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

Was it “an unfortunate attempt to second-guess or even force a ‘do over’ of the appraisal,” as the one side would have it? Or was it a “rigged” and “corrupted” appraisal process that took place behind closed doors and severely undervalued the subject interest “by tens of millions of dollars” by relying on “false and misleading” financial information, as the other side would have it?

That was the question posed in Yakuel v Gluck, 2020 NY Slip Op 31251(U) [Sup Ct NY County May 7, 2020], in which Manhattan Commercial Division Justice Joel M. Cohen considered whether to enforce a single-appraiser buy-sell agreement styled as a repurchase option included in an amendment to an LLC operating agreement.

The case involves a “performance branding” and digital marketing agency called Agency Within LLC (“Within”) co-founded by Joseph Yakuel and Andrew Gluck in 2015. Yakuel held directly or indirectly 65% of Within’s membership interests and served as managing member and CEO. Gluck held the remaining 35% and served as COO. Currently, Within boasts 125 employees and a roster of major clients including Nike, Facebook, and Shake Shack.

The Repurchase Option

In 2018, Yakuel and Gluck adopted an amendment to Within’s operating agreement granting Gluck anti-dilution rights. The amendment also included the Repurchase Option, “exercisable at any time,” allowing the company or Yakuel to purchase all of Gluck’s interest for an amount equal to “fair market value . . . reduced by appropriate valuation discounts to account for the minority interest represented by [Gluck’s] Units, the lack of marketability of such Units, and such other applicable valuation discounts.” Continue Reading This Single-Appraiser Buy-Sell Agreement Was Asking for Trouble

Three shareholders co-own an 8-year old internet-based “marketeer” business that imports Chinese-manufactured sinks, faucets, and related plumbing fixtures that it sells primarily to distributors and retailers in the United States. They successfully apply with a bank for an increased credit facility up to $10 million. The loan application includes monthly cash flow projections prepared by the company’s CFO forecasting over 40% increase in sales the following fiscal year. The owners also submit their personal net worth statements valuing the company around $30 million.

The executed loan agreement includes borrower representations that the cash flow projections have a “reasonable basis.” The personal financial statements include signed certifications that the statements “are true and give a correct showing of my financial condition” and that the statements are submitted to “induce” the bank to extend credit and knowing that the bank “will rely upon the accuracy of all information and representations contained in this financial statement.” Applicable federal law criminalizes the knowing submission of false information to the bank to obtain a loan.

Three months later, one of the owners claiming shareholder oppression petitions for judicial dissolution. The other owners exercise their statutory right to purchase the petitioner’s 24% interest for “fair value.” By statute, the valuation date is the day before the filing of the petition, i.e., also about three months after the cash flow projections and personal financial statements were prepared and submitted to the bank.

At trial, the petitioner trumpets the respondents’ $30 million company valuation on their net worth statements given to the bank and the bank’s reliance thereon. Petitioner’s valuation expert, building on the management projections supplied to the bank, values the company around — you guessed it — $30 million giving 50/50 weight to his discounted cash flow (DCF) income approach (approximately $21.4 million) and his guideline public company market approach (approximately $38.8 million).

The court in its post-trial decision values the company around $6 million or 20% of the value concluded by the petitioner’s expert. Where did the other $24 million go? Read on and find out. Continue Reading $30 Million Appraisal of Plumbing Fixtures “Marketeer” Goes Down the Drain at Fair Value Hearing

I’m very excited to announce my latest podcast interview featuring Donald J. Weidner, Dean Emeritus of the Florida State University College of Law. But first . . .

LLC statutes include default rules that govern the firm’s internal affairs unless provided otherwise by an operating agreement adopted by the members. When the members lack an operating agreement, the LLC statute’s default rules are the operating agreement.

If you compare most LLC statutes today with the ones initially enacted in the ‘80s and ‘90s, albeit with some variation among the states, you’ll find a major shift away from member liquidity rights. Members generally no longer have a default right to withdraw and be bought out. Default rules for the non-judicial dissolution and winding up of LLCs were changed from those akin to an at-will partnership to those emulating the corporation’s perpetual existence. Access to judicial remedies became harder by importation from corporate law of the direct versus derivative distinction.

