Don’t Miss the 2020 LLC Institute Virtual Meeting!

It’s that time of year again, when leading experts and practitioners in the field of closely held business entities gather for the LLC Institute’s spectacular CLE program. It’ll be a virtual meeting this year, which unfortunately means there won’t be the usual opportunities to talk shop and socialize outside the meeting room. The good news is, the virtual program with sessions on November 6, 9, 11, and 13 is more accessible, affordable, and easier to fit into busy schedules. This year’s agenda includes several programs of special interest to business divorce aficionados, with a focus on LLCs. For more information about the program and registration, click here.

Unlike states that have enacted the Uniform Revised LLC Act with its provisions for judicial expulsion of an LLC member, New York’s LLC Law contains no such provision. Instead, in New York, only non-judicial expulsion is recognized and only if authorized by the operating agreement.

Until now, New York judicial precedents addressing the expulsion of an LLC member generally fall into one of two categories. First, there are those in which the operating agreement is completely silent on member expulsion, in which event the courts disallow attempts to expel a member. Chiu v Chiu is the leading appellate case for that proposition. Here’s another.

Second, there are cases in which the operating agreement expressly authorizes member expulsion for defined causes involving breach of duty and other misconduct, in which event the disputes center on whether the expelled member’s conduct falls within the defined causes. Harker v Guyther is one of the better examples in this category. Here’s another.

Thanks to a ruling this month by the Brooklyn-based Appellate Division, Second Department, in Garcia v Garcia, we can now welcome a third category of expulsion case, which we’ll dub cases involving a “naked” expulsion clause. Why naked? The LLC agreement includes the single word “expulsion” as an event of member dissociation but contains no provisions expressly addressing the grounds or procedure for expulsion.

In Garcia, the appellate panel affirmed the lower court’s ruling enforcing the majority members’ vote to expel a minority member accused of diverting company funds. The court also affirmed the lower court’s determination of the value of the expelled member’s interest in two LLCs.  Continue Reading Court Enforces LLC Agreement’s “Naked” Expulsion Clause

Five years ago, we wrote about an important decision from the Delaware Chancery Court, In re Carlisle Etcetera, LLC, 114 A3d 592 [2015], in which a court recognized for the first time the existence under Delaware law of a viable cause of action for “equitable dissolution” of an LLC based upon the court’s equity powers, notwithstanding the existence of a statute explicitly setting forth the grounds for judicial dissolution.

In our write up on Carlisle, we noted that creative litigants in New York might “analogize Carlisle’s recognition of equitable LLC dissolution to New York’s recognition of common-law dissolution for closely held corporations.” We concluded our article by commenting that we knew, at that time, of “no New York case addressing” whether there exists in New York a viable claim for “common-law dissolution of an LLC.”

Five years later, we’re pleased to write about a first-impression decision issued last week by Brooklyn Commercial Division Justice Leon Ruchelsman, in which a creative litigant persuaded the Court to become the first in New York to recognize the existence of a viable cause of action for common-law dissolution of an LLC, notwithstanding the existence of the LLC judicial dissolution standard found in Section 702 of the Limited Liability Company Law (the “LLC Law”). Continue Reading First-Impression Decision Recognizes a Cause of Action for Common-Law LLC Dissolution

Interview with Bob Ambrogi on This Week In Legal Blogging

Last week I had the pleasure of being interviewed for a live webcast by blogging pioneer, legal journalist, and LexBlog publisher and editor-in-chief Bob Ambrogi on his program, This Week in Legal Blogging. The webcast (available on YouTube here and available as a podcast here) is the latest in a series of interviews by Bob of veteran law bloggers. During the half-hour interview, among other topics, Bob and I chat about how I gravitated to starting New York Business Divorce back in 2007; the nature of a business divorce law practice; my “value added” approach to writing about business divorce cases; and the power of niche law blogging in building reputation and attracting clients. Hope you like it!

The white glove, prewar cooperative apartment building at 510 Park Avenue and 61st Street in Manhattan is, for those who reside there, an address that shouts out, “I’ve made it to the top!” Located amidst the headquarters of some of the largest banks, private equity firms, multi-national corporations, and law firms, apartments at 510 Park, when they occasionally come to market, go for the many millions. Pets allowed, if you’re interested.

