First a books and records proceeding. Then a declaratory judgment action. Then dissolution proceedings. Six years of litigation including two appellate rulings, just to establish who’s a shareholder and who’s not, all because the owners of two closely held corporations formed decades ago never bothered to issue stock certificates or otherwise attend to corporate formalities.
It didn’t help that the two corporations, formed in the 1960’s, never elected pass-through taxation as subchapter S corporations, hence the companies never issued form K-1’s identifying the shareholders and their stock percentages.
In last week’s appellate ruling in Zwarycz v Marnia Construction, Inc., 2015 NY Slip Op 06239 [2d Dept July 22, 2015], which affirmed a June 2014 post-trial decision by Westchester County Supreme Court Justice Robert DiBella, the plaintiff Michael Zwarycz overcame the absence of a stock certificate or any other direct evidence of share ownership to establish his 50% interest in two corporations that own residential apartment buildings in Yonkers, New York.
Zwarycz’s victory last year before Justice DiBella turned bittersweet, however, when his follow-up petitions to dissolve the two corporations based on deadlock and internal dissension were dismissed by a different judge. Those November 2014 rulings are the subject of Zwarycz’s pending appeals. Continue Reading
If you’ve got an owner-operated, closely held business entity that pays no dividends, and it features controlling and non-controlling ownership interests, generally it’s a good idea to include in the owners’ agreement provisions for the compulsory buyback of the non-controlling owner’s interest upon termination of employment.
The reasons are fairly obvious. The last thing anyone needs is an outside owner with trapped-in capital, possibly having to go out-of-pocket for taxes on phantom income, who may feel compelled to challenge the controller’s financial and management decision-making, possibly through a books-and-records demand and/or a lawsuit asserting derivative claims or seeking judicial dissolution, as the only means available to pressure the controller into a reasonable buyout.
While I’m a fan of such forced buybacks, I’m less wild about buyback provisions that reduce the amount to be paid for the equity interest of a non-controlling owner whose termination is for cause. I get the idea — to incentivize an owner/employee to keep to the straight and narrow — but too many times I’ve seen trumped-up terminations for cause by a financially incentivized controller followed by litigation brought by the financially penalized, expelled owner who contests cause, especially when the alleged misconduct is claimed to fall within a broad, catch-all category such as violation of company policy or failure to perform duty.
Case in point: last week’s appellate ruling in Matter of Bonamie, 2015 NY Slip Op 06191 [3d Dept July 16, 2015]. Bonamie involves a company called Ongweoweh Corp. which, according to its website, was founded in 1978 by Frank Bonamie in upstate New York and is “a Native American-owned, pallet management company providing pallet & packaging procurement, recycling services and supply chain optimization programs.” According to this trade publication, in 2010 Frank’s son Daniel became the company’s CEO and president. Continue Reading
Not surprisingly, the vast majority of business divorce cases involve firms with valuable assets and/or profitable operations. After all, outside of creditor claims in bankruptcy court, who wants to invest time and money fighting over the corpse of a business with little or no equity value?
Still, it happens once in a while. Take, for example, a case recently decided by Manhattan Commercial Division Justice Shirley Werner Kornreich involving a limited liability company that was up and running for a couple of years before it went insolvent and shut down. Almost five years after a minority member brought suit against the controlling majority member, and after the court’s denial of summary judgment on the plaintiff’s primary claim for recovery, the majority member settled the case for $30,000 which, I imagine, is a small fraction of the legal fees spent by both sides.
Justice Kornreich’s decision in Mazel Capital, LLC v Laifer, 2015 NY Slip Op 30295(U) [Sup Ct NY County Mar. 3, 2015], tells the story of a short-lived business called Heartwatch that unsuccessfully marketed a heart monitoring device in tandem with a live 24-hour call center staffed by cardiologists and other medical professionals. In 2006, the business was organized as an LLC by its founder and sole managing member, Dr. Franklyn Laifer, a retired cardiologist and the defendant in the case. The plaintiff, Mazel Capital, LLC, initially invested $250,000 cash and contributed other assets in consideration of a 9% membership interest in Heartwatch. A year later Mazel invested another $300,000 cash, raising its stake to 12%. Dr. Laifer’s son and others invested another $100,000 in exchange for an 8% membership interest, leaving Dr. Laifer with the remaining 80% for his “sweat equity.”
