In 2005, Luciano Bonanni sued his business partners in a profitable limited liability company that provides MRI scanners to hospitals and management services to an affiliated radiology practice. The thrust of Bonanni’s multiple-count complaint was that the majority members had squeezed him out of the business, discontinued his profit share, and canceled his 20% membership interest.
In one of the earliest rulings in the case, which I featured in the very first post I published on this blog in 2007, the presiding judge, Suffolk County Commercial Division Justice Elizabeth Hazlitt Emerson, dismissed Bonanni’s claim for judicial dissolution of the LLC. Justice Emerson’s decision, which pre-figured by several years the Second Department’s landmark opinion in 1545 Ocean Avenue, held that Bonanni’s reliance on the grounds for dissolution available to oppressed minority shareholders under Business Corporation Law § 1104-a did not state a valid claim for relief under LLC Law § 702 governing judicial dissolution of LLCs.
As it turned out, the dismissal of the dissolution claim probably was a blessing in disguise for Bonanni. The company continued to generate healthy profits for many years while the litigation dragged on, culminating with a lengthy bench trial on Bonanni’s assorted direct and derivative claims. Earlier this month, Justice Emerson’s post-trial decision in Bonanni v Horizons Investors Corp., 2016 NY Slip Op 50281(U) [Sup Ct Suffolk County Mar. 9, 2016], found in Bonanni’s favor on most of his claims, including a determination that the defendants unlawfully converted his 20% membership interest by pretending he had withdrawn from the LLC.
The price tag? When all is said and done, including damages on Bonanni’s direct claims, his share of derivative damages, an upcoming accounting, and hefty interest charges at the 9% statutory rate, the recovery likely will exceed $1 million.
Justice Emerson’s 15-page decision is rich in detail concerning the genesis and evolution of the business, known as MRI Enterprises, LLC, formed in 2001 by Bonanni, an executive of an MRI equipment manufacturer known as Fonar Corp., as a 20% member, along with three others including a radiologist who collectively held the other 80%.
The business took seed when an opportunity arose to provide MRI scanners to two hospitals operated by the New York City Health and Hospitals Corporation (“HHC”). A separate medical practice owned solely by the radiologist was formed to provide patient services and to employ the radiologists who read the MRI scans. The LLC and the medical practice entered into a management services organization agreement under which the LLC earned handsome fees providing the practice with office space, non-medical personnel, billing and collection services, and other benefits. By 2003 the business began to generate profits which were distributed pro rata based on membership percentages; none of the principals received a salary.
Tensions among the LLC members arose in 2003 and percolated for the next two years over the selection of non-Fonar MRI equipment and entitlement to commissions on MRI sales to HHC. The conflict came to a head at a meeting in April 2005 at which the other members rejected Bonanni’s proposal to install Fonar equipment at one hospital. According to the other members, at the meeting Bonanni verbally announced his decision to resign and redeem his 20% interest. Bonanni denied doing so.
Soon afterward Bonanni discovered that the other three members had been paid their monthly distributions but that his share was not paid. He sent a letter to the other members accusing them of breaching the LLC’s operating agreement, declaring that the company “must proceed” to be sold based on their exclusion of Fonar equipment, stating that he “remains a 20% member of the LLC,” offering to sell his interest in the LLC, and threatening dissolution in the absence of an agreement.
Bonanni sent a second letter advising that he had received an offer from two radiologists to purchase his membership interest for $250,000, and offering to sell the interest to the other members pursuant to the operating agreement’s right of first refusal.
The other members replied in a pair of letters stating that, going forward, there would be no profit distributions; that members would be paid salaries for services; accusing Bonanni of favoring Fonar’s interests above the LLC’s; directing him not to take any actions on the LLC’s behalf; noting that “[a]t the last Board meeting on April 26, 2005, attended by all members, you announced your decision to resign”; and demanding that Bonanni “abide by” the operating agreement “in submitting your resignation and sale of your 20% interest” for $45,000 — a price apparently based on a value in the original operating agreement that was never updated as intended.
Bonanni sent a reply letter denying that he “resigned, wish to resign or have any intention of resigning from MRI Enterprises, LLC” and calling “misguided” the other members’ reliance on the operating agreement’s redemption provisions since, as Bonanni wrote, “I am not withdrawing from the Company and do not wish to leave.”
Following the correspondence, the other members reallocated Bonanni’s 20% membership among themselves and, in the following years, took millions of dollars in profit distributions including payments for services which Justice Emerson characterized as “disguised distributions” of the LLC’s profits.
In 2011, HHC terminated its agreement with the LLC. In 2012, the three controlling members transferred all of the LLC’s assets to the medical practice in consideration of the partial satisfaction of purported loans made to the LLC. In fact, according to Justice Emerson’s decision, the medical practice owed substantially more money to the LLC than the LLC owed to the practice. By 2013, when trial began, the other three LLC members continued to operate the MRI facility at one HHC hospital.
Bonanni brought suit against the other members in July 2005 after being frozen out of management and deprived of distributions. As mentioned above, his claim for judicial dissolution was dismissed early on. The remaining direct and derivative claims for breach of fiduciary duty, unjust enrichment, breach of contract, conversion, looting, waste, and misappropriation of the LLC’s assets and corporate opportunities, went to trial in 2013 after lengthy delays due to discovery, numerous pre-trial motions, and Bonanni’s representation by seven different attorneys.
