It seems a bit exaggerated to liken the deterioration of a relationship between 50/50 business partners to a fatal disease, but in the case of Pathology Associates of Ithaca, P.C., recently pronounced dead by act of judicial dissolution, the comparison may be apt.

The story of Pathology Associate’s demise seems to be more about a clash of personalities than about the usual disputes over money, side dealing, freeloading, and succession plans. The lower court’s post-trial decision granting dissolution, recently affirmed on appeal, mentions the “mentor/mentee” and “healthy functional” relationships that existed between the two pathologists-shareholders — whom I’ll refer to as Dr. P and Dr. S — from the time Dr. P joined the more senior Dr. S’s practice as an employee in 2013. The working relationship blossomed in 2018 when Dr. S granted Dr. P a 50% interest in the practice. Yet within two short years, under the stress of new demands on the practice occasioned in large part by the COVID pandemic, the two doctors landed in court as adversaries when Dr. P sued in Tompkins County Supreme Court for judicial dissolution, claiming dissension and deadlock under Section 1104 of New York’s Business Corporation Law.

Continue Reading The Pathology of Deadlock Dissolution

Litigated business breakups are often highly intense and emotional for the participants. The intensity and emotion multiply when the litigants are close family members.

If you add to the mix several years and more than ten rounds of motion practice, a successful judicial dissolution and winding up, an appeal, a remand, a motion for summary judgment, and another motion for summary judgment, lawyers and clients can become exceedingly close through the experience.

This week, we’re pleased to feature a story about two longtime favorite clients and the Homerian odyssey of litigation they endured, resulting in a recent victory in the form of total dismissal of what remained of a complaint filed by a son against his own father and stepmother for dissolution of a landscape and masonry supply business and accompanying damages claims related to six parcels of real property on which the business operated based upon a theory of “misappropriation of corporate opportunity.”

The Company, its Ownership Structure, and the Six Parcels of Real Estate

Joseph founded Jos. M. Troffa Landscape and Mason Supply, Inc. (the “Company”) as sole shareholder in the 1970s. Over time, Joseph grew the Company into a very successful business.

In the 1990s, Joseph gifted his son from his first marriage, Jonathan, shortly after he graduated high school, half the shares of the Company for no consideration.

The Company operated on six adjacent parcels of real estate in East Setauket, New York, five of which Joseph and his second wife, Laura, acquired over a period of decades through two real estate holding companies, NIMT Enterprises, LLC (“NIMT”) and L.J.T. Development Enterprises, Inc. (“LJT”).

The sixth parcel – a 1.78 piece of unimproved land known as the “Compost Yard” – Joseph acquired in his own name in March 2013. According to Joseph and Laura, Jonathan always knew and agreed that NIMT (of which Jonathan was a 1% member), LJT, and Joseph were to be the owners of the properties; it was only after lawyers got involved that Jonathan devised a scheme to sue Joseph, Laura, and their real estate companies in connection with those properties.

Continue Reading A Litigation Odyssey
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Having spent the better part of my career litigating disputes between minority and majority owners of closely-held businesses, I can comfortably say that all else equal, I would prefer to be a minority shareholder of a New York corporation than a minority member of a New York LLC.

With share ownership comes the protections specifically enumerated in the Business Corporation Law and a rich body of caselaw concerning shareholders’ rights and the need for courts to protect shareholders from majority overreach.

LLCs, by contrast, we often describe as “creatures of contract,” and courts tend to focus less on protection of the minority members and more on determining and enforcing the parties’ intent at the outset of their relationship. That focus sometimes puts too much faith in the belief that members enter into a thoughtful, ex ante agreement governing their relationship and any potential fallout. It takes minutes to create an LLC and execute a fill-in-the-blank operating agreement, and that is exactly what many business owners do. Then when a dispute arises, a court’s first instinct is to scrutinize the same document that the owners may not even have read when the LLC was formed. 

Those observations explain why I thoroughly enjoyed reading Professor Megan Wischmeier Shaner’s recent article in the Columbia Business Law Review, Corporate Resiliency and Relevancy in the Private Ordering Era (available on SSRN here). Professor Shaner, the Arch B. & Jo Anne Gilbert Professor of Law at University of Oklahoma College of Law, presents her compelling observations that the contract-based focus often associated with LLCs is migrating to corporations, producing unintended consequences. 

