Welcome to this year’s Winter Case Notes where, amidst the arctic blast currently sweeping most of the nation, I offer shortish takes on several court decisions in recent business divorce cases.
This year’s edition features notable decisions by New York courts stemming from cases with, shall we say, not your typical fact patterns:
- Affirming the lower court’s post-trial verdict rejecting a shareholder’s claim to enforce an alleged agreement requiring the defendant shareholder, following the plaintiff’s acquittal on murder charges, to transfer back to the plaintiff shares he sold to the plaintiff in the course of the plaintiff’s lengthy criminal proceedings;
- Without deciding whether the death — accidental in this case — of an LLC member qualifies as a withdrawal for purposes of LLC Law § 509’s buyout provision, ordering the surviving member to turn over books and records to the estate representative but only through the date of death; and
- Denying interim injunctive relief restoring a minority shareholder to his former management position in a group of auto dealerships upon the court’s finding that the plaintiff failed to establish a likelihood of success on his claims of minority shareholder oppression and that the governing agreements were never effective.
Shareholder Wins Murder Acquittal But Can’t Recover Shares
It would be hard to make up facts like those in Harris v Reagan. The plaintiff 45% shareholder of a company that owned two car dealerships was charged with the murder of his wife. Fearful that the murder charge would cause the auto manufacturers to terminate their franchise, the plaintiff entered into a formal shareholder agreement with the defendant 55% shareholder whereby, if convicted and after exhausting all appeals, the plaintiff would transfer his shares to a trust for the benefit of his children and the defendant would then purchase the shares over a period of 20 years paying $15,000 per month. If ultimately acquitted, a side agreement provided that the plaintiff’s and defendant’s ownership interests would adjust to 75% and 25%, respectively.
After the plaintiff was convicted by a jury and while awaiting sentencing, plaintiff and defendant entered into a new, second agreement to transfer his shares directly to the defendant who also agreed to assume all the outstanding debt of the dealerships and commenced making the $15,000 monthly payments directly to the plaintiff.
Long story short, plaintiff’s conviction was set aside, followed by a second trial at which he was re-convicted and began serving his sentence, followed by a successful appeal, followed by a third trial ending in a hung jury, followed by his acquittal after a bench trial.
Now a free man, the plaintiff sued defendant for breach of contract and seeking specific performance of an alleged agreement to retransfer him the ownership of his shares. In support, he offered a copy of the first agreement for the transfer of his shares to a trust that contained a footnote providing that, if he was acquitted, the monthly payments made by defendant would constitute “salary” and plaintiff’s shares would be transferred back to him.
The defendant contended that the footnote was a forgery, and that the first agreement was terminated by the second agreement transferring plaintiff’s shares directly to the defendant who made monthly payments directly to plaintiff, as further evidenced by the contemporaneous transactional documents and the company’s subsequent tax reporting for many years.
After a nonjury trial the court agreed with the defendant and dismissed the complaint. Plaintiff fared no better on appeal to the Appellate Division, Third Department. It held that the first agreement was terminated by the second agreement, and that the record did not support plaintiff’s argument that the parties intended to be bound by the first agreement after its expiration.
As for the purported footnote contained in plaintiff’s version of the initial agreement, deploying restrained language the appellate court found that “the record fails to credibly demonstrate that the parties had contemplated or agreed to such term” and, even if they had, that it failed for lack of consideration.
An Unusual Intersection of LLC Law Sections 509 and 608
In Matter of Piepes v Arshravan, an LLC formed to organize and run food festivals had two 50/50 members, one of whom subsequently died in a car accident. The decedent’s estate’s administrator made requests to the surviving member for information concerning the company’s operations and financial condition. Not satisfied with the response, the administrator petitioned to inspect the company’s books and records and to compel production of financial information on an ongoing, monthly basis.
In conference with the court, it became apparent to all that the ultimate resolution “may involve” a sale of the decedent’s interest to the surviving member, and that any such sale would require a valuation of the company and due diligence by the administrator. The sticking point? The administrator insisted on being provided with financial information until the time a transaction is culminated whereas the surviving member insisted on a cutoff as of the decedent’s date of death.
The court’s analysis focused on two provisions of the LLC Law. First, it considered Section 509 which entitles a “withdrawing member” to payment for the fair value of its shares “as of the date of withdrawal.” Wrote the court:
Section 509 appears to put a stop sign upon “withdrawal of a member.” The issue is whether death is a withdrawal from membership. Neither party has submitted authority equating death with withdrawal in the absence of an operating agreement or the like.”