For one of its corporate-titan residents named James Cayne, the former CEO of Bear Stearns, however, the shouting is more along the lines, “I’m being screwed by the co-op’s board!” Or, at least, that’s what Cayne alleged in a lawsuit styled as a books-and-records proceeding seeking co-op records relating to the board’s rejection of a series of prospective purchasers of Cayne’s 5-bedroom, 6-bath apartment.

At its core, Cayne’s unusual books-and-records petition pleaded that the board President’s “personal animus” toward him — the alleged result of a grudge dating from 1999 when the two were involved in litigation and a bidding war over a pair of maid’s rooms in the building — led him and the rest of the board at his behest to turn down a succession of proposed buyers of Cayne’s apartment between 2016 and 2019, and to deny him the ability to sublet the apartment while trying to sell it.

In a decision filed late last month by Manhattan Supreme Court Justice Nancy M. Bannon in Matter of Cayne v 510 Park Avenue Corp., the court dismissed Cayne’s petition on the grounds that his “overly broad” demand for records was “supported only by speculation” of mismanagement by the co-op’s board. The board’s rejection of Cayne’s proposed purchasers did not alone establish a “proper purpose” for the demand under either the books-and-records statute (Business Corporation Law § 624) or under the shareholder’s common-law right of inspection.

Continue Reading Court Bounces Books-and-Records Petition in Feud Over Park Avenue Co-op Board’s Rejection of Prospective Purchasers

A minority shareholder petitioning for dissolution under BCL § 1104-a must establish, by a preponderance of the evidence, that the majority shareholders have engaged in “illegal, fraudulent or oppressive actions,” (BCL § 1104-a(a)(1)), or that the “property or assets of the corporation are being looted, wasted, or diverted for non-corporate purposes by its directors, officers or those in control of the corporation,” (BCL § 1104-a(a)(2)).

The New York Court of Appeals, in its landmark ruling construing § 1104-a, Matter of Kemp & Beatley, 64 NY2d 63, 73 [1984], put a finer point on what constitutes “shareholder oppression” under § 1104-a, establishing a “reasonable expectations” test under which “oppression should be deemed to arise only when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decision to join the venture.”  The Court cautioned, however, that “[i]t would be contrary to this remedial purpose to permit [the statute’s] use by minority shareholders as merely a coercive tool.  Therefore, the minority shareholder whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression should be given no quarter in the statutory protection.”

Based on this guidance, it is not at all uncommon to see allegations of misconduct and improprieties hurled in both directions in a § 1104-a dissolution proceeding.  An ousted minority shareholder alleges that he was wrongly shut out of the corporation, denied employment, dividends, and access to information.  Majority shareholders answer that the minority shareholder was ousted due to his own misconduct, so he is a bad faith petitioner with no right to seek dissolution.  See this previous post on Kimelstein v. Kimelstein; this post on Sansum v. Fiorati; Matter of Hannon (J.B.H.H. Corp.), No. 604817/99 [Sup. Ct. N.Y. Co. Oct. 13, 2000] [dismissing dissolution petition by 33% shareholder who defrauded the corporation out of approximately $1,000,000]. Continue Reading Court Rejects Oppressed Shareholder’s Bid for Dissolution or Buy-Out, Finds Money Damages Sufficient

“The Company is formed for any valid business purpose”

Nine seemingly benign words in the garden-variety operating agreement of a realty holding LLC. Nine words that, as one judge opined under similar circumstances some years ago, are tantamount to “no stated purpose.” Yet, in a case decided earlier this month called Lazar v Attena LLC, 2020 NY Slip Op 33003(U) [Sup Ct NY County Sept. 9, 2020], those nine innocuous words produced a first-round knockout of a dissolution petition brought by members of three affiliated LLCs that had sold off their realty assets and essentially had already wound up their business. Let me explain.

Under section 702 of the New York LLC Law, as construed by the courts, an LLC member may apply for judicial dissolution if either (1) management is unable or unwilling to permit or promote the LLC’s “stated purpose” as expressed in the operating agreement or articles of organization, or (2) continuing the LLC is financially unfeasible. The vast majority of LLC dissolution cases fit within the first, failed-purpose category.

