Anatomy of a Dissolution Slugfest: Part II
This is the second in a series of postings on a multi-faceted corporate dissolution battle waged in Nassau County Supreme Court called Matter of Marciano (Champion Motor Group, Inc.) involving three partners and a luxury automobile dealership.
Part I of the series (read it here) summarized the basic facts and discussed the defendants’ initial challenge to the plaintiff Marciano’s standing to seek dissolution. The court’s decision identified evidence suggesting that, as the defendants’ argued, the plaintiff deliberately elected not to have his alleged 38% ownership interest reflected in the corporate records or in tax filings. Ultimately, however, the court refused to dismiss the case because of the disputed facts surrounding the issue of plaintiff’s share ownership.
In this Part II, we examine the several other issues of interest addressed by Justice Ira Warshawsky in his initial decision in the case dated September 5, 2006.
1. Defendants’ argument that their exclusion of plaintiff from the business was reasonable following his indictment for stock fraud.
The majority owner defendants contended that, even assuming plaintiff Marciano could establish his ownership percentage in Champion above the minimum 20% required by the dissolution statute (BCL § 1104-a), their decision to exclude him from any involvement in the business, following his criminal indictment for stock fraud in December 2004, was reasonable as a matter of law.
As with the issue of stock ownership, Justice Warshawsky concluded that the reasonableness of defendants’ exclusionary actions "must await further factual development through discovery in the underlying action". The defendants’ evidence of damaging repercussions and concrete economic injury to the business from Marciano’s indictment, the court found, was "anecdotal" and lacked "determinative foundational support in the record".
Continue Reading...Anatomy of a Dissolution Slugfest: Part I
Question: What do you get when you take a luxury automobile dealership consisting of multiple corporations and limited liability companies, stir in three business partners, add contradictory documents concerning one partner’s ownership interest, season with a federal indictment of that same partner for stock fraud following which the other two partners freeze him out of the business, top off with a pair of litigators and bring to a boil?
Answer: A great recipe for a corporate dissolution slugfest recently played out in Nassau County Supreme Court.
Business divorce devotees can go to school on this case, thanks to a series of fact-filled and law-laden written decisions authored by Justice Ira B. Warshawsky of the Nassau County Supreme Court, Commercial Division. About the only disappointing thing about this battle royal, entitled Matter of Marciano (Champion Motor Group, Inc.), is that the plaintiff’s first name isn't Rocky.
This first of five consecutive postings on the Marciano case summarizes the underlying facts. It then examines the court’s handling of the primary defense raised by the defendants in their initial attack on the dissolution petition, in which they challenge Marciano’s standing as a shareholder to seek dissolution. In subsequent postings New York Business Divorce will discuss a number of other issues discussed in each of the court’s four, separate decisions, including:
- whether Marciano’s criminal indictment justified the defendants’ decision to exclude him from the business;
- Marciano’s application under Section 702 of the LLC Law to dissolve the several LLCs formed by the parties;
- Marciano’s request for appointment of a limited receiver or financial monitor to oversee the business;
- Marciano’s request for access to all corporate records;
- Marciano’s request to compel distributions to him pending the proceedings;
- Marciano’s application to amend his pleading to add post-commencement derivative claims for waste and mismanagement;
- Defendants’ application made after discovery for summary judgment dismissing the action based on lack of standing and Marciano’s eventual guilty plea to unrelated federal charges;
- Marciano’s application to dismiss defendants’ “unclean hands” and estoppel defenses; and
- Marciano’s application for injunctive relief concerning the defendants’ alleged self-dealing when they assigned the dealership’s lease to a related company in which they alone are principals, following which the related entity exercised an option to purchase.
LLC Members May Bring Derivative Suits
The New York Court of Appeals (the state's highest court), in a split decision with a vigorous dissent by three of the court's seven judges, today resolved the hotly debated question whether members of New York limited liability companies may bring derivative suits on the LLC's behalf. Answer: they may. Here's the decision in Tzolis v. Wolff.
A number of lower courts, in refusing to grant member standing to sue derivatively, interpreted the LLC Law's legislative history as indicative of the legislature's deliberate omission of statutory authority for derivative suits. The Court of Appeals majority held otherwise, finding the legislative history "too ambiguous to permit us to infer that the Legislature intended wholly to eliminate, in the LLC context, a basic, centuries-old protection for shareholders, leaving the courts to devise some new substitute remedy" (p. 11).
Waving the separation of powers banner, the dissenters accuse the majority of "judicial fiat" by "effectively rewrit[ing] the law to add a right the Legislature deliberately chose to omit", adding: "The proponents of derivative rights for LLC members -- who were unable to muster a majority in the Senate -- have now obtained from the courts what they were unable to achieve democratically" (p. 20).
The availability to LLC members of derivative rights will have a substantial impact on LLC member relations and the kind of litigation that may ensue when members seek judicial recourse. Without such rights, members holding minority interests in LLCs had little recourse against majority abuses that caused direct injury only to the LLC (e.g., taking excessive compensation or other forms of self dealing). The LLC Law's provision for judicial dissolution has not proved to be a potent remedy in the face of typical operating agreement provisions giving broad management control to the majority owners. Today's decision in Tzolis evens the playing field by providing an alternative avenue for judicial relief.
Continue Reading...One Case, Three Great Issues
When it comes to reading court decisions in business divorce cases, I have a number of pet issues. If I come across a decision with one such issue, I’m happy. Two in the same opinion, I’m thrilled. Three in the same opinion, it’s like hitting the trifecta.
