This first post of 2024 brings the New York Business Divorce Blog into its eighteenth calendar year of weekly commentary on disputes among co-owners of closely held businesses.

This year, let business owners and their counsel resolve to carefully document their investment and ownership transactions.  If the past eighteen years of our covering all varieties of bitter and costly litigation that can result from poorly documented transactions among business owners is not enough motivation to stick to that resolution, this week’s post piles on the reasons.

One of the most common disputes that a poorly documented investment in a closely held company will produce is one of characterization: is the investment a loan or an equity purchase?  That dispute can get particularly thorny in the context of limited liability companies, where non-existent operating agreements, lack of certificated ownership interests, and an apparently prevalent attitude of informality provide prime conditions for ambiguity.

Another ripe area for dispute stems from the reality that many business owners choose to operate through their wholly-owned entities.  Individual A agrees to invest $100,000 in NewCo in exchange for an ownership stake, but then arranges for his company, ACo, to make the $100,000 investment.  Who owns the interest in NewCo, A or ACo?  When does it matter?

Those questions feature prominently in a recent decision from Judge Paul G. Gardephe in the Southern District of New York, Melwani v Eagle Point Fin. LLC (17-CV-8308, 2023 WL 8850097, at *1 [SDNY Dec. 21, 2023]), which tees up one of the first must-see business divorce trials of 2024.

The Oral Investment Agreement.

The dispute at the center of this week’s post stems from a poorly documented investment in Eagle Point Financial, LLC, a payment processing company originally owned by Hunter Lipton.  In 2010, Lipton solicited Lokesh Melwani’s investment in Eagle Point, and Melwani—through his wholly-owned corporation, Cantal Trade—invested $300,000 in Eagle Point pursuant to an oral agreement with Lipton.

The entire documentary record of the investment consisted of two email chains.  In the first, Lipton tells Melwani to “please send the $200,000 (two hundred thousand dollars as discussed).”  Melwani responds, “Ok, will be done.”  In the second, Melwani wrote:

Just wanted to outline the deal we had discussed on the phone and the terms I am willing to proceed with:

  1. $100,000 USD (One hundred thousand usd) for an additional 12.5% of the company.
  2. The funds will be sent in two tranches, of $50,000 each. The first will be sent tomorrow, July 1st. The second at date to be determined.
  3. If the company feels It does not need the second $50,000, the company has the right to do so and my equity will be diluted accordingly.
  4. The company and myself will work towards figuring out the most efficient method for repayment of the above, either through consultancy, and or dividend payments.
  5. During my next visit to New York we work towards putting together a shareholders agreement.
  6. That you keep kicking ass in the sales department, [and] bringing in the big deals.
  7. That we continue to work together with complete integrity, honesty, positive energy and love in order to build a brilliant business.

Let me know If you agree . . .

To that proposal, Lipton responded, “Agreed.  With love.”

Following that exchange, Melwani caused Cantal to wire an additional $100,000 to Eagle Point.

Eagle Point Liquidates, Snubs Melwani and Cantal.

In 2011, Eagle Point’s assets were sold to a third party for $1.2 million.  In connection with that sale, Eagle Point reported as a liability a $300,000 “loan payable” to Cantal.  Within three months, the sale proceeds were distributed to Lipton and a number of third parties, including MDF Holdings LLC, a company owned by Lipton’s father-in-law.  Neither Cantal nor Melwani received any distribution of sale proceeds.  In subsequent correspondence between the parties, Lipton took the position that Melwani’s $300,000 was a loan from Cantal, not an equity purchase.

That prompted Melwani and Cantal to sue Lipton, Eagle Point, and MDF Holdings in New York State Court.  Melwani and Cantal alleged that the Eagle Point asset sale was a fraudulent transaction designed to misappropriate funds to the related MDF, enabling MDF’s acquisition of a telecommunications business. 

After some initial skirmishes, including removal of the case to the Southern District of New York, the District Court in 2019 stayed the case as to Lipton, who had filed a bankruptcy petition in Nevada.    

The case continued as against the remaining defendants.  By report and recommendation dated August 4, 2022 (to which no side objected and which was subsequently adopted), the claims against MDF were dismissed because Melwani could not prove that MDF participated or knew about the Eagle Point asset sale.  Eagle Point’s motion for summary judgment was denied, since Lipton’s bankruptcy had impeded Melwani’s ability to get potentially crucial discovery from Lipton. 

