As many judges and lawyers know, Superstorm Sandy has been used in litigation over the years as an excuse for things ranging from the seriously bad, like destroyed evidence, to the more mundane, like blown court deadlines. In Cardino v Peek-A-Boo, Inc., 2017 NY Slip Op 31657(U) [Sup Ct, Suffolk County July 28, 2017], a litigant did his best to try to persuade Suffolk County Supreme Court Justice James Hudson that Sandy made it “impossible” for him to comply with a post-dissolution order to turn over all merchandise of an adult bookstore, appropriately named “Peek-A-Boo, Inc.,” to a court-appointed receiver. Cardino provides some guidance on a rarely litigated issue – the potential consequences of violating a post-dissolution receivership order.

The Dissolution Decision

As recounted in an earlier decision, Peek-A-Boo was a New York corporation formed by a father and son, the Lombardos, to own and operate an adult shop. The petitioner, Cardino, sued the Lombardos to dissolve Peek-A-Boo under Section 1104-a of the Business Corporation Law, claiming he was “shut out” of the business. Suffolk County Supreme Court Justice Jeffrey Arlen Spinner held that the Lombardos oppressed Cardino and dissolved the corporation. Continue Reading Superstorm Sandy Unable to Wash Away Sin of Contempt

Over the years I’ve litigated and observed countless cases of alleged oppression of minority shareholders by the majority. Oppression can take endlessly different forms, some more crude than others in their execution, some more draconian than others in their effect.

If there was an award for the crudest and most draconian case of shareholder oppression, Matter of Twin Bay Village, Inc., 2017 NY Slip Op 06024 [3d Dept Aug. 3, 2017], decided earlier this month by an upstate appellate panel, would be a serious contender.

The case involves a bitter dispute between two branches of the Chomiak family over a lakefront resort called Twin Bay Village located on beautiful Lake George in upstate New York. In 1957, the husband-and-wife founders, Stephan and Eleonora Chomiak, opened the summer resort on land they owned. They and their two sons, Leo and Vladimir, together ran the business until 1970 when they transferred ownership of the land and business to newly-formed Twin Bay Village, Inc. owned 26% by each parent and 24% by each son. Continue Reading And the Award For Most Oppressive Conduct By a Majority Shareholder Goes to . . .

SurchargeHidden in plain view in Section 1104-a (d) of the New York Business Corporation Law, which authorizes an oppressed minority shareholder to petition for judicial dissolution, is a provision empowering the court to adjust stock valuations and to “surcharge” those in control of the corporation for “willful or reckless dissipation or transfer” of corporate assets “without just or adequate compensation therefor.”

A second, fleeting reference to surcharge appears in Section 1118 (b) of the buy-out statute, empowering the court in its determination of the stock’s fair value to give effect to any surcharge “found to be appropriate” under Section 1104-a.

The ordinary definition of surcharge, at least in the context of settling accounts, is to show an omission for which credit ought to have been given. But what does it mean in its statutory setting, and how has it been applied by the courts? Continue Reading The Elusive Surcharge in Dissolution Proceedings

gas pumpA gas station in Poughkeepsie, New York, is the prosaic setting for a noteworthy decision last month by Dutchess County Supreme Court Justice Christine A. Sproat judicially dissolving a limited liability company owned equally by two brothers.

The court’s unpublished decision in Matter of Zafar (M&D of Dutchess, LLC), Index No. 3123/15 [Sup Ct Dutchess County Dec. 4, 2015], is one of the few LLC dissolution cases I’ve seen centered on allegations of looting and diversion. While looting and diversion are expressly made grounds for dissolution under the statute governing close corporations, they are not mentioned in the LLC dissolution statute. Nonetheless, the court in Zafar found that the nature and extent of the managing member’s “persistent self-dealing and dishonest conduct” — I’m quoting from the court’s decision — made it, in the language of LLC Law § 702, “not reasonably practicable to carry on the business . . . in conformity with the articles of organization.”

The case pits petitioner Mobashar Zafar against his younger brother Dawood Ahmed as 50/50 members of M&D of Dutchess, LLC. According to Zafar’s petition (read here), the brothers owned the gas station as tenants in common from 1986 until they conveyed it to their newly formed LLC in 1999 at which time the station was under lease to a third-party operator. The brothers never had a written operating agreement but in practice agreed that the younger brother, Ahmed, who lived in the area, would alone manage the LLC’s business affairs. Continue Reading Court Dissolves LLC Due to Managing Member’s “Self-Dealing and Dishonest Conduct”

For the past ten years, a chain of walk-in airport spas called XpresSpa has offered soothing massage and a range of other personal care services to stressed-out air travelers. Now it’s the company’s principals who could use some stress relief following a court decision earlier this month holding that a restructuring involving a capital infusion by a private equity firm unintentionally triggered dissolution of XpresSpa’s parent company under a provision in its operating agreement. The parent company must now prepare for a painful unwinding and liquidation at the direction of a court-appointed receiver.

