I was especially drawn to the case I’m about to introduce involving LLC member withdrawal, owing to the Jacobs v Cartalemi case that I litigated to a successful conclusion about two years ago, also involving member withdrawal.

In Jacobs, the court held that a member who withdrew from the LLC as of right under the default statute, where the operating agreement was silent on withdrawal, nonetheless was obligated to comply with the operating agreement’s right of first refusal provision, thereby defeating the member’s statutory demand for payment of the fair value of his shares. The provision by its terms was triggered by a member who “desires to sell his, her or its Membership Interest,” which the court interpreted to encompass a member’s notice of withdrawal and demand for payment.

The Point 128 LLC v Choi, decided earlier this month by Manhattan Commercial Division Justice Andrea Masley, did not involve a formal withdrawal notice and demand for payment of fair value as in Jacobs. Rather, in Choi the question presented was whether attempts to obtain a buyout and the filing of a related lawsuit brought by the LLC’s minority members against the controlling members, sought to circumvent and breach the operating agreement’s anti-withdrawal provisions. Continue Reading A Case of LLC Withdrawal Symptoms

There are countless New York corporations in which the owners are equal 50 / 50 shareholders and co-members of a two-member board. Where one sues the other for judicial dissolution, and the ground for dissolution is “deadlock” and/or “internal dissention”  under Section 1104 of the Business Corporation Law (the “BCL”), does the “resignation” of one director end the impasse, requiring denial or dismissal of the Continue Reading Resignation: Antidote for Internal Dissention and Deadlock?

Not for the first time (see herehere, and here ), I find myself intrigued by the federal courts’ resistance to hearing state law claims for judicial dissolution of business entities where subject matter jurisdiction otherwise exists based on diversity of citizenship.

The doctrinal device employed by federal courts to dismiss dissolution claims (without prejudice to re-filing in state court) is called Burford abstention based on a 1943 Supreme Court case of that name. The doctrine holds that a federal court sitting in diversity jurisdiction should abstain from deciding the case to avoid needless disruption of state efforts to establish coherent policy in an area of “comprehensive state regulation.”

The leading precedent in the Second Circuit U.S. Court of Appeals (which includes federal courts in New York) is Friedman v Revenue Management, Inc., 38 F3d 668 [2d Cir. 1994], where the court applied Burford abstention to dismiss a complaint seeking judicial dissolution of a New York corporation under Section 1104 of the Business Corporation Law based on shareholder deadlock. As Friedman explained:

Under these circumstances, abstention would avoid needless interference with New York’s regulatory scheme governing its corporations. New York has a strong interest in the creation and dissolution of its corporations and in the uniform development and interpretation of the statutory scheme regarding its corporations.

Since Friedman, federal trial courts in New York (and most other federal circuits) uniformly have abstained from adjudicating  statutory dissolution claims.

But what about common-law dissolution claims? Under the leading New York case, Leibert v Clapp, 13 NY2d 313 [1963], common-law dissolution is available where:

the directors and majority shareholders ‘have so palpably breached the fiduciary duty they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by statute.”’

The test for common-law dissolution essentially requires courts to apply fiduciary standards to alleged misconduct by company controllers. Federal courts in diversity and federal question cases routinely hear and decide common-law claims for breach of fiduciary duty. Should fiduciary-based, common-law dissolution claims be treated differently, as part of New York’s “regulatory scheme governing its corporations,” such that Burford abstention applies? Continue Reading Another Door Closes to Federal Court in Judicial Dissolution Cases

As is my custom, I devote a post on this blog to each new episode of my Business Divorce Roundtable podcast. Episode 20, featuring Part Two of my interview of Professor Peter Molk on the topic of LLCs, is now available and can be heard by clicking on the link at the bottom of this post.

