A year ago I wrote a piece called The Elusive Surcharge in Dissolution Proceedings highlighting the rare appearance in the case law of the surcharge provision found in Section 1104-a (d) of the Business Corporation Law. The provision allows a court in dissolution proceedings brought by an “oppressed” minority shareholder to “order stock valuations be adjusted and may provide for a surcharge upon the directors or those in control of the corporation upon a finding of willful or reckless dissipation or transfer of assets or corporate property without just or adequate compensation therefor.”

If something strikes you amiss, at least as to the provision’s first clause concerning stock valuation, you’re not alone. If the court orders dissolution, there’s no stock valuation to be adjusted, right? The best (if not wholly satisfactory) answer I can give points to subsection “b” of BCL Section 1118, enacted at the same time as Section 1104-a, which allows the court, in determining the fair value of the petitioner’s shares once there has been a buy-out election, to “giv[e] effect to any adjustment or surcharge found to be appropriate in the proceeding under section 1104-a of this chapter.”

To my eye, that’s just sloppy legislative drafting. The stock valuation adjustment and surcharge both feed off the same thing: a transfer of corporate assets without fair consideration. The drafters should have excised the needlessly confusing reference to stock valuation adjustment in Section 1104-a (d), and more simply should have provided in Section 1118 (b) that the court, in determining the fair value of the petitioner’s shares, can “give effect to any surcharge found to be appropriate under section 1104-a (d) of this chapter.” How the surcharge is to be given effect — whether by way of a pro rata distribution to the petitioner of a discrete surcharge amount on top of the fair value award, or by factoring (“adjusting”) it into the business appraisal upon which the fair value award is based — is up to the appraisal experts and ultimately the court. Justice Dianne Renwick’s 2006 decision in the Exterior Delite case gives guidance to that effect.

The legislative sloppiness continues to have real-world consequences, which is why I’m revisiting the subject a year later prompted by a trial court decision earlier this month in Matter of Carter (Ricwarner, Inc.), 2017 NY Slip Op 51479(U) [Sup Ct Bronx County Nov. 2, 2017]. Continue Reading The (Even More) Elusive Surcharge in Dissolution Proceedings

The self-proclaimed entrepreneur and guiding force behind his soon-to-be ex-wife’s highly successful, multi-office pediatric dental practice known as Kiddsmiles is not smiling after the court in Savel v Savel, Short Form Order, Index No. 006375-15 [Sup Ct Nassau County May 19, 2017], dismissed his claim, among others, to impose a constructive trust upon 50% of his wife’s ownership interest in a series of professional limited liability companies.

The facts of the case, as presented in the husband’s complaint in his civil action, which he filed some months after he filed a separate divorce action against his wife, involve tawdry, self-incriminating allegations of illegal kickbacks for patient referrals from which the husband, who is not a dentist, personally benefitted through his separate consulting company that received the alleged kickbacks under the guise of phony “rental” payments.

Between the governing statute’s ironclad requirement that members of a dental practice organized as a professional service LLC be licensed dentists, and the husband’s admitted receipt of kickbacks for patient referrals in violation of the Public Health Law, it’s no wonder the court dismissed the husband’s claims seeking to enforce illegal arrangements. Continue Reading Divorcing Husband Not Smiling Over Court’s Rejection of Ownership Interest in Wife’s Dental Practice

A dissolution petitioner received the judicial equivalent of the old quip “Where’s the beef?” in a Brooklyn appeals court decision last week reversing an order dissolving a limited liability company under Section 702 of the Limited Liability Company Law. In Matter of FR Holdings, FLP v Homapour, 2017 NY Slip Op 07439 (2d Dept Oct. 25, 2017), the Appellate Division, Second Department, sent the case back to the drawing board, despite the LLC having been in receivership for more than two years, because the petitioner “offered no competent evidentiary proof” in support of his petition for dissolution.

A Common Fact Pattern

FR Holdings involved a common fact pattern. 3 Covert LLC (“Covert”) was formed to own and operate a mixed-use apartment and commercial building in Brooklyn.  Under the operating agreement, the purpose of the member-managed LLC was “to purchase and sell residential and commercial real estate and to engage in all transactions reasonably necessary or incidental to the foregoing.” Section 6.01 (a) of the operating agreement permitted most actions by “the vote or consents of holders of a majority of the Membership Interests.” As alleged in the petition, the LLC had five members, four of whom each held 12.5% interests. The fifth member, FR Holdings, owned a 50% interest. Continue Reading “Where’s the Beef?” Says Appeals Court, Reversing LLC Dissolution

Did you know there’s such a thing as an “inadvertent partnership”?

The basic definition of a partnership, under both the original Uniform Partnership Act (1914) and the most recent version of the Revised Uniform Partnership Act (1997), is “an association of two or more persons to carry on as co-owners a business for profit.” The later Act, in Section 202 (a), adds a caveat not found in the original: “whether or not the persons intend to form a partnership.”

