According to its website, Brooklyn-based wholesale food distributor Jersey Lynne Farms traces its roots to the 1940’s when Vito Loconte began a door-to-door business selling loose eggs in mushroom baskets. Seventy years later, Jersey Lynne Farms is a major, full line food distributor selling to supermarkets, institutions, convenience and bagel stores, delicatessens, diners and restaurants throughout the metropolitan New York area.
In the 1990’s, a few years before he died, Loconte transferred stock ownership and management of Jersey Lynne Farms to his son Michael and daughters Dorine, Diane and Maria, some of whose spouses also took jobs in the family business. In 1999, the four siblings transferred ownership of the building that houses the distribution business to a newly formed limited liability company, named Caterina Realty, LLC, of which each sibling is a 25% member-manager. Since then Caterina Realty leases the property to Jersey Lynne Farms as sole tenant.
The Falling Out
Family unity fractured in 2011 when Michael, Diane and Maria banded together to oust Dorine as an officer, director and employee of Jersey Lynne Farms. They also fired Dorine’s husband from his position in charge of purchasing. That same year, a dispute erupted over the terms of a new lease between Jersey Lynne Farms and Caterina Realty. Relying on widely disparate appraisals, Dorine argued for an annual base rent of $600,000 compared with the $342,000 annual base rent adopted in the lease ultimately approved by her three siblings in late 2011.
The Separation Agreement and Release
Between December 2011 and June 2012, with the assistance of legal counsel on both sides, the siblings negotiated an agreement to resolve Dorine’s termination issues. The negotiations culminated with a Separation Agreement and General Release between Dorine and Jersey Lynne Farms dated June 28, 2012, setting forth terms for payment of compensation and benefits along with non-compete and non-disclosure provisions. The agreement left intact Dorine’s 25% stock interest in Jersey Lynne Farms.
The Agreement contains a broad, general release by Dorine (read here), the pertinent portion of which reads as follows in which Jersey Lynne Farms is referred to as the “Company” and Dorine as “Employee”:
Employee . . . knowingly and voluntarily forever releases and discharges the Company and its past and present affiliates, subsidiaries, parent companies, predecessors, insurers, successors and assigns and its and their current and former partners, members, owners, shareholders, officers, directors, employees, employee benefit plans, attorneys, fiduciaries, representatives and agents both individually and in their business capacities (collectively, the “Releasees”), of and from any and all claims, complaints, demands, lawsuits, causes of action or expense of any kind (including attorney’s fees and costs) . . . whether known or unknown, that Employee now has or ever had against the Releasees as of the signing of this Agreement, including but not limited to Claims related to or arising from Employee’s employment with the Company and/or the termination thereof; Claims arising under common law; Claims for breach of contract and in tort . . . It is further expressly agreed and understood by Employee that the release contained herein is a GENERAL RELEASE.
Dorine’s Lawsuit
In June 2013, Dorine filed suit against her siblings asserting individual and derivative claims on behalf of Caterina Realty. The complaint (read here) accuses the siblings of self-dealing in violation of fiduciary duty owed to Caterina Realty and Dorine for the wrongful purpose of benefitting their status as shareholders of Jersey Lynne Farms. Essentially, Dorine claimed that, by entering into the December 2011 lease at a drastically below-market rent, and by shifting to Caterina Realty certain expenses that ought to be borne by Jersey Lynne Farms as tenant, the defendants rendered Caterina Realty unprofitable while increasing the amount of income of Jersey Lynne Farms to be used to pay salaries and other benefits to the defendants.
In their answer (read here), the defendants alleged that Dorine’s claims are barred by the release contained in the June 2012 Separation Agreement, and they counterclaimed to enforce its forfeiture provisions based on Dorine’s alleged breach.