Continue Reading The Corporation is Becoming More Contract Focused, But Don’t Call it an LLC Just Yet

De facto dividend. Disguised dividend. Constructive dividend. They all refer to the same thing: monies in excess of reasonable compensation taken by owners of closely held companies, booked as deductible employment compensation rather than as a non-deductible distribution from profits. For companies taxed as C corporations — as opposed to S corporations and other pass-through entities taxed as partnerships — because they are paid from after-tax income, declared dividends effectively are subject to double taxation at the company and shareholder levels.

The tax laws thus provide no small incentive for owners of closely held companies to pay themselves, shall we say, generous compensation in lieu of declaring and paying dividends. This being a blog about disputes between business co-owners, I approach the topic not from the standpoint of tax compliance but, rather, to address how de facto dividends can surface in business divorce litigation as fodder for allegations of oppressive conduct by majority shareholders against minority shareholders.

De Facto Dividends as Potential Tools of Oppression

There are a number of scenarios that give rise to disputes over real or imagined de facto dividends.

One of the most common ones occurs with companies all of whose owners are employed in the business. Often because of the above-mentioned tax incentives, the companies declare no dividends while the owners take salaries plus periodic or year-end bonuses of any excess cash as employment compensation. The problem arises when one or more of the owners is forced out by the others without any recourse or buyout rights under a shareholders agreement. The ousted shareholder no longer receives a salary and the company continues its no-dividend policy while the remaining owners split among themselves the ousted shareholder’s former compensation and/or use it to hire a replacement worker if needed. The ousted shareholder (or LLC member) is left high and dry financially, with no income from a company he or she still owns and, if it’s a pass-through entity, having to go out of pocket to pay personal income taxes on any phantom income reported on their K-1s.

Continue Reading When Do Disguised Dividends Add Up to Minority Shareholder Oppression?
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One of the most difficult periods in the lifecycle of a closely-held company is the period following the death of an owner.  Apart from having to fill whatever business responsibilities the deceased owner left behind, the surviving owners often find themselves amid prime conditions for dispute: they wish to continue the business without interruption from the deceased owner’s estate, while the estate is interested in liquidating the deceased owner’s interest at any cost.

In New York, the rights of the estate of a deceased LLC member are codified in Section 608 of the LLC Law.  That section provides:

The member’s executor, administrator, guardian, conservator or other legal representative may exercise all of the member’s rights for the purpose of settling his or her estate or administering his or her property, including any power under the operating agreement of an assignee to become a member.

Two important takeaways from this language.  First, for the purpose of settling the estate, the executor can exercise whatever rights that the deceased member had.  And second, upon the death of a member, the estate does not automatically become a member; it can choose to exercise any power under the operating agreement of “an assignee to become a member.”  The reference to the rights of an assignee invokes Section 603 of the LLC law, under which the assignee of a member’s interest becomes an “economic interest holder,” but not a full-fledged member, unless the remaining members consent or it is expressly authorized by the operating agreement.

There’s some tension between those two takeaways.  On the one hand, the deceased member had the common-law right under Tzolis v Wolff to sue derivatively for injury to the LLC and the statutory right under Section 702 of the LLC law to petition for dissolution of the LLC.  But those rights are expressly reserved only for members; a mere assignee has no standing to sue derivatively (see Kaminski v Sirera, 169 AD3d 785 [2d Dept 2019]) or petition for dissolution of the LLC (see LLC Law 702 [“upon application by or for a member“]). 

How is that tension resolved?  We previously covered the cases of Budis v Skoutelas, Short Form Order, Index No. 702060/13 [Sup Ct, Queens County July 16, 2014] and Pappas v 38-40 LLC, 2018 NY Slip Op 30329(U) [Sup Ct NY County Feb. 22, 2018], in which the court held that the estate of a deceased LLC member had no standing to assert derivative claims on the LLC’s behalf.  What’s more, Section 608 is identical to Section 18-705 of the Delaware LLC Act, and Courts interpreting that provision have also held that upon the death of a member, the member’s estate becomes an “economic interest holder,” who lacks standing to prosecute derivative claims or to seek dissolution (see Estate of Calderwood v ACE Group Intl. LLC, 157 AD3d 190, 194 [1st Dept 2017] [derivative claims]; In re Carlisle Etcetera LLC, 114 A3d 592, 597 [Del Ch 2015] [dissolution]).

