One of the earliest signs that a closely-held business is headed for divorce lies in how its owners treat new opportunities. When the relationship among the owners reaches a certain level of distrust, an owner presented with a potentially valuable opportunity is naturally tempted to pursue the opportunity independently, rather than through the business. That temptation explains why we business divorce litigators frequently see claims for “usurpation of corporate opportunity.”

A species of the breach of fiduciary duty claim, a claim for usurpation of corporate opportunity is derivative—asserted on behalf of the company—and disarmingly simple to allege (“You engaged in deal X personally, in violation of your fiduciary duties to bring that deal to the company”).

Despite its frequency and apparent simplicity, a claim for usurpation of corporate opportunity often is difficult to prove, requiring the plaintiff to confront a bevy of difficult questions: What about the company and the opportunity begets the legitimate expectation that the fiduciary was required to bring it to the company before pursuing it independently? What if the company lacked the funding or legal authority to pursue the opportunity? Did the fiduciary act in bad faith to personally profit from the opportunity? What if the counterparty was unwilling to deal with the company? And, perhaps most importantly, what state’s law applies to the claim?

Two recent cases out of the Manhattan Commercial Division and the U.S. District Court for the Southern District of New York provide a fine springboard to unpack these questions and explore the bounds of the corporate opportunity doctrine under New York and Delaware law.

Continue Reading A Recurring Business Divorce Feature: Usurpation of Corporate Opportunity

The statutes authorizing judicial dissolution of Delaware LLCs (LLC Act § 18-802) and New York LLCs (LLC Law § 702) essentially are the same: the petitioner must show that it is no longer “reasonably practicable” to carry on the business in conformity with the LLC’s operating agreement. Not much guidance there.

Delaware’s Chancery Court got a head start over New York’s courts in crafting a standard for determining when the statute is satisfied. Coincidentally or not, a string of the earliest, major Chancery Court decisions construing § 802 involved 50/50 deadlock cases (Haley v Talcott [2004], Silver Leaf [2005], Fisk Ventures [2009], Lola Cars [2009], Vila v BVWebTies [2010]). Those primordial opinions crafted what has become a standard explication of the statute’s requirements — even showing up in dissolution cases pleading grounds other than deadlock! Here’s how the Fisk Ventures opinion put it:

The text of § 18-802 does not specify what a court must consider in evaluating the “reasonably practicable” standard, but several convincing actual circumstances have pervaded the case law: (1) the members’ vote is deadlocked at the Board level; (2) the operating agreement gives no means of navigating around the deadlock; and (3) due to the financial condition of the company, there is effectively no business to operate.

In each of the above-mentioned cases, the deadlock was uncontested or at least found by the court to be genuine, i.e., there was no argument and/or no finding that the petitioner had manufactured a deadlock in bad faith for the very purpose of seeking dissolution.

The closest to that I saw is then-Vice Chancellor Strine’s passing remark in the Vila case that “this is not a case in which Vila in bad faith manufactured a phony deadlock.”

The next closest to that remark that I could find involving a Delaware LLC, at least temporally (and oddly from a jurisdictional standpoint), is a 2016 Tennessee Chancery Court opinion in which the court cited that same remark in Vila in support of the court’s decision denying the plaintiff’s motion for a summary judgment of judicial dissolution of a Delaware LLC. In that case the plaintiff proffered evidence from which the factfinder could reasonably infer that dissolution based on alleged deadlock was sought in bad faith to secure for plaintiff’s sole benefit the LLC’s business opportunity.

The wait for the Delaware Chancery Court to squarely address and uphold a defense to a petition to dissolve a Delaware LLC under § 802 based on manufactured deadlock, is over. Earlier this month, in In re Dissolution of Doehler Dry Ingredient Solutions, LLC, Mem. Op., C.A. No. 2022-0354-LWW [Del. Ch. Sept. 15, 2022], Vice Chancellor Lori W. Will dismissed at the pleading stage a dissolution petition on the ground, among others, that the petition’s allegation of deadlock based on petitioner’s declared intent to withhold future consents from certain “critical” actions was a “contrived attempt to manufacture deadlock.” Let’s take a closer look. Continue Reading Contrived LLC Deadlock Doesn’t Cut the Delaware Dissolution Mustard

New York’s default rules regarding LLC members’ rights to transfer their interests appear in sections 603 and 604 of the LLC Law. Section 603 provides that a membership interest is fully assignable, but the assignee does not become a full-fledged member; she becomes an economic interest holder entitled to receive the distributions and profit and loss allocations of the assignor. Section 604 requires the consent of at least the majority of the other members before an assignee can become a member.

