Appellate Court Reinstates LLC Manager in Dispute with Investor in Vodka Venture
The highly competitive and lucrative market for premium vodka has spawned some of the most creative advertising and promotional campaigns known to consumers (think Absolut). A new market entrant offering vodka imported from Holland under the brand name Medea, sold in special bottles designed with an interactive LED ticker display, has spawned a different kind of competition, of the litigious sort, involving a fight for control between an angel investor and the managing member of the company.
An appellate court decision issued last week in Lehey v. Goldburt, 2011 NY Slip Op 08670 (1st Dept Dec. 1, 2011), reinstated the managing member whom the lower court had removed and replaced with the investor on the latter's application for interim relief. The decision reinforces the constraints lower courts face in granting provisional remedies without holding an evidentiary hearing to resolve conflicting allegations. The decision also addresses an interesting issue of contract construction arising from an arguable inconsistency between the operating agreement's provisions for the appointment and removal of managers.
Continue Reading...Court Sends Everyone Home Empty Handed in Bitter Business Breakup
Reading the post-trial decision by Suffolk County Commercial Division Justice Emily Pines in Nastasi v. Carlino, 2011 NY Slip Op 30626(U) (Sup. Ct. Suffolk County Mar. 8, 2011), one can't help but be struck by the utter futility of an intense three-year litigation between business partners over a now-defunct company in which the court finds them all at fault and sends them all home empty handed.
Aletto & Nastasi Ltd. ("A&N") was formed in 2004 by shareholders Nastasi (40%), Carlino (40%) and Aletto (20%) to operate a marble and granite sales business including warehouse and showroom in Bohemia, New York. Nastasi managed the business until early 2008 when Carlino and Aletto held a shareholders meeting without proper notice at which they voted to remove Nastasi from management and, as described in the court's decision, "had him thrown off the property" after they determined that Nastasi was running sales through a separate company wholly owned by Nastasi.
In May 2008, Nastasi filed a petition for judicial dissolution of A&N as an oppressed minority shareholder under Section 1104-a of the Business Corporation Law. Carlino and Aletto responded in kind with their own suit against Nastasi and his separately owned companies seeking an accounting based on Nastasi's alleged conversion of corporate funds for his own personal use and breach of fiduciary duty.
Continue Reading...Top 10 Business Divorce Cases of 2010
I'm pleased to present my third annual list of the year's top ten business divorce cases. This year's crop includes some very important decisions concerning the standard for LLC dissolution, expulsion of LLC members, buyouts triggered by dissolution petitions, stock valuation, and much, much more. All ten were featured in this blog previously; click on the case name to read the full treatment. And the winners are:
1. Matter of 1545 Ocean Avenue, LLC, 72 AD3d 121, 2010 NY Slip Op 00688 (2d Dept Jan. 26, 2010), in which the Second Department differentiated dissolution of LLCs from business corporations and pronounced a contract-based standard for judicial dissolution of LLCs giving primary weight to the terms of the operating agreement.
2. Jain v. Rasteh, Decision and Order, Index No. 109920-09 (Sup Ct NY County Feb. 1, 2010), where the court upheld the right of the LLC's majority member to expel a minority member for breach of the operating agreement.
3. Chiu v. Chiu, 71 AD3d 646, 2010 NY Slip Op 01768 (2d Dept Mar. 2, 2010), holding that courts have no statutory authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy.
4. Matter of Superior Vending, LLC, 71 AD3d 1153, 2010 NY Slip Op 02801 (2d Dept Mar. 30, 2010), in which the court upheld as an "equitable method of liquidation" the return of the petitioner's capital contribution in exchange for his membership interest in the LLC.
5. Matter of Eklund Farm Machinery, Inc., 73 AD3d 1319, 2010 NY Slip Op 04097 (3d Dept May 13, 2010), in which the court construed BCL Section 1217 to limit the commission payable to receivers in corporate dissolution cases.
Continue Reading...
Not a Capital Idea: Making Unauthorized LLC Capital Calls
If you're the majority member of a New York limited liability company (LLC), and either you have no written operating agreement, or you have one but it's silent on the issue, repeat after me: I cannot make a compulsory capital call; I cannot make a compulsory capital call; I cannot make a compulsory capital call.
Alternatively, you can read a recent decision by Kings County Commercial Division Justice David I. Schmidt in Georgi v. Polanski, Decision and Order, Index No. 10406/10 (Sup Ct Kings County Sept. 22, 2010), where the court denied a preliminary injunction application by a purported majority member of an LLC who sought to expel the minority member after he failed to comply with the majority member's unauthorized capital call.
