What are the current, hot topics in the law of business divorce? I’ve been thinking about this in preparation for a speaking engagement later this month, and thought I’d preview my choices for the hot-topic list in the hope that some interested readers might offer their own ideas about unsettled areas of the law governing dissolution cases and other types of disputes among co-owners of closely held business entities.
Not surprisingly, a majority of the topics I’ve come up with concern limited liability companies, which first came into being in New York in 1994. Case law applying the LLC Law got off to a tepid start — it wasn’t until 2010 that an appellate court authoritatively construed LLC Law § 702 governing judicial dissolution — but the pace of court decisions concerning LLCs has quickened in recent years as the LLC slowly but surely has supplanted the traditional business corporation as the preferred form of entity for privately-owned companies.
So, without further ado, here’s my list of hot topics in business divorce:
Equitable Buy-Out in LLC Dissolution Cases. In contrast to oppressed minority shareholder dissolution petitions involving closely-held corporations (see Business Corporation Law § 1118), the LLC Law has no provision authorizing courts to compel a buy-out of the complaining or respondent LLC members as a remedy in judicial dissolution cases brought under LLC Law § 702. There nonetheless have been several appellate decisions affirming or ordering a compulsory buyout as an “equitable” remedy, of which the most notable is the Second Department’s 2013 ruling in Mizrahi v. Cohen where the court compelled a buy-out requested by the petitioner of the respondent member’s 50% interest. These few cases, each involving their own, peculiar set of facts, provide little guidance as to the circumstances under which courts will or won’t grant an equitable buy-out, or as to the interplay between equitable buy-out and LLC agreements that may limit dissolution remedies. It also remains to be seen whether buy-out awards in LLC cases will be based on the fair value standard used in statutory buy-outs of oppressed minority shareholders.
LLCs and Fiduciary Waiver. The courts have recognized an LLC manager’s statutory and common law fiduciary duties of loyalty and care. Unlike Delaware’s LLC Act, the New York statute does not authorize the partial or total elimination of manager fiduciary duties, although LLC Law § 417 does authorize the operating agreement conditionally to eliminate a manager’s “personal liability” for breach of duty. I’ve seen very few New York decisions addressing the mandatory versus permissive nature of fiduciary duties of LLC managers, or examining the extent to which the operating agreement can insulate a manager from judicial scrutiny of his or her actions and omissions within the fiduciary sphere. It’s inevitable that new lawsuits will ripen involving New York LLC agreements requiring the courts to grapple with the enforceability of potentially dispositive fiduciary waivers.
Exclusivity of Appraisal Remedy for LLC Freeze-Out Mergers. There’s been only a few decisions thus far involving challenges to freeze-out mergers of LLC members under LLC Law § 1002, including the SBE Wall case decided almost a year ago. Section 1002, which gives LLC members the right to dissent from a merger or consolidation and to demand the appraised value of their membership interest, was modeled almost verbatim after § 121-1102(d) of the Revised Limited Partnership Act. The latter statute, unlike its counterpart in the Business Corporation Law, and as construed by New York’s high court in the Appleton case, does not permit a dissenting limited partner to allege fraud or other illegality as grounds to avoid the otherwise exclusive appraisal remedy. The few lower court rulings in LLC cases thus far have not addressed Appleton‘s impact on the right of a dissenting LLC member to seek to enjoin or set aside a disputed merger. I suspect strongly the exclusive-remedy argument based on Appleton will be raised and decided in the not-too-distant future.
Deadlock as Grounds for LLC Dissolution. In the 1545 Ocean Avenue case, which is the leading case on LLC dissolution, the court observed that member or manager deadlock, while it may be a factor, is not an “independent” ground for dissolution under LLC Law § 702, which the court construed as requiring a showing of financial infeasibility or the inability to achieve the LLC’s purpose within the context of the LLC’s operating agreement. Delaware case law, in contrast, has firmly cemented deadlock as ground for dissolution. The different approaches to deadlock can be critically important in the context of certain LLCs, such as real estate holding companies, where the assets may continue to generate sufficient income regardless of member deadlock over the continuation or disposition of the assets. I have a strong feeling this is an issue that will continue to percolate in the courts.
Dissolution of Foreign Entities. Earlier this year, writing about the Bianchi case, I highlighted anew a decades-long split between the First and Second Departments of the Appellate Division on the question whether New York courts have jurisdiction of lawsuits seeking to dissolve foreign business entities (yes in the First Department, no in the Second Department). Courts outside of New York also have gone both ways (read here and here). Ultimately the issue will have to be resolved by New York’s Court of Appeals, but I’ve been saying that seemingly forever and, still, no case presenting the issue has made its way to the high court.
Marketability Discount in Fair Value Cases. New York is in the minority of jurisdictions that authorize consideration of a discount for lack of marketability in applying the fair value standard in statutory appraisal proceedings triggered by a dissolution petition or merger. On the other hand, New York case law squarely agrees with the overwhelming majority of jurisdictions that prohibit consideration of a discount for lack of control a/k/a minority discount, which therefore requires the business appraiser to value the interest at the controlling, non-marketable level of value. However, as I highlighted in a post I wrote over three years ago, there is a substantial body of opinion among leading appraisal experts that no empirical support exists for application of a marketability discount to a controlling interest, and that applying the marketability discount effectively constitutes a prohibited minority discount. This argument briefly won the day in the Giaimo case before being rejected on appeal. Will some bold litigant give it another try? Undoubtedly.
Filing of Dissolution Petition as RFR Trigger. The Second Department’s 1986 decision in the Doniger case was the first of a half-dozen or so appellate and trial court rulings over the following 25 years analyzing whether the filing of a dissolution petition itself triggered the company’s or respondents’ right to purchase the petitioner’s shares at the price and on the terms stipulated in the shareholders’ agreement’s right-of-first-refusal (RFR) provision. The results have varied based on arguably inconsequential differences in the phraseology of the RFR, leaving shareholders and their legal advisors, who may be considering bringing a dissolution petition, at risk of unwittingly triggering a contractual buy-out at a price less than fair value and on highly unfavorable payment terms. I wouldn’t go so far as to say there are completely irreconcilable differences among the appellate rulings, but an opinion someday from the Court of Appeals would go a long way toward bringing predictability to the current state of uncertainty.
Do you know of other hot topics in business divorce? Post a comment below and let us know.