Like the Energizer bunny, some business divorce lawsuits keep going and going and going. Years of protracted litigation, brutal though they may be upon the parties, are a bonanza for voyeuristic business divorce practitioners when the result is thoughtful, precedential decisions that clarify prior rules of law, or better yet, announce new ones. Kassab v Kasab is a perfect example.

Begun nine years ago, Kassab involves two brothers so at odds they seem to disagree how to spell their own last name. For years, 75% owner Avraham and 25% owner Nissim battled over their interests in two entities, one a corporation referred to “Corner,” the other a limited liability company referred to as “Mall,” each of which owned an adjacent parcel of vacant land operated together as a parking lot in Jamaica, Queens.

Over the years, Kassab has spawned no less than five separate lawsuits, five appearances on this blog (read here, here, here, here, and here), and five published appeals court decisions, the latest two issued just last week by the Brooklyn-based Appellate Division – Second Department.

Last week’s companion decisions are Kassab v Kasab, ___ AD3d ___, 2021 NY Slip Op 03837 [2d Dept June 16, 2021], and Kassab v Kasab, ___ AD3d ___, 2021 NY Slip Op 03836 [2d Dept June 16, 2021]. The former emanated from a post-trial decision granting a petition for corporate dissolution. The latter emanated from a pre-answer decision dismissing a petition for LLC dissolution. Polar opposite outcomes.

Side-by-side, last week’s Kassab decisions perfectly illustrate a point we have made on this blog many times: the legal standards for judicial dissolution of corporations and limited liability companies are very different, the standards to dissolve an LLC in some ways more exacting and difficult to prove, and so allegations that might suffice to dissolve a corporation may not even come close to dissolve an LLC. Certain language from the latter Kassab decision addressing LLC dissolution may also have implications for another important issue no New York appeals court has addressed: whether New York law would recognize a viable cause of action for “common-law dissolution” of an LLC. Continue Reading To Dissolve or Not to Dissolve, that is the Question. The Answer is Both.

Iowa was one of the first states to adopt the 2006 Revised Uniform Limited Liability Company Act.  As of this year, 21 others have done so not including New York which continues to limp along with its creaky LLC Law enacted in 1994.

Iowa’s statute governing judicial dissolution of LLCs is based on RULLCA Section 701 which in the main carried forward the provisions in Section 801 of the predecessor Uniform Limited Liability Company Act (1996). The statute authorizes judicial dissolution upon application by a member on the principal grounds (1) that it is not reasonably practicable to carry on the LLC’s business affairs in conformity with its organizational documents, or (2) the controlling managers or members are acting in an “oppressive” manner that is directly harmful to the member seeking dissolution.

I’ve previously written about several interesting decisions by Iowa’s intermediate appellate courts in LLC dissolution cases (here, here, and here). Last month, in its first foray into LLC dissolution, the Iowa Supreme Court interpreted and applied Iowa’s LLC dissolution statute in a fascinating case called Barkalow v Clark. The case involves a dispute among family members who formed an LLC to acquire rental properties near the University of Iowa football stadium in Iowa City.

The court’s lively and scholarly opinion, authored by Justice Edward Mansfield, agreed with the lower court that the petitioning member did not establish oppression, but reversed the lower court’s dissolution order where the LLC was fulfilling its intended contractual purpose. For business divorce practitioners and others who study closely held business entities, Barkalow is a case well worth reading and understanding. Continue Reading Judicial Dissolution of LLCs Under RULLCA: Iowa Supreme Court Takes the Stage

Last week, Peter Mahler blogged about a recent decision holding that a minority shareholder’s claim against its majority co-owners for breach of fiduciary duty in connection with a sale of the business to a third party overcame for pleading purposes a broad general release delivered by the minority shareholder as part of the deal documents. In that case, Shilpa Saketh Realty, Inc. v Vidiyala, 191 AD3d 512 [1st Dept 2021], the court reversed dismissal and reinstated the plaintiff’s claims.

This week, we consider a variation on the theme of fiduciary duty claims overcoming contractual provisions limiting or eliminating those very duties, this time in the context of a so-called “exculpatory” clause in an LLC operating agreement and an appeal from a post-trial judgment of dismissal.

