Advancement and Indemnification

See full size imageIf there’s a more litigious partnership falling-out than that of the closely-held mortgage company, Private Capital Group (PCG), I don’t know about it.  The case, entitled Ficus Investments, Inc. v. Private Capital Management, LLC,  has racked up 87 motions since it was filed in Manhattan Supreme Court in March 2007, including several contempt applications.  The court’s docket lists over 2,300 separate documents filed, and the case isn’t even close to being tried.  There have been three interlocutory appeals decided thus far, with several others awaiting decision.  Did I mention the parties have filed at least five other, related cases?

PCG was a New York-based Florida limited liability company formed to buy, manage and sell non-performing mortgages.  Ficus Investments, Inc. (Ficus), the 80% member and sole manager of PCG, put up $300 million debt financing.  Private Capital Management (PCM), the 20% member, operated PCG’s mortgage business by PCM’s two beneficial owners, Thomas Donovan and Lawrence Cline.  The conflagration started a little over a year after operations began, in March 2007, when Ficus ousted Donovan and Cline and brought suit accusing them of misappropriating over $20 million.

The complex, high stakes litigation not surprisingly has generated millions in legal bills, which in turn has spawned a litigation within the litigation over the issue of the defendants’ entitlement to advancement and indemnification of legal expenses under the provisions of PCG’s operating agreement. 

A year ago I wrote about a January 2009 appellate decision in Ficus in which the court held that the primary defendant, Thomas Donovan, as a former officer of PCG was entitled to seek advancement of his legal defense costs under the operating agreement.  The primary issue there was whether the trial court’s issuance of preliminary injunctions against Donovan defeated his advancement rights.  Manhattan Commercial Division Justice Bernard Fried ruled (read here), and the Appellate Division affirmed (read here), that the ultimate determination of Donovan’s indemnification rights had no impact on his interim advancement rights under the operating agreement’s terms.  The rulings resulted in reimbursement to Donovan of approximately $1.5 million in legal fees incurred through the end of 2007, which was upheld by yet another appellate court ruling in June 2009 (read here).

As it turned out, 2007 was just a warm-up for the next year, in which Donovan incurred another $3.8 million in legal defense costs for which he also sought advancement.  Ficus opposed the bulk of the request, arguing that Donovan was not entitled to advancement for fees incurred opposing Ficus’s applications for discovery and contempt sanctions concerning Donovan’s alleged misconduct after he was terminated as an officer, during the course of litigation.  Donovan’s alleged misconduct included the "hacking" of former co-defendant Cline’s e-mail account — early in the case Cline and Ficus entered into settlement and cooperation agreements — and failing to turn over company books and records in violation of court order.

The arguments raised in this second go-round, and the court’s recent decision in favor of Ficus, raise novel legal issues with important ramifications for advancement and indemnification litigation in this and other cases.

Continue Reading Do Advancement and Indemnification Rights Include Defense Costs of Litigation Misconduct After Officer Leaves Company?

For years I’ve been carping about the substantive and procedural inadequacies of New York’s LLC judicial dissolution statute.  LLC Law Section 702, which was modeled after the rarely utilized limited partnership dissolution statute, consists in its entirety of the following two sentences:

On application by or for a member, the supreme court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability  company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.  A certified copy of the order of dissolution shall be filed by the applicant with the department of state within thirty days of its issuance.

At the time of the LLC Law’s adoption in 1994, the legislature’s minimalist approach made some sense because of tax considerations requiring avoidance of certain corporate characteristics including continuity of life.  The IRS’s subsequent implementation of check-the-box regulations freely permitting partnership tax treatment of LLCs, and the 1999 LLC Law amendments restricting member withdrawal from LLCs, largely eliminated the legislative rationale for Section 702 as enacted, leaving the statute, in my view, not up to the complex task of adjudicating LLC breakups (hence the title of my June 2002 article published in the New York State Bar Journal, Vol. 74, No. 5, "When Limited Liability Companies Seek Judicial Dissolution, Will the Statute Be Up to the Task?").

