Winding Up an Acrimonious Partnership Following Death of a Partner
According to a summary on the website of the Uniform Law Commissioners, thirty-four states have adopted the Revised Uniform Partnership Act of 1994 (RUPA) which, among other significant changes to the original Uniform Partnership Act of 1914 (UPA), no longer provides for automatic dissolution of a general partnership upon the ordinary dissociation of a partner, including upon the death of a partner. Under the default rules of RUPA §§601 and 801, the partnership continues after the death of a partner subject to the partnership's obligation under §701 to purchase the deceased partner's interest for a buyout price equal to the greater of liquidation or going-concern value. (Read here a summary of RUPA's major revisions. Read here the text of RUPA.)
New York is in the minority of states that has not adopted RUPA. Thus under §62(4) of New York's UPA-based Partnership Law enacted in 1919, absent contrary agreement the death of a partner automatically triggers dissolution of an at-will general partnership. While Partnership Law §73 permits continuation of the partnership accompanied by a buyout of a deceased member's interest under certain, narrowly-defined circumstances (e.g., see my previous piece on the Vick v. Albert case), otherwise the partnership must be dissolved and its business wound up.
Such was the case in Matter of Franzese (Franzese Realty Associates), 2009 NY Slip Op 33139(U) (Sup Ct Nassau County Dec. 16, 2009), in which Nassau County Commercial Division Justice Timothy S. Driscoll was tasked with cleaning up a messy dispute between the surviving siblings of a family-owned real estate partnership. Franzese does not involve any novel legal issues, but it nonetheless merits attention as an example of how courts deal with some of the typical problems that arise during the winding up of the partnership, and particularly the question of receivership.
Continue Reading...Court Rejects Unconscionability Argument in Family Partnership Valuation Case, Concludes that "Full and True Value" Equals "Net Book Value" as Defined by Agreement
Those who follow the society pages may recall that gossip columnist, television reporter and socialite Claudia Cohen married, had a child with and later divorced billionaire Ronald Perelman, and that she died tragically young in 2007. Less well known is the fact that Cohen herself came from family wealth; her father, Robert Cohen, built a highly successful media distribution business known as Hudson Media. It is from the Cohen-family wealth, and the sorting out of Claudia Cohen's estate, that the following tale of partnership valuation controversy emerges, culminating with a recent New Jersey court decision in Estate of Cohen v. Booth Computers, Memorandum Decision, C.A. Docket No. BER-C-135-08 (N.J. Super. Ct. Aug. 4, 2009).
In 1978, when Claudia was 27 and her two brothers were 21 and 19, their parents set up a general partnership called Booth Computers (the "Partnership") with the children as equal one-third partners. The idea was to provide income for the children and to shift assets for tax and estate planning purposes from the parents to the children. The children did not negotiate the Partnership Agreement which was prepared at the parents' direction by one of their lawyers. Later the same year, a limited partnership was formed called HCMJ Realty Ltd. ("HCMJ") of which the parents owned a 55% general partner interest and the Partnership was given a 45% limited partner interest. HCMJ's limited partnership certificate reflected a $90,000 cash contribution by the Partnership.
HCMJ's sole asset was a Palm Beach ocean front estate used as the Cohen family vacation home, which was transferred by another Robert Cohen entity to HCMJ in 1978. In addition to its 45% interest in HCMJ, the Partnership directly owned a pair of New Jersey commercial warehouses acquired in 1980 and 1984. The court's opinion doesn't disclose the warehouse purchase prices or indicate if they were conveyed to the Partnership by other Cohen-owned entities. In any event, none of the three Cohen children put their own money into the Partnership.
Continue Reading...Terminated Member of Professional Corporation is Not Entitled to Statutory Stock Redemption
Professional service corporations are "interesting" and "strange creatures". So says Nassau County Commercial Division Justice Ira B. Warshawsky in an interesting (but not strange) post-trial decision issued last month, rejecting a claim for statutory buyout in a suit brought by a terminated partner in a law firm organized as a professional corporation.
The case is Lubov v. Welikson, 2008 NY Slip Op 28392 (Sup Ct Nassau County Sept. 29, 2008). You can read the decision here. Additional background is found in the court's January 2008 decision denying summary judgment motions (read here).
The law firm in Lubov initially was organized in 1989 as a general partnership. In 1993 it converted to a professional service corporation ("P.C.") under Article 15 of the Business Corporation Law. P.C.s are a popular form of limited liability entity eligible for partnership tax treatment, available to lawyers, doctors, accountants and other regulated professions.
The plaintiff alleged that prior to the firm's conversion to a P.C. the partners made an agreement to redeem the interest of a withdrawing partner for the sum of the partner's capital contribution and percentage of accounts receivable. Plaintiff also alleged that the shareholders nee partners of the P.C. adopted the same agreement.
