Access to Books and Records

After two years, 300+ docket entries, and 12 motions, a lawsuit among members of a Delaware LLC that owned a 5-story apartment building on Manhattan’s Upper East Side (the “UES Building”) acquired to provide short-term rentals for international leisure and corporate travelers, and whose business was decimated by anti-Airbnb legislation, is barely past the pleadings stage and likely can look forward to years more litigation.

Manhattan Commercial Division Justice Jennifer G. Schechter’s recent decision in Favourite Ltd. v Cico, 2018 NY Slip Op 32781(U) [Sup Ct NY County Oct. 30, 2018], permitting the LLC and some of its members to file an amended pleading against the LLC’s former managing members, addresses several issues of interest including whether the legislature’s action automatically triggered dissolution under the operating agreement’s arguably conflicting provisions, and whether the former managers’ attempted reinvestment of proceeds from the UES Building’s sale in another property violated the operating agreement’s purpose clause.

According to the Second Amended Complaint ultimately allowed by the court, the two defendants as sole managing members of Upper East Side Suites, LLC, formed in Delaware in 2007, solicited investors from Italy’s business community who contributed $4.75 million to buy the UES Building to operate a short-term rental business. What allegedly followed is a scheme by the defendants of “self-dealing, mismanagement, waste of assets, fraud, and forgery that resulted in the loss of every cent of the $4.75 million invested.” Continue Reading Outlawing of LLC’s Short-Term Rental Business Brings Long-Term Litigation

Let’s face it. In business divorce, the accounting cause of action doesn’t get a lot of love. It’s not as sexy as the torts (conversion, breach of fiduciary duty, waste, etc). It lacks the oomph of judicial dissolution.

Nonetheless, accounting claims are ubiquitous in business divorce litigation, pleaded practically as a matter of course. Sometimes the claim is tacked on as if by rote, perhaps simply to beef up a petition, complaint, or counter complaint. But other times, like the books and records proceeding, the accounting cause of action can be a vital tool in the closely-held business owner’s litigation toolbox.

Ancient Roots

The accounting cause of action has its roots in a basic, ancient principle of partnership law: partners owe one another fiduciary duties, including the duty to account. The common-law duty of partners to account to one another and to the partnership is codified in Sections 42, 43, and 44 of the New York Partnership Law. Although there are not any quite comparable statutes in the Business Corporation Law (Section 720 provides a narrower right to sue a director or officer for an accounting) or the Limited Liability Company Law, it is well-settled that the obligation of business owners to account to one another is fully applicable to closely-held corporations and LLCs. Continue Reading Accounting Unchained: Is the Closely Held Business Owner’s Right to an Accounting Absolute?

Over the last several years, the books-and-records proceeding and its corresponding shareholder rights of inspection seem to have entered a bit of renaissance period in the courts. We here at New York Business Divorce have reported on at least nine decisions primarily addressing the topic since September 2014, going on record to proclaim the phenomenon as a “boost” for the summary proceeding, by which minority owners in closely-held businesses can get a window into the management and operation of the companies from which they’ve been shut out. We’ve even gone so far as to suggest that books-and-records proceedings may be “on a roll” of late, both in terms of an expansion what constitutes a “proper purpose” for bringing the proceeding, as well as in terms of the scope of information attainable.

That trend, at least with respect to the frequency with which issues related to inspection rights are being litigated, appears to be continuing into 2018. What follows are summaries of three of this year’s more notable decisions addressing inspection rights – all from Manhattan Supreme Court, as it happens.

But first, a quick refresher on the subject matter at hand… Continue Reading Inspection Rights, Oral Operating Agreements, and Other Pop-Diva Delights

“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

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 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?

I’ve seen LLC operating agreements ranging from one page to over 100. Usually there’s a direct relationship between the length of the agreement and the complexity of the LLC’s capital and management structure.

But if there’s one thing I’ve learned about LLC agreements, it’s that no matter how comprehensive and tome-like their design, there’s no guarantee that a future, unanticipated dispute won’t expose the inevitable cracks in the design prompting the need for court intervention. Indeed, depending on the drafter’s skill, one can argue the more complex the LLC agreement, the greater the risk of a court contest over its interpretation.

