Anatomy of a Dissolution Slugfest: Part III
This is the third in a series of postings on a multi-faceted corporate dissolution battle waged in Nassau County Supreme Court called Matter of Marciano (Champion Motor Group, Inc.) involving three partners and a luxury automobile dealership.
Part I of the series (read it here) reviewed the basic facts of the case and discussed the defendants’ initial, unsuccessful challenge to Marciano’s standing to seek dissolution based on allegations that he deliberately sought to conceal from tax authorities and federal prosecutors his stock ownership interest. Part II (read it here) reviewed a number of additional issues addressed in the court’s September 2006 initial decision in the case, including the defendants’ argument that they acted reasonably by excluding Marciano from the business after his criminal indictment; Marciano’s request to dissolve the related LLC’s; and Marciano’s application for various forms of interim relief and for extensive discovery.
In this Part III, we turn to the second of Justice Warshawsky’s four written opinions in the case, dated June 15, 2007, in which he considers Marciano’s motions to compel payment to him of distributions pending the litigation and for leave to amend his complaint to add claims based on defendants' alleged financial abuses in the year following commencement of the litigation.
1. Marciano’s motion to compel interim distributions.
A minority shareholder who is frozen out of the business and subsequently files for judicial dissolution is hardly surprised when the controlling shareholders cut off distributions while the litigation rages. The Appellate Division, First Department's decision in Matter of HGK Asset Management, Inc. (Greenhouse), 238 AD2d 291 [1997], authorizes a court to order payment of salary and benefits to the excluded shareholder pending the dissolution proceeding. The Second Department's decision in Deborah Int’l Beauty Ltd. v. Quality King Distributors, Inc., 175 AD2d 791 [1991], also gives courts authority to enforce provisions in shareholder agreements mandating distribution of net income pending dissolution proceedings.
Continue Reading...Read All About It! Publication Notice of Dissolution Proceedings
Most business co-owners prefer to keep their internal disputes private, lest competitors get a whiff and take advantage with the customers, or because it might give customers or suppliers an excuse to back out of pending deals. When an owner goes to court to ask for judicial dissolution of the business, however, thanks to statutory publication requirements and internet access to court filings, the whole world is watching.
Section 1106 of the Business Corporation Law (BCL) requires the court, upon the presentation of a petition seeking judicial dissolution of a closely held corporation, to make an order to show cause setting a date for a hearing to determine if the corporation should be dissolved. For readers who haven’t seen one, here’s what a typical order to show cause in a dissolution case looks like.
Subdivision (b) of the statute also requires, among other things, that the text of the order to show cause be published at least once in each of the three weeks before the hearing date in one or more newspapers of general circulation in the county in which the office of the corporation is located. If, perhaps, in a moment of excruciating boredom, you've ever spent time perusing the legal advertisements in your favorite newspaper's classified ads section, amidst the dozens of announcements of newly formed limited liability companies and spouses disowning the debts of their soon-to-be-ex-spouses, you may have run across a notice of a judicial dissolution proceeding.
I like to think that long ago, when our wise legislators originally enacted the publication requirement, they had more in mind than generating legal advertising revenues for newspaper publishers. I imagine back then, when population centers were smaller, corporations fewer and access to court filings harder to come by, it made sense for the protection of creditors and potential creditors to publish a notice in the local newspaper whenever someone filed a petition for corporate dissolution.
Today, with instant access via the internet to a vast array of business and financial information as well as online court records, the publication requirement seems like a relic. It can be, however, a very expensive relic. Depending what county you’re in – New York County being the most expensive – and whether the court requires publication in a single newspaper or multiple newspapers, the cost of publication can run in the thousands of dollars.
The publication requirement can also raise tactical considerations, including:
- Subdivision (e) of BCL § 1106 permits the court to require the costs of publication to be borne by the corporation "or such other persons as the court may order." A minority shareholder seeking dissolution has a strong incentive to impose publication costs on the corporation, if not the majority owners.