Plaintiff's percentage interest in the P.C. started at 30%. In 1994 he voluntarily surrendered half his interest at the same time he began working fewer days and pursued other personal business affairs. At the time, he allegedly asked about redemption of the surrendered shares, but supposedly was put off by the majority shareholder. Plaintiff's percentage interest rose to 16% in 1997 when another 10% shareholder left the firm.
Continue Reading...Court Refuses to Apply Marketability and Minority Discounts in Valuing Deceased Partner's Interest
A federal appeals court once remarked that "the valuation of a closely held company is an inexact science", adding, "some might say an art" (Okerlund v. U.S., 365 F3d 1044 [Fed. Cir. 2004]). Looking at the gallery of New York valuation law, the artist must be Jackson Pollack.
By that I mean, the valuation rules seem like a hodgepodge when one compares the different settings in which interests in closely held companies are valued by the New York courts, including dissenting shareholder appraisals and oppressed minority shareholder buyouts under the Business Corporation Law, accounting proceedings under the Partnership Law, and equitable distribution proceedings under the Domestic Relations Law. This holds especially true with respect to valuation discounts, as highlighted in a recent appellate decision concerning a fractured partnership in a case called Vick v. Albert, 47 AD3d 482 [1st Dept 2008] (read decision here).
Vick involved a nasty family feud that spawned multiple litigations and arbitration lasting almost a decade. Beginning in 1975, Susan Vick and her brother, Richard Albert, co-owned a number of investment real properties in New York City. Some of the properties they owned as tenants in common, others were owned by partnerships in which Vick, Albert and others held partnership interests. Vick died in 1999, leaving her interests to her two children. About eight months after their mother's death, the children sued their uncle and others seeking, among other things, a partition of certain properties and a dissolution and accounting with respect to various partnerships. The complaint alleged that the uncle took exclusive control of the partnerships' books, records, properties and assets; that he misappropriated certain assets including rental income for his own benefit; and that he failed to wind up the partnerships' affairs after his sister died and failed to provide a final accounting for each of the partnerships. (The appellate court's decision unfortunately recites very few facts. More can be learned from the prior lower court decisions, two of which from 2001 and 2004 can be viewed here and here.)
Continue Reading...High Court Restricts Remedies of Limited Partner Alleging Fraud by General Partner in Merger Transaction
On March 18, 2008, the New York Court of Appeals, which is New York's highest court, decided Appleton Acquisition, LLC v. National Housing Partnership (read decision here). The decision holds that a limited partner may not bring an action seeking damages or rescission based on allegations of fraud by the general partner in connection with a merger transaction, and that the statutory appraisal proceeding is the exclusive remedy for such claims. As a result, the plaintiff in Appleton, which acquired partnership interests post-merger from limited partners who did not exercise appraisal rights, was out of court and out of luck.
The limited partnership known as Beautiful Village ("BV") owned and managed a New York City apartment complex which received federal financing under HUD's Section 8 affordable housing program. By 2002, BV owed over $1.5 million to the corporate General Partner's parent company. Rather than foreclosing, the General Partner proposed that BV merge into a new limited partnership owned by the parent company, with each limited partner receiving $100 or 2.5 common units of the parent company for their BV shares. The limited partners received proxy statements disclosing the conflict of interest between the General Partner and its parent company, and advising that rejection of the merger would likely lead to foreclosure resulting in adverse tax consequences for the limited partners. The proxy also notified the limited partners of their alternative right to institute a judicial appraisal proceeding to receive the fair value of their partnership interests. None of the limited partners exercised their appraisal rights. In September 2002, the merger was approved and the limited partners' interests in BV were extinguished.
Three years later, plaintiff Appleton Acquisitions, LLC ("Appleton"), which had no prior involvement with BV, purchased from the former BV limited partners their equitable or partnership shares together with any legal claims they had against BV, the General Partner and its parent company. Appleton then filed a lawsuit against the latter entities asserting three causes of action for rescission of the merger and ancillary money damages on the grounds of fraud, breach of fiduciary duty and negligent misrepresentation. Appleton alleged that the proxy statement contained false and misleading statements and that the General Partner had depressed the value of the BV partnership interests by failing to enroll in a certain HUD program that would have provided BV with additional Section 8 rent subsidies. These allegations were also used to support two additional claims seeking monetary damages for breach of contract and aiding and abetting breach of fiduciary duty.
Continue Reading...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.
Lawyers Suing Lawyers
A decision last week by New York’s highest court may have registered an uptick on the public’s schadenfreude meter, at least among the portion of the public who hold the legal profession in low esteem and who therefore might enjoy the sight of internecine warfare among splitting partners of a law firm.
