A little over three years ago I reported on the first round of a fascinating “food fight” among four siblings, each of whom is a 25% shareholder of a Brooklyn-based, second-generation food distributor known as Jersey Lynne Farms, Inc. (the “Corporation”), and each of whom also is a 25% member of Catarina Realty, LLC (the “LLC”) which leases its sole realty asset to the Corporation.
The occasion back then was the court’s decision in Borriello v Loconte denying a dismissal motion in a derivative suit brought by Dorine Borriello on the LLC’s behalf in which she alleged that her three siblings breached fiduciary duty by leasing its realty to the Corporation at a drastically below-market rent and by imposing on the LLC certain expenses that ought to be borne by the Corporation as tenant.
In 2011 — the same year her siblings entered into the challenged lease — they ousted Dorine as a director, officer, and employee of the Corporation. In 2012 Dorine and her siblings negotiated a Separation Agreement and General Release setting forth terms for payment of compensation and benefits along with non-compete and non-disclosure provisions. The agreement left intact Dorine’s 25% stock interest in the Corporation.
Dorine’s derivative suit filed in 2013 claimed that the 2011 below-market lease rendered the LLC unprofitable while increasing the Corporation’s income used to pay salaries and other benefits to her siblings. The first round went to Dorine when the court ruled that her General Release did not encompass her derivative claim and enjoined her siblings from advancing their legal expenses from LLC funds.
In the end, however, and subject to any appeals Dorine may bring, it appears that the siblings have won the food fight’s final rounds.
The Court’s Mid-Trial Dismissal of Dorine’s Derivative Action
Dorine’s derivative action went to trial in August 2016 before Brooklyn Commercial Division Justice Sylvia Ash. Both sides offered the testimony of expert appraisers as to the rental value of the LLC’s property. Defendants’ expert was the same appraiser who in 2011 determined a fair market annual rent of $342,000 which the majority defendants adopted for the contested 2011 lease. Dorine’s expert testified that the fair market rent was near $600,000 annually.
Following completion of the expert testimony the defendants moved for a directed verdict which Justice Ash granted. In her transcript ruling (read here), Justice Ash found that the defendants did not breach fiduciary duty by relying on the 2011 appraisal in fixing the rent and that such reliance was protected from liability under the LLC’s operating agreement; that Dorine had not offered any proof undermining the appraiser’s independence; that Dorine’s expert’s appraisal relied on geographically remote comparables; and that since 2011 the LLC has remained profitable.
Dorine subsequently moved on procedural and substantive grounds to set aside the court’s decision granting a directed verdict. In a written Decision and Order dated April 3, 2017, Justice Ash denied Dorine’s motion, finding anew that Dorine failed to offer competent evidence questioning the independence of the defendants’ appraisal or any bad faith on the defendants’ part in relying on the appraisal.
The Court’s Summary Dismissals of Dorine’s Dual Petitions to Dissolve Both Companies
Dorine seemingly pulled out all the stops in August 2016 by filing for judicial dissolution of both the LLC and the Corporation in two separate proceedings.
She first filed the LLC dissolution proceeding the day before the start of the trial of her LLC derivative action. The petition’s gravamen (read here) was that her siblings were using the 2011 lease “as a vehicle to improperly waste and drain assets” of the LLC, and that dissolution also was warranted in anticipation that her siblings would enter into a similarly unfavorable “sweetheart” lease when the 2011 lease expired at the end of 2016.
Following the court’s dismissal of the derivative action challenging the same 2011 lease, not surprisingly the siblings moved to dismiss the petition, which Justice Ash granted by Decision and Order dated March 22, 2017, stating that “[t]his Court . . . has already determined, after a trial, that the Respondents have acted properly with regards to the subject lease with Jersey Lynne. Thus, Boriello is collaterally estopped from asserting the alleged impropriety of the lease with Jersey Lynne as a basis for Caterina’s dissolution.”
Dorine’s second dissolution petition, aimed at the Corporation and filed two weeks after the mid-trial dismissal of her LLC derivative action, met the same fate, albeit on different grounds.
Her petition (read here) asserted claims for dissolution both under Business Corporation Law Section 1104 based on “internal dissension” and under Section 1104-a based on oppression, corporate waste and diversion of assets. Neither claim survived her siblings’ subsequent dismissal motion which Justice Ash granted by Decision and Order dated March 30, 2017.
First, Justice Ash held that Dorine lacked standing under Section 1104 — the so-called “deadlock dissolution” statute — because it requires the petitioner to own 50% of the corporation’s voting stock whereas Dorine only owns 25%.
Second, as to the Section 1104-a claim, Justice Ash held that, as a matter of law, Dorine’s Separation Agreement and General Release “for which she was paid a severance package” barred her freeze-out oppression claim based on alleged exclusion from participation in management. Justice Ash also dismissed Dorine’s allegations of waste as “conclusory” and because “the petition fails to allege that any of the individual Respondents are misusing corporate assets for their personal gain.”
In hindsight, and without firsthand knowledge of the particulars, it’s all too easy to give advice about what could have been done to avoid a messy and likely painful series of litigations among family members like the one here. All I’ll say is, when you have a bitter falling out among family members who co-own a non-dividend paying business from which they take out profits in the form of employment compensation, the prospects for avoiding future strife are almost always better with a buy-out rather than, as occurred in this case, the ousted family member remaining as an outside minority owner whose interest in receiving profit distributions conflicts with the interests of the inside majority owners in reinvesting profits, compensating themselves for their labors, and perhaps bringing their children into the company as next-generation owner/managers.
Update March 25, 2020: On appeal by Dorine from the mid-trial dismissal of her derivative action, the Appellate Division today reversed Justice Ash’s decision and remanded the case for a new trial. The appellate ruling can be read here. The court accepted Dorine’s argument that Justice Ash improperly relied on the defendants’ expert’s testimony in deciding a motion for a directed verdict.