An unintentional partnership? The official comment to Section 202 explains it’s one that can be created inadvertently and even contrary to one’s “subjective” intentions. It also tells us that it’s a universally accepted concept:

The addition of the phrase, “whether or not the persons intend to form a partnership,” merely codifies the universal judicial construction of UPA Section 6(1) that a partnership is created by the association of persons whose intent is to carry on as co-owners a business for profit, regardless of their subjective intention to be “partners.” Indeed, they may inadvertently create a partnership despite their expressed subjective intention not to do so. The new language alerts readers to this possibility.

In other words, it’s what the putative co-owners do in furtherance of a profit-seeking business — rather than what they think or say they’re doing — that evidences intent and determines the existence of a partnership. Hence, in the absence of a written partnership agreement, one or both of two putative co-owners can call it a partnership and refer to each other as partners without it being a legally recognized partnership while, conversely, they can affirmatively disavow a partner relationship yet be found by a court to have created a partnership with enforceable partner rights and obligations.

In the modern era of closely held business entities dominated by S corporations and LLCs, both of which feature limited liability along with pass-through taxation, general partnerships are rarely chosen as vehicles for multi-owner business enterprises (with the exception of professional firms organized as limited liability partnerships). Nonetheless, what we do see with some frequency are lawsuits in which the plaintiff alleges and seeks to enforce an oral partnership agreement where, after an initial period of business collaboration — usually measured in months not years — and before the parties are able to formalize the proposed business entity, the defendant calls it off. Hammond v Smith, decided last summer by the Appellate Division, Third Department, is the latest example.

Continue Reading Calling an Organization a Partnership Doesn’t Make it One, But Not Calling it a Partnership Doesn’t Make it Not One. Got It?

I’ve seen LLC operating agreements ranging from one page to over 100. Usually there’s a direct relationship between the length of the agreement and the complexity of the LLC’s capital and management structure.

But if there’s one thing I’ve learned about LLC agreements, it’s that no matter how comprehensive and tome-like their design, there’s no guarantee that a future, unanticipated dispute won’t expose the inevitable cracks in the design prompting the need for court intervention. Indeed, depending on the drafter’s skill, one can argue the more complex the LLC agreement, the greater the risk of a court contest over its interpretation.

Take the recent case of Tungsten Partners LLC v Ace Group International LLC, 2017 NY Slip Op 32025(U) [Sup Ct NY County Sept. 20, 2017], in which Manhattan Commercial Division Justice Shirley Werner Kornreich was called upon to decide whether the plaintiff holder of a 4% non-voting profits interest, identified as a “Management Member” in a 65-page operating agreement (plus another 170 pages of schedules and exhibits), was a member of the subject Delaware LLC for purposes of demanding access to books and records under § 18-305 of the Delaware LLC Act. Continue Reading A Member By Any Other Name . . . May Have Access to LLC Books and Records

Minority shareholder oppression and deadlock are the twin pillars of most business divorce litigation. Both are codified in the vast majority of statutes authorizing proceedings for judicial dissolution of closely held corporations and, to a lesser extent, limited liability companies. Both encompass infinite permutations of  behaviors — of both the well and ill-intended variety — among business co-owners that make any working definition of the two doctrines only marginally more useful than Justice Potter Stewart’s famous “I know it when I see it” definition of obscenity.

From my casual observations over the years, I’d say the courts probably have devoted far more attention to formulating and refining the standard for minority shareholder oppression, which is of more recent vintage than deadlock as ground for judicial dissolution and typically is not defined in the statutes. Oppressive conduct is evaluated in most states under one of three judicially-created formulations: majority conduct that defeats the reasonable expectations of the minority shareholder; breach of the fiduciary duty of good faith and fair dealing majority shareholders owe minority shareholders; and burdensome, harsh, and wrongful conduct constituting a visible departure from the standards of fair dealing majority shareholders owe minority shareholders in close corporations.

I’ve not encountered comparable attempts to formulate a deadlock standard, although one might think the term deadlock needs no judicial interpretation à la oppression. After all, the dictionaries tell us that deadlock is a state of impasse or inability to progress when two opposing factions with equal control can’t come to agreement on something. But the dictionary definition doesn’t get us very far in the context of judicial dissolution proceedings. For example, 50/50 owners in an otherwise well-functioning company could be deadlocked over what shape table to buy for their conference room; no one would suggest that deadlock of this sort would warrant a judicial death verdict for the company. And what about a feigned deadlock created by one faction in pursuit of a break-up, buy-out, or other strategic objective?

In my case-law travels I’ve come across decisions that catalog prior cases granting dissolution as illustrative categories of disagreement warranting dissolution, e.g., impasse over distributions or the hiring or firing of key personnel, but I’ve seen no attempt to fashion an overall framework for evaluating claims of deadlock, that is, until last month’s opinion in Koshy v Sachdev (read here) in which the Supreme Judicial Court of Massachusetts, in its first-ever effort to construe that state’s deadlock-dissolution statute, devised a four-factor test to determine whether a “true deadlock” exists. Continue Reading Court Defines “True Deadlock”

New York’s LLC judicial dissolution statute, Section 702 of the Limited Liability Company Law, provides far more limited grounds to dissolve a business than the Business Corporation Law – a harsh reality for allegedly mistreated minority members highlighted by a recent decision by Manhattan Supreme Court Justice David B. Cohen.

