Dissolution Counterclaim Fails to Stall Action for Goods Sold and Delivered
There are a couple of lessons to be learned from a recent decision by Nassau County Supreme Court Justice Daniel Palmieri in a quirky case called The Woods Knife Corp. v. Eastman Machine Co., 2009 NY Slip Op 32069(U) (Sup Ct Nassau County Sept. 2, 2009).
The first is, a minority shareholder who also does business with the corporation, and who fails to secure safeguards in the shareholders' agreement concerning the commencement of lawsuits by the corporation regarding their business dealings, cannot count on shareholder dissension issues to forestall enforcement of the corporation's commercial rights.
The second lesson is, if you're going to seek involuntary corporate dissolution, you must follow the procedural dictates of Section 1106 of the Business Corporation Law, which requires commencement of a special proceeding by petition and order to show cause with publication and service upon necessary parties including the state tax commission. A counterclaim for judicial dissolution in an existing litigation won't cut it.
The case involves two companies, Woods Knife Corporation and Eastman Machine Company, both formed many decades ago. Eastman, owned by the Stevenson family, manufactures cloth cutting machines. Woods Knife, owned 49% by the Stevenson family and 51% by the Woods family, manufactures blades used in Eastman's machines. The original agreement contained Eastman's pledge to "make every effort" to purchase its blade requirements from Woods Knife, but also permitted Woods Knife to sell to others. Nonetheless, over time Woods Knife became wholly dependent on Eastman for sales of its blades.
Continue Reading...Court Grants Dissolution, Rejects Claim that Failed Buy-Sell Agreement Was "Ploy" by Petitioner to Take Over Corporation's Retail Store Lease for His New Business
Has anyone else noticed an uptick in the number of cases asserting claims for breach of fiduciary duty and fraud arising from stock buy-outs among owners of closely held companies? Perhaps it should be called the Littman Effect, after the First Department's 2008 decision in Littman v. Magee, where the court upheld this type of claim notwithstanding broad releases and disclaimers in the buy-out agreement. (Read my post on Littman here.)
The most recent example is a case called Matter of Lerman (Tive Clothing, Inc.), Short Form Order, Index No. 2947/09 (Sup Ct Nassau County July 8, 2009), involving a single-outlet clothing store known as Effie's owned 50-50 by two shareholders. Although Lerman offers a twist on the usual fact pattern -- the fight was over the consequences of a contemplated buy-out that did not occur -- it flows from the same idea, viz, that Shareholder A wrongfully induced Shareholder B to enter into a buy-out agreement by withholding material information that Shareholder A was duty-bound to disclose.
The facts in Lerman are not complicated. The two owners, Lerman and Knaffo, set up their corporation, called Tive Clothing Inc. ("Tive"), and operated the store in leased space for almost 20 years before their relationship began to unravel over profitability and other financial issues. In June 2007 they reached an interim solution in the form of a stockholders' agreement with a buy-sell provision that permitted either of them to offer their shares to the other at a fixed price. If the offeree declined to purchase, Tive was to be dissolved and the inventory liquidated.
Continue Reading...Can Corporate Dissolution Proceedings Be Brought in Federal Court?
This month's Business Valuation Update includes a lengthy analysis of a recent stock valuation decision in a high-stakes corporate dissolution case, Kaplan v. First Hartford Corp., 2009 WL 737681 (D. Me. Mar. 20, 2009), brought by an oppressed minority shareholder of a Maine corporation that developed, owned and operated strip malls. The court, which had to contend with three different expert appraisals that came in $9 million at bottom and $48 million at top, valued the entire enterprise at $15 million based on "Pink Sheets" market trades adjusted -- as required by Maine's buyout statute -- to exclude any minority and marketability discounts. The decision is well worth the read for students of the art of stock valuation, but that's not what I want to address here. Rather, what I find most interesting about the case is who decided it: a federal judge.
Why is that interesting? The federal courts have two basic sources of subject matter jurisidiction: (1) the case involves a federal question, meaning the complaint asserts claims arising under federal statute or the U.S. Constitution, and (2) diversity of citizenship, meaning in most cases that the plaintiffs and defendants are citizens of different states. The typical case seeking judicial dissolution of a state-chartered corporation seeks state law remedies solely, which leaves diversity of citizenship as the only possible avenue to bring a corporate dissolution case in federal court.
