The New York Times yesterday published an article entitled Climate Change Enters the Therapy Room discussing persons suffering from “climate anxiety.” As a northeasterner, the frigid, snow-blessed, ground-freezing winter we’re having has eased my own concern after years of abnormally mild winters. Probably short-sighted. Probably irrational. We take solace where we can find it.

Here’s another soul-soothing affirmation of winter: this blog’s annual Winter Case Notes. This year’s edition features four recent decisions by New York courts:

  • rejecting a putative LLC member’s tax estoppel argument raised in opposition to a summary judgment motion declaring its non-membership;
  • denying dismissal of a shareholder’s individual claims pleaded alongside derivative claims arising from the controlling shareholder’s failure to pay company payroll taxes;
  • granting summary judgment upholding the plaintiff’s claimed 49.9% LLC membership as recorded in the operating agreement over the defendant’s objection that the transaction actually was a loan disguised as an LLC interest to sidestep ancient Jewish law proscribing loan interest; and
  • denying summary judgment in a dispute between family members over the ownership of a realty holding corporation featuring allegations of a forged stock certificate.

Court Rejects Tax Estoppel in Dispute Over LLC Ownership

Business divorce litigation frequently involves disputes over a party’s claimed ownership interest in the company, especially when the interest is not certificated or otherwise documented by an agreement among the owners. In such cases involving pass-through tax entities, the company’s Form K-1s issued to the partners typically take center stage, with one side claiming the other is estopped from taking a position in court that contradicts the ownership shown by the K-1s. A recent post on this site by Frank McRoberts explains the two competing strands of New York case law on tax estoppel, one strand holding tax returns are not determinative of ownership status, the other holding they are. As you would expect, the outcome depends on who signed the tax returns and who provided the information in them.

In Tradesman Program Managers, LLC v Doyle, decided earlier this month by the Appellate Division, First Department, the court affirmed a decision by Manhattan Commercial Division Justice Andrea Masley rejecting the tax estoppel argument made by the putative holder (JCB) of an 18.75% membership interest in an LLC. The 18.75% allegedly consisted of a 2.5% interest held by JCB’s principal plus a 16.25% interest assigned effective January 1, 2017 by another of the original LLC members. The LLC’s 2017 tax return prepared and filed in 2018 included JCB’s K-1 reporting the 18.75% interest. Later in 2018, the LLC’s controlling members expelled the principal, redeemed the 2.5% interest, and filed a lawsuit seeking a declaration that the assignment to JCB violated the operating agreement’s transfer restrictions and was a nullity.

On appeal, the court affirmed the lower court’s judgment declaring that JCB was not a member. The court agreed with Justice Masley that the 2017 K-1 issued to JCB did not estop the LLC from disregarding JCB’s claimed membership interest, for two reasons. First, quoting from its recent opinion in PH-105 Realty Corp. v Elayaan, the court noted that tax estoppel applies where “the party seeking to contradict the factual statements as to ownership in the tax returns signed the tax returns, and has failed to assert any basis for not crediting the statements.” The plaintiff in Tradesman, however, “did not sign the K-1 in question” and “offered a reasonable explanation why the statement contradicts reality – namely, the affidavit of one of its managers stating that it paid distributions to JCB solely on the basis of misrepresentations made to plaintiff” by the putative assignor. Second, the purported assignment to JCB was dated more than a year before its formation. “Accordingly,” the court wrote, “the assignments were made to a nonexistent entity incapable of receiving them, thus rendering those assignments void.”

Plaintiff’s Direct Claims Alleging Potential Personal Liability for Payroll Taxes Did Not Duplicate Derivative Claims

I recently wrote about the frequency of first-round skirmishes in business divorce litigation over the pleading of direct vs. derivative claims. Here we go again.

In another First Department decision earlier this month, the court in Newman v Newman affirmed a decision by Manhattan Commercial Division Justice Barry R. Ostrager denying a motion to dismiss the plaintiff son’s individual claims against his father for breach of fiduciary duty, unjust enrichment and constructive trust as duplicative of the son’s derivative claims on behalf of their co-owned company, Port Parties, Ltd. In his complaint, the son alleged that the father’s failure to pay company payroll taxes exposed the son as a company owner to potential civil and criminal liability. The appellate panel agreed that the alleged harm to plaintiff “is an individual harm sufficiently ‘separate and distinct’ from the harm suffered by the corporation on account of defendants’ failure to pay certain state and federal taxes” and that “the benefit the corporation seeks to recover on its claim to compensate it for the alleged failure to pay certain taxes would not necessarily be the same benefit sought by plaintiff, who seeks the resolution of the potential civil and criminal liability for the conduct alleged.”

