Fall Road

In the world of business divorce litigation, this summer saw everything but a slowdown.  We witnessed (and blogged about) Justice Crane cap a long-running fair value proceeding with helpful guidance on appraisals and discounts, watched the birth of a potential claim for equitable dissolution of Delaware LLCs, and heard from the Court of Appeals on the internal affairs doctrine. 

Now, along with shorter days, crisper mornings, and the sound of school buses returning to their routes, comes more fresh cases and hot topics.  Especially in the context of limited liability companies, the ingenuity of closely held business owners, the variety of their arrangements/disputes, and the creativity of counsel all ensure that the already rich body of caselaw governing LLCs and their members will grow even richer.

This week’s post kicks off the season with some fall table-setting.  Two cases, both of which should cause an LLC to think twice about what it means to award equity to an employee, are worth closely watching as the leaves turn.

Continue Reading Conditional Grants of Membership Interests Are a Roadway to Courtroom Conflict
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The absolute litigation privilege is a long-standing legal principle that statements made during the course of a judicial proceeding by participants in the proceeding (whether parties, attorneys, witnesses, or judges) are absolutely privileged, protecting the speaker from subsequent claims of defamation or libel arising out of those statements.

The public policy objective behind the privilege is fairly straightforward. Parties to an action should be free to litigate their case—whether zealously prosecuting their claims or vigorously defending against an adversary’s claims—without fear that statements made during litigation will open them up to future claims for defamation. A recursive loop of litigation (i.e. suing you because of what you said when you sued me) serves no one, least of all the courts.

As such, the privilege is a broad one. When applied, it offers a complete defense regardless of the truthful of the statement, even where the statement was made with malice or ill-intent.  

But, broadly applied does not mean blindly applied. The application of the privilege to contract claims is a question courts have only recently started to wrestle with.

Today’s post concerns a decision out of the Delaware Chancery Court, in which the Court was tasked with determining whether the absolute litigation privilege bars the exercise of a contractual repurchase option triggered by claimed disparaging statements made in a prior litigation.  

In Sevatec Holdings Inc. v Octo Platform Equity Holdings, LLC, C.A. No. 2022-0437-PRW, the Court held that, no, the absolute litigation privilege “has no bearing on the validity of the repurchase.”

The Business

Sevatec, LLC, founded in 2003 by Sonny Kakar, was a technology services firm that provided a variety of design, development, security and operations, as well as cloud service and data integration services to federal agencies. Over the years, it steadily grew from a small business into a solid mid-tier federal IT service provider.

Octo Consulting Group, LLC, founded in 2006, operated in a similar market, providing technology and IT modernization services to federal agencies.

At the time of the November 2020 merger, both companies were ready to expand, with certain synergies between them that would serve the combined business well. In fact, just 2 years later, in December 2022, IBM purchased the business.

The Contracts

Operating under parent company Octo Platform Equity Holdings, LLC (i.e. the defendant in this action), Kakar was to join the business as Head of Strategy and Vice Chair of the Board. Kakar also received shares in the company through a holding company, Sevatec Holdings, Inc. (i.e. the plaintiff here).

Kakar had an executive employment agreement that included a commitment not to “publish or communication” any “disparaging” statements about Octo. Such “disparaging” remarks include: “those intended to impugn the character, honesty, integrity, reputation” or “business abilities in connection with any aspect of the operation of business of the individual or entity being disparaged.”

Octo’s contractual right of repurchase, governed by a side-letter agreement and the company’s operating agreement, could be triggered by: “a material breach by Mr. Kakar of any of the restrictive covenants with respect to confidentiality… non-competition, non-solicitation, non-interference or non-disparagement obligations in either his [Employment Agreement] or his Non-Competition Agreement.”