The decision by Manhattan Commercial Division Justice Melvin L. Schweitzer in JPS Partners v Binn, 2014 NY Slip Op 31204(U) [Sup Ct, NY County May 6, 2014], came at the behest of a 1.93% investor in the parent company, a New York limited liability company known as Binn and Partners, LLC, controlled by its sole managing member, Moreton Binn. The dissident member, apparently alone among the company’s investors, refused to consent to the proposed restructuring. Mr. Binn nonetheless proceeded with the transaction after amending the LLC’s operating agreement in a manner designed to blunt the dissenting member’s objection. Justice Schweitzer found that the amendment exceeded Mr. Binn’s authority and that the restructuring constituted a transfer of the LLC’s assets within the meaning of the operating agreement’s provision requiring dissolution upon “the Transfer of substantially all of the assets of the Company.”

Assuming the decision stands — Mr. Binn and the LLC have filed a notice of appeal — the court’s ruling offers an important lesson about drafting dissolution provisions in LLC operating agreements so as not to empower passive minority investors in start-up companies from interfering with growth opportunities requiring new sources of capital. Continue Reading Transfer of LLC’s Assets to Subsidiary Triggers Unintended Dissolution

I recently came across a fascinating article in which the authors, two prominent professors of law and economics, rely on experimental evidence to argue that courts should utilize the “shotgun” mechanism to resolve business divorce cases involving deadlock between two, 50/50 owners. The shotgun basically involves one owner setting a buyout price and the other owner opting to buy or sell at that same price, the theory being that the one setting the price, uncertain whether he or she will end up buyer or seller, effectively will be forced to offer a reasonable price for a business whose “true” market value otherwise may be very difficult to ascertain.

I’ll be posting more about this important and thought provoking article in the near future. (For those who can’t wait, here’s a link to the article by Professors Claudia Landeo and Kathryn Spier available on SSRN.) The topic for today is inspired by one particular court decision cited in the article, in which the judge not only ordered the sale of a deadlocked service business as a going concern using a shotgun mechanism, but also imposed a limited duration non-solicitation injunction upon whichever of the two shareholders ended up the seller.

The case, decided over 10 years ago by then-Vice Chancellor Jack B. Jacobs of the Delaware Court of Chancery (currently serving as a Justice of the Delaware Supreme Court), is Fulk v. Washington Service Associates, Inc., 2002 WL 1402273 (Del. Ch. June 21, 2002) (read here). It’s a case that deserves more attention than evidenced by the paucity of citations to it in subsequent case law. It’s a case that puts to the forefront questions about the appropriate reach of the judicial power in dissolution cases, to maximize shareholder value for both sides in winding up a 50/50 company with substantial good will that one of the two owners is threatening to walk off with. Continue Reading How Should Courts Maximize Shareholder Value When Dissolving Deadlocked Companies?

One of the most frequently encountered preliminary skirmishes in shareholder litigation involving closely held business entities focuses on whether the plaintiff’s claims are properly classified and brought either as direct claims for individual relief or as derivative claims for recovery on behalf of the entity. This duality — direct or derivative — has major consequences at the pleading stage and beyond.

Yet, as the Appellate Division, First Department, recently observed in Yudell v. Gilbert, where it expressly adopted Delaware’s formulation for distinguishing between the two based primarily on who suffers the alleged harm, “[s]ometimes whether the nature of the claim is direct or derivative is not readily apparent.”

The line between direct and derivative gets especially blurry when the only two shareholders involved are the aggrieved plaintiff and the defendant whose alleged misconduct results in the wholesale transfer of the corporation’s assets to the defendant or the defendant’s affiliate. Such cases may give rise to direct claims that, in other contexts, might be classified as derivative.

Take, for example, the case of Barmash v. Perlman, 2013 NY Slip Op 31518(U) (Sup Ct NY County July 3, 2013), decided earlier this month by Manhattan Commercial Division Justice Melvin L. Schweitzer. In Barmash, Justice Schweitzer denied a motion to dismiss a complaint brought by a minority shareholder where the claimed breaches by the controlling shareholder, constituting what the court labeled the “de facto liquidation” of the corporation, resulted in harm to the corporation to be pursued derivatively, but also caused injury “uniquely and individually” to the plaintiff minority shareholder permitting direct recovery.  Continue Reading Minority Shareholder’s De Facto Liquidation Claim: Direct, Derivative, or Both?

The contractarian recoils at the notion of equitable remedies in LLC dissolution cases. Allowing judges to grant relief ex post facto based on principles of equity untethered to the parties’s operating agreement, the contractarian argument goes, erodes the contract-based nature of the LLC — that which makes LLCs fundamentally different from corporations — and breeds moral hazard by rescuing LLC members from their shortsighted failure to bargain for desired rights and remedies in the LLC agreement.