The Motions
The defendants moved to dismiss the complaint based on Dorine’s release as to the challenged lease and other actions that pre-dated the release, and based on Caterina Realty’s operating agreement as to actions post-dating the release. Defendants’ memorandum of law (read here) contended that the broadly-worded release of all claims known or unknown against Jersey Lynne Farms’ “shareholders, officers, directors . . . both individually and in their business capacities” necessarily included Dorine’s claims against her siblings relating to the December 2011 lease between Caterina Realty and Jersey Lynne Farm. Defendants also argued that the majority-rule provisions in Caterina Realty’s operating agreement, by which the defendants had approved various expenses challenged in Dorine’s suit, required dismissal with respect to their post-release actions.
Dorine opposed the motion and cross moved for summary judgment dismissing defendants’ affirmative defense and counterclaim predicated on the release. Dorine’s memorandum of law (read here) argued that her release, which does not mention Caterina Realty, was limited to claims arising out of her termination of employment with Jersey Lynne Farms. Dorine also moved for a preliminary injunction against defendants’ use of Caterina Realty funds to advance the defendants’ legal defense costs, on the ground that the operating agreement, although it authorized indemnification for claims against member-managers, did not authorize advancement of defense costs.
The Court’s Decision
In her decision last week in Borriello v Loconte, 2014 NY Slip Op 50241(U) [Sup Ct Kings County, Feb. 24, 2014], Brooklyn Commercial Division Presiding Justice Carolyn E. Demarest agreed with Dorine (a) that the release does not cover transactions unrelated to Jersey Lynne Farms, (b) that the Caterina Realty operating agreement’s majority-rule provision does not insulate defendants from Dorine’s claims based on breach of fiduciary duty, and (c) that Caterina Realty may not advance legal defense costs of the individual defendants.
The Release. Justice Demarest frames her analysis of the release with the principle that, “[i]n construing the meaning and coverage of a general release, the court must consider the controversy being settled and the purpose for which the release was actually given.” The release in question, she notes, was negotiated and signed in the context of Dorine’s termination of employment at Jersey Lynne Farms and “should be interpreted in that context.” She also notes that the releasees “are defined by their relationship to [Jersey Lynne Farms]” and that the individual defendants “are released from claims in their capacity as directors, officers and employees of [Jersey Lynne Farms].”
Justice Demarest’s decision expressly rejects the defendants’ argument that the phrase “including but not limited to” prior to the listing of possible claims relating to Dorine’s employment with Jersey Lynne Farms bars “any imaginable claims” that Dorine may have against the individual defendants. She writes:
[T]he General Release does not extend to cover claims relating to Caterina or the individual defendants in their capacity as directors and officers of Caterina. Caterina is not an affiliate, subsidiary, parent company, or predecessor of [Jersey Lynne Farms]. Caterina is not a party to the subject General Release, nor is it ever mentioned in the document. Although the directors and officers of [Jersey Lynne Farms] who are released by the General Release are the same individuals who comprise the board of Caterina, they are not protected from claims of any alleged wrongdoing with respect to Caterina. The individual defendants’ liability with respect to their fiduciary duties as directors of Caterina is distinct from their obligations as directors of [Jersey Lynne Farms] and there is nothing in the General Release that refers to the defendants as directors of Caterina.
Based on the court’s construction of the release as excluding matters relating to Caterina Realty, Justice Demarest accordingly grants Dorine’s motion to dismiss the defendants’ affirmative defense and counterclaim.
The Operating Agreement. Justice Demarest next addresses and rejects defendants’ argument that the provision for action by majority vote in Caterina Realty’s operating agreement provides a complete defense to Dorine’s claims arising from her siblings’ approval, over her dissenting vote, of certain payments of expenses by Caterina Realty on behalf of Jersey Lynne Farms, and reduced monthly distributions to Caterina Realty’s members. Justice Demarest observes that managers of limited liability companies have fiduciary duties of care and loyalty which impose upon them the burden of demonstrating fairness in instances of self-dealing. “The fact that the defendants,” she writes, “as majority members, approved certain actions by a vote does not automatically preclude a claim for breach of fiduciary duty and self-dealing, particularly where all of the majority members allegedly have a conflict of interest as officers and employees of [Jersey Lynne Farms].”
