Last month, in Flor v Greenberg Farrow Architectural Inc., a three-judge panel of the New Jersey Appellate Division handed down an opinion with important lessons for business owners and practitioners in states that have adopted the Revised Uniform LLC Act, such as New Jersey, as well as in states that haven’t, such as New York.

The main lesson for those both in RULLCA and non-RULLCA states — one familiar to readers of this blog — is the danger of letting LLC formation and operation get ahead of the LLC’s constitutive documentation to the point where the putative LLC co-members disagree whether they entered into a binding transaction or, at most, a non-binding agreement to agree.

For those in RULLCA states, whose LLC statutes authorize judicial dissociation a/k/a expulsion of an LLC member, the additional lesson is not to underestimate the importance of the equities, both as to the circumstances justifying expulsion and the potential consequences that flow from expulsion.

Continue Reading Judicially Expelled Member Pays Heavy Price For Abandoning LLC

Misappropriation of corporate opportunity is one of our favorite, most frequently blogged topics on New York Business Divorce. A special kind of breach of fiduciary duty, the corporate opportunity doctrine holds that “corporate fiduciaries and employees cannot . . . divert and exploit for their own benefit any opportunity that should be deemed an asset of the corporation.”

Recently, we’ve written about some rather egregious examples of corporate opportunity misappropriation: total theft of entire businesses through the secret formation of a new entity and clandestine transfer of all of the oldco’s assets to newco. For interested readers, here are links to recent articles on Ng v Asquared and O’Mahony v Whiston.

Far less frequently, because decisions involving it are quite rare, we’ve written about the doctrine of faithless servant in business divorce cases. Another special kind of breach of fiduciary duty rooted in agency law, the faithless servant doctrine holds that “[o]ne who owes a duty of fidelity to a principal and who is faithless in the performance of his services is generally disentitled to recover his compensation, whether commissions or salary,” from the first act of disloyalty.

A key difference between the two common-law doctrines: misappropriation of corporate opportunity requires proof of actual damages. Faithless servant does not: it is an equitable forfeiture doctrine requiring a disloyal (i.e., “faithless”) agent to “disgorge” all compensation earned during the period of his or her disloyalty, even if the employer suffered no ascertainable damage from the agent’s disloyalty.

For the first time on this blog, the corporate opportunity and faithless servant doctrines converge in Owen v Hurlbut, 80 Misc 3d 1234(A) [Sup Ct, Monroe County Nov. 2, 2023]).

In Owen, Monroe County Surrogate and Acting Supreme Court Justice Christopher S. Ciaccio ruled that a shareholder’s scheme to misappropriate all the assets of an entity by transferring them to a secretly-formed, new entity provided the legal basis for disgorgement of three years – and more than one and a half million dollars – of the shareholder’s employment compensation under the faithless servant doctrine.

Continue Reading A Potent Combo: Misappropriation of Corporate Opportunity Meets Faithless Servant
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The books and records demand often is the opening act in business divorce litigation.  The relatively low burden that an owner must meet in order to obtain access to a company’s books and records (discussed here), and the availability of an accelerated special proceeding in New York courts makes the demand a logical opening salvo in many intra-company disputes.  It is a relatively speedy and cost-effective tool for a minority owner investigating misconduct or otherwise contemplating litigation against the majority. 

But there still is plenty of strategy to consider.  If ownership of the company is in dispute, asserting a books and records demand may bring that question to the forefront before it is truly ripe for litigation.  Likewise, a books and records demand may implicate not only the records of the company itself, but also the records of related companies and affiliates.  Finally, depending on the obligations set forth in the owners’ agreement, a demand for books and records may be a two-way street, imposing obligations on the owners themselves.

Each of these considerations plays strongly in a series of recent decisions from New York State and Federal Courts:

Continue Reading Proceed with Caution: Strategy Considerations Before Making a Books and Records Demand

I recently had the privilege of speaking to an audience of judges of the New York Supreme Court Commercial Division at Fordham Law School’s Eileen Bransten Institute on Complex Commercial Litigation. Naturally, the topic was business divorce litigation. My co-panelists Chris Mercer (Mercer Capital) and William Savino (Woods Oviatt Gilman LLP) respectively spoke about the marketability discount in fair value appraisal proceedings and caselaw developments concerning closely held business corporations.

