We often cover preliminary injunctions on the pages of this blog because they are a powerful tool in the business divorce litigator’s toolbox: they force court action early in the case, they can protect rights that are difficult to monetize, and they set the tone for the litigation going forward.  Requests for preliminary injunctions generally come early in the case, and they seek to impress upon the court the need for immediate action in order to maintain the status quo.

When a closely-held business threatens to reorganize its ownership to the exclusion of one owner, courts are receptive to requests for preliminary injunctions enjoining the restructuring until the ownership dispute can be sorted out in litigation.  See this court’s enjoining dilution of an LLC member’s interest, or this court’s enjoining a freeze-out merger cancelling an owner’s shares.

Both of these cases featured, to some degree, a race between the parties.  The company notified the owner that the dilution or freeze-out would occur on a certain date, and the owner scrambled to request a preliminary injunction enjoining that action before that effective date.  While it can seem trivial, that race is critical.  Because a preliminary injunction is designed to maintain the status quo, courts are far more likely to enjoin action before it happens than undo it after the fact.  That’s the tough lesson that an LLC member facing termination of his membership status learned in Costello v Molloy et al., 73 Misc 3d 1206(A) [Sup Ct 2021].

Continue Reading Too Little, Too Late: Court Sides with Ousted Member, but Denies Preliminary Injunction Undoing Termination

Ownership status in a closely-held business is the first and most vital box almost every business divorce petitioner must check.

Equity ownership is the sine qua non of many essential legal rights in the business divorce litigant’s toolkit, including standing to sue for dissolution, to sue derivatively on behalf of the entity, to bring a books and records proceeding, etc.

Evidence of Ownership in Business Divorce Cases

Proof of ownership status comes in many forms. It is surprising to some that the absence of stock certificates, on its own, “does not preclude a finding that a particular individual has the rights of a shareholder” (Zwarycz v Marnia Const., Inc., 130 AD3d 922 [2d Dept 2015]). Aside from stock certificates, courts may consider any and all “other available evidence” to determine “whether a putative shareholder in fact and law enjoys that status” (Kun v Fulop, 71 AD3d 832 [2d Dept 2010]).

What evidence do courts consider to determine ownership status? Courts look at many factors, including the exchange of consideration to acquire equity either in the form of cash or provision of labor, issuance of ownership certificates, corporate resolutions, meeting minutes, internal financial documents, loan documents and guarantees of corporate debt, the holding out to the public of individuals as owner or non-owner, etc. A wonderfully thorough treatment of these various “indicia” of ownership status is found in the post-trial, lower court decision in Matter of Pappas v Corfian Enters., Ltd., 22 Misc 3d 1113 [A] [Sup Ct, Kings County 2009], affd 76 AD3d 679 [2d Dept 2010].

And then there are tax returns, which have spawned an ever-expanding universe of litigation on the issue of the extent to which a tax return alone can prove whether an individual is, or is not, an owner of a closely-held business. This article will focus on two competing strands of New York case law, each rooted in a single New York Court of Appeals decision, one strand holding that tax returns are not determinative of ownership status in a closely-held business, the other holding that they are dispositive. Continue Reading The Doctrine of Tax Estoppel in Ownership Status Disputes

Any shareholder, partnership, or LLC agreement that doesn’t include a well-crafted buy-sell provision triggered by an owner’s death, withdrawal, expulsion, disability, or other separation event is an agreement asking for trouble. Put otherwise, the absence of a public market for equity interests in a closely held business virtually assures that a poorly conceived or non-existent buy-sell agreement is a dissension and litigation breeder. The potential for hostilities exists both before and after a trigger event when the buy-sell provision fails to offer fair value, or fails to include the necessary parameters for an appraisal process, or imposes grossly unfair payment terms.

To the rescue comes estate planner and buy-sell agreement maven Paul Hood with his new book, Buy-Sell Agreements: The Last Will & Testament for Your Business. Paul’s background as a tax lawyer and estate planner, as well some family history involving a buyout of his grandfather when Paul was a boy, drew his interest to buy-sell agreements which became a major focus of his long career.

