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...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...Statute and Cases Create Uncertainty Over LLC Member's Right to Inspect Books and Records
Strained relations between managing and non-managing members of limited liability companies (LLC) sometimes lead to fights over the former's denial to the latter of access to company records. Section 1102 of the New York Limited Liability Company Law (LLCL) sets forth a three-part scheme governing the maintenance of, and member access to, LLC records.
The first part, Section 1102(a), requires that every LLC maintain five specific categories of records:
(1) if the limited liability company is managed by a manager or managers, a current list of the full name set forth in alphabetical order and last known mailing address of each such manager;
(2) a current list of the full name set forth in alphabetical order and last known mailing address of each member together with the contribution and the share of profits and losses of each member or information from which such share can be readily derived;
(3) a copy of the articles of organization and all amendments thereto or restatements thereof, together with executed copies of any powers of attorney pursuant to which any certificate or amendment has been executed;
(4) a copy of the operating agreement, any amendments thereto and any amended and restated operating agreement; and
(5) a copy of the limited liability company's federal, state and local income tax or information returns and reports, if any, for the three most recent fiscal years.
Note that the preceding list limits financial information to recent tax returns. This becomes more important under the second part, Section 1102(b), which provides for member access to LLC records including all the records mandated under Section 1102(a), as follows:
Continue Reading...Any member may, subject to reasonable standards as may be set forth
in, or pursuant to, the operating agreement, inspect and copy at his or her
own expense, for any purpose reasonably related to the member's interest
as a member, the records referred to in subdivision (a) of this section, any
financial statements maintained by the limited liability company for the three
most recent fiscal years and other information regarding the affairs of the
limited liability company as is just and reasonable.
50% Shareholder May Not Sue Other 50% Shareholder in Company's Name
The concept of the corporation as a separate "person", with a legal identity distinct from its shareholders and the ability to sue and be sued in its own name, is the cornerstone of the corporate form of business organization. The essential corporate attribute of limited liability and the attendant imposition of fiduciary duties of loyalty and care on those entrusted to manage the corporation's affairs, could not comfortably exist without corporate separateness.
Okay, I admit that's a highfalutin way to introduce the discussion that follows, of a trite lawsuit between shareholders of a two-bit sports memorabilia business, but that's the beautiful thing about the law, its noblest notions inform even the most mundane of disputes.
The dispute in question is the subject of a decision last month by New York County Supreme Court Justice Joan Madden in a case called Sports Legends, Inc. v. Carberry, 2008 NY Slip Op 30718(U) (Sup Ct NY County Mar. 10, 2008) (read decision here). The case arose when one of two 50% shareholders of a sports memorabilia business caused a suit to be filed in the name of the corporation against the other shareholder, asserting claims to recover company merchandise allegedly taken by the defendant and not returned. The primary issue in the court's decision, of no interest here, was whether the action was barred by the statute of limitations (the court found that it was). Secondarily, and the reason I'm discussing the case, the court addressed the issue whether the shareholder who brought the suit in the company's name had the authority to do so.
Continue Reading...Court Upholds Authority of 50% Shareholder/President to Sign Lease Without Co-Owner's Approval
Internal shareholder disputes involving closely held corporations can take several different forms when they land in court. The type of litigation addressed primarily by this blog is the dissolution proceeding, in which the ultimate objective is the company's liquidation or, as usually happens, a buyout. Sometimes, as a prelude to dissolution proceedings or negotiated buyout, one shareholder files suit accusing another shareholder of engaging in unauthorized company transactions. Such tactical lawsuits can be particularly effective with companies with 50/50 shareholders where the complainant believes with some justification the court is more likely to enforce the rights of a co-equal owner to an equal say in the company's business affairs.
Along these lines comes the fascinating case of Hellman v. Hellman (read decision here) involving a fight between two brothers each owning 50% of the shares in a lighting business founded by their father in the 1950s, called Maynards Electric Supply. The decision, written by Justice Kenneth R. Fisher of the Commercial Division in Rochester, is a scholarly and highly instructive exegesis on the interplay between officer and board authority in the closed corporation setting where, typically, no one pays attention to corporate formalities until it's too late.
Brothers Glenn and Bruce Hellman are Maynards' sole shareholders and directors. Both are actively employed in the business. Bruce is President and Treasurer. Glenn is Vice-President and Secretary. The business operated since 1985 in a building owned jointly by the two brothers and two other siblings. The lease was scheduled to expire at the end of June 2005. In 2004, Bruce began lease negotiations with the owner of another building ("Stockwood"). Bruce informed Glenn of the negotiations. Glenn disagreed with the proposed relocation. Lawyers for the two exchanged letters in which Glenn warned that Bruce lacked authority on his own to make commitments on the company's behalf. Bruce's lawyer sent Glenn the proposed form of lease. Glenn objected anew to Bruce's authority to enter into the lease. In May 2005, Bruce announced that the company would not be renewing the existing lease upon termination. Two days before the termination date, Bruce as President executed in the company's name a five-year lease with Stockwood. Shortly thereafter he informed Glenn of the new lease and advised of a planned move the coming Fall. Glenn's lawyer wrote to Stockwood maintaining that Maynards had not approved the lease.
Continue Reading...