In the annals of business divorce litigation and assorted other disputes between co-owners of closely held business entities, the cause of action for breach of the implied covenant of good faith and fair dealing likely wins the prize for the claim least understood by practitioners and most frequently dismissed by judges.

As I’ve written before, and as Professor Dan Kleinberger noted in his guest post on this blog, at least part of the confusion comes from its name. Start with the term “implied covenant.” To the average reader, it connotes a duty imposed by law without regard to the parties’ intentions and without mutual consent, like a fiduciary duty (the implied covenant often is referred to as the “implied duty”). Next comes “good faith,” connoting something done sincerely and honestly, without malice, disloyalty, or a desire to deceive or defraud. Finally comes “fair dealing.” Fair is fair is the opposite of unfair, right? Put them all together, and you’ve got what sounds like an all-purpose “lite” version of some quasi-fiduciary duty, enabling a court of equity to apply free-floating standards of honesty and fairness to adjust relations between business partners.

By and large, court decisions out of the Delaware Chancery Court have done a far better job than their New York counterparts in explaining the implied covenant’s strictly contractual roots and its parsimonious reach. A particularly good example is Vice Chancellor Sam Glasscock III’s recent Memorandum Opinion in Miller v HCP & Co., C.A. No. 2017-0291-SG [Del Ch Feb. 1, 2018], in which he dismissed a suit brought by a minority member of an LLC alleging that the controller breached the implied covenant by selling the company for $43 million to a third party via private sale rather than conducting an open-market sale or auction to ensure maximum value for all members under the operating agreement’s waterfall. Continue Reading Will Someone Please Re-Name the Implied Covenant of Good Faith and Fair Dealing?

The test for judicial dissolution of LLCs under LLC Law § 702, as laid down in 1545 Ocean Avenue, initially asks whether the managers are unable or unwilling to reasonably permit or promote realization of the LLC’s “stated purpose” as found in its operating agreement.

I would venture to say that the overwhelming majority of operating agreements, in their purpose clauses, use the phrase “any lawful business” which, not coincidentally, mirrors the enabling language found in LLC Law § 201, authorizing LLCs to be formed for “any lawful business purpose.” Boiler-plate or not, using “any lawful business” in the purpose clause can be a prudent drafting technique to avoid future conflict or need to amend the operating agreement should the LLC’s business model change in response to future events. Of course, there are some circumstances, often involving single asset real estate holding companies, when stating a specific purpose is the more prudent technique.

Which is why last summer’s decision by the Appellate Division, Second Department in Mace v Tunick was such an eye opener. In Mace, the court held that the “any lawful business” purpose clause in the operating agreement at issue did not state any purpose, and on the basis that the lower court had engaged in impermissible fact-finding on a pre-answer dismissal motion, reversed the lower court’s summary dismissal of the minority member’s dissolution suit and remanded the case for further proceedings.

If “any lawful business” states no purpose, I queried in my prior post on the case, does “the primary focus of the judicial dissolution standard under 1545 Ocean Avenue — whether the LLC’s managers are willing or able to achieve its stated purpose under the operating agreement — merely becomes a waystation on the road to more protracted litigation proceedings requiring discovery and evidentiary hearings”?

I still don’t have the definitive answer to that question, but I can tell you what happened in Mace on remand to the lower court, and after the lower court conducted a trial. Continue Reading The Purposeless Purpose Clause Makes a Comeback — Or Does It?

Business valuation contests in court, including those arising out of shareholder and partnership disputes, inevitably boil down to a battle of the appraisal experts, among whom Chris Mercer of Memphis-based Mercer Capital is one of the best known and most accomplished.

A listing of Chris’s professional accreditations, publications, speaking engagements, and expert witness engagements could fill a small book. To those who follow statutory fair value appraisal cases in New York, you know that Chris has played an outsized role as testifying expert in some of the most important and precedent-setting cases, including the Ferolito (AriZona Iced Tea) case, the Giaimo case, the Chiu case, and the recent Kassab case. Chris and some of his many publications also have been featured on this blog (here and here) and as the first guest on my Business Divorce Roundtable podcast doing a deep dive into the divisive discount for lack of marketability.

I recently invited Chris back onto the podcast to talk about a blog post of his entitled “A Reluctant Expert Witness Confesses” which in turn is based on a talk he gave last Fall at a business valuation conference. I assure you Chris’s “confessions” are not of a criminal nature although, as you’ll hear Chris describe, when he testified as an expert for the very first time in an imposing courtroom setting, as he was given the oath the thought involuntarily flashed through his mind, “I’m guilty!”

Rather, in our conversation Chris shares a series of interesting and often colorful insights he’s gained over many years of testifying as an expert business appraiser about the do’s and don’ts of testifying, his likes and dislikes about being an expert witness, what engagements he’ll take and which ones he won’t, and a number of other observations about his experiences as an expert on and off the witness stand.