Take the recent case of Tungsten Partners LLC v Ace Group International LLC, 2017 NY Slip Op 32025(U) [Sup Ct NY County Sept. 20, 2017], in which Manhattan Commercial Division Justice Shirley Werner Kornreich was called upon to decide whether the plaintiff holder of a 4% non-voting profits interest, identified as a “Management Member” in a 65-page operating agreement (plus another 170 pages of schedules and exhibits), was a member of the subject Delaware LLC for purposes of demanding access to books and records under § 18-305 of the Delaware LLC Act. Continue Reading A Member By Any Other Name . . . May Have Access to LLC Books and Records

The third time definitely wasn’t a charm for the plaintiff in Austin v Gould, 2017 NY Slip Op 31494(U) [Sup Ct NY County July 13, 2017], in which the court dismissed ill-pleaded claims for “unfettered and unlimited access to all books and records” of a series of Delaware limited liability companies and their wholly-owned real estate subsidiaries.

The decision by Manhattan Commercial Division Justice O. Peter Sherwood is the latest in a series of trial and appellate court rulings, spread over seven years and three separate lawsuits, rejecting claims by the LLCs’ non-managing one-third owner against the managing two-thirds owner allegedly for failing to distribute millions in management and acquisition fees.

The plaintiff’s two prior lawsuits — the first filed in 2010 and, after its dismissal, the second filed in 2013 — hit dead ends for various reasons including untimeliness and pleading deficiencies. The third lawsuit, filed in 2016, asserted claims for access to the LLCs’ books and records along with damages claims for breach of fiduciary duty and conversion. Continue Reading Books and Records Case Illustrates Crucial Importance of Pre-Suit Demand

CondoThis post concerns an atypical form of business organization — the condominium — in the context of disputes over access to books and records. Access to books and records is a subject that has garnered increased judicial attention in recent years as more New York litigants and their counsel discover the utility of commencing summary proceedings to enforce statutory and common-law inspection rights of shareholders in traditional corporations and of members of LLCs.

What I find most interesting is the seemingly expansive approach the courts have taken in upholding inspection rights regardless of business form based on common law rather than statute, as reflected in two cases decided last month involving condominiums.

Unincorporated Condo vs. Incorporated Co-op

The most recent government census data tallies over 300,000 co-op apartment units in New York City and over 100,000 condominium units. The approximate 3:1 ratio is destined to shrink, however, as the number of new and converted condominium buildings coming onto the market in recent years has far exceeded new and converted co-op buildings, among other reasons, due to the strong preference for condominium ownership by foreign buyers and less onerous restrictions on re-sale. Continue Reading Courts Expand Books and Records Access for Condo Owners

subsidiary

Two decisions do not a trend make, but I can’t shake the feeling that the Appellate Division, First Department, is telling trial judges to take a broader view of shareholder statutory and common-law rights to inspect corporation books and records.

The first decision, two years ago, was the McGraw-Hill case which I reported on here. In that case, the First Department reversed a lower court’s ruling denying a shareholder’s inspection petition under Section 624 of the Business Corporation Law and common law. The petitioner sought records concerning the McGraw-Hill Board of Directors’ oversight of purported wrongdoing by its wholly-owned subsidiary, the Standard & Poor’s credit rating agency. The appellate ruling focused on the proper-purpose standard, holding that the petitioner’s stated purpose to investigate alleged misconduct by McGraw-Hill’s management and obtaining information that may aid in litigation are proper purposes “even if the inspection ultimately establishes that the board had engaged in no wrongdoing.” Essentially, the ruling eliminated the Catch-22 of requiring outside shareholders to tender proof of management wrongdoing to gain access to company records enabling them — or not — to show wrongdoing.

The petition in McGraw-Hill sought records of the parent company in which the petitioners held shares, not the subsidiary. Last week, in Matter of Pokoik v 575 Realties, Inc., 2016 NY Slip Op 06648 [1st Dept Oct. 11, 2016], in a decision of apparent first impression, the First Department again reversed a lower court ruling denying inspection rights and held that the petitioner was entitled under the common law to inspect records of the corporation’s wholly-owned subsidiary. Continue Reading Ruling Upholds Shareholder’s Right to Inspect Subsidiary’s Books and Records