The title of this post is a riff on English playwright Brian Clark’s play Whose Life Is It Anyway? set in the hospital room of a car accident victim rendered quadriplegic, who must overcome opposition to his determination to end his life by euthanasia.
The play came to mind when I read the recent decision by Westchester Commercial Division Justice Alan D. Scheinkman in Briarcliff Solutions Holdings, LLC v. Fifth Third Bank (Chicago), Decision and Order, Index No. 70431/2012 (Sup Ct Westchester County Apr. 25, 2013), in which opposing stakeholders in a paralyzed, defunct limited liability company are fighting over who has the right to control and potentially terminate a lawsuit brought in the name and right of the LLC against one of the factions. The court’s ruling, in the procedural setting of a preliminary injunction motion, is notable primarily for its novel application of the irreparable injury requirement to a threatened board takeover designed to thwart prosecution of claims against the very same putative board members.
The lawsuit concerns a company known as Briarcliff Solutions Group, LLC (“BSG”) that, prior to its cessation of business in March 2011, owned operating subsidiaries that provided enterprise software solutions to leading retailers and wholesale distributors. At the risk of oversimplification, Faction #1 led by Paul Lightfoot held a majority equity stake in BSG while Faction #2 (a small group of private institutional and individual lenders) financed the company with rights to obtain majority control of the company’s managing Board of Directors in the event of loan default.
According to Faction #1’s complaint (read here), after BSG experienced “technical defaults” of its financial ratios under its loan agreements, Faction #2 manipulated BSG’s finances and interfered with its loan repayments to enable it, in late 2009, to seize Board control. Faction #2 then allegedly engaged in a series of self-interested dealings to strip BSG of its cash reserves, to destroy its future prospects, and ultimately, in March 2011, to non-judicially foreclose and take ownership of BSG’s only assets consisting of its stock ownership of the two operating subsidiaries.
Two key events set up the subsequent struggle for control of BSG addressed by Justice Scheinkman’s decision. First, all four of Faction #2’s Board representatives resigned en masse after the March 2011 non-judicial foreclosure without designating replacements, leaving Faction #1’s representative, Mr. Lightfoot, as the sole Board member. Second, Faction #2 further manifested its “abandonment” of BSG, as Justice Scheinkman called it, by “deliberately” allowing a default judgment to be taken against the assetless BSG in the latter part of 2011 after Mr. Lightfoot sued the company for severance due under his employment agreement.
Faction #2 Tries to Regain Board Control After the Lawsuit is Filed
In December 2012, Faction #1 filed a damages lawsuit asserting claims directly in BSG’s name as well as derivatively against Faction #2’s constituents for breach of fiduciary duty, breach of contract, and breach of the covenant of good faith and fair dealing. The complaint’s gravamen is that the constituents of Faction #2 conspired to force BSG into an “artificial” loan default in order to gain Board control for the ultimate purpose of misappropriating BSG’s assets.
In January 2013, members of Faction #2 gave notices reclaiming the four Board seats they had resigned in 2011. They also gave notice of a special Board meeting in early February to consider and vote upon a resolution to appoint counsel to seek dismissal of the “unauthorized” lawsuit brought in BSG’s name and to file a voluntary bankruptcy petition on BSG’s behalf. (Read here the notice of special meeting.)
Faction #1 Seeks an Interim Injunction
Faction #1 quickly responded by filing a motion by Order to Show Cause (read here) for a preliminary injunction preventing Faction #2 from taking control of BSG’s Board or otherwise interfering with the prosecution of the lawsuit. Following oral argument at which defense counsel claimed to be appearing on BSG’s behalf (read here a transcript of the proceedings), the Order to Show Cause signed by Justice Scheinkman granted a temporary restraining order that barred Faction #2 from holding a Board meeting or taking any action on BSG’s behalf pending the motion.
In its supporting memorandum of law (read here), Faction #1 argued primarily that Faction #2’s announced intention to terminate the lawsuit against them, or to impede its prosecution by placing BSG in bankruptcy, constituted an unfair and unreasonable self-interested transaction that was voidable under § 411(b) of the LLC Law. Faction #1 also argued that Faction #2 violated provisions of BSG’s Operating Agreement by resigning without providing the required 60-days notice and without designating replacements, and that by abandoning BSG for two years Faction #2 waived any right to appoint directors or was estopped from doing so.