It’s up close. It’s personal. It’s fun. I invite you to listen by clicking on the link at the bottom of this post.

By the way, if you’re a business divorce lawyer or business appraisal expert who’d like to share with podcast listeners a real-life experience from one of your cases for a Business Divorce Stories episode (no need to use real client, company or case names), please get in touch with me by phone or email and I’ll be happy to set up a recording session in person or via Skype.

The steady flow and scholarly character of Delaware Chancery Court opinions in company valuation contests provide an important resource and learning tool for business divorce practitioners, appraisers, and judges in New York and elsewhere.

Over the years, I’ve reported on a number of Chancery Court decisions in statutory fair value cases arising from dissenting shareholder proceedings. In this post, I highlight two recent post-trial opinions by Vice Chancellors Sam Glasscock (photo left) and Tamika Montgomery-Reeves (photo right) addressing valuation and what I’ll call quasi-valuation in more atypical settings.

In the first case, Vice Chancellor Glasscock applied a fair value standard to resolve a buy-out settlement agreement between ex-spouses who co-owned two operating companies and a real estate holding company. In the second case, Vice Chancellor Montgomery-Reeves determined whether a biotechnology start-up company was insolvent for purposes of appointing a receiver under Section 291 of the Delaware General Corporation Law. Continue Reading Delaware Chancery Court Rulings Address Valuation and Insolvency Disputes

This winter forever will be remembered in the Northeast as the winter of the “bomb cyclone,” which gets credit for the 6º temperature and bone-chilling winds howling outside as I write this. So in its honor, I’m accelerating my annual Winter Case Notes synopses of recent business divorce cases, which normally don’t appear until later in the season.

This year’s selections include a variety of interesting issues, including LLC dissolution based on deadlock; the survival of an LLC membership interest after bankruptcy; application of the entire-fairness test in a challenge to a cash-out merger; an interim request for reinstatement by an expelled LLC member; and a successful appeal from a fee award in a shareholder derivative action.

Deadlock Between LLC’s Co-Managers Requires Hearing in Dissolution Proceeding

Advanced 23, LLC v Chamber House Partners, LLC, 2017 NY Slip Op 32662(U) [Sup Ct NY County Dec. 15, 2017].  Deadlock is not an independent basis for judicial dissolution of New York LLC’s under the governing standard adopted in the 1545 Ocean Avenue case but, as Manhattan Commercial Division Justice Saliann Scarpulla explains in her decision, when two co-equal managers are unable to cooperate, the court “must consider the managers’ disagreement in light of the operating agreement and the continued ability of [the LLC] to function in that context.” In Advanced 23, the co-managers exchanged accusations of bad acts and omissions, e.g., one of them transferring LLC funds to an unauthorized bank account, raising material issues of fact as to the effectiveness of the LLC’s management and therefore requiring an evidentiary hearing, which is just what Justice Scarpulla ordered. Of further note, in a companion decision denying the respondent’s motion to dismiss the petition (read here), Justice Scarpulla rejected without discussion the respondent’s argument that judicial dissolution under LLC Law § 702 was unavailable based on a provision in the operating agreement stating that the LLC “will be dissolved only upon the unanimous determination of the Members to dissolve.” In that regard, the decision aligns with Justice Stephen Bucaria’s holding in Matter of Youngwall, that even an express waiver of the right to seek judicial dissolution of an LLC is void as against public policy. Continue Reading Winter Case Notes: LLC Deadlock and Other Recent Decisions of Interest

I’m delighted to present my 10th annual list of this past year’s ten most significant business divorce cases.

This year’s list includes seven noteworthy appellate decisions, two of which — Mace v Tunick and Shapiro v Ettenson — are poised to have major impact on future operating agreements and business divorce cases involving LLCs.

The growing dominance of the LLC as the preferred choice of business entity also is reflected in this year’s list, all but three of which resolve disputes among members of LLCs.

Rounding out the list are two decisions, in the Kassab and Levine cases, involving interesting and important issues in fair value contests.

All ten decisions were featured on this blog previously; click on the case name to read the full treatment. And the winners are: Continue Reading Top 10 Business Divorce Cases of 2017

The East River and roughly five miles as the pigeon flies separate the equally beautiful courthouses of the Appellate Division, Second Department in Brooklyn and the Appellate Division, First Department in Manhattan. Because of the limited jurisdiction and very selective docket of New York’s highest court known as the Court of Appeals, in the vast majority of cases these two intermediate appellate courts effectively are the courts of last resort for their respective geographic slices of downstate New York.

Over many years, a different sort of divide has separated the two appellate courts when it comes to statutory fair value proceedings and, in particular, their treatment of the controversial discount for lack of marketability (DLOM).

