Minority shareholder oppression and deadlock are the twin pillars of most business divorce litigation. Both are codified in the vast majority of statutes authorizing proceedings for judicial dissolution of closely held corporations and, to a lesser extent, limited liability companies. Both encompass infinite permutations of  behaviors — of both the well and ill-intended variety — among business co-owners that make any working definition of the two doctrines only marginally more useful than Justice Potter Stewart’s famous “I know it when I see it” definition of obscenity.

From my casual observations over the years, I’d say the courts probably have devoted far more attention to formulating and refining the standard for minority shareholder oppression, which is of more recent vintage than deadlock as ground for judicial dissolution and typically is not defined in the statutes. Oppressive conduct is evaluated in most states under one of three judicially-created formulations: majority conduct that defeats the reasonable expectations of the minority shareholder; breach of the fiduciary duty of good faith and fair dealing majority shareholders owe minority shareholders; and burdensome, harsh, and wrongful conduct constituting a visible departure from the standards of fair dealing majority shareholders owe minority shareholders in close corporations.

I’ve not encountered comparable attempts to formulate a deadlock standard, although one might think the term deadlock needs no judicial interpretation à la oppression. After all, the dictionaries tell us that deadlock is a state of impasse or inability to progress when two opposing factions with equal control can’t come to agreement on something. But the dictionary definition doesn’t get us very far in the context of judicial dissolution proceedings. For example, 50/50 owners in an otherwise well-functioning company could be deadlocked over what shape table to buy for their conference room; no one would suggest that deadlock of this sort would warrant a judicial death verdict for the company. And what about a feigned deadlock created by one faction in pursuit of a break-up, buy-out, or other strategic objective?

In my case-law travels I’ve come across decisions that catalog prior cases granting dissolution as illustrative categories of disagreement warranting dissolution, e.g., impasse over distributions or the hiring or firing of key personnel, but I’ve seen no attempt to fashion an overall framework for evaluating claims of deadlock, that is, until last month’s opinion in Koshy v Sachdev (read here) in which the Supreme Judicial Court of Massachusetts, in its first-ever effort to construe that state’s deadlock-dissolution statute, devised a four-factor test to determine whether a “true deadlock” exists. Continue Reading Court Defines “True Deadlock”

Regular readers of this blog know it’s been anything but summer doldrums in the world of business divorce, what with case law developments such as the Appellate Division’s potentially far-reaching ruling on the purposeless purpose clause and LLC dissolution in Mace v Tunick reported in last week’s post, and the astonishing story of minority shareholder oppression in the Twin Bay Village case also reported earlier this month.

This year’s edition of Summer Shorts picks up the summer pace with short summaries of three must-read decisions by New York and Delaware courts on three very different business divorce topics: use of a Special Litigation Committee to evaluate derivative claims brought by LLC members (New York); grounds for dissolution and the court’s remedial powers in shareholder oppression cases (New York); and LLC deadlock dissolution (Delaware).

Appellate Ruling Rejects Appointment of Special Litigation Committee in LLC Derivative Suit Where Not Authorized By Operating Agreement

LNYC Loft, LLC v Hudson Opportunity Fund I, LLC, 2017 NY Slip Op 06147 [1st Dept Aug. 15, 2017].  In Tzolis v Wolff, New York’s highest court recognized a common-law right of LLC members to sue derivatively on behalf of the LLC. Subsequent lower court decisions have clarified other aspects of the right by analogy to corporation law, such as requiring the plaintiff LLC member to allege pre-suit demand or demand futility. In shareholder derivative suits involving corporations, the board’s inherent authority to appoint a Special Litigation Committee composed of independent and disinterested directors to assess derivative claims is well established and, when properly implemented, can result in the court’s dismissal of derivative claims based on the SLC’s conclusion that the claims do not merit prosecution by the corporation. Continue Reading Summer Shorts: Three Must-Read Decisions

Food-Fight1A little over three years ago I reported on the first round of a fascinating “food fight” among four siblings, each of whom is a 25% shareholder of a Brooklyn-based, second-generation food distributor known as Jersey Lynne Farms, Inc. (the “Corporation”), and each of whom also is a 25% member of Catarina Realty, LLC (the “LLC”) which leases its sole realty asset to the Corporation.

