stock certificate 1First a books and records proceeding. Then a declaratory judgment action. Then dissolution proceedings. Six years of litigation including two appellate rulings, just to establish who’s a shareholder and who’s not, all because the owners of two closely held corporations formed decades ago never bothered to issue stock certificates or otherwise attend to corporate formalities.

It didn’t help that the two corporations, formed in the 1960’s, never elected pass-through taxation as subchapter S corporations, hence the companies never issued form K-1’s identifying the shareholders and their stock percentages.

In last week’s appellate ruling in Zwarycz v Marnia Construction, Inc., 2015 NY Slip Op 06239 [2d Dept July 22, 2015], which affirmed a June 2014 post-trial decision by Westchester County Supreme Court Justice Robert DiBella, the plaintiff Michael Zwarycz overcame the absence of a stock certificate or any other direct evidence of share ownership to establish his 50% interest in two corporations that own residential apartment buildings in Yonkers, New York.

Zwarycz’s victory last year before Justice DiBella turned bittersweet, however, when his follow-up petitions to dissolve the two corporations based on deadlock and internal dissension were dismissed by a different judge. Those November 2014 rulings are the subject of Zwarycz’s pending appeals. Continue Reading Fifty Years a Stockholder, Six Years to Prove it in Court

Del Ct Chancery 2Viewing the arc of Delaware Chancery Court jurisprudence over the last two decades implementing that state’s Limited Liability Company Act, and witnessing the Delaware legislature’s frequent amendments to the statute in reaction to judicial developments, you can’t help but detect a pattern of maintaining the unique attributes of the Delaware LLC, as compared to other forms of business entity, by:

  • rigorously promoting freedom of contract (in the form of the LLC agreement) and its corollary, “you made your bed now lie in it”;
  • deciding internal governance disputes within the bounds of the interplay of the Delaware LLC Act’s default rules and the LLC agreement; and
  • strongly disfavoring judicial intervention based on open-ended notions of fairness (the main exception being when managers take on fiduciary duties by agreement or by default under the statute).

Stated simply, in Delaware certainty trumps indeterminacy.

Well, not always, as seen in a first-impression ruling last week by Vice Chancellor J. Travis Laster in In re Carlisle Etcetera LLC, C.A. No. 10280-VCL (read here), in which the court held that the assignee of an LLC membership interest, who as a non-member and non-manager lacked standing to seek involuntary dissolution under Section 18-802 of the Delaware LLC Act, nonetheless had standing to seek equitable dissolution under the Chancery Court’s common-law authority as a court of equity.  Continue Reading Delaware Chancery Court Endorses Equitable Dissolution of LLC

shutterstock_121625548It’s not that I get nostalgic about derivative lawsuits (or Oldsmobiles), it’s just that it feels like we’re in a brave new world when it comes to adapting hoary corporate doctrine to that unincorporated upstart known as the limited liability company.

The clash between old and new looms in a derivative action concerning an LLC pending before Erie County Commercial Division Presiding Justice Timothy J. Walker called Univest I Corp. v Skydeck Corp., Index No. 2014-811644. The case stems from a dispute between the 50% managing member (BDC) and 50% non-managing member (Univest) of 470 Pearl Street, LLC, which was formed in 2004 for the purpose of acquiring for future development a parking lot in Buffalo, New York. Pending the development, BDC and Univest agreed to lease the parking lot to a BDC affiliate known as Skydeck Corp. The lease granted 470 Pearl the right to terminate the lease on 60-days notice.

In 2014, Univest, acting in 470 Pearl’s name, issued a termination notice to Skydeck under authority of an unusual provision in 470 Pearl’s operating agreement that gave either member the unilateral right “to cause 470 Pearl to terminate” the Skydeck lease. Two lawsuits followed Skydeck’s refusal to vacate. In the first, Justice Walker granted Univest a declaratory judgment upholding its termination notice and ordering Skydeck, pending further order, to pay an increased monthly rent (read amended complaint here and the court’s order here).

Shortly afterward, Univest commenced a derivative summary eviction proceeding on behalf of 470 Pearl, naming both Skydeck and BDC as respondents (read petition here). Now, let me pause the story for a moment. I’m not a landlord-tenant lawyer. If you’d asked me, before I looked into the Univest case, whether a non-controlling, non-managing corporation shareholder or LLC member could bring an eviction proceeding against the corporation’s or LLC’s tenant, I’m sure I would have guessed “no” for at least two reasons. First, I would have assumed the governing statute in Article 7 of the Real Property Actions and Proceedings Law somehow limits standing to seek relief to the owner or its authorized agent. Second, evicting a third-party tenant strikes me as quintessential management action. Imagine the chaos if any minority owner of a real estate operating company could take it upon themselves to launch eviction proceedings. But I would have guessed wrong. Gorbrook Associates, Inc. v Silverstein, 40 Misc 3d 425 [Dist. Ct. Nassau County 2013], a case of apparent first impression, held that a non-controlling, minority shareholder may bring derivatively an eviction proceeding.  Continue Reading Not Your Father’s Derivative Action

The statutes and judge-made law governing dissolution and other claims among co-owners of closely held business entities can vary significantly from state to state. Depending on the states, there also can be much in common, which is why I like to keep an eye on developments outside New York, and not just Delaware which tends to have the most advanced business-law jurisprudence.