The earliest version of the DLOM divide concerned whether it should apply to good-will value only, that is, not to the value of realty, cash, and other net tangible assets. For over two decades, prevailing Second Department case law limited application of DLOM in that fashion; the First Department did not. The decisions of one court didn’t acknowledge the other’s. Then, in 2010, without discussion or even acknowledging a change, the Second Department in the Murphy case seemingly healed the rift by dropping the good will limitation.

I say seemingly because, in recent years, the DLOM divide between the two appellate courts quietly has resurfaced in the context of fair value contests involving real estate holding companies where, on the Manhattan side of the river, First Department cases have accepted the appropriateness of a marketability discount on account of the realty’s “corporate wrapper.” Meanwhile, on the Brooklyn side of the river, Second Department cases have rejected DLOM on the theory that the value of a realty holding entity is the value of the realty or, alternatively, that a marketability discount already is incorporated in the underlying realty appraisal by way of an assumed market-exposure period. Continue Reading A River’s Divide: Time for the Manhattan and Brooklyn Appellate Courts to Agree on Marketability Discount in Fair Value Proceedings

When the tsunami of LLC enabling statutes swept the U.S. in the late ’80s and early ’90s, including New York in 1994, many included a default rule authorizing as-of-right member withdrawal and payment for the “fair value” of the membership interest. The default rule was one of many designed to avoid C corporation-style “double taxation” of LLC earnings. After 1997, when the IRS adopted check-the-box regulations cementing pass-through partnership tax treatment for LLCs, New York and other states flipped the default rule, i.e., members are no longer permitted to withdraw unless authorized by the operating agreement.

When New York amended its withdrawal provision, LLC Law § 606, it included a new subsection “b” grandfathering LLCs formed before the amendment’s 1999 effective date, meaning that withdrawal under the “old” § 606 and fair-value buyout under LLC Law § 509’s default rule remain available for members of pre-1999 LLCs — so long as not otherwise provided in the operating agreement. The Chiu case, which I wrote about here, is an example of one such case resulting in a fair-value buyout of a withdrawn member.

After the amendments, some pre-1999 New York LLCs adopted new operating agreements or amended their existing ones to prohibit withdrawal. Some, as in Chiu, did not.

This is a story about one LLC that did not, but with a very different outcome than Chiu. The story’s punch line, which makes it a fascinating one, is that even though the minority member, seeking to force a fair-value buyout, was found to have properly invoked his uncontested right to withdraw under the old § 606, in the end the lower and appellate courts held that his withdrawal did not trigger a statutory buyout under § 509 because the LLC’s operating agreement included mandatory rights of first refusal — with which the minority member never complied — that displaced the buyout statute’s default rule.

The case, Matter of Jacobs v Cartalemi, was decided last week by the Appellate Division, Second Department, along with two decisions in companion appeals in related cases in which the court held that upon withdrawal the minority member also lost his standing to pursue derivative claims against the controlling member. I’ll explain all below, but before doing so I must disclose that, along with co-counsel, my firm and I represent the controlling member of the LLC in each of the cases. Continue Reading Operating Agreement Defeats Statutory Buyout Rights Upon LLC Member’s Withdrawal

This week marks the tenth anniversary of the launch of this blog. Every Monday morning since, come hell, high water, or in the middle of a trial, I’ve posted a new article — 534 articles, to be exact. I joke that if you don’t see a new post come Monday morning, check the obituaries.

I had no idea what to expect when I started the blog. Would anyone read it? Would I have enough material to write about every week? Would I have the time to write every week? How could I add value for the reader, beyond mere descriptions of recent court decisions in business divorce cases? Would the blog generate new clients and new relationships with other professionals in the field?

With ten years behind me, I can safely say my expectations have been exceeded more than I ever could have imagined. Here are some of the most important lessons blogging has taught me:

  1. Blogging Brings Relationships. The blog has fostered many new and lasting relationships with other lawyers, judges, academics, and business appraisers from across the country. We share ideas, cases and articles of interest, and use each other as sounding boards. We invite each other to speak at bar association meetings and legal education conferences. The growing network of relationships goes hand-in-hand with the growing recognition of business divorce as a distinct sub-genre of commercial litigation and legal theory in which clients are best served by lawyers and other professionals with specialized knowledge in the field. Ten years ago, I was one of very few lawyers who called themselves business divorce lawyers. Today, there are many lawyers across the country who identify themselves as specialists in business divorce, a handful of whom also have started blogging.
  2. Blogging Brings Clients. The biggest and most pleasant surprise from blogging has been its ability to attract new clients. Very early on, the blog became and has remained the primary generator of new clients big and small for my business divorce practice. Prior to the blog, for years I’d been writing about business divorce in traditional legal publications. The idea of putting my writing online came to me in the mid aughts, inspired by a couple of pioneering law blogs and by some prospective client inquiries from business owners who somehow found my law journal writings online. I was attracted to the blogging format and figured it would make my writing more accessible to business owners, who, like the rest of civilization, increasingly looked to the internet to educate themselves and get answers to legal problems before calling a professional. Blogging allows lawyers to demonstrate their expertise, personality, and passion for the subject matter to consumers of digital media like nothing else. Google does the rest, at least when it comes to bringing potential new clients to your door.
  3. Blogging Enhances Expertise. Regular blogging keeps a lawyer at the top of their game. I’m constantly on the prowl for new court decisions, legislative developments, and articles of interest to share with my readers. The blog’s ravenous maw demands no less. The educational value of the research and writing, driven by the imperative to achieve mastery of the subject matter for my readers, is priceless when it comes to representing clients in my own business divorce practice.
  4. Numbers Don’t Matter. The success of a law blog is not measured by the numbers of visitors and page views. In the early days I obsessively tracked those numbers. It took me a while to realize they don’t matter, especially for a blog that focuses on a micro-niche, non-volume practice area like business divorce. The most popular posts I ever wrote for this blog, generating hundreds of thousands of views, were about a business divorce between the father and son stars of the reality TV show, American Chopper. The numbers were gratifying but the viewers responsible for those numbers — fans of the TV show with no personal interest in business divorce — were not my intended audience.
  5. Long Posts Can Work. When I started the blog I deliberately kept the posts short — less than 500 words — under the commonly-held view that the attention span of online readers is too short for long-form blogging. Within a half year, however, I found myself consistently writing posts over 1,000 words and sometimes well in excess of that figure — a habit I’ve rarely departed from ever since. Of course the longer pieces take more time to write; typically I’ll devote 4 or 5 hours every weekend to the task. The longer posts also place a premium on adopting a more journalistic and less legalistic writing style, which is no small challenge when writing principally about court decisions. I don’t imagine that all those who encounter my posts get past the first paragraph, much less read the entire thing. But as I said above, law blogging is not about reaching the widest possible audience, it’s about reaching the right audience. For me, a distressed business co-owner or his or her consultant is the right audience — an audience that, I’ve become convinced over the last 10 years, finds value in the more nuanced analysis and value-added commentary that long-form blogging enables.

Some thanks are in order, firstly to my regular readers these past ten years, whose kind words of appreciation and encouragement make it all worthwhile. Special thanks to Kevin O’Keefe and his fantastic Lexblog team for designing and hosting the blog these many years, and to my firm’s Marketing Director Lorraine Sullivan and her dedicated staff for their support. Finally, thanks to the many fine judges of the great State of New York, whose labors, interpreting and applying the law in some of the toughest business divorce cases anywhere, provide the oxygen for this blog.

Onward to the next ten years of blogging!

I wish I could take credit for it, but I can’t. The phrase “bare naked assignee” was coined by the preeminent scholar and LLC maven Professor Daniel Kleinberger whose massive oeuvre (not to mention his guest posts on this blog here and here) includes a wonderful article published in 2009 called The Plight of the Bare Naked Assignee (available here on SSRN ). As described in the abstract, the article addresses the “new and separate opportunity for oppression” that “exists because LLC law purports to (1) recognize a species of persons holding legal rights vis-á-vis the LLC (assignees) while (2) denying those persons any remedies whatsoever in connection with those rights.”

Under the LLC statutes in New York and most other states, except as otherwise provided in the operating agreement, LLC membership interests are freely assignable in whole or in part. As the Professor’s article explains, the bedrock “pick your partner” principle of partnership law found expression in the default rules of LLC statutes which, contrary to traditional corporation laws, require majority (or unanimous) consent of the other LLC members for an assignee to become a full-fledged member with both economic and voting/management rights. Typical of these statutes, New York’s LLC Law § 603 provides that, absent such consent, the assignee has no right to participate in LLC management “or to exercise any rights or powers of a member” and only has the right “to receive, to the extent assigned, the distributions and allocations of profits and losses to which the assignor would be entitled.”

The vast majority of written operating agreements that I’ve encountered include detailed articles addressing the rights of members to assign (or not) their membership interests and, when permitted, what if any rights non-member assignees possess other than the right to receive distributions and profit/loss allocations. Of course, absent an operating agreement, the rights of an assignee are governed by the statutory default rules.

The Professor’s article broadly discusses theory and case law surrounding the difficulties faced by non-member assignees a/k/a transferees — oftentimes the heir of a deceased member — when it comes to protecting their economic interests against managerial abuse by the LLC’s controllers. My focus here addresses only one, narrow aspect of such protection, namely, the ability of a non-member assignee to inspect LLC records in the absence of dispositive rules in an operating agreement or, as in what I believe is a small minority of states including Texas, a statute giving assignees inspection rights. Continue Reading Can the Bare Naked Assignee Demand Access to LLC Records?