My segment offered what I labelled a “semi-critical retrospective” assessment of the state of New York law concerning LLC business divorce. First, I discussed how tax considerations dictated key elements of the original design and subsequent amendment of New York’s LLC Law. I also observed how those developments have hobbled the ability of New York courts to resolve disputes among co-owners of LLCs and especially in dissolution cases, at least compared to the majority of states that have adopted the Revised Uniform LLC Act or otherwise have similarly updated their LLC statutes, unlike New York.

Next, I gave a chronological, verbal travelogue of court decisions I selected as the “greatest hits” of New York case law since the LLC Law’s enactment in 1994. I highlighted those that have shaped business divorce litigation involving LLCs, showcasing both the statute’s limitations and how courts have achieved some workarounds.

I thought it might be useful to share with a wider audience the substance of my presentation. What follows is adapted from the handout material I prepared for the Commercial Division judges.

Continue Reading New York LLC Caselaw’s Greatest Hits
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The corporation of which you are a shareholder just sent you notice that it plans to merge with another corporation.  And although the other existing shareholders will have their shares exchanged for shares of the new corporation, your shares will be cancelled and exchanged for cash.  Once the merger closes, you are out.

You resolve to challenge the merger.  You’ve done nothing wrong, and you’d like to continue as a shareholder rather than have your investment liquidated.  Where do you begin?  

Any challenge to any merger of a New York Corporation starts with: (i) the rules, which are set forth in Article 9 of New York’s Business Corporation Law and (ii) the principles set forth by the Court of Appeals in Alpert v 28 Williams St. Corp., 63 NY2d 557, 569 (1984). 

Van Horne v Ben-Dov, 2023 NY Slip Op 05212 (1st Dept Oct. 12, 2023), a recent decision from the First Department—and a case that Peter Mahler and I had the pleasure of litigating—provides the playbook for turning those rules and principles into a successful challenge, and it adds some additional wrinkles along the way. 

Continue Reading How to Stop a Cash-Out Merger from Cancelling Your Shares

Occasionally, we come across court cases in which the majority owners so egregiously mistreated their minority co-owners that it’s difficult not to write about it — if only as a lesson in what not to do to separate oneself as co-owners.

There are, of course, many ways close business co-owners can legally separate co-owners. A negotiated, voluntary buyout is one option. If permitted under the entity’s governing statutes and contracts, if any, a cash-out merger is another option. A third option is litigation wherein the petitioner, or respondent, may request a compelled or equitable buyout of one side’s interest by the other.

But what one should never do, lest face some potentially harsh legal consequences, is secretly transfer the entity’s assets to another, strip the original entity of any value, and leave the minority owner holding an empty bag with no money for his or her converted equity.

Former Manhattan Commercial Division Justice Shirley Werner Kornreich encountered this fact pattern in a decision we wrote about five years ago, Stavroulakis v Pelakanos, 58 Misc 1221(A) [Sup Ct, NY County 2018]).

In Stavroulakis, the majority owners of a corporation that owned the “Bareburger” chain of restaurants transferred all of the business’s assets to a new entity in which the minority owner, who was abroad at the time, lacked any interest, leaving the transferring entity “an empty shell.” Things went poorly for the majority owners in that case, Justice Kornreich granting the defrauded minority owner summary judgment on liability on several claims.

The facts of a recent decision, Ng v Asquared Group, Inc., ___ AD3d ___, 2023 NY Slip Op 04598 [2d Dept Sept. 13, 2023]), are eerily similar, and in several respects much worse, than those Justice Kornreich excoriated in Stavroulakis.

Continue Reading Bad Things Can Happen When You Steal a Business from a Minority Co-Owner

New York courts are not in the vanguard when it comes to devising less drastic, alternative remedies in LLC judicial dissolution cases.

In their defense, there’s nothing in Article 7 of New York’s LLC Law that expressly authorizes the courts to do so. When a member of a New York LLC brings an action for judicial dissolution, as far as the dissolution statute, Section 702, is concerned, the outcome presents the court with a binary choice: dissolve or don’t dissolve. Unfortunately, unlike its counterpart statute governing close corporations, the LLC Law offers courts no express authority to grant any less drastic remedy such as an elective buy-out.

