Failure to Disclose Stock Interest in Bankruptcy Petition Defeats Standing in Later Dissolution Proceeding
It's not often that bankruptcy law intersects with corporate dissolution proceedings based on deadlock or minority shareholder oppression, but when it does, likely it's bad news for the petitioner seeking to liquidate the company or to be bought out by another shareholder.
Such was the fate of the plaintiff in a recently decided dissolution case called Light v. Boussi, 2008 NY Slip Op 51212(U). In 2006, plaintiff Beril Light sued Samuel Boussi for an accounting, imposition of constructive trust, damages and an order compelling dissolution of a real estate holding company formed in 1995 called 10-18, Inc. Light claimed that he and Boussi were 50-50 shareholders. Light alleged that Boussi failed to maintain corporate formalities, provide him with notice of corporate meetings or financial information, or distribute to Boussi 50% of the company profits. Boussi denied that Light ever was a shareholder and also asserted as affirmative defenses that Light lacked legal capacity to sue, and that Light's claims were barred by the doctrine of judicial estoppel.
Both defenses arose from the fact that in 1998, Light and his wife filed a voluntary petition under Chapter 11 of the Bankruptcy Code. Their petition listed various assets owned by them including real properties and interests in stock corporations, but made no mention of 10-18, Inc. The bankruptcy court entered a final decree in 2002, Light's bankruptcy case was closed, and the trustee was discharged.
Continue Reading...Indemnity Provision Can Tilt the Playing Field in Litigation Between Business Partners
For the business owner without access to the company checkbook, and who therefore must foot his own legal bills, about the only thing worse than litigating a business divorce with a co-owner is seeing her use company funds to pay her lawyer.
Case precedent makes it pretty clear that, in a straightforward dissolution proceeding in which the company is a nominal party rather than an active litigant, neither side has the right to tap company funds for legal fees. But often the dissolution claim by the non-controlling owner is tied to other claims seeking to impose personal liability against officers or managers of the company. When that happens, the defending officer-owners may invoke a contractual right to indemnity including advancement of legal expenses by the company. Alternatively, where the defending officer-owners have board control, they may authorize indemnity and advancement under indemnification statutes.
The latter occurred in Van Der Lande v. Stout, 3 AD3d 261 (1st Dept 2004), where a minority member of an LLC brought a derivative action accusing the majority members of waste, fraud and mismanagement, alongside a separate proceeding to dissolve the LLC. Over the plaintiff's objection the defendant majority members made a substantial capital call upon all members -- including the plaintiff -- to fund the advancement of legal fees in defense of the derivative action. The plaintiff moved for a preliminary injunction to prevent the LLC from compelling him to make contributions. The trial court denied the motion. The appeals court upheld the order under the authority of Section 420 of the New York Limited Liability Company Law, which allows the LLC to advance and pay its members' legal expenses absent a final adjudication that the individual defendants acted in bad faith, were dishonest or personally gained profit to which they were not entitled. "That plaintiff commenced the lawsuit which caused the need for the additional contribution", the court added, "does not constitute an exception to his obligations to the LLC."
Continue Reading...Decision Lowers the Bar for Former Partner's Claims of Fraudulent Buyout
When non-controlling partner A sells out to controlling partner B, following which B sells the company to a third party at a disproportionately high premium over A's price, A may suspect that B withheld information pertaining to the company's value at the time of A's sale. The question is, does A have a valid claim against B to recover a share of the re-sale profits? Does caveat venditor give way to a fiduciary-based, affirmative obligation on B's part to disclose to A any and all information material to the sale price?
An opinion handed down last week by an appellate court in Manhattan appears to lower the bar for such a lawsuit, and sends a cautionary message to transactional counsel concerning the effectiveness of seller representations and releases in partner buyout agreements.
In Littman v. Magee, 2008 NY Slip Op 05347 (1st Dept June 10, 2008), Steven Littman held an 18.7% membership interest in Rockwood Realty Associates LLC, a real estate investment firm formed in 1996 and managed by another LLC controlled by Rockwood's majority owners. Littman's 28-page complaint essentially alleged that the majority owners engaged in a squeeze-out through property sales that forced Littman to incur large personal tax bills on undistributed K-1 profits, contrary to an alleged "understanding" when the company was formed that distributions sufficient to cover taxes would be made.