The facts in Georgi are relatively straightforward. In 2004, Tina Georgi and Andrew Polanski as 50-50 members formed A&T Partners, LLC to own and operate commercial realty at 60 Pulaski Street in Brooklyn. According to Georgi, she and Polanski made initial capital contributions of $40,000 and $90,000, respectively, plus they obtained a $200,000 mortgage loan secured by an adjoining property also co-owned by the two of them. In 2008, Georgi obtained on A&T's behalf a $640,000 construction loan which she alone personally guaranteed. That same year Georgi caused A&T to return $40,000 to Polanski who by that time was unemployed.
Continue Reading...Tzolis No Solace for Proponent of LLC Member Expulsion
Two cases do not a trend make, but I can't shake the feeling that the Brooklyn-based Second Department appeals court has clamped down on the era of freewheeling judicial remedies in business breakup cases involving limited liability companies.
As I reported here, last January the Second Department issued a major ruling in the 1545 Ocean Avenue case articulating a new, tougher standard for LLC dissolution, in line with the Delaware approach, in which freedom of contract and fidelity to the operating agreement are paramount. Earlier this month, the Second Department issued another significant ruling in Chiu v. Chiu, 2010 NY Slip Op 01768 (2d Dept Mar. 2, 2010), holding that courts have no statutory authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy. In so ruling, the court turned its back on the appellant's argument that judicial expulsion should be recognized as a common law remedy under the reasoning of the Court of Appeals' 2008 decision in Tzolis v. Wolff, 10 NY3d 100, where it divined a common law basis for LLC derivative actions.
Chiu arises from a bitter family dispute between older brother Winston Chiu (WC) and younger brother Man Choi Chiu (MCC) featuring multiple lawsuits over a real estate holding limited liability company called 42-52 Northern Blvd., LLC formed in 1999. The property was purchased for approximately $5.5 million. The LLC had no written operating agreement. The LLC's 1999 and 2000 tax returns identified WC and MCC as holding 25% and 75% interests, respectively. Under a 1999 agreement, WC had certain rights to purchase the 75% interest held by his brother.
Continue Reading...The Perils of For-Cause Expulsion Provisions in LLC Agreements
A number of valuable lessons can be learned from a recent decision by Manhattan Commercial Division Justice Melvin L. Schweitzer (pictured) in Jain v. Rasteh, Decision and Order, Index No. 109920-09 (Sup Ct NY County Feb. 1, 2010), where the court summarily dismissed a complaint by a minority member of a limited liability company who was expelled from the LLC for breach of its operating agreement.
The last time I wrote on the subject (read here) I noted that, unlike some other states, New York's LLC Law has no express provision authorizing or prohibiting member expulsion, although LLCL Section 701(b) mentions member expulsion in the context of various events (death, retirement, bankruptcy, etc.) not requiring the LLC's dissolution. Jain involved an LLC formed under Delaware's LLC Act, which, unlike New York's law, expressly authorizes the LLC agreement to provide for the elimination or forfeiture of a member's interest for failure to comply with the LLC agreement, or under any other circumstances specified in the LLC agreement (see Delaware LLC Act Section 18-306 and Section 18-502(c)).
The subject of Jain is a New York based, two-member company formed in Delaware in 2008 to provide investment management and advisory services for a hedge fund. The defendant Majority Member contributed most of the firm's capital and held an 83% profit interest. The plaintiff Minority Member held the balance. Section 5 of the LLC agreement designated the two as co-managers, however it also gave the Majority Member the final say in case of disagreement on any issue with specified exceptions such as dissolution and admission of new members.
Section 12 of the LLC agreement, entitled "Withdrawal of a Managing Member," included a subsection (a)(ii) governing involuntary withdrawal by the Minority member, authorizing the Majority Member to "require" him to withdraw at any time for "Cause" as defined. The definition included conviction for felony or violation of securities laws, fraud, or "a material breach of this Agreement." Section 13 of the LLC agreement entitled the Minority Member to be paid specified percentages of the firm's net profit over the three years following any such involuntary withdrawal, depending on the number of years of service. For termination after less than two years -- which is what happened -- the Minority Member's share of net profit goes from 4.25% in the first year down to about 1.4% in the third year. Under Section 17 of the LLC agreement, following his termination for any reason the Minority Member is prohibited for six months from competing with the company or soliciting any of its clients or employees.
Continue Reading...Divided Appeals Court Upholds Removal of LLC Member-Manager Contrary to Voting Agreement
In a 3-2 decision, a panel of Appellate Division, First Department judges last week upheld the removal of an LLC member-manager by majority vote of the members, notwithstanding provision in the operating agreement requiring all members to vote for the ousted member-manager in any election for managers. The case is Ross v. Nelson, 54 AD3d 258, 2008 NY Slip Op 06504 (1st Dept 2008).
