Folks hearing the phrase “business divorce” for the first time tend to focus unconsciously on the word “divorce,” tuning out the word “business.” The irony is that most business divorce cases have nothing to do with matrimonial disputes.
But that’s not always the case. From time to time, we write about matrimonial disputes that spill over into the commercial courts, and vice versa. Last fall, I wrote about a matrimonial-turned-business dispute simultaneously playing out in Delaware Chancery Court and Manhattan’s Matrimonial Division between reality television personality Julia Haart and her former paramour, billionaire Silvio Scaglia, over ownership of modeling agency Elite World Group, Inc.
It’s not common at all, though, to see business dissolution proceedings play out in matrimonial court, which is why a recent decision from Manhattan Supreme Court Justice Kathleen Waterman-Marshall is so fascinating.
In a wonderfully-written decision, N.F. v J.D. (2022 NY Slip Op 51294[U] [Sup Ct, NY County Dec. 21, 2022]), Justice Waterman-Marshall considered several intriguing questions:
- The power of New York’s matrimonial courts to judicially dissolve closely-held business entities considered “marital assets”
- The power of matrimonial courts to order a spouse to non-judicially dissolve an entity
- The power of matrimonial courts to appoint temporary receivers of business entities, including receiverships over non-party controllers of marital asset business entities
- The power of matrimonial courts to order a temporary receiver to decide whether to seek dissolution
The Marriage and the Hedge Fund Formed with Marital Assets
In 2010, Husband and Wife were married. Husband worked in the finance industry covering emerging markets. Husband and Wife had substantial securities assets, jointly investing in three separate brokerage accounts worth between $2 and $3 million.
In 2018, Husband and Wife formed a hedge fund, a Delaware-incorporated limited liability company (the “Company”), to hold and manage their investments, funding the Company with assets transferred from their three brokerage accounts.
Husband and Wife entered into a Limited Liability Company Agreement (the “LLC Agreement”) stating that Husband and Wife were 50% members of the Company. “Ostensibly,” wrote the Court, “the addition of Wife as a member of the Company was in recognition of the fact that it is a marital asset.”
The Company invested in emerging markets — “specifically, China and Russia” — known for high volatility, including potentially high returns but also heavy losses.
Managing the Company was a separate, New York-incorporated LLC owned and managed exclusively by Husband (“Management”).
Husband’s Violation of the Automatic Orders
In 2020, Wife filed for divorce.
Under Domestic Relations Law (“DRL”) § 236 B, the filing of a matrimonial lawsuit results in what are known as “automatic orders,” providing that neither party may, among other things:
sell, transfer, encumber, conceal, assign, remove or in any way dispose of, without the consent of the other party in writing, or by order of the court, any property . . . individually or jointly held by the parties, except in the usual course of business, for customary and usual household expenses or for reasonable attorney’s fees in connection with this action.
Unbeknownst to Wife, in 2021, Husband executed several amended and restated LLC Agreements for the Company, in part to offer interests in the Company to more than a dozen third-party investors as part of a previously-agreed-to plan between Husband and Wife, but in the process eliminating Wife’s membership interest without her knowledge or consent.
In the words of the Court, “The end result of the 2021 LLC Agreements is simply this: Husband disposed of Wife’s membership interest in the Company and took complete ownership and control of the Company and its assets for himself.”
Wife allegedly did not learn of the loss of her membership interest in the Company, nor Husband’s sale of membership interests in the Company to investors, until well into the matrimonial litigation as part of the pre-trial discovery process.
Meanwhile, the Company was heavily exposed to Russian securities, which the Court wrote “are locked up and may be lost forever,” apparently due to global sanctions from the war in Ukraine. “Consequently,” wrote the Court, “the Company’s value decreased from $6.7 million to $1.6 million, a loss of approximately $5.1 million.”
The Motion for Dissolution and/or Appointment of a Receiver
Immediately after Wife learned of the $5.1 loss in the Company’s value, she moved, pursuant to DRL § 234, for an order dissolving the Company, liquidating and distributing its assets, or, in the alternative, appointing a temporary receiver to manage the Company during the litigation.
The Court framed the issue as follows:
This case involves an examination of the breadth, and the limits, of the Court’s equitable power under DRL § 234 to issue preliminary injunctive relief to protect martial assets subject to equitable distribution. The power is not so broad as to permit this court to judicially dissolve a foreign limited liability company which is a marital asset. However, it is broad enough to allow the court to fashion a remedy to preserve the company where one party has improperly disposed of the other party’s interest therein, refused to comply with court orders, and allegedly mismanaged the company such that it suffered substantial losses to its value.
Under the principle that New York courts lack subject matter jurisdiction to dissolve foreign entities (read about this doctrine here and here), the Court declined to dissolve the Company. Nor did the Court appoint a receiver of the Company because of language in the Company’s LLC Agreement permitting receivership only in the event of liquidation.
