The Importance of Identifying Your Client -- And Who's Not Your Client -- When Preparing Shareholder Agreements
You're an attorney. You're approached by Mortimer who tells you that he recently formed a new business corporation with Archibald, and that they want to hire you to prepare a shareholders' agreement. You also learn that Mortimer is the 51% "money" partner while Archibald is the 49% operating partner.
You've prepared many a shareholders' agreement, and you know that the interests of Mortimer as majority owner and Archibald as minority owner inherently are in conflict on diverse management and financial issues, not to mention restrictions on stock transfer and redemption. Should you represent both Mortimer and Archibald, or only one of them? The disparate financial wherewithal and contributions of the two partners only accentuates the conflict. If you represent Mortimer alone, and Archibald has no attorney of his own, is that a problem?
The rules of professional ethics set forth standards and proscriptions governing the simultaneous representation of multiple clients with conflicting interests. Under the right circumstances, with appropriate client counseling and disclosure, it may be ethically acceptable to represent both Mortimer and Archibald in the preparation of the shareholders' agreement. In all events, it is vitally important that the attorney identify and document exactly whom they're representing -- and whom they're not representing -- in these situations. The lawyer who fails to do so is taking on risk of a subsequent lawsuit by a disappointed shareholder for malpractice or fiduciary breach.
Continue Reading...Court Enjoins "Squeeze-Out" Capital Call by Controlling Members of LLC
Baseball has the squeeze play. Majority owners of closely held companies have the squeeze out. It's only fitting, then, that I refer to what happened in the recently decided case, Cooperstown Capital, LLC v. Patton, 2009 NY Slip Op 02277 (3d Dept Mar. 26, 2009), involving a dispute between majority and minority owners of a baseball camp, as the "squeeze-out play."
Martin and Brenda Patton owned land in upstate New York about 20 miles from the Baseball Hall of Fame in Cooperstown. In 2004, they entered into agreements with Cooperstown Capital, LLC to build and operate a baseball camp and hotel on the Patton land. The Pattons contributed the land to Abner Doubleday, LLC ("Abner") in exchange for 35% membership interests in Abner and a second company formed to operate the baseball camp, called Cooperstown All Star Village, LLC ("CASV"). Cooperstown Capital paid $400,000 and gave a $1 million promissory note for 35% interests in the two companies. A third investor, Marco Lionetti, acquired the remaining 30% interests.
The $1 million promissory note was made payable to the Pattons, but the operating agreements designated the payments as operating expenses of the companies and treated Cooperstown Capital's additional capital contributions as credits against the Patton note.
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.
Controlling Shareholder's Dilution of Minority Interest Requires Bona Fide Business Purpose
Squeeze-out of minority shareholders in close corporations can take many different forms. One common technique is stock dilution. The careful minority shareholder will insist, before investing capital or sweat equity, on a shareholders' agreement that preserves his or her percentage by a combination of preemptive rights, super-majority approval requirements for changes in authorized and issued shares, and other protective devices. Absent such bargained-for protection, however, is a minority shareholder's stake at the mercy of the controlling faction?
The answer is a qualified "no", according to a recent decision by New York County Commercial Division Justice Herman Cahn in Dingle v. Xtenit, Inc., 20 Misc 3d 1123(A) (Sup Ct NY Co 2008), where the court elevated the controlling shareholder's fiduciary duty over his reliance on statute and the business judgment rule in refusing to dismiss the minority shareholder's wrongful dilution claim.
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