Franklin C. McRoberts, counsel in the Uniondale office of Farrell Fritz and a member of the firm’s Business Divorce Group, prepared this article.


Board members’ decisions to award compensation packages for themselves can present some thorny issues. In a close corporation, shareholders typically serve as officers and directors, and have a reasonable expectation of compensation in lieu of dividends or distributions. But dissenting shareholders or directors, armed with the benefit of hindsight, can, and often do, criticize a board’s compensation decisions as excessive, claiming self-dealing, looting, and waste. What statutory protections do board members have when making compensation decisions? To what extent can board members truly rely on those protections?

In Cement Masons Local 780 Pension Fund v Schleifer, 56 Misc 3d 1204 [A], 2017 NY Slip Op 50875 [U] [Sup Ct NY County June 29, 2017], Manhattan Commercial Division Justice Saliann Scarpulla considered these issues in a thoughtful opinion, in which she relied on some relatively infrequently litigated provisions of the Business Corporation Law (“BCL”). The decision is also noteworthy for its reliance on decisional law from Delaware on not one, but two important issues of law, one of which was an apparent question of first impression in New York. Although Cement Masons Local involved a public company, it addressed the same statutes that govern close corporations, and provides helpful guidance to board members, and counsel, when weighing compensation decisions. Continue Reading Navigating Rocky Shoals and Safe Harbors When Board Members Fix Their Own Compensation

The third time definitely wasn’t a charm for the plaintiff in Austin v Gould, 2017 NY Slip Op 31494(U) [Sup Ct NY County July 13, 2017], in which the court dismissed ill-pleaded claims for “unfettered and unlimited access to all books and records” of a series of Delaware limited liability companies and their wholly-owned real estate subsidiaries.

The decision by Manhattan Commercial Division Justice O. Peter Sherwood is the latest in a series of trial and appellate court rulings, spread over seven years and three separate lawsuits, rejecting claims by the LLCs’ non-managing one-third owner against the managing two-thirds owner allegedly for failing to distribute millions in management and acquisition fees.

The plaintiff’s two prior lawsuits — the first filed in 2010 and, after its dismissal, the second filed in 2013 — hit dead ends for various reasons including untimeliness and pleading deficiencies. The third lawsuit, filed in 2016, asserted claims for access to the LLCs’ books and records along with damages claims for breach of fiduciary duty and conversion. Continue Reading Books and Records Case Illustrates Crucial Importance of Pre-Suit Demand

Franklin C. McRoberts, counsel in the Uniondale office of Farrell Fritz and a member of the firm’s Business Divorce Group, prepared this article.


A business’s failure to pay state taxes can be a problem if the entity later wants to bring a lawsuit, or its non-controlling owners want to sue on the entity’s behalf.

Under Section 203-a of the New York Tax Law, a New York business entity’s failure to pay franchise taxes for two years can result in automatic dissolution of the entity by proclamation of the New York State Secretary of State. Once a corporation is dissolved by proclamation for failure to pay franchise tax, it “does not enjoy the right to bring suit in the court of this state, except in [very] limited respects specifically permitted by statute.” Moran Enterprises, Inc. v Hurst, 66 AD3d 972 [2d Dept 2009].

What happens when an out-of-state entity, or shareholders on the entity’s behalf, attempt to sue in a New York court, despite the business not having paid taxes for several years in its home state? New York County Commercial Division Justice Anil C. Singh recently considering that question, specifically with respect to a Delaware entity, in Juma Technology Corp. v Servidio, Decision and Order, Index No. 151483/2016 [Sup Ct, NY County May 24, 2017]. Continue Reading Minority Shareholders’ Derivative Suit Foiled by Voiding of Corporation’s Charter for Nonpayment of Taxes

NY

DelawareThe common perception among practitioners familiar with the business entity laws of New York and Delaware is that Delaware law generally is friendlier to, and more protective of, majority ownership and management interests.

Two recent cases — one from each state — highlight at least one important area where the common perception does not apply: majority rights under the statutory default rules to adopt or amend an LLC operating agreement without the consent of all the members.

The difference between the two states can have critical consequences for both majority and minority members of the many LLCs that, for better or worse, are formed without a written operating agreement.

The New York case is one I previously wrote about on this blog. Last January, in Shapiro v Ettenson, the Appellate Division, First Department, in a case involving a three-member LLC that was formed without a written operating agreement, affirmed a lower court’s decision construing Section 402 (c) (3) of the New York LLC Law (“except as provided in the operating agreement . . . the vote of a majority in interest of the members entitled to vote thereon shall be required to . . . adopt, amend, restate or revoke the articles of organization or operating agreement”) to permit the two-member majority to adopt a written operating agreement almost two years after the LLC was formed and began operating, without the third member’s consent and notwithstanding certain provisions in the agreement that modified the statutory default rules adversely to the third member. Continue Reading Delaware Ruling Highlights Difference With New York Over Amending LLC Agreements

Litigating

There’s little doubt in my mind that “business divorce” has achieved name recognition as a distinct subgenre of commercial litigation whose regular practitioners, by dint of experience dealing in and out of court with the many and varied legal and practical issues arising from dysfunctional family and non-family owned closely-held businesses, offer clients a level of expertise not shared by civil litigation generalists.

