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Here in New York, we’re about to say goodbye to a winter season like we haven’t seen in many years: prolonged, bitter cold; several prodigious snowfalls; and iced-over ponds. To all of which I say—hooray! Winter as it’s meant to be.

But however temperate or severe the season, this blog’s annual Winter Case Notes trudges on, offering brief accounts of recent decisions of interest to business-divorce aficionados.

This year’s selection features:

  • a truly odd case involving an LLP governed by an LLC operating agreement,
  • an interesting decision involving an LLC agreement’s advancement provision not fully aligned with the paired indemnification provision, and
  • a failed effort by laid-off workers to impose their former employer’s WARN Act liability on the company’s passive shareholders via Section 630 of the Business Corporation Law.

A Partnership Masquerading as an LLC, or Vice Versa?

Here’s one I’ve never seen before.

Two accountants operating as a general partnership reconstituted the firm by registering with the Department of State as a limited liability partnership. Instead of entering into a new partnership agreement, however, they executed what appears to be an off-the-shelf, fill-in-the-blanks LLC operating agreement, apparently prepared (if that’s the right word) by a lawyer. The cover page reads, in all caps:

LIMITED LIABILITY COMPANY OPERATING AGREEMENT OF DEL REY & COMPANY CPAS LIMITED LIABILITY PARTNERSHIP.

The agreement was signed on the firm’s behalf by one of the two partners as “Managing Member.”

How could no one notice the mind-boggling discrepancy? Granted, the year was 1996—“only” two years after New York enacted legislation authorizing LLCs and LLPs. Still, you’d think someone in the professional mix would have appreciated that LLCs and LLPs are completely different species of business entities governed by different statutory regimes.

What could possibly go wrong?

As it turns out, quite a bit—according to a decision issued last December in Gavin v Del Rey, Tanzi, Guglietta, D’Ambrosi, CPAS, LLP, in which the court denied dueling motions for summary judgment.

Plaintiff Gavin began working for the firm in 1990. It was undisputed that in 2008 she was granted a 5% non-equity interest in the firm and that, in 2017, the firm was renamed Del Rey, Tanzi & Gavin LLP.

In 2018, Del Rey died. The firm purchased his estate’s interest for $1 million, payable over five years and personally guaranteed by Gavin and the other two partners.

It also was undisputed that, in early 2019, the surviving partners orally agreed to give Gavin a 39% equity interest in the firm. While the agreement was never reduced to writing, the firm subsequently issued Form K-1s to Gavin for tax years 2018 through 2020 listing her profit, loss, and capital share as 39% and showing her $123,960 capital contribution.

The story took a different turn in early 2020 when Gavin’s other two partners announced they needed to part ways with her. She left the firm the next day and never returned.

Almost two years later, she sued the firm and its “Managing Member” seeking an accounting and damages in an amount equal to the value of her alleged 39% equity interest in the firm.

Following discovery both sides moved for summary judgment. After raising the issue whether, under the Partnership Law, Mr. Del Rey’s death in 2018 triggered the firm’s dissolution, the court turned to the elephant in the room:

Defendant asks this Court to recognize that [the firm] has operated as a partnership “registered with the New York Department of State as a limited liability partnership since 1996, pursuant to Partnership Law § 121- 1 500 et seq.” However, the conflict between the registration status and the terms of the 1996 Operating Agreement raises a material issue of fact and law–the first of many–as to whether the parties intended to form a partnership or a limited liability company, whether the 1996 Operating Agreement is valid and enforceable, and–if so–how this Court should apply the 1996 Operating Agreement vis-a-vis the parties’ claims and counterclaims.

Among the other factual disputes was the defendants’ claim that the oral agreement to grant Gavin a 39% interest was contingent on unresolved conditions, and her response that the firm is bound by the Form K-1s reflecting her 39% share.

On that point, the court held that the K-1s were relevant but not determinative, and that the evidence required “additional credibility determinations not yet appropriate” at the summary judgment stage.

Both sides filed notices of appeal to the Appellate Division, Second Department. The appeal won’t be decided until long after the case goes to trial, currently scheduled to begin later this month.

