclaimed for his full, pro rata share of the partnership’s value upon dissolution. Continue Reading Partner Who Wrongfully Dissolved Partnership Hit With Whopping 66% Minority Discount