The occasion back then was the court’s decision in Borriello v Loconte denying a dismissal motion in a derivative suit brought by Dorine Borriello on the LLC’s behalf in which she alleged that her three siblings breached fiduciary duty by leasing its realty to the Corporation at a drastically below-market rent and by imposing on the LLC certain expenses that ought to be borne by the Corporation as tenant.

In 2011 — the same year her siblings entered into the challenged lease — they ousted Dorine as a director, officer, and employee of the Corporation. In 2012 Dorine and her siblings negotiated a Separation Agreement and General Release setting forth terms for payment of compensation and benefits along with non-compete and non-disclosure provisions. The agreement left intact Dorine’s 25% stock interest in the Corporation.

Dorine’s derivative suit filed in 2013 claimed that the 2011 below-market lease rendered the LLC unprofitable while increasing the Corporation’s income used to pay salaries and other benefits to her siblings. The first round went to Dorine when the court ruled that her General Release did not encompass her derivative claim and enjoined her siblings from advancing their legal expenses from LLC funds.

In the end, however, and subject to any appeals Dorine may bring, it appears that the siblings have won the food fight’s final rounds. Continue Reading “Food Fight” Sequel Ends Badly for Ousted Sibling

SushiThe Japanese word “omakase” translates as “I’ll Ieave it up to you” and is used by patrons of sushi restaurants to leave the selection to the chef rather than ordering à la carte.

The minority member of an LLC that operates a high-end Japanese restaurant in Brooklyn featuring omakase service, and who sued for judicial dissolution, recently learned a different meaning of omakase, as in, don’t leave it up to the court to protect you from being frozen out by the majority member when you don’t have a written operating agreement, much less a written operating agreement containing minority-interest safeguards.

The hard lesson learned by the petitioner in Matter of Norvell v Guchi’s Idea LLC, 2016 NY Slip Op 32307(U) [Sup Ct Kings County Nov. 18, 2016], has been taught before, starting most prominently with the First Department’s 2013 decision in Doyle v Icon, LLC and reinforced by that court two years later in Barone v Sowers, holding that minority member claims of oppressive majority conduct including systematic exclusion from the LLC’s operations and profits, in the absence of a showing that the LLC is financially unfeasible or not carrying on its business in conformity with its operating agreement, do not constitute grounds for judicial dissolution under LLC Law § 702. Continue Reading Another Frozen-Out Minority LLC Member’s Petition for Dissolution Bites the . . . Sushi?

tie-breaker[N.B. Younger readers of this post may be forgiven for not catching the title’s play on the refrain of a certain 1976 hit song by one of the oldest and most hirsute recording groups around. Click here if you’re still stumped.]

LLC deadlock’s been on my mind more than usual of late, after interviewing LLC maven John Cunningham for a podcast and last week co-presenting with John a webinar on the subject for the ABA Young Lawyer’s Division.

During the webinar’s Q&A session, a listener asked about potential liability of an appointed deadlock tie-breaker. I mentioned that I had not seen any cases involving the issue. Lo and behold, several days later up popped a decision by Queens County Commercial Division Justice Martin E. Ritholtz presenting exactly that issue, in which the court denied the tie-breaker’s motion for summary dismissal of a claim brought against her for breach of fiduciary duty by one of two 50/50 members of a family-owned LLC. Fakiris v Gusmar Enterprises LLC, 2016 NY Slip Op 51665(U) [Sup Ct Queens County Nov. 21, 2016]. Continue Reading She’s a Tie-Breaker, She’s a Risk Taker

Bad Faith 1In New York, the bad faith defense in dissolution proceedings traces its lineage to Matter of Kemp & Beatley, 64 NY2d 63 [1984], a landmark ruling by the state’s highest court that set the standard for minority shareholder oppression under § 1104-a of the Business Corporation Law, where the court wrote in dicta that “the 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.”

Several years ago, I gave headline treatment to Justice Vito DeStefano’s decision in Feinberg v Silverberg recognizing the bad faith defense as applicable also in deadlock dissolution cases between 50/50 shareholders under BCL § 1104 notwithstanding a line of appellate rulings indicating that the underlying reasons for dissension and deadlock are not relevant. In reconciling those seemingly contradictory cases, Justice DeStefano wrote that the “manufactured creation of the dissension . . . is the sine qua non of bad faith” which “would belie a finding that the shareholders’ dissension poses an irreconcilable barrier to the continued functioning and prosperity of the corporation.”

