The highly competitive and lucrative market for premium vodka has spawned some of the most creative advertising and promotional campaigns known to consumers (think Absolut). A new market entrant offering vodka imported from Holland under the brand name Medea, sold in special bottles designed with an interactive LED ticker display, has spawned a different kind of competition, of the litigious sort, involving a fight for control between an angel investor and the managing member of the company.

An appellate court decision issued last week in Lehey v. Goldburt, 2011 NY Slip Op 08670 (1st Dept Dec. 1, 2011), reinstated the managing member whom the lower court had removed and replaced with the investor on the latter’s application for interim relief. The decision reinforces the constraints lower courts face in granting provisional remedies without holding an evidentiary hearing to resolve conflicting allegations. The decision also addresses an interesting issue of contract construction arising from an arguable inconsistency between the operating agreement’s provisions for the appointment and removal of managers.

Medea vodka is the brainchild of company co-founders Tim Goldburt and Matt Sandy. The brand’s patented bottle design has a programmable LED display that can scroll six customized messages of up to 255 characters each. In June 2007, Goldburt, Sandy and a few others formed a Delaware limited liability company known as FSJ, LLC to develop and market the Medea brand. The sole source of start-up financing was Joseph Lehey, a 10% member who agreed to invest $10 million payable in four equal installments over two years, pursuant to a subscription agreement, letter of intent and operating agreement that promised him a priority return of his investment before profit distributions to members. Article II(2) of the operating agreement (read here) designated Goldburt and fellow member David Perillo as sole managers of FSJ.

Sales of Medea vodka launched in 2010 with a splash of publicity fueled by its unique packaging. By then, however, the relationship between Lehey and his operating partners had soured, depending on which side’s version, because of Lehey’s failure to fund his final $2.5 million contribution or because of the operating partners’ waste and looting of Lehey’s investment and the vodka sales proceeds. 

In September 2010, Lehey filed suit in Manhattan Supreme Court asserting individual and derivative claims against Goldburt, Sandy, Perillo and others seeking damages and injunctive relief including the removal of Goldburt as FSJ’s manager (read complaint here). In November 2010, Commercial Division Justice Charles E. Ramos denied Lehey’s application to appoint a temporary receiver for FSJ but ordered the defendants to turn over all relevant financial and business records.

In January 2011, by which time all of FSJ’s members other than Goldburt and Sandy had assigned  their membership interests to Lehey, giving him at least a two-thirds membership interest, Lehey noticed a meeting of the members at which he voted to appoint himself FSJ’s manager over Goldburt’s and Sandy’s objection.

In March 2011, claiming that the defendants had failed to comply with the court’s prior order to turn over records and that he was still being frozen out of management, Lehey moved for an order removing Goldburt as manager (Perillo previously resigned his manager position) and designating Lehey as FSJ’s sole manager. Lehey alternatively asked the court to reconsider his prior application for appointment of a temporary receiver. Lehey’s supporting memorandum of law (read here) argued that “in order to avert complete destruction of [Lehey’s] investment at Defendants’ hands, [Lehey] or a temporary receiver must be put in control of the Company immediately.” Defendants’ opposing memorandum (read here) argued that Lehey has no relevant experience running a company such as FSJ; that the defendants had complied fully with the court’s order to produce company information; and that Lehey’s application failed to demonstrate the requisite danger to FSJ’s property to justify the “drastic” remedy of receivership.

At the oral argument of the motion on May 2, 2011 (read transcript here), Defendants’ counsel argued that under Article II(2) of the operating agreement, designating Goldburt manager “for the duration of the Company,” he could only be removed by unanimous vote of the other members for “theft, fraud or forgery.” This did not, however, mollify the court’s concern for the company’s assets upon learning that there was an unpaid $250,000 warehouseman’s charge for storage of the company’s vodka inventory worth between $3 million and $4 million.