Below are five business divorce cases decided by appellate courts outside New York that made a splash in 2014. As you might expect, four of the five involve that relatively new business entity form, the limited liability company. The one involving a traditional business corporation, however, likely made the biggest splash.

Ritchie v Rupe, 2014 WL 2788335 [Tex. Sup Ct June 20, 2014]. The Lone Star State takes the prize for the most controversial business divorce decision in 2014, thanks to the Texas Supreme Court’s decision in Ritchie which, as one commentator put it, effectively “gutted the cause of action for shareholder oppression in Texas.” A Texas intermediate appellate court ruling in 1988, which had been followed ever since, recognized a compulsory buyout remedy for oppressed minority shareholders under a broad test for oppression mirroring New York’s reasonable-expectations standard. No more. The Ritchie court, in a 6-3 decision, narrowly defined oppressive conduct by majority shareholders as “when they abuse their authority over the corporation with the intent to harm the interests of one or more of the shareholders, in a manner that does not comport with the honest exercise of their business judgment, and by doing so create a serious risk of harm to the corporation.” The Ritchie majority then applied the coup de grâce by construing the applicable Texas statute as limiting the remedy for oppressive conduct to the appointment of a “rehabilitative receiver.” Bye bye buyout. For a more detailed analysis of Ritchie‘s impact on Texas business divorce litigation, check out my friend Ladd Hirsch’s posts here, here, and here on his Texas Business Divorce blog.   Continue Reading Round-Up of Recent Business Divorce Cases From Across the Country

Ready to take a pop quiz? Here we go:

  1. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under the deadlock statute, Business Corporation Law § 1104?  __ Yes  __ No
  2. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under the oppressed shareholder statute, Business Corporation Law § 1104-a?  __ Yes  __ No
  3. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under common law?  __ Yes  __ No
  4. Can a 50% shareholder of Company A, who also is a director of Company B in which Company A holds a majority interest, petition for judicial dissolution of Company B under common law?  __ Yes  __ No

Let’s see how you did. If you answered “Yes” to #1, you’re right. But that was easy. Without even looking at the statute, BCL § 1104, logic tells you that a shareholder who possesses half the available voting power — that is, not enough to secure majority approval for shareholder or board action but enough to block the other 50% shareholder from doing the same — should be able to seek dissolution where deadlock results from disagreement with the other 50% shareholder. Continue Reading Take the 50% Shareholder/Dissolution Pop Quiz!

The rules of standing to seek judicial dissolution of closely held New York business corporations can be confusing. Correction: they are confusing.

Here I’m not referring to disputes over whether someone is a shareholder at all, or holds a specific percentage. I’ve posted many an article on this blog about dissolution cases in which the petitioner’s stock ownership was challenged for lack of documentation and/or as inconsistent with the entity’s organic instruments, tax returns and other business records.

Rather, I’m referring to the statutory criteria for standing and the judicial application of those criteria to situations in which a challenge is raised concerning whether a particular, otherwise-uncontested ownership interest confers eligible holder status as to the entity whose dissolution is sought.

Let’s start with the statutes.

Section 1104 of the Business Corporation Law.  This statute authorizes a petition for judicial dissolution based on director or shareholder deadlock and internal dissension brought by “the holders of shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors.” Note that the statute requires the petitioner to own voting shares, and that it specifies a 50% voting interest — no more, no less. Continue Reading Understanding Standing in Corporate Dissolution Cases

Minority Shareholder alleging oppressive acts by Majority Shareholder sues for judicial dissolution of ABC Co. under § 1104-a of the Business Corporation Law. Majority Shareholder elects to purchase Minority Shareholder’s shares under BCL § 1118, thereby converting the case to a valuation proceeding. After numerous adjournments, Minority Shareholder discharges his counsel and fails to appear at court conferences. The court marks the proceeding “off calendar” without prejudice to restore it by motion. Minority Shareholder never moves to restore. The buy-out never takes place.

Several years later, during which Minority Shareholder has had no involvement in ABC Co.’s business, up pops a new lawsuit by Minority Shareholder, not for dissolution but, rather, asserting individual and derivative claims against Majority Shareholder for taking excessive compensation and seeking damages for breach of shareholders’ agreement and to recover Minority Shareholders’ ongoing percentage of profits. Majority Shareholder opposes the new lawsuit, contending that Minority Shareholder ceased being a shareholder of ABC Co. upon the Majority Shareholder’s election to purchase years earlier in the dissolution case, and that Minority Shareholder’s sole remedy is to pursue the buy-out in that prior proceeding.