Has the bad faith defense similarly osmosed to LLC dissolution? While I’m not aware of any New York cases directly addressing the issue, a recent decision by Chancellor Ellen Hobbs Lyle of the Tennessee Business Court in Wilford v Coltea, Case No. 15-856-BC [Tenn. Ch. Ct. 20th Dist. May 16, 2016], echoes Justice DeStefano’s rationale in upholding a bad faith defense in a dissolution case involving a Delaware LLC whose two 50/50 members seemingly were at an alleged managerial impasse with no way out. Continue Reading Bad Faith Defense Gets Boost in LLC Dissolution Case

ExpulsionThere are arguments pro and con when it comes to the power to expel a/k/a dissociate an LLC member. On the one hand, expulsion can be viewed as a necessary measure to preserve the LLC as a going concern when faced with persistent misconduct or failure to perform by one of its members. On the other hand, depending how broadly or narrowly the expulsion criteria are drawn, the power to expel can be a tool of oppression and abuse by those wielding it for their self-advantage.

Expulsion can occur in one of two ways. First, the operating agreement can authorize member expulsion under specified circumstances by self-executing action of the other members or managers. This is not a feature I regularly come across in operating agreements of LLCs, especially those whose membership consists of founding owners actively involved in the business.

Second, in states that have adopted the Revised Uniform LLC Act — to date numbering 16 plus the District of Columbia; New York is not one of them — courts are authorized to expel an LLC member on application by the company or a member on three specified grounds, two of which entail fault-based standards based on intentionally wrongful conduct or material breach, and the third of which dispenses with the notion of wrongful conduct by authorizing judicial expulsion of a member who

has engaged or is engaging in conduct relating to the company’s activities and affairs which makes it not reasonably practicable to carry on the activities and affairs with the person as a member.

Not surprisingly, the open-endedness of the above provision when utilized in LLC disputes has generated litigation, with New Jersey courts taking the lead. Last week, in IE Test, LLC v Carroll, 2016 WL 4086260 [NJ Sup Ct Aug. 2, 2016], that state’s Supreme Court handed down a major decision in which it reversed the lower courts’ summary judgment order expelling an LLC member and adopted a series of factors to assist trial courts in determining whether it is not reasonably practicable to operate an LLC in light of a subject member’s conduct. Continue Reading New Jersey Supreme Court Raises the Bar for Judicial Expulsion of LLC Members

The tiny state of Delaware plays an enormous role in this country’s corporate life. Delaware has long been the overwhelmingly preferred state of incorporation for publicly owned companies, and its cutting-edge (many would also say pro-management) enabling acts for closely held business entities have made it an exporter to the other 49 states of countless privately owned corporations, limited partnerships, and limited liability companies that have no connection to Delaware other than their state of formation.

The Delaware judicial system serves an integral role in maintaining the state’s corporate hegemony. The Delaware Court of Chancery is widely viewed as the country’s preeminent business-law trial court by virtue of its broad jurisdiction over Delaware business entities both public and private, and thanks to a judicial selection process that promotes the best and brightest candidates for the court’s judgeships including one Chancellor and four Vice-Chancellors whose typically thorough and scholarly written opinions are closely followed by lawyers and judges throughout the country.

Business divorce practice nationwide is no less susceptible to the influence of the Delaware legislative and judicial juggernaut. In New York, as in other states that are home to many Delaware-formed business entities, the internal affairs doctrine mandates application of Delaware law to disputes among entity co-owners, and jurisdictional constraints require owners seeking the ultimate remedy of judicial dissolution to do so in the Delaware Chancery Court. The Chancery Court’s interpretation of Delaware business entity statutes governing internal relations among co-owners of closely held business entities also has had significant influence over the interpretation of counterpart statutes in other states by their judiciaries. (A prominent example of this is the Second Department’s 2010 decision in the 1545 Ocean Avenue case which drew heavily upon Delaware Chancery Court precedent in setting the standard for judicial dissolution of LLCs under Section 702 of New York’s LLC Law.)