Court Rejects Claim that Membership Interest Recorded in Operating Agreement Was Disguised Loan

Business divorce meets Bible in YMSF Family Partnership LP v Beitel, featuring a dispute between Orthodox Jews over the plaintiff’s investment in a real estate holding LLC. In 2013 the plaintiff family limited partnership paid $800,000 allegedly for a 49.9% membership interest in the LLC. In 2017, after the defendant controlling member denied requests for access to books and records, the plaintiff filed an action seeking a declaratory judgment that it is a member of the LLC with all rights of membership including  access to books and records. In support of its motion for summary judgment, the plaintiff relied on the 2013 operating agreement recording its $800,000 “contribution” “paid toward purchase of entity” and 49.9% membership interest.

The defendants opposed on the ground that the operating agreement did not intend to provide an ownership interest to the plaintiff. Rather, as related in the decision by Brooklyn Commercial Division Justice Leon Ruchelsman, the defendants maintained:

the transaction was only one of a loan provided by the plaintiff and the operating agreement was worded in that fashion to avoid the appearance of an interest bearing loan prohibited by Jewish law. The defendants assert that the principals of the plaintiff as well as the defendant are all Orthodox Jews and purposefully and intentionally crafted the transaction as an operating agreement as such to avoid the appearance of a prohibited interest bearing loan.

Justice Ruchelsman rejected the argument and granted summary judgment for plaintiff, finding that “the terms of the operating agreement are clear and are not ambiguous in any manner” and that its provision setting forth the plaintiff’s $800,000 “contribution” and membership percentage “plainly and unmistakably afford the plaintiff with membership interests in the entity.” Justice Ruchelsman also discounted as inadmissible parol evidence the defendants’ reliance on a “heter iska” entered into by the parties, described as “a religious document utilized to circumvent the Jewish prohibition against interest by treating all loans as partnerships or business ventures.”

Court Orders Trial on Issue of Father’s Donative Intent for Inter Vivos Gift of Stock in Family Business

Messy are the facts in Lurie v Lurie, where the Appellate Division, Second Department, affirmed another of Justice Ruchelsman’s orders, this time denying summary judgment in a dispute over ownership of a family-owned realty firm. The case pits son Neil against his father Abraham and (indirectly) sisters Leila and Susan in a fight over the ownership of Lurie Management Corp. (LMC) which holds title to a commercial property in Brooklyn that houses other Lurie owned operating companies. Neil, alleging that in 1998 his father gifted him the father’s 100% stock interest in LMC via a stock certificate executed by the father, filed suit in 2018 after the father’s attorney sent Neil a letter stating that Abraham had transferred his 100% ownership of LMC to three trusts managed by Neil’s sisters for the benefit of Neil (49%) and his sisters (51%), and that the father was considering selling the property.

Not until two years into the litigation did Neil find and produce the 1998 stock certificate after testifying that it had been destroyed in a fire in 2006 in which the company’s accountant had perished. Abraham and the sisters’ Trusts moved for summary judgment on their counterclaim for a declaration of their ownership of LMC, claiming that Abraham’s signatures on the certificate were forged. Neil responded with a handwriting expert’s report concluding that Abraham’s signatures were genuine. Talk about messy tax returns: Justice Ruchelsman’s decision (read here) details ownership information in LMC’s Form 1120 tax returns between 2004 and 2019 reporting Neil’s 100% ownership in certain years, Abraham’s 100% ownership in certain years, Neil’s 75% ownership in certain years, and the sister’s partial ownership in certain years.

Little wonder that Justice Ruchelsman found questions of fact concerning the corporation’s ownership based on the disputed testimony concerning the stock certificate’s authenticity, the conflicting tax returns, and other hotly disputed facts.  Likewise, the Second Department expended few words affirming Justice Ruchelsman’s decision:

Here, the defendants established, prima facie, a lack of donative intent for Abraham’s alleged inter vivos gift of ownership of LMC to Neil in 1998. In opposition, however, the plaintiffs raised triable issues of fact as to whether Abraham had the requisite donative intent to make an irrevocable present transfer of the stock and whether that transfer was actually effectuated. [¶] Contrary to the defendants’ contention, the testimony of Neil and LMC’s accountant as to how the stock certificate for LMC, which those witnesses testified had been lost in a fire in 2006, came to be found by the accountant in January 2020, only raised an issue of credibility that cannot be determined on a motion for summary judgment. [¶] The defendants’ remaining contentions are without merit. [Citations omitted.]

The appeal also challenged Justice Ruchelsman’s denial of summary judgment likewise contesting Neil’s 100% ownership by gifting from Abraham of three operating companies. The Appellate Division’s affirmance without discussion as to those entities is the subject of a pending motion for reargument by Abraham and the sisters’ trusts.