New York Business Divorce : New York Business Dissolution Lawyer & Attorney : Farrell Fritz Law Firm : Buy-outs, Shareholder Disputes : New York, NY

 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.

• Email This
• Print
• Comments
• Trackbacks

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. 

• Email This
• Print
• Comments
• Trackbacks

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.

• Email This
• Print
• Comments (1)
• Trackbacks

In almost all states, the limited liability company in recent years has become the business organization form of choice for closely held entities.  By far the most popular LLC Act for use in forming sophisticated LLCs is the Delaware Act.  There are presently something like 7 million U.S. LLCs of which approximately 600,000 are Delaware LLCs.

As a New York practitioner who handles all types of messy disputes between business co-owners, I know first hand the outsized claim of Delaware law on jurisdictional choice of entity as well as the powerful influence of Delaware decisional law even in disputes involving non-Delaware entities.  I also know -- because it's written right into the Delaware LLC Act -- that freedom of contract is the cornerstone of Delaware LLC jurisprudence, and therefore nothing contributes more to the long-term health and welfare of a Delaware LLC -- or any LLC, for that matter -- than having a carefully planned, comprehensive, forward-looking, well-drafted operating agreement.

In 2009, Wolters Kluwer Law & Business published what quickly has become the preeminent formbook and practice manual on forming Delaware LLCs entitled Drafting Delaware LLC Agreements.  The co-authors are John M. Cunningham and Vernon R. Proctor.  I am very pleased to present this first of a two-part interview of the authors of this extremely well-written and user-friendly manual, which also includes a CD containing over two dozen sample Delaware operating agreements.

In this first part of the interview I talk with John Cunningham (pictured left), a member of the New Hampshire and Massachusetts bars whose practice focuses on forming LLCs for business start-ups and on restructuring existing businesses.  Among his many achievements John was a principal drafter of the New Hampshire LLC Act.  He is not only the co-author of Drafting Delaware LLC Agreements but also is the sole author of Drafting Limited Liability Company Operating Agreements, the leading U.S. general  (i.e., non-state specific) LLC formbook and practice manual.  I hope you find the interview, which begins after the jump, as interesting and useful as I did.

• Email This
• Print
• Comments
• Trackbacks

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:

• Email This
• Print
• Comments
• Trackbacks

If you've ever studied partnerships or limited liability companies, chances are you know of Professor Larry Ribstein, the Mildred Van Voorhis Jones Chair in Law at the University of Illinois College of Law.  In fact, the same can be said for securities law, choice of law, jurisdictional competition, the portrayal of business in film, the law business, and a host of other topics that come under his penetrating analysis.  Professor Ribstein is co-author of the leading treatises on LLCs and partnerships along with two business associations casebooks, and he has written or co-authored about 140 articles.  His ABA Top-100 blog (Ideoblog.org) addresses legal and economic issues of interest to lawyers and the business world on a daily basis.  His books include The Sarbanes-Oxley Debacle and The Constitution and the Corporation (both with Henry Butler), The Law Market (with Erin O'Hara) and The Economics of Federalism (with Kobayashi).

To this vast ouevre Professor Ribstein now adds his latest book published by the Oxford University Press, entitled The Rise of the Uncorporation.  The book covers the history, law and finance of unincorporated firms which, since LLC enabling statutes swept the country in the early 1990's, have become the dominant business form for non-publicly traded companies, and are poised to enter the large-firm realm of private equity, hedge funds and publicly traded partnerships (e.g., Chrysler LLC).  Professor Ribstein's book identifies competition between the states and among business forms to constrain regulatory excesses as one of many reasons for the growing dominance of the "uncorporation."  For anyone interested in this area of law, it is must reading.

I'm fortunate that Professor Ribstein agreed to answer some questions about his book and related topics for this blog.  The Q&A follows.  Enjoy.   

Mahler:  Congratulations on your new book, The Rise of the Uncorporation, which you describe in your introduction as "the first general theoretical and practical overview of alternatives to incorporation."  Since my practice deals mostly with closely held business firms, my first questions are whether the issues and themes you develop in the book divide into two separate universes, one for the large, publicly owned firm and another for the smaller, owner-managed companies, and whether the problems engendered by the corporate form are greater for one than the other?

