It’s late August, when the lure of the seashore and vacation plans push aside all but the most serious work-related endeavors, and when I share with my readers a few short summaries of recent decisions of interest in business divorce cases.
First, we’ll look at a decision in a dispute among former law firm partners in which the court upheld a partnership agreement amendment by the defendant majority partners, reducing the plaintiff’s percentage interest after he announced his intention to withdraw but before the actual withdrawal became effective. Next up is a relatively rare decision in an LLC dissolution case granting a motion to disqualify defense counsel under the advocate-witness rule of professional conduct. In the third case highlighted below, the Delaware Chancery Court dismissed a books-and-records action for lack of standing where the shares issued to the plaintiff never existed.
Court Enforces Eve-of-Withdrawal Reduction of Partnership Interest
Zohar v LaRock, Short Form Order, Index No. 14826/10 [Sup Ct Nassau County July 25, 2016]. Article 8-B of New York’s Partnership Law authorizes regulated professional practices to organize as registered limited liability partnerships. The LLP form is highly popular with law firms because it offers the same limited liability protection afforded corporation shareholders and LLC members, except for their own professional negligence or malpractice. The LLP otherwise is subject to the same statutes and common-law rules governing general partnerships, which give partners great leeway in ordering their own affairs in their partnership agreement.
Such was the case in Zohar, essentially an accounting action brought by a former partner in a personal injury law firm whose partnership agreement permitted a partner to withdraw upon 60-days written notice with a buy-out at “net book value.” Shortly after the plaintiff, who held a 25% partnership interest, informed them that he intended to withdraw, his two partners called a partnership meeting at which they reduced the plaintiff’s partnership interest to 15% under a provision in the partnership agreement allowing amendments by two-thirds vote. A few days later the plaintiff gave his 60-day written notice of withdrawal.
The Court’s decision, by Commercial Division Justice Stephen A. Bucaria, observed as follows in upholding the amendment, which had the effect of reducing from 25% to 15% the plaintiff’s share of net attorney fees generated by open cases which settled after the amendment date (but preserved his otherwise vested 25% interest in other law firm assets):
“In the absence of prohibitory provisions of the statutes or of rules of the common law relating to partnerships, or consideration of public policy, the partners . . ., as between themselves, may include in the partnership articles any agreement . . . concerning the sharing of profits and losses, priorities of distribution on winding up . . ., and other matters” (Bailey v Fish & Neave, 8 NY3d 523, 528-29 ). The partners may agree to be bound by majority vote as to the most fundamental change, dissolution, as well as matters of payment and compensation (Id). The majority may agree to switch from an accrual to a cash-based system, and make other retroactive changes, to the compensation of partners who have not yet withdrawn from the partnership.
Agreements among co-owners of business entitles generally allowing amendment by less than unanimous consent often carve out certain decisions requiring unanimity, typically including changes in ownership interests. The partnership agreement in Zohar had no such carve-out.
Update July 31, 2020: Hard to believe it took four years to obtain appellate review, but here we are in 2020 with a decision this month by the Appellate Division, Second Department, modifying Justice Bucaria’s order and remitting the case to recalculate the buyout price in accordance with the terms of the partnership agreement and not as a dissolved partnership.
Attorney Disqualified Under Advocate-Witness Rule in LLC Dissolution Case
Zuckerman v Shaknovich, Short Form Order, Index No. 604957/15 [Sup Ct Nassau County June 27, 2016]. Rule 3.7 (a) of New York’s Rules of Professional Conduct prohibits a lawyer from “act[ing] as advocate before a tribunal in a matter in which the lawyer is likely to be a witness on a significant issue of fact,” subject to a series of exceptions. Not infrequently the rule is invoked in support of attorney disqualification motions in dissolution cases where the attorney representing one of the litigants also prepared the organizational documents upon the entity’s formation.
My general impression from reading decisions of this sort is that they rarely succeed because the targeted attorney’s testimony adds little or nothing of substance to the unambiguous terms of the documents he or she drafted. Zuckerman is the exceptional case in which the court, by Commercial Division Justice Vito M. DeStefano, granted a disqualification motion in an LLC dissolution case where the defendant’s attorney, acting solely as attorney for that same individual at the time of entity formation, drafted certain disputed documents including an Acknowledgement of Redemption and a related spreadsheet.
The court’s decision provides no other details, however the underlying motion papers reveal a threshold dispute whether the documents prepared by the defendant’s attorney around the time of formation, which purported to show that the plaintiff had relinquished his membership interest in the LLC, were bona fide or prepared solely for purposes of obtaining financing for a realty acquisition by the LLC, with an understanding between the two members that the plaintiff remained a member.
Holder of Invalidly Issued Shares Denied Inspection of Books and Records
Pogue v Hybrid Energy, Inc., C.A. 111563-VCG [Del. Ch. Aug. 5, 2016]. The first sentence in this opinion by Vice Chancellor Glasscock of the Delaware Court of Chancery, in a shareholder suit for inspection of books and records, notes that it “comes before the Court in a posture unique, I believe, in our case law.” This is no hyperbole, as shown by the opinion’s introductory summary of the operative facts:
The Plaintiff, James Pogue, was an employee of the Defendant Hybrid Energy, Inc. He alleges that, at the time he was hired in 2011, the Company issued to him a stock certificate representing one million shares of Hybrid common stock. Despite this fact, the record demonstrates that Hybrid, at the time, had no treasury shares available to distribute; its certificate of incorporation authorized the issuance of only 1,500 shares, which were all the outstanding, held by its principal, Thomas Lull. According to Pogue, the illusion that he was an owner of Hybrid stock was furthered by the payment of “dividends” in the years after 2011. Pogue was also represented on Hybrid’s stock ledger as an owner of stock of the Company. The evidence in the record, however, demonstrates that the 2011 “stock issuance” was void and that Pogue’s stock certificate is a nullity.
The plaintiff, innocent of any reason to believe he had been issued phantom shares, argued that his inclusion as a stockholder on the company’s stock ledger conclusively established his right to inspect books and records under Section 220 of Delaware’s General Corporation Law. Despite its “equitable sympathy” for the plaintiff’s position, the court disagreed, holding that inclusion in the stock ledger created a rebuttable rather than irrebuttable presumption of stockholder status, and that plaintiff’s standing to inspect books and records was defeated by the undisputed evidence that the shares seemingly issued to him never existed.
Does that leave the plaintiff with no remedy? Vice Chancellor Glasscock is careful to point out that his decision does not address the plaintiff’s right to relief under theories of fraud, breach of contract, estoppel, or under DGCL Section 205 (a) (4) which gives the Chancery Court exclusive jurisdiction over actions brought by “any record or beneficial holder of valid stock or putative stock,” to “[d]etermine the validity of any corporate act or transaction and any stock, rights or options to acquire stock.”