The court next looked at Section 608 granting an estate representative the right to exercise “all of the member’s rights for the purpose of settling his or her estate or administering his or her property.” On its face, the statute does not suggest a time constraint on an estate representative’s exercise of the decedent’s informational rights for purposes of settling the estate.
Ultimately, the court adopted the surviving member’s position and ordered production of books and records for the last three fiscal years up to the decedent’s date of death. Giving the administrator a partial win, the court allowed him for “good cause shown” following inspection to “seek whatever other discovery deemed reasonably necessary beyond the date of [the decedent’s] passing to complete his Commission as Executor.”
Like the court, I’ve not seen any case precedent addressing whether a member’s death constitutes withdrawal for purposes of LLC Law Section 509. I have my doubts it is, but if the parties are truly headed toward a buyout of the decedent’s interest, and if they nonetheless agree that any valuation will be as of date of death, that sidesteps the need for any legal determination of the issue. If the parties are unable to reach a voluntary buyout, the Section 509 “stop sign” likely vanishes.
A Failed Attempt to Push the Oppression Envelope
It remains to be seen whether the Appellate Division, First Department’s 2022 somewhat cryptic decision in the Stile case, which fellow blogger Peter Sluka wrote about here, recognized an independent claim for minority shareholder oppression outside a claim for judicial dissolution under BCL Section 1104-a. The court there affirmed the lower court’s denial of a motion to dismiss a money damages claim based on alleged oppression.
Inspired or not by Stile, a more recent non-dissolution oppression claim popped up in Darwish Auto Group, LLC v TD Bank, N.A. in the context of a motion seeking preliminary injunctive relief. Under the standard tripartite test for such interim relief, the court was required to assess whether the claimant alleging oppression established a likelihood of success on the merits of the claim. The court ultimately found that the claimant failed to show a likelihood of success, but the mere fact that the court considered the merits of the claim deserves attention.
The case involves companies that own and operate ten car dealerships of which Mr. Darwish is the sole owner. In 2022, the companies obtained a $62 million loan which required the dealerships to adopt operating agreements appointing a three-member board of managers (the “Governance Agreements”) providing that “no manager may act alone.”
The lawsuit grew out of various and sundry disputes between Mr. Darwish and the two other board members whom he does not control and who accused Mr. Darwish of a series of unauthorized actions leading to their termination of his employment agreement and other steps designed to prevent his unilateral actions.
The other board members initiated suit by the companies against Mr. Darwish, who counterclaimed based on allegations that the Governance Agreements were never effective in view of the dealerships’ pre-existing agreements with the auto manufacturers that identified him as the sole Dealer Principal and allegedly required that he have control over the dealerships.
On that ground, and also based on his claim that the other board members’ actions constituted actionable oppression including breach of fiduciary duty, Mr. Darwish sought a preliminary injunction effectively restoring his unfettered authority as Dealer Principal and manager of the dealerships.
The court denied injunctive relief. It found that Mr. Darwish failed to establish a likelihood of success establishing that the Governance Agreements were ineffective and, of more interest to this writer, establishing that he was an oppressed shareholder. As to the latter, the court noted Mr. Darwish’s reliance on case authorities applying the reasonable expectations test under the judicial dissolution statute, BCL 1104-a. Given the uncontested terms of the Governance Agreements, as well as Mr. Darwish’s own employment agreement, the court failed to discern “how he could have had any reasonable expectation of governance, management or employment rights” beyond those agreements. As the court summed up:
These agreements plainly contemplated — and, in fact, required — Darwish to comply with the governance structure to which he assented, adhere to the directives issued by the Governing Bodies, and act as a responsible steward of the Dealerships and their resources. Plaintiffs did not find these expectations to have been met, and Darwish offers no convincing basis for the Court to find otherwise. [¶] Thus, even assuming that principles of shareholder “oppression” under BCL § 1104-a (a) (1) are applicable to Darwish’s claim for breach of fiduciary duty, Darwish has not demonstrated a reasonable probability of success on such a claim.”
Note that in the last sentence quoted above, the court “assumes” without deciding that an oppression claim exists outside of BCL § 1104-a. If such a claim is inextricably linked to the reasonable expectations test, and not just a convenient description for conduct otherwise constituting breach of fiduciary duty, it’s hard to foresee the oppression claim taking on a life of its own outside of § 1104-a.