Operating agreements often include a provision supplementing those default rules, restricting members from assigning their interests to limited circumstances, such as upon unanimous consent of the members, or only to a member’s children or heirs. Transfer restrictions like these often make good business sense; they protect against the risk of outside ownership, and they ensure that members may not transfer their interests to satisfy creditors.

Some operating agreements go a step further, specifying that assignments made in violation of its restrictions are void. In transfer restriction clauses, “void” is a magic word. For more than 30 years, New York Courts have held that assignments made in violation of a transfer restriction—while they may give rise to a damages claim—are not invalid unless the operating agreement clearly specifies that “transfers made in violation of this section are void” (Macklowe v 42nd St. Dev. Corp., 170 AD2d 388, 389 [1st Dept 1991]).

Use of the term “void,” to describe non-compliant transfers can also preclude application of certain equitable defenses, resulting in seriously perplexing results. In XRI Investment Holdings LLC v Holifield, No. 2021-0619 [Del. Ch. September 13, 2022]), the inequitable result required by the term “void” in the transfer restriction prompted the trial court to suggest an alternate approach and encourage an appeal so that the Delaware Supreme Court can reconsider its laws regarding the magic word “void.” The decision should leave no one wondering why the Delaware Chancery Court is the vanguard of developments in the laws of corporate governance.

Continue Reading Magic Words Still Matter, and Equitable Defenses Can’t Save a “Void” Transfer

The legal concept of “conflicts of laws” is difficult, to say the least, confounding even seasoned litigators and judges, with bulky treatises and entire law school classes devoted to the subject.

Generally speaking, the term of art “conflicts of laws” refers to the question of how to determine which state’s laws provide the rules of decision to resolve a particular problem, controversy, or dispute.

For example, when a business divorce litigant sues, he or she may allege a mix of substantive claims, like breach of contract, breach of fiduciary duty, and accounting (among any number of other colorful claims in the business divorce litigant’s palette). Conflicts of laws problems arise when the entity is incorporated in one state (for example, Delaware), but the entity operated, the applicable contract was made, or the alleged tortious activity occurred, in another state (for example, New York).

To determine whether the plaintiff sufficiently alleged or proved the essential elements of a legal cause of action, the court must first determine which state’s laws govern the claim. Sometimes, a claim will be sufficient under the laws of one state, but insufficient under another, so the conflict-of-law analysis may be outcome determinative of whether the plaintiff can pursue or recover on a particular claim. Continue Reading Conflicts of Laws and the Internal Affairs Doctrine

What makes a partnership a partnership? What makes a partner a partner? To be clear, I’m referring to partners in a general partnership.

Although the heyday of general partnerships is long past, replaced by other forms of limited liability business entities, we in the business of business divorce still encounter and litigate cases in which two or more individuals, sometimes with written agreements but more often without, enter into an unincorporated, joint business arrangement of some sort only to have a later falling out at which point one or the other players asserts there is no legally cognizable partnership or joint venture, or that there is a partnership but Person X is not a partner.

We’ve seen and frequently written about the latter type of partnership dispute involving law firms organized as limited liability partnerships. LLPs, as they’re known, are simply general partnerships available to certain licensed professionals including lawyers, featuring a qualified form of limited liability unlike the traditional partnership in which the general partners are personally liable for the debts of the partnership. LLPs otherwise are governed by the same, general partnership law that governs any kind of general partnership.

It’s no accident that law firms occupy a disproportionate share of the litigated cases involving disputed partner status. In large part that’s because of the widespread use of the title “partner” for lawyers of a certain seniority who are more accurately defined as contract or non-equity partners, which admittedly sounds like an oxymoron. In many such cases, the dispute hinges on the wording of the partnership agreement — if there is one — and/or the manner of compensation of the disputed partner and/or the firm’s tax reporting of the disputed partner’s compensation and share of the partnership’s capital, income, and loss.

