New York’s Business Corporation Law (BCL) provides three pathways for non-controlling shareholders to achieve involuntary (judicial) dissolution. The first two are well known to business divorce practitioners and to regular readers of this blog:

  • a petition under BCL § 1104 (a) by a shareholder holding 50% of the voting shares on the grounds of director deadlock, shareholder deadlock, or “internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders”; and
  • a petition under BCL § 1104-a by a shareholder holding at least 20% of the voting shares on the grounds of “illegal, fraudulent or oppressive actions” or looting, waste, or diversion of corporate assets by the directors or those in control of the corporation.

The third pathway is far less familiar and is rarely invoked: a petition under BCL § 1104 (c) by any holder of any percentage of shares entitled to vote at an election of directors on the ground that

the shareholders are so divided that they have failed, for a period which includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired or would have expired upon the election and qualification of their successors.

If you read it too quickly, you might think all the statute requires is the simple failure to hold a board election on two consecutive, annual meeting dates — not a high hurdle for the countless, small close corporations that ignore corporate formalities including annual shareholder meetings. Not to be overlooked, however, are the critical words, “the shareholders are so divided that they have failed . . . to elect.”

Those words tripped up the petitioner in a noteworthy case recently decided by Manhattan Commercial Division Justice Andrea Masley. In Matter of Gupta [E.J.’s Bucket Buddies, Inc.], 2020 NY Slip Op 32446(U) [Sup Ct NY County July 24, 2020], Justice Masley summarily dismissed for legal insufficiency a § 1104 (c) dissolution petition brought by a 25% shareholder of a realty holding corporation due to the petition’s omission of any allegation that the shareholders “have ever held an annual meeting or elected directors during the company’s existence.” Continue Reading Dissolve for Failure to Elect a Board? Better Demand an Election First

The mystique of the jury trial is deeply embedded in the social consciousness of our country. Non-lawyers who think of litigation tend to recall courtroom thrillers like To Kill a Mockingbird, Erin Brockovich, or Philadelphia. These movies, like the vast majority of courtroom dramas, depict jury trials. Since the public so closely associates trials with juries, litigants are sometimes disappointed to learn that jury trials are uncommon in business litigation generally, and exceedingly rare in business divorce litigation.

The reality is that jury trials are only available in certain types of cases, depending on the relief sought. A recent decision by Manhattan Commercial Division Justice Marcy S. Friedman, Quazzo v Quazzo, 2020 NY Slip Op 32342(U) [Sup Ct NY County July 17, 2020], highlights some of the reasons few business divorce cases wind up before juries. In Quazzo, Justice Freidman took an uncommonly nuanced and thoughtful approach to the difficult, and in some ways conflicting legal rules that govern parties’ rights to a jury trial. The outcome was a case where some of the many claims will be tried in a jury trial (whenever they resume post-COVID), and some will be tried to the judge in a non-jury (or “bench”) trial.

The Underlying Dispute

Quazzo is a ten-year-long litigation between a daughter, Cristina, and her father, Ugo, consisting of a proceeding for judicial dissolution of three family-owned, and a separate plenary action for various claims including money damages and equitable relief. Quazzo has twice previously graced this blog’s pages. In 2014, we wrote a post (read here) about Justice Friedman’s decision denying Ugo’s motion for summary judgment dismissing Cristina’s dissolution petition. Five years later, we wrote a second post (read here) about Justice Friedman’s decision denying Cristina’s motion for summary judgment on her petition for dissolution. As a result of those decisions, the case headed towards two likely outcomes: settlement or trial. Cristina and Ugo so far have chosen the latter. Continue Reading A Business Divorce Rarity: The Jury Trial

Some years ago I had the good fortune to join the ABA Business Law Section’s Committee on LLCs, Partnerships and Unincorporated Entities which, among its other scholarly pursuits in the field of alternative entities, organizes the incomparable LLC Institute held annually. The law professors, practicing attorneys, and other professionals who comprise the Committee’s membership, and who reconvene each year at the LLC Institute to keep abreast of developments in the law, renew acquaintances, and celebrate each year’s winner of the prestigious Martin I. Lubaroff Award, share a deep and abiding interest in analyzing and shaping the positive and common law governing alternative entities.

