Stratospheric real estate values in New York City have bestowed great wealth on those lucky or wise enough to have invested before or in the early stages of the city’s demographic, cultural, and commercial renaissance over the last 25 or so years.
The dramatic rise in property values also has spawned more than its fair share of business divorce litigation by exacerbating the divergence of interests among co-owners, between those who desire to sell and take their profit and those who prefer to hold and/or develop the property. This phenomenon is especially observable in family-owned real estate holding companies where the potential for intra- and inter-generational conflict is more pronounced.
Take the case of the Kassab brothers, who co-own through two holding companies a nondescript, outdoor parking lot also home to a flea market near downtown Jamaica, Queens. The property consists of three contiguous parcels with a footprint of about 42,000 square feet. Under existing zoning the properties are buildable as of right to about 380,000 square feet. Recent valuation estimates for the undeveloped properties, which were acquired by the Kassabs between 1992 and 2001 at a small fraction of current value, start over $14 million.
In 2013, the younger brother owning 25% sued to dissolve the holding companies — one organized as a corporation, the other as a limited liability company — claiming oppression and freeze-out by his elder brother owning the other 75%. The younger brother claims the freeze-out tactics are designed to force him to sell his interest to his elder brother for a pittance. The elder brother counters that he has no desire to deprive his younger brother of his ownership rights and that his younger brother is attempting to force him to sell the properties due to the younger brother’s supposedly dire financial straits.
Last week, the case produced not one, not two, but three separate appellate decisions addressing a potpourri of rulings on issues of vital interest to business divorce counsel. Summaries follow after the jump.
Decision #1: Oppression Not Grounds for LLC Dissolution
Unlike its Business Corporation Law counterpart, New York’s LLC Law § 702 does not specify the controlling members’ oppressive conduct as ground for judicial dissolution. The point was driven home forcefully by the Appellate Division, First Department, in its Doyle and Barone decisions which I wrote about here and here.
In the first of its three decisions last week in Kassab (read here), the Appellate Division, Second Department, citing with approval the Doyle and Barone decisions, affirmed the lower court’s dismissal of the younger brother’s second cause of action in his amended petition (read here) for dissolution of the subject LLC, in which he alleged his elder brother’s oppressive conduct and efforts to exclude him from LLC management. Wrote the court:
[T]he petitioner failed to state a cause of action for judicial dissolution of the LLC pursuant to Limited Liability Company Law § 702 based on his allegations of oppressive conduct and the respondent’s efforts to exclude him from the management of the LLC (see Doyle v Icon, LLC, 103 AD3d 440). The petitioner’s allegations, if true, would not establish that “the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or [that] continuing the entity is financially unfeasible” (Matter of 1545 Ocean Ave., LLC, 72 AD3d 121, 131; see Barone v Sowers, 128 AD3d 484; Doyle v Icon, LLC, 103 AD3d 440). The petitioner’s allegations concerning the operating agreement, if true, establish that the stated purpose of the LLC did not include the petitioner’s participation in management decisions (see Matter of Eight of Swords, LLC, 96 AD3d 839, 840). Further, the petitioner’s allegations that the respondent failed to pay him his share of income earned by the LLC, and regarding the value of the property owned by the LLC, if true, would show that the LLC was financially feasible (see Doyle v Icon, LLC, 103 AD3d 440).
Also of interest is Decision #1’s affirmance of the lower court’s dismissal of the amended petition’s third cause of action, pleaded in the alternative to dissolution, claiming the right to withdraw from the LLC under LLC Law § 606 and the accompanying right to be paid fair value for the younger brother’s 25% membership interest under LLC Law § 509. The claim relied on the operating agreement’s provision stating that a member “may withdraw from the Company in accordance with the LLCL.” The court’s ruling rejected the argument that the provision varied § 606’s default rule prohibiting withdrawal unless provided otherwise in the operating agreement. My guess is that whoever prepared the operating agreement took the “may withdraw” language from a form that pre-dated the 1999 amendment of § 606 which reversed the section’s original default rule permitting withdrawal as of right.
