"Unusual Actions Breed Unusual Outcomes": Delaware Court Dismisses Non-Voting Trust's Action to Dissolve LLC Born of Estate Plan
A bench ruling and supplemental letter opinion last month in an unusual case called The Homer C. Gutchess 1998 Irrevocable Trust v. Gutchess Companies, LLC, C.A. No. 4916-VCN, adds another chapter to the growing book of Delaware Court of Chancery decisions addressing judicial dissolution of limited liability companies under §18-802 of the Delaware LLC Act. In Gutchess's dismissal of a dissolution petition, we see once again the Delaware court's elevation of the private ordering of LLC affairs, as expressed in the operating agreement, over challenges to the LLC's ongoing existence based on "equitable" factors. The transcript of counsel's argument and the bench ruling on February 16, 2010, can be read here. The supplemental letter opinion dated February 22, 2010, can be read here.
What makes Gutchess particularly interesting is the subject LLC's origin as an estate planning device and its design featuring an almost complete division of the economic interest, held by an inter vivos trust, and the voting control and management exercised originally by the grantor and subsequently by his wife and son.
The story begins in 1904, when George Gutchess founded a small lumber mill called Gutchess Lumber in upstate New York. His grandson and successor, Homer C. Gutchess, greatly expanded the company's operations, turning it into a leading supplier of hardwood lumber in the Northeast U.S. In 2002, around the same time the company transitioned to employee ownership, Homer and his estate planning advisors formed Gutchess Companies, LLC to hold Homer's shares in the operating company. The LLC's operating agreement reflects an almost complete split of the voting interest from the equity interest, with Homer retaining 100% of the voting interest but only 1% of the equity, his wife, Martha, holding another 1% equity, and the rest of the equity (98%) being held by The Homer C. Gutchess 1998 Irrevocable Trust. Later, on the advice of counsel, Homer transferred the voting interest to Martha. Homer died in 2006, after which Martha designated their son, Gary, as the LLC's sole manager.
Continue Reading...It Only Took 16 Years: New York Appellate Court Defines Standard for Judicial Dissolution of Limited Liability Companies
No more complaining about the absence of appellate guidance on the standard for judicial dissolution of limited liability companies under §702 of the LLC Law. Finally, almost 16 years after the cryptically-worded statute became law, the Appellate Division, Second Department, in Matter of 1545 Ocean Avenue, LLC, 2010 NY Slip Op 00688 (2d Dept Jan. 26, 2010), offers a carefully considered explanation of what §702 means -- and what it doesn't mean -- in a decision also notable for a two-judge dissent from the majority's disposition of the case without an evidentiary hearing.
As discussed below, the 1545 Ocean opinion's motif is fidelity to the LLC's operating agreement. This contract-centric approach sharply distinguishes LLC dissolution from partnership and close corporation dissolution cases in which implied fiduciary duties and untethered notions of fairness permeate the courts' analysis. It also brings New York LLC jurisprudence closer in line with Delaware's approach to LLC dissolution fueled by the admonition contained in §1101(b) of the Delaware LLC Act, to give "maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements."
It's no surprise that the signed opinion's author is Associate Justice Leonard B. Austin (pictured) who was appointed to the appellate bench in 2009 after serving ten years as trial judge in the Commercial Division of the Nassau County Supreme Court. Justice Austin's Commercial Division caseload, among other types of business disputes, included a steady influx of judicial dissolution proceedings involving closely held corporations and LLCs. That experience undoubtedly gave him a first-hand feel for the analytical and practical difficulties posed by these cases and an appreciation of the legal and business community's need for greater certainty in applying the broad and undefined terms of the dissolution statutes.
There's another reason I'm not surprised by Justice Austin's authorship. In June 2002, I wrote an article for the New York State Bar Association Journal on LLC dissolution (read it here) in which I observed that most of the few cases decided to that point freely borrowed from corporate dissolution norms applicable in cases involving oppressed minority shareholders and internal dissension. I did, however, cite a trial court decision in a case called Matter of Quinn, NYLJ Apr. 20, 2000, p. 32, col. 6 (Sup. Ct. Nassau County), as the sole example I'd found of a court, consistent with §702's language, focusing on whether the complained-of grounds for dissolution conformed to the members' operating agreement. The judge who decided Quinn? Justice Austin.
