“The Company is formed for any valid business purpose”

Nine seemingly benign words in the garden-variety operating agreement of a realty holding LLC. Nine words that, as one judge opined under similar circumstances some years ago, are tantamount to “no stated purpose.” Yet, in a case decided earlier this month called Lazar v Attena LLC, 2020 NY Slip Op 33003(U) [Sup Ct NY County Sept. 9, 2020], those nine innocuous words produced a first-round knockout of a dissolution petition brought by members of three affiliated LLCs that had sold off their realty assets and essentially had already wound up their business. Let me explain.

Under section 702 of the New York LLC Law, as construed by the courts, an LLC member may apply for judicial dissolution if either (1) management is unable or unwilling to permit or promote the LLC’s “stated purpose” as expressed in the operating agreement or articles of organization, or (2) continuing the LLC is financially unfeasible. The vast majority of LLC dissolution cases fit within the first, failed-purpose category.

The failed-purpose test’s focus on the LLC’s “stated purpose” has generated controversy and litigation, especially in dissolution cases involving realty holding LLCs. For instance, in 2015, in the Ross case that I wrote about here, Justice Timothy Driscoll cited the operating agreement’s broad purpose clause (“any lawful act or activities for which limited liability companies may be formed under the [NY LLC Law]”) in dismissing a dissolution petition brought after the LLC’s sole realty asset was sold and the controlling members decided to reinvest the sale proceeds in a new property rather than distributing them.  The court rejected the petitioner’s contention that the LLC’s no-longer-achievable, unwritten, sole purpose was to acquire and operate the original property. Continue Reading The Purposeless Purpose Clause Rides Again

In Jacobs v Cartalemi, now the leading case on the subject of LLC member withdrawal (which our firm had the pleasure of litigating), the Appellate Division – Second Department repeated a well-established principle of law: “The right to an accounting is premised upon the existence of a confidential or fiduciary relationship and a breach of the duty imposed by that relationship respecting property in which the party seeking the accounting has an interest.”

The Cartalemi Case

In Cartalemi, the Court applied this rule of law to reverse the denial and grant dismissal of an accounting claim of a withdrawn LLC member. The Court held, “Here, the plaintiff’s right to an accounting was based on his ability to prove that [his co-member] breached his fiduciary duty to [the LLC], a claim that is entirely derivative and which the plaintiff, having withdrawn as a member from [the LLC], no longer had standing to maintain.” Under Cartalemi, a withdrawn LLC member lacks standing to bring a derivative claim for an accounting post-withdrawal from the LLC.

Is the rule the same for partnerships? If not, why is there a difference? A recent decision from the same appeals court that issued Cartalemi highlights important some distinctions between the accounting rights of withdrawn owners of LLCs and partnerships. Continue Reading Two Entities, Two Outcomes: Withdrawal and the Right to an Accounting

There’s tremendous diversity from state-to-state when it comes to statutory and judge-made law in business divorce cases. The basic fact patterns one sees in cases from across the country, however, don’t vary nearly as much. This juxtaposition of divergent law and convergent fact patterns makes it all the more interesting to follow case law developments from outside my home state of New York, to see how the outcomes and rationales differ from, or resemble those, of New York courts.

To illustrate the point, as I did several years ago, below I summarize five, recent appellate rulings in business divorce cases from around the country addressing issues of universal interest to business divorce practitioners. They include a Massachusetts decision in which a member left to compete against his own LLC; a Maryland case deciding whether a request for receivership triggers buy-out rights; a Mississippi decision allowing a dissolution complaint to go forward based on an alleged “lowball” buy-out offer; a District of Columbia ruling in a dispute following the death of a 50% LLC member; and a Nebraska decision in a contested fair value appraisal case.

Massachusetts Court Holds that LLC Agreement’s Permissive “Other Activities” Provision Trumps Member’s Fiduciary Duty  

In Butts v Freedman, 96 Mass. App. Ct. 827 [2020], the Massachusetts appellate court affirmed a post-trial judgment dismissing a lawsuit brought by one of two members of a Massachusetts LLC against the other member who, while still a member, left their investment banking firm to start up a competing firm. While agreeing with the plaintiff that the defendant, “as a member of a closely held corporation [sic],” owed a fiduciary duty to the plaintiff and their jointly-owned LLC, the court upheld the defendant’s position that his alleged wrongful conduct nonetheless was permitted by the “Other Activities” provision of the LLC’s operating agreement, stating: Continue Reading Business Divorce Nation: A Cross-Country Tour of Recent Decisions of Interest

With apologies to the King James Bible, what the Manhattan real estate market giveth, a poorly conceived partnership agreement taketh away.

It’s the best explanation I can offer for three successive lawsuits lasting almost fifteen years and counting between two partners in a general partnership that owns a full-floor unit in a commercial co-op building in Manhattan’s Garment District and, since the death of one of the partners in 2011, between the deceased partner’s estate and the surviving partner.

The partnership, known as S-L Properties, acquired the unit in 1984. Its two partners, Robert Liss and Sage Systems, Inc., held 43.07% and 56.93% partnership interests, respectively. Under their agreement, the partners each took assigned portions of the unit for the use of their two, separate businesses. From what I can tell, the purchase price was around $250,000. For anyone familiar with Manhattan real estate values, that tells you right away that, whatever was paid for the unit in 1984, its value grew exponentially by the time litigation broke out in 2006, and super-exponentially at current market values.  That’s the “giveth” part.

