The Lowbet Realty saga, featuring the dissolution court’s rarely used authority to rescind an unauthorized sale of the corporation’s realty under Business Corporation Law § 1114, has finally ended after six years with a decision by the Appellate Division, Second Department, affirming the lower court’s order letting stand the realty’s sale to a bona fide purchaser for value. Matter of Hu (Lowbet Realty Corp.), 2018 NY Slip Op 03529 [1st Dept May 16, 2018].

Title companies across the city undoubtedly breathed a sigh of relief.

Lowbet Realty involves one of the most brazen, contemptuous heists of corporate assets amidst a dissolution proceeding you’ll ever encounter. The shorter version — click here and here for more detailed accounts in my two prior posts about the case — is the story of an estranged husband and wife who co-owned a single-asset realty holding company known as Lowbet Realty Corp. formed in 1980 and managed solely by the 25% shareholder-wife as the titular president after the 75% shareholder-husband in 1995 returned to live in China permanently.

In 2006, the husband removed his wife as president and named himself and his son as sole officers, even while his wife continued for years afterward to control the property consisting of a 19-unit residential apartment building. In 2011, after the corporation was administratively dissolved for failure to file franchise reports, the husband filed a petition for judicial supervision of the corporation’s winding up and liquidation, at which time the court issued an order prohibiting both husband and wife from participating in the management of the realty or removing corporate assets absent court approval. Continue Reading Bona Fide Purchaser Avoids Rescission of Minority Shareholder’s Unauthorized Sale of Corporation’s Realty

Mediation, as commonly understood in the context of alternative dispute resolution, employs a neutral third party to facilitate negotiation and voluntary agreement between the parties. Unlike arbitration, the mediator does not conduct an evidentiary hearing, is able to “caucus” separately with each side, and does not impose a solution or issue a legally binding award.

Or so I thought, until I came across last week’s appellate ruling in Korangy v Malone, 2018 NY Slip Op 03767 [1st Dept May 24, 2018], in which the court affirmed an order dismissing claims by one 50% LLC member against the other 50% member based on the outcome of a prior, “binding mediation” conducted pursuant to a provision in the LLC’s operating agreement addressing member deadlock.

When I did a little online research, I found commentary about binding mediation — in which mediators usually impose a legally enforceable resolution only after they fail to produce a voluntary settlement — both negative (“a trap for the unwary”) and positive (“more cost effective than arbitration”). I also got the sense that the inclusion of mandatory, binding mediation clauses in commercial contracts, insofar as it has achieved any significant level of acceptance, mostly is confined to standardized transactions such as construction and reinsurance contracts.

Whatever their utility in those contexts, does it make sense to include an ex ante provision for binding mediation as a deadlock-breaking device in a shareholders or operating agreement, such as the one in Korangy v Malone? I doubt it, but let’s first take a look at the case. Continue Reading Anyone Think Binding Mediation to Break Deadlock Is a Good Idea?

The Nobel Prize symbolizes the apex of human achievement in the arts and sciences. It is no guarantee, however, that its recipients are equally adept when it comes to their own business endeavors.

Dr. Günter Blobel, pictured accepting his Nobel Prize in Medicine in 1999 for his revolutionary work in molecular cell biology, shortly afterward formed a business venture with two others — one his research assistant, the other a corporate lawyer — to commercialize a patented process called Chromovert, used in cell discovery assays. Almost two decades later, their company, Chromocell Corp., appears to be flourishing.

Not so for Dr. Blobel’s relationship with his fellow shareholders, eventually naming them defendants in a lawsuit he brought in Manhattan Supreme Court, seeking to enforce an alleged oral agreement to equalize his ownership stake. It didn’t turn out well for Dr. Blobel, whose suit was dismissed earlier this year by Manhattan Commercial Division Justice Andrea Masley in Blobel v Kopfli, 2018 NY Slip Op 30298(U) [Sup Ct NY County Feb. 13, 2018].

Five days after the court’s decision, Dr. Blobel succumbed to cancer at the age of 81. Continue Reading No Prize for Nobel Laureate in Fight for Bigger Stake in Biotech Company

Transactional lawyers who assist clients in the formation and restructuring of business entities, and the litigators who clean up the transactional lawyers’ occasional messes, each have lessons to learn from last week’s appellate ruling in 223 Sam, LLC v 223 15th Street, LLC, 2018 NY Slip Op 03118 [2d Dept May 2, 2018].

The lesson for transactional lawyers is, when you go to the time, trouble and client expense of negotiating and preparing a shareholders or operating agreement, every time you transmit via email or other means a copy of the unsigned agreement, no matter how preliminary or advanced the draft, include a proviso that there is no binding agreement until the parties exchange fully signed copies. Or better yet, put the proviso in the body of the agreement. Or both.

For litigators, the lesson is twofold. First, litigation, like a prize fight, usually goes a number of rounds before there’s a victor (or, more likely, a settlement). An early round win, such as defeating the adverse party’s bid for a preliminary injunction, is no guaranty the other side won’t prevail, with or without an assist from a panel of appellate judges. Second, if you’re litigating a governance or ownership dispute between putative co-owners of a realty holding entity, it’s usually not a good idea to file a lis pendens against the real property unless you (or your client) are prepared to pay the other side’s legal fees to secure its cancellation. Continue Reading If LLC Agreement Must Be in Writing, Must it Be Signed?