Now let's examine the 1545 Ocean decision.
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...Fired Minority Shareholder's Oppression Claim Not Barred by At-Will Employment Provisions in Shareholders' Agreement
Some months ago, in a post about the intersection of the at-will employment doctrine and fiduciary duty among shareholders in close corporations, I wrote:
The most common allegation of oppression by minority shareholders involves termination of employment by the controlling shareholders. The Court of Appeals in Matter of Kemp & Beatley noted that obtaining employment is often the main reason for becoming a shareholder in a closely held company that typically pays no shareholder dividends. As I've pointed out before, case law holds that the majority's termination of the minority's at-will employment does not give rise to a wrongful termination remedy under either a contract or tort theory, but it may be oppressive for purposes of seeking judicial dissolution where the shareholder joined the venture with the reasonable expectation of getting and keeping a job.
This principle is vividly on display in a recently decided case called Ambar v. Devington Technologies, Ltd., 2009 NY Slip Op 32373(U) (Sup Ct NY County Oct. 13, 2009), where the court refused to dismiss a petition for involuntary corporate dissolution brought by a minority shareholder whose employment was terminated by the controlling shareholders, notwithstanding at-will employment provisions in their shareholders' agreement.
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...Controlling Shareholder's Unreasonable Refusal to Admit Petitioners' Stock Ownership Constitutes Ground for Corporate Dissolution, Incurs Award of Attorney's Fees
"Well over one and a half years have been wasted on a defense which is utterly without support."
Pretty strong stuff, coming from a recent decision by Nassau County Commercial Division Justice Stephen A. Bucaria in Rosenfeld v. Luccaro, 2009 NY Slip Op 30963(U) (Sup Ct Nassau County Apr. 23, 2009), where the court granted dissolution of two closely held corporations based on "hopeless" deadlock and bitter dissension between two 50% shareholder factions. The court's sharp words were provoked by the respondent's assertion that the petitioners were not -- and had never been -- shareholders, despite a seeming avalanche of corporate and tax records to the contrary.
The subject corporations were formed in the 1970s by 50-50 shareholders Anthony Luccaro's father and Walter Rosenfeld to own and operate a marina called Toms Point Marina located in Port Washington on Long Island. Anthony Luccaro subsequently acquired his father's interest, and Rosenfeld died some time in the 1980s. His estate's distributees included his second wife, Judith, and his three children from a prior marriage.
Fast forward to 2007, when the Rosenfeld children commenced judicial dissolution proceedings under Sections 1104 and 1104-a of the Business Corporation Law, claiming deadlock and oppression by Luccaro who allegedly refused to recognize the election of petitioner Todd Rosenfeld as director, refused access to the bylaws and other books and records, threatened the life of petitioner Steven Rosenfeld if he entered the marina property, operated the marina as a cash business without proper controls and employed his family members without proper accounting, refused to issue K-1 tax forms to the Rosenfelds, and took cash and other distributions for himself without making any distributions to the Rosenfelds.
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...Majority Shareholders of Accounting Firm Held Liable for Value of Deceased Minority Shareholder's Interest After They Formed New Firm Using Old Firm's Assets and Good Will
It may surprise some of you to learn that the Surrogate's Courts in New York have jurisdiction to hear petitions for judicial dissolution of closely held corporations involving the estate of a deceased shareholder. These cases are relatively rare -- most shareholder agreements contain provision for mandatory stock redemption upon death -- but they do happen from time to time. Case in point: last month the Appellate Division, Second Department, affirmed a ruling by the Surrogate's Court awarding the estate of a deceased minority shareholder the value of its stock interest, to be paid by the surviving shareholders in proportion to their stock interests. Matter of Verdeschi, 2009 NY Slip Op 05355 (2d Dept June 23, 2009).
As laid out more fully in the underlying September 2006 Decision and Order issued by Westchester County Surrogate's Court Justice Anthony Scarpino, Jr., Verdeschi involves an accounting firm known as G.B. Tepper & Associates Ltd. ("Tepper & Associates") organized in 1992 as a business corporation (as opposed to the more common professional corporation) with four shareholders: the decedent, Carl Verdeschi (35%), Gerald Tepper (35%), Monte Tepper (15%) and Jay Samuels (15%). They had no shareholders agreement. Prior to Verdeschi's death in late 2003, each shareholder received a salary and a share of profits proportionate to their stock percentage. After Verdeschi died, the surviving shareholders conducted no further business through Tepper & Associates. Instead, Monte Tepper and Jay Samuels formed a new firm known as Tepper Tax Associates, Inc. ("Tepper Tax") which occupies the same office used by Tepper & Associates, provides the same accounting services to the old firm's clients, and uses all of the old firm's office equipment, computers and furnishings. The new firm also employed Gerald Tepper.