The partnership had a 40-year fixed term under its written partnership agreement, subject to early termination in the event of a partner’s death, upon which the surviving partner has an option to purchase the deceased partner’s interest for a fixed price essentially equal to the decedent’s cash contributions plus 6% interest from the date of each contribution. That’s the “taketh away” part.

The litigation unfolded in three acts:

  • In Act One, Liss sought judicial dissolution of the partnership and liquidation of the partnership’s realty asset for Sage’s alleged violations of the proprietary lease’s subletting provisions.
  • In Act Two, Liss filed a second lawsuit against Sage for an accounting. Following Liss’s death, Sage filed an amended countersuit to compel a buy-out of the Liss estate’s partnership interest at the fixed price under the partnership agreement.
  • In Act Three, Sage sued Liss for contractual indemnification of its legal expenses defending the dissolution lawsuit.

Intrigued? Read on to find out what happened. Continue Reading A Partnership Dissolution in Three Acts Over Fifteen Years and Counting

Several weeks ago, I had the pleasure of first appearing on this blog, with a piece about a Delaware Chancery Court decision considering—as a matter of apparent first impression—whether an LLC could exercise, then walk back a call option allowing the LLC to purchase a member’s interest at a price established by a three-appraisal process.

I am equally pleased to return this week to weigh in on a recent decision by Justice Masley of the New York County Commercial Division regarding the inverse: a Delaware LLC member’s put option.  A put option provides the holder with the right to sell her interest back to the LLC at a specified price.  In a world where an LLC member’s exit rights is a thorny issue for the brightest (and most interested) minds—as covered here—put rights provide a member with an efficient and straightforward mechanism to cash out her interests.

While put rights generally are a strong exit mechanism, GMX Technologies v. Pegasus Capital Advisors, Dec. & Order, Index No. 654056/2019 (Sup Ct NY County Aug. 8, 2020), considers a potentially significant limitation: can an LLC member exercise a bargained-for, contractual put right if doing so would render the company insolvent?

Handbags and Herbicides

The dispute in GMX Technologies stems from a complicated cross-investment arrangement between Arnold Simon—a fashion-industry titan turned CEO of GMX Technologies LLC, an agricultural biotech startup—and Pegasus Asset Management’s Leiber Portfolio Company (“Leiber”), which owns the once-popular Judith Leiber handbag brand. Continue Reading Departing LLC Members: Exercise Your Put Option Before Insolvency Approaches

Oral agreements – and oral modifications of written agreements – are a constant source of litigation in business divorce cases. Alleged oral agreements are subject to attack based upon legal enforceability – as well as their ability to be proven with adequate evidence. As a general matter, legal enforceability of an alleged oral agreement among business owners concerning their rights as owners depends first and foremost upon the kind of entity involved.

Limited Liability Companies

Section 102 (u) of the Limited Liability Company Law (the “LLC Law”) defines the term “operating agreement” as a “written agreement of the members.” LLC Law § 417 (a) provides that the LLC’s members “shall adopt a written operating agreement.” As we noted previously, the wording of the LLC Law differs markedly from Delaware’s LLC Act and that of many other states, which explicitly permit oral operating agreements.

Based upon the language of the LLC Law, the prevailing view in New York is that oral operating agreements are unenforceable. For example, in Shapiro v Ettinson, 146 AD3d 650 [1st Dept 2017], the court held that an alleged oral agreement requiring member unanimity to adopt an operating agreement was unenforceable because LLC Law § 417 “requires a written operating agreement, and where there is no operating agreement or the operating agreement fails to address issues in dispute, the default provisions under the Limited Liability Company Law govern.” Continue Reading Enforceability of Oral Operating, Shareholder, and Partnership Agreements

Usually I open my annual Summer Shorts post with some breezy comment about summer vacations, travel, or poolside reading. But this shelter-at-home year we find ourselves living and working in profoundly different circumstances, so I’ll skip the usual pleasantries and get straight to the subject matter consisting of short summaries of five recent decisions of interest involving disputes between business co-owners, four by New York courts and one from Mississippi.

This year’s summaries include:

  • a decision upholding the termination for cause of an LLC member based on a felony conviction that preceded his membership;
  • a decision denying a motion to dismiss a statutory counterclaim for deadlock dissolution which the  plaintiff unsuccessfully argued was foreclosed because of the plaintiff’s own request for dissolution;
  • a decision refusing to limit the plaintiff limited partners’ access to books and records under the normal rules governing discovery in plenary actions based on provisions in the partnership agreement giving the general partner discretion to withhold certain information;
  • a decision denying defense motions to dismiss a statutory dissolution action on procedural grounds and based on issue or claim preclusion;
  • and finally, an unusual decision by the Mississippi Supreme Court in an oppression case brought by a 49% shareholder against the other 51% shareholder, affirming the trial judge’s remedial order for the transfer of a 1% interest thereby equalizing the two shareholders at 50/50, in lieu of dissolution.

Continue Reading Summer Shorts: For-Cause Termination of LLC Member and Other Decisions of Interest

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?