Pay attention to your K-1s or they may come back to bite you, is the lesson of Bruder v Hillman, Docket No. A-5055-15T1 [N.J. Super. Ct. App. Div. June 27, 2017], decided last week by a New Jersey appellate panel which rebuffed a limited partner’s attack on the validity of the partnership’s conversion to a limited liability company.

The court’s opinion describes the plaintiffs as “sophisticated real estate investors”  who in 1984 formed a New Jersey limited partnership to own and operate a large apartment complex in Virginia which some years later filed for bankruptcy.

The bankruptcy case settled in 1992 with a restructure agreement and an amended partnership agreement under which the defendants invested almost $12 million and took control of the partnership as general partner, with the plaintiffs retaining limited partner interests. Continue Reading In Dispute Over Partnership’s Conversion to LLC, Court Finds No Duty to “Spoon-Feed” Sophisticated Investor

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

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

StandingThis article was co-authored by Franklin C. McRobertscounsel in the Uniondale office of Farrell Fritz and a member of the firm’s Business Divorce Group.


The rules of “standing” in business divorce litigation generally require that the plaintiff have an ownership interest in the business entity at the time of the alleged wrongful conduct and, for derivative claims brought on the entity’s behalf, throughout the litigation.

In Lewis v Alcobi, 2017 NY Slip Op 30664(U) [Sup Ct NY County Apr. 6, 2017], Manhattan Commercial Division Justice Anil C. Singh considered whether a parent’s assignment of her young daughter’s membership interest in a limited liability company as security for the other parent’s unpaid debt deprived the daughter of standing to sue, despite the daughter’s claim to have received no consideration for the assignment.

The case provides useful lessons for litigating disputes of this sort and, perhaps more importantly, for transactional attorneys considering the use of LLC membership interests to secure payment obligations. Continue Reading Assignment of LLC Interest Defeats Standing Despite Alleged Lack of Consideration

Buy-SellAt least on paper, shotgun provisions in shareholder and operating agreements provide an elegant and efficient buy-out solution when business owners can’t get along and need a divorce. In a two-owner company, the one who “pulls the trigger” names a price at which he or she either will buy the other’s interest or sell to the other. The other owner has a specified amount of time to decide which. Since the offeror doesn’t know who will be the buyer, in theory there’s a great incentive to name an objectively fair price. The agreement usually also will prescribe payment terms. No need for appraisal. No fuss. No muss.

I’m not aware of any data-based studies on the subject, but I believe experienced lawyers would concur that shotgun clauses, although frequently included in owner agreements, are rarely invoked. Why is that? I can only speculate that owners generally prefer other ways to achieve a breakup without the uncertainty of knowing who will end up with the business. Also, owners are reluctant to be the trigger-puller, that is, there’s a natural preference to be the one with the option to buy or sell at a price named by the other.

Shotguns also can suffer from informational and financial asymmetries between the owners, a problem highlighted in my two-part, online interview of Professors Landeo and Spier some years ago (here and here). As Professor Spier described it: Continue Reading Aim Carefully Before Pulling Trigger on Shotgun Buy-Sell Agreement

USA

It’s true that the statutory and common-law rules at play in business divorce cases can vary widely from state to state. But it’s also true that court decisions in one state can influence courts in other states, and can provide business divorce lawyers with fresh ideas and novel arguments. I like to think of it as legal cross-pollination.

For many years, one of the nation’s leading authorities on business organization law, Professor Elizabeth Miller at Baylor Law School, has been collecting, curating, and publishing detailed synopses of cases from around the country involving LLCs and other unincorporated business entities, with a large complement of dissolution, breach of fiduciary duty, and other cases featuring disputes among business co-owners. It’s a terrific resource for keeping up with nationwide case law developments. Some of Professor Miller’s summaries can be found online, but the best way for lawyers to gain access to them on a regular basis is to join the LLCs, Partnerships and Unincorporated Entities Committee of the ABA’s Business Law Section. That’s the same committee that sponsors the incomparable LLC Institute every year.

Professor Miller’s most recent sampling of (non-Delaware) partnership and LLC cases was presented at a session of the 2017 Spring Meeting of the Business Law Section in New Orleans. I’ve selected from it and further distilled in the following summaries a quintet of business divorce cases from a quintet of states other than New York. Continue Reading Business Divorce Nation: Five States, Five Cases

jurisdiction1I can count on one hand the number of federal court cases I’ve featured on this blog since I started it almost 10 years ago — and that’s no coincidence.