But if those cases make a trend, it may have been bucked by the Second Department’s recent decisions in Andris v 1376 Forest Realty, LLC, at 2023 NY Slip Op 00995 and 2023 NY Slip Op 00996, which together reinstated a dissolution claim brought by the estate of a deceased member.

1376 Forest Realty LLC

In 2006, Elizabeth Ayvis and Astrid Spatola formed as equal 50% members 1376 Forest Realty LLC (“1376 LLC”), and they transferred ownership of certain Staten Island real property to the LLC.  They never executed an operating agreement governing the affairs of 1376 LLC.

Ayvis died in 2016.  In 2019, Ayvis’ Estate petitioned for dissolution of 1376 LLC based on the allegations that: (i) the Estate was a 50% member of 1376 LLC, (ii) Spatola was mismanaging the LLC, and (iii) continuing the business of the LLC was financially unfeasible.  The Estate also sought an accounting of the company.

Spatola moved to dismiss the accounting claim.  In response, the Estate cross-moved for summary judgment on its dissolution petition (a strange procedural move as I see it, since there’s little difference between the dissolution petition itself and a motion for summary judgment on the petition).  Finding that an earlier-executed survivorship agreement between the parties governs, the trial court denied the Estate’s cross motion for summary judgment on its dissolution petition.

Following the court’s denial of the Estate’s cross motion, Spatola sought summary judgment dismissing the dissolution petition, arguing that since the Court denied the Estate’s motion for summary judgment, “there are no further issues left to be determined by the Court.”  The Estate opposed Spatola’s motion; just because its motion for summary judgment on its dissolution claim was denied, the Estate contended, does not mean that the petition should be dismissed.  The trial court granted Spatola’s motion and dismissed the dissolution petition.

Spatola curiously did not argue that Ayvis’ Estate lacked standing to seek dissolution and the Court did not raise the issue on its own.  Notwithstanding the language of Section 608 of the LLC law, all of the trial court submissions assume that upon Ayvis’ death, her Estate became a full-fledged, 50% member of the LLC with standing to seek dissolution.

The Appeal

Ayvis’ Estate appealed both the order denying its motion for summary judgment dissolving 1347 LLC and the order granting Spatola’s motion for summary judgment dismissing the dissolution petition.  Again, no party on appeal contested whether the Estate had standing to seek dissolution. 

In a pair of decisions published last week, the Second Department reinstated the dissolution claim by (i) affirming the trial court’s denial of the petitioner’s motion for summary judgment on her dissolution claim and (ii) reversing the trial court’s grant of summary judgment in favor of respondent.  In its order reversing the trial court’s grant of summary judgment dismissing the dissolution petition (2023 NY Slip Op 00996), the Second Department held:

The Supreme Court should have denied the respondents’ motion, in effect, for summary judgment dismissing the cause of action for dissolution of the LLC, as the respondents failed to establish their prima facie entitlement to judgment as a matter of law.  Contrary to the determination of the court, the respondents did not eliminate all triable issues of fact as to the cause of action for dissolution of the LLC in that they failed to show, as a matter of law, that it is “reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement”

In its companion order affirming the trial court’s denial of the Estate’s motion for summary judgment on dissolution (2023 NY Slip Op 00995), the Second Department commented directly on the ability of the Estate to seek dissolution:

Although the death of a member of a limited liability company does not trigger dissolution of that limited liability company (see Limited Liability Company Law § 701[b]), Limited Liability Company Law § 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” (see Crabapple Corp. v Elberg, 153 AD3d 434, 435).  Thus, contrary to the respondents’ contention, the petitioner, as executor of the decedent’s estate, has the authority to exercise the decedent’s rights in the LLC for the purpose of settling the estate. . .

According to the Second Department, therefore, Section 608 gives the estate of a deceased member standing to pursue a dissolution claim, despite the language in Section 702 stating that only a member can petition for dissolution.

