In my business divorce practice I deal with many closely held corporations that have only a few or perhaps just two shareholders, each of whom is actively involved in running the business. Within that category are many companies whose owners essentially ignore some if not all the corporate formalities mandated by New York’s Business Corporation Law.

Foremost among the neglected formalities is a functioning board of directors as required by BCL 701 (“the business of a corporation shall be managed under the direction of its board of directors”), the members of which “shall be elected” at “each annual meeting of shareholders” as required by BCL 703. At least while relations among the owners are copacetic, I’m sure I’d be met with incredulous looks if I were to recommend annual board elections and regular board meetings complete with meeting minutes to a small group of operating owners who are in regular if not daily contact with one another.

Relations among co-owners can sour for many reasons. One of the more common reasons for dissension is a co-owner’s self-interested transaction with the company. Apart from whether the transaction breaches a common-law fiduciary duty, when the actor is a director — even if only nominally so — enter the “Interested Directors” statute, BCL 713, which imposes a series of guardrails on the ability of a director to engage the corporation in a contract or other transaction with any other entity in which the director has a substantial financial interest.

Continue Reading Enforcing the Guardrails on Transactions Involving Interested Directors of Close Corporations

Sections 706 (d) and 716 (c) of the Business Corporation Law (the “BCL”) both contain a “for cause” standard for judicial removal of corporate directors and officers. Complaints with claims for judicial corporate director and officer removal are common. Decisions actually ordering removal are rare. Very rare. Over the past two decades, there have been less than a dozen appeals court decisions to even cite BCL 706 or 716, and not one involved actual removal on the merits of an officer or director.

The closest to reach the merits of a removal claim, Colucci v Canastra (130 AD3d 1268 [3d Dept 2015]), ruled that four shareholders of a corporation that owned and operated a golf course “submitted prima facie evidence” warranting a trial whether “there was cause for defendant’s removal due to his use of Hillcrest’s profits to pay for clubhouse operations that only benefitted him.”

Last month, in Gam v Dvir (___ AD3d ___, 2024 NY Slip Op 00181 [2d Dept Jan. 17, 2024]), a Brooklyn-based appeals court became the first in a generation to consider the merits of a lower court’s decision ordering judicial removal of a corporate officer or director.

Continue Reading The Flexible “For Cause” Standard for Director and Officer Removal

More often than not, the centerpiece of an intra-owner business dispute is a claim that those in control of the business breached their fiduciary duties to the company or the minority owners.  While often easy to assert, the breach of fiduciary duty claim is subject to incredibly nuanced legal theories, including those surrounding agreed-upon conduct, safe harbors, conflicts of interest, business judgment, reasonable means, and different standards of review.  Litigants often agree that a majority shareholder or director owes fiduciary duties to the company, then sharply disagree on what those duties are and how their conduct should be adjudged.  

This week’s post takes us to the halls of Delaware Chancery Court, where a recent decision from Vice Chancellor Laster, In re Sears Hometown and Outlet Stores, Inc. Stockholder Litig., 2019-0798-JTL [Del Ch Jan. 24, 2024], offers a first-of-its-kind roadmap for assessing the fiduciary duties owed by a majority shareholder.

Continue Reading The First State Defines the Scope of Majority Shareholder Fiduciary Duties

Capital contributions by business owners are the lifeblood of any newly formed business entity. Typically the lifeblood consists of cash, but not always. In many instances the contribution may consist of tangible (e.g., real property) or intangible (e.g., intellectual property rights) assets. In other instances it may consist of services provided by an equity owner.

As in most if not all states, New York’s statutes governing business entities sensibly permit various forms of capital contributions as consideration for equity interests. With minor variations each of Section 504 of the Business Corporation Law, Section 121-501 of the Revised Limited Partnership Act, and Sections 102(f) and 501 of the Limited Liability Company Law provide that capital contributions may take the form of cash, property, services rendered, or promises to provide any of the foregoing.

LLCs and Indeterminate Membership Interests

The default rules under New York’s LLC Law are modeled on what I call indeterminate or variable membership interests. The measure of a member’s voting power (LLCL 402[a]), profit and loss share (LLCL 503), share of distributions (LLCL 504), and share of net assets distributed upon dissolution (LLCL 704[c]) all are based on the proportionate “value” of each member’s “contributions” which in theory may vary over time.

Most of the LLCs I encounter in my practice have operating agreements that depart from the default rules by granting the members fixed voting and economic rights based on static membership percentages which may be based on actual contributions or an arbitrary incentive-based allocation such as equal shares for all members. To the extent such operating agreements leave room for post-formation adjustments to member percentages and allocations, it’s usually captured by a provision contemplating possible additional cash contributions down the road.