A Loan or Equity Purchase?  By Melwani or Cantal?

While the case was stayed as to Lipton, Melwani made a series of procedural missteps that substantially pared down his claims.  First, following the withdrawal of his attorneys, Melwani elected to proceed pro se.  But his wholly-owned company, Cantal, could not prosecute its claims without counsel.  When Cantal failed to retain counsel after an extended period, its claims were dismissed.  Second, in connection with Lipton’s bankruptcy case, Melwani and Lipton entered into a stipulation dismissing, with prejudice, claims that were nearly identical to Melwani’s claims in the federal case.  Over Melwani’s objection, Judge Gardephe gave that stipulation res judicata effect, which led to the dismissal of Melwani’s claims against Lipton.  Only Melwani’s claims against Eagle Point survived.   

Following the dismissal of Cantal’s claims, and after Melwani declined to take additional discovery from Lipton, Eagle Point resubmitted its motion for summary judgment.  Eagle Point’s motion raised two questions concerning the investment agreement:

First, was the investment agreement an equity purchase, as Melwani contends, or a loan, as Eagle Point contended?  Eagle Point’s “loan” theory was flimsy.  Not only does the parties’ email chain reference an “additional 12.5% of the Company,” but subsequent correspondence from Lipton also appeared to confirm that the agreement awarded some equity stake.  Presumably sensing that Melwani had the upper hand, Eagle Point ultimately conceded that the $300,000 investment was “in exchange for 32.5% ownership of Eagle Point.”

Second, was the investment agreement between Eagle Point and Melwani, or Eagle Point and Cantal?  Since Cantal’s claims were previously dismissed, Eagle Point argued that the investment agreement was between Eagle Point and Cantal, and that Melwani—even as Cantal’s sole shareholder—lacks standing to assert Cantal’s rights.  Even worse, Eagle Point contended, the question of whether Cantal or Melwani is the proper party to the investment agreement demonstrates that there was no agreement at all: there could be no meeting of the minds when there was no mutual agreement as to who the parties were.

Melwani, for his part, argued in his pro se submission that the agreement was between himself and Eagle Point.  Lipton sought funds from him, and “Cantal was simply a vehicle that [he] used to transfer the funds.”

Pro Se Melwani Gets a Trial.

By order dated December 21, Judge Gardephe denied Eagle Point’s motion.  The Court first held that the investment was an equity purchase—“a 300,000 investment was made in Eagle Point in exchange for a 32.5% interest in the company.”  That, said the Court, was enough to constitute “a meeting of the minds as to the essential terms of the transaction.” 

But the Court could not decide on summary judgment whether Eagle Point contracted with Melwani, Cantal, or both:

The Court concludes that there are material issues of fact as to whether Melwani or Cantal was the contracting party, or whether the contracting parties were both Melwani and Cantal. . . nothing in the record demonstrates that Eagle Point contracted with Cantal rather than with (1) Melwani, or (2) Melwani and Cantal.”

The Court set the matter down for a February bench trial on that issue.

What will that trial look like?  I see a boatload of potentially relevant evidence and key questions: How did Melwani document, if at all, Cantal’s investment in his own records?  Has Melwani ever relied upon the separateness between himself and Cantal?  Has Lipton?  Was Cantal ever involved in any of the seven points that Melwani and Lipton discussed in their email chain?    

Get Counsel Early

Two years ago, we covered on this blog a similar dispute over an informal agreement to purchase an equity interest in an LLC (read here).  In that case, the Court considered text messages between the parties in 2020—when their dispute was simmering—as probative of the terms of the alleged 2018 oral agreement.  We highlighted then the need to retain counsel at the very outset of a dispute.

The same lesson applies here.  Judge Gardephe’s summary judgment order repeatedly cites to Lipton’s post-agreement emails to shed light on the terms of the investment agreement—including whether the agreement was with Melwani or Cantal.  In one exchange that surely will feature prominently at the trial, Lipton asked Melwani, “Can you email me the entity you sent the money from and where and what company we will be sending the money to.”  Cases can be won or lost in the window between when parties retreat to their corners and when counsel gets involved; get counsel early.