LLC Members: Memento Mori

Based on my research, 1376 Forest is the first Appellate Division case that supports an estate’s right to seek dissolution of an LLC based on the decedent’s status as a former member.  But proceed with caution: because neither party raised the issue of the Estate’s standing in any submissions to the trial court or the Second Department, a narrow reading of 1376 Forest might conclude that the case’s impact on the rights of the estate of a deceased member is mere dicta, particularly since lack of standing is an affirmative defense that is waived if not timely raised.

Can 1376 Forest be harmonized with Budis and Pappas?  Perhaps.  Both Budis and Pappas considered LLCs with operating agreements providing that the “successor in interest” of a deceased LLC member shall succeed to the decedent’s economic rights but shall not acquire member status.  It’s therefore possible to view those cases as ones where the operating agreements alter the default rules of LLC Law 608, while 1376 Forest deals exclusively with the default rules.  But I’m not convinced.  The “successor in interest” language of the operating agreements in Budis and Pappas strikes me as consistent with Section 608, not as a modification to it.

Until a more definitive case comes along, I expect estate counsel to cite 1376 Forest and LLC Law 608 as altering the balance of power in disputes with the surviving members of an LLC, whether over dissolution or conceivably asserting derivative claims.  The best way to avoid that dispute is with a well-crafted buy-sell agreement specifying a means for valuing and liquidating the deceased member’s interest upon their death.

Notwithstanding that the pictured snow globe is the only snow I’ve seen in my neck of the woods this balmy winter, I’m pleased to present my annual Winter Case Notes collection of recent court decisions of interest.

This year’s collection features a relatively rare example of a court awarding punitive damages against a company controller for breach of fiduciary duty; a decision denying enforcement of allegedly promised “equity” in an LLC; and a decision dismissing untimely fraud claims against co-members of a realty holding LLC.

Shareholder Derivative Action Yields $1 Million Punitive Damages Award Against Company Controller

Clients complaining of fiduciary breaches by their business partners often ask whether they can recover punitive damages. I usually answer yes but add, it’s a high bar to get them and the success rate is low. Here’s one of the success stories.

In 2019, Reggie Middleton, the founder/CEO of a fintech company named Veritaseum, Inc., got into hot water with the SEC which accused him of raising millions of dollars through an initial coin offering without registering with the SEC while misleading investors to attract more funds with false information. The SEC action culminated with a settlement agreement requiring Middleton to pay disgorgement and prejudgment interest over $8 million plus a civil penalty of $1 million.

Continue Reading Winter Case Notes: Punitive Damages Awarded for Breach of Fiduciary Duty and Other Recent Decisions of Interest

Nine months ago, we wrote about a 20% shareholder, Alvin Clayton Fernandes, whose bare bones petition Manhattan Supreme Court Justice Frank P. Nervo found stated sufficient grounds to judicially dissolve a seemingly successful modeling agency, Matrix Model Staffing, Inc.

Fernandes’ primary ground for dissolution was that his 80% co-shareholder, Jacquelyn Willard, named Fernandes without his knowledge as the entity’s “responsible person” for withholding and remitting employee income and payroll taxes. Willard allegedly failed to pay employment taxes, saddling Fernandes with personal liability for a $210,000 Trust Fund Recovery Penalty.

“Failing to pay tax liabilities is corporate mismanagement,” ruled the Court in Fernandes v Matrix Model Staffing, Inc. (2022 NY Slip Op 31317(U) [Sup Ct, NY County 2022]), “which defeats a petitioner’s reasonable expectations sufficient to constitute oppression” under Section 1104-a of the Business Corporation Law (the “BCL”).

Because the record was bereft of evidence, though, the Court declined to grant the petition, instead referring the matter to a special referee under BCL § 1109 to conduct an evidentiary hearing on three issues:

  • the “underlying facts of the petition for dissolution;”
  • the “merits of the petition;” and
  • the “appropriate remedy.”

This article picks up 13 days after Justice Nervo issued his decision, when Willard, Matrix’s majority shareholder — hoping to stop dead in its tracks any further litigation over dissolution or an “adequate alternative remedy” to dissolution — filed with the Court a Notice of Election to purchase Fernandes’ stock for “fair value” under BCL § 1118.