The risk of member disputes over contributions is greater for LLCs either with no written operating agreement, and therefore governed by the statutory default rules, or with operating agreements that replicate the default rules. The latter often appear when LLCs use off-the-shelf operating agreements offered by various vendors such as LegalZoom. For those LLCs, when member relations sour and a power struggle ensues, there’s a strong incentive to challenge the value of member contributions where the facts warrant it.

This can take the form of claims that a managing member falsified the LLC’s accounting records and tax filings to record values for cash contributions that were never made or for services that never were disclosed or the subject of an agreed valuation among the members. The accusation invariably is tied to a claim for a greater share of voting rights, profit and loss allocations, or distributions.

Continue Reading The Perils of Indeterminate LLC Membership Interests, Redux

There are many paths to a fair value appraisal proceeding. A road less traveled begins at Section 910 of the Business Corporation Law (the “BCL”).

BCL § 909 (a) requires board and shareholder approval for a “sale, lease, exchange or other disposition of all or substantially all the assets of a corporation, if not made in the usual or regular course of the business” of the corporation.

BCL § 910 (a), in turn, provides that a shareholder who timely dissents from a corporation’s sale, lease, exchange or other disposition of “all or substantially all” assets shall “have the right to receive payment of the fair value of his shares” in an amount for the parties to litigate and the court to decide in a fair value appraisal proceeding under BCL § 623.

Cases involving a shareholder’s right to fair value appraisal of his or her stock resulting from an “all or substantially all” sales transaction are rare.

More than a dozen years ago, Peter Mahler wrote about one such case, Barasch v Williams Real Estate Co. (33 Misc 3d 1219[A] [Sup Ct, NY County 2011]).

In Barasch, former Commercial Manhattan Division Justice Bernard Fried held that a complex, multi-step reorganization ultimately resulting in the acquisition of 65% of the corporation’s former interests by a new investor triggered a shareholder’s right to dissent and cash out in an appraisal proceeding.

The Appellate Division – First Department later affirmed Justice Fried’s Barasch decision, but on other grounds, ruling that the entity was “estopped” from denying the transaction was an “all or substantially all” transaction because it sent a notice of shareholders meeting stating that it was exactly that: a “disposition of substantially all of the assets” of the company (100 AD3d 562 [1st Dept 2012]).

In his piece on Barasch, Peter Mahler wrote that the case fell in a “grey area” between, on the one hand, a clear right to appraisal from a sale or disposition that “terminates the corporation’s existence or operation,” and, on the other hand, a clear absence of right to appraisal where a corporation “merely transfers some of its assets to subsidiaries.”

Earlier this month, in Haruvi v Hungerford (81 Misc 3d 1229[A] [Sup Ct, NY County Jan. 16, 2024]), Manhattan Commercial Division Justice Andrew Borrok decided another “grey area” BCL § 909 case. In some ways, Haruvi’s facts, especially the complexity of the deal, resemble those of Barasch. But the legal outcome could not have been more different.

Continue Reading Direct to Beneficial: Change of Corporate Ownership Structure Yields No Right to Dissent and Seek Appraisal

When a closely-held business is profitable, self-interested owners naturally want a bigger slice of the pie, especially where the personal relationships among the owners are frayed.  Perhaps that’s why we often discuss the value of freeze-out mergers as a mechanism for those in control of a closely-held corporation or limited liability company to squeeze a minority owner out of the business’ future profits. 

Equity dilution is another common method by which those in control of a corporation or LLC attempt to squeeze out a minority owner.  For one, stock dilution impairs the minority owner’s ability to influence company action by voting his shares, and it lessens the owner’s right to participate pari passu in the distributions or dividends of the company.  Perhaps more importantly, a minority owner can see his or her ownership interest diluted below certain critical thresholds—for instance, the 20% ownership required to petition for dissolution under BCL 1104-a.

Despite the potentially drastic consequences of stock dilution, many closely-held businesses we encounter fail to adequately address the issue of dilution in their governing documents.  And New York caselaw on the issue leaves plenty to be desired.  Let’s interpret those factors as an invitation to review the basics, key caselaw, and the current status of the improper dilution claim.

Continue Reading Let’s Talk About Dilution

Welcome to this year’s Winter Case Notes where, amidst the arctic blast currently sweeping most of the nation, I offer shortish takes on several court decisions in recent business divorce cases.