None of this sits well with Dean Weidner, widely recognized as one of the country’s leading experts on partnerships, limited liability companies and fiduciary duties. In addition to serving as Dean of FSU’s College of Law for almost 25 years, and where he continues to teach business law as the Alumni Centennial Professor, Dean Weidner was the Reporter for the Revised Uniform Partnership Act (1994) and is co-author of a leading treatise on RUPA published by Thomson Reuters. Dean Weidner also maintains a private practice as a mediator and arbitrator with the Florida law firm Upchurch Watson White & Max.

I first encountered Dean Weidner at last year’s LLC Institute meeting in Tampa where he gave the keynote address. His talk presented a critical analysis of the scaling back of LLC member liquidity rights and, in general, of the “corporate-ization” of LLCs contrary to what he terms the “presumptive intention” of the “target group” for LLC default rules, namely, small groups of entrepreneurs who form businesses without the benefit of counsel.

Dean Weidner’s address became the basis for his forthcoming article in the ABA’s quarterly journal, The Business Lawyer, entitled LLC Default Rules Are Hazardous to Member Liquidity, the full text of which can be downloaded at the SSRN website.

I was very pleased and grateful when Dean Weidner agreed to be interviewed for my Business Divorce Roundtable podcast, which you can enjoy by clicking on the below link. LLC member illiquidity, i.e., the inability of a non-controlling member to exit and realize the value of his or her interest, is a root cause of many of the disputes that end up in the hands of business divorce lawyers. It’s also a subject Dean Weidner discusses with great authority, insight, and passion.

The ongoing coronavirus / COVID-19 pandemic has quite literally impacted everyone and everything in New York, including the courts, which were forced to temporarily cease non-essential functions. The result was a short-lived interruption in new business divorce decisions. But we are happy to see decisions of interest to this blog’s readers issuing once again, including a brand new opinion from Manhattan Commercial Division Justice Jennifer G. Schecter involving an attempted dissolution of a business in one of the most heavily impacted sectors of the economy: the health club space.

Justice Schechter’s opinion in Warner v Heath, Decision and Order, Index No. 654714/2018 [Sup Ct NY County May 1, 2020], has plenty of interest to business divorce aficionados:

  • thoughtful legal analysis on (i) the law of LLC dissolution, (ii) the direct versus derivative nature of LLC-member fiduciary duties where a potential sale of the business is involved, and (iii) the availability of punitive damages in business divorce cases
  • highly-quotable passages that courts and litigants may find helpful
  • some tantalizing remarks suggesting that the pandemic’s devastating economic impact on businesses may have implications for future LLC dissolution claims

There’s a lot to unpack from Warner. Let’s get started. Continue Reading Will the Pandemic Be a Boon for Future LLC Dissolution Claimants?

If you read most any operating agreement for a manager-managed LLC, chances are you’ll find somewhere in it a grant of decision-making authority in the manager’s “sole and absolute discretion” or verbiage to similar effect. Sometimes the grant of authority is cast generally; sometimes it’s limited to specified actions.

Giving each of the words their ordinary dictionary meaning, the phrase “sole and absolute discretion” sounds, well, pretty darn sole, absolute, and discretionary. No room for disagreement or legal challenge by the non-managing members, right?

In many if not most instances, that would be correct. But not all. So when is “sole and absolute discretion” not the final word on manager decision-making?

According to a recent decision by the Manhattan-based Appellate Division, First Department, in Shatz v Chertok, __ AD3d __, 2020 NY Slip Op 01383 [1st Dept Feb. 27, 2020], a “sole and absolute discretion” clause in the operating agreement does not by itself defeat a claim by a non-managing member for breach of fiduciary duty when the managing member allegedly exercises its discretion “in bad faith so as to deprive the other party of the benefit of the bargain.” Continue Reading When an LLC Manager’s “Sole and Absolute Discretion” is Neither Sole Nor Absolute