Three shareholders co-own an 8-year old internet-based “marketeer” business that imports Chinese-manufactured sinks, faucets, and related plumbing fixtures that it sells primarily to distributors and retailers in the United States. They successfully apply with a bank for an increased credit facility up to $10 million. The loan application includes monthly cash flow projections prepared by the company’s CFO forecasting over 40% increase in sales the following fiscal year. The owners also submit their personal net worth statements valuing the company around $30 million.

The executed loan agreement includes borrower representations that the cash flow projections have a “reasonable basis.” The personal financial statements include signed certifications that the statements “are true and give a correct showing of my financial condition” and that the statements are submitted to “induce” the bank to extend credit and knowing that the bank “will rely upon the accuracy of all information and representations contained in this financial statement.” Applicable federal law criminalizes the knowing submission of false information to the bank to obtain a loan.

Three months later, one of the owners claiming shareholder oppression petitions for judicial dissolution. The other owners exercise their statutory right to purchase the petitioner’s 24% interest for “fair value.” By statute, the valuation date is the day before the filing of the petition, i.e., also about three months after the cash flow projections and personal financial statements were prepared and submitted to the bank.

At trial, the petitioner trumpets the respondents’ $30 million company valuation on their net worth statements given to the bank and the bank’s reliance thereon. Petitioner’s valuation expert, building on the management projections supplied to the bank, values the company around — you guessed it — $30 million giving 50/50 weight to his discounted cash flow (DCF) income approach (approximately $21.4 million) and his guideline public company market approach (approximately $38.8 million).

The court in its post-trial decision values the company around $6 million or 20% of the value concluded by the petitioner’s expert. Where did the other $24 million go? Read on and find out. Continue Reading $30 Million Appraisal of Plumbing Fixtures “Marketeer” Goes Down the Drain at Fair Value Hearing

I’m very excited to announce my latest podcast interview featuring Donald J. Weidner, Dean Emeritus of the Florida State University College of Law. But first . . .

LLC statutes include default rules that govern the firm’s internal affairs unless provided otherwise by an operating agreement adopted by the members. When the members lack an operating agreement, the LLC statute’s default rules are the operating agreement.

If you compare most LLC statutes today with the ones initially enacted in the ‘80s and ‘90s, albeit with some variation among the states, you’ll find a major shift away from member liquidity rights. Members generally no longer have a default right to withdraw and be bought out. Default rules for the non-judicial dissolution and winding up of LLCs were changed from those akin to an at-will partnership to those emulating the corporation’s perpetual existence. Access to judicial remedies became harder by importation from corporate law of the direct versus derivative distinction.

None of this sits well with Dean Weidner, widely recognized as one of the country’s leading experts on partnerships, limited liability companies and fiduciary duties. In addition to serving as Dean of FSU’s College of Law for almost 25 years, and where he continues to teach business law as the Alumni Centennial Professor, Dean Weidner was the Reporter for the Revised Uniform Partnership Act (1994) and is co-author of a leading treatise on RUPA published by Thomson Reuters. Dean Weidner also maintains a private practice as a mediator and arbitrator with the Florida law firm Upchurch Watson White & Max.

I first encountered Dean Weidner at last year’s LLC Institute meeting in Tampa where he gave the keynote address. His talk presented a critical analysis of the scaling back of LLC member liquidity rights and, in general, of the “corporate-ization” of LLCs contrary to what he terms the “presumptive intention” of the “target group” for LLC default rules, namely, small groups of entrepreneurs who form businesses without the benefit of counsel.

Dean Weidner’s address became the basis for his forthcoming article in the ABA’s quarterly journal, The Business Lawyer, entitled LLC Default Rules Are Hazardous to Member Liquidity, the full text of which can be downloaded at the SSRN website.

I was very pleased and grateful when Dean Weidner agreed to be interviewed for my Business Divorce Roundtable podcast, which you can enjoy by clicking on the below link. LLC member illiquidity, i.e., the inability of a non-controlling member to exit and realize the value of his or her interest, is a root cause of many of the disputes that end up in the hands of business divorce lawyers. It’s also a subject Dean Weidner discusses with great authority, insight, and passion.

