When the tsunami of LLC enabling statutes swept the U.S. in the late ’80s and early ’90s, including New York in 1994, many included a default rule authorizing as-of-right member withdrawal and payment for the “fair value” of the membership interest. The default rule was one of many designed to avoid C corporation-style “double taxation” of LLC earnings. After 1997, when the IRS adopted check-the-box regulations cementing pass-through partnership tax treatment for LLCs, New York and other states flipped the default rule, i.e., members are no longer permitted to withdraw unless authorized by the operating agreement.

When New York amended its withdrawal provision, LLC Law § 606, it included a new subsection “b” grandfathering LLCs formed before the amendment’s 1999 effective date, meaning that withdrawal under the “old” § 606 and fair-value buyout under LLC Law § 509’s default rule remain available for members of pre-1999 LLCs — so long as not otherwise provided in the operating agreement. The Chiu case, which I wrote about here, is an example of one such case resulting in a fair-value buyout of a withdrawn member.

After the amendments, some pre-1999 New York LLCs adopted new operating agreements or amended their existing ones to prohibit withdrawal. Some, as in Chiu, did not.

This is a story about one LLC that did not, but with a very different outcome than Chiu. The story’s punch line, which makes it a fascinating one, is that even though the minority member, seeking to force a fair-value buyout, was found to have properly invoked his uncontested right to withdraw under the old § 606, in the end the lower and appellate courts held that his withdrawal did not trigger a statutory buyout under § 509 because the LLC’s operating agreement included mandatory rights of first refusal — with which the minority member never complied — that displaced the buyout statute’s default rule.

The case, Matter of Jacobs v Cartalemi, was decided last week by the Appellate Division, Second Department, along with two decisions in companion appeals in related cases in which the court held that upon withdrawal the minority member also lost his standing to pursue derivative claims against the controlling member. I’ll explain all below, but before doing so I must disclose that, along with co-counsel, my firm and I represent the controlling member of the LLC in each of the cases. Continue Reading Operating Agreement Defeats Statutory Buyout Rights Upon LLC Member’s Withdrawal

This week marks the tenth anniversary of the launch of this blog. Every Monday morning since, come hell, high water, or in the middle of a trial, I’ve posted a new article — 534 articles, to be exact. I joke that if you don’t see a new post come Monday morning, check the obituaries.

I had no idea what to expect when I started the blog. Would anyone read it? Would I have enough material to write about every week? Would I have the time to write every week? How could I add value for the reader, beyond mere descriptions of recent court decisions in business divorce cases? Would the blog generate new clients and new relationships with other professionals in the field?

With ten years behind me, I can safely say my expectations have been exceeded more than I ever could have imagined. Here are some of the most important lessons blogging has taught me:

  1. Blogging Brings Relationships. The blog has fostered many new and lasting relationships with other lawyers, judges, academics, and business appraisers from across the country. We share ideas, cases and articles of interest, and use each other as sounding boards. We invite each other to speak at bar association meetings and legal education conferences. The growing network of relationships goes hand-in-hand with the growing recognition of business divorce as a distinct sub-genre of commercial litigation and legal theory in which clients are best served by lawyers and other professionals with specialized knowledge in the field. Ten years ago, I was one of very few lawyers who called themselves business divorce lawyers. Today, there are many lawyers across the country who identify themselves as specialists in business divorce, a handful of whom also have started blogging.
  2. Blogging Brings Clients. The biggest and most pleasant surprise from blogging has been its ability to attract new clients. Very early on, the blog became and has remained the primary generator of new clients big and small for my business divorce practice. Prior to the blog, for years I’d been writing about business divorce in traditional legal publications. The idea of putting my writing online came to me in the mid aughts, inspired by a couple of pioneering law blogs and by some prospective client inquiries from business owners who somehow found my law journal writings online. I was attracted to the blogging format and figured it would make my writing more accessible to business owners, who, like the rest of civilization, increasingly looked to the internet to educate themselves and get answers to legal problems before calling a professional. Blogging allows lawyers to demonstrate their expertise, personality, and passion for the subject matter to consumers of digital media like nothing else. Google does the rest, at least when it comes to bringing potential new clients to your door.
  3. Blogging Enhances Expertise. Regular blogging keeps a lawyer at the top of their game. I’m constantly on the prowl for new court decisions, legislative developments, and articles of interest to share with my readers. The blog’s ravenous maw demands no less. The educational value of the research and writing, driven by the imperative to achieve mastery of the subject matter for my readers, is priceless when it comes to representing clients in my own business divorce practice.
  4. Numbers Don’t Matter. The success of a law blog is not measured by the numbers of visitors and page views. In the early days I obsessively tracked those numbers. It took me a while to realize they don’t matter, especially for a blog that focuses on a micro-niche, non-volume practice area like business divorce. The most popular posts I ever wrote for this blog, generating hundreds of thousands of views, were about a business divorce between the father and son stars of the reality TV show, American Chopper. The numbers were gratifying but the viewers responsible for those numbers — fans of the TV show with no personal interest in business divorce — were not my intended audience.
  5. Long Posts Can Work. When I started the blog I deliberately kept the posts short — less than 500 words — under the commonly-held view that the attention span of online readers is too short for long-form blogging. Within a half year, however, I found myself consistently writing posts over 1,000 words and sometimes well in excess of that figure — a habit I’ve rarely departed from ever since. Of course the longer pieces take more time to write; typically I’ll devote 4 or 5 hours every weekend to the task. The longer posts also place a premium on adopting a more journalistic and less legalistic writing style, which is no small challenge when writing principally about court decisions. I don’t imagine that all those who encounter my posts get past the first paragraph, much less read the entire thing. But as I said above, law blogging is not about reaching the widest possible audience, it’s about reaching the right audience. For me, a distressed business co-owner or his or her consultant is the right audience — an audience that, I’ve become convinced over the last 10 years, finds value in the more nuanced analysis and value-added commentary that long-form blogging enables.