These observations are prompted by a recent decision by New York County Commercial Division Justice Bernard J. Fried in a case I’ve previously written about called Ficus Investments, Inc. v. Private Capital Management, LLC.  Ficus is a highly contentious dispute between LLC members involving accusations that the managing members misappropriated over $20 million.  Last January, an appellate ruling enforced the lead defendant’s right to advancement of his legal defense costs as provided by the operating agreement (see my earlier post here).

Continue Reading Application for Judicial Dissolution of LLC Must Be Made by Complaint or Petition, Mere Motion Will Not Suffice

Presiding Justice Jonathan Lippman of the Appellate Division, First Department (pictured), who was recently nominated by Governor Paterson to become New York’s Chief Judge on the Court of Appeals, has written a significant decision addressing rights of advancement and indemnification for litigation expenses in the limited liability company setting.   Ficus Investments, Inc. v. Private Capital Management, LLC, 61 AD3d 1, 2009 NY Slip Op 00263 (1st Dept Jan. 20, 2009).

Not only is the substantive issue in the case — affirming the right of an LLC member-manager to require the LLC to advance legal expenses defending an action brought by another LLC member — one of great importance, the decision also reads like a legal travelogue in which a New York court looks to Delaware law to construe an operating agreement of a Florida LLC headquartered in New York.

Private Capital Group (Capital) is a Florida LLC owned 80% by the plaintiff Ficus Investments, Inc. (Ficus) and 20% by defendant Private Capital Management, LLC (Management).  Capital buys, manages and sells non-performing mortgages, and was capitalized by loans from Ficus over $300 million.  Capital began operations in December 2005.  A dispute arose after Management’s two owners, Thomas Donovan and Lawrence Cline, transferred about $10 million from Capital to Management.  Under Capital’s operating agreement, Donovan served as Capital’s CEO and Cline as its President.  In March 2007, Ficus adopted resolutions taking over Capital’s management and it also commenced a lawsuit against Donovan, Cline and Management for breach of fiduciary duty, conversion and unjust enrichment.

Continue Reading New York Court Follows Delaware Law to Construe Advancement and Indemnification Provisions of Florida LLC’s Operating Agreement

For the business owner without access to the company checkbook, and who therefore must foot his own legal bills, about the only thing worse than litigating a business divorce with a co-owner is seeing her use company funds to pay her lawyer.

Case precedent makes it pretty clear that, in a straightforward dissolution proceeding in which the company is a nominal party rather than an active litigant, neither side has the right to tap company funds for legal fees.  But often the dissolution claim by the non-controlling owner is tied to other claims seeking to impose personal liability against officers or managers of the company.  When that happens, the defending officer-owners may invoke a contractual right to indemnity including advancement of legal expenses by the company.  Alternatively, where the defending officer-owners have board control, they may authorize indemnity and advancement under indemnification statutes.

The latter occurred in Van Der Lande v. Stout, 3 AD3d 261 (1st Dept 2004), where a minority member of an LLC brought  a derivative action accusing the majority members of waste, fraud and mismanagement, alongside a separate proceeding to dissolve the LLC.   Over the plaintiff’s objection the defendant majority members made a substantial capital call upon all members — including the plaintiff — to fund the advancement of legal fees in defense of the derivative action.  The plaintiff moved for a preliminary injunction to prevent the LLC from compelling him to make contributions.  The trial court denied the motion.  The appeals court upheld the order under the authority of Section 420 of the New York Limited Liability Company Law, which allows the LLC to advance and pay its members’ legal expenses absent a final adjudication that the individual defendants acted in bad faith, were dishonest or personally gained profit to which they were not entitled.  “That plaintiff commenced the lawsuit which caused the need for the additional contribution”, the court added, “does not constitute an exception to his obligations to the LLC.”

Continue Reading Indemnity Provision Can Tilt the Playing Field in Litigation Between Business Partners