The ongoing coronavirus / COVID-19 pandemic has quite literally impacted everyone and everything in New York, including the courts, which were forced to temporarily cease non-essential functions. The result was a short-lived interruption in new business divorce decisions. But we are happy to see decisions of interest to this blog’s readers issuing once again, including a brand new opinion from Manhattan Commercial Division Justice Jennifer G. Schecter involving an attempted dissolution of a business in one of the most heavily impacted sectors of the economy: the health club space.

Justice Schechter’s opinion in Warner v Heath, Decision and Order, Index No. 654714/2018 [Sup Ct NY County May 1, 2020], has plenty of interest to business divorce aficionados:

  • thoughtful legal analysis on (i) the law of LLC dissolution, (ii) the direct versus derivative nature of LLC-member fiduciary duties where a potential sale of the business is involved, and (iii) the availability of punitive damages in business divorce cases
  • highly-quotable passages that courts and litigants may find helpful
  • some tantalizing remarks suggesting that the pandemic’s devastating economic impact on businesses may have implications for future LLC dissolution claims

There’s a lot to unpack from Warner. Let’s get started. Continue Reading Will the Pandemic Be a Boon for Future LLC Dissolution Claimants?

If you read most any operating agreement for a manager-managed LLC, chances are you’ll find somewhere in it a grant of decision-making authority in the manager’s “sole and absolute discretion” or verbiage to similar effect. Sometimes the grant of authority is cast generally; sometimes it’s limited to specified actions.

Giving each of the words their ordinary dictionary meaning, the phrase “sole and absolute discretion” sounds, well, pretty darn sole, absolute, and discretionary. No room for disagreement or legal challenge by the non-managing members, right?

In many if not most instances, that would be correct. But not all. So when is “sole and absolute discretion” not the final word on manager decision-making?

According to a recent decision by the Manhattan-based Appellate Division, First Department, in Shatz v Chertok, __ AD3d __, 2020 NY Slip Op 01383 [1st Dept Feb. 27, 2020], a “sole and absolute discretion” clause in the operating agreement does not by itself defeat a claim by a non-managing member for breach of fiduciary duty when the managing member allegedly exercises its discretion “in bad faith so as to deprive the other party of the benefit of the bargain.” Continue Reading When an LLC Manager’s “Sole and Absolute Discretion” is Neither Sole Nor Absolute

Two of my pet topics — dysfunctional buy-sell agreements and application of federal court abstention doctrine in private company disputes — intersect in a decision issued last month in Ray v Raj Bedi Revocable Trust, Case No. 3:19-CV-711 DRL-MGG [N.D. IN. Mar. 11, 2020].

The District Court’s opinion tells the story of peripatetic litigation over the implementation of the buy-sell agreements’ poorly conceived appraisal provisions that, like Gilbert and Sullivan’s wandering minstrel, “tuned its supple song” as the case journeyed from Michigan state court across the border to Indiana state court and then Indiana federal court. The shame of it is, after logging all that mileage, the underlying dispute remains unresolved and likely headed back to Michigan state court. Perhaps the greater shame of it is that the agreements mandated appraisals and arbitration to resolve any disputes over pricing the buyouts.

The case arose following the death of one of two 50% owners of two realty-holding Indiana corporations named C.F.B., Inc. (“CFB”) and C.F.B. Real Estate Corp. (“CFBRE”). The owners had executed buy-sell agreements for the shares in each corporation, giving the surviving owner the option to purchase the other’s shares upon his death.

The Buy-Sell Provisions

The two agreements have different provisions governing the process for pricing the shares.

Section 10 (F) of the CFB buy-sell agreement contemplates an annual review of the shares’ value but that “the value be set by arbitration” if no value is stipulated in the same year a trigger event such as death occurs. Initially it contemplates each side appointing an arbitrator and the two arbitrators trying to reach agreement. If they can’t, “they shall appoint a third arbitrator and a decision by the majority as to the value of each share shall be binding upon each of the SHAREHOLDERS.” It further provides that “the arbitrators required hereunder shall be certified public accountants practicing in Indiana or Michigan.” Continue Reading Buy-Sell Agreements Are Supposed to Deter Litigation, Not Foment It

LLC enabling legislation swept the country in the late 1980s through the mid 1990s. By the turn of the century we saw a trickle of litigation working its way through the courts involving disputes among LLC co-owners. A decade later, as the popularity of LLCs blossomed, the trickle became a steady stream. Fast forward to the present, when LLCs have thoroughly upstaged the closely held business corporation as the entity of choice, the stream has become a river.