Continue Reading...Court Grants 50% LLC Member's Petition for Judicial Dissolution of Passive Holding Company
A recent decision by New York County Commercial Division Justice Bernard J. Fried addresses issues of interest concerning (a) the standing of an assignee of a member's economic interest to seek judicial dissolution of an LLC, and (b) grounds for dissolution of a two-member, 50-50 LLC that functioned as a holding company for a non-managing minority interest in another company.
The memorandum decision in Matter of Cline (Private Capital Management, LLC), Index No. 650117/09 (Sup Ct NY County May 29, 2009), grows out of a mega-lawsuit started by Ficus Investments, Inc. (Ficus) against Thomas Donovan, Lawrence Cline and Private Capital Management, LLC (PCM). PCM, a New York LLC co-owned 50-50 by Donovan and Cline, was the managing 20% member of a Florida LLC called Private Capital Group, LLC (PCG) that purchased, managed and sold non-performing mortgages. Ficus, which invested $300 million in the venture, held the remaining 80% interest. In 2007, Ficus terminated PCM as PCG's manager and brought suit against it along with Donovan and Cline allegedly for misappropriating over $20 million.
Early on Cline settled with Ficus and entered into a cooperation agreement as part of which he conveyed to a Ficus-owned entity called PCM Interest Holding, LLC (Holding) all of Cline's economic interest in PCM and his irrevocable voting proxy. Meanwhile, amidst burgeoning litigation proceedings between Donovan and Ficus, in April 2008 Justice Fried ruled that Donovan was entitled to advancement of his legal expenses under PCG's operating agreement. Ficus's appeal from that ruling was rejected in January 2009 (read here my post on the appellate ruling). In February 2009, Justice Fried also granted PCM's motion for advancement of its legal expenses. As part of the same ruling, Justice Fried denied without prejudice a procedurally defective cross-motion by Ficus and nominal defendant Cline seeking judicial dissolution of PCM (read here my post on that ruling).
Continue Reading...Fiduciary Breach Can Result in Shareholder Oppression, But Is Shareholder Oppression a Breach of Fiduciary Duty?
A recent Northern District New York federal court decision (HT Eric Fryar) caught my eye when I read a passage explaining the court's reasons for denying a motion to dismiss a plaintiff's claim against fellow shareholders for breach of fiduciary duty. The court in Rusyniak v. Gensisi, 2009 WL 1269911 at *14 (NDNY May 5, 2009), starts off simply enough, with the observation that the relationship between shareholders in closely held corporations is a fiduciary one. In the next sentence, the court writes:
More specifically, it "is the fiduciary duty owed by . . . majority shareholder[s] in a closely held corporation to a minority shareholder, not to engage in oppressive actions toward minority shareholders." (Italics added.)
The internal quote is from McCagg v. Schulte Roth & Zabel LLP, 20 Misc 3d 1139(A) (Sup Ct NY County Aug. 1, 2008). Both Rusyniak and McCagg cite the New York Court of Appeals' seminal decision in Matter of Kemp & Beatley, 64 NY2d 63, 73 (1984), construing the term "oppressive action" as used in the judicial dissolution statute, Section 1104-a of the Business Corporation Law, to mean "majority conduct [that] substantially defeats expectations [of the minority shareholder] that, objectively viewed, were reasonable under the circumstances and were central to the petitioner's decision to join the venture."
There are many cases in which courts have found that majority shareholder conduct constituting breach of fiduciary duty -- be it self dealing or theft of corporate opportunity or other "classic" violations of the duties of loyalty and care meant to squeeze out the minority shareholder -- satisfies the reasonable-expectations test of oppression. But, is the opposite true? Does proof of oppression constitute breach of fiduciary duty, as Rusyniak suggests?
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."
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...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.
