It’s commonly said there are three things that matter with real estate: location, location, location. Likewise, three things matter when choosing a lawyer to set up a limited liability company: experience, experience, experience.

Tom Rutledge’s terrific blog, Kentucky Business Entity Law, last week highlighted a case in which the admitted inexperience of the lawyer who organized an LLC ultimately proved fatal to its existence and to a farming operation owned by the same family for four generations over 100 years. It’s a sobering lesson for anyone contemplating forming a new LLC for a start-up business or to serve as the ownership vehicle for an existing business.

Felt v Felt, No. 18-0710, 2019 WL 2372321 [Iowa Ct App June 5, 2019], involved a dissolution lawsuit among the three children of Richard Felt, the third-generation owner of an Iowa farm. One of the children, David, worked and lived on the family farm for decades when his father was diagnosed with cancer in 2013 and died in 2015. Richard’s will left his property equally to David and his two siblings, Susan and Daniel. Continue Reading Trouble Down on the Farm: The Importance of Using Experienced Counsel When Forming an LLC

Often business owners enter into arbitration agreements because they hope it will result in a speedier, less expensive resolution than litigation to disputes with their co-owners. Arbitration agreements often achieve that result. But sometimes, epic disputes arise over the scope of arbitration agreements and the power of arbitrators to decide controversies under them.

In Matter of Capital Enters. Co. v Dworman, 2019 NY Slip Op 04494 [1st Dept June 6, 2019], a Manhattan appeals court, after three years of litigation and multiple appeals, decided the novel question of whether an arbitrator has the power to order dissolution of a New York partnership, and if so, the extent of the arbitrator’s discretion to fashion a remedy for winding up the partnership’s affairs.

The Partnership

Capital Properties Company (the “Partnership”) was a New York general partnership formed in the 1960s. The Partnership owned three residential apartment buildings in Manhattan. Alvin Dworman and Michael Palin (through another entity, Capital Enterprises Company), were the two, equal general partners of the Partnership. In 1981, Dworman and Palin entered into a written partnership agreement. Continue Reading Can an Arbitrator Order Extra-Judicial Dissolution?

If you’re a member of a multi-member LLC, and especially if it’s manager-managed, here’s a reason you might want to check under the hood of your LLC agreement: if the business goes belly up amidst squabbling or worse among the members and managers, to whom does the LLC agreement give authority to file for bankruptcy? The members? The managers? A majority of the managers or just one?

These are not just theoretical questions, having been the focus of a very recent decision by a federal district court, affirming a bankruptcy judge’s dismissal of a Chapter 11 bankruptcy filing on behalf of an LLC made by one of three managing members over the objection of the other two, in Catalyst Lifestyles Sport Resort, LLC v Sherrard, Opinion and Order, 2:18-CV-302-HAB [U.S. Dist. Ct. N.D. Ind. May 22, 2019].

The Catalyst case lies at the intersection of business divorce and bankruptcy law. The court’s opinion doesn’t describe the nature of Catalyst’s business, only that it is a member-managed Indiana LLC formed in 2015; that it has one 50% member (Tony) and two additional members (Josh and Todd) holding the remaining 50%; and that Catalyst’s downfall was due “at least in part” to conflict among the members that eventually resulted “in a flurry of court filings” beginning in 2017.

Tony filed the first state court lawsuit for injunctive relief after he was removed from the company’s bank account. Todd then filed a state court petition for judicial dissolution of Catalyst in which he alleged that the company was insolvent and could no longer operate because Tony refused to work with the other managers. Continue Reading Who Gets to Play the Bankruptcy Card Under Your LLC Agreement?

I’ve long been intrigued with the frequency of litigation — especially in Delaware Chancery Court — over advancement of legal fees of a corporate director or officer or LLC manager who’s the target of a lawsuit by the entity with which he or she is or was affiliated.

After all, advancement rights are straightforward, at least in concept:

  • The company’s organizational documents either do or do not require the company to advance a director’s or officer’s or manager’s attorney’s fees during the course of the litigation.
  • If they do, the target of the company’s claims either is or is not within the category of persons entitled to seek advancement.
  • If the target’s status qualifies him or her for advancement, either the claims asserted against the target are or are not the type of claims for which advancement is required, that is, arising “by reason of the fact” that the target is or was a director, officer, or manager.

