A year and a half ago, we blogged about a decision in which Bronx County Supreme Court Justice Llinet M. Rosado ruled that a shareholder’s alleged stock transfer through a bequest in his last will and testament was ineffective to transfer the stock to his widow where a written shareholders’ agreement prohibited transfers except to the shareholder’s “issue” (a legal term of art for children) or to any other person upon “unanimous consent” of all shareholders.

Sebrow v Sebrow (69 Misc 3d 1064 [Sup Ct, Bronx County 2020]), stands for the proposition, expressed by other courts in cases like Matter of Gusman (178 AD2d 597 [2d Dept 1991]), and Isaacson v Beau Label Corp., (93 AD2d 880 [2d Dept 1983]), that written transfer restrictions or buy-sell agreements governing closely-held business interests will trump, and potentially defeat, conflicting testamentary bequests. For that reason, closely-held business owners and their estate lawyers should always satisfy themselves that their estate plans do not contravene any of the decedent’s contracts.

Recently, three separate courts issued a trio of decisions in the ongoing Sebrow litigations both cementing and expanding upon the holdings of the original Sebrow decision. Each decision was a decisive loss for Berry Sebrow (“Betty”), the widow who claimed to have acquired shares of stock from her deceased husband, David Sebrow (“David”), through a residuary clause in David’s will. Continue Reading Three Strikes You’re Out: Sebrow Revisited

The current issue of The Business Lawyer, a quarterly publication of the ABA’s Business Law Section that rightly bills itself as “the premier business law journal in the country,” features a pair of dueling articles of great interest to scholars, practitioners, and other students of the limited liability company. The articles’ authors, whom I’ve had the good fortune getting to know at annual meetings of the LLC Institute and who have guest posted on this blog (here and here) and spoke on my podcast (here), are among the leading authorities in the country on closely held business entities and, in particular, unincorporated entities including partnerships and LLCs.

I’m speaking of Donald J. Weidner (pictured left), Dean Emeritus and Alumni Centennial Professor at Florida State University College of Law, and Daniel S. Kleinberger (pictured right), Emeritus Professor of Law at Mitchell Hamline School of Law.

Among his many accomplishments outside academia, Dean Weidner is co-author of The Revised Uniform Partnership Act published by Thomson Reuters, was the Reporter for the Revised Uniform Partnership Act (1994), and has written numerous articles on partnerships, limited liability companies, and financial accounting (SSRN author page here).

Professor Kleinberger’s extra-curricular contributions are no less impressive, including co-author of a leading treatise on LLCs published by Warren Gorham & Lamont, Co-Reporter and Principal drafter of statutory text and Official Comments to the Revised Uniform Limited Liability Company Act (2006), and author of a host of articles in law reviews and journals (SSRN author page here).

As any long-time reader of this blog knows, and as I wrote not long ago, one of the more common issues litigated at the outset of business divorce litigation involving LLCs as well as close corporations are motions to dismiss a minority member’s direct claims against managers that should have been brought derivatively under the prevailing Tooley test for direct versus derivative claims. The two articles by Dean Weidner and Professor Kleinberger offer a spirited point and counter-point debate between two schools of thought concerning the ability of LLC members to pursue and obtain effective remedies for misconduct claims against LLC managers, either as direct or derivative claims, and the ability (or not) of conflicted LLC managers to gain control of those claims through appointment of a surrogate Special Litigation Committee (SLC) once the claims are characterized either as direct (no SLC) or derivative (yes SLC). Continue Reading LLCs, Direct vs. Derivative Claims, and Special Litigation Committees: A Lively Debate

The emergence of the Limited Liability Company as the preferred form of closely-held business association in New York has spawned a glut of litigation over disputed membership status in LLCs, many of which are covered in the pages of this Blog (here and here, for starters). Non-existent or ignored operating agreements, lack of certificated ownership interests, and the informal deals that seem prevalent among LLC members provide prime conditions for a fight over membership in an LLC.

Disputes over membership in LLCs often feature one faction—the party disputing the claimed membership—citing to the operating agreement or requirements for admission to membership that were not satisfied, and the other faction—the party claiming membership—relying on some other agreement or representation. In Sobel v Tulchiner (covered here), the defendant pointed to an operating agreement declaring himself the sole member, while plaintiff relied on a Department of Health Application stating that he was one of multiple members. In Cupcake v Boomboom (covered here), the plaintiff looked to an operating agreement identifying the members, while defendant relied upon a submission to the State Liquor Authority identifying different members.