The Dispute

Though Octo announced its successful integration of the Sevatec businesses in April 2021, behind the scenes, there was trouble in paradise. The parties unsurprisingly point the finger at each other for the breakdown in the relationship. Whatever the reason, the relationship rapidly unraveled a mere 9-months into the merger:

  • In August 2021, Octo issued a notice of for-cause termination and removal to Kakar.
  • On January 14, 2022, Kakar sued Octo for defamation in Virginia state court based on the issuance of the termination notice. On the same day, Kakar simultaneously commenced an action in Delaware Superior Court asserting a number of business tort claims for fraudulent inducement and breaches of the transaction documents, among others.
  • On February 14, 2022, Octo sent Kakar a repurchase notice exercising its option to repurchase Kakar’s shares triggered by the “publicly filed” complaints containing allegedly defamatory statements in violation of Kakar’s non-disparagement obligations.
  • In March 2022, Kakar commenced the 3rd action between the two camps in as many months, this time in the Delaware Court of Chancery, chiefly challenging Octo’s right to repurchase and claiming deficiencies in its exercise thereof.

After whittling down the various claims and counterclaims, the two Delaware cases were consolidated, and the parties cross-moved for partial summary judgment.

An Inherent Tension Between a Freedom to Litigate and a Freedom to Contract

Delaware Superior Court Judge Paul R. Wallace, sitting by designation, determined from the outset that the “bulk of this consolidated action will proceed to trial,” but that “in an attempt to clear the legal underbrush,” the Court’s analysis would focus on the repurchase.

The Court identified the three Delaware cases that discuss the applicability of the absolute litigation privilege’s protection to contractual claims, and highlighted the tension that exists “in balancing the public policy interest of encouraging the freedom of a person to pursue one’s claims in court and that of upholding the freedom of contract”:

  • Ritchie CT Opps, LLC v Huizenga Managers Fund LLC (2019): Plaintiffs sought to enjoin defendants from making allegedly disparaging statements in other lawsuits defendants commenced. The court, in applying the privilege, denied the injunction as it would not “vindicate” the parties’ contractual rights, but would instead, “render contract rights effectively unenforceable.”
  • Sheehan v Assured Partners, Inc. (2020): Seller sold his business and entered into an employment agreement with the purchaser, including reciprocal non-disparagement obligations. After the closing, the buyer discovered alleged fraud and sued the seller. Seller, then, sued the buyer for breach of the non-disparagement clause. The court applied the privilege, barring the seller’s breach of non-disparagement claim, “because of the risk of ‘chilling litigation’ and creating an unending cycle of side-litigation.”
  • Feenix Payment Sys, LLC v Blum (2022): Defendant asserted the absolute privilege to defamation and contract-based claims based on allegedly defamatory statements in his pre-litigation letter. The Court declined to apply the privilege, holding that the application of the privilege would “undermine” the parties’ freedom of contract, as the defendant was a “sophisticated party who consented to the non-disparagement and confidential provisions” and should therefore be held “to the obligations he decided to assume.”

In Delaware, Contractarianism Reigns Supreme

The arguments on both sides are compelling.

Octo relied on Feenix to argue that the litigation privilege does not relieve Kakar of his contractual obligations, as extensively negotiated and agreed to. Unlike in Ritchie CT Opps and Sheehan, Octo is not seeking an injunction or asserting a defamation claim, nor it is otherwise looking to control Kakar’s litigation strategy. Instead, Octo seeks only to enforce its contractual right to exercise its repurchase option triggered by Kakar’s disparaging statements, albeit made in the context of litigation.

On the other hand, and relying on Ritchie CT Opps and Sheehan, Kakar argued that enforcing the repurchase option would violate the absolute litigation privilege because it would impermissibly chill Kakar’s litigation against Octo. Since the privilege bars Octo from outright asserting defamation and contractual non-disparagement causes of action against Kakar based on the Virginia and Delaware complaints, the privilege should also bar triggering Octo’s repurchase option based on those same claimed disparaging statements.

The Court sided with Octo, holding: “Seva’s request finds no support in Delaware’s contractarian regime.”

