Someday, perhaps, I’ll find the comedic inspiration to come up with a joke that begins, “An LLC, a partnership, and a close corporation walk into a bar . . ..” Until then, I’ll have to satisfy myself with writing about an LLC, partnership, and close corporation that walk into a blog, offering the following, short treatments of three recent decisions of interest by New York courts:

  • The first, involving an LLC, features a dispute arising from a somewhat unusual right of first refusal provision in an LLC operating agreement that authorizes an intra-member buyout of membership interests triggered by the receipt of an outside offer to purchase the LLC’s sole realty asset.
  • The second, involving a partnership, addresses whether a partner of a dissolved law firm can seek an accounting of an alleged successor law firm formed without him by his former partners.
  • The third, involving a close corporation, considers whether an alleged oral agreement to grow and manage a karaoke lounge without salary in exchange for a 25% equity interest if the venture became profitable, entitled the manager to 25% of the venture’s value following his ouster.

Court Enforces Right of First Refusal for Purchase of Membership Interests Triggered by Outside Offer for LLC’s Real Property

Last month, Brooklyn Commercial Division Justice Reginald A. Boddie issued a noteworthy Decision and Order in Orange Gowanus LLC v Ben-Yosef involving an action by an LLC member to enforce a right of first refusal to acquire its co-owners’ membership interests upon the LLC’s receipt of an outside offer to purchase the real property owned by the LLC’s wholly-owned subsidiary.

Continue Reading Recent Decisions Enforce LLC Member’s Right of First Refusal, Restrict Partnership Accounting, and Allow Damages Claim for Breach of Oral Shareholders Agreement
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Resolving ownership disputes with a buyout at auction has a tempting simplicity.  The buyout gives the owners the divorce they need.  And the auction—particularly a blind auction, in which no owner is aware of the other’s bid—arguably leaves little room for dispute over the value of the company.  For these reasons, it is easy to see why a court charged with overseeing the dissolution of a 50/50 closely-held company might prefer an auction giving each owner the chance to buy out his or her co-owner.

But auctions also bring the potential for abuse and distrust.  They put the better-heeled owner in a position of power, and one owner may have a better understanding of the company’s value than the other.  They also require a degree of good faith by either side. Count Victor Lustig leveraged the opacity of the blind auction process to sell the Eiffel Tower twice; feuding business owners have reason to be wary.

Upon the court-ordered dissolution of a corporation, BCL 1111(c) provides that the court may, “in its discretion” provide for the distribution of the corporation’s property.  A recent case out of the Appellate Division, Second Department, ANO, Inc. v Goldberg, considers whether that discretion allows the court to direct a blind auction buyout (2023 NY Slip Op 02508 [2d Dept May 10, 2023]).

Continue Reading Second Department Rejects Private Auction for Deadlocked Corporation

Occasionally, we come across post-trial decisions with such scathing rebuke of one side that it’s difficult to imagine why the loser ever chose to take the case to trial. O’Mahony v Whiston is a perfect example.

Years into a protracted derivative lawsuit by a 20% founding shareholder against his co-founder 60% shareholders over their misappropriation of “Smithfield,” an Irish sports bar in Manhattan, New York County Commercial Division Justice Jennifer G. Schechter colorfully warned the litigants of the trial risks when she denied summary judgment:

[T]he court would be remiss if it did not take this opportunity to encourage a sober reckoning on each side, as the parties (or at least their attorneys) have an unjustifiably rosy view of their respective positions such that each side believes sanctions are warranted against the other due their contentions being frivolous. Not so. An impartial view of the record makes clear that while the parties’ actions certainly suffered from shortcomings, each side has a certain amount of justification for what they did. Before trial, perhaps cooler heads will prevail. For this reason, the pre-trial process will be delayed for 30 days, during which the parties shall personally meet for good faith settlement discussions.

Instead of settling, both sides appealed. In the resulting decision, the Appellate Division ruled: “Summary judgment was properly denied” because the record raised numerous issues of fact, including, according to the appeals court:

  • “whether a bar opened by defendants qualified as a corporate opportunity of the bar and corporation owned by plaintiffs and defendants together”;
  • “whether assets of the corporation, including its goodwill, were given to the new bar for no consideration”;
  • “whether the individual defendants looted, committed waste, or paid themselves unfair bonuses”;
  • “whether a loan issued by plaintiffs to the corporation was repaid;” and
  • “whether the individual defendants’ treatment of plaintiffs amounted to shareholder oppression.”

Issues of fact framed succinctly, the parties proceeded to a bench trial before Justice Schechter in January 2022. What resulted was an absolutely devastating finding of liability and damages against the defendant majority shareholders for misappropriation of corporate opportunity, including a rare imposition of punitive damages and an accounting surcharge. Justice Schechter’s post-trial decision is a tour de force, well worth a read. But first, the basic facts.