Contrary to its morbid subtitle, Paul’s book lays out in carefully organized fashion a detailed, comprehensive set of the practical, financial, tax, insurance, and other considerations that go into the drafting of a buy-sell agreement designed to allow business continuity and liquidity for a departing owner. The book is a terrific resource for lawyers and other professional business advisors. But it’s also written for business owners as an educational tool allowing them to have informed discussions with their professional advisor engaged to draft the business’s organizational documents including the buy-sell.

I recently interviewed Paul about his book and some of the issues surrounding buy-sell agreements for the Business Divorce Roundtable podcast. I guarantee you’ll find his commentary as sparkling as it is informative. I invite you to give it a listen by clicking the below link.

 

 

Business divorce has a way of drawing quick and often lopsided battle lines. Many disputes in closely-held companies feature one outspoken owner feuding with a united group of the remaining owners over management or participation in the company. Depending on the ownership percentages held by each faction, corporate shareholders on either side of those battle lines have at their disposal a broad range of potential remedies under both the BCL and the common law—freeze outs, dissolution proceedings, claims for money damages, and bids for injunctive relief, to name a few.

Disputes of this variety are often resolved with a buyout of the outspoken owner. Other times, the parties agree that the dissident owner remains an owner, but forfeits any right to an active role in the company and agrees to stay away from company operations. For instance, a corporation agrees to some schedule of regular payments (whether salary, distributions, or some mix of the two) to the dissident shareholder, and in return, the complaining shareholder butts out of company business; he agrees to have no role in the company’s management and foregoes his right to sue the company or other shareholders for anything other than non-payment of his regular due. When his vote as a shareholder is required, he agrees to simply vote his shares in accordance with the recommendation of the board of directors.

“Stay away” settlement agreements like this one have some obvious appeal: they satisfy (and silence) the outspoken shareholder without requiring the company to immediately come up with the cash that a buyout would require. But there are downsides: disputes may arise over the payments, flaws in the settlement documents may be leveraged by either side, and, ultimately, the fighting factions remain joint owners.

This week’s post considers one potential pitfall to stay away settlement agreements: what happens when the outspoken shareholder dies? In Stile v C-Air Customhouse Brokers-Forwards, Inc., Index No. 656575/2020 [Sup Ct, New York County 2021], the New York County Supreme Court declined to dismiss a suit by the estate of a shareholder subject to a stay away settlement agreement on the grounds that the stay away obligations did not expressly apply to the shareholder’s successors.

Continue Reading Stay Away Settlement Between Closely-Held Corporation and Dissident Shareholder Goes Away Upon Shareholder’s Death

Who says email is more efficient and cheaper than regular mail?

Not the manager of the McGuire family real estate business after winning a lower court ruling only to see it reversed on appeal last month in a decision agreeing with his siblings that his issuance of dilutive capital calls, notice of which he emailed to them, was ineffective because the governing LLC agreement required all notices to be sent by first class mail.

The case and the decision by the Appellate Division, Fourth Department in McGuire v McGuire is not as simple as it sounds. Permit me to explain.

According to the complaint filed by three of the six McGuire siblings (referred to collectively by their first name initials, JKM) against their brother James, in the 1990s all six obtained equal membership interests in a number of holding companies originally formed by their father that owned dozens of commercial real properties as well as health care businesses and skilled nursing facilities. In 2006, James formed a real estate development and property management company, McGuire Development Co., LLC (MDC), also owned in equal percentages by all six siblings, to manage the McGuire family business empire. Continue Reading Court Cancels Capital Call For Want of a Postage Stamp

Most folks associate beer with pleasure. Beer brings the happy, and many craft brewers will tell you they went into business for that very reason. But an investor in a Bushwick, Brooklyn beer brewing company and taproom startup was anything but happy after his co-members began taking steps to dilute his membership interest in the limited liability company, resulting in fast and furious litigation and an immediate injunction motion to halt the alleged “freeze out.”

According to his complaint, Peter Lengyel-Fushimi (“Peter”) was a molecular biologist by training who decided to pursue his passion for craft beer making and “dedicate his life to beer.” Peter “committed himself to his new goal of opening a brewery,” took a series of apprenticeships in local breweries to learn the trade, and ultimately partnered with Anthony Bellis (“Anthony”) and Zachary Kinney (“Zachary”) to form Kings County Brewers Collective, LLC (the “Brewery”).