HeymanLadigAll of which is why I’m excited to invite readers to listen to my most recent podcast episode on the Business Divorce Roundtable entitled “Business Divorce, Delaware Style” featuring my interview of two leading Delaware litigators — Kurt Heyman (photo left) and Pete Ladig (photo right) — talking about what it’s like to litigate business divorce cases in the Chancery Court and current developments in Delaware law affecting such cases including important decisions I’ve written about on this blog in the TransPerfect, Carlisle, and Meyer cases.

Click on the link at the bottom of this post to hear the interview.

Kurt Heyman is a founding partner of Proctor Heyman Enerio LLP in Wilmington, Delaware, where he focuses his practice on corporate governance, partnership and limited liability company disputes in the Delaware Court of Chancery. Kurt lectures and writes extensively on business divorce and other corporate governance topics, he’s Co-Chair of the Business Divorce Subcommittee of the ABA Business Law Section, and he leads the Business Divorce and Private Company Disputes group on LinkedIn.

Pete Ladig is Vice Chair of the Corporate and Commercial Litigation Group at Morris James also in Wilmington. Pete concentrates his practice in the areas of corporate governance and commercial litigation, stockholder litigation, fiduciary duties, partnership and limited liability company disputes, and class action and derivative litigation. He’s also active in the ABA Business Divorce Subcommittee and has published articles on business divorce topics including a must-read post on his firm’s blog called What Is Business Divorce? Pete also co-hosts a podcast called CorpCast discussing corporate and commercial law in Delaware.

If you’re interested in business divorce, you’ll certainly enjoy listening to my interview of Kurt and Pete, both of whom speak on the subject with great authority, insight, and passion.

tie-breakerThe New York Business Corporation Law offers the 50% shareholder of a close corporation two avenues to judicial dissolution: deadlock at the board or shareholder level or internal dissension under BCL § 1104, and oppressive actions by the directors or those in control of the corporation under BCL § 1104-a.

The 50% petitioner faces an important strategic decision whether to invoke one or the other (or both) of the statutes. That’s because § 1104-a — but not § 1104 — triggers the respondent’s elective right under BCL § 1118 to acquire the petitioner’s shares for fair value. As I’ve written previously, often a 50% petitioner may gain greater negotiating leverage by proceeding solely under § 1104 based on deadlock, thereby depriving the other 50% faction of a statutory buy-out opportunity.

I can only speculate whether a strategic decision of that sort was at work in Matter of Hudson (Pure Lime USA, Inc.), Short Form Order, Index No. 600127/16 [Sup Ct Nassau County June 16, 2016], in which Nassau County Commercial Division Justice Stephen A. Bucaria dismissed the 50% shareholders’ § 1104 dissolution petition that superficially asserted director deadlock, but where the governing shareholders agreement authorized one of the respondent’s designees on the four-member board to cast the deciding vote in case of a tie vote. How can there be deadlock, the winning argument went, when the parties had a tie-break provision specifically designed to avoid deadlock? Continue Reading Tie-Breaker in Shareholders Agreement Defeats Deadlock Dissolution Petition

CunninghamNew Hampshire lawyer John Cunningham eats, sleeps and breathes limited liability companies.

Seriously, John has carved out for himself a niche practice as one of the foremost experts in the country on the formation of limited liability companies and the drafting of LLC operating agreements.

He shares his knowledge through his many lectures and publications, including his leading LLC formbook and practice manual, co-authored by Vernon Proctor, called Drafting Limited Liability Company Operating Agreements published by Wolters Kluwer, and his highly informative blog Cunningham on Operating Agreements. John also chaired the committee that wrote the New Hampshire Revised LLC Act enacted in 2013.

From a business divorce perspective, management deadlock is a recurrent problem and precipitator of litigation for LLCs with two equal members. I didn’t fully grasp the potential magnitude of the problem, however, until I read John’s recent article in the Wealth Counsel Quarterly called “Avoiding Deadlocks in LLC Operating Agreements” in which he cited an IRS statistic that 25% of all LLCs nationwide consist of two members. My own experience jibes with John’s article’s observation, that “the members of most two-member LLCs are equal in voting and profit shares,” and that

For all of these LLCs, the issue of deadlock is major. Even in the best two-member LLC, it is likely that deadlock issues will eventually arise, and can destroy an otherwise promising LLC.

Continue Reading John Cunningham on Avoiding Deadlock in Two-Member LLCs