Continue Reading Misappropriated Watering Hole Becomes Money Judgment Sinkhole

Statutory fair value appraisal proceedings in New York come in two flavors. First, there’s the buy-out appraisal under Business Corporation Law § 1118 triggered by a minority shareholder’s petition for judicial dissolution. Second, there’s the appraisal proceeding under BCL § 623 triggered by a shareholder’s, LLC member’s, or limited partner’s dissent from a merger, consolidation, or sale of all or substantially all the firm’s assets.

There are commonalities and differences between the two types of appraisal proceedings. The basic approach to the determination of fair value is the same:

  • While neither statute defines “fair value,” almost 30 years ago New York’s highest court, in Friedman v Beway Realty, declared “there is no difference in analysis between stock fair value determinations under Business Corporation Law § 623, and fair value determinations under Business Corporation Law § 1118.”
  • As summed up in the landmark Blake v Blake Agency case, in both types of proceedings fair value “should be determined on the basis of what a willing purchaser, in an arm’s length transaction, would offer for the corporation as an operating business, rather than as a business in the process of liquidation.” In both types of appraisal proceedings, the three major elements of fair value are net asset value, investment value and market value, without consideration of any minority discount for lack of control but permitting consideration of a discount for lack of marketability.

The differences between the two types of appraisal proceedings include:

  • BCL § 623(h)(4) requires the court to consider “the nature of the transaction giving rise to the shareholder’s right to receive payment for shares and its effects on the corporation and its shareholders, the concepts and methods then customary in the relevant securities and financial markets for determining fair value of shares of a corporation engaging in a similar transaction under comparable circumstances and all other relevant factors” — language not found in BCL § 1118 that can make a meaningful difference as highlighted by New York’s Court of Appeals in Matter of Cawley v SCM Corp.
  • In proceedings under § 623 involving corporations (but not LLCs and limited partnerships), simultaneous with the required offer to the dissenting shareholder the company must tender 80% of the offered price. Section 1118 has no such requirement. The different rules make sense since a dissenting shareholder loses shareholder status immediately upon consummation of the corporate transaction whereas the petitioning minority shareholder in a dissolution proceeding remains a shareholder even after the buyout election until the buyout is consummated by means of a settlement or following the court’s fair value award.

Interest on Fair Value Awards: The Statutes

Here’s another important difference: Under § 1118(b), “the court, in its discretion, may award interest from the date the petition is filed to the date of payment for the petitioner’s share at an equitable rate” (italics added). That’s all the statute says on the subject.

Continue Reading Fair Value Awards: A Matter of Interest
Road Trip

When a minority shareholder petitions for dissolution of a corporation on the grounds of oppressive or illegal conduct (see BCL 1104-a), Section 1118 of New York’s Business Corporation Law allows the corporation or any other shareholder to elect to purchase the petitioning shareholder’s shares “at their fair value and upon such terms and conditions as may be approved by the court.” 

Several years ago, Peter Mahler explored the BCL 1118 election in the aptly-titled post, A Deep Dive into the Election to Purchase in Dissolution Proceedings.  That post borrows its description of the section 1118 election from the Court of Appeals in Matter of Pace Photographers, Ltd., which calls the election “a defensive mechanism for the other shareholders and the corporation, giving them an absolute right to avoid the dissolution proceedings and any possibility of the company’s liquidation by electing to purchase petitioner’s shares at their fair value and upon terms and conditions approved by the court.”  

New York is not alone in providing such a defensive mechanism for corporations and shareholders facing dissolution.  Many other states, including California, Nebraska, Illinois, and Florida, have similar statutes.  This week’s post takes a look at several recent decisions concerning buyout elections across the country.  While each case features different statutory language, our New York readers would be wise to note the persuasive power of these cases on the sometimes thin body of New York caselaw concerning section 1118 elections. 

Continue Reading A Cross-Country Road Trip of Elections to Purchase in Dissolution Proceedings

No corporate lawyer wants to get drawn into a nasty litigation between an entity’s owners. But the reality is that corporate and general counsel often find themselves unwittingly ensnared in business divorce cases. Sometimes a corporate transaction is the genesis of litigation, and corporate counsel’s role or advice may be exceedingly important.

Other times, corporate counsel may have served in a joint, dual, or uncertain capacity, providing advice to the entity and its owners simultaneously. This can create particular problems when formerly aligned interests diverge.

In this week’s business divorce, we’ll consider three doctrinal pitfalls for corporate and general counsel in business divorce litigation: the fiduciary exception to the attorney client privilege, the joint representation exception to the attorney-client privilege, and a virtual per se rule of disqualification for litigation counsel who previously served as corporate counsel for a closely-held entity whose owners become adverse.

Continue Reading Pitfalls for Corporate Counsel in Business Divorce Disputes

Husband owns 99% membership of manager-managed LLC. Children own remaining 1%. Postnuptial agreement says husband’s “interest” in LLC goes to wife. LLC agreement says any transferee is not admitted as a member absent the manager’s discretionary consent. Postnup gets triggered when marriage breaks up. Husband-appointed manager withholds consent to wife’s admission as member, relegating her to holder of an economic interest. Wife sues to enforce postnup, arguing it encompasses husband’s “entire” LLC interest including voting and other rights appurtenant to membership. Children-members argue mother merely holds economic interest in LLC. Who wins?

