I can’t say what the number is, but my own experience tells me that a significant percentage of lawsuits by a minority owner of a closely-held company against those in control of the company include a demand for an accounting. And at the risk of over-generalizing, I’d say that in many if not most of those cases, the accounting demand is not the central focus of the minority owner’s claim; it is a tacked-on, ancillary cause of action, pleaded in general terms and almost as a matter of course. Sometimes, as this blog has covered, plaintiffs demand an accounting without even realizing what they’re asking for.
An equitable accounting is not a books and records demand. Rather, it requires the fiduciary—in business divorce litigation, those in control of the company—to prepare detailed and supported schedules of income and expenses over a defined period, followed by the plaintiff’s filing of objections to the accounting, followed by proceedings, often before a court-appointed referee, to hear and recommend or determine the accounting. Once complete, “the plaintiff gets an order directing payment of the sum of money found due” (Ederer v Gursky, 881 NE 2d 204 ).
The potentially significant undertaking of an accounting might explain why it is so often demanded in business divorce litigation. By invoking a demand for an equitable accounting, a closely-held business owner raises the specter of a time consuming, expensive, and needling process in which costs will almost certainly be disproportionally borne by the company and those in control.
Perhaps due to its potential potency, courts have tempered the equitable accounting remedy with several principles that are now well-worn grounds for dismissal of an equitable accounting claim.
First, a member or shareholder seeking an accounting must establish that a pre-suit demand for such an accounting was made and refused (New York Studios, Inc. v Steiner Digital Studios, 151 AD3d 454, 455 [1st Dept 2017] [“In the absence of an allegation that plaintiffs demanded an accounting, the claim for an accounting fails to state a cause of action”]; Mawere v Landau, 130 AD3d 986, 990 [2d Dept 2015] [“The complaint failed to state a cause of action for an accounting, as the plaintiff failed to allege that he made a demand for an accounting . . . and that they failed or refused to provide such an accounting”]). While this pre-suit demand requirement is not quite as rigorous as the pre-suit demand requirement for derivative actions (see Kaufman v Cohen, 307 AD2d 113 [1st Dept 2003]), at least a general allegation of a prior demand and refusal is required.
Second, the equitable accounting claim is premised not only on a fiduciary relationship between the plaintiff and the fiduciary, but also on “a breach of the duty imposed by that relationship respecting property in which the party seeking the accounting has an interest” (Jacobs v Cartalemi, 156 AD3d 605, 608 [2d Dept 2017] [covered in this post]). Based on this principle, a standalone claim for an accounting that does not allege at least some wrongdoing by the fiduciary is unlikely to survive. But even these principles have exceptions, as highlighted in Frank McRoberts’ post on the curious case of Webster v Forest Hills Care Ctr., LLC, which suggested that the right to an accounting might be absolute.
Third, where the alleged wrongdoing necessitating the accounting causes harm to the company as opposed to the individual shareholder, the accounting claim is derivative. This means that a plaintiff seeking an equitable accounting based on misuse or misallocation of the company’s assets must satisfy the prerequisites to a derivative suit, including a particularized pre-suit demand and an ownership interest in the company throughout the litigation (Cartalemi, 156 AD3d at 608 [holding that the plaintiff’s withdrawal from the LLC defeated his claim for an accounting]).
Fourth, “[t]o be entitled to an equitable accounting, a claimant must demonstrate that he or she has no adequate remedy at law” (Unitel Telecard Distribution Corp. v Nunez, 90 AD 3d 568 [1st Dept 2011]).
These principles bring us to a recent case adopting several other interesting—and, as best as I can tell, novel under New York Law—limitations on New York’s cause of action for an equitable accounting, First Equity Realty v The Harmony Group II, Index No. 650273/2015 (Sup Ct, New York County Mar. 3, 2022).
New York County Commercial Division Justice Joel Cohen described the dispute in First Equity as “the aftermath of what had been an amicable business divorce.” Madison Avenue Investment Partners, LLC (“MAIP”) was an investment LLC jointly owned by Ronald Dickerman (through his wholly owned company, “FER”) and Bryan Gordon (through his wholly owned company, “Harmony”). At the outset of their relationship, FER and Harmony jointly managed MAIP and its investments pursuant to the operating agreement of MAIP, which also set forth detailed guidelines for distributions of cash resulting from MAIP’s investments.
FER Steps Away from Management, Relies on Harmony/MAIP to Make Distributions
Around 2002, FER and Harmony sought to end their business relationship. They entered into a letter agreement whereby Harmony would continue day-to-day management of the business and assets of MAIP and would provide distributions to FER in accordance with the distribution provisions of the amended operating agreement of MAIP. The parties also agreed to pursue new investments separately—Dickerman as “Ronco”; Gordon as “Bryco”—and to grant each other a carried interest in those investments for a two-year period following the letter agreement.