Reminiscent of Shilpa, in John v Varughese, 2021 NY Slip Op 03026 [2d Dept May 12, 2021], the appeals court partially modified dismissal of the minority member’s derivative complaint and directed entry of a money judgment in the company’s favor on one narrow aspect of its fiduciary duty claim, notwithstanding the existence of the operating agreement’s exculpatory clause. Before we get to particular facts of Varughese, though, let’s take a look at the law of LLC operating agreement exculpatory clauses. Continue Reading “Intentional” Breach of Fiduciary Duty Defeats Operating Agreement’s Exculpatory Clause

The New York Court of Appeals’ 2012 opinion in Pappas v Tzolis, decided in the wake and spirit of that court’s rulings the year before in the Centro Empresarial v America Movil and Arfa v Zamir cases, raised the bar for claims of fraud and breach of fiduciary duty brought by non-controlling shareholders and LLC members in connection with buyout transactions. In so doing, the Centro-Arfa-Pappas trilogy rejected a line of cases decided by the Appellate Division, First Department, which seemingly held that a fiduciary involved in a self-interested transaction with another owner can almost never rely on a release or fiduciary waiver to avoid liability against allegations of non-disclosure and fraudulent inducement.

The plaintiffs-sellers in Pappas filed a post-buyout suit against the defendant-buyer after learning that, at the time of the buyout, he had an undisclosed deal with a third party for the sale of the company’s primary asset at a price exponentially higher than the value paid for the plaintiffs’ shares. The First Department sustained the fiduciary breach and fraud claims as pleaded.

The Court of Appeals reversed and dismissed the suit based on the buyout agreement’s explicit waiver of fiduciary duty. The Court of Appeals focused on the complaint’s allegations that the plaintiffs’ relationship with the buyer, Tzolis, “had become antagonistic to the extent that plaintiffs could no longer reasonably regard Tzolis as trustworthy” and that “reliance on Tzolis’s representations as a fiduciary would not have been reasonable.” The court’s opinion also noted that the plaintiffs were “sophisticated businessmen represented by counsel.”

A recent appeal to the First Department in Shilpa Saketh Realty, Inc. v Vidiyala put to the test that court’s application of the principles laid down by the Court of Appeals in Pappas. As best as I can tell, Shilpa is only the second post-Pappas First Department decision in which it entertained a shareholder dispute involving claims of fiduciary breach and fraud connected to a stock purchase agreement that included a fiduciary waiver and/or release.

On the prior occasion, in Malta v Gaudio, the court cited Pappas in a decision affirming the dismissal of a fiduciary breach claim as barred by a broad release provision. The court noted that the plaintiff was a “sophisticated principal represented by independent counsel” who admitted that he no longer trusted his co-owner at the time of the transaction — seemingly a slam-dunk application of Pappas.

The First Department also cited Pappas in last February’s Shilpa ruling. In contrast to Malta, however, the court in Shilpa reversed the dismissal of fraud and fiduciary breach claims notwithstanding the presence of a broad release and a fiduciary waiver-like provision in the transaction documents involving the sale of the company to a third party for $500 million. Why the different outcome? Read on.

Continue Reading Appellate Ruling Puts Pappas v. Tzolis to the Test

The heyday of common-law dissolution — if it ever had one — is long past, largely displaced by a statutory dissolution remedy for oppressed minority shareholders paired with an elective buy-out option for the respondent majority shareholders.

New York’s version of the statutory remedy, section 1104-a of the Business Corporation Law enacted in 1979, authorized shareholders holding at least 20% of the voting shares in an election of directors to petition for judicial dissolution based on “oppressive actions” and other misconduct by the majority including illegality, fraud, looting, waste, and diversion of corporate assets. Courts subsequently interpreted the undefined term “oppressive actions” as meaning conduct that defeats the minority shareholder’s “reasonable expectations” upon joining the enterprise, such as termination without cause of one’s employment and positions as an officer and director.

A “special solicitude toward the rights of minority shareholders of closely held corporations” was how the New York Court of Appeals in Matter of Kemp & Beatley subsequently described the legislature’s motivation for enacting section 1104-a, the implication being that common-law dissolution didn’t sufficiently protect the locked-in minority shareholder against majority abuse and overreach. Common-law dissolution’s remedial reach simply was too short.

Since section 1104-a’s enactment in 1979, common-law dissolution’s utility effectively is limited to actions by shareholders with less than 20% of the voting shares.

Under the case law, common-law dissolution requires the minority shareholder to show, as articulated by the Court of Appeals in Leibert v Clapp, that “the directors and majority shareholders . . . 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.” In other words, to prevail under the common-law standard the minority shareholder essentially has to show that a rogue majority is operating the company as their personal fiefdom for their sole benefit. Not an easy undertaking.

With that background, let’s take a look at two recent court decisions in which the plaintiffs’ common-law dissolution claims suffered setbacks.

