Judicial Estoppel Doctrine Defeats Ex-Convict's Standing to Bring Shareholder Derivative Action Based on Failure to Disclose Alleged Stock Interest to Probation Authorities at Time of Sentencing
The doctrine of judicial estoppel in general prevents a party who asserts a factual position in one legal proceeding from taking an inconsistent position in subsequent litigation. Judicial estoppel occasionally comes into play in shareholder disputes when the complaining party's status as a shareholder, and thus his or her standing to sue, is challenged based on the failure to disclose the stock interest in prior legal proceedings.
For example, last year I wrote about a case called Light v. Boussi in which the court dismissed a corporate dissolution proceeding brought by a putative 50% shareholder due to his failure to list the shares as an asset in his prior bankruptcy proceeding. A recent decision by Suffolk County Commercial Division Justice Emily Pines provides another example, this time involving a shareholder's derivative action in which the plaintiff failed to disclose his alleged stock interest at the time of his sentencing in prior criminal proceedings. Watkins v. J C Land Development, Ltd., Short Form Order, Index No. 30679-08 (Sup Ct Suffolk County June 19, 2009).
The plaintiff, William "Chip" Watkins, filed a shareholder's derivative action in 2007 alleging that he owned a 50% stock interest in a real estate company called J C Land Development, Ltd. ("JCLD") formed on March 25, 1999. Watkins alleged that he invested $600,000 in JCLD including $130,000 in start-up cash. Watkins claimed that the other 50% shareholder, John Cenci, and another co-defendant as "agent" subsequently diverted ownership of JCLD's real properties by placing title in their own names for "no adequate consideration". The suit asked to set aside the allegedly improper transactions and to have the title to the real properties transferred to the corporation.
Continue Reading...Court Permits Direct Rather Than Derivative Recovery in Post-Dissolution Action Against Controlling Shareholder for Misappropriation of Assets Held by Second Corporation Found to be "Mere Continuation" of Dissolved Corporation
New York County Commercial Division Justice Bernard J. Fried recently handed down a post-trial decision in a fascinating shareholder dispute between family members that required the court to address two significant issues:
Can a shareholder action for misappropriation of corporate assets be brought individually rather than derivatively after the corporation's dissolution?
Does the "mere continuation" doctrine, under which a creditor of a dissolved corporation may reach assets of a de facto successor corporation, apply even absent a transfer of assets to the successor?
The case is Miot v. Miot, 2009 NY Slip Op 51605(U) (Sup Ct NY County July 15, 2009).
Miot is the story of one brother, Alvin, who for many years owned and ran a construction and real estate business, and who in March 1985 gifted to his brother, Sanford, a 70% stock interest in a corporation called Madcat Realty Corp. ("Madcat I") which owned a commercial building on Kane Street in Brooklyn. Sanford knew of the shares, but had no knowledge of Madcat I's business affairs or even whether it owned any assets. The other 30% was owned by Alvin's wife, Harriet, who nominally served as secretary-treasurer and signed whatever corporate documents were given to her for signature, but who also had no knowledge of the company's business affairs. There were no shareholder or director meetings, and neither Sanford nor Harriet ever exercised shareholder rights. Alvin, who died in 2001, maintained sole control of the corporation. With respect to the corporation's records, Justice Fried found it "unclear" whether they exist or ever existed, with the exception of a blank stockbook that was located.
Continue Reading...Court Orders Hearing On Minority Shareholder's Petition for Common Law Dissolution
Minority shareholders in closely held New York corporations, unlike many other states, must hold at least 20% of the corporation’s voting shares to petition for judicial dissolution on grounds of oppression under Section 1104-a of the Business Corporation Law. There’s little if any legislative history to explain the arbitrary 20% threshold. I imagine it was included as a compromise to satisfy legislators opposed to judicial interference with traditional corporate majority rule.
Shareholders with less than 20%, and without any claim for breach of shareholders' agreement, have limited options to right perceived wrongs by the controlling shareholders. They may bring a derivative action under BCL Section 626 for corporate waste, diversion of assets or other wrongs causing injury to the corporation, but first they either must make proper demand upon the board of directors or demonstrate demand futility. BCL Section 627 also requires a derivative plaintiff-shareholder with less than a 5% interest to give security for the corporation's costs including legal expenses. Furthermore, depending on the circumstances, commencing a plenary action for breach of shareholders' agreement or asserting derivative claims for recovery on the corporation's behalf may not provide sufficient leverage to induce a buy-out of the plaintiff's shares, assuming the plaintiff is pursuing an exit strategy.
The below-20% shareholder has one other option: common law dissolution. It carries no minimum ownership percentage. It's harder to establish than statutory oppression under BCL 1104-a, and rarely successful, but under the right circumstances it may give such a shareholder at least a toe-hold toward dissolution, which also may be enough to induce serious buy-out negotiations.
A recent decision by Queens County Commercial Division Justice Orin R. Kitzes presents one of the relatively rare instances in which a claim for common law dissolution successfully advances past the pleading stage. The case, Matter of Mouzakitis (Pearl Nightlife, Inc.), Index No. 28420/08 (Sup Ct Queens County Feb. 24, 2009), was previously featured on this blog when the court initially dismissed without prejudice a common law dissolution petition because the plaintiff's husband, who co-owned the shares as tenants by the entirety, was not a party to the action. Husband and wife thereafter filed a new action as co-plaintiffs, again suing for common law dissolution.