The frequency of advancement litigation surely is influenced by its high stakes, both dollar-wise and leverage-wise, especially when the company is closely held and the adverse parties are co-owners. From the dissident owner’s perspective, he or she not only could be paying crippling legal fees to defend the claims, but as an equity owner he or she may also be paying indirectly the company’s legal fees, creating great pressure to settle absent advancement. It’s the opposite for the controlling owners: if advancement is required, indirectly they are financing the majority of all legal fees on both sides while incentivizing the dissident owner to litigate to the hilt. Continue Reading Ambiguous Advancement Provision Favors Former Officer and Director

This is the story of a deadlock resolution provision that backfired. It is a long story — 94 pages long to be exact. That is the length of Chancellor Bouchard’s characteristically detailed and thorough post-trial opinion issued last week in Acela Investments v DiFalco, C.A. No. 2018-0558-AGB [Del Ch May 17, 2019], in which he ordered the dissolution of a deadlocked start-up developer of abuse-deterrent opioid pain medications after finding that the LLC agreement’s deadlock resolution provision had planted the seeds of its own demise.

The Delaware limited liability company involved in Acela is named Inspirion Delivery Services (IDS) which owns two FDA-approved drugs. The venture was co-founded by a chemical engineer (DiFalco), a pharmaceutical industry scientist (Shah), and a pharmaceutical industry executive (Aigner). IDS attracted tens of millions of private equity dollars to fund drug development and the long and taxing drug-approval process. By the time of the lawsuit, only one of IDS’s two approved drugs was in production with limited commercial success.

IDS’s “Bespoke Governance Structure”

IDS’s LLC agreement contains what Chancellor Bouchard described as a “bespoke governance structure” in which Aigner as CEO and DiFalco as President performed their duties subject to each other’s “advice and consent,” and either Aigner alone or DiFalco and Shah together can veto any action of the IDS board of managers.

Continue Reading Can a Deadlock Resolution Provision Cause Deadlock? This One Did

Over the years, we’ve written a lot about limited partnership, corporation, and LLC “fair value” appraisal proceedings. An appraisal proceeding is a statutory remedy that allows a minority business owner to “dissent” from a business transaction and/or withdraw from the business and have a court determine the “fair value” of his or her interest in the business, usually for the purpose of a buyout of that interest by the majority owners or the entity itself.

Despite all we’ve written on the subject of appraisal proceedings, we have never given extensive treatment to the procedures involved in the run-up to, and initiation of, an appraisal proceeding. In New York, the steps one must take to commence an appraisal proceeding depend on the kind of entity involved, and are set forth in various statutes contained in the Partnership Law, the Business Corporation Law (“BCL”), and the Limited Liability Company Law (“LLC Law”). The purpose of this article is to collect those various statutes in a single reference source. This article is in response to a specific reader request. You ask, we deliver.

Step One: The Triggering Event

The first step in any appraisal proceeding is the occurrence of an event giving rise to a right of appraisal. There are myriad ways business owners can wind up in an appraisal proceeding, a subject about which we gave extensive treatment in this article. Some examples include “wrongful” partner withdrawal under Partnership Law 69, death or retirement of a partner under Partnership Law 73, the filing of a buyout election under BCL 1118 in response to a petition for corporate dissolution based upon oppression, and LLC member withdrawal under LLC Law 509. Continue Reading How to Initiate a Fair Value Appraisal Proceeding – a Dissenter’s Checklist

A Plug for Cunningham on IRC 199A

Tax issues always have been an integral factor in valuing closely held business entities, whether for purposes of a court-supervised buyout or otherwise. The Tax Reform Act of 2018 added an important, new deduction for pass-through business owners, called the 199A deduction, providing business owners with federal income tax deductions of up to 20% of their net business income. I’ve started to see business appraisals that deal with the 199A deduction and, of course, the 199A deduction can provide substantial tax savings for business owners in the ordinary course, having nothing to do with appraisals or business divorce scenarios.

Taking advantage of the 199A deduction also can require a restructuring of the business, which is why I’m recommending a new book by my friend John Cunningham called Maximizing Pass-through Deductions under IRC Section 199A published by Wolters Kluwer. John has made it his mission to educate and help business owners navigate the complexities of the 199A deduction and with restructuring their businesses when required. Some of you may recognize John’s name from posts on this blog or my interview of John on my podcast on various LLC issues–a topic on which John also is a top expert and author of the leading LLC formbook and practice manual entitled Drafting Limited Liability Company Operating Agreements also published by Wolters Kluwer.

It was, as both principals of a start-up management consulting business testified at trial, a “partnership made in heaven,” which doesn’t exactly bode well for the celestial ambitions of the rest of us given that the litigation between the partners lasted longer than the partnership.

Vice Chancellor Glasscock’s recent valuation opinion in Smith v Promontory Financial Group, LLC, Mem. Op., C.A. No. 11255-VCG [Del Ch Apr. 30, 2019], tells the fascinating story of two individuals — Neil Smith, a seasoned management consultant in the profit improvement field, and Eugene Ludwig, a former U.S. comptroller of the currency and head of a financial services advisory firm — who together formed a Delaware company called Promontory Growth and Innovation, LLC (PGI), to provide management consulting services to financial services companies to enhance earnings and business performance.