Continue Reading Common-Law Dissolution Hits Speed Bumps in Recent Decisions

In an earlier post, we wrote about a fascinating law firm limited liability partnership dispute culminating in a thoughtful post-trial decision by Erie County Commercial Division Justice Timothy J. Walker. Capizzi v Brown Chiari LLP involved two separate, full-blown litigations and bench trials more than a decade apart on the same issue: whether the law firm’s named partners were true “equity” partners of the firm. The legal significance of this issue was that if the firm’s named partners were true “equity” partners, then each had the power to unilaterally withdraw from and dissolve the partnership under Section 62 (1) (b) of the Partnership Law because the partnership lacked an agreement otherwise prohibiting withdrawal.

What made the Capizzi litigation unconventional was that Capizzi took essentially opposite positions as defendant in the first lawsuit and plaintiff in the second. In the prior lawsuit, Frascogna v Brown, Chiari, Capizzi & Frascogna, LLP, Capizzi opposed the position of his former law partner, Frascogna, who argued that he was true equity partner and dissolved the law firm as a matter of law when he formally withdrew from the firm. Capizzi lost that lawsuit, the Court concluding that all four of the original partners including, including Capizzi, were equity / general partners of the firm with the power to dissolve it unilaterally. After losing that lawsuit, the three remaining partners, including Capizzi, re-formed the firm under the same terms as the original.

Years later, Capizzi took the opposite position he took and lost in the first litigation, arguing that he was a true equity / general partner of the firm, and that his unilateral withdrawal from the firm caused its dissolution under Partnership Law § 62 (1) (b). In support of his position, Capizzi relied upon years of tax returns filed by the law firm and its name partners which he said showed that all three were general partners of the firm.

This unique fact pattern was the perfect setup to implicate multiple legal “estoppel” doctrines at once, namely, collateral estoppel, judicial estoppel, and tax estoppel. As we noted in our prior article, Justice Walker’s post-trial decision relied upon two of these doctrines – collateral estoppel and tax estoppel – to rule that Capizzi’s former partners, Brown and Chiari, were estopped from contesting Capizzi’s status as an equity / general partner of the firm due to the post-trial holding in the original Frascogna partnership litigation and the filing of tax documents stating that Capizzi was a general partner.

Last week, in Capizzi v Brown Chiari LLP, ___ AD3d ___, 2021 NY Slip Op 02956 [4th Dept May 7, 2021], a Rochester-based appeals court issued a decision affirming Justice Walker’s post-trial decision. Interestingly, though, the appeals court affirmed on different grounds that those relied upon by the lower court, suggesting that the higher court may have had some concerns with the lower court’s collateral and tax estoppel holdings. With Capizzi as a springboard, we’ll take a closer look at the doctrines of collateral estoppel, judicial estoppel, and tax estoppel as applied in business divorce cases. Continue Reading Battle of the Estoppels

Anyone who keeps up with the public equity markets knows that the volume of IPOs generated by Special Purpose Acquisition Companies, better known as SPACs, has exploded over the last two years. Writing for his Wealth Matters column (5/7/21), Matt Sullivan of the NY Times reports that “[s]o far this year, nearly 300 SPACs have been created and taken public, more than the 248 offerings in all of last year and up from 59 in 2019.”

For those not familiar with SPACs, essentially they are publicly traded, non-operating, shell companies formed to raise capital to acquire and convert to public ownership a privately-owned operating company. SPACs are also referred to as “blank check” companies because investors buy shares before any merger or acquisition opportunity is identified. The IPO process for SPACs avoids much of the burden, expense, and lengthier regulatory compliance associated with traditional IPOs.

The SPAC is controlled by a “sponsor” management company typically organized as a limited liability company. The sponsor receives a percentage of shares at the time of the offering — normally 20% — which are put in escrow pending consummation of a potential acquisition within a two-year period. Post-acquisition, the sponsor distributes shares to its members subject to certain triggers such as termination of a lockout period or the reaching of a specified share price. If no acquisition is consummated within the fixed period, the investors get their money back.

The sponsor LLC is subject to the same trials and tribulations of any LLC as far as rights, duties, and potential conflicts among the members. Or perhaps not quite the same, given that, unlike most small, owner-operated start-up sales or service companies formed as LLCs, often without any written operating agreement, the sponsor typically is formed under Delaware law by sophisticated investors/managers using experienced transactional lawyers from major law firms to prepare intensely considered operating agreements.

But, as we all know, having sophisticated investors with agreements prepared by experienced counsel is no guarantee that LLC members will not turn on each other. That brings me to a decision last month by U.S. District Judge Victor Marrero of the Southern District of New York in Vogel v Boris involving a falling out between members of a SPAC sponsor following the completion of an acquisition. The question presented to the court was whether the sponsor’s operating agreement contemplated a one-deal company and terminated upon completion of the one deal or, as the plaintiff contended, it prohibited the other members from organizing another SPAC transaction without his consent, effectively giving him an ongoing participation right in any subsequent SPAC transactions. Continue Reading It Was Only a Matter of Time: SPAC Meets Business Divorce

Under both New York and Delaware law, members of an LLC may petition for judicial dissolution on the grounds that the management is so hopelessly deadlocked that the LLC can no longer function in accordance with its purpose as defined in its governing documents.