The failed-purpose test’s focus on the LLC’s “stated purpose” has generated controversy and litigation, especially in dissolution cases involving realty holding LLCs. For instance, in 2015, in the Ross case that I wrote about here, Justice Timothy Driscoll cited the operating agreement’s broad purpose clause (“any lawful act or activities for which limited liability companies may be formed under the [NY LLC Law]”) in dismissing a dissolution petition brought after the LLC’s sole realty asset was sold and the controlling members decided to reinvest the sale proceeds in a new property rather than distributing them.  The court rejected the petitioner’s contention that the LLC’s no-longer-achievable, unwritten, sole purpose was to acquire and operate the original property. Continue Reading The Purposeless Purpose Clause Rides Again

In Jacobs v Cartalemi, now the leading case on the subject of LLC member withdrawal (which our firm had the pleasure of litigating), the Appellate Division – Second Department repeated a well-established principle of law: “The right to an accounting is premised upon the existence of a confidential or fiduciary relationship and a breach of the duty imposed by that relationship respecting property in which the party seeking the accounting has an interest.”

The Cartalemi Case

In Cartalemi, the Court applied this rule of law to reverse the denial and grant dismissal of an accounting claim of a withdrawn LLC member. The Court held, “Here, the plaintiff’s right to an accounting was based on his ability to prove that [his co-member] breached his fiduciary duty to [the LLC], a claim that is entirely derivative and which the plaintiff, having withdrawn as a member from [the LLC], no longer had standing to maintain.” Under Cartalemi, a withdrawn LLC member lacks standing to bring a derivative claim for an accounting post-withdrawal from the LLC.

Is the rule the same for partnerships? If not, why is there a difference? A recent decision from the same appeals court that issued Cartalemi highlights important some distinctions between the accounting rights of withdrawn owners of LLCs and partnerships. Continue Reading Two Entities, Two Outcomes: Withdrawal and the Right to an Accounting

There’s tremendous diversity from state-to-state when it comes to statutory and judge-made law in business divorce cases. The basic fact patterns one sees in cases from across the country, however, don’t vary nearly as much. This juxtaposition of divergent law and convergent fact patterns makes it all the more interesting to follow case law developments from outside my home state of New York, to see how the outcomes and rationales differ from, or resemble those, of New York courts.

To illustrate the point, as I did several years ago, below I summarize five, recent appellate rulings in business divorce cases from around the country addressing issues of universal interest to business divorce practitioners. They include a Massachusetts decision in which a member left to compete against his own LLC; a Maryland case deciding whether a request for receivership triggers buy-out rights; a Mississippi decision allowing a dissolution complaint to go forward based on an alleged “lowball” buy-out offer; a District of Columbia ruling in a dispute following the death of a 50% LLC member; and a Nebraska decision in a contested fair value appraisal case.

Massachusetts Court Holds that LLC Agreement’s Permissive “Other Activities” Provision Trumps Member’s Fiduciary Duty  

In Butts v Freedman, 96 Mass. App. Ct. 827 [2020], the Massachusetts appellate court affirmed a post-trial judgment dismissing a lawsuit brought by one of two members of a Massachusetts LLC against the other member who, while still a member, left their investment banking firm to start up a competing firm. While agreeing with the plaintiff that the defendant, “as a member of a closely held corporation [sic],” owed a fiduciary duty to the plaintiff and their jointly-owned LLC, the court upheld the defendant’s position that his alleged wrongful conduct nonetheless was permitted by the “Other Activities” provision of the LLC’s operating agreement, stating: Continue Reading Business Divorce Nation: A Cross-Country Tour of Recent Decisions of Interest

With apologies to the King James Bible, what the Manhattan real estate market giveth, a poorly conceived partnership agreement taketh away.

It’s the best explanation I can offer for three successive lawsuits lasting almost fifteen years and counting between two partners in a general partnership that owns a full-floor unit in a commercial co-op building in Manhattan’s Garment District and, since the death of one of the partners in 2011, between the deceased partner’s estate and the surviving partner.

