Winning the Dissolution Battle, Losing the War
Most business divorce litigation involving closely held companies results either in a buyout of one party by the other, or the two sides dividing the remaining assets and going their separate ways.
The biggest problem getting to the buyout is the absence of a public market to establish the value of the interest being acquired, particularly when dealing with a non-controlling interest in a sales or services-based operating company. The buyer and seller, even when advised by qualified business appraisers, can be light years apart on price due to different assumptions about a host of valuation inputs some of which necessarily require subjective analysis.
Splitting up the business can be very easy or very difficult, depending on the specifics of the business. It tends to be more difficult when there is value associated with the defunct company's name or other such intangible good will value at the enterprise level (as opposed to personal good will that follows the individual business partner wherever he or she goes).
Litigation means time, expense and uncertainty, all of which can jeopardize the potential benefits of an eventual buyout or business split-up. It is difficult for the controlling owner to invest and make business plans while under the cloud of a prospective buyout of uncertain magnitude. The risks can be even greater in a split-up scenario for business partners who, perhaps as a matter of business survival, begin taking unilateral and sometimes surreptitious steps at odds with each other, designed to retain for themselves the loyalty and business of key customers and vendors.
These ruminations, and the title of this post, are inspired by recent decisions in two cases in which business partners remain locked in protracted and undoubtedly expensive litigation even after one side's initial attempt to achieve judicial dissolution became moot.
The first decision is Mouhlas Realty, LLC v. Koutelos, 2009 NY Slip Op 30893(U) (Sup Ct Queens County Apr. 7, 2009). If the party names sound familiar, that's because I highlighted a prior decision in this LLC dissolution case in a post last year (read here). In the prior decision, Queens County Supreme Court Justice Patricia Satterfield held that the petitioner, who owned a minority membership interest in the LLC, failed to establish grounds for judicial dissolution under LLC Law Section 702, and also held that the controlling members had no right to compel an "equitable" buyout of the petitioner's interest -- thereby leaving the litigants locked in a relationship neither wants. The decision also left unresolved a series of counterclaims brought by the controlling members against the petitioner, including one seeking imposition of a judicial lien on her membership interest on account of an unsatisfied demand for capital contribution.
Justice Satterfield's recent decision addresses the controlling members' motion for summary judgment on those unresolved claims. The controlling members argued, based on the "law of the case" doctrine, that the court's prior rejection of the minority member's grounds for dissolution, including her objection to a mandatory capital contribution, entitled them to judgment against her for specific performance enforcing the capital contribution requirement and imposing a lien. Justice Satterfield disagreed, stating that her prior decision did not determine the propriety of the capital call, only that there was no statutory prohibition against it, and that the petitioner failed to show that the LLC is unable to function in accordance with its operating agreement or that the business is failing financially.
So here it is, over a year after the minority member sued for dissolution, and even though the issue of dissolution has been taken out of the case, the parties seemingly are not one step closer to resolving their broken relationship. Have the parties been discussing a buyout? I don't know, I can only assume that they have and, if so, that the demand and offer are too far apart due to different views of the business value and/or the impact on price of the capital call.
The second case is Stack v. O'Higgins, 2009 NY Slip Op 30874(U) (Sup Ct NY County Apr. 2, 2009), decided by the newest member of the Commercial Division of the New York County Supreme Court, Justice Shirley Werner Kornreich. The plaintiff, Lawrence Stack, and the defendant, Michael O'Higgins, are 50-50 members of an LLC called Stack's Sales East Coast LLC ("SSEC") which buys and sells rare coins, medals, paper currency and other numismatic items. In September 2006, Stack brought an action for judicial dissolution of SSEC due to disagreement regarding the proposed transfer of Stack's membership interest. It appears from the court's docket that the case got bogged down in discovery for the next year and a half. Again, I don't know if any buyout negotiations took place in the interim.
What we do know from the court's decision is that in May 2008, Stack changed course by sending O'Higgins a written notice purporting to exercise his right under the operating agreement to cancel SSEC's license to use the word "Stack" in its company name or otherwise. The relevant section of the operating agreement expressly conditioned the license termination on Stack's withdrawal from SSEC or SSEC's dissolution, so O'Higgins responded with a letter demanding confirmation of Stack's withdrawal, which Stack gave by written notice in September 2008. Soon thereafter, O'Higgins filed a certificate of amendment changing SSEC's name to "Steib's Sales East Coast LLC."
Did Stack's withdrawal from SSEC, which effectively mooted his claim for dissolution, end the hostilities? Not by a long shot. Even after the formal withdrawal, O'Higgins apparently continued to use Stack's name to market and advertise his business, as evidenced by certain trade journal ads and online directories. This prompted Stack to file a motion to amend his complaint to add claims for breach of contract, a declaratory judgment and a permanent injunction. O'Higgins opposed the motion on the grounds that Stack's withdrawal from SSEC mooted the entire action and that, in any event, his company's official change of name met any obligation under the operating agreement to cease using Stack's name. Justice Kornreich rejected O'Higgins' contentions and, for the most part, granted Stack leave to amend his complaint.
