Not surprisingly, the vast majority of business divorce cases involve firms with valuable assets and/or profitable operations. After all, outside of creditor claims in bankruptcy court, who wants to invest time and money fighting over the corpse of a business with little or no equity value?
Still, it happens once in a while. Take, for example, a case recently decided by Manhattan Commercial Division Justice Shirley Werner Kornreich involving a limited liability company that was up and running for a couple of years before it went insolvent and shut down. Almost five years after a minority member brought suit against the controlling majority member, and after the court’s denial of summary judgment on the plaintiff’s primary claim for recovery, the majority member settled the case for $30,000 which, I imagine, is a small fraction of the legal fees spent by both sides.
Justice Kornreich’s decision in Mazel Capital, LLC v Laifer, 2015 NY Slip Op 30295(U) [Sup Ct NY County Mar. 3, 2015], tells the story of a short-lived business called Heartwatch that unsuccessfully marketed a heart monitoring device in tandem with a live 24-hour call center staffed by cardiologists and other medical professionals. In 2006, the business was organized as an LLC by its founder and sole managing member, Dr. Franklyn Laifer, a retired cardiologist and the defendant in the case. The plaintiff, Mazel Capital, LLC, initially invested $250,000 cash and contributed other assets in consideration of a 9% membership interest in Heartwatch. A year later Mazel invested another $300,000 cash, raising its stake to 12%. Dr. Laifer’s son and others invested another $100,000 in exchange for an 8% membership interest, leaving Dr. Laifer with the remaining 80% for his “sweat equity.”
The LLC’s operating agreement gave Dr. Laifer exclusive management authority but also provided that he was “not entitled to any compensation for serving as Manager.” A contemporaneous side agreement placed limits on monthly expenditures during the first six months absent Mazel’s consent.
Heartwatch went insolvent and ceased operations in 2008. In 2010, after Dr. Laifer allegedly refused to provide it with access to the LLC’s financial records, Mazel filed a books and records proceeding which it later amended to assert direct and derivative claims against Dr. Laifer. The amended complaint’s chief claim alleged that Dr. Laifer breached the operating agreement by causing the LLC to pay himself around $200,000 compensation.
Dr. Laifer countered that he was entitled to take salary for serving as medical director of a separate company wholly owned by Dr. Laifer that allegedly provided medical services to customers of Heartwatch. The fact that the monies were paid to him by Heartwatch, and not by his other company, supposedly was in keeping with Dr. Laifer’s “indifference to corporate formalities and tax laws.”
Mazel also claimed that Dr. Laifer fraudulently induced it to make its second $300,000 investment based on his allegedly false promise to abide by the 2006 operating agreement and letter agreement. It further claimed that Dr. Laifer violated the operating agreement and “wasted” approximately $300,000 in the form of excessive “consulting fees” paid to third persons who served as de facto employees (prompting Justice Kornreich to comment in her decision, “Stunningly, . . . [Dr. Laifer] states that Heartwatch’s employees were designated and paid as independent contractors for tax purposes, even though they were really employees.”).
Following completion of discovery Dr. Laifer moved for summary judgment dismissing the amended complaint. Click here and here to read his opening and reply briefs, and here to read Mazel’s opposing brief.
Justice Kornreich’s decision denied summary judgment on the issue of whether Dr. Laifer’s receipt of about $200,000, allegedly for serving as medical director of his other company, violated the operating agreement’s prohibition on him receiving a salary for running Heartwatch. Said the judge (“Remote” is the name of the other company):
Laifer argues that he was permitted to subcontract with Remote and that he could make himself an employee of Remote, thereby causing Heartwatch to incur an obligation to pay him a salary. Doing so, however, seems at odds with the intent of the Operating Agreement, which granted Laifer most of Heartwatch’s equity in consideration for his uncompensated work. Though subcontracting with Remote was perfectly acceptable, Laifer effectively paying himself a salary for running Remote seems tantamount to paying himself a salary for running Heartwatch. This, perhaps, might be a breach of the duty of good faith and fair dealing, even if the Operating Agreement does not expressly prohibit it because the parties’ intent to compensate Laifer with sweat equity may have been defeated by Laifer becoming a salaried employee of Remote.
Mazel does not affirmatively move for summary judgment. The court upon reviewing the record, believes that a question of fact exists as to whether Laifer’s salary was improper. Intent, after all, is a question of fact.
Dr. Laifer’s motion fared better in several other respects. First, Justice Kornreich agreed to dismiss Mazel’s fraudulent inducement claim, which was based on Laifer’s alleged promise to abide by the operating agreement and side agreement, “because this is a claim based on promises of future performance of a contract” and because Mazel “cannot assert reasonable reliance because it had the right under the Operating Agreement to inspect Heartwatch’s books and records.”
Second, the judge rejected Mazel’s waste claim in regard to the $300,000 in “consulting fees” paid to third parties, stating that “Mazel’s challenge to the wisdom of those expenditures is legally irrelevant under the business judgment rule.”
Third, Justice Kornreich struck Mazel’s demands for punitive damages and attorney’s fees, commenting that “[c]ommercial breach of contract claims only impacting the parties do not ordinarily warrant punitive damages” and that the allegedly “egregious nature of Laifer’s conduct,” without more, does not overcome the absence of an “unmistakably clear” agreement for payment of the other party’s attorney’s fees.
The decision has some pointed dicta that undoubtedly sent a message to the parties about the dubious cost-benefit ratio of taking the case to trial. Referring to the surviving derivative claim to recover Dr. Laifer’s salary, Justice Kornreich wrote:
[O]f the amount at issue (less than $200,000), only 12% is effectively recoverable by plaintiff because the breach of contract cause of action is asserted derivatively. Though Laifer could be compelled to pay all $199,127 back to Heartwatch, only approximately $20,000 would be distributable to the investors, and, at most, no more than $12,000 would be due Mazel ($1,000 would actually go to Laifer’s son.) [Citations omitted.]
Message received. About two months after the court’s decision, the parties entered into a Stipulation of Settlement (read here) disposing of the case upon Dr. Laifer’s payment of $30,000 — only $10,000 more than the judge’s figure.
So, after all, Heartwatch was yet another corpse not worth fighting over.