Yet another membership perk is access to the Committee’s Listserv on ABA Business Law Connect (for ABA members only) where Committee members from across the country regularly raise questions and exchange ideas on a host of topics mostly concerning LLCs and partnerships. Last week, California attorney Gerald Niesar kicked off an interesting discussion that generated dozens of thoughtful responses with a message entitled, “Does an LLC Member Have an Absolute Power to Extricate Him/Herself from the LLC?”

It’s a topic that resonates strongly with business divorce practitioners who frequently are asked (a) to advise clients looking to exit an LLC or partnership or who have co-owners looking to do so, and/or (b) to initiate or defend litigation stemming from a member’s lawful or unlawful exit.

There is much wisdom shared in the exchange of messages that took place. For practitioners and others unable to access ABA Connect, what follows is a condensed account, with attribution, highlighting some of the 30+ messages on the topic of LLC member exit rights.

  • The set-up in Mr. Niesar’s kick-off message is a member of a California LLC who feels “trapped” in the LLC with a co-member who is jeopardizing the licensed LLC’s regulatory compliance. The solution offered is to quit (“dissociate” from) the LLC even though it might violate the operating agreement. Mr. Niesar went on to observe that, while certain provisions in California’s LLC Act provide a member with the right to dissociate “rightfully or wrongfully . . . by express will,” others arguably render the right to dissociate not “absolute” if restricted by the operating agreement. On the other hand, he continued, if the operating agreement waives the right to dissociate, wouldn’t that simply be the “wrongful” dissociation expressly authorized by the statute or, he rhetorically asked, “does the 13th amendment not apply to LLCs?”

Continue Reading Does an LLC Member Have Absolute Power to Withdraw from the LLC?

I’ve represented clients on both sides of freeze-out mergers of privately owned business entities, so I’m very familiar with their uses, misuses, potential advantages, and potential disadvantages to both freeze-ors and freeze-ees.

Over the years this blog has featured numerous articles about cases involving freeze-out mergers which you can readily access by clicking on the Topics dropdown menu on the right sidebar and selecting Freeze-Out Merger.

If you do, you will find that, when it comes to litigation over the validity of a freeze-out merger, as opposed to valuation contests triggered by a freeze-out merger, most of the reported New York court decisions over the last 10+ years involve limited liability companies. I attribute the phenomenon to the relatively young age of the LLC Law’s merger-related provisions compared to their gray-haired Business Corporation Law counterparts, and the absence thus far of appellate case law construing those provisions.

Which makes all the more interesting a decision last week by Manhattan Commercial Division Justice Jennifer G. Schecter in Van Horne v Ben-Dov, preliminarily enjoining a freeze-out merger of a close corporation for lack of a valid business purpose. In the interest of full disclosure, my firm and I along with my colleague Peter Sluka represent the plaintiffs in the case. Continue Reading “Rank Pretext Will Not Do”: Court Enjoins Freeze-Out Merger With No Corporate Benefit

I don’t know if empirical studies have been done comparing the relative frequency or ratio of disputes and litigation over member status in LLCs versus shareholder status in close corporations. My impression as an avid follower of case law in New York and other states is that LLC disputes over member status win that dubious distinction. If I’m right, the question is, why? Is there something innate about the LLC form that gives rise to a higher incidence of litigation over an individual’s or entity’s ownership stake?

I believe the answer is “yes” at least to some extent based on the peculiar default rules — often mirrored or made even more restrictive in operating agreements — governing the transfer of membership interests. I’ve seen and written about any number of cases in which the membership interest asserted by a transferee comes to naught, or is relegated to an economic interest only, because of a failure to obtain the consent of the members or managers in compliance with requirements in the statute or operating agreement. Other contributing factors, not limited to transferees, may be the relative infrequency compared to corporations with which LLC membership interests are formally certificated, and default rules permitting variable voting and economic percentages based on changes in a member’s capital account.

All of which is by way of introduction to three, recent court decisions by three different New York City judges addressing disputed ownership interests, two involving LLCs and one a close corporation. Two of the three involve family-owned companies, where naturally there tends to be less adherence to formalities, which reminds me of a wonderful quote in a paper by the late, great Larry Ribstein (read here) in which, commenting on the family origins of partnerships, he wrote:

The earliest small firms were partnerships, which began as intimate, usually family, relationships. They were referred to as ‘compagnia,’ which means those sharing bread, reflecting their origins in households. Kinship ties were an important mechanism for controlling agency costs. Kerim told James Bond in From Russia With Love, “all of my key employees are my sons. Blood is the best security in this business.”

To which I can only add, except when it’s not.