But the Court concluded:
Husband’s violation of the automatic orders, concealment of the revised LLC Agreements, failure to provide information as to the Company’s assets, refusal to abide by this Court’s order, and alleged irresponsible investment decisions which caused substantial losses, mandates preliminary injunctive relief to protect and preserve Wife’s expectancy in the Company and prevent its further dissipation.
Relying upon what the Court described as its “broad equitable power, under DRL § 234, to issue orders concerning the possession of marital assets to prevent their disposition or dissipation during the pendency of a matrimonial action,” the Court ruled that it “could direct” the Husband, “in his capacity as the sole member-manager of Management, a New York LLC, over whom and over which it has jurisdiction, to dissolve the Company” non-judicially.
But the Court ultimately declined to order Husband to dissolve the Company because “the record does not establish that dissolution is absolutely necessary or appropriate at this time,” and might harm third-party investors in the Company.
Instead, separately relying upon what the Court described as its broad power under DRL § 234 to “appoint a temporary receiver for marital assets where property subject to equitable distribution is in danger of being lost, damaged, or destroyed,” the Court ruled that it may “appoint a temporary receiver for Management” – not the Company itself – “in place and instead of Husband, which person will assume the duties and obligations of Management during this litigation in order to protect and preserve the Company’s assets.”
Recognizing that Management was a non-party entity, the Court concluded that it nonetheless had the power to bind it to an injunction / receivership order because “it is a captive entity of Husband” and “does not operate independently of Husband.”
The Court instructed the receiver, as part of its charge, to undertake an “assessment of the Company’s assets and liabilities, and the risks and benefits attendant to dissolution, should that action be necessary.”
In other words, the Court put the onus on the receiver to determine, in the first instance, whether to dissolve the Company.
The Powers of Matrimonial Courts to Judicially Dissolve Domestic Entities
Is there any reason, in theory, why the Matrimonial Division of the Supreme Court might lack the power, in a proper case, to dissolve a domestic business entity? I think not.
Under the New York State Constitution, only the Supreme Court has jurisdiction to order dissolution of a marriage. Under the State Constitution, the Supreme Court is a court of “general original” (i.e., “unlimited”) jurisdiction, meaning it is “competent to entertain all causes of action unless its jurisdiction has been specifically proscribed” (People v Correa, 15 NY3d 213  [quotations omitted]).
Of course, most business divorce cases are venued in the Commercial Division of the Supreme Court, though occasionally they wind up in Surrogate’s Court (read here and here). That is partly because most of the business dissolution statutes, including for limited partnerships (see Partnership Law § 121-802), corporations (see Business Corporation Law § 1112), and LLCs (see Limited Liability Company Law § 702), provide that a proceeding for judicial dissolution shall be brought in the “Supreme Court in the judicial district in which the office” of the entity is located.
Based upon the rules, there doesn’t seem to be any reason why the Matrimonial Division of the Supreme Court, in theory, would lack jurisdiction to dissolve a domestic business entity if the Court deemed it necessary for the preservation of martial assets.
In fact, more than a decade ago, Peter Mahler wrote about Rossignol v Rossignol (82 AD3d 1335 [3d Dept 2011]), a case in which the Court implied, though did not rule directly, that matrimonial courts have the power to grant dissolution of entities owned solely by the husband and wife based upon DRL § 234’s empowerment, in the Rossignol Court’s words, “to determine all issues with respect to property owned by the parties.”
The Court’s conclusion that it had the power to order Husband to non-judicially dissolve the Company, in particular, was rather unlike any ruling I have seen in a business divorce case in the commercial courts, where it can often be frustratingly challenging, to say the least, to persuade courts to dissolve entities, particularly under the stringent standard governing LLC dissolution.
I asked Michael DiFalco of Garden City-based matrimonial boutique Aiello & DiFalco LLP, to comment on the Court’s expansive view of its powers, and the unusual relief it fashioned, in N.F. v J.D.
Here’s Michael’s take:
Prior to the 2009 enactment of the Automatic Orders which now apply in all matrimonial actions, matrimonial courts relied upon DRL § 234 to restrain marital assets in order to preserve them until the court had an opportunity to equitably distribute the marital estate.
Although the Automatic Orders now restrict parties from transferring assets in order to prevent the dissipation of marital assets, the primary remedy for a violation is to hold a party in contempt. Such a blunt tool would not effectively help the wife in N.F. v J.D. Instead, the Court relied upon DRL § 234 to carefully craft an appropriate order.
N.F. v J.D. demonstrates the incredible flexibility of the simple provisions contained in DRL § 234 to tailor an equitable remedy. The same one-paragraph statute that allows a court to award title or exclusive use and occupancy of the marital residence to one party, or to claw back transfers from a joint bank account, is applied to the unique set of facts to appoint a receiver to take control over a hedge fund and possibly dissolve the entity. Powerful relief for a spouse in need of a remedy.