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...Dissolution May Be Sole Remedy When Minority Shareholder's At-Will Employment is Terminated
It's among the most common scenarios seen by business divorce lawyers: A minority shareholder of a non-dividend paying close corporation -- let's call him Joe the Shareholder -- for years has been a full-time employee, officer and director of a company he co-founded. Joe the Shareholder's salary and occasional bonus are the sole source of return on his investment in the company. Without any advance notice, the majority shareholders fire Joe the Shareholder, remove him from the payroll, cut off his access to the company computer and change the office locks. Joe the Shareholder can't believe that, as a company owner, he can be fired and thrown out by his business partners just like that. Joe the Shareholder wants to know what his remedies are and, in particular, whether he can sue for wrongful termination of his employment to recover lost salary and other damages.
Joe the Shareholder has a standard shareholders' agreement that gives a majority of the Board of Directors control of all company business affairs. The shareholders' agreement does not fix any definite term of employment for any of the company's shareholders, and it has no language limiting the Board's authority to terminate an officer or employee with or without cause. Joe the Shareholder has no separate employment agreement with the company.
So what's the answer to Joe the Shareholder's question? In New York, without any agreement for employment of a definite duration, Joe the Shareholder is considered an at-will employee of his own company who can be fired for any or no reason (except for reasons made illegal under federal and state workplace anti-discrimination laws), and therefore he has no claim for wrongful termination of his employment. If Joe the Shareholder has any remedy, he must look to his statutory right to seek judicial dissolution for shareholder oppression under Section 1104-a of the Business Corporation Law.
Continue Reading...Delaware Court of Chancery Narrowly Construes LLC Dissolution Statute
When it comes to rulings by its Court of Chancery, what happens in Delaware definitely does not stay in Delaware.
Each year Delaware breeds for export thousands of corporations, LLCs and limited partnerships. Many of those Delaware entities have their principal place of business in New York; their internal affairs, when adjudicated by New York courts, are governed by Delaware statute and case law. In addition, the unsurpassed quality, scholarship and keen attention to precedent that characterize Chancery Court decisions make them a powerful guiding force in the judicial formulation nationwide of domestic business laws and policy.
All that being said, as I've commented before, one area of growing divergence between Delaware and New York law has been in the areas of LLC governance and judicial dissolution. The Delaware Chancery Court's pronouncements strongly emphasize the members' virtually unfettered contractual freedom to order their own relationships in the operating agreement, including enforcement of fiduciary outs and judicial dissolution waivers, and the Court's concomitant aversion to judicial intervention. In contrast, New York courts by and large have not hesitated to impose fiduciary obligations on LLC managers and to import dissolution principles developed in the context of shareholder corporation breakups.
Case in point: In re Seneca Investments, LLC, 2008 WL 4329230 (Del. Ch. Sept. 23, 2008) (read decision here), in which the Delaware Chancery Court recently dismissed a petition to dissolve a Delaware LLC brought by a minority member who'd been removed from his management positions by the majority. This is one of the few cases construing Delaware's LLC dissolution statute, and the result stands as a warning to any minority member who does not bargain for status protection and/or fair exit mechanisms in the operating agreement.
Continue Reading...A Case of Mutual Frustration: Minority Member of LLC Can't Compel Dissolution, Majority Can't Compel Buyout
It's the perfect LLC storm: Accusations by the minority member of overreaching and breach of fiduciary duty by the controlling members, no operating agreement, and an LLC statute that affords neither party a judicial means of achieving the separation they each want.
The case, Matter of Koutelos (Mouhlas Realty, LLC), was decided last month by Queens County Supreme Court Justice Patricia P. Satterfield (read decision here). The petitioner, Mary Koutelos, holds approximately 15% membership interest in Mouhlas Realty, LLC which was formed in 2000 as a member-managed LLC. The decision doesn't describe the LLC's business or tell us if Koutelos is actively involved in running it. All we can glean is that Koutelos filed a petition under LLC Law Section 702 for judicial dissolution of the LLC based on allegations of overreaching and breach of fiduciary duty by two of the other three members, apparently involving a capital call and/or loan to be used for compensation of one or more member-managers; the members have no operating agreement; and the other members refused Koutelos's request to adjourn a meeting.
The decision also tells us that the "respondent" -- we don't find out if this refers to the LLC or one of the other members individually -- filed an answer with a counterclaim for an "equitable buyout" conditioned on the court applying a 30% discount for lack of marketability in valuing the petitioner's interest.