LLC Managers Win Unusual Advancement Dispute

In my experience — representative or not — the scope of the typical advancement provision in owner agreements is coextensive with the scope of the paired indemnification provision. In its simplest expression, the agreement’s advancement provision will in so many words say that a director, officer, member, manager, etc. who qualifies for indemnification also qualifies for advancement.

If that observation is correct, there’s nothing typical about the advancement dispute decided by Manhattan Commercial Division Justice Anar R. Patel in ET JV Holdings, LLC v TBH-ASL BSA Member LLC.

The case pits the famous fashion designer Elie Tahari against consumer brand management company Bluestar. In 2017, Tahari and Bluestar formed TBH Brand Holdings LLC to which Tahari contributed his brand for licensing by Bluestar to distributors and production companies.

Tahari, his son and CEO Jeremy Tahari, and their affiliated entities sued Bluestar and its principals to enforce a buy-back provision in the holding company’s operating agreement. Bluestar countersued the Taharis, asserting claims including breach of fiduciary duty and tortious interference.

The fiduciary duty claims were based on the Taharis’ roles on the Board of Managers and the duties they allegedly owed to the company and its members.

The Taharis subsequently moved for advancement of attorneys’ fees under Section 4.1(b) of the operating agreement. Bluestar opposed the motion, arguing that:

  • the Taharis were not “Managers” as defined in Section 4.1, and
  • the claims against them did not arise from acts taken “in connection with the Company” under the indemnification provision.

Justice Patel rejected the first argument with the succinct observation: the Taharis “are on the Board of Managers and therefore [are] “Managers.'”

The second argument presented the more interesting interpretive issue.

Section 4.1(a), the indemnification provision, limits coverage to acts performed or omitted by Managers “in connection with the Company.” Section 4.1(b), which addresses member-against-manager disputes (including derivative claims), contains no such limitation.

Bluestone argued that the “in connection with the Company” qualifier should nevertheless apply to Section 4.1(b). Justice Patel disagreed.

She held that the provisions reflect a deliberate distinction:

  • Section 4.1(a) governs indemnification for acts taken in connection with the Company.
  • Section 4.1(b) governs advancement only involving internal disputes and does not require that the acts be connected to the Company.

Because Section 4.1(b) lacks the “in connection with the Company” language–and requires repayment if indemnification ultimately proves unavailable–the court held that the Taharis were entitled to advancement.

Why one subsection includes the phrase and the other omits it is hard to fathom. Section 4.1(a) already contains advancement-type language (“which attorneys’ fees . . . shall be paid as incurred”) while Section 4.1(b), which addresses insider disputes, omits the “in connection with the Company” limitation altogether.

Did the drafters consider the phrase unnecessary in the insider-dispute context? Perhaps. But the drafting choice ended up driving the result.

Passive Shareholders Held Not Liable for WARN Act Violations

This one falls outside the business-divorce arena but is nevertheless noteworthy–particularly for owners of closely held business entities with 50 or more employees, who may be subject to New York’s Worker Adjustment and Retraining Notification (WARN) Act.

The WARN Act requires covered employers to provide advance notice of certain mass layoff and provides administrative and civil remedies for noncompliance.

Importantly, the WARN Act does not impose liability on owners or managers.

By contrast, Section 630 of New York’s Business Corporation Law imposes liability on a corporation’s ten largest shareholders for unpaid employee wages.

Last month, in Chen v Shah, a court confronted a case of first impression: whether employees who obtained an uncollectible default judgment against their former employer for WARN Act violations could recover against two of the company’s shareholders under BCL Section 630.

The court said no.

It first noted that the WARN Act judgment was based on a statutory formula, not on wages actually earned for work performed. It also observed that the defendants were passive shareholders.

Applying familiar canons of statutory interpretation, the court rejected the plaintiffs’ argument that Section 630 overrides the WARN Act’s limitation of liability to the business enterprise itself. The court also pointed to the limited liability principle at the heart of the corporate form.

The workers may or may not have other avenues for imposing secondary liability–for example, under the Uniform Voidable Transactions Act–but it is difficult to argue that the court got it wrong in concluding that Section 630 is not the proper vehicle.