Earlier this year, in my annual Winter Case Notes, I wrote about a December 2021 decision in the Epstein v Cantor case in which the court dismissed all the non-contract claims in a complaint brought by a putative partner of a law firm organized as an LLP against his alleged partner claiming he and others had “raided” the partnership by transferring its assets and clientele to other firms. One factor the court prominently cited in ruling that Epstein was not a partner of the firm was the fact that, under the parties’ written partnership agreement, he received a percentage of a certain portion of the firm’s gross income while all net profits and losses were allocated to the defendant Cantor, as also reflected in the LLP’s tax returns. The decision cited in support the New York Court of Appeals’ 1958 opinion in Steinbeck v Gerosa for the proposition, which I’ve seen expressed in countless cases involving disputed partner status, that “[a]n indispensable essential of a contract of partnership or joint venture, both under common law and statutory law, is a mutual promise or undertaking of the parties to share in the profits of the business and submit to the burden of making good the losses.”

The Court Grants Reargument

Last March, however, the Epstein case took on new life following a motion to reargue by Epstein who argued that Steinbeck was overruled sub silentio by the Court of Appeals’ 2018 opinion in Congel v Malfitano, a wrongful partnership dissolution case that I wrote about here, in which the Court, quoting from a 1939 Court of Appeals opinion in Lanier v Bowdoin, wrote:

The partners of either a general or limited partnership, as between themselves, may include in the partnership articles any agreement they wish concerning the sharing of profits and losses, priorities of distribution on winding up of the partnership affairs and other matters. If complete, as between the partners, the agreement so made  controls.

Continue Reading Is Loss Sharing an “Indispensable Essential” of Partnership?

In shareholder derivative litigation, defendants occasionally argue that the plaintiff – who ostensibly sues on behalf of the company and its owners in a fiduciary capacity – has some form of conflict of interest with the company or its remaining owners, so the court should disqualify the plaintiff from serving as plaintiff. The classic, most simple conflict of interest is where the plaintiff herself has engaged in some form of wrongdoing against the company, for which the entity or its owners have lodged (or may lodge) counterclaims.

The theory is that if the plaintiff is herself a bad actor, she cannot be expected to be an adequate steward and representative of the legal rights and interests of the entity she herself has harmed. In New York, one most often sees this argument asserted in the form of a pre-answer motion to dismiss for lack of capacity or standing to sue under CPLR 3211 (a) (3). Continue Reading The “Conflict of Interest” Defense to Shareholder Derivative Standing

Nestled between Broadway and Church Street in New York City’s hottest neighborhood is the landmarked, stone-façade building at 66-68 Reade Street.  Now marketed as the superluxury boutique condominium complex 66 Reade, the historic building and its cast iron columns evoke the most stately parts of New York City’s architectural polish.

The conversion of 66 Reade to luxury condominiums was the product of a 15-year partnership between Jean Hieber, the owner of the property, and Fred Taverna, Hieber’s property manager and a trusted advisor.  After years of apparent cooperation, fissures emerged in the parties’ relationship as they approached the finish line.  Ultimately, the parties commenced dueling lawsuits against one another, each side hurling a bevy of claims and defenses at the other, and Business Divorce aficionados took notice.

As units in the building were marketed in the high seven-figures, the first round of the contentious dispute behind the project concluded with Manhattan Commercial Division Justice Borrok dismissing Hieber’s claims to specifically enforce a compelled sale of Taverna’s 25% interest in the project for $40.  Hieber Reade Street LLC v Taverna, Index No. 655454/2021 (NY County 2022) offers well-reasoned guidance on the conceptual separateness between claims to specifically enforce a buy-sell agreement, on the one hand, and damages claims, on the other.

Continue Reading Never the Twain Shall Meet: Damages Claims Do Not Offset the Purchase Price in Buy-Sell Agreements

Welcome to the 12th annual edition of Summer Shorts. This year’s edition features brief commentary on a handful of recent decisions by New York trial judges and appellate courts in a variety of business divorce cases involving capital calls, recapitalization, dissolution agreements, derivative vs. direct claims, and judicial dissolution. Click on the case names to read the decisions.

“Grammatical Irregularities” Don’t Govern Operating Agreement’s Capital Call Provision 

Chen v 697 Dekalb LLC, 2022 NY Slip Op 32418(U) [Sup Ct Kings County July 18, 2022].  Does an operating agreement’s provision stating that “additional capital contribution may be made at such time and in such amounts as the Members shall determine” require unanimous consent of the LLC’s members, or does majority consent suffice? Brooklyn Commercial Division Justice Leon Ruchelsman found that this and other “grammatical irregularities” in the agreement concerning member consent to assignment and the admission of new members “do not govern the plain meaning of the agreement” in this suit brought by a 25% member seeking judicial dissolution of a realty-holding LLC after the majority members threatened dilution unless he contributed an additional $485,000 on top of his original $300,000 investment.