Decision #2: No Cognizable Claim for Equitable Buyout of LLC Interest
New York’s LLC Law has no provision authorizing an elective or compulsory buy-out of a petitioner seeking judicial dissolution under § 702 of the statute. In the Superior Vending and Mizrahi cases, which I wrote about here and here, the Appellate Division, Second Department, nonetheless authorized the so-called “equitable buyout” giving trial judges the discretionary remedial authority to compel a buyout in lieu of dissolution.
In Kassab, as an alternative to his claim seeking judicial dissolution of the parties’ LLC, the younger brother’s amended petition included an eighth cause of action asserting a common-law right to an equitable buyout of his 25% membership interest at a value to be determined by judicial appraisal. The trial court granted the elder brother’s dismissal motion.
In last week’s Decision #2 (read here), the Appellate Division, Second Department, affirmed the lower court’s order, essentially making the point that an equitable buyout is an alternative remedy when the petitioner establishes a basis for dissolution, not a stand-alone cause of action. Therefore, the court held, Decision #1 dismissing the LLC dissolution claim foreclosed an equitable buyout remedy. In the court’s own words:
Here, accepting as true the facts alleged in the petition/complaint and according the petitioner the benefit of every favorable inference (see Leon v Martinez, 84 NY2d at 87), the petitioner failed to state a cause of action for an “equitable buyout” of his interest in the LLC. While “[t]he Limited Liability Company Law does not expressly authorize a buyout in a dissolution proceeding'” (Mizrahi v Cohen, 104 AD3d 917, 920, quoting Matter of Superior Vending, LLC [Tal-Plotkin], 71 AD3d 1153, 1154), “in certain circumstances, a buyout may be an appropriate equitable remedy upon the dissolution of an LLC” (Mizrahi v Cohen, 104 AD3d at 920 [emphasis added]). Here, since this Court has determined, in a companion appeal, that the petitioner failed to state a cause of action for the judicial dissolution of the LLC pursuant to Limited Liability Company Law § 702, there is no basis to invoke the equitable remedy of a buyout (see Matter of Kassab v Kasab, _____ AD3d _____ [Appellate Division Docket No. 2014-03785]). Accordingly, the Supreme Court properly granted that branch of the respondent’s motion which was to dismiss the eighth cause of action for failure to state a cause of action.
Also noteworthy in Decision #2 is the court’s affirmance of the lower court’s dismissal of the younger brother’s additional claims in his amended petition for rescission of the LLC’s operating agreement and for removal of the elder brother from management of both holding companies or to compel the sale of the properties owned by them in the absence of their dissolution.
Decision #3: Contempt Upheld for Using Company Funds for Legal Fees
The use of company funds by one side or the other to pay their legal fees is a recurrent issue in dissolution litigation. The last of the Kassab trio of decisions doesn’t address the substantive rules governing when such payment is or isn’t allowed. Rather, it spells out the unpleasant consequences when a party disobeys a court order barring such payment.
I previously wrote about the lower court’s order in Kassab holding the elder brother in contempt for disobeying the court’s order restraining him at the outset of the case from “transferring, removing, hypothecating, secreting or in any way disposing of any and all income and property of [the company], except in the ordinary course of business” (read here). The younger brother successfully applied to hold him in contempt after discovering company checks totaling $36,000 paid to his elder brother’s lawyers for their services in the dissolution case. The judge ordered the elder brother to return the $36,000 to the company and to reimburse his younger brother $25,000 for his own legal fees prosecuting the contempt motion.
Decision #3 (read here) affirmed the lower court’s order, finding that the younger brother had proven by “clear and convincing evidence” his brother’s knowing disobedience of the court’s “lawful order” by using funds belonging to the company to pay his legal fees, and that the younger brother was prejudiced by the offending conduct. The court specifically rejected the elder brother’s contention that the payments fell within the restraining order’s exception for expenses incurred in the ordinary course of business.
What remains of the case after the three decisions? Still standing are the younger brother’s claim for dissolution of the corporation based on shareholder oppression under § 1104-a of the Business Corporation Law, along with damages claims for breach of fiduciary duty and breach of contract.