That brings us to a recent decision by New York County Justice Borrok, Sherman v Zampella, in which the court considers the plaintiff’s claim that text messages establish that he was a 9.9% member of an immensely valuable cryptocurrency business, despite the plaintiff’s admitted non-compliance with the member-admission requirements of the operating agreement.

Continue Reading Text Messages Trump Formalities in Ownership Dispute Over Cryptocurrency Business

Disputes over capital accounts and equity percentages are frequent fodder for business divorce litigation — especially in LLCs without operating agreements. Exemplars previously treated on this blog include Chiu v Chiu, an LLC appraisal case in which the court found that the 75% member improperly accounted for monies it loaned to the company as capital contribution in an attempt to eliminate or at least diminish the withdrawing 25% member’s ownership percentage, and YMSF Family Partnership LP v Beitel where the court rejected a claim designed to de-equitize a 49.9% LLC member based on an allegation that its capital contribution was a disguised loan.

A pair of recent decisions, in two cases involving disputes between members of realty-holding LLCs, addressed the loan vs. capital contribution conundrum in unusual circumstances:

  • In Moskowitz v Fischer, decided by Suffolk County Commercial Division Justice Elizabeth H. Emerson, a 50% member of a defunct realty-holding LLC (Member #1) sued the LLC’s accounting firm for fraud and malpractice alleging that, in cahoots with the other 50% member who also served as tax partner (Member #2), and without advising Member #1, it amended the LLC’s tax return to convert to equity Member #1’s non-performing $1 million loan made to the LLC many years earlier, for which Member #2 had given his personal guarantee, for the purpose of defeating Member #1’s separate, derivative lawsuit against Member #2 seeking to enforce the loan guarantee.
  • In JDS Fourth Avenue JV LLC v Largo 613 Baltic Street Partners LLC, decided by Manhattan Commercial Division Justice Andrew Borrok, the 51% member of a realty-holding LLC sued the 49% member alleging default on an approximate $1 million, undocumented, demand-loan obligation which, in its defense and the subject of its motion to dismiss based on documentary evidence, the 49% member contended was an equity distribution.

Continue Reading A Loan Is a Loan Is a Loan, Except When It’s Equity

You know you’re in big trouble if the post-trial decision in a lawsuit you filed begins like this:

The court finds the plaintiff, Rowen Seibel, not credible. This is primarily because it appears he fabricated evidence and then compounded that fabrication by using the same evidence to lie to this court.”

That was the inauspicious start for Seibel to a Decision After Trial issued two weeks ago by Manhattan Commercial Division Justice Melissa A. Crane in a litigation between celebrity chef Gordan Ramsay and Ramsay’s former business partner.

Ramsay and Seibel were 50% / 50% owners of a California limited liability company, The Fat Cow, LLC, formed the same day as a Delaware limited partnership, FCLA, LP (an acronym for “Fat Cow Los Angeles”), of which Ramsay and Seibel were 49% / 49% limited partners and The Fat Cow the 2% general partner, to develop, own, and operate a restaurant of the same name in Los Angeles, California. The entities had written operating and limited partnership agreements, the former governed by California law, the latter by Delaware law.

The two-week bench trial preceding Justice Crane’s interesting post-trial decision was of two lawsuits consolidated for trial. Continue Reading Gordon Ramsay’s The Fat Cow: Dishing Up Damages and Dissolution

A number of lawsuits have percolated through New York’s courts over the past five years between Adam Max, son of world-renowned visual artist Peter Max, and Adam’s sister, Libra, over control and management of the family business, ALP, Inc., a corporation Peter formed in 2000 to produce, maintain, market, license, and commercialize his prolific catalogue of artwork.

One of those cases culminated in a recent decision by the Manhattan-based Appellate Division – First Department, Max v ALP, Inc., 203 AD3d 580 [1st Dept 2022], in which the Court brought to conclusion a putative shareholder derivative lawsuit Adam brought against Libra in 2019, which Justice Bannon dismissed in full, the dismissal of which the appeals court then affirmed in full. Continue Reading Principles of Fiduciary Deference: The Business Judgment Rule and Exculpatory Clauses

In 2008, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery — one of the many intellectual giants and gifted writers who’ve occupied seats on that bench — published an article in the Delaware Journal of Corporate Law entitled Goodbye to the Contemporaneous Ownership Requirement.  The article argued that the contemporaneous ownership rule in shareholder derivative actions, embodied in DGCL Section 327 (“In any derivative suit instituted by a stockholder of a corporation, it shall be averred in the complaint that the plaintiff was a stockholder of the corporation at the time of the transaction of which such stockholder complains or that such stockholder’s stock thereafter devolved upon such stockholder by operation of law”) and likewise in New York’s BCL Section 626 (b), should be abolished as “unnecessary,” “incoherent,” “ill-suited to each of the purposes advanced to support it,” and “arbitrarily mandat[ing] the dismissal of potentially meritorious claims.”