Within what has become a vast body of case law over the last two decades stemming from LLC internal disputes, I see two fields of member conflict that not only quantitatively occupy large swaths of that body, but also qualitatively distinguish LLC litigation from its counterpart litigation involving disputes among shareholders of close corporations.

One is judicial dissolution. Although the Revised Uniform LLC Act adopted in many states has partially reduced the dissimilarity between grounds for judicial dissolution and available remedies compared to prevailing forms of corporate dissolution statutes, there remains in New York and many other states an unbridgeable, substantive gap between the dissolution standards and remedies in the two statutory schemes. As New York’s leading appellate decision on LLC dissolution opined ten years ago, “since the Legislature, in determining the criteria for dissolution of various business entities in New York, did not cross-reference such grounds from one type of entity to another, it would be inappropriate for this Court to import dissolution grounds from the Business Corporation Law or Partnership Law to the LLCL.”

The other is the validity and effect of membership interest transfers and other dispositions of membership interests. There are few if any statutory default rules constraining lifetime or post-mortem transfer of shares–with all their attendant voting, economic, and other rights–by a shareholder of a close corporation. Any constraints that do exist will be found in the shareholders’ agreement or by-laws and, even then, case precedent holds that any such limitations may not cross mandatory rules in the business corporation law and may not otherwise impose “unreasonable” restraints on alienation. Continue Reading Turmoil Follows Involuntary Transfers of LLC Membership Interests

We’ve written from time to time, including here and here, about the need to allege pre-suit demand or demand futility where a shareholder seeks to sue derivatively on behalf of a corporation for whom the court has appointed a receiver. Pre-receivership, the board of directors is entitled to decide whether to bring a lawsuit on the corporation’s behalf. Under Section 626 (c) of the Business Corporation Law, a shareholder seeking to sue derivatively on behalf of the corporation must allege (i) pre-suit demand upon the board to commence a lawsuit on behalf of the corporation or (ii) that a demand upon the board of directors to commence suit would be “futile.”

Things change when a receiver is appointed. In an order appointing a receiver, the court typically gives to the receiver, and takes from the board, the power to decide whether to commence suit on the corporation’s behalf. In that situation, the putative shareholder derivative plaintiff must allege pre-suit demand or demand futility upon the receiver. The concept is straightforward, but putative derivative plaintiffs often overlook it.

Take, for example, a recent decision by Manhattan Commercial Division Justice Andrea J. Masley in Culligan Soft Water Co. v Clayton Dubilier & Rice, LLC, 2020 NY Slip Op 30828(U) [Sup Ct, NY County Mar. 19, 2020]. Culligan did not involve a closely-held business, but it did contain a particularly useful explanation of the applicable law in New York on the subject of alleging pre-suit demand upon a court-appointed receiver, or in that case, “liquidator,” including the subject of a pre-suit demand relating back to a prior-filed pleading. Continue Reading The Pre-Suit Demand Requirement for a Corporation in Liquidation or Receivership

The proverb “All for the want of a horseshoe nail” aptly describes the possibly mortal blow dealt by the Appellate Division’s recent decision in Favourite Ltd. v Cico, 2020 NY Slip Op 01463 [1st Dept Mar. 3, 2020], to a lawsuit initiated by non-managing members of a manager-managed Delaware LLC whose certificate of formation was cancelled for the ministerial failure to designate a new registered agent within 30 days after its old one resigned.

Favourite involves the alleged mismanagement of a Delaware LLC by its former managing members in connection with the financing, operation, and sale of a Manhattan residential apartment building acquired by the LLC to provide short-term rentals for international leisure and corporate travelers. The business was decimated in 2012 by anti-Airbnb legislation, leading to a mortgage default, foreclosure action, and distress sale. The managers used the net sale proceeds as a down payment made by a newly formed LLC to purchase another building, but the purchase never materialized.