Stack, as Stack's Rare Coins, and O'Higgins, as Steib's Sales East Coast, are now business competitors fighting each other for customers, sources and for the good will they spent years developing jointly. Dissolution is out of the picture. Yet they are still locked in a three-year old litigation that drains their financial resources, places in the public record matters that most business owners prefer to keep private, and distracts from time better spent building their business.
In both of these cases, Koutelos and Stack, the defendants avoided dissolution and were able to carry onward in control of the business. In that narrow sense they won the dissolution battle. But in both cases the war goes on to an uncertain end as they continue to litigate their unresolved business and financial differences.
Spouses Holding Shares as Joint Tenants Must Jointly Petition for Corporate Dissolution
When husband and wife hold shares as joint tenants with right of survivorship, can one of them seek corporate dissolution without joining the other?
The answer is "no," according to a recent decision by Queens County Supreme Court Justice Patricia P. Satterfield in Matter of Mouzakitis (Pearl Nightlife, Inc.) (read decision here).
Petitioner Marianthi Mouzakitis and her husband, Leonidas, own 15% of the common shares of Pearl Nightlife, Inc. as tenants by the entirety. The corporation operates a restaurant in Bayside, New York, that opened in March 2008. The Mouzakitises contributed $125,000 for their interest. Ms. Mouzakitis alleged that the controlling shareholders failed to make required contributions, failed to pay salaries and dividends, withheld access to corporate books and records, and diverted corporate funds and assets including liquor and food allegedly diverted to other restaurants separately owned by the corporation's president. In May 2008, the other shareholders allegedly had the petitioner arrested at the restaurant.
As a 15% shareholder, Ms. Mouzakitis lacked standing to seek judicial dissolution under Sections 1104 (deadlock - 50%) or 1104-a (oppression - 20% minimum) of the Business Corporation Law. She therefore petitioned for common law dissolution of the corporation which, as framed by the New York Court of Appeals in Leibert v. Clapp, 13 NY2d 313 (1963), can be sought by any minority shareholder where the majority shareholders "so palpably breached their fiduciary duties they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by the statute."
The respondents contended that the petitioner could not bring the action without her husband since they owned the shares as tenants by the entirety, a form of ownership whereby each spouse holds an undivided interest in the whole of the property with rights of survivorship. Respondents relied on Rust v. Turgeon, 295 AD2d 962 (4th Dept 2002), where the court dismissed a deadlock dissolution claim for lack of standing under BCL Section 1104. The petitioner in Rust alleged that he and a second shareholder owned 100% of the corporation's shares as joint tenants with right of survivorship. The court ruled that if Rust
were determined to be a joint tenant of all of the shares, his interest would be an undivided interest in all of the shares, and he could not be deemed a holder of one half of the shares as required by[BCL] 1104(a).
In opposition, Ms. Mouzakitis relied on case law permitting one cotenant to enforce and preserve jointly held property rights. Her attorney also advised the court that he spoke by phone with the husband, Leonidas, who was in Greece, and that the husband "agreed to this action to enforce the parties' rights."
Justice Satterfield agreed with the respondents and denied the petition without prejudice to renewal, stating that the petitioner, "if she is so advised, may remove the unnecessary obstruction to her case which has appeared at its early stage by having her husband join a new proceeding."
I confess, I'm a little puzzled by the disposition in light of the fact that, according to the docket information available online, the caption of the proceeding names both husband and wife as petitioners. Under rules of New York practice, when there are multiple petitioners united in interest, only one of them need verify the petition (CPLR 3020(d); BCL 1105). I can only speculate that something in the record indicated to the court that the husband never authorized counsel to name him as a petitioner.
I also wonder if the necessary-party doctrine isn't the better analysis of the problem in Mouzakitis. In Rust, the petitioner lacked standing to proceed under BCL 1104 because, as a joint owner with the respondent of 100% of the corporation's shares, he could not under any circumstances satisfy the statute's requirement of a 50% stock interest. The common law dissolution sought in Mouzakitis has no standing requirement other than being a shareholder, which Ms. Mouzakitis certainly is. Given her husband's joint, undivided interest in the shares and his right of survivorship, he should be deemed a necessary party under CPLR 1001(a) whose joinder likely cannot be excused given that a judgment of dissolution would terminate his interest in the shares.
Update: After husband and wife jointly filed a new dissolution proceeding, in a February 2009 decision Justice Kitzes denied the respondents' motion to dismiss the case. Read about it here.