You know there’s something unusual going on in a case involving a dispute between co-members of an LLC — a form of business entity that didn’t exist in New York until 1994 — when the key legal precedents cited in the parties’ briefs date from the nineteenth and early twentieth centuries.

By any measure, Horowitz v Montauk U.S.A., LLC, No. 16-3912 [2d Cir. Apr. 20, 2018], is an unusual case, stemming from a fiercely contentious battle between 50/50 co-owners for control of a highly successful restaurant and night spot called The Sloppy Tuna located on the beach in Montauk, New York, a popular summer resort on the eastern tip of Long Island. The dispute, which is still going strong after four years, has spawned at least a half dozen lawsuits in state and federal courts in New York and Georgia, and landed operational control of The Sloppy Tuna in the hands of a court-appointed receiver.

Horowitz is a lawsuit brought in federal court by one of The Sloppy Tuna’s 50% members (Member #1) seeking injunctive relief and damages against the restaurant entity, a New York LLC (Restaurant), for trademark infringement based on the alleged unauthorized use of various trademarks and domain names related to The Sloppy Tuna that Member #1 registered in the name of his solely-owned company (Montauk).

The threshold issue teed up for the court in Horowitz — this post won’t address the several other issues addressed in the court’s opinion — and the reason I call the case unusual, is whether the Restaurant’s other 50% member (Member #2), who was not named as a party to the trademark action and who did not move to intervene in the action personally, under governing New York law has the right to defend the suit derivatively on behalf of the Restaurant. Continue Reading Court Grants 50% LLC Member Derivative Right to Defend Action Brought by Other 50% Member’s Solely Owned Company

Recently, in two separate cases, two New York judges construing two LLC agreements of two LLCs formed under the laws of two different states — Delaware and Nevada — came to the same conclusion when faced with the same argument by the LLCs’ controllers who contended that minority members waived the right to institute litigation asserting derivative claims based on provisions in the agreements requiring managerial or member consent to bring an action on behalf of the company.

In both cases, the judges rejected the waiver argument after finding that the language of the provisions upon which the controllers relied did not expressly prohibit derivative claims. The more interesting question not reached, at least in the case of the Delaware LLC for reasons I’ll explain below, is whether the statute authorizing derivative claims is mandatory or permissive.

Talking Capital

The first case, Talking Capital LLC v Omanoff, 2018 NY Slip Op 30332(U) [Sup Ct NY County Feb. 23, 2018], involves a New York-based, three-member Delaware LLC in the factoring business, providing financing to telecommunications firms that route international calls. The suit was filed by one of the members against the other two and their principals, at heart alleging derivative claims for usurpation of business opportunity, breach of the LLC agreement, and breach of fiduciary duty by forming a competing entity in league with the LLC’s third-party lender. Continue Reading Can LLC Agreement Waive Right to Sue Derivatively? Not in These Two Cases

“We are poster-boys for why family members should not go into business together.”

So says respondent Paul Vaccari in his affidavit opposing the petition of his brothers Richard and Peter seeking to dissolve their jointly owned corporation that owns a five-story, mixed-use building in Manhattan’s Hell’s Kitchen, housing the operations of Piccinini Brothers, a third-generation wholesale butcher and purveyor of meat, poultry and game established by the brothers’ grandfather and great-uncle in the 1920’s.

The family-owned business at the center of Vaccari v Vaccari, 2018 NY Slip Op 30546(U) [Sup Ct NY County Mar. 28, 2018], decided last month by veteran Manhattan Commercial Division Justice Eileen Bransten, is a classic example of fraying family bonds in the successive ownership generations caused by divergent career interests and sibling sense of injustice over disparate treatment by their parents.

While Vaccari will not go down in the annals of business divorce litigation as a landmark case, it does add incrementally and usefully to the body of case law addressing the grounds available or not to establish minority shareholder oppression. Justice Bransten’s opinion also serves as an important reminder to counsel in dissolution proceedings of their summary nature and of the potentially high cost of noncompliance with the Commercial Division’s practice rules. Continue Reading Shareholder Oppression Requires More Than Denial of Access to Company Information

There’s a lot to digest in last week’s decision by the Court of Appeals — New York’s highest court — affirming and modifying in part the intermediate appellate court’s ruling in Congel v Malfitano, a “wrongful dissolution” case I previously covered here and here, in which a minority partner in a general partnership that owns a shopping mall, whose former 3% interest had a stipulated top-line, pro rata value of $4.85 million, after massive valuation discounts and a seven-figure damages award for the majority’s legal fees, ended up with a judgment against him for about $1 million.

