De Facto Dissolution of LLC Does Not Terminate Members' Fiduciary Duty or Avoid Accounting for Subsequent Profits
An important appellate decision handed down earlier this month holds that LLC members' fiduciary duties to each other do not expire upon the de facto termination of the members' business relationship, but, rather, continue until formal voluntary or involuntary dissolution. As a result, members who continue to do business through the old LLC, or who start up a new competing company prior to formal dissolution of the old LLC, must account to the excluded members for pre-dissolution profits.
The case, Matter of Beverwyck Abstract, LLC, 2008 NY Slip Op 06337 (3d Dept July 17, 2008), has its genesis in a business arrangement between the two individual owners of real estate and mortgage brokerage firms (I'll refer to them as the Brokers) and an Attorney who owned a title abstract firm called Gateway Title Agency, LLC. Previously, the Brokers had teamed up with a different attorney to form Beverwyck Abstract, LLC to perform title work, however that attorney soon withdrew from the firm. In September 2001, the Brokers assigned a 49% membership interest in Beverwyck to Gateway, with the understanding that the Brokers' mortgage company would refer title work to Gateway. Beverwyck had no assets at the time and Gateway made no capital contribution. The fees generated by Gateway's title work would belong to Beverwyck and would then be distributed 1/2 to the Brokers and 1/2 to Gateway. At the same time, the Brokers would arrange for the Attorney to act as the bank closing attorney for the Brokers' mortgage company, with those fees being retained by the Attorney.
Delaware and New York Courts Agree that 50% LLC Member May Not Hire Lawyer to Represent Company Adverse to Other 50% Member
There's been a recent flurry of courtroom battles over the authority of one 50% owner to engage counsel to represent the company adverse to the other 50% owner in dissolution proceedings or other types of internecine corporate warfare. I've previously written about some of these cases, including Sports Legends, Inc. v. Carberry, in which the court dismissed as unauthorized a suit by the corporation initiated by one 50% shareholder against the other for conversion of company assets (read here), and the infinitely fascinating Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC, where one 50% LLC member hired company counsel in a multi-faceted litigation with the other 50% member that included dueling dissolution applications (read here and here).
Two new decisions reinforce the general proscription against the hiring and militant alignment of company counsel by one 50% owner against the other. One comes out of the Delaware Court of Chancery, which many -- present company excluded, I'm a dyed-in-the-wool New York partisan -- consider the premier business law court. The other decision appears to be the final word in the Caplash saga.
Continue Reading...Court Discounts Fair Value Award for Built-In Gains Tax in Shareholder Oppression Case
In a posting last December I wrote about an important estate tax case, Jelke v Commissioner, in which a federal appeals court adopted a bright-line rule requiring 100% discount for built-in capital gains tax ("BIG") in the valuation of C corporation assets. At the time I made the following prediction about Jelke's impact on stock valuation in corporate dissolution cases:
Jelke likely will not have wide impact on valuation contests in dissolution cases, for two main reasons. First, the great majority of dissolution cases involve S corporations and other entities that opt for pass-through partnership tax treatment. Second, the standard of value in estate tax cases such as Jelke is fair market value as opposed to the fair value standard specified by New York’s buyout statute. In a BCL §1118 valuation case involving a real estate holding C corporation called Matter of La Sala, a New York trial court refused to apply a discount for BIG tax liability on the ground that it was required to value the corporation as a going concern and, therefore, it would not consider capital gains taxes triggered upon liquidation. Undoubtedly, this will not be the last word on the subject of BIG discounts in stock valuation proceedings.
I was right about one thing: it was not the last word on BIG and §1118 stock valuation proceedings. As it turns out, when I wrote those words there already was percolating in Nassau County Supreme Court a buy-out proceeding in a shareholder oppression case, Murphy v. U.S. Dredging Corp., requiring the court to decide the same issue presented in the La Sala case, namely, the appropriateness under the fair value standard of applying a BIG discount to the appreciated assets of a real estate holding C corporation. The Murphy court's answer -- applying a partial discount based on the present value of future gains taxes -- lands between Jelke's 100% discount and La Sala's zero discount.
Continue Reading...Court Orders Return of Investment as Equitable Remedy in LLC Dissolution Proceeding
It would be hard to find a business dissolution case with messier facts and thornier legal issues than Tal v. Superior Vending, LLC, 2008 NY Slip Op 51205(U) (June 6, 2008). The 28-page decision by Justice Alan D. Scheinkman of the Westchester County Supreme Court's Commercial Division describes a business relationship between two individuals that arose from friendship and degenerated in bitter acrimony and litigation over the dissolution of a limited liability company that supplied and maintained vending machines. The decision also grapples with a novel remedial problem: After Partner A freezes out Partner B, how does a court equitably liquidate a company whose assets and business have been transferred to another company controlled by Partner A which thereafter acquires additional assets that are commingled with the original assets, thus making it impossible to determine the assets and value of the company being dissolved? Justice Scheinkman's solution -- a money judgment in favor of the frozen-out partner equal to his capital investment plus interest -- is equally novel.
Peter Plotkin started a vending machine business in 1997 called Superior Vending Corp. ("SV Corp.") that reached almost $1 million in gross revenues by 2000 when Arik Tal became his business partner. Tal and his wife had become friends with Plotkin and his wife, and had rented a summer house together. In exchange for a 50% interest in SV Corp., in August 2000 Tal invested $170,000 which was used to acquire the assets of another vending company called Vernon Vending Corp. Tal also guaranteed payment of the $150,000 purchase price balance. In October 2000, Plotkin and Tal formed a new LLC called Superior Vending, LLC ("SV LLC") to which they informally transferred all the assets of SV Corp. Plotkin and Tal both were active in the business. They had no shareholders agreement for SV Corp. and no operating agreement for SV LLC.
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