The non-jury trial continued for 30 days over the course of 14 months, with over 200 exhibits and testimony by all the principals and Bonanni’s forensic accountant.
The Decision: Liability
“The central issue in this case,” Justice Emerson began her liability discussion, “is whether [Bonanni] effectively withdrew from membership in [the LLC].” The defendant members contended that he did, relying on their own testimony that he verbally resigned at the April 2005 meeting, and on the statement by Bonanni in his May 2005 letter that he was “[unable] to continue as a member, without Fonar’s presence at either [of the two HHC hospitals].”
Justice Emerson didn’t buy the argument by a long shot, pointing out initially that, under the January 2004 Amended Operating Agreement, no member could voluntarily withdraw for two years, i.e., before January 2006. As the judge wrote:
The defendants contend that Bonanni orally withdrew . . . on April 26, 2005, and that he memorialized the withdrawal in his letter dated May 12, 2005. Those dates are less than two years from the date of execution of the Amended Operating Agreement. Thus, no withdrawal was permitted at that time. Even if the defendants waived the two-year requirement, any withdrawal had to be in writing. Bonanni’s May 12, 2005, letter and subsequent correspondence do not indicate that [he] was withdrawing from MRI LLC. Rather, they indicate that Bonanni wanted . . . to continue to be a member of MRI LLC until he could sell [his] 20% interest to the defendants or a third-party for what he considered a fair price.
Justice Emerson also pointed to the statement in the defendants’ responsive letter that “[y]ou are a 20% equity holder of this company.” The defendants, she held, had the right under the operating agreement to match the $250,000 third-party offer for Bonanni’s interest, but did not have the right to compel him to redeem his shares for $45,000 which applied only upon a member’s death or withdrawal.
In addition, Justice Emerson credited Bonanni’s testimony that he did not want to withdraw from the LLC, and that he merely wanted to stop serving as its manager, as consistent with the operating agreement’s provision authorizing a member-manager to resign as manager and maintain his membership.
The heart of Justice Emerson’s liability finding against the defendants for breach of fiduciary duty, breach of contract, and conversion of Bonanni’s membership interest appears in the following passage from the decision:
Rather than compensate Bonanni for [his] ownership interest in MRI LLC, the defendants used Bonanni’s purported withdrawal as a pretext to freeze [him] out. Profits, which had been the sole source of compensation for the members of MRI LLC, were no longer distributed, and compensation was based solely on services rendered. Bonanni’s responsibilities for the day-to-day operation of the business were taken away and given to Kalish. Even though Bonanni no longer wanted to be the “face” of MRI LLC or its manager, he could have been given other responsibilities, but he was barred from taking any action or acting in any capacity on behalf of MRI LLC. He, therefore, was unable to perform any services for which [he] would be compensated. In addition, [his] 20% ownership interest was divided among the other members of MRI LLC, with Horizons/Fernandez receiving 10% and Adex/Kalish and Dr. Hausknecht receiving 5% each. The payments to them for the services they rendered to MRI LLC after Bonnani’s ouster were, in fact, distributions of MRI LLC’s profits and were made in direct proportion to their new ownership interests in MRI LLC (50-25-25). Neither Bonanni nor [his company] have received any compensation from MRI LLC since Bonanni withdrew $3,000 from MRI LLC’s checking account on May 10, 2005.
The Decision: Damages
On his direct claims for damages, Justice Emerson awarded Bonanni the principal sum of $568,000, representing 20% of the profits paid to the other members in the period May 2005 through start of trial in October 2013, plus 9% interest computed from the midpoint in August 2009. The judge also found that Bonanni is entitled to an accounting of all payments from the LLC to the other members after October 2013, as well as from the medical practice (presumably excluding profits for patient services) as the LLC’s “alter ego and successor-in-interest.”
On Bonanni’s derivative claims for looting, waste and misappropriation, Justice Emerson ordered the defendants to pay the LLC $415,000 for an MRI scanner transferred to the medical practice without fair consideration, plus another $327,000 for legal fees of the defendants paid by the LLC, plus interest on those amounts at 9%. Given that the LLC ceased operations around 2011-12, and presuming it has no other creditors, 20% of the derivative award should translate into another $150,000 for Bonanni plus interest.
The Takeaway: Normally, when you read that a plaintiff replaced his lawyer in the same case seven times, you assume the plaintiff’s case has some serious problems, or the plaintiff is unable to pay his lawyers, or both. In Bonanni, though, there seems to have been an obvious ticking time bomb in the defendants’ case insofar as it rested entirely on the assertion of a hotly contested, unrecorded, verbal withdrawal from the LLC that was (a) counter to the prohibition on early withdrawal in the operating agreement, (b) contradicted by Bonanni’s post-meeting correspondence, and (c) contradicted by the defendants’ own post-meeting correspondence. Perhaps the defendants figured they could win a war of attrition, but the longer they ran the business profitably, the more financial incentive Bonanni had to continue prosecuting the case. Bonanni also reminds us of the perils of using a so-called “certificate of value” or fixed price for the buy-out of an owner’s interest triggered by death or withdrawal. The members of the LLC in Bonanni, as I’ve seen in many other cases, apparently never did periodic re-appraisals of the company as contemplated by its operating agreement, which may have distorted the defendant members’ risk assessment and contributed to their costly determination to tough it out through trial.