I like to think that my blog, in its tenth year and still chugging along, has contributed to the enhanced recognition along with the efforts of a small but growing cadre of fellow bloggers, contributors of articles in legal publications, and speakers at bar association programs and business valuation seminars.

Now, with the publication of a smartly constructed and well-written treatise called Litigating the Business Divorce (Bloomberg BNA 2016), the law practice of business divorce truly has come of age.

LBD, as I’ll call it, is the fruit of a two-year project led by contributing editors Kurt Heyman and Melissa Donimirski in collaboration with an all-star cast of contributing authors. Kurt is a partner and Melissa a senior associate at the firm of Heyman Enerio Gattuso & Hirzel LLP in Wilmington, Delaware. Kurt, a seasoned business divorce litigator whom I’ve known for about ten years and whom I interviewed last year for my podcast, is a founding Co-Chair of the Business Divorce Subcommittee of the ABA Business Law Section, Business and Corporate Litigation Committee. Continue Reading Announcing Must-Have Treatise on Business Divorce Litigation

limited partnershipNotwithstanding the ascendency of the limited liability company, the Delaware limited partnership continues to serve as an important, tax-advantaged vehicle for certain capital-intensive ventures — especially in the energy sector — featuring centralized management and limited liability for large numbers of passive investors.

Late last month, the Delaware Supreme Court handed down two noteworthy decisions springing from suits by limited partners challenging the fairness of conflicted transactions by general partners that were approved by conflicts committees. In one, the high court affirmed Chancery Court’s order rejecting a claim based on the implied duty of good faith and fair dealing where the transaction’s approval by the conflicts committee complied with the agreement’s safe harbor provision and thus contractually precluded judicial review. Employees Retirement System v TC Pipelines GP, Inc., No. 291, 2016 [Del. Sup. Ct. Dec. 19, 2016].

In the other, Supreme Court reversed Chancery Court’s post-trial decision holding the general partner liable in damages owed directly to limited partners for a conflicted, over-priced  “dropdown” transaction by the general partner. The high court disagreed with Chancery Court’s application of the Tooley standard, instead finding that the claims were exclusively derivative and that the post-trial, pre-judgment acquisition by merger of the partnership extinguished the plaintiff limited partner’s standing to seek relief. El Paso Pipeline GP Company, LLC v Brinckerhoff, No. 103, 2016 [Del. Sup. Ct. Dec. 20, 2016].

Together, the two decisions re-affirm the primacy of contract in the realm of alternative entities including limited liability companies, limited partnerships, and master limited partnerships. Continue Reading Limited Partners Take a Licking in Two Delaware Supreme Court Decisions

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

spaceballs

To Mel Brooks’ collection of hit films, Oscars, and countless other comedic works and awards can now be added the distinction of having his 1987 Star Wars parody, Spaceballs, cited by the decidedly non-comedic Delaware Court of Chancery in support of its construction of an LLC agreement’s provision for advancement and indemnification in a lawsuit arising from a soured business relationship between the majority and minority members of a Delaware company formed in 2007 called Quivus Systems, LLC.

The transcript decision by Vice Chancellor Tamika Montgomery-Reeves in Harrison v Quivus Systems, LLC, C.A. No. 12084-VCMR [Del Ch Aug. 5, 2016], granted summary judgment on a claim for advancement of legal expenses in favor of the plaintiff Harrison, a principal of Quivus’s 45% member and its former CEO who was terminated in 2014 and then sued the following year in Washington D.C. Superior Court by the 55% member, Soroof International Corp., allegedly for mismanagement, incompetence, and looting.

Harrison filed his Chancery Court action after Soroof rejected his demand for advancement for all expenses, including legal fees, he incurred and would continue to incur in defending against all but one count in the D.C. action, as well as in prosecuting his counterclaims in the D.C. action. Continue Reading When Will Then Be Now? Court Construes LLC Agreement’s Advancement Provision With An Assist From Spaceballs

shorts

It’s late August, when the lure of the seashore and vacation plans push aside all but the most serious work-related endeavors, and when I share with my readers a few short summaries of recent decisions of interest in business divorce cases.

First, we’ll look at a decision in a dispute among former law firm partners in which the court upheld a partnership agreement amendment by the defendant majority partners, reducing the plaintiff’s percentage interest after he announced his intention to withdraw but before the actual withdrawal became effective. Next up is a relatively rare decision in an LLC dissolution case granting a motion to disqualify defense counsel under the advocate-witness rule of professional conduct. In the third case highlighted below, the Delaware Chancery Court dismissed a books-and-records action for lack of standing where the shares issued to the plaintiff never existed.

Court Enforces Eve-of-Withdrawal Reduction of Partnership Interest

Zohar v LaRock, Short Form Order, Index No. 14826/10 [Sup Ct Nassau County July 25, 2016]Article 8-B of New York’s Partnership Law authorizes regulated professional practices to organize as registered limited liability partnerships. The LLP form is highly popular with law firms because it offers the same limited liability protection afforded corporation shareholders and LLC members, except for their own professional negligence or malpractice. The LLP otherwise is subject to the same statutes and common-law rules governing general partnerships, which give partners great leeway in ordering their own affairs in their partnership agreement. Continue Reading Summer Shorts: Partnership Interest Reduction and Other Recent Decisions of Interest

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.