In 2014, Peter, Anthony, and Zachary entered into an Operating and Subscription Agreement, according to which each became a manager and 25.33% “Class A” membership interest holder, collectively owning 76% of the Brewery. The remaining 24% membership interests were sold to investors denominated “Class B” and “Class C” interests, the Class B member having limited voting rights, and the Class C members no voting rights only an economic interest. Peter held the title of Head of Beer Production / Operating Manager.

Important for his later injunction application, a standard merger and no-oral-modification provision in Section 10.1 of the Operating Agreement provided, “This agreement constitutes the whole and entire agreement of the parties with respect to the subject matter of this agreement, and it shall not be modified or amended in any respect except by a written instrument executed by all of the Members.”

Continue Reading Court Enjoins Dilution of Brewing Company LLC Membership Interest

It’s not surprising that Vice Chancellor Zurn’s recent, first-impression decision in In re Coinmint, LLC, aligning itself with rulings in many other states including New York, found that Delaware courts lack subject matter jurisdiction over petitions to dissolve non-Delaware business entities — in this case, a Puerto Rico limited liability company. It’s also not surprising that the Delaware Chancery Court, better known for leading rather than following the pack when it comes to business law, is addressing the issue for the first time decades after New York and other state courts have done so. After all, Delaware is famous as an exporter of Delaware entities operating in other states, not as an importer of non-Delaware entities operating in Delaware.

Delaware’s lopsided trade imbalance as an entity exporter explains the highly unusual path Coinmint took to VC Zurn’s jurisdictional ruling. The company, which operates a data center in upstate New York and reputedly is among the largest bitcoin mining firms in the world, began its life in 2016 as a Delaware limited liability company owned 50/50 by two childhood friends, Prieur Leary and Ashton Soniat. Leary contributed “sweat equity” by running Coinmint’s day-to-day operations while Soniat provided the necessary funding. In October 2017, the two owners reached a compromise agreement on an adjusted equity split of 81.8%-18.2% in Soniat’s favor reflecting his tens of millions in additional capital contributions as the company expanded operations.

In early 2018, looking to reap certain tax benefits, the company filed a Certificate of Conversion with the Delaware Secretary of State, redomesticated in Puerto Rico, and thereafter operated as a Puerto Rican entity.

In 2019, as the owners’ relationship deteriorated due to disagreements over the company’s management, Soniat exercised his majority voting power (gained from the dilution of Leary’s interest) as a member and on the board of managers by amending Coinmint’s operating agreement, removing Leary from the board, and designating Soniat’s holding company as sole manager.

In late 2019, Leary filed suit in Delaware Chancery Court. Leary’s amended complaint sought to nullify Coinmint’s conversion to a Puerto Rican entity on the grounds that it was done without Leary’s knowledge or consent, and did not comply with the operating agreement’s formalities. His complaint also asserted that Soniat’s amendment of the operating agreement, removal of Leary from the board, and dilution of Leary’s membership interest and voting rights underlying those actions did not comply with the formal requirements of the operating agreement governing additional capital contributions. Soniat’s millions in cash infusions, Leary contended, therefore should be treated as loans. Leary also sought judicial dissolution of Coinmint under Section 802 of the Delaware LLC Act. Continue Reading Delaware Declines Subject Matter Jurisdiction Over Judicial Dissolution of Foreign Entities

Welcome to this 11th annual edition of Summer Shorts! This year’s edition features brief commentary on half a dozen business divorce cases of interest from across the country. Four of the cases involve disputes among LLC members, one among shareholders of a family-owned corporation, and one among partners in limited partnerships. Two of the cases involve buyout appraisal proceedings. Click on the case names to read the decisions.