Essentially, Ludwig had the rainmaking connections with CEOs of large companies while Smith had the expertise to close the deals and perform the client projects. PGI’s business model contemplated a very small number of one-shot engagements each year with large corporations, charging a contingency fee based on a percentage of the client’s increased profits. Landing an account, as Smith described it at trial, was like “finding the needle in the haystack,” requiring meeting with the right executive at the right time. Continue Reading Half-Baked LLC Agreement Yields Improvised Valuation Decision

“I will not seek or accept an award in excess of $74,999.99, inclusive of punitive damages, attorney’s fees and the fair value of any injunctive relief.”

With that statement, in Paddison v Paddison, Civil Action No. 19-2109 [U.S. Dist. Ct. E.D. La. Apr. 16, 2019], one of two brothers in a business divorce showdown over their jointly owned LLC just barely managed to defeat the other brother’s effort to litigate the case in federal court based on diversity jurisdiction, which requires an amount in controversy in excess of $75,000.

OK, math sticklers, I confess, I should have entitled this post, For Want of Two Pennies. It just didn’t sound as good.

This blog previously has featured several posts (here, here, here, and here) highlighting the barriers to litigating business divorce cases in federal court where subject matter jurisdiction is limited to (1) claims arising under federal law or (2) where there is complete diversity of citizenship between the adverse litigants and the amount in controversy exceeds $75,000. Continue Reading For Want of a Penny: Business Divorce Case Almost Makes it Into Federal Court

As it approaches its sixth anniversary with little sign of letting up, the highly contentious litigation between brothers and business partners Nissim and Avraham Kassab is the gift that keeps on giving, at least to us outside observers and business divorce aficionados.

In one after another decision over the years, Justices Orin Kitzes (since retired) and Timothy J. Dufficy of the Queens County Supreme Court have tackled a series of thorny legal issues arising out of the brothers’ dysfunctional relationship as co-owners of a corporation (“Corner”) and an LLC (“Mall”) that own adjoining, vacant parcels in downtown Jamaica, Queens, operated together as a single parking lot and for weekend flea markets. In 2013, Nissim as 25% owner sought judicial dissolution of both on grounds of oppression, breach of fiduciary duty, and looting by Avraham who in turn accused NIssim of diverting parking lot and flea market revenues for his personal benefit.

Nissim ultimately won his bid to dissolve Corner under BCL § 1104-a. Justice Dufficy’s August 2017 post-trial decision appointed a receiver who, after Avraham declined the court’s offer to purchase Nissim’s shares for fair value, last year auctioned off Corner’s vacant parcels to a real estate developer for about $19 million. Continue Reading Third Time’s Not a Charm in LLC Dissolution Case

One of the great ironies of New York business divorce litigation is that so much of it involves the breakup of law firms. Perhaps it’s because New York is the center of the legal universe and the home state of thousands of law firms. Maybe it’s because lawyers are litigious by nature. Another, less obvious reason: law firms often imprecisely use the term “partner” to describe their lawyers.

Under Section 10 of the Partnership Law, the term “partnership” means an association of two or more people to carry on a business for profit “as co-owners.” By definition, “partner” means an owner who shares in profits and losses. But the archetypal law firm general partnership long ago gave way to other business forms, and even law firms that still adhere to the partnership form adopt agreements opting out of the default rules to provide for a wide variety of so-called “partners” –  “equity partner,” “non-equity partner,” “income partner,” “profits partner,” “contract partner,” “general partner,” “limited partner.” The use of the term “partner” to describe folks who are not equity “partners” creates the potential for ambiguity, and ambiguity begets litigation.

If there is apparent ambiguity, to what extent must courts rely on the entity’s tax returns to decide the issue of ownership? In Mahoney-Buntzman v Buntzman, 12 NY3d 415 [2009], New York State’s highest court wrote a seemingly hard-and-fast rule: “A party to litigation may not take a position contrary to a position taken in an income tax return.” Business divorce lawyers love to cite this rule when they believe it helps their position to prove or disprove ownership status in a business. A few months ago, we wrote about precisely such a case, Rosin v Schnitzler, 2018 NY Slip Op 32320(U) [Sup Ct, Kings County Sept. 4, 2018], in which Commercial Division Justice Lawrence S. Knipel, relying on Mahoney-Buntzman, held that an LLC’s filing of Schedule K-1s identifying the plaintiff as a member proved his membership status in the business. Continue Reading The Law Firm “Partner”- A Rose by Any Other Name . . .