Continue Reading...Further Thoughts on Youngwall and Judicial Dissolution of the Unprofitable LLC
Matter of Youngwall debuted on this blog last April (read here) when I wrote about a March 2008 decision (read here) by Nassau County Commercial Division Justice Stephen A. Bucaria, dissolving and appointing a receiver for a manager-managed LLC owned by two brothers. The court premised dissolution primarily on its finding that the LLC was not currently profitable.
Perry Youngwall, who opposed the dissolution petition brought by his brother, Nils, subsequently moved for reconsideration and to vacate the decision on various grounds. The headline grabber from Justice Bucaria's July 2008 decision denying the motion, which I wrote about last week (read here), was his ruling that the operating agreement's waiver of a member's right to seek judicial dissolution was unenforceable as against public policy.
This week, I want to re-examine the court's justification for dissolving the LLC, this time with the benefit of some additional facts brought out in the July 2008 decision.
Continue Reading...Judicial Dissolution of the Unprofitable LLC
This is a tale of two cases, decided five years apart, involving my all-time favorite business divorce topic: judicial dissolution of the limited liability company (LLC). The cases raise the interesting question whether a member may seek dissolution on the ground that the LLC is not profitable.
First, a bit of background for the uninitiated. The LLC is an unincorporated business entity that combines the limited liability benefits of the corporation with the favorable pass-through tax treatment of partnerships. Compared to the highly structured, mandatory provisions of the business corporation laws, the LLC laws offer far more flexibility and freedom of contract among the LLC members to order their ownership, economic and managerial relations as they see fit. LLCs are fast on the way to becoming the preferred form of closely held business organization. Already, in a number of states including Delaware, new LLC filings outnumber new corporation filings.
The New York LLC Law's sparsely worded provision for judicial dissolution, codified in Section 702 of the LLC Law, borrowed its language from the limited partnership law. Section 702 provides in relevant part:
Continue Reading...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.
Roundup of 2007 Business Divorce Cases
The New York Law Journal recently published, for the 9th consecutive year, my annual review of business divorce cases (read it here). Most of the cases discussed in the article have been mentioned in previous postings.
Here's a rundown of the article's choices for 2007's most interesting business divorce cases, with links provided to the cases and to previous postings:
- Dissolution and Right of First Refusal: Matter of Schneck (R&J Components Corp.) (discussed here) and Matter of Schwimmer (El-Roh Realty Corp.), where two judges reached opposite results on the issue of whether the petitioner's filing of a dissolution petition triggered a right of first refusal and mandatory buyback under the shareholders' agreement.
- LLCs and Temporary Receivers: At the Airport, LLC v. Isata, LLC (discussed here) in which the court held that the LLC Law does not authorize the court to appoint a temporary receiver until after dissolution is ordered.
- Grounds for Dissolution: Matter of Cheung (Ho Foong Shiu Realty Corp.) and Matter of Livolsi (111 Glen Street Corp.) (discussed here) in both of which the courts denied dissolution petitions brought by 50% shareholders claiming oppression by the other shareholder.
- Restrictive Covenants: Matter of Autz (Ronald C. Fagan, M.D. and Arthur Lutz, M.D., P.C.) (discussed here) where the court ruled that the sale in liquidation of the company's good will is a sale "under compulsion" and therefore does not trigger an implied covenant not to solicit customers.
- Pre-Conversion Agreements: Matter of Hochberg (Manhattan Pediatric Dental Group, P.C.) (discussed here) in which the court compelled arbitration of a dissolution case under an arbitration clause in a partnership agreement that pre-dated the conversion of the business to a professional corporation.
- Partner Limited Liability Shield: Ederer v. Gursky (discussed here) where New York's top court interpreted Section 26(b) of the Partnership Law as not shielding partners in limited liability partnerships from personal liability against claims for breach of the partnership's or partners' obligations to each other.
If you'd like to read some of my previously published annual reviews, look under Links on the right sidebar of this blog's home page where you'll find links to my articles covering the years 2003 through 2006.
Next week, New York Business Divorce returns to Anatomy of a Dissolution Slugfest, Part III.