- Insofar as publication may increase the odds of a business competitor learning of the dissolution case and using it to its competitive advantage, the shareholder more likely to end up as the purchaser in a buyout settlement may want to avoid the potential loss of goodwill from publication, and therefore may seek to adjourn the hearing date pending negotiations in order to defer publication.
What happens if the petitioner fails to comply with the publication requirement by the date of the hearing? The petition won’t be dismissed, but the proceeding will be adjourned until after publication, which usually translates into at least one month’s delay. Here’s a case where the court ordered an adjournment for publication.
By the way, New York’s Limited Liability Company Law has no such publication requirement for dissolution of LLCs.
Get Thee to the Commercial Division!
In 1995, following a successful pilot program in the New York County Supreme Court, the statewide court administration created a Commercial Division in that county and in Monroe County to handle business-related cases only. Since then the program has expanded to eight additional counties: Albany, Erie, Onondaga, Kings, Queens, Nassau, Suffolk and Westchester.
Here’s an overview of the Commercial Division from its website:
The Commercial Division serves as a vehicle for resolution of complicated commercial disputes. Successful resolution of these disputes requires particular expertise across the broad and complex expanse of commercial law. Because disclosure in commercial cases can be complicated, protracted and expensive, particularly in light of electronic discovery, the Division makes use of vigorous and efficient case management. The court sets deadlines and enforces them, managing discovery as needed to protect the rights of the parties to fair disclosure while minimizing expense and delay. Motion practice, especially in the form of motions to dismiss or for summary judgment, is particularly common in commercial cases. The caseload of the Division is thus particularly demanding, requiring of the court scholarship in commercial law, experience in the management of complex cases, and a wealth of energy.
The popularity of the Commercial Division among commercial litigators and the business community is driven in large part by the business-law expertise of its judges. The ability to tap such expertise, and to achieve a relatively fast resolution, is particularly useful to business owners and their counsel who get caught up in a business divorce.
The Commercial Division’s rules specify that cases involving dissolution of corporations, partnerships, limited liability companies, limited liability partnerships and joint ventures qualify for assignment to the Commercial Division. Counsel for the party who initiates the dissolution is required to submit a brief signed statement justifying the Commercial Division designation. If initiating counsel fails to file the dissolution petition as a Commercial Division case, the respondent’s counsel may write a letter to the Administrative Judge within 10 days after receipt of the RJI (Request for Judicial Intervention) requesting a transfer into the Commercial Division.
A number of Commercial Divisions, including those in New York, Kings, Nassau and Westchester Counties, also have established ADR (Alternative Dispute Resolution) programs that permit the judges to require the parties to participate in mediation using a roster of qualified volunteer lawyers. Mediation permits the combatants to air their grievances and objectives face-to-face in a controlled setting that can foster creative solutions to the difficult issues involved in separating or otherwise resolving their business interests.
Addendum (January 24, 2008): I received an interesting message in response to this entry from a lawyer representing a respondent in a dissolution case. The petitioner's counsel did not file the proceeding as a commercial case. The initiating order to show cause sought a preliminary injunction which was conferenced with the assigned non-Commercial Division judge and scheduled for a hearing. The respondent's counsel then timely delivered a letter to the Administrative Judge requesting transfer into the Commercial Division. Although the Administrative Judge acknowledged that the case qualified for assignment to the Commercial Division, the request was denied on the grounds that the assigned judge had already spent time on the case; that the case was not complex; that few assets were involved; and based on the petitioner's allegation that the delay resulting from re-assignment was prejudicial. Although the Commercial Division Rule states that cases meeting the specified criteria "will be heard" in the Commercial Division, it also provides that assignment decisions by the Administrative Judge are final and subject to no further administrative review or appeal.
LLC Dissolution and Receivers
New York’s statutory scheme for dissolution of closely held business entities sometimes looks like a crazy quilt. For instance, for reasons that defy all logic, a petition for dissolution of a business corporation based on shareholder oppression triggers an absolute right on the part of the other shareholders to avoid dissolution by purchasing the petitioner’s shares for fair value, but if the petition is based on director or shareholder deadlock, there’s no buyout right. A petition for dissolution of a business corporation requires service upon the state tax commission and publication notice of the order to show cause in advance of the hearing, but no such service or publication is required in a proceeding for judicial dissolution of a limited liability company (LLC).