The decision denies both the defendant majority members’ motion to dismiss the complaint and the plaintiff’s motion for summary judgment granting judicial dissolution, finding a “fundamental disagreement between the parties” precluding a summary determination “whether the initial contribution made by the plaintiff was intended to be the only contribution he needed to make or whether others were necessarily contemplated,” as well as “whether the company maintains the necessary finances to continue and whether it remains viable.”

Oddly, neither the parties’ briefs nor the decision mentions the governing Amended Operating Agreement’s omission of any provision authorizing dilution or other consequences for a member’s failure to make an additional capital contribution, as required by LLC Law § 502(c). The omission arguably takes on even greater weight in view of the capital call provision in the LLC’s original operating agreement, to which the plaintiff is not a signatory, authorizing the managers to make capital calls and allowing contributing members to make up a non-contributing member’s shortfall, thereby triggering adjustment of the members’ percentage ownership interests. Continue Reading Summer Shorts: LLC Dissolution and Other Recent Decisions of Interest

A rarely litigated provision of the New York Limited Liability Company Law (the “LLC Law”), Section 1006, authorizes the conversion of a general or limited partnership to a New York LLC through a statutorily-prescribed process, similar in ways to a merger, including the partners’ adoption of an “agreement of conversion” and the filing of a “certificate of conversion” with the New York State Department of State.

LLC Law 1006 and Partnership Law 121-1102

Like a merger, LLC Law 1006 provides the option to limited partners – but not general partners – to opt out from the transaction (i.e., dissent) and seek “fair value” in an appraisal proceeding governed by the procedures set forth in Section 121-1102 of the Revised Limited Partnership Act, found in Article 8-a of the New York Partnership Law (the “Partnership Law”). The leading case on Partnership Law 121-1102 is the 2008 Court of Appeals decision in Appleton Acquisition.

LLC Law 1006’s heyday was in the late 1990s and early 2000s, following New York’s adoption of the LLC Law effective in 1994, when many owners of partnerships opted to convert to the LLC form to enjoy the combined benefits of limited personal liability, pass-through tax status, and the flexibility to organize LLCs in many different ways in the operating agreement.

The Dearth of Case Law

Until last month, there were exactly nine reported decisions on Westlaw addressing LLC Law 1006. Virtually none of them addressed the correct interpretation and applicability of the statute. Until three weeks ago, the leading case on LLC Law 1006 was Miller v Ross, a case which invalidated on technical grounds a partnership to LLC conversion, but which could hardly be described as a treatise on the subject given its brevity (i.e., one paragraph).

Continue Reading A Fresh Take on Partnership to LLC Conversions

In 1950, Sam Hoffman and his two sons, Hyman and Melvin, founded Brooklyn-based Cornell Beverages, Inc. to manufacture and distribute seltzer. Those were the days when “seltzer men” made weekly home deliveries of cases of siphon seltzer bottles.

Seventy years later, the seltzer men and siphon bottles are long gone, and the primary occupation of the third-generation inheritors of the family business seems to be delivering cases of legal papers to each other.

Cornell still makes and distributes seltzer beverages, but only a trickle compared to its heyday, and not a profitable trickle at that. But don’t get too nostalgic or shed too many tears for the third-generation owners, owing to their forebears who had the foresight to acquire not only the industrial property where Cornell manufactures the seltzer, but another eight commercial properties in close proximity, all told with a current appraised value over $40 million.

Likely the patriarch, Sam, could not have foreseen the legal travails of his four grandchildren, each a 25% shareholder of Cornell and the real estate holding companies, driven in large part by three factors: the demise of the seltzer business in tandem with the phenomenal appreciation of the real estate; only two of the four grandchildren entered the business with salaried positions; and a shareholders’ agreement providing for a buyout at book value of the shares of any shareholder who wishes to exit.

For one of the “outside” shareholders who drew no salary and sought to monetize her 25% share of the trapped-in value of the real estate, those factors most likely contributed to her decision to sue for judicial dissolution of the three companies, claiming she was the victim of a freeze-out. After seven years of litigation, she walked away with nothing to show for it except legal bills, having suffered post-trial dismissals of her dissolution petitions which, just last week, were affirmed on appeal. Continue Reading Minority Shareholder’s Petition to Dissolve Seltzer Business Loses Its Fizz