True, on a couple of occasions New York appellate courts have ordered buy-outs in LLC dissolution cases. In 2004 in Lyons v Salamone, the Appellate Division, First Department ordered a closed auction sale with the two members bidding for each other’s membership interest as an “equitable method of liquidation.” In 2013 in Mizrahi v Cohen, under the unusual facts in that case the Appellate Division, Second Department ordered one 50% member to sell his interest to the other 50% member at a judicially determined value as an “appropriate equitable remedy upon the dissolution of an LLC.”

In neither of those cases was there a “liquidation” or a “dissolution” of the LLC. It’s as if the courts felt compelled to describe the buy-out remedies as such in obeisance to the confines of the statute.

Courts in many if not most other states do not operate under the same statutory confines in LLC dissolution cases. In the 24 states that, so far, have adopted the Revised Uniform LLC Act — proposed RULLCA legislation is pending in 4 additional states — under Section 701(b) courts are given carte blanche to “order a remedy other than dissolution.” The official commentary to Section 701(b) notes that “[i]n the close corporation context, many courts have reached this position
without express statutory authority, most often with regard to court-ordered buyouts of oppressed shareholders.”

Continue Reading The Magnolia State Wins the Prize for Novel Alternative Remedies in LLC Dissolution Cases
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The owners’ agreement is the backbone of the closely-held business.  In intracompany LLC disputes, few things are more important than what the operating agreement has to say on the subject.  As a consequence, the pages of this blog are packed with cases pitting clashing interpretations of an operating agreement against each other (see this post, and this one, for starters). 

The prospective nature of an operating agreement often makes its interpretation complicated.  Operating agreements are drafted at the start of the business, then they lie dormant for years until a dispute arises.  By that time, the nature of the business or the context of the provisions may have fundamentally changed. And even the provisions that seemed most straightforward years ago can become murky.

Despite those complications, when faced with differing interpretations of an operating agreement, Courts go back to the basics of contract interpretation. The First Department’s recent decision in Southern Advanced Materials, LLC v Abrams, 2023 NY Slip Op 04704 [1st Dept Sept. 21, 2023], treats us to a lengthy discussion of how those basics work.

Continue Reading Dissolution Defined: The First Department’s Recent Guidance on Interpreting Operating Agreements

Imagine devoting years of costly litigation to rescinding a $1 million equity investment in an LLC for fraudulent inducement, prevailing on the merits by clear and convincing evidence after a full trial, but losing anyway because you named the wrong defendant.

That was the painful outcome for an allegedly defrauded restaurant investor in a recent decision by Manhattan Commercial Division Justice Jennifer G. Schecter.

In Han v Kwak (2023 NY Slip Op 33207[U] [Sup Ct, NY County Sept. 14, 2023]), the Court framed the issue as follows:

This case ultimately turns on a purely legal question: whether rescission or rescissory damages are available solely against a defendant who is not a party to the transaction that he fraudulently induced.

As it turns out, the sole defendant named on the fraud claim, Robert Kwak (“Kwak”), was a signatory to the contract the defrauded investor, Janet Han (“Han”), sued to rescind. As the Court noted, Kwak’s signature appeared on the contract, but he signed only in an official capacity, not in his personal capacity. This subtle distinction proved disastrous for Han, who ultimately walked away with nothing after an otherwise successful trial.

Continue Reading Damages or Rescission? When Electing Fraud Remedies Choose Wisely

In my experience, most operating agreements of New York LLCs include a provision barring amendments unless made in writing and executed by all members. Such provisions are especially prevalent with smaller, member-managed LLCs as opposed to larger, manager-managed LLCs having some number of passive investors. With the latter, I would venture to say that the larger the company in terms of its capitalization and assets, the more its governance resembles traditional corporate-style management, and the greater the number of its inactive members (especially if there are multiple classes of investing members, some of which have limited or no voting rights more akin to limited partners), the more likely it is to find at least some power of non-unanimous amendment reserved to the controlling members.

But whatever the size, membership structure, or governance of the LLC, before drafting an amendment provision in the initial operating agreement, and certainly when considering any post-formation amendment to the existing operating agreement, attention must be paid to Section 417 (b) of the New York LLC Law which contains default limitations on the power to amend without the consent of each “adversely affected” member.

Continue Reading Use Caution When Amending Your Operating Agreement Without Unanimous Consent