Winning the Dissolution Battle, Losing the War
Most business divorce litigation involving closely held companies results either in a buyout of one party by the other, or the two sides dividing the remaining assets and going their separate ways.
The biggest problem getting to the buyout is the absence of a public market to establish the value of the interest being acquired, particularly when dealing with a non-controlling interest in a sales or services-based operating company. The buyer and seller, even when advised by qualified business appraisers, can be light years apart on price due to different assumptions about a host of valuation inputs some of which necessarily require subjective analysis.
Splitting up the business can be very easy or very difficult, depending on the specifics of the business. It tends to be more difficult when there is value associated with the defunct company's name or other such intangible good will value at the enterprise level (as opposed to personal good will that follows the individual business partner wherever he or she goes).
Litigation means time, expense and uncertainty, all of which can jeopardize the potential benefits of an eventual buyout or business split-up. It is difficult for the controlling owner to invest and make business plans while under the cloud of a prospective buyout of uncertain magnitude. The risks can be even greater in a split-up scenario for business partners who, perhaps as a matter of business survival, begin taking unilateral and sometimes surreptitious steps at odds with each other, designed to retain for themselves the loyalty and business of key customers and vendors.
These ruminations, and the title of this post, are inspired by recent decisions in two cases in which business partners remain locked in protracted and undoubtedly expensive litigation even after one side's initial attempt to achieve judicial dissolution became moot.
Continue Reading...Application for Judicial Dissolution of LLC Must Be Made by Complaint or Petition, Mere Motion Will Not Suffice
For years I've been carping about the substantive and procedural inadequacies of New York's LLC judicial dissolution statute. LLC Law Section 702, which was modeled after the rarely utilized limited partnership dissolution statute, consists in its entirety of the following two sentences:
On application by or for a member, the supreme court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement. A certified copy of the order of dissolution shall be filed by the applicant with the department of state within thirty days of its issuance.
At the time of the LLC Law's adoption in 1994, the legislature's minimalist approach made some sense because of tax considerations requiring avoidance of certain corporate characteristics including continuity of life. The IRS's subsequent implementation of check-the-box regulations freely permitting partnership tax treatment of LLCs, and the 1999 LLC Law amendments restricting member withdrawal from LLCs, largely eliminated the legislative rationale for Section 702 as enacted, leaving the statute, in my view, not up to the complex task of adjudicating LLC breakups (hence the title of my June 2002 article published in the New York State Bar Journal, Vol. 74, No. 5, "When Limited Liability Companies Seek Judicial Dissolution, Will the Statute Be Up to the Task?").
These observations are prompted by a recent decision by New York County Commercial Division Justice Bernard J. Fried in a case I've previously written about called Ficus Investments, Inc. v. Private Capital Management, LLC. Ficus is a highly contentious dispute between LLC members involving accusations that the managing members misappropriated over $20 million. Last January, an appellate ruling enforced the lead defendant's right to advancement of his legal defense costs as provided by the operating agreement (see my earlier post here).
Continue Reading...Court Rejects Bid by Corporate Dissolution Petitioner to Voluntarily Withdraw Case Without Prejudice
If you're going to accuse your business partner of bad acts and ask for judicial dissolution of the business, be prepared to settle or take the case all the way to trial. That seems to be the message given to the petitioner in one recent dissolution proceeding when the court turned down her request to discontinue the case "without prejudice" to her bringing a future dissolution proceeding based on the same allegations. Matter of Holland (Romper Nursery, Inc.), Short Form Order, Index No. 8871/07 (Sup Ct Nassau County Dec. 30, 2008).
The underlying dispute is a fascinating one involving one of the toughest nuts to crack in the realm of business divorce: What should a court do when a 50% shareholder seeks judicial dissolution of a profitable operating company under the deadlock statute (BCL 1104) on the ground of "internal dissension" due to personal animus between the two shareholders? I wrote an October 2004 article for the New York State Bar Association Journal on the subject, in which I concluded that
Cases decided under the internal dissension statute exhibit something of a split personality, depending on whether the court views the corporation, successful or not, as more akin to a partnership terminable at will, or as an entity distinct from its owners, to be maintained if financially viable notwithstanding internecine warfare. Arguably, this duality is inherent in the statute’s requirement that the petitioner establish both the existence of internal dissension and that the factions are so divided that dissolution would be beneficial to the shareholders. In other words, the statute can be read such that the cessation of shareholder hostilities itself is an adequate benefit of dissolution, or it can be read to require some other benefit (i.e., financial) that may be hard to show when the business is otherwise viable and making money.