The Bich Family. Société Bic S.A., the French maker of the ubiquitous BiC ballpoint pen and disposable lighter, was founded at the end of WWII by Marcel Bich. The Bich family, among the wealthiest in France, reportedly owns around 46% of the company’s stock and maintains voting control. Around the time of Marcel’s death in 1994, his son Bruno took over as CEO.

The Postnup. In 2008, Bruno and his then-wife of 30 years, Veronique, entered into a First Amended Postnuptial Agreement concerning the ownership and distribution of marital property. The Postnup, which was made in New York and is governed by New York law, reflects the parties’ express intent to implement an equal division of marital property upon the happening of certain “Operative Events” including written notice of intent to separate. The parties were counseled by highly experienced matrimonial lawyers including the renowned Raoul Felder for Veronique.

Continue Reading Operating Agreement Trumps Postnup in High Stakes Battle Over Transfer of LLC Interest
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In 1941, two of the three shareholders of Ringling Bros.-Barnum & Bailey Combined Shows, Inc. entered into an agreement stating that they would vote their combined 630 of the outstanding 1000 shares of Ringling Bros. stock together. If they could not agree on a matter put to vote, they each agreed to submit the matter to an arbitrator, then vote according to his recommendation.

Five years later, Ringling Bros.’ shareholders convened to elect directors. One shareholder sought to enforce the 1941 agreement, while the other argued that the agreement was invalid. Ultimately, the Delaware Chancery Court enforced the agreement, holding:

A group of shareholders may, without impropriety, vote their respective shares so as to obtain advantages of concerted action. They may lawfully contract with each other to vote in the future in such a way as they, or a majority of their group, from time to time determine.”

(Ringling Bros.-Barnum & Bailey Combined Shows v Ringling, 53 A2d 441 [1947]). The Voting Agreement was born.

In the years since Ringling Bros., statutes and caselaw have imposed several limitations on shareholders’ ability to enter into enforceable voting agreements. But those limitations apply in the corporate context—few have migrated over to LLC member voting agreements. And as a recent decision from the First Department, Tsai v Lo, 212 AD3d 547 [1st Dept 2023], demonstrates, LLC member voting agreements may have fewer formality requirements than one might expect.

Continue Reading First Department Recognizes Cause of Action for Specific Performance of LLC Member Voting Agreement

Litigants assert with growing frequency “faithless servant” claims in business divorce cases. New York’s faithless servant doctrine, and the legal standards governing faithless servant claims, emanate from two ancient decisions that continue to crop up in the case law.

Ancient Roots

In Turner v Kouwenhoven (100 NY 115 [1885]), New York’s highest court ruled that where an agent engages in “misconduct and unfaithfulness which substantially violates the contract of service,” he can recover “nothing for the part of the term past, nor for the future” as compensation.

In Murray v Beard (102 NY 505 [1886]), the same Court ruled:

An agent is held to uberrima fides in his dealings with his principal; and if he acts adversely to his employer in any part of the transaction, or omits to disclose any interest which would naturally influence his conduct in dealing with the subject of the employment, it amounts to such a fraud upon the principal as to forfeit any right to compensation for services.

Recent Expression

In its most recent faithless servant case, the Court of Appeals wrote, “One who owes a duty of fidelity to a principal and who is faithless in the performance of his services is generally disentitled to recover his compensation, whether commissions or salary,” from the first act of disloyalty (Feiger v Iral Jewelry, Ltd., 41 NY2d 928 [1977]).

Continue Reading Faithless Servant in Business Divorce Cases

It seems a bit exaggerated to liken the deterioration of a relationship between 50/50 business partners to a fatal disease, but in the case of Pathology Associates of Ithaca, P.C., recently pronounced dead by act of judicial dissolution, the comparison may be apt.

The story of Pathology Associate’s demise seems to be more about a clash of personalities than about the usual disputes over money, side dealing, freeloading, and succession plans. The lower court’s post-trial decision granting dissolution, recently affirmed on appeal, mentions the “mentor/mentee” and “healthy functional” relationships that existed between the two pathologists-shareholders — whom I’ll refer to as Dr. P and Dr. S — from the time Dr. P joined the more senior Dr. S’s practice as an employee in 2013. The working relationship blossomed in 2018 when Dr. S granted Dr. P a 50% interest in the practice. Yet within two short years, under the stress of new demands on the practice occasioned in large part by the COVID pandemic, the two doctors landed in court as adversaries when Dr. P sued in Tompkins County Supreme Court for judicial dissolution, claiming dissension and deadlock under Section 1104 of New York’s Business Corporation Law.

Continue Reading The Pathology of Deadlock Dissolution