The Court acknowledged the tension between the freedom to litigate and the freedom to contract, both of which have strong public policy behind it. While the privilege bars contractual non-disparagement claims, the Court declined to extend it one step further, “to expand the scope of the absolute litigation privilege as a means to nullify the repurchase of a member’s interest in a Delaware limited liability company,” a proposition the Court found had no support in Delaware.

The “specter of potentially chilling litigation by enforcing the Repurchase Option” was, in the Court’s eyes, weaker in comparison to the precedent cases, in that Kakar “is free to continue litigating his claims.” In other words, the Court held Kakar to the consequences of his choice to litigate, relying on Delaware’s “maximum freedom in allowing parties to order their governance arrangements.”

Lingering Questions

But isn’t there a chilling effect on litigation, though?

While I don’t disagree with the Court that the absolute litigation privilege should not be wielded as a sword—or rather, a pen—to effectively change the terms of extensively negotiated agreements between highly sophisticated parties (and their army of lawyers), there is something… unsettling about the Court characterizing the repurchase as a “collateral effect” of Kakar’s decision to litigate his claims against Octo.

It seems a little harsh forcing a litigant to choose between keeping their claims but losing their shares, or vice versa. Aside from the obvious financial impact of losing shares in a successful company, what if Kakar had asserted derivative claims? Wouldn’t Octo’s exercise of the repurchase option destroy the shareholder standing required to maintain those claims?

I suppose the appropriate response is an exhortation that clients and their counsel carefully read and consider buy-sell or repurchase clauses contained in any governing agreement, particularly with respect to the triggers, as we have cautioned on this blog time and time again.

That the 3 Delaware cases cited were issued within the last 5 years points to an emerging application of an ancient doctrine to keep an eye on.

What about New York?

New York case law is even more sparse on the topic. Although we’ve covered the absolute litigation privilege once before on this blog (see Frank McRobert’s post here), the only case coming close to a similar fact pattern as Sevatec that I came across was TRB Acquisitions LLC v Yedid, 215 AD3d 40 [1st Dept 2023], where the First Department reinstated plaintiffs’ claim for breach of a confidentiality and non-disparagement agreement as improperly dismissed. But there, in declining to apply the absolute litigation privilege, the First Department relied on an exception to the privilege (as opposed to relying on freedom of contract principles), finding: “An extortion attempt by threatening to provide false testimony in a separate action if his demand in the arbitration was not accepted and, following rejection, affirmatively reaching out to plaintiffs’ adversaries in the separate Reebok litigation, indeed offering to provide false testimony in that action—is a course of conduct for which the protection afforded by an absolute privilege is appropriately withdrawn.”

But, in Gottwald v Sebert, 40 NY3d 240, 253 [2023], issued just a few months after the TRB decision, the New York Court of Appeals addressed a line of cases standing for the proposition that the absolute litigation privilege may be “lost if abused,” and abrogated those cases. Specifically, the Court of Appeals held that the “sham exception” to the absolute litigation privilege is “inconsistent with the absolute privilege recognized by this Court for statements made in connection with judicial proceedings.”

How New York Courts address this going forward has yet to be seen, as there have not been any cases testing the application of exceptions to the privilege since Gottwald.  Given the above, I’m just not sure how a New York court would decide a case like Sevatec today.

If Sisyphus were a judge, he’d be assigned the Fuks case.

Fuks began on December 26, 1996. Fire up your mental time machine, travel back in time, and picture what was going on in your life those many years ago.

I just finished my first semester of college. My biggest worry was what to do for New Year’s Eve because my favorite band was not playing MSG. Over the next 28 years, I attended and graduated college. Moved to Colorado. Moved back to New York. Attended and graduated  law school. Took the bar exam. Began and grew a law career. Met friends, lost friends, got married, had two kids, got divorced, got promoted to partner, got remarried to the greatest woman ever. And all this time, the Fuks case remained a constancy, a Sisyphean boulder for the unfortunate jurists assigned to it.