Case No. 1: S.O.S. Realty Associates LLC v Blumberg, 2020 NY Slip Op 32200(U) [Sup Ct NY County July 7, 2020] 

The aptly named S.O.S. Realty Associates LLC was formed in 1995 to own and manage a 15-unit Manhattan apartment building, owned 50/50 by Naomi Blumberg and Melvyn Oberlander. In late 1998 or early 1999, according to the complaint, pursuant to a pair of Assignment and Acceptance Agreements, Naomi “attempted” to assign 10% of her membership interest to her son David and another 10% to her daughter Lynda. According to S.O.S.’s complaint, the agreements were signed by Oberlander, Naomi, and Lynda but, “upon information and belief,” David never signed them even though a signature above his signature line appears on the documents. Continue Reading Disputes Over Member Status Continue to Roil the LLC Waters

In the famous case of Meinhard v Salmon, Justice Benjamin Cardozo wrote in lofty language that lawyers of maltreated business owners have loved to quote ever since that the duty of loyalty among closely-held business owners is exceedingly high:

Not honesty alone, but the punctilio of an honor the most sensitive, is . . . the standard of behavior.”

Countless published decisions since cite Meinhard. Steeped in morality-laden language (no “morals of the marketplace” here), it is unsurprising that the tort of breach of fiduciary duty as expressed in Meinhard has become the workhorse of New York business divorce litigation.

Over the years, the common-law cause of action for breach of fiduciary duty has evolved into a remarkably versatile claim, encompassing a vast — almost limitless — range of conduct that can be characterized as misappropriation, self-dealing, waste, or disloyalty. Breach of fiduciary duty in New York also has a number of odd legal quirks, making it a powerful weapon in the petitioner / plaintiff’s arsenal when thoughtfully pled.

As just one example, the claim has not one, not two, but three potential statutes of limitations. If the claim seeks solely money damages, the limitations period is three years. But plead the claim as one seeking equitable relief, and the limitations period jumps from three to six years. Plead the claim as “fraud-based,” and the limitations period extends ever further – six years from the date of the fraud, or two years from when the fraud could have been discovered with reasonable diligence, whichever is longer.

A recent decision from a Rochester-based appeals court, Howard v Pooler, ___ AD3d ___, 2020 NY Slip Op 03347 [4th Dept June 12, 2020], highlights two other exceedingly useful aspects of the tort of breach of fiduciary duty: first, the availability of “disgorgement” of profits from one who breaches a fiduciary duty even in the absence of any actual damages as a result of the breach; and second, the potential for the non-breaching party to recover its attorneys’ fees prosecuting the fiduciary duty claim where the claim is pled derivatively on behalf of the entity. Continue Reading The Common-Law Tort of Breach of Fiduciary Duty: The Total Package

FGLS Equity LLC was one of many feeder funds caught up in the maelstrom that followed the exposure and meltdown in 2008 of the Bernie Madoff Ponzi scheme. It lost virtually all of its money in its account with Bernard L. Madoff Investment Securities (BLMIS). Eventually, Irving Picard, the Trustee appointed by the Bankruptcy Court to oversee BLMIS’s  liquidation, allowed and paid FGLS’s claim in the much-reduced sum of $3.45 million based on the “net investment method” which ignored all fictitious profits. Mr. Picard also disallowed any credit for the $3.15 million that in 2002 was “rolled over” into FGLS from a predecessor feeder fund called C&P Associates.

The founder and manager of FGLS and C&P, and the direct conduit to Bernie Madoff and BLMIS, was Steven Mendelow. In 2010, Mr. Picard sued Mr. Mendelow and his wife to recover over $14 million in allegedly fraudulent transfers to them from BLMIS. In 2018, after Mr. and Mrs. Mendelow both died, Mr. Picard recovered almost $10 million from their estates in settlement of the fraud claims. The settlement contained a “no admission of liability” provision.

The resolution of FGLS’s claims in Bankruptcy Court and the deaths of the Mendelows closed one litigation chapter but laid the groundwork for another. Last month, the second chapter culminated with a first impression decision by Manhattan Commercial Division Justice Joel M. Cohen, who was tasked with deciding whether to approve a plan of liquidation proposed by a member-appointed liquidator under an important but untested statute, Section 703 of New York’s LLC Law, over the fierce objections of a number of FGLS members. The case is Matter of FGLS Equity LLC, 2020 WL 2557877, 2020 NY Slip Op 31476(U) [Sup Ct NY County May 20, 2020]. Continue Reading Business Judgment Rule Prevails in Fight Over Liquidation Plan for Dissolved Madoff Feeder Fund

This post is authored by Peter J. Sluka, a senior associate in the Manhattan office of Farrell Fritz and a member of the firm’s Business Divorce Group.