Maine: Authority to Appoint LLC Manager (Zelman v Zelman)

Ask yourself, does the following provision in an LLC agreement — “The Manager has authority, without the vote or consent of the Members, to amend the Company Agreement to reflect the addition or substitution of Members or the Manager” — give the LLC’s manager the authority to appoint his or her replacement without member consent? Not according to the Maine Supreme Judicial Court’s ruling late last year in which it affirmed a lower court’s judgment dismissing the putative replacement manager’s claim seeking a declaration validating his status as manager of a family-owned, realty holding LLC. The previous manager appointed him manager at the same time he sold his interest in the LLC to the appointee who was one of the LLC’s existing members and a former manager. The Supreme Court looked to the dictionary, defining “amend” as to “make minor changes in (a text) in order to make it fairer, more accurate, or more up-to-date.” Ruling against the appellant, the court wrote:

Given this definition, the plain language of section 13.20(A) [the provision quoted above] permits a manager to modify the operating agreement to update it based on decisions made in accordance with other sections of the operating agreement, e.g., section 2.7, which grants the members the ability to elect a manager by a two-thirds majority, or section 10.10, which grants the members the ability to remove a manager for cause by a two-thirds majority. Section 13.20(A) is not ambiguous, and the plain language of the contract clearly reflects a purely clerical role by a manager to alter the operating agreement to reflect decisions undertaken by the authority granted in other sections of the operating agreement. The court therefore did not err in determining that section 13.20(A) did not give William the authority to appoint Andrew as a manager of the LLC.

Continue Reading Summer Shorts: Business Divorce Cases From Across the Country

In an article from a little over a month ago, we summarized New York’s LLC judicial dissolution statute with the comment, “Breaking up can be hard to do.”

Our remark was meant to encapsulate the frequency with which trial level courts dismiss – and appeals courts affirm dismissal and reverse denial of dismissal – of LLC judicial dissolution petitions / complaints at the pleadings stage for failure to plead, and inability to show, the two-pronged standard for judicial LLC dissolution.

A Decision and Order issued last week by Brooklyn Commercial Division Justice Reginald A. Boddie provides an added twist on that phrase: “Even if it’s unopposed, breaking up can be hard to do.” Continue Reading Swing and a Miss: Unopposed LLC Dissolution Claim Denied

Of all the factors considered by business divorce lawyers and appraisers when valuing an owner’s interest in a closely-held company, the calculation and applicability of a discount for lack of marketability (“DLOM”) is among the most fertile grounds for sharp disagreement.

It’s easy to imagine why. For one, in cases where parties offer competing appraisals of an interest in a closely-held company (such as fair value proceedings under New York Business Corporation Law Sections 623 or 1118), the DLOM often is the largest driver of the differences between the two appraisals, and the parties naturally focus their efforts on the issues producing the largest swings in value.  Second, application and calculation of the DLOM involves—perhaps more than anywhere else in the business appraisal process—a considerable amount of judgment.  The appraiser’s judgment calls in applying a DLOM are frequent targets for attorneys seeking to undercut or enhance the final number.

One need not look far to find disputes over DLOMs playing out in courts across the country.  Consider for example, Peter Mahler’s encapsulation of the DLOM debate in New York here, the apparent divergence between the First and Second Departments regarding the DLOM in real estate holding companies under the statutory fair value standard (explained here), or the Indiana Court of Appeals’ refusal just weeks ago to apply any DLOM whatsoever under the fair market value (FMV) standard to a wife’s share of a dental practice because, as that court observed, “dental practices are easily tradeable as they have a ready market of purchasers (new dentists) graduating each year.” (Kakollu v Vadlamudi, 21A-DC-96 [Ind Ct App July 26, 2021]).

Putting hard numbers to the extent of professionals’ disagreement concerning the DLOM, Business Valuation Resources recently released its annual survey regarding calculation and application of the DLOM.  Gathering responses from more than 200 valuation professionals, the BVR Survey on Methods Used for Estimating a Discount for Lack of Marketability demonstrates that, with respect to almost all matters DLOM, a general consensus is rare.  For example, to the question, “Would you apply a DLOM to a 100% interest in a private company?,” 33% of those surveyed indicated that they would, 27% indicated that they would not, and 40% indicated “maybe.”

In the wild west of DLOM calculation and application, I recently came across a novel issue that, in my view, merits serious consideration from business owners, litigators, and appraisers: how should contractual restrictions on a controlling owner’s ability to transfer his or her control factor into the calculation of the DLOM?

Continue Reading Fueling the DLOM Debate: Control Transfer Restrictions and the Discount for Lack of Marketability