Anatomy of a Dissolution Slugfest: Part II
This is the second 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) summarized the basic facts and discussed the defendants’ initial challenge to the plaintiff Marciano’s standing to seek dissolution. The court’s decision identified evidence suggesting that, as the defendants’ argued, the plaintiff deliberately elected not to have his alleged 38% ownership interest reflected in the corporate records or in tax filings. Ultimately, however, the court refused to dismiss the case because of the disputed facts surrounding the issue of plaintiff’s share ownership.
In this Part II, we examine the several other issues of interest addressed by Justice Ira Warshawsky in his initial decision in the case dated September 5, 2006.
1. Defendants’ argument that their exclusion of plaintiff from the business was reasonable following his indictment for stock fraud.
The majority owner defendants contended that, even assuming plaintiff Marciano could establish his ownership percentage in Champion above the minimum 20% required by the dissolution statute (BCL § 1104-a), their decision to exclude him from any involvement in the business, following his criminal indictment for stock fraud in December 2004, was reasonable as a matter of law.
As with the issue of stock ownership, Justice Warshawsky concluded that the reasonableness of defendants’ exclusionary actions "must await further factual development through discovery in the underlying action". The defendants’ evidence of damaging repercussions and concrete economic injury to the business from Marciano’s indictment, the court found, was "anecdotal" and lacked "determinative foundational support in the record".
Continue Reading...Dissolution and the 50% Shareholder
In the judicial dissolution arena, one of the trickiest decisions faced by counsel representing a 50% shareholder of a closely held New York corporation is whether to ask for dissolution based on deadlock under Section 1104 of the Business Corporation Law (BCL), or based on allegations that the other 50% shareholder is guilty of illegal, fraudulent or oppressive conduct or has looted, wasted or diverted corporate assets under BCL Section 1104-a, or under both statutes.
The choice can have a dramatic effect on the outcome of the proceedings, not just because of the different proofs required, but because only one of the statutes – BCL Section 1104-a – triggers the other shareholder’s right to avoid dissolution by electing to purchase for “fair value” the shares of the petitioning shareholder. (See previous post on the subject.)
In many business divorce cases involving two 50% shareholders there nonetheless is one natural buyer and one natural seller. Sometimes it’s because one of the two controls more of the client relationships. Sometimes it’s because one of the two personally or through a separate company owns the realty leased by the co-owned company. Sometimes it’s because one of the two has far deeper pockets. In these situations, the 50% shareholder who wants out and his or her counsel must think long and hard about whether they gain or lose bargaining leverage by handing the opposing shareholder the right to force a buyout. In my experience, a deadlock petition under BCL Section 1104 usually packs a bigger wallop than an 1104-a petition by denying the automatic buyout and thereby putting added pressure on the shareholder who may be more motivated to keep the company as a going concern.
Continue Reading...Dissolution of LLCs vs. Corporations: There Are Important Differences
Judicial dissolution of a New York limited liability company (LLC) is governed by Section 702 of the LLC Law (LLCL), whereas judicial dissolution of a closely held business corporation is governed by Article 11 of the Business Corporation Law (BCL). Under Section 702, a court may order LLC dissolution “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” That’s it. No more.
Article 11 of the BCL is more expansive. Section 1104(a) authorizes a petition for judicial dissolution by a 50% shareholder based on various deadlock scenarios. Section 1104-a permits judicial dissolution at the behest of an “oppressed” minority shareholder or where the controlling shareholders divert or waste company assets or otherwise are guilty of illegal or fraudulent actions toward the other shareholders.
Depending on the provisions of the LLC operating agreement, conduct that would constitute grounds for dissolution under Article 11 of the BCL also may constitute grounds under LLCL Section 702. But not always, as one minority member of an LLC recently found out when the court dismissed his request for judicial dissolution. According to the court’s decision, the minority member alleged that the majority members engaged in “illegal, fraudulent and oppressive conduct” – terms that are lifted right out of BCL Section 1104-a. The court ruled that “[w]hile such allegations are grounds for dissolution under [BCL] § 1104-a, they are not grounds for dissolution of a limited liability company”. The case, Bonanni v. Horizons Investors Corp., was decided by Justice Elizabeth Hazlitt Emerson of the Suffolk County Supreme Court, Commercial Division.
The lesson is clear: A complaint or petition for dissolution of an LLC should reflect Section 702’s provisions by alleging a genuine conflict between, on the one hand, the adverse member’s alleged misconduct or other conditions warranting dissolution and, on the other hand, the terms of the operating agreement or articles of organization.