The LLC’s operating agreement gave Dr. Laifer exclusive management authority but also provided that he was “not entitled to any compensation for serving as Manager.” A contemporaneous side agreement placed limits on monthly expenditures during the first six months absent Mazel’s consent. Continue Reading
Judicial dissolution of a business entity, whether pursuant to statute or common law, is an equitable remedy subject to equitable defenses, including the doctrine of “unclean hands.”
As described a few years ago by Justice Emily Pines in the Kimelstein dissolution case, the unclean hands doctrine “bars the grant of equitable relief to a party who is guilty of immoral, unconscionable conduct when the conduct relied on is directly related to the subject matter in litigation and the party seeking to invoke the doctrine was injured by such conduct.”
The doctrine has been employed in dissolution cases in two ways. First, it can defeat a petitioner’s standing to seek dissolution, as in Kimelstein where Justice Pines held that the petitioner’s admitted concealment from his ex-wives, creditors and federal government of his alleged, undocumented 50% equity interest in two corporations owned by his brother barred him from asserting the requisite stock holdings to seek statutory dissolution. Second, even when the petitioner’s stock ownership is conceded, the doctrine can bar the petitioner’s dissolution claim on the merits.
The doctrine’s latter use rarely has been successful. A recent exception is Sansum v Fioratti, 128 AD3d 420 [1st Dept 2015], in which the Appellate Division, First Department, ordered the dismissal of a common-law dissolution claim brought by a 6% shareholder in an art gallery based on the plaintiff’s “embezzlement” of company funds for which he pled guilty to larceny and related charges. The decision packs an even more powerful punch by virtue of the court’s summary disposition of the claim, disagreeing with the lower court that a hearing was required and invoking the doctrine of in pari delicto (Latin for “in equal fault”) to reject the plaintiff’s counter-argument, that the defendant stockholders themselves conducted illegal business operations. Continue Reading
Partnership dissolution cases have an especial poignancy, more so than cases involving other forms of business entities.
I think it’s because general partnerships are a dying breed of business association, supplanted in our litigious society by limited liability entities such as S corporations and LLCs.
The occasional partnership dissolution cases that land in court these days tend to involve family or multi-family real estate partnerships formed decades ago, in which one or more of the original partners have passed away or are approaching retirement and looking either to exit or to transfer their partnership interest and/or management role to their children. Fittingly, along with elderly parties the statutes governing the disputes are found in the superannuated New York Partnership Law, essentially unchanged since its adoption in 1919.
Such was the case in Breidbart v Olshan, Decision and Order, Index No. 003610/12 [Sup Ct Nassau County May 27, 2015], involving a realty partnership formed in 1977 to acquire and develop under a long-term lease a commercial office building in Lake Success on Long Island. The partnership, known as Boundary Realty Associates, consisted of three partners: Olshan (50%), Rosenberg (25%), and Breidbart (25%). The written partnership agreement provided that the partnership would employ as managing agent for the first three years a firm owned and operated by Olshan at a fixed commission of 4% of gross rental income. The agreement also provided for termination of the partnership in 2020 or sooner upon the consent of a majority in interest of the partners. Continue Reading
If you’ve studied New York dissolution law, you know that, unlike proceedings involving close corporations, there’s no statutory authority for a court-ordered buy-out when a member of a limited liability company petitions for judicial dissolution under LLC Law § 702.
You also know, especially if you follow this blog, that notwithstanding the absence of such authority, on a few occasions New York courts have invoked their common-law powers of equity to compel buy-outs in LLC dissolution cases, or have reached the same result by characterizing the buy-out as a form of liquidation.
The selected valuation date can make a critical difference in determining the value of an equity interest in the business. In dissolution proceedings involving close corporations, the statute authorizing a buy-out election, Business Corporation Law § 1118, stipulates valuation as of the day before the filing of the petition. We don’t have similarly definitive guidance on the LLC side because there’s no enabling statute, but the few LLC cases decided so far suggest some answers. Continue Reading
Several years ago I had my first encounter as a business divorce lawyer with an LLC agreement purchased from the online legal forms provider, LegalZoom.
The case involved a two-member New York LLC that, in the four or five years it operated, achieved enviable growth and profits. The two members were highly educated individuals with ample business experience.