A Case of Mutual Frustration: Minority Member of LLC Can't Compel Dissolution, Majority Can't Compel Buyout
It's the perfect LLC storm: Accusations by the minority member of overreaching and breach of fiduciary duty by the controlling members, no operating agreement, and an LLC statute that affords neither party a judicial means of achieving the separation they each want.
The case, Matter of Koutelos (Mouhlas Realty, LLC), was decided last month by Queens County Supreme Court Justice Patricia P. Satterfield (read decision here). The petitioner, Mary Koutelos, holds approximately 15% membership interest in Mouhlas Realty, LLC which was formed in 2000 as a member-managed LLC. The decision doesn't describe the LLC's business or tell us if Koutelos is actively involved in running it. All we can glean is that Koutelos filed a petition under LLC Law Section 702 for judicial dissolution of the LLC based on allegations of overreaching and breach of fiduciary duty by two of the other three members, apparently involving a capital call and/or loan to be used for compensation of one or more member-managers; the members have no operating agreement; and the other members refused Koutelos's request to adjourn a meeting.
The decision also tells us that the "respondent" -- we don't find out if this refers to the LLC or one of the other members individually -- filed an answer with a counterclaim for an "equitable buyout" conditioned on the court applying a 30% discount for lack of marketability in valuing the petitioner's interest.
Addressing Koutelos's dissolution claim first, Justice Satterfield notes that, in typical fashion, the LLC's articles of organization "contain no provision relating to the operation of the business other than the paragraph stating that the limited liability company is to be managed by 1 or more members." In the absence of an operating agreement, Koutelos must demonstrate that the LLC cannot function in accordance with the LLC Law's default provisions. (For more on dissolution and the "statutory operating agreement," see Matter of Spires (Lighthouse Solutions, LLC), 4 Misc3d 428 (Sup Ct Monroe County 2004).)
Koutelos is unable to convince the court of the LLC's impairment. First, the management scheme to which she objected -- I'm guessing that the other members reduced or eliminated her duties -- is permissible under LLC Law Section 401 which, absent contrary provision in the articles of organization or operating agreement, vests management in all the members.
Second, in regard to alleged improper compensation, LLC Law Section 411 gives the managers authority to fix the compensation of managers for services in any capacity and, under Section 402(c)(2), a majority in interest of the members may approve incurring indebtedness other than in the ordinary course of business.
Third, while the LLC Law contains no specific provision to compel additional capital contributions, "neither is there statutory prohibition against the practice, and the payment of an additional capital contribution properly voted for by the members has been approved judicially" (citing Van Der Lande v. Stout, 13 AD3d 261 (1st Dept 2004)).
Fourth, the court faults Koutelos for failing to verify personally the petition or to submit her own affidavit in support. The verification of the petition by counsel, who lacks personal knowledge of the facts, does not constitute evidence in admissible form.
Justice Satterfield accordingly holds that the petition does not plead the requisite grounds for dissolution under Section 702 based on the absence of facts showing that the LLC is "unable to function in accordance with its articles of organization or [statutory] operating agreement, or that the business is failing financially."
The court next addresses the counterclaim for equitable buyout. Why "equitable"? Because Article 7 of the LLC Law governing judicial dissolution has no provision for buyout, in contrast to Section 1118 of the Business Corporation Law which gives the respondent shareholders the right to purchase the shares of a minority shareholder who seeks dissolution under BCL Section 1104-a.
The respondent argued that a right to an equitable buyout was recognized in Lyons v. Salamone, 32 AD3d 757 (1st Dept 2006). In Lyons, upon granting the minority member's petition for judicial dissolution of an LLC based on the majority member's financial improprieties, the trial court ordered a "mutual buyout" or closed auction whereby each member would bid for the other's interest. The Appellate Division, First Department, upheld the order over the petitioner's objection that a buyout remedy is not authorized by the LLC Law. (Lyons is discussed in detail in my annual review of business divorce cases of 2006 published in the New York Law Journal, read here.)
In Koutelos, Justice Satterfield rules that, to the extent the counterclaim was asserted only as an alternative to dissolution, it is rendered moot by dismissal of the petition. In any event, according to Justice Satterfield, Lyons did not recognize a right to an equitable buyout. Rather, she concludes, Lyons "merely approved a liquidation method fashioned by the [lower] court in connection with the dissolution and sale of a business."
On top of that, Justice Satterfield continues, "even if respondent did have a right to buy out petitioner's interest, it would not be entitled to condition such buyout on a perceived right to a 30% unmarketability discount in the valuation of the interest."
So there you have it. Ms. Koutelos wants out but has no right to withdraw or dissolve. The other members want her out but have no right to expel her or to compel her to sell her interest. It's easy to say that the parties have only themselves to blame for failing to enter into an operating agreement with buy-sell provisions, but that doesn't solve the problem. What would solve the problem is an amendment to the LLC Law authorizing an election to purchase and a valuation procedure as provided in BCL 1118.