An end of sorts finally arrived in June, when Manhattan’s Appellate Division – First Department issued Fuks v Rakia Assocs., 228 AD3d 501 [1st Dept 2024]. In Fuks, the Court affirmed the imposition of a $375,000 money damages award in favor of a 50% general partner against the other for breach of fiduciary duty.

What jumped out about Fuks was not the case’s astounding longevity, but the following snippet of legal doctrine:

While there was little direct evidence of the amount of damages, there is no question that Shomron’s breaches caused plaintiff injury. This, along with the other evidence in the record of damages caused by Shomron, was sufficient, given the special nature of fiduciary duty claims and the lenient standard for proof of damages in such cases.

Is there a more “lenient standard” for “proof of damages” where the plaintiff alleges breach of fiduciary duty? If so, when will courts apply this more forgiving evidentiary standard?

We’ll consider those questions in this week’s piece.

Continue Reading Breach of Fiduciary Duty: A More “Lenient Standard” for Damages?
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“It all started when the distributions stopped.”  In my travels as a business divorce litigator, I’ve seen many disputes between LLC co-owners that begin with that message.  A minority owner is content to remain a “silent partner”—letting the majority run the business—for as long as the checks keep coming.  Once the distributions stop, the minority partner begins to distrust, investigate, and second-guess, and the embryo of a business divorce takes shape.

But unless they find evidence of the majority’s self-dealing or other affirmative misconduct, minority owners seeking to restart a dried-up distribution tap find themselves at the bottom of a very steep climb.  Absent some provision in the operating agreement saying otherwise, the decision to distribute profits lies in the discretion of those in control.  That reality can lead to frustration and financial strain, particularly when the minority owner relies on the distributions as a return on their investment.

So, under what circumstances can a minority LLC owner compel the majority to issue distributions?  That question, and a recent decision from New York County Justice Reed, Schneider v Pine Mgt., Inc., 2024 NY Slip Op 51030(U) [NY County Aug. 8, 2024], inspires today’s discussion. 

Continue Reading Prudent Management or Financial Starvation: Can Minority Members Compel the Majority to Make Distributions?

Welcome to this 14th annual edition of Summer Shorts. This year’s edition features brief commentary on three recent decisions by New York courts in business divorce cases. The featured cases involve a suit pitting three siblings against their aunt and uncle over a realty holding LLC initially co-owned by the siblings’ deceased mother; the grant of a large bonding requirement in a fair value appraisal proceeding that landed the subject company in Bankruptcy Court; and a dispute between former partners in a dissolved law firm over the post-dissolution allocation of cases and fees. Click on the case names to read the decisions.

Did These Alleged One-Third LLC Members Need an LLC Law § 608 Rescue?

In the last year there have been significant court decisions in business divorce cases seemingly expanding the rights of representatives of the estates of deceased LLC members. Last year, in Andris v 1376 Forest Realty LLC, New York’s Appellate Division, Second Department, condoned without discussion a judicial dissolution petition by the executor of a deceased LLC member under § 608 of New York’s LLC Law, which confers upon the estate representative “all of the member’s rights for the purpose of settling his or her estate or administering his or her property” (read here).

Continue Reading Summer Shorts: An Unusual Application of LLC Law § 608 and Other Decisions of Interest

Contracts with “prevailing party” provisions offer the tantalizing, coveted prospect of the winner recovering attorneys’ fees from the loser in legal disputes over the contract’s enforcement.

Prevailing party fee-shifting provisions are an exception to the litigant-loathed “American rule,” under which the winner cannot recover attorneys’ fees from the loser unless explicitly authorized in an “unmistakably clear” contract, statute, or court rule.

A simple prevailing party provision goes something like: “If either party brings an action to enforce the terms of this agreement, the prevailing party shall be entitled to reimbursement of its reasonable attorneys’ fees, costs, and expenses in connection with such action.”