In Ederer v. Gursky, 9 NY3d 514 (2007), Lawyer A joined and became a 30% shareholder along with Lawyer B (who then held 70%) of a small law firm organized as a professional corporation (PC). Several years later they re-organized the firm as a registered limited liability partnership (LLP) and took in three new partners who collectively held a 15% partnership interest, leaving Lawyer A with 30% and Lawyer B with 55%. Two years later, Lawyer A decided to leave the firm – according to him, because of a falling out with Lawyer B over a firm client; according to Lawyer B, because the firm was in financial dire straits for which Lawyer A was partially responsible – following which he entered into a written withdrawal agreement with the LLP setting forth various financial and case-sharing arrangements. Six months later, Lawyer A sued the LLP and each of its four remaining partners claiming breach of the withdrawal agreement and seeking an accounting and certain profit shares.
Garden variety financial disputes among former business or law partners do not usually garner the attention of New York’s Court of Appeals. This one did, however, because of the defendant partners’ reliance on a provision in the statute governing LLPs that, in general terms, shields partners of LLPs from vicarious liability for obligations of the LLP or for the negligence of their law partners. The case thus raised a novel question of statutory construction whether Section 26(b) of the Partnership Law was meant to protect only against partner liability asserted by third parties or whether, as the defendants argued, it also encompasses liabilities among the partners.
The Court’s decision traces the highly interesting history of partnership liability laws, including the nationwide surge of LLP formations in the aftermath of the savings and loan crisis of the 1980s when regulators went after deep-pocketed law firms to recover massive bank losses. In a 5-2 majority decision, the Court handed victory to Lawyer A by concluding that Section 26(b) only addresses a partner’s vicarious liability for partnership obligations to third parties and does not extend to claims among the partners of the LLP.
The dissenting judges note that Lawyer A’s withdrawal caused the firm’s finances to deteriorate and thereby rendered the firm unable to satisfy its obligations under the withdrawal agreement. They raise two provocative questions: Under these circumstances why should a former law partner be able to collect the firm’s debt from the “innocent” individual partners where a third-party creditor could not, and why should partners of an LLP be saddled with an obligation from which they would be shielded had the firm remained organized as a PC? The majority’s decision, laying emphasis on statutory construction rather than policy, means it will be up to the legislature to amend the law if it sees the same anomaly as do the dissenters.
Update (May 2, 2008): In Kuslansky v. Kuslansky, Robbins, Stechel & Cunningham, LLP, 50 AD3d 1100 (2d Dept 2008), the Appellate Division, Second Department, under the authority of the Court of Appeals' Ederer decision, reversed a lower court's decision dismissing an action brought by a former law firm partner for breach of contract based on the alleged failure of the defendants to pay him the value of his interest in the subject partnership as provided for in the parties' partnership agreement upon a partner's withdrawal from the partnership.
Partnership Agreement Controls Dissolution Notwithstanding Conversion to Corporation
Individuals and companies have a choice of entities – some requiring more formalities than others – through which to pool their resources and efforts in pursuit of a common business goal. Joint ventures and general partnerships are on the less formal side of the spectrum and are often used in the early stages of a business project to keep costs down before the project’s viability is established, and before limited liability becomes an issue. Until the proliferation of limited liability partnerships and like statutory business forms, many professional firms including lawyers and doctors traditionally operated as general partnerships.
It is not uncommon for written joint venture or partnership agreements to include a buy-sell agreement. If the joint venture or partnership later converts to a corporation or limited liability company, and the owners do not make a superseding shareholder or operating agreement, is the prior agreement enforceable when a shareholder or LLC member wants out or seeks judicial dissolution?
The answer is complicated by a long line of New York case precedent, most notably Weisman v Awnair Corp., 3 NY2d 444 (1957), decided by New York’s highest court, holding that a partnership may not exist where the business is conducted in corporate form, and parties may not be partners between themselves while using the corporate shield to protect themselves against personal liability.
A couple of newer decisions by intermediate appellate courts, however, take a modified approach to the issue permitting enforcement of the pre-conversion agreement. In Matter of Hochberg (Manhattan Pediatric Dental Group, P.C.), 41 AD3d 202 (1st Dept 2007), two dentists formed a practice and entered into a partnership agreement containing an arbitration clause and also requiring that a partner seeking dissolution first offer his interest to the other. Years later they converted the practice to a professional corporation, but without making a new agreement. When one of them later sought dissolution, the other sought to compel arbitration under the old partnership agreement. The appellate court, reversing the trial court’s decision, ruled that such pre-conversion agreements are enforceable as long as the rights of creditors or other third parties are not involved and the parties’ rights under the partnership agreement are not in conflict with the corporation’s functioning. Judicial dissolution of the dental practice would be inappropriate, the court added, in that it would allow avoidance of the buyout provisions by seeking such dissolution.
The best practice, of course, is to make a new written agreement when converting to a new form of entity, or at least indicate in writing whether the old agreement survives the conversion.