In accordance with their letter agreement, FER received K-1s reflecting its ownership in MAIP, but it did not receive its proper percentage of distributions from MAIP. Although both the operating agreement and the letter agreement gave FER fairly robust rights to receive detailed monthly reports and accountings, FER did not meaningfully exercise those rights until 2015.
In a complaint first filed in 2015, FER alleged that from 2002 through 2008, MAIP/Harmony shorted FER on distributions to which it was entitled. For 2009 through 2013, FER alleged that it did not receive any distributions from MAIP whatsoever.
The Accounting Claim
In addition to its breach of contract claims centered upon MAIP/Harmony’s alleged failure to make proper distributions, FER demanded in its fourth amended complaint that Harmony render an accounting of MAIP.
FER’s demand for an equitable accounting was a tactical decision. By the time FER asserted that claim, FER knew that its contract-based claims that MAIP/Harmony failed to pay FER required distributions as early as 2002 faced a serious statute of limitations hurdle. But because the limitations period on a claim for an accounting against a fiduciary does not begin to run until there is an open repudiation of the fiduciary’s obligation (Homapour v Harounian, 182 AD3d 426, 430 [1st Dept 2020]), FER argued that irrespective of the timeliness of its contract claims, its demand that Harmony account for all transactions of MAIP and settle them as appropriate was timely because the fiduciary relationship between FER and Harmony was not repudiated until 2015.
The Post-Trial Ruling
The parties tried their claims in a two-day bench trial last summer and submitted extensive post-trial briefing—during which FER insisted on its absolute right to call Harmony to account for all transactions at MAIP since 2002. FER also argued in post-trial briefing that the Court should short-circuit the accounting process and simply enter judgment in its favor on the accounting claim for the amount of the underpaid distributions, which had been conclusively established through discovery.
In his characteristically thorough findings of fact and conclusions of law, Justice Cohen rejected FER’s accounting claim for two reasons.
First, the Court held that there was no need for an accounting due in part to the years-long discovery process in this case. Another detailed accounting of the same financials that were subject to discovery would shed no greater light on Harmony’s management of MAIP’s finances than discovery already had:
[A] separate accounting would be a futile exercise. The parties have already spent years in litigation, with the full CPLR discovery arsenal at their disposal. Both sides were sufficiently satisfied with the output of that process to declare ready for trial. Even assuming there are gaps in the available records, ‘ordering an accounting would not cure this shortcoming. To order an accounting that will not, and cannot, be complete or helpful serves no discernable [sic] purpose.’
Second, the Court held that under the circumstances of this case, FER’s accounting claim was subject to the same six-year statute of limitations as FER’s breach of contract claim, which accrued long before Harmony openly repudiated its fiduciary relationship with FER:
However, based on the evidence at trial, the application of equitable tolling is not so simple in this case as a search of open repudiation. As noted above, FER and Mr. Dickerman had the clear right and opportunity to monitor their interests in MAIP’s distributions but failed to do so. In those circumstances, the Court believes that equitable tolling should not apply to FER’s accounting claim, which essentially is the same as its breach of contract claim. Accordingly, the accounting claim is barred by the six-year statute of limitations.
In other words, despite the existence of an ongoing fiduciary relationship between FER and Harmony/MAIP, the Court found that FER’s accounting claim nonetheless accrued and was not tolled during that fiduciary relationship because FER failed to diligently monitor MAIP’s distributions and financial circumstances.
I see two important principles emerging from First Equity that further temper the potency of the equitable accounting claim:
First, a court will be reluctant to direct a costly and lengthy accounting exercise if it will be futile. While we caution not to confuse an equitable accounting with an inspection of books and records, a litigant seeking an accounting after having had a chance to pursue broad discovery of the company’s books and records should be prepared to demonstrate why, even after full disclosure of all material financials, the circumstances still require the fiduciary to render an accounting.
Second, while the statute of limitations on an accounting claim generally does not begin to run until there has been an open repudiation of the fiduciary relationship giving rise to the accounting, that general rule may not apply where the plaintiff failed to diligently monitor her interest in the company, especially where the plaintiff had robust rights of inspection and access to records, as FER did in First Equity.
Given the ubiquity of accounting claims in business divorce cases, I dare say that it will not be long before these principles are tested and further refined in subsequent cases.
In the Delmonico’s case, a special referee and Justice Cohen denied the petitioners’ request for an equitable accounting based on the extensive discovery that preceded the hearing: “Petitioners have been provided access to all of Ocinomled’s financial books and records which were recoverable and have had ample opportunity to have those records reviewed and analyzed by their own expert . . . Consequently, directing Respondents to provide a ‘full accounting’ is, in my opinion, pointless at this time.”
The First Department today reversed the denial of the accounting claim, holding that “While it is clear that respondents produced the full books and records, and the Special Referee went through thousands of documents and reviewed numerous expert reports, this is insufficient . . . particularly because respondents’ bookkeeping was described as inadequate, and sometimes nonexistent, and there was evidence respondents intentionally destroyed key financial data during the litigation.”