Prevailing party provisions can be simple to read, but difficult to apply, occasionally spawning a litigation within a litigation over whether one side or the other actually prevailed. A court’s task of determining whether one side or the other – or any side at all – is the prevailing party gets complicated when each side lobs a raft of claims and counterclaims against the other, and neither wins much of the relief it sought.

This problem arose in a recent decision concluding a proceeding to confirm an arbitration award in an astoundingly long-running legal dispute among three doctors in a medical practice called New York Urologic Institute (“NYUI”).

YC MD, P.C. v Shusterman (___ AD3d ___, 2024 NY Slip Op 03893 [2d Dept July 24, 2024]), is a warning to petitioners / plaintiffs to critically and objectively assess the strength of their claims before embarking upon a legal proceeding under a contract with a prevailing party provision. Unsuccessful prosecution of those claims can have dire consequences, the resulting fee award dwarfing any actual monetary award to either side.

Continue Reading “Prevailing Party” Attorneys’ Fee Provisions
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“[I]n this world nothing can be said to be certain, except death and taxes.”

— Benjamin Franklin, 1789

A solid succession strategy is a critical element of corporate planning, but one that is all too often sidelined until it is too late. Under the glow and excitement of starting and growing a business, who wants to talk about the death of an owner? But, as business divorce litigators, we have all seen one too many cautionary tales of the impact that an unplanned death can have on a business and its surviving owners, particularly where there is no governing agreement in place.

In February 2023, my colleague, Peter J. Sluka, posted an insightful analysis of Andris v 1376 Forest Realty, LLC— a case so nice, we featured it twice (here and here)— which supported an executor’s right to seek judicial dissolution of an LLC following the death of a 50% member under the default provisions of New York’s LLC Law 608. In so doing, Andris appeared to buck the trend in New York of analogous precedent in which New York courts previously denied an estate’s standing to assert derivative claims (as belonging only to a member and not an assignee or economic interest holder).

Peter anticipated seeing a rise in estate counsel now pushing for the exercise of member rights, including dissolution, citing to Andris and LLC Law 608. That is, “until a more definitive case comes along.” That definitive case may have arrived, fresh out of the hallowed halls of the Delaware Chancery Court.

In a 68-page Post-Trial Opinion in a case involving the Goldman real estate empire, Vice Chancellor J. Travis Laster confronted the scope of Section 18-705 of the Delaware Limited Liability Company Act (the equivalent to New York’s LLC Law 608) which presented issues of first impression in Delaware: Gurney-Goldman v. Goldman, C.A. No. 2023-1124-JTL (Del. Ch. July 12, 2024)

Continue Reading When It Talks Like a Member, Walks Like a Member, Acts Like a Member… But Isn’t a Member: First Impression Chancery Decision Rules on Estate’s Exercise of Member Rights “For Proper Purpose”

Delaware Chancery Court’s contractarian approach to all things LLC, embedded statutorily in Section 18-1101(b) of the Delaware LLC Act (“It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements”), has been no less forceful in its rich body of caselaw tethering LLC members to the text of their operating agreement when addressing applications for judicial dissolution of LLCs under Section 18-802 of the Act.

Section 18-802, which closely resembles New York’s LLC Law Section 702, authorizes Chancery to decree dissolution of an LLC “whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.” In a string of seminal decisions including Haley (2004), Silver Leaf (2005), Seneca (2008) Fisk Ventures (2009), and Arrow (2009), Chancery developed a two-prong standard for judicial dissolution either where there exists deadlock that prevents the LLC from operating with no mechanism in the operating agreement to break deadlock, or where the LLC’s purpose as defined in the operating agreement cannot be carried out.

In Vice Chancellor Laster’s 2015 Carlisle opinion, which I wrote about here, the court broke new, not-so-contractarian ground by holding that it could order the dissolution of an LLC under the court’s traditional equity jurisdiction at the behest of a non-member assignee of a membership interest who otherwise lacked standing to seek dissolution under Section 18-802.

