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 . . .

Most judicial dissolution cases in New York courts involve a single entity. When the target of dissolution is structured as a holding company for one or more operating or asset-based companies with asymmetric management, the issues can get hairier.

Case in point: Brooklyn Commercial Division Justice Lawrence Knipel’s recent decision in Matter of Lev v Rosenberg, 2019 NY Slip Op 30824(U) [Sup Ct Kings County Mar. 13, 2019].

I’ll get to the mulligan in a bit.

The Lev case pits two co-owners against a third. The two petitioned under § 121-803 (a) of the Revised Limited Partnership Act for judicial supervision of the winding up of a real estate limited partnership of which the third owner was the sole managing 1% general partner. They also sought the appointment under LLC Law § 703 (a) of a liquidating trustee for an LLC formed by the three of them as co-equal one-third members to hold a 98.9% limited partner interest and a 0.25% general partner interest in the partnership. The partnership’s realty consists of a low-income residential apartment building in Brooklyn apparently valued north of $30 million. Continue Reading No Mulligan But No Matter for LLC’s Majority Members After Voluntary Dissolution

The discoverability of materials in civil litigation in general resists any hard and fast rules, other than that the scope of discovery is broadly defined and liberally applied under the rules of civil procedure in both state and federal cases, and that judges are afforded broad discretion in deciding what’s “material and necessary” (NY CPLR 3101 (a)) or “relevant” (Fed.R.Civ.P. 26 (b) (1)) based on the specific facts and issues in each case.

In contested stock valuations triggered by elections to purchase in statutory dissolution or dissenting shareholder cases, it’s only natural that purchaser and seller both are motivated to obtain discovery from the other for possible use at trial of any pre-litigation appraisals of the corporation’s equity, whether or not obtained in contemplation of litigation, in the hope that the appraisal will undermine the valuation performed by the other’s expert witness at trial.

Business and real estate appraisals may be secured in the ordinary course for a host of different reasons having nothing to do with shareholder disputes. The probative value of the appraisal in any subsequent litigation over stock value may depend on its proximity in time to the valuation date in the case, its purpose, the standard and premise of value employed, and other variables.

Occasionally, a stock valuation contest is triggered by the death of a shareholder under the terms of a shareholder agreement requiring a buy-out of the estate’s shares, or involves a statutory buy-out of shares owned by a living shareholder who acquired the shares by inheritance from a former, deceased shareholder. In such cases, the purchaser may seek discovery of any stock appraisal done for purposes of reporting the stock’s value on the Form 706 tax return that must be filed on behalf of the deceased shareholder’s estate. Continue Reading Disclosure of Estate Tax Stock Appraisals in Shareholder Disputes

When 50/50 co-owners of a business are deadlocked on a major business decision, unless they have a written agreement in which a declared deadlock triggers a buy-sell process or appointment of a specific third person to cast a deciding vote, the unresolved deadlock may lead to litigation or even dissolution of the business entity.

In many instances deadlock is not the cause of a dysfunctional relationship between the 50/50 owners but, rather, is symptomatic of an irreconcilable breakdown of their personal relationship and/or divergence of interests. In those cases, either the owners will negotiate an amicable separation or they will end up in court litigating claims for dissolution, breach of fiduciary duty, accounting, etc. Or, if the owners have an agreement with an arbitration clause, their legal claims will be litigated privately before an arbitrator.

But what if the deadlock isn’t just a signpost on the road to dissolution? What if co-owners who otherwise have a healthy working relationship simply can’t agree on a particular business issue of importance, such as fixing an annual budget or opening or closing a business location or expanding a product line? If their agreement has no mechanism for breaking it, how can the deadlock be resolved without allowing the disagreement to fester into something bigger and potentially more disruptive?

It’s a question arbitrator/mediator Erica Garay of Garay ADR Services tackles in a recent article published in the Nassau Lawyer called Using an Arbitration Clause to Break Corporate Deadlock. Her solution is addressed to transactional lawyers: broaden the scope of the arbitration clause in the shareholder or operating agreement, beyond the standard references to disputes and claims, to mandate binding arbitration of deadlock if good faith negotiations don’t do the trick.

I was both intrigued and puzzled by Erica’s proposal. On the one hand, I’m a big believer in alternative dispute resolution in most if not all business divorce matters, particularly mediation. On the other hand, unless the clause names as arbitrator someone known to the owners and who’s familiar with the business, the idea of putting a pure business decision (as opposed to resolution of a legal claim) in the hands of a law-trained arbitrator who’s a stranger to the business struck me as a hard sell to business owners.

My own solution was to invite Erica onto my Business Divorce Roundtable podcast for what turned out to be a lively and thought-provoking interview on the subject of arbitrating deadlock. I came away from the interview more convinced, at least for certain types of deadlock where an arbitrator who doesn’t know the business can decide the issue based largely on objective criteria, that Erica’s idea has validity, although it would require forethought and definition in the agreement of the specific types of deadlock that would trigger a duty to arbitrate.

You can listen to the interview with Erica by clicking on the link that follows. You also can subscribe to the podcast on iTunes, SoundCloud, Stitcher, or wherever you listen to podcasts. If you’re a lawyer, business appraiser or business owner with a business divorce story you’d like to share for a future podcast, drop me a line at pmahler@farrellfritz.com.

Years ago, we wrote about the perils of “impromptu” settlements in business divorce cases – settlements eked out at the courthouse, on the fly, under pressure, during conferences, hearings, or trials. The resulting agreements tend to be memorialized in on-the-record, transcribed settlements made verbally between lawyers, clients, and the judge.

In-court settlements are both common and vital to litigation, the ultimate goal of which, of course, is to resolve disputes. But sometimes the parties’ eagerness to resolve a lengthy, difficult litigation can cause them to overlook or ignore subtle (or not-so-subtle) aspects of the deal vital to the overall transaction.

In a recent decision, fissures in the façade of an impromptu settlement began to appear almost from the moment the parties put their agreement on the record. What followed was a series of painful, two-and-a-half year, post-settlement proceedings – a veritable parade of horribles that reached its climax in a decision last month by a Manhattan appeals court in Kadosh v Kadosh, 169 AD3d 439 [1st Dept Feb. 7, 2019]. Continue Reading A Pig in a Poke: The Rollercoaster Kadosh Settlement Litigation