Continue Reading...Court Adds Accounting Remedy to LLC Members' Arsenal
A year ago, in Tzolis v. Wolff, 10 NY3d 100 (2008), New York's highest court recognized the common law right of LLC members to bring a derivative action on the LLC's behalf. Late last month, in Gottlieb v. Northriver Trading Co., LLC, 58 AD3d 550 (1st Dept 2009), an intermediate appellate court cited Tzolis in support of its decision recognizing the right of LLC members to seek an equitable accounting under common law.
The "equitable action on account" has a rich legal history in early English and American law, reflecting a time when forms of pleading and the scope of judicial powers made sharp distinctions between actions "at law" and those "in equity." In modern usage, the accounting action allows a trust beneficiary, partner, etc. to compel a fiduciary entrusted with property to render an account of his or her actions and for the recovery of any balance found to be due. The accounting involves more than simply turning over existing financial records. In New York practice, if the court grants an accounting, it may order the fiduciary to prepare a "long accounting" with detailed schedules of income and expenses over a defined period, followed by the filing of objections to the accounting, followed by proceedings before a court-appointed referee to hear and determine the accounting. (To view a form of order of reference to determine an account, click here.)
Continue Reading...Top 10 Business Divorce Cases of 2008
The nominations are in, the votes are counted, envelope please! Following are my picks for last year's top 10 business divorce cases, all of which were featured in prior posts:
- Tzolis v. Wolff, 10 NY3d 100 (2008), in which the Court of Appeals resolved conflicting First and Second Department decisions on the question whether LLC members can bring derivative actions on the LLC's behalf. They can.
- Matter of Beverwyck Abstract, LLC, 53 AD3d 503 (3d Dept 2008), in which an appellate court upheld a lower court's ruling that the de facto dissolution of an LLC did not terminate the members' fiduciary duty to account for ongoing profits up until formal dissolution.
- Tal v. Superior Vending, LLC, 20 Misc 3d 1103(A) (Sup Ct Westchester County 2008), in which the court crafted an equitable remedy in an LLC dissolution by ordering a return of the petitioner's investment.
- Dingle v. Xtenit, Inc., 20 Misc 3d 1123(A) (Sup Ct NY County 2008), in which the court required a bona fide purpose for a controlling shareholder's dilution of the minority shareholder's interest.
- Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC, 19 Misc 3d 1138(A) (Sup Ct Monroe County May 12, 2008), subsequent decision, 20 Misc 3d 1104(A), in which the court upheld the petitioner's standing to seek LLC dissolution after finding that the other member lacked authority to engage the LLC's attorney who had accepted the petitioner's resignation.
- Hellman v. Hellman, 19 Misc 3d 695 (Sup Ct Monroe County 2008), modified, 2009 NY Slip Op 02418 (4th Dept Mar. 27, 2009). involving a corporation owned 50-50 by brothers, in which the court upheld a new company lease executed by the brother who served as president over the other's objection that the lease required board approval.
- Murphy v. U.S. Dredging Corp., 2008 NY Slip Op 31535 (Sup Ct Nassau County May 19, 2008), a valuation proceeding involving shares in a subchapter C real estate holding corporation in which the court applied a discount for built-in capital gains.
- Matter of Youngwall, 2008 NY Slip Op 30811(U) (Sup Ct Nassau County Mar. 14, 2008), adhered to upon reargument in unreported decision dated July 28, 2008, in which the court granted dissolution of an unprofitable LLC and also ruled that a provision in the operating agreement waiving the right to seek judicial dissolution is void as against public policy.
- Ross v. Nelson, 54 AD3d 258 (1st Dept 2008), in which the court enforced the LLC's default statute in upholding a majority vote of the members to remove one of the managers.
- Manitaras v. Beusman, 56 AD3d 735 (2d Dept 2008), in which the court found that an LLC operating agreement's silence on the sale of the LLC's sole asset permitted majority approval under the default statute even though the sale automatically triggered dissolution.
What will 2009 bring? It's not illogical to think that the stress of the economic meltdown will lead to an increase in business divorce. But in my years watching the scene I've never detected any correlation between business cycles and the rate of litigious business break-ups involving closely held companies. If anything, I would lean in favor of the theory that financial success and opportunity in a business create even more incentive for dissension among co-owners. A recent NY Times article pointed out how falling real estate values are impeding marital divorces by eliminating the primary resource for financial settlement. I think a similar phenomenon could be at play with businesses in the current climate, by reducing the upside for a disgruntled owner contemplating a tactical lawsuit designed to induce a buyout.
Post-Tzolis Rulings Address Demand and Contemporaneous Ownership Requirements for LLC Derivative Actions
Last February, in Tzolis v. Wolff, 10 NY3d 100 (2008), the New York Court of Appeals ruled that members of limited liability companies may bring derivative actions on behalf of LLCs notwithstanding the legislature's deliberate omission of statutory authorization for derivative actions when it enacted the LLC Law in 1994. (Read my post on Tzolis here).
The dissenting judges in Tzolis objected that the majority had created a common law right of derivative action "unfettered by the prudential safeguards against abuse that the Legislature has adopted when opting to authorize this remedy in other contexts," namely, the statutory provisions imposing demand, contemporaneous ownership, security, attorney fees and settlement restrictions on derivative suits brought on behalf of business corporations and limited partnerships.
The majority responded to this charge, stating that "the right to sue derivatively has never been 'unfettered'"; that "the limitations on it are not all of legislative origin"; and most importantly:
What limitations on the right of LLC members to sue derivatively may exist is a question not before us today. We do not, however, hold or suggest that there are none.
In Tzolis's aftermath, lower courts have taken their cue from the majority's response by imposing prior demand and contemporaneous ownership requirements on putative LLC derivative plaintiffs.
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...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...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, 10 NY3d 100 (2008).
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...