The proverb “All for the want of a horseshoe nail” aptly describes the possibly mortal blow dealt by the Appellate Division’s recent decision in Favourite Ltd. v Cico, 2020 NY Slip Op 01463 [1st Dept Mar. 3, 2020], to a lawsuit initiated by non-managing members of a manager-managed Delaware LLC whose certificate of formation was cancelled for the ministerial failure to designate a new registered agent within 30 days after its old one resigned.

Favourite involves the alleged mismanagement of a Delaware LLC by its former managing members in connection with the financing, operation, and sale of a Manhattan residential apartment building acquired by the LLC to provide short-term rentals for international leisure and corporate travelers. The business was decimated in 2012 by anti-Airbnb legislation, leading to a mortgage default, foreclosure action, and distress sale. The managers used the net sale proceeds as a down payment made by a newly formed LLC to purchase another building, but the purchase never materialized.

In 2015, non-managing members holding more than 50% of the membership interests, as permitted by the operating agreement, voted to remove the managers and then brought suit against them. The suit initially named the LLC (along with some of the non-managing members) as plaintiff but it was dropped in the first amended complaint after losing its legal representation. Continue Reading Unauthorized Certificate of Revival Dooms Delaware LLC’s Claims Against Former Managing Members

The Comic Strip is the oldest stand-up comedy showcase club in New York City. Its co-founders Robert Wachs and Richard Tienken opened the club in 1975 on Manhattan’s Upper East Side. Over the last 45 years a veritable who’s who of the comedy world has performed on its stage, including George Carlin, Eddie Murphy, Richard Pryor, Chris Rock, Jerry Seinfeld, Robin Williams, and the list goes on.

Off stage, however, things are not so funny.

In the wake of co-founder Robert Wachs’ death in 2013, litigation broke out over the club’s finances and management between Tienken and Wachs’ widow, Tess Wachs, who succeeded to her husband’s 50% ownership of the corporation, Comic Strip Promotions, Inc. Over a four-year span, a half dozen or so legal proceedings have bounced back and forth between arbitration and court, much of which is omitted in the following description. Continue Reading No Laughing Matter: Deadlock Dissolution Petition Targets Legendary NYC Comedy Club

I’m always disappointed by appellate opinions that decide novel or unsettled issues in business divorce cases with little or no analysis. It seems like a lost opportunity to provide guidance in future cases. The Appellate Division, Second Department’s opinion last week in PFT Technology, LLC v Wieser, 2020 NY Slip Op 01942 [2d Dept Mar. 18, 2020], is one of those.

PFT is a case I’ve previously featured on this blog three times over it’s eight-year life span, addressing Nassau County Commercial Division Justice Stephen A. Bucaria’s novel rulings in an LLC dissolution case:

  • ordering the LLC to advance all parties’ legal fees to “level the playing field” (read here);
  • fixing the valuation date for a buyout of the defendant 25% member’s interest on the day before the LLC filed suit in July 2012 (read here); and
  • rejecting the LLC’s subsequent request to withdraw its dissolution claim in connection with its unsuccessful bid to enjoin the minority member from operating a competing business (read here).

The trial of the case yielded rulings on a number of important issues concerning fair value appraisals generally, one of which was the subject of my recent article entitled Post-Valuation Date Distributions: Should They Be Credited Against Fair Value Awards? The article summarized the few and arguably conflicting lower court cases addressing whether an award to the exiting shareholder of his or her pro rata share of post-valuation date distributions made during the proceeding’s pendency, i.e., prior to consummation of the buyout, constitutes “double dipping.”

Having already written extensively on the case background and the court’s pretrial rulings in my prior posts, I won’t do it again here. If you’re not inclined to read the prior posts, what you need to know is:

  • The subject LLC, in the business of detecting gas and fluid leaks in power networks for public utilities, had four 25% members.
  • In 2011, either three of the members froze out the fourth or the fourth “abandoned” the business, depending which side’s story you accept.
  • In 2012, the three members brought suit in the name and right of the LLC asserting claims against the fourth and also seeking the LLC’s dissolution or “reconstitution” without the fourth.
  • The fourth counter-sued for a buyout of his 25% interest.
  • Notwithstanding the absence of any buyout authorization in the LLC Law’s provisions governing judicial dissolution, the court ordered a fair value appraisal and “equitable” buyout of the fourth’s interest, apparently without objection by the other three members.