At the risk of vastly over-simplifying VC Laster’s multi-pronged argument, the central point he made is that, as long as the derivative plaintiff is a shareholder upon commencing the action and for its duration, it’s meaningless whether the plaintiff owned shares at the time of the challenged corporate action because the claim belongs to the corporation and is being brought for the benefit of the corporation, not the shareholder.

In one of his subsequent opinions questioning the rule’s wisdom, Bamford v Penfold, L.P., VC Laster dropped an intriguing footnote referring to a “provocative article” published in 2010 by Professor of Law Lawrence Mitchell of The George Washington University entitled Gentleman’s Agreement: The Anti-Semitic Origins of Restrictions on Stockholder Litigation (available here).  As the title suggests, Professor Mitchell’s thesis is that the statutory contemporaneous ownership rule and other restrictions on derivative actions including the security requirement for small shareholders, first enacted in New York in 1944 and in Delaware the following year, were promoted by the non-Jewish, corporate defense bar dominated by white-shoe law firms to stymie shareholder suits being brought by predominantly Jewish lawyers.  From the footnote:

In 1944, the New York legislature adopted a suite of statutory limitations on derivative actions that included a security-for-expenses requirement and a contemporaneous ownership requirement. Professor Mitchell has argued that the legislation was influenced by the anti-Semitic prejudices of the predominantly non-Jewish defense bar and their reaction to the perceived prevalence with which predominantly Jewish lawyers represented plaintiffs in stockholder derivative actions challenging the corporate establishment. The New York initiative had widespread influence, as “[p]assage of the New York statute inspired a burst of heated attacks on the derivative suit as an abusive and corrupt device from supporters of business interests throughout the country.” Donna I. Dennis, Contrivance and Collusion: The Corporate Origins of Shareholder Derivative Litigation in the United States, 67 Rutgers U. L. Rev. 1479, 1520 (2015). Delaware notably did not adopt a security-for-expenses statute, but it seems likely that the 1945 enactment of Section 327 was spurred by the New York initiative.

Whatever its origins, VC Laster’s advocacy seeking to eliminate the contemporaneous ownership rule has not spurred its repeal by the Delaware legislature, hence Section 327 remains on the books.  Which brings me to an interesting opinion handed down last week by Chancellor Kathaleen St. J. McCormick in SDF Funding LLC v Fry in which, after remarking that Section 327’s contemporaneous ownership requirement “is not universally beloved” and referring to VC Laster’s scholarship on the issue, she considered and ultimately rejected the argument of a putative derivative plaintiff who ran afoul of the rule, that he should be afforded “equitable standing” to prosecute the action.

Continue Reading Equitable Standing in Shareholder Derivative Suit Bows to the Contemporaneous Ownership Rule

It’s hard not to feel sorry for the petitioner in Fernandes v Matrix Model Staffing, Inc., Decision and Order, Index No. 160294/2021 [Sup Ct, NY County Apr. 20, 2022].

In Fernandes, Manhattan Supreme Court Justice Frank P. Nervo authored a thorough, step-by-step analysis of the legal issues and defenses most commonly raised in support of and in opposition to a petition for corporate dissolution based upon “illegal, fraudulent or oppressive actions” by the entity’s controllers under Section 1104-a (a) (1) of the Business Corporation Law (the “BCL”).

The Court serially ruled that the petitioner stated sufficient grounds to dissolve Matrix Model Staffing, Inc. (“Matrix”), a modeling agency with offices in New York, Florida, and California, and that the respondent entity: (i) failed to demonstrate petitioner’s lack of standing, (ii) failed to raise a genuine issue of fact as to any of the facts in the petition, (iii) failed to demonstrate the existence of an “adequate, alternative remedy” to dissolution, and (iv) failed to forestall dissolution by exercising the buyout election under BCL § 1118. Sounds like a winning petition.

