Impasse Over Winding Up of Realty Company Leads to Judicial Dissolution
 On April 6, 2010, I'll be giving a talk sponsored by the Corporations Law Committee of the New York County Lawyers' Association on the subject of involuntary removal of LLC members, highlighting recent developments in New York case law and related operating agreement considerations. The program starts at 6:30 p.m. at the NYCLA's downtown Manhattan address, 14 Vesey Street, 4th floor Board Room. For more information contact Committee Chair Kaiser Wahab at kwahab@wrlawfirm.com. |
Let's face it. There are no bright lines when it comes to the standard for judicial dissolution of a close corporation on petition by a 50% shareholder alleging deadlock and internal dissension under §1104 of the Business Corporation Law. Instead, as I wrote some years ago in a NY State Bar Ass'n Journal article, the case law has developed incrementally and without discernable pattern, based on the peculiar facts and equities of each case. The court decisions, especially at the appellate level where it counts most, give us a result but little or no guidance for future cases.
Case in point: Matter of Poritzky (Dream Weaver Realty, Inc.), 2010 NY Slip Op 01486 (2d Dept Feb. 16, 2010), decided last month by the Brooklyn-based Appellate Division, Second Department. The court's short decision, affirming the lower court's order granting dissolution of a two-shareholder, 50-50 corporation, offers no factual analysis or anything to distinguish the case from others in which dissolution was denied, and contains but a few citations and standard quotes to the effect that determination of fault is not material when deadlock and dissension exists.
It turns out, however, that lurking in the case record, beneath the bland surface of the appellate court's order, is a rarely seen issue that merits attention, namely, what happens when the two 50% shareholders agree to wind up the business and sell its assets, but can't or won't agree how to accomplish it? More specifically, under such circumstances is judicial dissolution and appointment of a liquidating receiver warranted without a hearing, even where the respondent shareholder offers some evidence (a) of bona fide negotiations and agreements with third-party buyers of the assets and (b) that private sale likely will produce substantially greater proceeds than a distress sale at public auction following dissolution?
Continue Reading...Two-Member LLC Operating Agreement Contains Recipe for Dissension and Litigation
Last month, in Lola Cars International, Ltd. v. Krohn Racing, LLC, No. 4479-VCN (Del. Ch. Nov. 12, 2009), Vice Chancellor John W. Noble of the Delaware Court of Chancery issued a 31-page letter opinion addressing a number of important issues, including the adequacy of a deadlock dissolution claim, in a dispute involving a two-member Delaware LLC that built and sold Daytona-class Lola race cars (pictured). The case is noteworthy in the business divorce arena for two reasons, one spot-lighted by the decision and the other further off-stage.
The plaintiff, Lola Cars International, Ltd. ("LCI"), as 51% member teamed with defendant Krohn Racing, LLC ("Krohn"), as 49% member, to form Proto-Auto, LLC ("Proto") to manufacture and sell Grand Am Series professional race cars. Despite LCI's majority interest, under Proto's operating agreement the two members were equally represented on its governing board. As one of Krohn's primary obligations under the Operating Agreement, it agreed to provide the services of its manager, Jeff Hazell, as Proto's chief executive officer. LCI and Krohn had a falling out within the first two years of their venture, prompting LCI to sue for dissolution.
Center stage in Lola is Vice Chancellor Noble's analysis of the standard for judicial dissolution of LLCs under Section 18-802 of the Delaware LLC Act, which substantially resembles Section 702 of New York's LLC Law in requiring a showing that it is "not reasonably practicable to carry on the business in conformity with" the LLC operating agreement. Lola makes no new law. Rather, it builds on Chancellor Chandler's analysis in Fisk Ventures, LLC v. Segal, 2009 WL 73957 (Del Ch. Jan. 13, 2009) (read my prior post on Fisk with a link to that decision here), summarized as follows in Lola:
Continue Reading..."Unclean Hands" Defense Can Backfire in Deadlock Dissolution Case
The seminal New York case defining "oppressive" conduct under the statute authorizing a minority shareholder to seek corporate dissolution, Matter of Kemp & Beatley, Inc., 64 NY2d 63, 74 (1984), cautioned that a minority shareholder "whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression should be given no quarter in the statutory protection." This language gave birth to what has become known as the "unclean hands" defense in shareholder oppression cases under Section 1104-a of the Business Corporation Law (BCL). The unclean hands defense often is based on allegations that the petitioning minority shareholder secretly is involved with or planning to launch a competing business to steal the customers and good will of the company whose dissolution is sought.