As regular readers of the blog surely are aware, there are few provisions in an LLC or shareholders agreement more likely to be the focus of dispute than the buy-sell provision. Most times, these disputes expose a flaw in the language of the buy-sell provision itself. A poorly defined price-fixing process results in litigation over that process; failure to specify which discounts should apply to an appraisal results in litigation over appropriate discounts; allowing a single appraiser to render a binding purchase price results in litigation over whether that appraiser was independent.

Recently, Vice Chancellor McCormick of the Delaware Chancery Court considered a challenge to enforcement of a buy-sell provision grounded not in an ambiguity of the provision, but in equivocal conduct of the LLC in exercising—or refusing to exercise, depending upon which side you ask—its rights under that provision. Specifically, V.C. McCormick considered whether an LLC, after electing to purchase the departing members’ interest under the buy-sell provision, could withdraw that election before the buyout price is established. The case offers some welcome clarity on precisely when the parties to a buy-sell agreement become obligated to go through with the sale.

The dispute in Walsh v. White House Post Productions, LLC, C.A. No. 2019-0419-KSJM [Del Ch Mar. 25, 2020], stems from the decision by creative visual effects studio Carbon VFX and its majority member, White House Post Productions, to separate from two of Carbon’s founders, Kieran Walsh and Francis Devlin.

Continue Reading Consider Whether Your Buy-Sell Provision is a Call Option Before Pulling the Trigger

The COVID-19 pandemic kept New York’s courthouses dark the last few months, but it didn’t slow down the output of decisions by Commercial Division judges. If anything, the pause of new case filings and non-emergency motions in pending cases allowed judges to catch up on the backlog of undecided motions, as evidenced by an uptick in the number of recently reported decisions involving disputes between co-owners of closely held business entities.

Of the ten New York counties with Commercial Divisions, Manhattan has the largest roster of Commercial Division judges and the most cases, so its biggest share of the reported business divorce decisions is no surprise. This post highlights three of these decisions by three different Commercial Division judges on a variety of interesting issues concerning choice-of-law and dissolution of a foreign business entity, the doctrine of in pari delicto as a defense to a shareholder derivative action, and the contested ownership of membership interests in a family-owned LLC.

Court Applies New York Law in Dismissing Claim to Dissolve Bahamian Company

BML Properties Ltd. v China Construction America, Inc., 2020 NY Slip Op 30816(U) [Sup Ct NY County Mar. 17, 2020], involves an unusual application of a New York choice-of-law provision in a joint venture agreement to a minority shareholder’s claim seeking oppression-based judicial dissolution of a Bahamian business entity. Continue Reading A Trio of Recent Business Divorce Decisions by Manhattan Commercial Division Judges

Corporate shareholder and LLC operating agreements routinely contain provisions addressing the transfer of equity interests upon the death of an owner of a closely-held business. Such provisions are vital for succession planning and multi-generational business continuity. But what happens if a contract provision governing distribution of an ownership interest upon death conflicts with the owner’s last will and testament?

In Harris v Harris, 2020 NY Slip Op 31570(U) [Supreme Court, New York County Apr. 23, 2020], Manhattan Supreme Court Justice Nanny M. Bannon considered this important question in the context of a bizarre dispute over the estate of a man who allegedly lived a double life. Upon his death, two sets of lovers and offspring claimed to have acquired the same ownership interest in his real estate business.

The LLC, its Members, and the Competing Claimants

The decedent, Steven Harris, was one of two co-equal founders of TJ Montana Enterprises, LLC, an LLC formed in the 1990s that owned a five-story residential apartment building in Manhattan’s East Village.

Steven had a wife, Bernice, and a daughter, Allison. Over his lifetime, Steven transferred various membership interests to Allison, so that by the time of his death in 2017, Steven owned 19.35% and Allison 30.65% of TJ Montana.

Steven also had an alleged mistress, Betsy, who legally changed her last name to “Harris,” and an alleged daughter out of wedlock, Tamara, who also assumed the last named “Harris.” Continue Reading How to Resolve Competing Estate Plans of an LLC Owner with a Double Life