Ribstein:  The fundamental distinction I make in the book is between corporations and what I call "uncorporations" -- that is, partnerships and other business forms such as the limited liability company that are based on the partnership.  So, no, I do not think that publicly held firms are in a separate "universe."  However, large uncorporations, such as publicly traded partnerships and private equity and hedge funds, raise separate issues. I deal with those issues in Chapter 8, as discussed below in answer to your question about the "architecture of corporate law."  The corporate form can raise significant problems for both types of firms.

• Email This
• Print
• Comments
• Trackbacks

The fascinating case of Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC, involving a multi-faceted litigation between 50-50 members of a dental surgery practice, was fodder last year for several appellate and trial court decisions which in turn were fodder for several posts on this blog (see here, here and here).  In what likely is the case's last hurrah, the Appellate Division, Fourth Department, earlier this month affirmed a series of trial court rulings by Monroe County Commercial Division Justice Kenneth R. Fisher including orders upholding the plaintiff's standing to seek dissolution and granting dissolution based on deadlock.

The threshold issue in the case was whether an attorney hired by the defendant 50% member, Dr. Mohammed Salahuddin, had authority under the operating agreement (a) to accept on the company's behalf a letter of resignation from the plaintiff Dr. Jolly Caplash, and (b) to assert counterclaims in the LLC's name against Dr. Caplash.  If the attorney had authority to accept the resignation letter, which in turn depended on which of the two doctors held the office of President in the aftermath of a June 2007 member meeting, Dr. Caplash's membership was terminated and he lacked standing to seek dissolution.

In February 2008, the Fourth Department ruled that the issue could not be resolved without a trial of disputed factual issues.  In a May 2008 mid-trial decision, Justice Fisher dismissed the counterclaims brought against Dr. Caplash in the LLC's name, concluding that even if Dr. Salahuddin was President of the LLC with general authority to hire company counsel, he had no authority to hire company counsel to prosecute an action against a co-equal 50% member.  Justice Fisher's June 2008 post-trial decision found that Dr. Caplash held the President's office and, therefore, the attorney hired by Dr. Salahuddin had no authority to accept Dr. Caplash's resignation letter on the company's behalf which left intact the latter's entitlement to judicial dissolution of the deadlocked company.

• Email This
• Print
• Comments
• Trackbacks

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.

• Email This
• Print
• Comments
• Trackbacks

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).

• Email This
• Print
• Comments
• Trackbacks

I've previously featured LLC member disputes in which the defending side achieves a potentially decisive tactical victory by saddling the complaining side with some or all of the defending side's legal expenses via indemnification and advancement provisions in the operating agreement and under LLC Law Section 420 (see here and here).

The Appellate Division, Second Department's recent decision in Fuiaxis v. 111 Huron Street, LLC, 58 AD3d 798 (2d Dept Jan. 27, 2009), presents a variation on the same theme, this time highlighting the controlling faction's successful reliance on the operating agreement's compulsory capital contribution provisions to force the complaining member to subsidize his opponents' legal defense.

George Fuiaxis is one of four members each with a 25% interest in a real estate company called 111 Huron Street, LLC.  An earlier lower court decision in the case indicates that Fuiaxis sued under LLC Law Section 702 to dissolve the LLC after he elected to withdraw, alleging that it was no longer reasonably practicable to carry on the business because of his withdrawal or, alternatively, due to "internal deadlock" between him and the other three members.  (Alas, the decision does not address how Fuiaxis had standing to seek dissolution after his withdrawal, or how the 25%-75% alignment created deadlock.)

• Email This
• Print
• Comments (1)
• Trackbacks

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:

1. 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. 
2. 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.
3. 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.
4. 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.
5. 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.
6. 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. 
7. 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. 
8. 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. 
9. 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. 
10. 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.

• Email This
• Print
• Comments
• Trackbacks

The whimsically named Rocketboom LLC runs a videoblog offering what it calls "daily internet culture."  A dust-up between the company's owners has now made a small but noteworthy contribution to the legal culture of New York LLCs, in the form of a recent appellate court decision holding that an LLC member may not intervene as a party defendant in a creditor's suit against the LLC, even if the suit and its settlement allegedly result from impropriety by the controlling member.  Baron v. Rocketboom, LLC, 2008 NY Slip Op 09656 (1st Dept Dec. 9, 2008).

Rocketboom was formed in 2005, owned 51% by Andrew Baron and 49% by Amanda Congdon.  Congdon stopped working at the company in June 2006 under disputed circumstances.  Congdon claimed that Baron terminated her.  Baron claimed that Congdon left voluntarily and thereby forfeited her membership interest.