If you haven’t already listened to Part One, I highly recommend you do so before listening to Part Two. This link will bring you to last month’s post with a link to Part One, in which I set the stage for the interview focusing on Professor Molk’s recently published law review article entitled Protecting LLC Owners While Preserving LLC Flexibility. In his article, Professor Molk develops the case for bifurcating LLC law depending on LLC owners’ projected sophistication. As he states in an online companion to his article, the proposed bifurcation “accomplishes the incompatible twin goals of giving LLC owners flexibility to set their internal governance rules while protecting relatively unsophisticated owners.”

In Part One of the interview, we mostly discuss the pros and cons of freedom-of-contract versus mandatory rules in what I call the two worlds of LLCs, the one generally involving larger and/or highly capitalized firms with “sophisticated” LLC owners who have bargaining power and access to competent legal and financial advisors, and the other generally involving smaller and/or thinly capitalized firms with “unsophisticated” LLC owners lacking similar expertise and means.

Part Two focuses on the mechanics of Professor Molk’s novel proposal for qualified LLCs. For those interested, his article contains a far more detailed exploration of his proposal while also anticipating and addressing potential criticisms.

Will Professor Molk’s proposal gain traction in any of our state legislatures? I’m not holding my breath, especially as regards the New York legislature which has barely tinkered with the state’s LLC  Law since its adoption 25 years ago while most other states have made major advances including adoption of the Revised Uniform LLC Act.

But even if it doesn’t produce concrete results, Professor Molk’s scholarship in this area of the law brings needed attention to the growing pains of the LLC form which, within the relatively short span of 30 or so years, has risen from obscurity to become the entity of choice across the country.

 

Imagine staging an Oscars-like award ceremony for business divorce cases:

Emcee: And the award for Best Oppressive Conduct Toward a Minority Shareholder in a Family-Owned Business Not Resulting in Dissolution goes to, envelope please, Egbert versus Egbert! [Audience applause] Accepting the award for the majority shareholders is Cruella Egbert.

Ms. Egbert: Thank you, thank you! Wow! What an honor! I just want to give a shoutout to Judge Cataract for not seeing through my argument that cousin Edsel’s reasonable expectations were not defeated when I threw his ass out of the company, cut off his family health insurance, and gave myself a large bonus. If Uncle Ralph and his lawyer are watching this, may you both rot in hell! 

I can’t match the drama, but I’m nonetheless pleased to present my 12th annual list of this past year’s ten most significant business divorce cases.

This year’s list offers a good mix of business entities: six involve disputes among LLC members, two involve law firms organized as limited liability partnerships, one involves an accounting firm organized as a professional corporation, and one involves a regular close corporation. All are trial court decisions save one appellate ruling.

All ten decisions were featured on this blog previously; click on the case name to read the full treatment. And the winners are:

Matter of Straka v Arcara Zucarelli Lenda & Assoc. CPAs P.C., 62 Misc 3d 1064, 2019 NY Slip Op 29017 [Sup Ct Erie County Jan. 9, 2019]. I headlined this case involving an accounting firm as Minority Shareholder Oppression in the #MeToo Era. It’s the first and perhaps only reported judicial dissolution case in which a court upheld a female minority shareholder’s oppression claim based in part on her male co-owners’ toleration of offensive, demeaning, and condescending behavior in the workplace.

Advanced 23, LLC v Chambers House Partners, LLC, 2019 NY Slip Op 30173(U) [Sup Ct NY County Jan. 22, 2019]. In another first, the court in this case effectively upheld a bad-faith petitioner defense in denying a 50% member’s petition to dissolve a realty holding LLC based primarily on the petitioner’s refusal to refinance the building’s mortgage in an effort to force out the other elderly, husband-and-wife 50% members.

Barrison v D’Amato & Lynch, LLP, 2019 NY Slip Op 30905(U) [Sup Ct, NY County Apr. 2, 2019]. This case, involving a damages suit by an expelled “partner” of a law firm who previously sued unsuccessfully for judicial dissolution, hinged on the plaintiff’s primary reliance on tax Form K-1s he received identifying him as a “general partner” in arguing that defendants were estopped from denying his general partner status. The court rejected plaintiff’s position based on lack of any other indicia of being an equity partner including capital investment, agreement to share losses, or control over firm policies and hiring.