Faction #2 counter-argued that Faction #1 was not entitled to interim injunctive relief, among other reasons, because Mr. Lightfoot lacked authority as sole director and as a non-officer to bring an action on BSG’s behalf under the terms of its Operating Agreement; that there is no res in which Faction #1 has a pre-existing interest to protect; that denial of injunctive relief would not prevent Faction #1 from proceeding with its lawsuit in a derivative capacity on BSG’s behalf; that the requested interim relief was merely “incidental” to the complaint’s claims for money damages; that Faction #2 did not abandon BSG which had merely been “dormant”; and that pursuant to the Business Judgment Rule the court should not interfere with BSG’s internal affairs at the behest of a “disgruntled” shareholder. (Read here Faction #2’s memorandum of law.)
The Court’s Ruling
Justice Scheinkman’s discussion of the tripartite standard for preliminary injunctive relief begins on page 20 of the decision.
He first addressed the irreparable harm requirement, noting that an injunction “should be denied in cases in which a party would be made whole through an award of money damages.” Citing a number of case authorities involving control contests in closely held companies, Justice Scheinkman found that Faction #1 satisfied the requirement:
since [Faction #2’s] attempt to “shift the balance of power and wrest complete control over the company” in an effort to thwart this lawsuit can constitute irreparable injury. . . . [Faction #1 has] articulated the irreparable injury they may suffer if [Faction #2 is] permitted to reappoint themselves as Board members and then proceed with the noticed meeting the purpose of which is to thwart [Faction #1’s] ability to seek redress against [Faction #2] in this action for their alleged breaches of fiduciary duty.
Three of the case precedents cited by the court were highlighted previously on this blog: Cooperstown Capital, LLC v. Patton, 60 AD3d 1251 (3d Dept 2009), where the court enjoined a discriminatory capital call that threatened to reduce significantly the plaintiff’s voting rights in the company (read here); Yemini v. Goldberg, 60 AD3d 935 (2d Dept 2009), where the court enjoined unilateral action by one of two 50% shareholders (read here); and Feinberg v. Silverberg, 2011 NY Slip Op 32299(U)(Sup Ct Nassau County 2011), where the court granted a preliminary injunction to protect the plaintiff’s right as a co-director and 50% shareholder to participate in decisions concerning compensation and distributions (read here).
Justice Scheinkman next examined whether Faction #1 was likely to succeed on the merits of its lawsuit. First, he concluded that it was “entirely unclear” whether the Business Judgment Rule applied under the circumstances to Faction #2’s threatened Board takeover, and that there were sufficient questions of fact presented as to whether Faction #2’s conduct involved bad faith or fraud. Second, he found a “valid argument” that Faction #2’s “long period of absence” from the LLC constituted a waiver of its rights to reappoint successor directors, and that Faction #1 presented evidence that Faction #2’s intent to use Board control to dismiss the lawsuit and file for bankruptcy “may very well constitute interested transactions rendering them null and void.”
Because these issues raised questions of fact, Justice Scheinkman concluded, an evidentiary hearing was required to determine whether a preliminary injunction is appropriate. He therefore ordered that the temporary restraining order granted in the Order to Show Cause be continued pending such hearing, and he “invite[d] counsel to consider consolidation of the hearing with the trial on the merits in order to avoid undue expense to the parties.”
Justice Scheinkman lastly addressed the third requirement for interim injunctive relief, i.e., whether a balancing of the equities favored Faction #1 because the irreparable injury to be sustained by them was more burdensome to them than the harm caused to Faction #2 through the imposition of an injunction. The court found that the balance of equities tipped in Faction #1’s favor since it sought to preserve the status quo whereas Faction #2 sought to upset the status quo by setting in motion a process that would potentially deny Faction #1 the right to seek redress in the lawsuit.
If you read the transcript of the argument on the show cause order and the decision in Briarcliff Solutions, you get the sense that Faction #2’s posture in the case is haunted by its walkaway in the prior severance-pay lawsuit brought by Mr. Lightfoot–also decided by Justice Scheinkman–which left Mr. Lightfoot with a default judgment against BSG stripped of all its assets following Faction #2’s foreclosure. Faction #2 tried to put the best face on its default by blaming it on a supposed lapse by the insurance carrier in authorizing defense counsel to appear in that case. Justice Scheinkman was buying none of it, writing in a detailed footnote on page 13 that Faction #2’s description of what occurred in the prior case was “entirely new (and somewhat suspect)” and was “belied” by the court’s decision in that case.