From inception Rocketboom was financed by Baron's father, Fred.  In October 2006, by which time Fred had loaned approximately $300,000, he and his son on Rocketboom's behalf executed a Loan and Security Agreement establishing a $500,000 loan facility collateralized by all property of Rocketboom.  In March 2007, Fred sued Rocketboom for nonpayment and to foreclose Rocketboom's interest in the collateral (read complaint here).

• Email This
• Print
• Comments
• Trackbacks (1)

"You can't dissolve the company, you're crazy!"

That more or less sums up one of the most novel defenses I've ever come across in a dissolution proceeding, in which the respondent 50% member of an LLC argued that the petitioning 50% member could not dissolve the company because he was under a mental disability as defined in the parties' operating agreement.  Although the defense ultimately failed in this case, there's a lesson to be learned about the proper drafting of disability clauses in shareholder and operating agreements. 

The case is Matter of Swett (Factors Walk, LLC) decided several years ago by Monroe County Commercial Division Justice Kenneth R. Fisher.  In 2002, Bradford Swett and W. Curtis Barnes as 50/50 members formed a limited liability company known as Factors Walk, LLC to develop and sell real estate consisting of a 75-acre subdivided tract.  The operating agreement vested management in the two members equally.  It also appears to have included a provision, not fully described in the court's decision, authorizing a member to precipitate voluntary dissolution simply by giving notice to the other member.

In 2005, Swett gave Barnes the prescribed notice following which he commenced a proceeding for judicial supervision of the winding up of the LLC pursuant to LLC Law Section 703(a).  The statute authorizes a member to seek such relief for an LLC that has been dissolved either voluntarily or by judicial decree under LLC Section 702.

• Email This
• Print
• Comments
• Trackbacks

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. 

• Email This
• Print
• Comments (2)
• Trackbacks (2)

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.

• Email This
• Print
• Comments (2)
• Trackbacks

I can't resist asking the above question in the wake of two recent decisions, one from Delaware Chancery Court invoking freedom of contract to enforce an LLC operating agreement's waiver of a member's right to seek judicial dissolution, and the other from New York's Commercial Division refusing on public policy grounds to enforce an operating agreement's in terrorem provision forfeiting the interest of any member who files for judicial dissolution.

The names if not the issues in both cases may sound familiar to regular readers of this blog.

The Delaware case is R&R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, 2008 WL 3846318 (Del. Ch. Aug. 19, 2008) (read decision here).  The factions in R&R have been waging a multi-front battle for years, with simultaneous lawsuits in Pennsylvania state and federal courts, New York state court, and most recently Delaware Chancery Court.  At issue is control of nine Delaware LLCs that own and operate a number of horse farms.  The Russet brothers put up most of the almost $10 million capital but gave 50% member Linda Merritt sole management authority under the operating agreements.

• Email This
• Print
• Comments (2)
• Trackbacks (1)

An important appellate decision handed down earlier this month holds that LLC members' fiduciary duties to each other do not expire upon the de facto termination of the members' business relationship, but, rather, continue until formal voluntary or involuntary dissolution.  As a result, members who continue to do business through the old LLC, or who start up a new competing company prior to formal dissolution of the old LLC, must account to the excluded members for pre-dissolution profits.

 The case, Matter of Beverwyck Abstract, LLC, 53 AD3d 903 (3d Dept 2008), has its genesis in a business arrangement between the two individual owners of real estate and mortgage brokerage firms (I'll refer to them as the Brokers) and an Attorney who owned a title abstract firm called Gateway Title Agency, LLC.  Previously, the Brokers had teamed up with a different attorney to form Beverwyck Abstract, LLC to perform title work, however that attorney soon withdrew from the firm.  In September 2001, the Brokers assigned a 49% membership interest in Beverwyck to Gateway, with the understanding that the Brokers' mortgage company would refer title work to Gateway.  Beverwyck had no assets at the time and Gateway made no capital contribution.  The fees generated by Gateway's title work would belong to Beverwyck and would then be distributed 1/2 to the Brokers and 1/2 to Gateway.  At the same time, the Brokers would arrange for the Attorney to act as the bank closing attorney for the Brokers' mortgage company, with those fees being retained by the Attorney.