Hanley v Hanley, 64 Misc. 3d 1202(A), 2019 NY Slip Op 50970(U) [Sup Ct Albany County June 13, 2019]. This is an unusual judicial dissolution case in which siblings battled over an estimated $50 million to $80 million of proceeds from the sale of the family-owned business. The court denied the respondents’ dismissal motion in which they argued unsuccessfully that their proposed $11 million severance package offered to the petitioner defeated his reasonable expectations as a minority shareholder.

Rosania v Gluck, 2019 NY Slip Op 32087(U) [Sup Ct NY County July 8, 2019]. In this case of first impression, the petitioner initially filed for judicial dissolution of 17 single-asset realty holding companies organized as Delaware LLCs. After respondents moved to dismiss the petition for lack of subject matter jurisdiction — New York appellate rulings uniformly hold that New York courts lack jurisdiction in dissolution cases involving foreign entities — the petitioner amended his petition to seek what he styled as alternative remedies including a forced sale of assets or a forced buy/sell. The court characterized the amended petition as an “ill-disguised attempt” at an “end run” around the jurisdictional proscription and granted respondents’ dismissal motion.

Capizzi v Brown Chiari LLP, 65 Misc 3d 1202(A), 2019 NY Slip Op 51471(U) [Sup Ct, Erie County Sept. 13, 2019]. This is the second case to make the top ten involving a law firm dissolution petition triggered when one of three partners withdrew from the partnership. The two other partners contended that the petitioner was collaterally estopped from claiming to be an equity partner based on his testimony many years earlier in another partnership lawsuit involving the same partners also triggered by another former partner’s withdrawal. The court rejected the collateral estoppel argument and held that the respondents themselves were estopped from denying petitioner’s partner status based on the partnership’s tax returns.

Roy Food and Wine LLC v Meregalli, 2019 NY Slip Op 32875(U) [Sup Ct NY County Sept. 25, 2019]. If you need a reminder that indeterminate membership interests in LLCs can create a mess, this case is it. The bare-bones operating agreement tied each member’s voting percentage to his or her variable capital account, without defining what constitutes a capital contribution. The minority owners, contending that the founding majority member never made the $600,000 cash contribution he claimed, sued to enforce their newly claimed majority vote removing the founder as managing member. The founder claimed his capital account included non-cash contributions preserving his majority voting rights. The result? Summary judgment denied.

Sternlicht v Daniel Z. Rapoport Associates, L.P., 2019 NY Slip Op 08141 [1st Dept Nov. 12, 2019]. Talk about too little too late. The operating agreement for the realty holding LLC in this case defined the death of a member as an automatic dissolution trigger unless the remaining members vote within 180 days to continue the business. A member died. No vote was taken within 180 days. Two members sued to enforce dissolution. Did it work? Not a chance. The member died 11 years earlier at which time his full membership interest passed to his heirs as authorized under the LLC agreement.

Rubin v Baumann, 2019 NY Slip Op 08011 [1st Dept Nov. 7, 2019]. This case in its first trip to the appellate court, centering on a failed attempt to enforce buy-sell provisions in an operating agreement of a realty holding LLC, stands as a reminder of the need for strict compliance with the agreement’s notice requirements. The plaintiff fared better in a second trip to the appellate court when it ruled that the operating agreement required his consent as 50% member to the retention of the other 50% member’s separate company as property manager.

Acela Investments v DiFalco, C.A. No. 2018-0558-AGB, 2019 WL 2158063 [Del Ch May 17, 2019]. Can a deadlock resolution provision in an LLC agreement itself be the cause of deadlock? It can and was in this case in which the Delaware Chancery Court ordered dissolution of a start-up pharmaceutical company. The problem was, the deadlock provision didn’t define what constituted a conflict of interest for purposes of bringing in an independent person to cast the deadlock breaking vote, nor did it specify who determines the existence of a conflict of interest.

In litigation, the term “spoliation” generally refers to loss or destruction of evidence. Spoliation can involve physical evidence, paper documents, or electronic data. Spoliation can be intentional or unintentional. Intentional or not, spoliation can result in harsh consequences.