A recent decision by Nassau County Commercial Division Justice Stephen A. Bucaria offers a winning threesome: (1) arbitrability of corporate dissolution petitions; (2) petitions seeking dissolution of out-of-state corporations; and (3) dissolution petitions that trigger mandatory buybacks under a shareholders’ agreement.
The case, Matter of Schneck (R&J Components Corp.), involves two brothers who went into, and eventually each inherited 50% interests in, an electronic parts business founded by their father who died in 1990. The business came to be organized as six separate companies, two of which were formed as out-of-state corporations but all of which operated in New York. The complaining Brother A claimed that Brother B had frozen him out of the business, denied him access to business records, and took hundreds of thousands of dollars more each year than Brother A was getting. Brother A sought judicial dissolution of all the companies based on internal dissension and deadlock under Business Corporation Law § 1104.
Brother B raised several defenses. First, he asked the court to stay the proceedings pending arbitration pursuant to a mandatory arbitration clause in the shareholders’ agreement. Such clauses routinely are enforced in dissolution proceedings. In this case, however, the court found that Brother B had waived arbitration by moving for summary judgment on the merits. Here’s the money quote: "The courtroom . . . may not be used as a convenient vestibule to the arbitration hall so as to allow a party to create his own unique structure combining litigation and arbitration."
Brother B fared better on his next defense aimed at the two non-New York corporations, successfully arguing that a New York court may not dissolve a foreign corporation even if its principal place of business is New York. The argument invoked the so-called "internal affairs" doctrine under which courts traditionally refuse to rule on the regulation and management of a foreign corporation. I have followed this issue for many years in the hope -- thus far unrealized -- that courts will re-analyze the wisdom of the internal affairs doctrine as applied to the dissolution of a corporation operating wholly within New York whose only connection to the other state is the place of incorporation. After all, New York courts routinely interpret and apply the law of other states in many other types of corporate governance disputes. Although the idea of a New York court ordering, e.g., Delaware's secretary of state to dissolve a Delaware corporation is no less repugnant than that of a Delaware judge ordering New York's secretary of state to dissolve a New York corporation, so long as the court has personal jurisdiction of the business owners it seems to me that either judge in either jurisdiction could order the parties to file a certificate of voluntary dissolution without offending the incorporating state's sovereignty. Also, there is at least one lower court decision (Matter of Dohring [CVC Products, Inc.], 537 NYS2d 767 [1989]) holding that, even if dissolution of a New York based foreign corporation technically is not within the court's power, it may adjudicate the case and fashion a lesser or alternative remedy that achieves "substantial justice" between the parties.
The third issue is one of my all-time favorites, about which a colleague and I wrote an article published in July 2006 in the New York Law Journal. Shareholders’ agreements frequently have stock transfer restrictions that grant a right of first refusal under certain circumstances, generally involving a shareholder who wishes voluntarily to sell his or her shares. Such provisions often include broad language that can be construed as triggering the duty to offer the shares for sale – typically at a formula price well below fair value – whenever there is an attempt to dispose of one's shares through any means, including judicial dissolution. In this case, the court concluded that the language was not broad enough and therefore it denied Brother B’s request to compel Brother A to convey his shares.
Decision Highlights Interplay Between Employment Status and LLC Membership
Closely held companies with multiple owners actively involved in the business sometimes use employment agreements between the company and the owners, separate and apart from the shareholders’ agreement (for corporations) or operating agreement (for LLCs). Such employment agreements are especially prevalent in medical practices where, among other reasons, restrictive covenants are routinely used to prevent departing doctors from establishing competing practices in the same locality.
Quite often the shareholders’ or operating agreement and the employment agreement will provide that, upon termination of employment, the shareholder or member is required to redeem his or her interest in the company on specified terms. Disputes and litigation, including proceedings for judicial dissolution of the business, may erupt when the outgoing owner perceives enough of a disparity between the specified compensation (or lack thereof) and the “real” value of his or her interest.
A decision last week by an intermediate appellate court in Rochester, involving a medical practice organized as an LLC, highlights the interplay between the interest redemption triggered by termination of employment and the threshold issue of standing to seek judicial dissolution of an LLC under Section 702 of the Limited Liability Company Law. The statute confers standing to seek dissolution upon members only.
In Caplash v Rochester Oral & Maxillofacial Surgery Assoc., LLC, the trial court summarily granted the plaintiff’s application to dissolve the practice. On appeal by defendant, the panel of five appellate judges unanimously reversed the lower court’s decision on the ground that defendant raised a genuine issue for trial whether, based on plaintiff’s apparent resignation, he was a member of the company within the meaning of the statute when he sought dissolution. Here’s what the court said:
The appellate decision does not reveal any additional facts, such as the percentage membership interest of the plaintiff and whether, for instance, the issue concerning the attorney’s authority to act on behalf of the company arose because the plaintiff and defendants were 50/50 members. In any event, the decision is another reminder that, no matter how high temperatures rise when business partners are on the brink of breakup, careful reading of agreements and obtaining advise of counsel should precede any decisive steps.Defendant submitted a letter from plaintiff to the company indicating that plaintiff was resigning as an employee of the company, and he also submitted a letter from an attorney who purported to accept plaintiff's resignation on behalf of the company. The company operating agreement unequivocally provides for the termination of membership in the event of the termination of a member's employment with the company, and plaintiff's employment agreement specifies that "This Agreement shall terminate . . . at any time by mutual agreement in writing by Employer and Employee." The record does not disclose the circumstances under which the attorney came to represent the company and whether such representation was authorized by the operating agreement. We thus conclude that there is an issue of fact whether plaintiff has standing to seek dissolution.