• Email This
• Print
• Comments
• Trackbacks (1)

It would be hard to find a business dissolution case with messier facts and thornier legal issues than Tal v. Superior Vending, LLC, 2008 NY Slip Op 51205(U) (June 6, 2008).  The 28-page decision by Justice Alan D. Scheinkman of the Westchester County Supreme Court's Commercial Division describes a business relationship between two individuals that arose from friendship and degenerated in bitter acrimony and litigation over the dissolution of a limited liability company that supplied and maintained vending machines.  The decision also grapples with a novel remedial problem:  After Partner A freezes out Partner B, how does a court equitably liquidate a company whose assets and business have been transferred to another company controlled by Partner A which thereafter acquires additional assets that are commingled with the original assets, thus making it impossible to determine the assets and value of the company being dissolved? Justice Scheinkman's solution -- a money judgment in favor of the frozen-out partner equal to his capital investment plus interest -- is equally novel.

Peter Plotkin started a vending machine business in 1997 called Superior Vending Corp. ("SV Corp.") that reached almost $1 million in gross revenues by 2000 when Arik Tal became his business partner.   Tal and his wife had become friends with Plotkin and his wife, and had rented a summer house together.  In exchange for a 50% interest in SV Corp., in August 2000 Tal invested $170,000 which was used to acquire the assets of another vending company called Vernon Vending Corp.  Tal also guaranteed payment of the $150,000 purchase price balance.  In October 2000, Plotkin and Tal formed a new LLC called Superior Vending, LLC ("SV LLC") to which they informally transferred all the assets of SV Corp.  Plotkin and Tal both were active in the business.  They had no shareholders agreement for SV Corp. and no operating agreement for SV LLC.

• Email This
• Print
• Comments (1)
• Trackbacks (1)

When non-controlling partner A sells out to controlling partner B, following which B sells the company to a third party at a disproportionately high premium over A's price, A may suspect that B withheld information pertaining to the company's value at the time of A's sale. The question is, does A have a valid claim against B to recover a share of the re-sale profits?  Does caveat venditor give way to a fiduciary-based, affirmative obligation on B's part to disclose to A any and all information material to the sale price?

An opinion handed down last week by an appellate court in Manhattan appears to lower the bar for such a lawsuit, and sends a cautionary message to transactional counsel concerning the effectiveness of seller representations and releases in partner buyout agreements.

In Littman v. Magee, 54 AD3d 14 (1st Dept 2008), Steven Littman held an 18.7% membership interest in Rockwood Realty Associates LLC, a real estate investment firm formed in 1996 and managed by another LLC controlled by Rockwood's majority owners.  Littman's 28-page complaint essentially alleged that the majority owners engaged in a squeeze-out through property sales that forced Littman to incur large personal tax bills on undistributed K-1 profits, contrary to an alleged "understanding" when the company was formed that distributions sufficient to cover taxes would be made.

• Email This
• Print
• Comments
• Trackbacks

When 50-50 business partners have a falling out, the ensuing battle for the high ground can lead one of them to take hostile action in the company's name without the other's consent.

Examples of the phenomenon, recently featured in this blog, include the case of Hellman v. Hellman, where the court upheld the authority of a 50% shareholder as president to enter into a lease opposed by the other shareholder, and Sports Legends, Inc. v. Carberry, where the court refused to authorize a lawsuit brought in the company's name by one 50% shareholder against the other.

Then there's Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC.  About four months ago I wrote about an appellate decision in the Caplash case in which the court reversed a trial court order dissolving a medical practice LLC because of unresolved factual issues concerning the plaintiff's standing to seek dissolution.  The issue before the court was whether to give legal effect to the plaintiff's letter to the company resigning his employment, and thereby terminating his LLC membership, where the company's requisite acceptance of the resignation was by letter from an attorney whose authority under the operating agreement to act on the company's behalf was not established.  The appellate court sent the case back to the trial court for a hearing to determine the issue.

Since then, there's been a flurry of activity in the Caplash case and a new trial court decision (reported at 19 Misc 3d 1138(A)) which, I'm happy to report, supplies many of the underlying facts missing from the appellate decision.  The recent decision, by Justice Kenneth R. Fisher of the Monroe County Supreme Court, Commercial Division, addresses two issues of interest.  First, it examines the interplay between the parties' operating agreement and the LLC Law in deciding whether the lawyer engaged by one member with 50% voting power had the authority to accept on the LLC's behalf the other member's resignation.  Second, it determines whether the same lawyer could act on the entity's behalf in asserting claims against the resigning member for wrongful competition and other economic injury to the LLC.