The colloquy took a different direction after the court noticed the provision in Article II(2) stating that the designated managers (Goldburt and Perillo) shall continue as such “until they shall no longer own any part of the Membership Interest.” Since Goldburt only held an indirect membership interest in FSJ through his ownership of RAM Phosphorix, LLC, which held a 27% membership interest in FSJ, as the court saw it “there is no manager” of FSJ.  Therefore, the court reasoned, Lehey must be appointed as receiver unless permitted to act as FSJ’s sole manager based on the January 2011 appointment of Lehey by his own vote.

On May 27, 2011, Justice Ramos signed a written order (read here) removing Goldburt and installing Lehey as FSJ’s sole manager. The order also required the defendants to turn over to Lehey’s control all of FSJ’s tangible and intangible property, bank accounts and books and records.

The defendants immediately filed a notice of appeal and one day later obtained from the Appellate Division, First Department, a stay of Justice Ramos’s order pending their appeal which was argued on November 10, 2011, and decided on December 1, 2011.

The First Department’s decision begins by cautioning that the purpose of a provisional remedy is not to determine the ultimate rights of the parties, but only to maintain the status quo until there can be a full hearing on the merits. The decision further notes that where conflicting affidavits raise sharp issues of fact, injunctive relief should not be granted without a hearing. 

The court then finds that the lower court erred by granting “any provisional relief, let alone the extraordinary one granted here,” without holding an evidentiary hearing. Here’s how the court explains it:

Plaintiff established some likelihood of success on the merits by demonstrating the various expenditures that were made without his written consent and by raising issues regarding the ownership of the patents, trademarks and FSJ’s inventory. However, he did not clearly establish that he would be irreparably harmed in the absence of a preliminary injunction or that FSJ’s property was in danger of being injured or destroyed such that the appointment of a temporary receiver was warranted (see CPLR 6301; 6401). Indeed, the status of FSJ’s assets was disputed, as was the propriety of the various expenditures and transfers of funds. Defendants also raised legitimate concerns about the future of FSJ should Goldburt be removed and plaintiff installed as manager. In particular, they noted Goldburt’s intimate knowledge of the company and its technology as well as the fact that Goldburt made many personal contacts with distributors, suppliers and others that were essential to the health of the company. Accordingly, an evidentiary hearing is warranted to the extent indicated.

The decision then addresses Goldburt’s status as manager under the operating agreement. The court observes that, although the Article II(2) provision appointing Goldburt and Perillo as managers “presumed that a manager had a membership interest in FSJ, Goldburt had an indirect membership interest in the company through his interest in defendant RAM Phosphorix, LLC, which had a membership interest, and Goldburt executed the agreement on RAM’s behalf.” The court also cites the removal provision in Article II(2), stating that Perillo and Goldburt shall be managers “unless removed as permitted hereby, or until they shall no longer own any part of the Membership Interest.” The court then registers its sharp disagreement with the lower court’s conclusion, stating:

For the motion court to read this language to mean that Goldburt was never properly a manager because he did not own a direct membership interest in the company leads to an absurd result and ignores the parties’ clear intent to have Goldburt serve as a manager. Thus, we read the agreement to unambiguously permit Goldburt to serve as manager, as this construction effectuates the parties’ intent.

The Appellate Division’s ruling leaves intact the lower court’s order insofar as it enjoins the defendants from transferring any of FSJ’s property, assets, inventory or funds, except as required in the ordinary course of business, and insofar as it declared that the parties’ operating agreement remains in full force and effect. But, at least for the time being, Goldburt continues to act as FSJ’s sole manager while the litigation rages onward including a newly filed amended complaint in which Lehey seeks treble damages for defendants’ alleged violations of the federal RICO Act.

It probably would have made no difference to the outcome, but I can’t help but point out that the Lehey decision nowhere acknowledges that FSJ is a Delaware limited liability company whose operating agreement in Article VII(10) states that “[t]his agreement shall be governed by and construed according to the laws of the State of Delaware.” It’s also noteworthy that the same provision includes a forum selection clause stating that the courts in New York County will have “exclusive jurisdiction” over any controversies arising from the agreement, which could create quite a sticky wicket if one side or the other were to ask for judicial dissolution of a Delaware LLC by a New York court (see my prior posts on that subject here, here and here).