Over the years since Kemp, the unclean hands defense also has crept into dissolution cases brought by a 50% shareholder under BCL Section 1104 based on deadlock and internal dissension. Unlike oppression cases under Section 1104-a, where the minority shareholder must prove some form of at-fault or unfair conduct by the majority, cases under Section 1104 focus on the deterioration of the relationship between the two 50/50 shareholders and the resulting corporate paralysis, without necessarily assigning fault to one side or the other.
A recent decision by Nassau County Commercial Division Justice Stephen A. Bucaria, in Matter of Rieger (Airmarine Electroplating Corp.), Short Form Order, Index No. 010524/09 (Sup Ct Nassau County Aug. 27, 2009), illustrates the difficulty of maintaining the unclean hands defense in a deadlock dissolution case where, absent compelling proof, the allegations of inequitable conduct by the petitioner can themselves contribute to the court's sense of shareholder hostility and corporate dysfunction warranting dissolution.
Continue Reading...No Exception to Arbitration for Deadlock Dissolution Petition, Court Rules
As I've previously pointed out (read here), when shareholder disputes arise, including corporate dissolution contests, courts will readily stay litigation proceedings in favor of arbitration where the parties' shareholders' agreement provides for mandatory arbitration. There is no exception for dissolution cases arising from 50-50 deadlock, as the unsuccessful petitioner recently learned in Matter of Brooks (Aqua Shield Inc.), Short Form Order, Index No. 1572/09 (Sup Ct Nassau County June 5, 2009).
Aqua Shield Inc. was formed in 2000 to market a patented telescopic swimming pool enclosure invented by co-founder and petitioner Bob Brooks who, along with his wife, holds 50% of the company's shares. The other 50% is held by investor Igor Korsunsky and his wife.
The October 2001 shareholders' agreement has a broad arbitration clause requiring arbitration of "any controversy or claim arising out of or relating to [this] Agreement or its breach . . .."
In November 2008, the Korsunskys commenced an arbitration proceeding with the American Arbitration Association (AAA) against the Brookses who interposed an answer. The AAA issued an order on motions and scheduling orders in February 2009, and scheduled a preliminary hearing for April 2009.
Continue Reading...Delaware Court of Chancery Grants Deadlock Dissolution Petition for LLC
The Delaware Court of Chancery last month granted a petition to dissolve a deadlocked Delaware limited liability company (LLC). Chancellor William B. Chandler III's carefully reasoned decision in Fisk Ventures, LLC v. Segal, 2009 WL 73957 (Del. Ch. Jan. 13, 2009), is likely to set the standard for cases of this sort inside and outside Delaware. It is must reading for business divorce practitioners whom increasingly are being called upon to handle breakups of LLCs as they become the predominant form of closely held business entity.
As important as the case is, I'm not going to give it my usual full-blown analysis, for two reasons. First, I'm in the middle of a trial and don't have the time. Second, excellent treatments already have been published by law professor bloggers Larry Ribstein (here) and Gary Rosin (here). So I'll just make a few quick observations on the Fisk case:
- Delaware's statute governing judicial dissolution of LLCs uses language substantially similar to New York's statute (LLC Law 702), authorizing dissolution "whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement."
- Chancellor Chandler sums up Delaware case law construing the statute as follows: "The text of § 18-802 does not specify what a court must consider in evaluating the “reasonably practicable” standard, but several convincing factual circumstances have pervaded the case law: (1) the members’ vote is deadlocked at the Board level; (2) the operating agreement gives no means of navigating around the deadlock; and (3) due to the financial condition of the company, there is effectively no business to operate."