Some thanks are in order, firstly to my regular readers these past ten years, whose kind words of appreciation and encouragement make it all worthwhile. Special thanks to Kevin O’Keefe and his fantastic Lexblog team for designing and hosting the blog these many years, and to my firm’s Marketing Director Lorraine Sullivan and her dedicated staff for their support. Finally, thanks to the many fine judges of the great State of New York, whose labors, interpreting and applying the law in some of the toughest business divorce cases anywhere, provide the oxygen for this blog.

Onward to the next ten years of blogging!

When you want to sue to dissolve a business in New York on behalf of the estate of a deceased shareholder, to which court should you go: Supreme or Surrogate’s Court?

For many practitioners, the Commercial Division of the Supreme Court, a specialized court in New York focusing on complex business-related disputes, is the venue of choice. Most types of disputes have a minimum monetary threshold for eligibility in the Commercial Division. Manhattan’s threshold is the highest – $500,000.  The rules of eligibility for cases to be heard in the Commercial Division, which you can read here, have three exceptions to the monetary threshold – one of which lists “[d]issolution of corporations, partnerships, limited liability companies, limited liability partnerships and joint ventures — without consideration of the monetary threshold.” In part because there is no monetary threshold for dissolution proceedings, practitioners in the several New York counties that have a Commercial Division usually litigate business dissolution disputes in the Commercial Division.

But once in a blue moon a dissolution case will wind up in the Surrogate’s Court. Continue Reading Surrogate’s Court Declines to Order Demise of Fashion Business

I wish I could take credit for it, but I can’t. The phrase “bare naked assignee” was coined by the preeminent scholar and LLC maven Professor Daniel Kleinberger whose massive oeuvre (not to mention his guest posts on this blog here and here) includes a wonderful article published in 2009 called The Plight of the Bare Naked Assignee (available here on SSRN ). As described in the abstract, the article addresses the “new and separate opportunity for oppression” that “exists because LLC law purports to (1) recognize a species of persons holding legal rights vis-á-vis the LLC (assignees) while (2) denying those persons any remedies whatsoever in connection with those rights.”

Under the LLC statutes in New York and most other states, except as otherwise provided in the operating agreement, LLC membership interests are freely assignable in whole or in part. As the Professor’s article explains, the bedrock “pick your partner” principle of partnership law found expression in the default rules of LLC statutes which, contrary to traditional corporation laws, require majority (or unanimous) consent of the other LLC members for an assignee to become a full-fledged member with both economic and voting/management rights. Typical of these statutes, New York’s LLC Law § 603 provides that, absent such consent, the assignee has no right to participate in LLC management “or to exercise any rights or powers of a member” and only has the right “to receive, to the extent assigned, the distributions and allocations of profits and losses to which the assignor would be entitled.”

The vast majority of written operating agreements that I’ve encountered include detailed articles addressing the rights of members to assign (or not) their membership interests and, when permitted, what if any rights non-member assignees possess other than the right to receive distributions and profit/loss allocations. Of course, absent an operating agreement, the rights of an assignee are governed by the statutory default rules.

The Professor’s article broadly discusses theory and case law surrounding the difficulties faced by non-member assignees a/k/a transferees — oftentimes the heir of a deceased member — when it comes to protecting their economic interests against managerial abuse by the LLC’s controllers. My focus here addresses only one, narrow aspect of such protection, namely, the ability of a non-member assignee to inspect LLC records in the absence of dispositive rules in an operating agreement or, as in what I believe is a small minority of states including Texas, a statute giving assignees inspection rights. Continue Reading Can the Bare Naked Assignee Demand Access to LLC Records?

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”