Apparently for reasons of speed and convenience — they had the financial wherewithal to hire a lawyer, but chose not to — they used LegalZoom to form the LLC including the articles of organization and operating agreement. The latter document reflected a 70/30 ownership split.
Years later the members’ relationship turned bitter, which is when I first got involved in what became a court case and eventually the liquidation and dissolution of what had been a successful business. As in every business divorce, the reasons for the demise of the business were complex and unique but shortcomings in the operating agreement also contributed significantly to the parties’ legal postures and willingness to risk litigation. Continue Reading
Judicial dissolution statutes for limited liability companies in New York, Delaware, and many other states use the contract-centric language drawn from limited partnership law, namely, whether it is reasonably practicable to carry on the business in conformity with the articles of organization and operating agreement.
Court decisions in both Delaware and New York have construed their respective LLC statutes as authorizing judicial dissolution when the purpose of the entity, as defined in the operating agreement, can no longer be achieved. For instance, former Vice Chancellor Chandler of the Delaware Chancery Court in his 2008 Seneca Investments decision, and then-Vice Chancellor Strine in his 2009 Arrow Investment Advisors decision, both used language suggestive of the LLC agreement as the sole source to which a court should look in determining the LLC’s purpose. In New York, Justice Austin, writing for the Appellate Division, Second Department, in the seminal 1545 Ocean Avenue decision, similarly crafted a dissolution standard keyed to the frustration of the LLC’s “stated purpose” in the context of its operating agreement.
Does that mean courts never look outside the LLC agreement when determining if its purpose no longer is achievable? And how should a court determine purpose when the LLC has no written agreement? Recent decisions from Delaware and New York provide some clues to the answers. Continue Reading
Rare is the petition for LLC dissolution not immediately greeted by a motion to dismiss by the non-petitioning members.
Don’t get me wrong. Pre-answer motions to dismiss are a staple of all kinds of litigation including business disputes. It’s just that, in my experience, as compared to more pedestrian matters such as contract disputes based on nonpayment or delivery of defective goods, the open-endedness of the standard for judicial dissolution of LLCs gives the non-petitioning member greater room and incentive to argue that the petition does not adequately allege grounds for relief and therefore should be dismissed out of the gate.
The member seeking dissolution and his or her counsel have choices to make that can affect the odds of surviving an early dismissal motion:
- File for dissolution by summons and complaint in a plenary action, or by petition in a special proceeding?
- If utilizing a special proceeding, commence it by order to show cause or by notice of petition?
- Whether using a complaint or petition, allege the bare minimum facts or lay out detailed testimonial and documentary evidence as if it were a summary judgment motion?
Business divorce and business valuation are inseparable. By that I mean, in almost every business divorce matter where the co-owners are beyond reconciliation, determining the value of the business is essential to any resolution, whether by settlement or court verdict, whereby one owner usually buys out the other or they divide the business assets.
Valuing a closely held business for which no active market exists is no simple thing. Sure, for certain industries there are rules of thumb that can give a very rough indication of value, e.g., EBITDA multiples, but the specific and often unique attributes of every business, including customer relationships, dependency on key personnel, accounting practices, and owner discretionary spending, make reliance on such simplistic formulas an unsatisfactory proposition in the super-charged, high stakes atmosphere of a contested separation of business partners.
So what valuation options does the business owner have? Sometimes the only feasible option is to engage an accredited business appraiser to prepare a comprehensive, detailed report setting forth the appraiser’s conclusion of value in a form admissible at trial, such as in dissolution proceedings when one side elects to buy out the other and the case is headed to a judicial hearing to determine the fair value of the seller’s shares. Such appraisals can take a significant amount of time to complete, depending in large part on the ease or difficulty of the appraiser’s access to company information, and can cost tens of thousands of dollars (or even six figures) depending on the size and complexity of the business (and the sophistication and billing rates of the appraisal firm, which can vary widely).
In most instances, when the parties to an incipient business divorce “lawyer up,” the need for a full-blown appraisal can be too remote to justify the effort and expense. The dispute may settle without litigation or in the early stages of a litigation. Or sometimes the parties litigate the grounds for dissolution over a period of months or even years before a buyout remedy is ordered.
It’s in the initial stages of a business divorce that a “quick-and-dirty” appraisal can be most useful and cost effective. Continue Reading