The partnership, known as S-L Properties, acquired the unit in 1984. Its two partners, Robert Liss and Sage Systems, Inc., held 43.07% and 56.93% partnership interests, respectively. Under their agreement, the partners each took assigned portions of the unit for the use of their two, separate businesses. From what I can tell, the purchase price was around $250,000. For anyone familiar with Manhattan real estate values, that tells you right away that, whatever was paid for the unit in 1984, its value grew exponentially by the time litigation broke out in 2006, and super-exponentially at current market values.  That’s the “giveth” part.

The partnership had a 40-year fixed term under its written partnership agreement, subject to early termination in the event of a partner’s death, upon which the surviving partner has an option to purchase the deceased partner’s interest for a fixed price essentially equal to the decedent’s cash contributions plus 6% interest from the date of each contribution. That’s the “taketh away” part.

The litigation unfolded in three acts:

  • In Act One, Liss sought judicial dissolution of the partnership and liquidation of the partnership’s realty asset for Sage’s alleged violations of the proprietary lease’s subletting provisions.
  • In Act Two, Liss filed a second lawsuit against Sage for an accounting. Following Liss’s death, Sage filed an amended countersuit to compel a buy-out of the Liss estate’s partnership interest at the fixed price under the partnership agreement.
  • In Act Three, Sage sued Liss for contractual indemnification of its legal expenses defending the dissolution lawsuit.

Intrigued? Read on to find out what happened. Continue Reading A Partnership Dissolution in Three Acts Over Fifteen Years and Counting

Several weeks ago, I had the pleasure of first appearing on this blog, with a piece about a Delaware Chancery Court decision considering—as a matter of apparent first impression—whether an LLC could exercise, then walk back a call option allowing the LLC to purchase a member’s interest at a price established by a three-appraisal process.

I am equally pleased to return this week to weigh in on a recent decision by Justice Masley of the New York County Commercial Division regarding the inverse: a Delaware LLC member’s put option.  A put option provides the holder with the right to sell her interest back to the LLC at a specified price.  In a world where an LLC member’s exit rights is a thorny issue for the brightest (and most interested) minds—as covered here—put rights provide a member with an efficient and straightforward mechanism to cash out her interests.

While put rights generally are a strong exit mechanism, GMX Technologies v. Pegasus Capital Advisors, Dec. & Order, Index No. 654056/2019 (Sup Ct NY County Aug. 8, 2020), considers a potentially significant limitation: can an LLC member exercise a bargained-for, contractual put right if doing so would render the company insolvent?

Handbags and Herbicides

The dispute in GMX Technologies stems from a complicated cross-investment arrangement between Arnold Simon—a fashion-industry titan turned CEO of GMX Technologies LLC, an agricultural biotech startup—and Pegasus Asset Management’s Leiber Portfolio Company (“Leiber”), which owns the once-popular Judith Leiber handbag brand. Continue Reading Departing LLC Members: Exercise Your Put Option Before Insolvency Approaches

Oral agreements – and oral modifications of written agreements – are a constant source of litigation in business divorce cases. Alleged oral agreements are subject to attack based upon legal enforceability – as well as their ability to be proven with adequate evidence. As a general matter, legal enforceability of an alleged oral agreement among business owners concerning their rights as owners depends first and foremost upon the kind of entity involved.

Limited Liability Companies

Section 102 (u) of the Limited Liability Company Law (the “LLC Law”) defines the term “operating agreement” as a “written agreement of the members.” LLC Law § 417 (a) provides that the LLC’s members “shall adopt a written operating agreement.” As we noted previously, the wording of the LLC Law differs markedly from Delaware’s LLC Act and that of many other states, which explicitly permit oral operating agreements.

Based upon the language of the LLC Law, the prevailing view in New York is that oral operating agreements are unenforceable. For example, in Shapiro v Ettinson, 146 AD3d 650 [1st Dept 2017], the court held that an alleged oral agreement requiring member unanimity to adopt an operating agreement was unenforceable because LLC Law § 417 “requires a written operating agreement, and where there is no operating agreement or the operating agreement fails to address issues in dispute, the default provisions under the Limited Liability Company Law govern.” Continue Reading Enforceability of Oral Operating, Shareholder, and Partnership Agreements