But that’s not the sort of equitable dissolution I want to focus on. The sort I have in mind is where the court entertains and grants a statutory claim for judicial dissolution of an LLC where the facts don’t fit neatly or at all the articulated standard yet the equities as between the parties demand dissolution as a matter of good old-fashioned fairness. Delaware’s contractarian LLC jurisprudence does not welcome that definition of equitable dissolution, nor can I point to any examples of Chancery decisions that fit that bill.

Until now, at least arguably.

In a post-trial opinion handed down earlier this month by Vice Chancellor Will in Gibson v Konick, the court ordered dissolution of an LLC formed for the purpose of owning a vacation home. The LLC had two, formerly romantically involved, 50/50 members. The operating agreement named one of them sole manager, hence there was no deadlock as that term is normally used to refer to the contractual inability to exercise managerial authority. The operating agreement’s stated purpose was to acquire, develop, and own residential property. Those purposes either were achieved or remained attainable.

So how did the court conclude grounds for dissolution under Section 18-802? As I see it, in a word: fairness.

Continue Reading Did Chancery Court Just Crack Open the Door to Equitable Dissolution of LLCs?

Buy-sell agreements come in all shapes and sizes. Some are straightforward. Others are outrageously complex, especially purchase price formulas. Some have triggers for death. Others disability. Retirement. Expulsion. Termination of officership, directorship, employment.

Some are mandatory. Others discretionary. Where buy-sell agreements are discretionary, a whole set of additional rules – the law of options – comes into play.

Under the law of options, “strict compliance with terms setting forth the time and manner of an option’s exercise” is indispensable (Agostino v Soufer, 12 AD3d 204 [1st Dept 2004]).

“Not only is strict adherence to the terms of an option ordinarily required, but it is a broadly accepted principle that time is of the essence with this type of contractual provision” (Urban Archaeology Ltd. v Dencorp Investments, Inc., 12 AD3d 96 [1st Dept 2004]). Failure to strictly comply with an option’s terms – especially a contractual closing deadline – can be deadly (see id. [“the court was without the power . . . to extend the buyout option beyond the contractually agreed-upon 90-day period”]).

But “a party to an option contract may waive its right to insist upon strict compliance with those terms, either expressly or by its conduct” (Lamberti v Angiolillo, 73 AD3d 463 [1st Dept 2010]). “A valid waiver” of an option exercise deadline “requires no more than the voluntary and intentional abandonment of a known right which, but for the waiver, would have been enforceable” (Gresser v Princi, 128 AD2d 752 [2d Dept 1987]).

These competing rules of law were at play in a recent appeals court decision in a particularly nasty father-son litigation over a donut franchise empire, Burns v C.R.B. Holdings, Inc. (___ AD3d ___, 2024 NY Slip Op 03609 [4th Dept July 3, 2024]).

Continue Reading Dollars, Donuts, and Buy-Sell Options
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Just a few weeks ago, I commented on a recent uptick in disputes centered on the breakup of professional services firms.  In those disputes, we expect that the demands of the legal, accounting, and medical professions draw individuals with keen attention to detail, focused on documentation, and prepared for all contingencies.  Less expected is the irony that many attorneys, accountants, and medical professionals fail to bring those attributes to the table when organizing their business relationships. 

The result of that failure is a tinderbox—poorly defined “partnership” relationships, mixed with high profit margins, difficult to value businesses, and type A owners willing to litigate their disputes.  The right spark triggers bitter and hotly contested litigation.  That part-legal, part-psychological phenomenon explains why business divorces of professional services corporations—especially law firms—can get complicated fast. 

Motivated by that uptick, Becky Baek and I were pleased to recently present a CLE on the complexities that arise in the dissolution or breakup of law firms.  Here are the highlights.

Continue Reading Special Considerations for Law Firm Breakups