Advancement. Justice Demarest lastly enjoins Caterina Realty from advancing the individual defendants’ legal fees and expenses in the case. She rejects defendants’ contention that, exercising their majority voting power, they properly authorized Caterina Realty to advance their expenses, either under Caterina Realty’s operating agreement or under § 420 of the Limited Liability Company Law. Citing the First Department’s ruling in Ficus Investments, Inc. v Private Capital Management, LLC, 66 AD3d 1 [1st Dept 2009], Justice Demarest writes that “[t]o determine whether the individual defendants are entitled to advancement of their legal fees, it is necessary to look to the language of the Operating Agreement.” Caterina Realty’s operating agreement, Justice Demarest writes, solely authorizes indemnification of members’ legal expenses “provided that the indemnitee is not found to be in breach of any duties to Caterina.” Further, “[t]he fact that individual defendants voted in favor of advancing legal fees to themselves in contravention of the Operating Agreement does not make the advancement valid.” Justice Demarest also finds that, even though an award of monetary damages could be awarded requiring defendants to reimburse Caterina Realty for advances, Caterina Realty “may be irreparably injured by the use of its funds for the defendants’ legal fees during the pendency of this action.”
A Few Takeaways
- When adverse parties are involved in multiple business enterprises, and enter into a settlement agreement that relates solely to one of them, counsel on both sides must pay extraordinarily careful attention to the scope of any release given. The negotiations and proposals exchanged by the lawyers for Dorine and her siblings in the months following her termination from Jersey Lynne Farms included terms relating to Caterina Realty and its lease with Jersey Lynne Farms, none of which ultimately was included in the Separation Agreement. Apparently, and notwithstanding the prior negotiations, neither lawyer thought it was in his client’s best interest to expressly address in the release the inclusion or exclusion of claims relating to Caterina Realty. I can only speculate, assuming they thought about it, that Dorine’s lawyer believed that silence equated exclusion whereas the siblings’ lawyer believed that silence equated inclusion. That’s a gamble only one side can win. It also can reflect a belief on one or both sides — and a difficult judgment call — that raising the issue explicitly might have blown up the negotiations and prevented any deal from being made.
- Section 420 of the LLC Law authorizes an LLC, subject to “standards and restrictions, if any, set forth in the operating agreement,” both to indemnify and to advance litigation defense expenses to a member or manager. Van der Lande v Stout, 13 AD3d 261 [1st Dept 2004], illustrates a case in which a majority of the LLC’s members, apparently in the absence of a provision in the operating agreement affirmatively authorizing or prohibiting advancement, successfully relied on the statute to defeat the suing minority member’s effort to enjoin advancement by the LLC. Justice Demarest’s decision, in contrast, construed Caterina Realty’s operating agreement as contravening the majority members’ vote authorizing advancement. Especially given the paucity of New York case law on the subject, and rather than leaving it to vagaries of future events and factional voting majorities, the best advice is to spell out in great detail in the operating agreement the members’ and managers’ rights to advancement and indemnification.
- I’ve written before (e.g. here) about the problems raised by divergent interests when business co-owners have a realty-owning business that leases space to their separate operating business. So long as Dorine and her siblings all worked at, and drew profits in the form of employment compensation from, Jersey Lynne Farms, it made little or no difference to them financially whether Caterina Realty charged too much, too little, or just the right amount of rent. All that changed once Dorine was expelled from Jersey Lynne Farms and lost her employment compensation, at which point her interest in receiving profit distributions from Caterina Realty diverged from her siblings’ interest in maximizing Jersey Lynne Farms’ income available for employee compensation. There are a variety of drafting solutions to mitigate the potential divergence of interests, including fair rent appraisals, but they all require the kind of careful foresight, planning and accommodation not often encountered in multi-generation, family-owned businesses.