Here at New York Business Divorce, we have never given full treatment to a business divorce decision involving the subject of spoliation, although our colleague, Kathryn Cole, often writes about spoliation at our sister blog, All About eDiscovery. You can read examples of her work on the subject here and here. As noted in those posts, spoliation is an ever-present danger in the highly-technical world of electronic discovery, where sanction orders based on spoliation are common, especially in Federal Court.

In business divorce litigation, decisions involving evidence spoliation are far less common, which is why a recent decision by an Albany appeals court caught our eye. In Soghanalian v Young, 176 AD3d 1422 [3d Dept Oct. 24, 2019], the missing evidence was not a mundane document or an email, but a rare antique automobile, a Mercedes 300 SL, zoomorphically known as the “Gull Wing.” Continue Reading Gull Wing Takes Flight, Pleading Gets Stricken

After three decades during which it rose from obscurity to become the entity of choice, the limited liability company remains an experiment in progress.

This is especially true when it comes to the internal relations of LLC members and managers, caught in the cross currents of the LLC’s freedom-of-contract foundation, oftentimes fuzzy statutory default rules, and the courts’ resort to traditional powers of equity to resolve the particular disputes that come before them.

In my experience advising LLC owners, litigating their disputes with co-owners, and keeping up with legislative and case law developments nationwide, I see two very different worlds of LLCs.

In the one are highly capitalized enterprises, usually manager-managed with any number of sophisticated non-managing members/investors, all of whom are represented by or have access to competent legal and financial advisors. For these LLCs, optimal efficiencies and allocation of capital can be achieved via negotiated operating agreements without need of mandatory statutory rules and judicial intervention on the side of equity.

In the other world are more thinly capitalized (at least at the start) owner operated and managed LLCs populated by relatively unsophisticated members, by which I mean without knowledge of the rules governing business organizations (or even know what an LLC is), without bargaining power, and without access to, or financial ability and motivation to hire, competent legal and financial advisors. Often these LLCs have no operating agreement, or a cookie-cutter agreement purchased online or prepared by an attorney without deep knowledge of LLC law. Many also involve family-owned businesses. For these LLCs, the argument is stronger for certain mandatory protections against opportunistic behavior by fellow members.

Which brings me to my latest podcast guest, Peter Molk, an Associate Professor of Law at the University of Florida Levin College of Law, who has established himself as one of the foremost thinkers in the field of LLC law. Longtime readers of this blog may recall a podcast interview I did with Professor Molk in 2016 concerning his groundbreaking study of how LLC owners contract around default statutory protections.

I reached out again to Professor Molk after reading his latest article on LLCs published in the U.C. Davis Law Review, entitled Protecting LLC Owners While Preserving LLC Flexibility. In his article, Professor Molk draws a line resonant with my “two worlds of LLCs” by proposing an accredited investor qualification borrowed from securities law to separate sophisticated and unsophisticated LLC owners, subjecting only the latter to a set of mandatory statutory protections. From the article’s abstract:

LLC statutes allow owners to restrict or completely waive standard governance protections required of other business forms. Corporate law mandatory stalwarts like fiduciary duties can be entirely eliminated in an LLC. This flexible approach has the potential to generate the most efficient governance relationships: tailored negotiation among LLC investors can produce an optimal set of governance terms that corporate law’s mandatory protections cannot. Yet when owners lack sophistication or bargaining power, contractual freedom allows for opportunistic terms that misprice capital, reduce investment, and inefficiently allocate capital across LLCs.

A series of cases involving opportunistic conduct have brought this problem to the fore. Recommendations for reform have focused on doing nothing, imposing mandatory protections, or relying on ad-hoc judicial interventions, but these solutions are each ultimately unsatisfying. I ultimately show how a model inspired by securities law’s accredited investor concept has the most promise to ensure LLCs’ continued viability as a distinct organizational form, with favorable liability and tax treatment to everyday investors and the freedom to craft unique governance relationships for sophisticated ones.