One other tidbit for those who don’t read the prior posts: If you’re wondering why the LLC’s three members holding an aggregate 75% membership interest had to seek judicial dissolution as opposed to dissolving voluntarily, the answer lies in the LLC’s operating agreement which required a super-majority in excess of 75%, i.e., unanimity, to dissolve voluntarily. Continue Reading No Double Dipping! Court Denies Post-Valuation Date Distributions in Equitable Buyout of LLC Member

Section 1104-a of the Business Corporation Law (the BCL) empowers courts to dissolve a corporation if the petitioning shareholder can establish either of two specified grounds for dissolution. Section 1104-a(a)(1) authorizes dissolution upon a showing of ” illegal, fraudulent or oppressive actions toward the complaining shareholders” by the “directors or those in control of the corporation” (emphasis added). Section 1104-a(a)(2) authorizes dissolution upon a showing that property or assets of the corporation are being “looted, wasted, or diverted for non-corporate purposes” by the “directors, officers or those in control of the corporation” (emphasis added).

At the end of the statute, the so-called “surcharge” provision, section 1104-a(d), empowers courts to “order stock valuations be adjusted” and to “provide for a surcharge upon the directors or those in control of the corporation upon a finding of wilful or reckless dissipation or transfer of assets or corporate property without just or adequate compensation” (emphasis added).

As noted with italics above, all three statutes contain an identical three-word phrase allowing courts to dissolve based upon conduct committed by, and/or impose a surcharge against, “those in control” of the corporation. What does it mean to be “in control?” As noted in a prior post, reported decisions involving a corporate dissolution petitioner seeking a surcharge against the respondent are exceedingly rare. Cases in which corporate dissolution petitioners obtain a surcharge are unicorn-like in their rarity – there is only a single case of which we are aware.

With the scarcity of case law on the subject of surcharges, a recent decision caught our eye, in which a court, apparently for the first time, considered what it means to be “in control” of the corporation for purposes of imposing a surcharge.

In Matter of Telano, Decision and Order [Sup Ct NY County Jan. 8, 2020], Manhattan Justice Joseph Risi tackled the interesting question of whether a shareholder petitioning for dissolution may sue a non-shareholder, director, or officer under the “surcharge” provision of section 1104-a(d) seeking in effect to use the statute as a substitute for an otherwise viable cause of action. Continue Reading Who Is a “Control” Person for Purposes of the Dissolution Statute’s Surcharge Provision?

Article 12 of New York’s Limited Liability Company Law authorizes the formation of professional service limited liability companies (PLLC). Eligible professions include lawyers, medical doctors, accountants, architects, and various other licensed occupations. Article 12 merely regulates the formation and the professional membership of PLLCs. Otherwise, PLLCs are governed by the same provisions of New York’s LLC Law applicable to non-professional LLCs.

I’m unfamiliar with the organizational or tax-related advantages or disadvantages, if any, peculiar to law firm PLLCs compared to the ubiquitous limited liability partnerships and professional corporations. What I can say is that, since 1994 when New York enacted its LLC Law, I’ve come across relatively few New York law firms organized as PLLCs. Nor have I seen, much less written about, any business divorce cases involving law firm PLLCs, which means either they’re out there operating flawlessly or, as I suspect, they’re few in number.

There’s always a first. Last month, Albany County Commercial Division Justice Richard M. Platkin decided Flink v Smith, 2020 NY Slip Op 50305(U) [Sup Ct Albany County Feb. 7, 2020], involving a dispute between former law partners following the collapse of their PLLC known as Flink Smith Law (FSL).