Let’s begin with a synopsis of Judge Eugene M. Fahey’s opinion for the court:

  • Instead of focusing, as did the lower courts, on whether the partnership met Partnership Law § 62 (1) (b)’s durational criteria of “definite term” or “particular undertaking,” the court decided the wrongfulness of the minority partner’s unilateral dissolution without recourse to the statute, and instead employed a purely contractual approach in affirming the lower courts’ finding of wrongful dissolution based on the partnership agreement’s “clear and unequivocal terms” providing the exclusive means by which the partnership could be dissolved.
  • The court affirmed the lower courts’ application of 35% marketability, 66% minority, and 15% goodwill discounts, which collectively erased around 80% of the stipulated top-line valuation. As to the minority discount, based on the objectives and policies underlying the “terminological difference” between the statutes, the court refused to read into Partnership Law § 69 (2) (c) (II) — which requires the court to determine the “value” of the partner’s interest when the remaining partners elect to continue the business following a wrongful dissolution — the case law disallowing any minority discount under the “fair value” standard found in sections 1118 and 623 of the Business Corporation Law governing buyouts in shareholder oppression and dissenting shareholder cases. Two of the panel’s seven judges dissented from this part of the court’s decision and would have disallowed the minority discount as a matter of law.
  • In the one bright spot for the minority partner, the court’s opinion struck the approximately $1.6 million (plus 9% interest) damages award for the majority’s legal fees, holding that the award contravened the so-called American Rule under which each side pays its own litigation expenses absent a contractual or statutory fee-shifting provision, and that the damages recoverable under Partnership Law § 69 are only designed to compensate for legal fees or other losses “incurred in carrying out separate acts necessitated by the breach.”

The court remitted the case to the trial court to recalculate damages (I’ll explain below). As best as I can tell, the likely net effect of the rulings will be to swing the judgment from around $1 million against the minority partner to around $1 million in his favor — still a jaw-dropping reduction from the pro rata value of the partnership interest he gave up.

Continue Reading New York’s High Court Takes Fresh Approach to Wrongful Dissolution, Sustains Valuation Discounts, Limits Damages in Partnership Case

New York’s business-entity statutes, like those across the nation, provide minority owners with the right to dissent from a merger and to be paid the fair value of the dissenter’s ownership interest. Now assume the dissenter also has an employment agreement with the pre-merger entity containing a non-compete provision. Can the post-merger surviving entity enforce the non-compete against an owner who exercises the statutory right to dissent? Does the answer depend solely on the terms of the employment agreement, or does the statutory protection of minority rights embedded in the merger statutes require a different analysis?

Those questions are especially important to certain professional organizations such as medical and accounting practices which traditionally bind their shareholders — or members, in the case of professional LLCs — to employment agreements containing non-compete and/or non-solicitation provisions, and which, due to accelerating market forces, experience significant merger activity.

In a recent first-impression decision by an intermediate appellate court in Colorado, the court denied enforcement of non-compete and liquidated damages provisions in an anesthesiologist’s shareholder employment agreement following his dissent from a merger. While the decision explicitly refused to construe the agreement’s enforceability without consideration of the dissenter’s statutory rights, implicitly it left undecided whether a firm can contract around those rights to enforce restrictive covenants against a dissenter who exits the practice and competes post-merger. Continue Reading You Dissented From a Merger. Are You Bound by Your Non-Compete?

Almost always there are elements of acrimony and intense emotion in litigation between co-owners of closely held business entities. The degree of toxicity can vary widely from case to case, although it tends to show up more conspicuously in litigation involving family-owned ventures.

Claims by non-controlling shareholders accusing controlling shareholders and directors of financial or other managerial abuses frequently are styled as derivative claims seeking recovery on the corporation’s behalf for harm to the corporation. In such suits, under the right circumstances the accused may challenge the accuser’s standing to pursue derivative claims based on conflict of interest.

Conflict of interest usually entails some tangible pecuniary interest held or asserted as a direct claim by the accuser that is adverse to the corporation or otherwise at odds with the claims asserted on behalf of the corporation. But a number of court decisions in New York also have cited as a factor in the analysis the accuser’s “animus” or “retaliatory” motive directed against the accused. The legal theory, akin to that applied in class actions, is that the accuser’s personal hostility and the resulting acrimony undermine the accuser’s ability to fairly and adequately represent the interests of the shareholders and the corporation.

Last year I posted about the decision in Pokoik v Norsel Realties in which a trial judge dismissed for lack of standing derivative claims brought by individuals holding an aggregate 11% interest in a realty-holding limited partnership. Among the reasons cited by the judge was that the plaintiffs “failed to demonstrate on this record that they are free from personal animus” as evidenced by the lead plaintiff’s “litigious nature” including several prior lawsuits against the defendants (including family members) alleging similar mismanagement claims, leading the court to conclude that the lawsuit was being wielded by the plaintiffs as “‘a weapon in the total arsenal’ so as to gain leverage in the other disputes.”

If, based on that decision, anyone thought freedom from personal animus is now part of the required showing by a derivative plaintiff, think again. Last week, the Manhattan-based Appellate Division, First Department, reversed the lower court’s decision and reinstated the derivative claims against some (but not all) of the named defendants. Continue Reading Appeals Court Reinstates Derivative Claims Dismissed for Conflict of Interest Where Parties’ Relationship Not “Especially Acrimonious”