In 2015, non-managing members holding more than 50% of the membership interests, as permitted by the operating agreement, voted to remove the managers and then brought suit against them. The suit initially named the LLC (along with some of the non-managing members) as plaintiff but it was dropped in the first amended complaint after losing its legal representation. Continue Reading Unauthorized Certificate of Revival Dooms Delaware LLC’s Claims Against Former Managing Members

The Comic Strip is the oldest stand-up comedy showcase club in New York City. Its co-founders Robert Wachs and Richard Tienken opened the club in 1975 on Manhattan’s Upper East Side. Over the last 45 years a veritable who’s who of the comedy world has performed on its stage, including George Carlin, Eddie Murphy, Richard Pryor, Chris Rock, Jerry Seinfeld, Robin Williams, and the list goes on.

Off stage, however, things are not so funny.

In the wake of co-founder Robert Wachs’ death in 2013, litigation broke out over the club’s finances and management between Tienken and Wachs’ widow, Tess Wachs, who succeeded to her husband’s 50% ownership of the corporation, Comic Strip Promotions, Inc. Over a four-year span, a half dozen or so legal proceedings have bounced back and forth between arbitration and court, much of which is omitted in the following description. Continue Reading No Laughing Matter: Deadlock Dissolution Petition Targets Legendary NYC Comedy Club

I’m always disappointed by appellate opinions that decide novel or unsettled issues in business divorce cases with little or no analysis. It seems like a lost opportunity to provide guidance in future cases. The Appellate Division, Second Department’s opinion last week in PFT Technology, LLC v Wieser, 2020 NY Slip Op 01942 [2d Dept Mar. 18, 2020], is one of those.

PFT is a case I’ve previously featured on this blog three times over it’s eight-year life span, addressing Nassau County Commercial Division Justice Stephen A. Bucaria’s novel rulings in an LLC dissolution case:

  • ordering the LLC to advance all parties’ legal fees to “level the playing field” (read here);
  • fixing the valuation date for a buyout of the defendant 25% member’s interest on the day before the LLC filed suit in July 2012 (read here); and
  • rejecting the LLC’s subsequent request to withdraw its dissolution claim in connection with its unsuccessful bid to enjoin the minority member from operating a competing business (read here).

The trial of the case yielded rulings on a number of important issues concerning fair value appraisals generally, one of which was the subject of my recent article entitled Post-Valuation Date Distributions: Should They Be Credited Against Fair Value Awards? The article summarized the few and arguably conflicting lower court cases addressing whether an award to the exiting shareholder of his or her pro rata share of post-valuation date distributions made during the proceeding’s pendency, i.e., prior to consummation of the buyout, constitutes “double dipping.”

Having already written extensively on the case background and the court’s pretrial rulings in my prior posts, I won’t do it again here. If you’re not inclined to read the prior posts, what you need to know is:

  • The subject LLC, in the business of detecting gas and fluid leaks in power networks for public utilities, had four 25% members.
  • In 2011, either three of the members froze out the fourth or the fourth “abandoned” the business, depending which side’s story you accept.
  • In 2012, the three members brought suit in the name and right of the LLC asserting claims against the fourth and also seeking the LLC’s dissolution or “reconstitution” without the fourth.
  • The fourth counter-sued for a buyout of his 25% interest.
  • Notwithstanding the absence of any buyout authorization in the LLC Law’s provisions governing judicial dissolution, the court ordered a fair value appraisal and “equitable” buyout of the fourth’s interest, apparently without objection by the other three members.

One other tidbit for those who don’t read the prior posts: If you’re wondering why the LLC’s three members holding an aggregate 75% membership interest had to seek judicial dissolution as opposed to dissolving voluntarily, the answer lies in the LLC’s operating agreement which required a super-majority in excess of 75%, i.e., unanimity, to dissolve voluntarily. Continue Reading No Double Dipping! Court Denies Post-Valuation Date Distributions in Equitable Buyout of LLC Member