This year’s edition features notable decisions by New York courts stemming from cases with, shall we say, not your typical fact patterns:

  • Affirming the lower court’s post-trial verdict rejecting a shareholder’s claim to enforce an alleged agreement requiring the defendant shareholder, following the plaintiff’s acquittal on murder charges, to transfer back to the plaintiff shares he sold to the plaintiff in the course of the plaintiff’s lengthy criminal proceedings;
  • Without deciding whether the death — accidental in this case — of an LLC member qualifies as a withdrawal for purposes of LLC Law § 509’s buyout provision, ordering the surviving member to turn over books and records to the estate representative but only through the date of death; and
  • Denying interim injunctive relief restoring a minority shareholder to his former management position in a group of auto dealerships upon the court’s finding that the plaintiff failed to establish a likelihood of success on his claims of minority shareholder oppression and that the governing agreements were never effective.
Continue Reading Winter Case Notes: Murder, Forgery, Accidental Death, Oppression, Oh My!

Parallel business divorce proceedings in the same or different courts alleging overlapping or duplicative claims are common.

When it occurs, judges must often determine whether to dispose of one so the other may proceed in the first instance under the “another action pending” ground for dismissal in CPLR 3211 (a) (4), whether to consolidate or join the two lawsuits in a single proceeding under CPLR 602, or whether to simply allow the two cases to proceed concurrently.

Parallel business and matrimonial divorce proceedings? Not so common. But that is exactly what happened in Malick v 302 East 105th St. LLC (2023 NY Slip Op 34417(U) [Sup Ct, NY County Dec. 12, 2023]).

Continue Reading Parallel Business and Matrimonial Divorce Proceedings

This first post of 2024 brings the New York Business Divorce Blog into its eighteenth calendar year of weekly commentary on disputes among co-owners of closely held businesses.

This year, let business owners and their counsel resolve to carefully document their investment and ownership transactions.  If the past eighteen years of our covering all varieties of bitter and costly litigation that can result from poorly documented transactions among business owners is not enough motivation to stick to that resolution, this week’s post piles on the reasons.

One of the most common disputes that a poorly documented investment in a closely held company will produce is one of characterization: is the investment a loan or an equity purchase?  That dispute can get particularly thorny in the context of limited liability companies, where non-existent operating agreements, lack of certificated ownership interests, and an apparently prevalent attitude of informality provide prime conditions for ambiguity.

Another ripe area for dispute stems from the reality that many business owners choose to operate through their wholly-owned entities.  Individual A agrees to invest $100,000 in NewCo in exchange for an ownership stake, but then arranges for his company, ACo, to make the $100,000 investment.  Who owns the interest in NewCo, A or ACo?  When does it matter?

Those questions feature prominently in a recent decision from Judge Paul G. Gardephe in the Southern District of New York, Melwani v Eagle Point Fin. LLC (17-CV-8308, 2023 WL 8850097, at *1 [SDNY Dec. 21, 2023]), which tees up one of the first must-see business divorce trials of 2024.

Continue Reading Ambiguous Agreement, Clear Consequences

Some years are easier than others to select the most significant business divorce cases. In this, the 16th year I’ve published this top-10 list, the task is made especially difficult by a veritable flood of court decisions involving novel issues in business divorce cases. But select I must.

The cases I’ve selected for this year’s list include decisions by New York courts and a couple of out-of-state courts at the trial and appellate levels, involving mostly limited liability companies but also a few close corporations. All ten decisions were featured on this blog previously; click on the case name to read the full treatment. And the winners are:

Doeblin v MacArthur Case law is clear that designated managing members of New York LLCs owe fiduciary duties whereas non-managing members do not. In Doeblin, Commercial Division Justice Andrea Masley was tasked with deciding whether a non-managing member who nonetheless allegedly acted in a managerial capacity owes a fiduciary duty to the company. Upon her review of applicable precedent, Justice Masley concluded that a fiduciary duty is imposed on a non-managing member who shares management duties or takes control of management duties where management duties are not shared. The facts alleged in the plaintiff’s complaint, Justice Masley held, did not make the cut. Case dismissed.

Andris v 1376 Forest Realty, LLC Section 702 of the LLC Law expressly confers standing to seek judicial dissolution on members. Section 608 provides that a deceased member’s executor “may exercise all of the member’s rights for the purpose of settling his or her estate.” Does Section 608 confer on the executor standing to seek judicial dissolution? Cases denying executors as non-members standing to pursue derivative claims suggest not. But in Andris, quoting Section 608’s language without further analysis, the Appellate Division, Second Department, affirmed the lower court’s denial of the executor’s motion for a summary judgment of dissolution based on disputed issues of fact concerning the grounds for dissolution. Given that the respondent in the lower court proceedings did not contest the executor’s standing to pursue dissolution, whether or not Andris made new law will need to be tested in future litigations.

Continue Reading Top 10 Business Divorce Cases of 2023