The article can be downloaded on SSRN here.

I had the pleasure of interviewing Professor Molk once again for the Business Divorce Roundtable podcast. In Part One of a two-part podcast, which you can hear by clicking on the below link, we talk mostly about the pros and cons of the freedom-of-contract paradigm for LLCs and its different impact on the two worlds of LLCs. In Part Two, which should be available in early 2020, the discussion focuses mainly on Professor Molk’s accredited investor proposal.

 

In the end, it wasn’t much of a fight.

The case of Huggins v Scott, decided last month by Justice W. Franc Perry of the Manhattan Supreme Court, illustrates anew the well-nigh insurmountable hurdle faced by a minority member seeking judicial dissolution of an economically viable LLC carrying on its business in conformity with its intended purpose.

The case tells the story of two longtime friends who became romantically involved and then became business partners before both relationships fizzled.

The Respondent is a female, registered amateur boxer and certified boxing coach who, in 2007, started a boxing club known as Women’s World of Boxing (WWB) to offer boxing workshops to teenage girls in under-served communities in Manhattan, Brooklyn, and the Bronx. Over the next decade, the unincorporated WWB had no permanent home and operated out of other boxing gyms.

Respondent organized WWB as a single-member New York limited liability company in 2014. In 2017, with financing help from Petitioner, who also personally co-guaranteed the lease, WWB constructed and opened its own boxing gym. Petitioner and Respondent entered into a written operating agreement under which they respectively held 40% and 60% membership interests. Continue Reading LLC Member’s Petition to Dissolve Boxing Club Dealt First Round KO

I’ve lost track of how many lawsuits I’ve seen between co-owners of New York City restaurants. It’s not surprising given the high percentage of restaurant failures in an intensely competitive market with high rents, high labor costs, and high everything else.

Another significant factor is the heavy initial investment required for start-up restaurants in the city. Aspiring restaurant entrepreneurs long on ideas and talent but short on cash and credit often will bring in friends and family as silent partners to provide the capital required to lease, build, equip, get regulatory approval, open, and carry the restaurant until it reaches profitability. The allure of owning a share of a restaurant managed by a friend or family member, especially for those with no experience in the industry, can dull awareness of the high risks involved. It also can mask the need for independent counsel to vet organizational agreements and the ongoing need to closely monitor restaurant finances.

I can only guess those factors were at play in Berman v Jankelowitz, 2019 NY Slip Op 32439(U) [Sup Ct NY County Aug. 15, 2019], a lawsuit brought by inactive, minority members of several LLCs formed to create and operate a pair of bistro-style restaurants known as Jack’s Wife Freda, located in Manhattan’s Soho and West Village neighborhoods. The lawsuit accused the managing majority members of “theft and waste of corporate assets, including valuable trademarks.”

In a decision early this year, the court ruled in defendants’ favor, upholding their separate ownership of the restaurants’ trademarked name and other intellectual property and their right to license it for use at a third location without plaintiffs’ participation. In that instance, the plaintiffs argued unsuccessfully that the critical language in the operating agreements’ purpose clause was ambiguous.

In its most recent decision, however, it was the defendants who unsuccessfully raised an ambiguity argument when the court adopted the plaintiffs’ construction of provisions in the LLC agreements requiring the defendant managing members to provide audited financial statements. Continue Reading Court Takes Ambiguity Off the Menu of Restaurant’s LLC Agreement

My last post on the subject of advancement and indemnification summarized the basic rules by which closely-held business owners, officers, directors, managers, and members may be entitled to use company funds to pay their legal fees.

This article considers the flip side of the coin: some common-law and statutory limits on the ability of businesses to advance and indemnify legal fees.

At first blush, advancement and indemnification rights may seem broad in business divorce disputes, but the doctrine of “unmistakably clear” fee-shifting agreements, the distinction between first- and third-party disputes, and the general prohibition on recovery of “fees on fees” all provide significant restrictions on advancement and indemnification rights. Continue Reading Can the Company Pay My Legal Fees? – Part Two