Here’s another. The statute governing judicial dissolution of LLCs, contained in Section 702 of the LLC Law (LLCL), has no provision for appointment of a temporary receiver to protect the company’s assets pending the dissolution proceeding. In contrast, Section 1113 of the Business Corporation Law (BCL) expressly authorizes a court to appoint a temporary receiver for that purpose in a dissolution proceeding.
The divergence on this point between the BCL and the LLCL is highlighted in a recently decided case called At the Airport, LLC v. Isata, LLC, 15 Misc 3d 1145(A) (Sup Ct Nassau County June 6, 2007). The case was brought by a 20% member of an LLC seeking its dissolution based on income diversion, financial mismanagement, and denial of access to company records. In a decision by Nassau County Supreme Court Justice Leonard B. Austin, the court notes that the only provision of the LLCL authorizing appointment of a receiver or liquidating trustee, found in LLCL Section 703(a), by its terms applies after the company has been dissolved. Said the court, "[petitioner] is putting the cart before the horse since there must first be a finding of the right to judicial dissolution before a receiver can be appointed."
The petitioner in that case was forced to seek appointment of a temporary receiver under the more formidable standards for receivership found in Article 64 of the Civil Practice Law and Rules. The court held that he failed to make the requisite clear showing that the company’s property was in imminent danger of being materially injured or destroyed, and therefore denied the application for appointment of a receiver.
The petitioner in the same case fared no better on a subsequent application for reconsideration based on newly discovered evidence (read opinion here). If anything, the court's second ruling makes the point more emphatically, that compared to applications involving corporations under the BCL, the courts have strictly limited authority to appoint a temporary receiver for an LLC prior to an order of dissolution.
For Want of a Nail, the Case Was Lost
A recent court decision reminds us how the simple, easily avoidable mistakes made by counsel at the outset of a dissolution case can end in a misfire -- and likely an angry client.
In Matter of Cohen (Last Choice Real Estate Corp.), Index No. 5940/07 (Sup Ct Nassau County July 18, 2007), Justice Stephen A. Bucaria of the Nassau County Supreme Court, Commercial Division, dismissed a deadlock dissolution petition brought by a 50% shareholder because the petition was verified by the shareholder’s attorney instead of by the shareholder. For readers who don’t know, under New York practice dissolution is sought by way of a petition in a special proceeding, as opposed to filing a complaint in a regular action. The petition must be verified, meaning the petitioner/shareholder must sign before a notary public an acknowledgment that he or she has read the petition and that its allegations are true to his or her own knowledge. A properly verified petition also functions as an affidavit and thus can be considered by the court as evidence. Under certain circumstances specified by statute (typically because the client does not reside in the same county as the attorney) the attorney is allowed to verify even though the attorney has no personal knowledge of the petition’s factual allegations.
What some attorneys may not appreciate, however, is that dissolution proceedings essentially start off as a paper trial, that is, the court can decide the case on the merits based on the dissolution petition and the answering papers. If the petition is verified by an attorney who lacks personal knowledge of the petition’s allegations, and there is no additional client affidavit supporting the merits, then the court cannot treat the petition as an affidavit, and the petitioner is left with no evidence in support of dissolution. Case over.
In this age of nearly instant communication and document transmission via email and overnight courier, there is little or no reason ever to forego client verification of a dissolution petition.
Update (June 3, 2008): Following the dismissal of his case, the petitioner filed a new dissolution proceeding supported by the petitioner's own affidavit alleging deadlock and dissension between the two 50% shareholders. The respondent moved to dismiss the new proceeding based on the doctrine of collateral estoppel, arguing that the prior dismissal had been for lack of any evidence to support dissolution. Justice Thomas Feinman ruled that the prior decision was not on the merits and denied the dismissal motion (read decision here).