Continue Reading The Worst of Both Worlds: Untimely Buyout Election Yields Full Merits Hearing and Huge Bond
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This blog frequently covers cases considering a shareholder’s request to dissolve a corporation under New York’s oppression-based corporate dissolution statute, BCL 1104-a.  That statute allows a shareholder to petition for dissolution of a corporation on the grounds that those in control of the corporation have engaged in “illegal, fraudulent or oppressive actions,” (BCL 1104-a[a][1]), or that the “property or assets of the corporation are being looted, wasted, or diverted for non-corporate purposes by its directors, officers or those in control of the corporation” (BCL 1104-a[a][2]).

But even upon a showing of oppression or other misconduct satisfying the requirements of BCL 1104-a, dissolution is not a given.  That is because BCL 1104-a(b) requires the court to consider “whether liquidation is the only feasible means whereby the petitioners may reasonably expect to obtain a fair return on their investment.”  Dissolution should be a remedy of last resort, and a court has broad discretion to fashion a less-drastic, alternative remedy to dissolution.  Consider, for example, this post about a case ordering a compelled buyout of the complaining shareholder (Zulkofske v Zulkofske, 2012 NY Slip Op 51210(U) [Suffolk Co., 2012]), or this post about a case finding money damages sufficient to remedy the oppressive conduct (Hammad v Jamal Kamal Corp., 68 Misc 3d 1227(A) [Queens Co., 2020]). 

Based on the principle that dissolution should be a remedy of last resort, the Court of Appeals in Matter of Kemp & Beatley introduced another layer into the “available remedies” analysis of BCL 1104-a(b).  Even when dissolution is an appropriate remedy, the court must give the shareholders the option to save the corporation by buying out the complaining shareholder: “[e]very order of dissolution . . . must be conditioned upon permitting any shareholder of the corporation to elect to purchase the complaining shareholder’s stock at fair value” (64 NY2d 63 [1984]).

Against this backdrop, consider the Second Department’s recent decision in Marum v Graffeo, which affirmed an order of dissolution of a closely-held corporation entered without a hearing, despite contested allegations and apparent non-consideration of alternative remedies (179 NYS3d 621 [2d Dept 2023]).

Continue Reading Dueling Dissolution Petitions Beget Dissolution Without Consideration of Alternate Remedies

This important question of whether non-manager, minority limited liability company owners owe fiduciary duties continues to bedevil New York litigants and courts.

The prevailing state of the law remains unsettled, with no explicit appeals court guidance to be found. Peter Mahler has written about this unresolved legal question a number of times, with three articles on the subject available here.

In Doeblin v MacArthur (2023 NY Slip Op 30133(U) [Sup Ct, NY County 2023]), Manhattan Commercial Division Justice Andrea J. Masley considered a variation of the question. Do minority LLC owners owe fiduciary duties to their co-members and to the company, at least for purposes of surviving a pre-answer motion to dismiss, where the complaint alleges that the defendant, although not an official manager, in some respects “acted in a ‘managerial capacity?’”

Continue Reading Do Non-Manager, Minority LLC Owners Owe Fiduciary Duties?

Since its legislative birthing in New York in 1994, the limited liability company has become the preferred choice of entity in New York and across the country. Over the ensuing 15 years or so, New York’s lower courts struggled to arrive at a consistent interpretation of LLC Law § 702’s enigmatic provision, patterned on that found in New York’s Revised Limited Partnership Act, authorizing judicial dissolution of LLCs “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.”

As I wrote in a NYSBA Journal article many years ago, in those early days, with no meaningful appellate guidance, some courts explicitly or implicitly treated LLCs as business corporations subject to the same judicial dissolution standards and remedies specified in Business Corporation Law Article 11.

A uniform standard under § 702 didn’t appear until 2010, when the Appellate Division, Second Department, issued its landmark decision authored by former Associate Justice Leonard B. Austin in Matter of 1545 Ocean Avenue, LLC.

In the court’s lengthy opinion, Justice Austin articulated a contract-centric approach under which a § 702 petitioner must establish, “in the context of the terms of the operating agreement or articles of incorporation, that (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible.”

Continue Reading Has the Time Come for New York to Follow Delaware and Officially Pronounce Deadlock as Ground for LLC Dissolution?