The Romper Nursery Case Background
The Romper Room Nursery School seems an unlikely setting for a bitter shareholder dispute. Jeanie Holland and Margaret Zack as 50-50 shareholders opened the nursery school in 1975. During the summer a day camp operates at the school's two locations in Great Neck and East Williston on Long Island. The school also offers bus transportation.
Continue Reading...Disputed Allegations of Shareholder Oppression Require Evidentiary Hearing
There's nothing special about the corporate dissolution case brought by David Wenger involving a family-owned construction business. The facts of the case are garden variety, as these things go. The case presents no novel legal issues. The court's decision, ordering an evidentiary hearing to determine the petition's disputed allegations of oppression, is nothing if not anti-climactic.
But that's exactly why I want to write about it, to illustrate what happens in the ordinary dissolution case, where there are no knockout punches in the first round. That plus, it's my first occasion to highlight a decision by Suffolk County Commercial Division Justice Emily Pines.
The court's decision in Matter of Wenger (L.A. Wenger Contracting Co.), Index No. 31701/08 (Sup Ct Suffolk County Nov. 12, 2008), describes a case of corporate and family dysfunction pitting father against son. In August 2008, the son, David, as a 31% shareholder filed a petition to dissolve L.A. Wenger Contracting Co. of which his father, Louis, is majority owner. Upon filing the petition David obtained a temporary restraining order enjoining his father from disbursing company funds to any shareholder, officer or director except in the ordinary course of business. David's petition also sought appointment of a receiver pursuant to Section 1113 of the Business Corporation Law.
Continue Reading...Timing is Everything When it Comes to the Buyout Election in Corporate Dissolution Cases
A recent decision by Queens County Commercial Division Justice Orin R. Kitzes in Matter of Weingarten (Thirty First Street Realty Corp.) calls attention to a critical issue in corporate dissolution proceedings, namely, the timing of the statutory election to purchase the petitioning shareholders' stock interest. First, some background.
Section 1104-a of New York's Business Corporation Law authorizes a petition for judicial dissolution of a close corporation brought by a shareholder holding at least 20% of the voting stock on the ground of "oppressive actions" by the controlling shareholders. The dissolution statute is counterbalanced by BCL Section 1118 which gives the respondent shareholders the absolute right to stay the dissolution proceeding and, ultimately, to avoid dissolution altogether by electing to purchase the petitioner's shares for fair value.
The right of election is not open-ended. Section 1118 requires that the election be made within 90 days after the petition is filed. Practitioners know that only the rare dissolution petition is decided on the merits within 90 days. This poses a quandary for the respondent inclined to fight the allegations of oppression but also not willing to put the company at risk of dissolution if the petitioner prevails on the merits.
Section 1118(c)(1) provides a semi-safety valve for this situation. It provides that if an election is made after 90 days,
Continue Reading...and the court allows such petition, the court, in its discretion, may award the petitioner his reasonable expenses incurred in the proceeding prior to such election, including reasonable attorneys' fees.
Spouses Holding Shares as Joint Tenants Must Jointly Petition for Corporate Dissolution
When husband and wife hold shares as joint tenants with right of survivorship, can one of them seek corporate dissolution without joining the other?
The answer is "no," according to a recent decision by Queens County Supreme Court Justice Patricia P. Satterfield in Matter of Mouzakitis (Pearl Nightlife, Inc.) (read decision here).
Petitioner Marianthi Mouzakitis and her husband, Leonidas, own 15% of the common shares of Pearl Nightlife, Inc. as tenants by the entirety. The corporation operates a restaurant in Bayside, New York, that opened in March 2008. The Mouzakitises contributed $125,000 for their interest. Ms. Mouzakitis alleged that the controlling shareholders failed to make required contributions, failed to pay salaries and dividends, withheld access to corporate books and records, and diverted corporate funds and assets including liquor and food allegedly diverted to other restaurants separately owned by the corporation's president. In May 2008, the other shareholders allegedly had the petitioner arrested at the restaurant.
Continue Reading...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:
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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.
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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.
Improper Verification of Dissolution Petition Leads to Case Dismissal
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).