One would be hard pressed to find a more powerful rejoinder to the contractarian argument than the case of Mizrahi v. Cohen, 2013 NY Slip Op 50092(U) (Sup Ct Kings County Jan. 15, 2013), decided last month by Brooklyn Commercial Division Justice Carolyn E. Demarest (pictured). What’s more, Justice Demarest’s opinion, in which she ordered a Lyons-style auction sale of LLC membership interests (I’ll explain below), is refreshingly candid about the court’s necessary employment of its equitable powers to avoid the glaring injustice that would have resulted in Mizrahi had the court stayed within the strict confines of the LLC agreement.

Mizrahi may sound familiar to regular readers of this blog. About a year ago I wrote about Justice Demarest’s prior decision in the case (read here) ordering dissolution of an LLC co-owned 50/50 by brothers-in-law. The LLC was formed to own, renovate and operate a small commercial building in Brooklyn used by the two members for their separate dental and optometry practices and to rent additional space to third-party tenants. Justice Demarest dissolved the LLC on the ground that continuing it was financially unfeasible due to the defendant member’s failure to provide needed financial support and his undermining of the LLC’s financial integrity by withholding rent and taking unauthorized cash withdrawals. Continue Reading Court Decision Boosts Equitable Buy-Out Remedy in LLC Dissolution Case

Someday, if and when the facts come out in discovery, we’ll learn what really happened in the curious case of Matter of Hu (Lowbet Realty Corp.), 2012 NY Slip Op 22314 (Sup Ct Kings County Nov. 2, 2012), in which a slippery minority shareholder somehow managed to sell the corporation’s sole realty asset and abscond with $1.6 million sale proceeds in violation of court order in a pending liquidation proceeding brought by the majority shareholder. In the meantime, the buyer and the property manager now find themselves ensnared in the majority shareholder’s effort to rescind the sale and to recover damages.

The court’s decision in Lowbet, issued earlier this month by Brooklyn Commercial Division Justice Carolyn E. Demarest, tells a remarkable story of brazen disobedience of court order by one Margaret Liu, a 25% shareholder of Lowbet Realty Corp. The decision also sheds light on an interesting, rarely seen procedural question in corporate dissolution proceedings, namely, whether the court may adjudicate within such summary proceedings a shareholder’s claim for relief against a third party who is neither a shareholder nor officer/director of the corporation, rather than being forced to commence a separate, plenary action by ordinary summons and complaint.

Background

The petitioner, Shau Chung Hu, was the 100% owner of Lowbet when, in 1980, it purchased a 19-unit apartment building in Brooklyn. In 1985, Hu married Margaret Liu and gave her a 25% stock interest in Lowbet. Mr. Hu and Ms. Liu separated in 1995, at which time Mr. Hu went to China where he has resided ever since, leaving Ms. Liu in full control over Lowbet. Continue Reading Dissolution Case Ensnares Buyer of Corporation’s Realty in Unauthorized Sale

Here we are again, in the doldrums of the last week of August. Offices are semi-deserted. The phones are quiet. Even the email traffic is down. Last chance to recharge the batteries before the post-Labor Day onslaught begins. A perfect time to offer vacationing readers summaries of a few recent decisions of interest involving disputes between business co-owners.

First, we’ll look at what appears to be a decision of first impression, holding that a liquidating receiver may consider the tax advantages of a shareholder bid for the dissolved corporation’s assets structured as a stock redemption. Then we’ll look at a pair of decisions addressing derivative versus direct claims, in one finding that the plaintiff’s claims were properly brought as direct claims, and in the other finding that the plaintiff failed to plead justification for failing to make a pre-suit demand.

Liquidating Receiver Authorized to Accept Shareholder Bid for Corporation’s Real Property Structured as Stock Redemption

Matter of Gohil (Bayside Mini Grocery, Inc.), 2012 NY Slip Op 30320(U) (Sup Ct Nassau County Jan. 23, 2012). The case was brought by the controlling shareholders of two corporations, one operating a bodega and the other owning the building housing the bodega, under §1103 of the Business Corporation Law for judicial dissolution of the corporations pursuant to majority shareholders’ resolution. In April 2011, the court appointed a receiver to liquidate the business and the real property. In July 2011, the court authorized the receiver to hire a real estate broker to market and sell the property at an initial listing price of $2.6 million. The court’s order also permitted the shareholders to put in topping bids to any outside offer. In August 2011, the broker obtained a $2.4 million all-cash outside offer. In September 2011, the petitioners put in a $2.5 million topping bid structured as a stock redemption agreement pursuant to which the respondents would sell to the realty corporation their 30% interest and petitioners would then own 100%. The proposed redemption also was designed to avoid approximately $75,000 in realty transfer taxes. The respondents did not at that time put in a topping bid, and the receiver determined that the petitioners’ bid was the highest offer.

Continue Reading Summer Shorts: Liquidating Receiver’s Authority to Compel Share Redemption and Other Recent Decisions of Interest