Justice Platkin’s decision, granting in part and denying in part the defendants’ pre-answer motion to dismiss the complaint, addressed interesting issues concerning the effect of the defendant members’ withdrawal from the PLLC on their undertakings in FSL’s operating agreement to buy out the plaintiff’s membership interest. It also addresses the plaintiff’s claims that his former partners conspired to unlawfully collapse FSL and divert its business to a newly created law firm. Continue Reading Forced to Buy Out Law Partner’s Interest In Defunct Firm, Years After Withdrawing? It Can Happen

Buyers of fine art must investigate the work’s provenance before closing the deal. The same holds true for anyone contemplating the acquisition by assignment of a membership interest in a limited liability company.

Not only must the assignee-to-be determine the provenance of the assignor’s membership interest, the LLC’s operating agreement also must be consulted for restrictions on transfer rights and, assuming transfer is permitted, whether an assignment conveys full membership rights or an economic interest only.

These lessons were learned painfully and too late to help the plaintiff in Behrend v New Windsor Group, LLC, in which an appellate court last month affirmed dismissal of the putative assignee’s lawsuit claiming a 50% membership interest in an LLC that owns a shopping center in Orange County, New York, allegedly acquired by assignment from someone who, as it turned out, held a contingent interest that never ripened into membership.

A Contingent Membership Interest Goes Bust

The LLC was formed by defendant Andrew Perkal in 2004 to acquire and operate a shopping center in New Windsor, New York. The operating agreement, never amended, named defendant Andrew Perkal and his wife as the sole members. It included a provision requiring prior unanimous consent of the other members to any member’s proposed transfer of his or her membership interest. Continue Reading Always Check Provenance Before Taking an Assignment of LLC Interest

Welcome to this year’s edition of Winter Case Notes in which I highlight a collection of recent court decisions of interest to business divorce aficionados by way of brief synopses with links to the decisions for those who wish to dig deeper.

This year’s synopses feature decisions by courts in New York, Colorado, and Delaware:

  • dismissing a minority shareholder’s dissolution petition brought outside the limitations period;
  • affirming a minority shareholder’s standing to sue derivatively where her stock sale to a third party was deemed invalid under the shareholders’ agreement;
  • rejecting derivative claims on behalf of a cancelled Delaware limited liability company;
  • dismissing a shareholder derivative suit alleging demand futility where the court found that a pre-suit letter to the board constituted a demand notwithstanding the letter’s explicit disclaimer; and
  • dismissing an appeal from a dissolution order brought by shareholders in the corporation’s name, on the ground that only the court-appointed receiver can act on the corporation’s behalf.

Court Dismisses Time-Barred Dissolution Petition

It’s no surprise that dissolution cases raising a statute of limitations defense are very few and very far between. When a non-controlling owner is frozen out and deprived of income, or disabling deadlock occurs, or the controller is suspected of looting, there’s powerful incentive to bring suit expeditiously. Continue Reading Winter Case Notes: Time-Barred Dissolution Petition and Other Decisions of Interest

Business Divorce 101: To be entitled to an accounting of a closely-held business, the plaintiff or petitioner must demonstrate the existence of a fiduciary relationship giving rise to a duty to account. Almost always, that requires establishing ownership status in the business — the existence of a general partnership, ownership of shares of stock in a corporation, possession of a membership interest in an LLC, etc.

Can one obtain a judicially-imposed accounting of a closely-held business in which one is not an owner? That was the question decided two weeks ago by a Brooklyn appeals court in Bonanni v Horizons Invs. Corp., 2020 NY Slip Op 00563 [2d Dept Jan. 29, 2020]. The answer may surprise you.

The MRI Business

In 2001, four investors formed MRI Enterprises, LLC (the “Company”) with the following stakes to provide magnetic resonance imaging services to local hospitals:

  • 20% – Plaintiff Bonanni, through his wholly-owned corporation, Plaintiff MRI Enterprises, Inc. (“MRI Inc.”)
  • 40% – Defendant Fernandez through his wholly-owned corporation, Defendant Horizons Investors Corp. (“Horizons”)
  • 20% – Defendant Kalish through his wholly-owned corporation, Defendant Adex Management Corp. (“Adex”)
  • 20% – Defendant Hausknecht

To comply with New York law, which prohibits the practice of medicine without a medical license, Hausknecht, a physician, formed Comprehensive Imaging of New York, PLLC (“CINY”), an entity in which Bonanni and MRI Inc. had no membership interest, to provide medical services associated with the Company’s machines. Continue Reading Bending the Rules of Standing: The De Facto Merger Doctrine

I’ve yet to see him make a court appearance, and hope I never do, but the Grim Reaper sure has a knack for disrupting business divorce litigation involving LLCs and limited partnerships.