To the hapless petitioner’s undoubted dismay, though, the Court still referred the matter to a referee for an evidentiary hearing. Let’s see why the Court might have felt compelled to order a hearing on a petition for which the respondent failed to show any real defense. Continue Reading The Evidenceless Petition to Dissolve

In a post two weeks ago, I wrote about a pair of ground-breaking law review articles by Professors Meredith Miller and Ann Lipton addressing an issue of growing attention in society at large and in legal circles concerning sex discrimination not only against employees of firms covered by Title VII and related state and local anti-discrimination laws, but also discrimination against owners of closely held firms by their co-owners.  Generally speaking, such business owners are not within the protected class of employees covered under anti-discrimination laws.

As I promised in that post, this week I’m pleased to present a new episode of the Business Divorce Roundtable podcast featuring an interview of Professor Miller discussing her article entitled Challenging Gender Discrimination in Closely Held Firms: The Hope and Hazard of Corporate Oppression Doctrine. The article was published last year in Volume 54 of the Indiana Law Review and can be read here.

Professor Miller has law degrees from Brooklyn Law School and Temple University School of Law, clerked for a New York Court of Appeals judge, and in 2006 joined the faculty at Touro Law Center where she teaches contracts, business organizations, and employment law. Twice she’s been honored by her students as Professor of the Year. She also maintains a private practice at Miller Law, PLLC concentrating in business and employment law, appeals, and consulting.

Inspired in part by the Straka case that I wrote about in 2019, in which a New York judge in a judicial dissolution case compelled a buyout of a 25% female shareholder of an accounting firm based in part on her male co-owner’s discriminatory behavior, Professor Miller’s article explores the potential use and limitations of minority shareholder oppression doctrine to address discrimination against female co-owners of closely held businesses.

I encourage you to read the entirety of Professor Miller’s article which includes some of the basics of oppression doctrine and employment discrimination law. Below you’ll find the article’s abstract and a link to the podcast. While you’re at it, check out some of the other 20+ interviews available on the Business Divorce Roundtable available here.

The #MeToo Movement has ushered sexual harassment out of the shadows and thrown a spotlight on the gender pay gap in the workplace. Harassment and unfair treatment have, however, been difficult to extinguish. This has been true for all workers, including partners – those women who are owners in their firms and claim that they have suffered harassment or unfair treatment based on gender. That is because a partner’s lawsuit for discrimination often will suffer an insurmountable hurdle: plaintiff’s status as a partner in the firm means that they may not be considered an “employee” under the relevant employment discrimination statutes. This article discusses an underexplored and underutilized potential alternative in seeking a remedy for discrimination: oppression (or “freeze out”) doctrine in the closely held business. The article begins with a discussion of the current jurisprudence addressing when an owner is an employee for purposes of employment discrimination statutes. It also explores the doctrine of minority shareholder oppression, both as an instrument of enforcing fiduciary obligations and as a statutory mechanism to petition for dissolution or seek other equitable relief. The article then brings these subjects together by discussing how a female owner’s claim of discrimination or harassment fits into existing minority oppression doctrine, and by comparing the substantive requirements of discrimination claims and corporate oppression claims.  Ultimately, this article concludes that one of the advantages of oppression doctrine is that it need not be framed in gender-based terms to succeed. Indeed, in discrimination cases it is often very difficult to prove that the employment decisions were “based upon sex,” and oppression doctrine bypasses this requirement. However, this advantage in any individual case may also prove to be a greater overall disadvantage because, without framing the claim in gender-based terms, the broader goals of workplace equality are not advanced.

 

Closely-held business owners often hope to avoid the costs and delays of litigation by including arbitration provisions in their partnership, shareholder, and operating agreements. Things can get tricky, though, when nonsignatories get embroiled in the dispute, as the plaintiff learned in a recent decision from Suffolk County Commercial Division Justice Elizabeth H. Emerson.

In Fritch v Bron (74 Misc 3d 1217 [A] [Sup Ct, Suffolk County Mar. 1, 2022]), Justice Emerson considered, but ultimately rejected as inapplicable under the particular facts of the case, three of the five theories under New York law for binding nonsignatories to arbitration agreements. Fritch was a thoughtful discussion of the law of enforcement of arbitration agreements against nonsignatories, and offers an opportunity for us to author our first article devoted exclusively to the subject. Continue Reading Binding Nonsignatories to Arbitration Agreements