In Matter of Felzen v PEI Mussel Kitchen, LLC, 2017 NY Slip Op 31831(U) [Sup Ct, NY County Sept. 1, 2017], Felzen sued to dissolve the company that operates a pair of Manhattan seafood restaurants named Flex Mussels, based upon allegations of breach of fiduciary duty, looting and oppression – frequent grounds for dissolution under Section 1104-a of the Business Corporation Law.  In Matter of Zafar, an earlier decision written about on this blog, comparable allegations – i.e., “persistent self-dealing and dishonest conduct” – sufficed to dissolve an LLC.  Let’s see how things turned out here. Continue Reading LLC’s Purpose Being Achieved? Business Doing Fine? Good Luck Getting Judicial Dissolution

Having read thousands of court opinions during my 30+ years as a litigator, I’ve learned to assume that there are things going on beyond what can be gleaned from the court’s written decision, and that these hidden factors may explain positions and outcomes that otherwise seem untenable.

I’m nonetheless having difficulty giving the benefit of the doubt to most of what happened in Verkhoglyad v Benimovich, 2017 NY Slip Op 51133(U) [Sup Ct Kings County Sept. 12, 2017], a case recently decided by the Brooklyn Supreme Court in which it denied enforcement of a mandatory forum selection clause, disregarded the operating agreement’s New Jersey choice-of-law provision by applying New York law to various claims, refused to enforce the agreement’s pre-suit mediation clause, and let proceed a claim for judicial dissolution of a New Jersey limited liability company despite governing appellate law stripping New York courts of jurisdiction over the dissolution of foreign business entities.

Verkhoglyad involves a short-lived, ill-fated enterprise between two individuals who were boyhood friends. In 2014, the plaintiff Verkhoglyad became a 50% co-managing member of defendant Benimovich’s existing HVAC business organized as a New Jersey LLC. They entered into a written operating agreement designating the LLC’s principal office in New Jersey and dictating application of New Jersey law to the operating agreement and its interpretation. It also includes the following provision captioned “Settlement of Disputes and Jurisdiction”: Continue Reading Read This Case. Slap Your Head. Not Too Hard.

The practical lesson for entrepreneurs of the case I’m about to describe is, never sign complex business agreements without your lawyer, and never ever sign such agreements in the last week of August when your vacationing lawyer is unreachable.

Deals to forge new business enterprises have a pace and momentum all their own. Business considerations, financial considerations, ownership considerations, legal considerations, tax considerations, personality considerations, and more — all have to coalesce and achieve critical mass in support of a meeting of the minds on the deal’s material terms to be memorialized in a binding, enforceable, written agreement.

The dynamics of the negotiations and externalities sometimes create a seize-the-moment mentality that induces one or both sides to push to sign an agreement that’s not fully baked, either to prevent a change of mind or with the expectation that remaining open issues can be cleaned up later. In even more extreme situations, the parties commit time and capital to the new venture while the negotiations are ongoing, that is, acting and treating each other as business partners before the deal is consummated.

Eagle Force Holdings, LLC v Campbell, Mem. Opinion, C.A. No. 10803-VCMR [Del Ch Sept. 1, 2017], decided earlier this month by Vice Chancellor Tamika Montgomery-Reeves of the Delaware Court of Chancery, is one of those extreme cases. Perhaps the most remarkable feature of the case, in which the court found unenforceable the transaction documents for a new venture, including signed operating and contribution agreements, is the heavy involvement of sophisticated legal counsel on both sides throughout the process — except for the critical moment when the two principals met alone and signed what was labeled a “draft” agreement just before the start of the Labor Day holiday weekend when their respective lawyers were unreachable. Continue Reading Don’t Let the Deal Get Ahead of the Documents

If you haven’t yet listened to prior episodes of the Business Divorce Roundtable (a) it’s time you did and (b) absolutely you won’t want to miss the latest episode (click on the link at the bottom of this post) featuring first-hand, real-life, business divorce stories told by business appraiser Tony Cotrupe of Melioria Advisors (photo left) and attorney Jeffrey Eilender of Schlam Stone & Dolan (photo right).

Tony’s and Jeff’s stories have a common element: both involve the contentious break-up of a poisonous business relationship between two brothers. The similarity ends there. In my interview of Tony, he puts us inside a fast-paced and ultimately successful effort by the feuding second-generation owners of a propane distributorship, guided by their respective lawyers working in collaboration, to avoid litigation by engineering a buy-out of one brother by the other based on Tony’s business appraisal as the jointly retained, independent evaluator. It’s a happy ending to what otherwIse could have turned into a drawn-out courtroom slugfest.

Courtroom slugfest aptly sums up Jeff’s story as counsel for the brother owning the minority interest in Kassab v. Kasab, a case I’ve featured on this blog several times including last month’s post-trial decision giving the other brother the opportunity to buy out the minority interest upon pain of dissolution if he doesn’t (read here, here, and here). Jeff’s insider analysis of the case provides unique insights into a multi-faceted, roller-coaster-ride of a case involving novel issues under the statutes and case law governing business corporations and limited liability companies.

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.