Federal courts are courts of limited jurisdiction, requiring either the presence of a claim arising under federal law — so-called federal question jurisdiction — or the opposing litigants are citizens of different states — so-called diversity jurisdiction.

Federal question jurisdiction rarely exists in business divorce cases involving the internal affairs of closely held business entities which are the peculiar province of state law. Federal courts are especially loathe to decide judicial dissolution cases, to the point where they routinely exercise their discretionary power to abstain from exercising jurisdiction even in dissolution cases where diversity exists (read here).

Inevitably there are some small number of diversity suits filed in federal court asserting state-law claims other than dissolution between business co-owners. Even in these cases, however, there is a potential trap for the unwary plaintiff if the subject business entity is a limited liability company, as nicely illustrated by a Manhattan federal judge’s decision last month in Sullivan v Ruvoldt, Opinion and Order, 16 Civ. 583 [SDNY Mar. 24, 2017]. Continue Reading Beware Diversity Trap in Federal Court Business Divorce Cases Involving LLCs

Brothers1Like most civil cases, the vast majority of business divorce disputes get resolved before trial, which is disappointing for us voyeurs since only at trial with live witnesses undergoing cross examination does one get the full flavor of the case’s factual intricacies, credibility issues, and the emotional undercurrents.

Even rarer are written post-trial decisions by judges with detailed findings of fact and conclusions of law, which is why I was so pleased recently to come across a trio of expansive post-trial decisions by Queens County Justice Timothy J. Dufficy in three business divorce cases involving family-owned businesses.

One of them, Shih v Kim, was featured in last week’s post on this blog, in which a romantically-involved couple started a business while engaged and continued as business partners even after the engagement broke off — until the defendant went rogue by diverting cash to himself and diverting business to a competing company.

The two other cases form interesting bookends, metaphorically speaking. Both involve businesses run by brothers. Both involve challenges to the documented ownership of the business. In one case, Justice Dufficy rejected a bid to establish an undocumented, de facto partnership interest and dismissed the case. In the other, Justice Dufficy upheld the documented, 50/50 ownership of an LLC, granted dissolution, and appointed a receiver. Let’s take a closer look. Continue Reading A Pair of Unbrotherly Business Altercations Go to Trial

Lady Justice

Welcome to another edition of Winter Case Notes in which I clear out my backlog of recent court decisions of interest to business divorce aficionados by way of brief synopses with links to the decisions for those who wish to dig deeper.

And speaking of digging deeper, if you don’t already know, New York’s e-filing system has revolutionized public access to court filings in most parts of the state. The online e-filing portal (click here) allows searches by case index number or party name. Once you find the case you’re looking for, you’ll see a chronological listing with links allowing you to read and download each pleading, affidavit, exhibit, brief, decision, or other filing. No more trips to the courthouse basement to requisition paper files!

This year’s synopses feature matters that run the gamut, from a claimed de facto partnership, to several disputes pitting minority against majority shareholders, to an LLC case in which the court resolved competing interpretations of a somewhat murky operating agreement. Continue Reading Winter Case Notes: De Facto Partnership and Other Recent Decisions of Interest

powerlessAn appellate decision last week sounds alarm bells for minority members of New York LLCs that have no operating agreement and for anyone considering becoming a minority member of an LLC without first having in place an operating agreement.

By the same token, the decision provides opportunities for majority members of existing LLCs without operating agreements to cement and expand their control powers.

Last week’s unanimous decision by the Manhattan-based Appellate Division, First Department in Shapiro v Ettenson, 2017 NY Slip Op 00442 [1st Dept Jan. 24, 2017], affirmed the lower court’s order enforcing an operating agreement signed by two of the LLC’s three co-founding, co-equal members, adopted two years after the LLC’s formation without the signature or consent of the LLC’s third member. Among other features, the operating agreement departed from the statutory default rule by authorizing the reduction of the percentage interest of a member who fails to satisfy a capital call approved by the majority, which is exactly what the two majority members did following their adoption of the agreement, along with eliminating the minority member’s salary. Continue Reading Thinking About Becoming a Minority Member of a New York LLC Without an Operating Agreement? Think Again