Is Minority Shareholder still a shareholder of ABC Co. with the right to assert shareholder claims in the new action, or is he limited to a buy-out remedy in the prior dissolution proceeding? Should the court grant Majority Shareholder’s dismissal motion based on the pendency of the prior dissolution proceeding? Continue Reading Buy-Out Interruptus: Court Okays New Suit Five Years After Unconsummated Election to Purchase in Prior Dissolution Case

They say this summer has been unusually cool in the Northeast, but it’s been a hot one for business divorce litigation, judging from the number of recent court decisions involving various and sundry disputes among co-owners of closely held businesses. So, once again, it’s time for my annual summertime post featuring a few, short summaries of recent decisions of interest in business divorce cases.

First, we’ll look at a decision by Justice Melvin Schweitzer in a battle between 50/50 ownership factions over control of an international translation services company with over 3,000 employees. Next up is Justice Carolyn Demarest’s ruling denying a change of venue in a corporate dissolution case. Last is a decision by Justice Marcy Friedman in which she addressed an interesting statute of limitations defense in a drawn-out dissolution case.

Shareholder of Parent Corporation Has Standing to Sue Derivatively to Remove Subsidiary’s Director But Not for Dissolution

Elting v Shawe, 2014 NY Slip Op 32126(U) [Sup Ct, NY County July 24, 2014]. It’s not everyday you encounter business divorce litigation on the scale of this case, involving a firm with over 3,000 employees and revenues over $350 million. The subject company is a closely held Delaware holding corporation owned 50/50 by two individuals who also comprise its two-director board, and its wholly owned New York subsidiary providing international translation services. One owner-director sued the other for alleged financial and management abuses, asserting direct and derivative claims seeking the defendant’s removal as an officer and director of the subsidiary under BCL §§ 706 (d) and 716 (c), and also seeking deadlock dissolution of the subsidiary under BCL § 1104 (a). Continue Reading Summer Shorts: Director Removal and Other Recent Decisions of Interest

 

Thirty years ago, in Matter of Kemp & Beatley, Inc., New York’s highest court defined minority shareholder oppression as “majority conduct [that] substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decision to join the venture.” For example, the court wrote,

A shareholder who reasonably expected that ownership in the corporation would entitle him or her to a job, a share of corporate earnings, a place in corporate management, or some other form of security, would be oppressed in a very real sense when others in the corporation seek to defeat those expectations and there exists no effective means of salvaging the investment. [64 NY2d 63, 73]

One of the rarer applications of the reasonable-expectations test in corporate dissolution proceedings occurs when the controlling shareholder denies outright the petitioner’s status as a shareholder. The few such reported cases usually feature corporations that never followed corporate formalities, never issued stock certificates, and have no written shareholders’ agreement. The Pappas case, about which I wrote here and here, is a good example of a case in which the respondent’s repudiation of the petitioner’s stock interest was the primary factor supporting the court’s finding of oppressive conduct. As the court in Pappas wrote, it is “difficult to recognize a more reasonable shareholder expectation than that its interest will not be repudiated in its entirety, and that legal action would be required to compel its acknowledgment.”

The complaining shareholders in Pappas had been employed by, and actively involved in the management of, the subject businesses, hence they offered a multi-faceted picture of oppressive conduct by the controller. But what about a putative minority shareholder who has no involvement in the business other than as a passive investor or donee of shares? Such a shareholder cannot allege loss of employment or exclusion from a role in managing the corporation’s affairs. Is the controller’s denial of the petitioner’s shareholder status, by itself, enough to establish oppressive conduct under Kemp‘s reasonable-expectations standard?  Continue Reading Is Denial of Shareholder Status Shareholder Oppression?

In Laurel Hill Advisory Group, LLC v American Stock Transfer & Trust Co., 2013 NY Slip Op 08351 [1st Dept Dec. 12, 2013], a Manhattan appellate panel recently reinstated a claim to enforce an alleged oral LLC agreement, among other provisions, granting the appellant a 10% membership interest. The decision turned on the lower court’s conclusion, with which the appellate panel disagreed, that the appellant had conceded the existence of a written operating agreement both that pre-dated the alleged oral LLC agreement and excluded him as a member.

The court’s brief decision aroused my curiosity, mostly because it didn’t mention the LLC’s state of formation which matters greatly because in some states, including New York, the LLC statutes mandate a written operating agreement. Nor did the opinion cite any case law on the point, from New York or elsewhere, that might have given it away.

Sure enough, when I checked the lower court’s decision (read here), I saw that the LLC in question, a New York based corporate governance/proxy solicitation firm known as Laurel Hill Advisory Group, is a Delaware LLC. Section 18-101(7) of the Delaware LLC Act defines an LLC agreement as “any agreement . . . written, oral or implied, of the member or members as to the affairs of a limited liability company and the conduct of its business.” Indeed, Delaware recently strengthened its policy protective of oral LLC agreements by amending § 18-101(7) to specify that such agreements are not subject to any statute of frauds, thereby legislatively overruling the Delaware Supreme Court’s 2009 ruling in Olson v Halvorsen. Continue Reading The Oral LLC Agreement: Boon or Bane?