LLC Member Disputes and the Attorney-Client Privilege
Over at the newly revived and highly recommended Unincorporated Business Law Prof Blog, there's news of a recent decision by a U.S. District Court in Nevada holding under federal law that for purposes of attorney-client privilege, a limited liability company is more akin to a corporation than a partnership and on that basis, ruling that communications between the LLC's manager and the LLC's counsel need not be disclosed to an LLC member and former manager who brought an action against the LLC. The case, Montgomery v. eTreppid Technologies, LLC, 2008 WL 1826818 (D. Nev. Apr. 18, 2008), appears to be the first published decision on this issue.
The privilege issue frequently arises in business divorce litigation where, typically, a non-controlling faction seeks access to the controlling faction's communications with attorneys who've worked for, and been paid by, the company. The issue tends to get further complicated by allegations that the legal work for the company in fact is being done for the interests of the controlling faction.
Montgomery involved a manager-managed LLC with a board-like management structure, hence an easier comparison to the corporate form. It'll be interesting to see how federal and state courts grapple with the issue in other cases, and whether courts will distinguish Montgomery in cases involving member-managed LLCs.
Caplash Redux: 50% Member Cannot Hire Lawyer to Represent LLC in Dispute with Other 50% Member
When 50-50 business partners have a falling out, the ensuing battle for the high ground can lead one of them to take hostile action in the company's name without the other's consent.
Examples of the phenomenon, recently featured in this blog, include the case of Hellman v. Hellman, where the court upheld the authority of a 50% shareholder as president to enter into a lease opposed by the other shareholder, and Sports Legends, Inc. v. Carberry, where the court refused to authorize a lawsuit brought in the company's name by one 50% shareholder against the other.
Then there's Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC. About four months ago I wrote about an appellate decision in the Caplash case in which the court reversed a trial court order dissolving a medical practice LLC because of unresolved factual issues concerning the plaintiff's standing to seek dissolution. The issue before the court was whether to give legal effect to the plaintiff's letter to the company resigning his employment, and thereby terminating his LLC membership, where the company's requisite acceptance of the resignation was by letter from an attorney whose authority under the operating agreement to act on the company's behalf was not established. The appellate court sent the case back to the trial court for a hearing to determine the issue.
Since then, there's been a flurry of activity in the Caplash case and a new trial court decision which, I'm happy to report, supplies many of the underlying facts missing from the appellate decision. The recent decision, by Justice Kenneth R. Fisher of the Monroe County Supreme Court, Commercial Division, addresses two issues of interest. First, it examines the interplay between the parties' operating agreement and the LLC Law in deciding whether the lawyer engaged by one member with 50% voting power had the authority to accept on the LLC's behalf the other member's resignation. Second, it determines whether the same lawyer could act on the entity's behalf in asserting claims against the resigning member for wrongful competition and other economic injury to the LLC.
Continue Reading...Dissenting Shareholder Loses Right to Receive Dividends Upon Merger Consummation
Like most states, New York's Business Corporation Law (BCL) permits a shareholder to opt out of mergers and certain other corporate restructurings by electing to be cashed out for the "fair value" of his or her shares. The so-called dissenting shareholder statute, BCL Section 623, sets forth procedures and deadlines for submission of the shareholder's written objection to the proposed transaction, for the corporation's making of a price offer, and for the filing of a judicial appraisal proceeding in the event the shareholder rejects the corporation's offer. A statutory appraisal proceeding also may result from a "freeze-out merger" in which the controlling shareholders compel minority shareholders to redeem their shares for cash. The dissenting shareholder statute typically comes into play with merger transactions involving corporations with relatively large capitalization and whose minority shareholders include passive investors. Section 1005 of the New York Limited Liability Company Law likewise permits members to dissent and cash out from mergers or consolidations involving LLC's.
A recent court decision, in a case called McCully v. Jersey Partners, Inc., 18 Misc 3d 1138(A) (Sup Ct NY Co 2008), raises a caution flag for dissenting shareholders and their counsel when it comes to asserting claims for dividends that accrue prior to merger consummation but are not payable until afterward.
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