To begin with, the statutory default rules for New York limited partnerships and limited liability companies essentially are the same for transfer of ownership interests and rights of the estate of a deceased partner or member. This is no coincidence. Many provisions in the LLC Law enacted in 1994 are modeled on the Revised Limited Partnership Act (RLPA) enacted several years earlier.

Death. Under the default rules governing the estate’s rights upon the death of a partner in a limited partnership or an LLC member (RLPA § 121-706; LLC Law § 608), the decedent’s executor or other legal representative may exercise all of the partner’s/member’s rights “for the purpose of settling his or her estate or administering his or her property,” including  any power under the partnership or operating agreement of an assignee to become a limited partner or member.

Assignment. Unlike shares in corporations, which generally are freely transferable and convey the entire package of economic, voting, and other rights associated with the shares, and except as otherwise provided by agreement, the assignment of LP and LLC interests conveys only the assignor’s rights to receive distributions and profit/loss allocation (RLPA § 121-702; LLC Law § 603). The assignee can become a partner or member only if the partnership or operating agreement so provides, or if the other partners or members give their consent (RLPA § 121-704; LLC Law § 604).

When the Grim Reaper strikes, the combined effect of the default rules can block an estate representative from commencing a derivative action against the entity’s controllers, or from stepping into the shoes of a decedent in a pending suit brought by the decedent while alive. The same holds true for actions seeking judicial dissolution and to inspect books and records, both of which statutorily condition standing on the petitioner being a partner or member.

This blog previously featured the Budis v Skoutelas and Pappas v 38-40 LLC cases in which courts held that the express terms of 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, deprived the decedents’ executors of standing to bring derivative actions against the LLC’s controlling members.

A first-impression decision last week by Manhattan Commercial Division Justice Andrew Borrok in Weinstein v RAS Property Management, LLC, 2020 NY Slip Op 20028 [Sup Ct NY County Feb. 5, 2020], makes it official: estate representatives of deceased limited partners get the same treatment. Continue Reading Death of Limited Partner Disarms Derivative Action

The case of Shapiro v Ettenson ranks as one of the more consequential ones in the realm of New York’s LLC jurisprudence.

For those not familiar with the case, about which I’ve posted before here and here, in 2015 the lower court ruled, and in 2017 the appellate court affirmed, that Section 402 (c) (3) of New York’s LLC Law authorized two members holding a majority interest in a three-member LLC to enforce against the third member, who never approved or signed it, an operating agreement adopted almost two years after the LLC’s formation, including provisions for mandatory capital calls and member expulsion. The ruling stands as a stark reminder to those contemplating joining an LLC as a minority member not to do so without having a definitive written operating agreement in place at the time of joinder.

Within days of the appellate court’s affirmance, the majority members sent a notice to Robert Shapiro, the minority member, expelling him from the LLC. The notice stated, in sync with the operating agreement’s expulsion provision, that Shapiro “failed or refused to perform his duties and responsibilities as a Member or Manager” and “engaged in unauthorized and other bad faith conduct that has had (and is continuing to have) a material adverse impact on the business or affairs of the Company.”

Shapiro responded with a new lawsuit contesting the grounds for his expulsion and asserting direct and derivative claims for damages against the majority members. Last month — over two years after the suit’s commencement — Manhattan Supreme Court Justice David Benjamin Cohen issued a ruling granting in part and denying in part the defendants’ motion challenging Shapiro’s amended complaint. While finding that certain claims were precluded by the initial litigation, and dismissing others, the court kept alive Shapiro’s claim for wrongful expulsion and upheld his standing to assert derivative claims. Shapiro v Ettenson, 2019 NY Slip Op 33793(U) [Sup Ct NY County Dec. 23, 2019]. Continue Reading The Curious Case of the Expelled LLC Member Bound by Operating Agreement He Never Signed