The underlying facts in Ross are described in the trial court's decision dated October 12, 2006, written by New York County Commercial Division Justice Helen E. Freedman. Since 1996, Dean Ross owned minority membership interests in two New York limited liability companies, each of which owned rental properties in Manhattan. The LLCs had substantially identical operating agreements naming Ross, Eric Nelson and Gary Podell as the member-managers. Each LLC also had a number of non-manager members. Things went smoothly until 2001, when severe strains developed in the relationship between Podell and Nelson on the one hand and Ross on the other. Podell and Nelson called meetings of the LLCs' members to vote on the removal of Ross as a member-manager, and to replace him with Ross's brother who also was a member of both LLCs. The resolutions passed. Ross brought suit seeking to invalidate the vote and to declare that he continued to be a member-manager of the LLCs. He also sought to recover one-third of property management fees that were paid to a separate company owned by Podell and Nelson.
Continue Reading...LLC Member's Marital Woes Lead to Loss of Membership Interest
Shareholder agreements for close corporations often include provisions designed to protect the company and its shareholders against involuntary stock transfers or other potentially disruptive court decrees arising from the dissolution of a shareholder's marriage. The same holds true for limited liability company (LLC) operating agreements and their members. Sometimes, as this week's featured case illustrates, such provisions can backfire when a member's marital woes coincide with internal disputes among the LLC's members.
Matter of Madelone (Viscomm Group, LLC), 18 Misc 3d 1131(A) (Sup Ct Albany County 2008), involved an LLC formed in 2003 by three members to engage in advertising and public relations. Initially, the three members -- Whitten, Harrington and Madelone -- each held a one-third interest. Whitten served as manager. Subsequently, a fourth person was brought in as a 10% member, reducing the others to 30% each.
In 2005, when Whitten was experiencing marital difficulties, he proposed certain amendments to the operating agreement which the membership adopted. The amendments required a member who files, or whose spouse files, for legal separation or divorce to sell, and the other members to buy, the membership interest of the member involved in the marital proceedings. The amendments also established a method for computing the purchase price and the payment terms. The following year, Whitten filed for separation from his wife whereupon he relinquished his position as manager and was appointed to a salaried position with the company, only to be reinstated as a member and manager upon reconciling with his wife.
Continue Reading...Expelling an LLC Member
Let's say you're one of the many thousands of business owners who have opted to organize their business as a limited liability company (LLC) rather than as a traditional shareholder corporation. Let's also say you have a business partner, Member X, who has a 25% membership interest in the business. Time passes and, unfortunately, Member X has become an impediment to the business's success to the point you conclude that the business can't continue with Member X. Finally, let's say Member X rejects every reasonable offer you make to buy him out of the business.
What are your choices? Do you have to hire a lawyer to bring an expensive legal action to be rid of Member X? Is that possible? Wouldn't it be much easier if, as Brooklyn Dodger fans famously taunted, you could just "Throw da bum out!"?
Utah is a long way from Brooklyn, but a recent decision by that state's highest court got me thinking about the issue.
In the Utah case, Duke v. Graham, 2007 UT 31, 158 P3d 540 (2007), the issue was whether an arbitrator was legally authorized to expel LLC members as a remedy for breach of their duties owed to the remaining members. In upholding the expulsion, the court examined Utah law that expressly authorizes LLC members to expel another member either when so authorized by the parties' Operating Agreement or by applying to a court based on the member's misconduct.
Unlike Utah, New York's LLC Law (LLCL) has no express provision authorizing non-judicial member expulsion or authorizing one member to bring a legal proceeding to expel another. The only tangential mention of the issue is in Section 701(b) of the LLCL under which, absent contrary provision in the operating agreement, member expulsion is one of several occurrences that do not result in dissolution unless the other members agree to dissolve.
So where does that leave you and Member X? As with most issues surrounding the internal affairs of LLCs, the answer lies in the operating agreement. A carefully drafted operating agreement should include dispute resolution and buy-sell provisions that enable the parties to separate their interests when they no longer can get along. The key is, at the outset of the business relationship, to create efficient exit mechanisms that provide all parties with a fair degree of financial security and business continuity. If the operating agreement provides for expulsion of a member under specified circumstances or by a specified majority vote, to avoid disruption and legal expense it also should provide the expelled member with payment for the fair value of his or her membership interest. At the same time payment terms must ensure the company's future viability. Absent such agreement, the fate of the business will be dictated by negotiating muscle or expensive legal proceedings including possible dissolution.