In those cases, courts will consider whether the LLC operating agreement contains some other mechanism to break the deadlock.  If the operating agreement itself provides a fair opportunity for the dissenting member who disfavors the inertial status quo to exit and receive the fair market value of her interest, it is at least arguable that the LLC can still proceed to function, because there exists an equitable way to break the impasse.

Coequal LLC members might agree in their operating agreement to break a deadlock with a shotgun buy-sell agreement.  In the event of a deadlock, the initiating member names a price, and thereby gives the other member the option to either buy the initiating member’s interest or sell his own interest at that price.  “I cut, you choose.”

In theory, because a shotgun buy-sell agreement can equitably break an impasse, a member’s electing to initiate the shotgun buy-sell procedure should foreclose a petition for deadlock-based dissolution.  In practice, disputes over the implementation of that election might make dissolution appropriate after all.  That’s the lesson of Seokoh, Inc. v Lard-PT, LLC, CV 2020-0613-JRS [Del Ch Mar. 30, 2021], in which Vice Chancellor Slights cited the flaws in the parties’ shotgun buy-sell agreement as the basis for his refusal to dismiss a 51% member’s petition for deadlock-based dissolution.

Continue Reading Holes in Shotgun Buy-Sell Agreement Keep Deadlock Dissolution Petition Alive

Now that I’ve got your attention, relax. At least for New York LLCs, a member can be expelled from an LLC only if expressly authorized by the operating agreement.

In my experience, expulsion provisions in LLC agreements are relatively rare, arguably for good reasons. For one, prospective, non-controlling participants in an LLC generally are loathe to subject the certainty of their investment to the discretion of a controlling member or members who have an inherent self-interest when deciding whether an expulsion trigger has occurred. For another, the financial terms of expulsion provisions tend to be punitive, returning to the expelled member substantially less than the fair value of their interest in the LLC as a going concern.

I’ve previously written about cases in which New York courts enforced expulsion provisions in LLC agreements for misappropriation of company funds, for felony conviction, and for material breach of the LLC agreement. Earlier this month I came across another case, one might say, that pushes the envelope to include a member’s statements made to third parties complaining about the LLC managers’ claimed failure to provide information in breach of the operating agreement. The statements allegedly constituted ground for expulsion under an expansive provision covering “any act or omission which, in the reasonable judgment of the Managers, is in bad faith and is detrimental to the interests of the Company, its Members or its Managers.”

Earlier this month, in Jacobowitz v Gutnick, a Brooklyn Supreme Court judge found that the challenged statements were non-actionable opinion and dismissed defamation claims brought by the plaintiff LLC and its managers against the defendant expelled member. The court nevertheless refused to dismiss the plaintiffs’ claim for a declaratory judgment enforcing the expulsion, holding that the non-defamatory nature of the statements is not determinative whether, in the “reasonable judgment of the Managers,” the defendant’s statements constituted bad-faith acts detrimental to the LLC, its managers, or members. Let’s take a closer look. Continue Reading Be Careful What You Say. It May Get You Expelled From Your LLC.

Of late I’ve been ruminating on New York’s membership in the shrinking pool of states that don’t recognize oppression of an LLC minority member by the controlling members or managers as ground for judicial dissolution.

The point indirectly was brought home by Professor Daniel Kleinberger’s recent article for the ABA’s Business Law Section in which he dissects last year’s decision by a Connecticut appellate panel in Manere v Collins interpreting that state’s Revised Uniform LLC Act which expressly includes oppression as one of the grounds for judicial dissolution. As the good professor highlights, the court’s decision freely borrows from the rich body of case law construing the term “oppression” as used in judicial dissolution statutes for closely held corporations in virtually every state save Delaware.

New York continues to buck the nationwide trend toward harmonization of close corporation and LLC law governing judicial dissolution, as made clear in cases such as Doyle v Icon and Barone v Sowers explicitly holding that New York’s LLC Law § 702 neither mentions nor otherwise accommodates oppression as a basis for seeking judicial dissolution.

Coincidentally, a case decided by the Manhattan-based Appellate Division, First Department, just a few days after Professor Kleinberger posted his article, starkly illustrates the disharmony of New York’s statutory schemes and the resulting disadvantageous position of a minority member of a New York LLC as compared to a minority shareholder of a New York close corporation when confronted with similar, allegedly oppressive behavior by the controlling co-owner. Continue Reading The Money’s There But Out of Reach for the Minority LLC Member