• Email This
• Print
• Comments
• Trackbacks (1)

Strained relations between managing and non-managing members of limited liability companies (LLC) sometimes lead to fights over the former's denial to the latter of access to company records.  Section 1102 of the New York Limited Liability Company Law (LLCL) sets forth a three-part scheme governing the maintenance of, and member access to, LLC records.

The first part, Section 1102(a), requires that every LLC maintain five specific categories of records:

(1)  if the limited liability company is managed by a manager or managers, a current list of the full name set forth in alphabetical order and last known mailing address of each such manager;

(2)  a current list of the full name set forth in alphabetical order and last known mailing address of each member together with the contribution and the share of profits and losses of each member or information from which such share can be readily derived;

(3) a copy of the articles of organization and all amendments thereto or restatements thereof, together with executed copies of any powers of attorney pursuant to which any certificate or amendment has been executed;

(4) a copy of the operating agreement, any amendments thereto and any amended and restated operating agreement; and

(5) a copy of the limited liability company's federal, state and local income tax or information returns and reports, if any, for the three most recent fiscal years.

Note that the preceding list limits financial information to recent tax returns.  This becomes more important under the second part, Section 1102(b), which provides for member access to LLC records including all the records mandated under Section 1102(a), as follows:

Any member may, subject to reasonable standards as may be set forth
in, or pursuant to, the operating agreement, inspect and copy at his or her
own expense, for any purpose reasonably related to the member's interest
as a member, the records referred to in subdivision (a) of this section, any
financial statements maintained by the limited liability company for the three
most recent fiscal years and other information regarding the affairs of the 
limited liability company as is just and reasonable.

• Email This
• Print
• Comments (1)
• Trackbacks

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:

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.

• Email This
• Print
• Comments (1)
• Trackbacks

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".

• Email This
• Print
• Comments
• Trackbacks

Closely held companies with multiple owners actively involved in the business sometimes use employment agreements between the company and the owners, separate and apart from the shareholders’ agreement (for corporations) or operating agreement (for LLCs). Such employment agreements are especially prevalent in medical practices where, among other reasons, restrictive covenants are routinely used to prevent departing doctors from establishing competing practices in the same locality.

Quite often the shareholders’ or operating agreement and the employment agreement will provide that, upon termination of employment, the shareholder or member is required to redeem his or her interest in the company on specified terms. Disputes and litigation, including proceedings for judicial dissolution of the business, may erupt when the outgoing owner perceives enough of a disparity between the specified compensation (or lack thereof) and the “real” value of his or her interest. 

A decision last week by an intermediate appellate court in Rochester, involving a medical practice organized as an LLC, highlights the interplay between the interest redemption triggered by termination of employment and the threshold issue of standing to seek judicial dissolution of an LLC under Section 702 of the Limited Liability Company Law.  The statute confers standing to seek dissolution upon members only.

In Caplash v Rochester Oral & Maxillofacial Surgery Assoc., LLC, 48 AD3d 1139 (4th Dept 2008), the trial court summarily granted the plaintiff’s application to dissolve the practice. On appeal by defendant, the panel of five appellate judges unanimously reversed the lower court’s decision on the ground that defendant raised a genuine issue for trial whether, based on plaintiff’s apparent resignation, he was a member of the company within the meaning of the statute when he sought dissolution. Here’s what the court said: 

Defendant submitted a letter from plaintiff to the company indicating that plaintiff was resigning as an employee of the company, and he also submitted a letter from an attorney who purported to accept plaintiff's resignation on behalf of the company. The company operating agreement unequivocally provides for the termination of membership in the event of the termination of a member's employment with the company, and plaintiff's employment agreement specifies that "This Agreement shall terminate . . . at any time by mutual agreement in writing by Employer and Employee." The record does not disclose the circumstances under which the attorney came to represent the company and whether such representation was authorized by the operating agreement. We thus conclude that there is an issue of fact whether plaintiff has standing to seek dissolution.

The appellate decision does not reveal any additional facts, such as the percentage membership interest of the plaintiff and whether, for instance, the issue concerning the attorney’s authority to act on behalf of the company arose because the plaintiff and defendants were 50/50 members. In any event, the decision is another reminder that, no matter how high temperatures rise when business partners are on the brink of breakup, careful reading of agreements and obtaining advise of counsel should precede any decisive steps.

• Email This
• Print
• Comments
• Trackbacks

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.

• Email This
• Print
• Comments (1)
• Trackbacks