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

Therapy1At first glance, you might think the plaintiff minority shareholder in Sardis v Sardis, 2017 NY Slip Op 27163 [Sup Ct Suffolk County May 11, 2017], achieved her derivative lawsuit’s goal when the defendant controlling shareholder, about a month after suit was filed, suddenly reversed course by revoking the corporation’s allegedly wrongful voluntary dissolution that seemingly was the lawsuit’s raison d’être.

You might also think, having apparently forced defendant’s capitulation, the minority shareholder would be entitled to recover her legal fees in the action as authorized by Section 626 (e) of the Business Corporation Law whenever a shareholder derivative action “was successful, in whole or in part, or if anything was received by the plaintiff . . . as a result of the judgment, compromise, or settlement of an action or claim.”

But, as often is the case in shareholder lawsuits, first impressions can be deceptive.

The Sardis case, in which Suffolk County Commercial Division Justice Elizabeth H. Emerson denied the plaintiff’s fee application seeking $650,000, is noteworthy for a couple of reasons. First, the facts and circumstances leading up to the decision — starting with the settlement of a complex matrimonial divorce in which the ex-spouses continued to co-own interests in a valuable operating company, followed by legal proceedings in Delaware, followed by legal proceedings in New York — tell a fascinating story of a high-stakes, three-dimensional legal chess game.

Second, and more importantly for practitioners, Justice Emerson’s opinion is one of the very few New York state court decisions that takes a probing look at the prevailing “substantial benefit” standard for an award of legal fees under Section 626 (e). Continue Reading Finding No “Therapeutic” Benefit to Corporation, Court Denies Fee Award in Discontinued Shareholder Derivative Action

NewYorkCourtofAppealsIn a controversial ruling last year in Congel v Malfitano, the Appellate Division, Second Department, affirmed and modified in part a post-trial judgment against a former 3.08% partner in a general partnership that owns an interest in a large shopping mall, and who unilaterally gave notice of dissolution, finding that

  • the partnership had a definite term and was not at-will for purposes of voluntary dissolution under Partnership Law § 62 (1) (b) based on the partnership agreement’s provisions authorizing dissolution by majority vote, notwithstanding a 2013 ruling by the Court of Appeals (New York’s highest court) in Gelman v Buehler holding that “definite term” as used in the statute is durational and “refers to an identifiable terminate date” requiring “a specific or even a reasonably certain termination date”;
  • the former partner’s unilateral notice of dissolution therefore was wrongful; and
  • having wrongfully dissolved the partnership and upon the continuation of its business by the other partners, under Partnership Law § 69 (2) (c) (II) the amount to be paid to the former partner for the value of his interest properly reflected a 15% reduction for the partnership’s goodwill value, a 35% marketability discount, a whopping 66% minority discount, and a further deduction for damages consisting of the other partners’ litigation expenses over $1.8 million including statutory interest.

The Appellate Division’s decision, which I wrote about here, and the former partner’s subsequent application for leave to appeal to the Court of Appeals, which you can read here, reveal, to say the least, a remarkable result: the former partner, whose partnership interest had a stipulated topline value over $4.8 million, ended up with a judgment against him and in favor of the other partners for over $900,000.

But the story’s not over. Last week, the Court of Appeals issued an order granting the former’s partner’s motion for leave to appeal. Sometime later this year, the Court of Appeals will hear argument in its magnificent courtroom pictured above and issue a decision in the Congel case which likely will have important ramifications for partnership law whatever the outcome. Continue Reading Court of Appeals to Decide Controversial Partnership Dissolution Case

cash registerAppellate case law in New York generally prohibits use of company funds to pay for legal defense costs in judicial dissolution proceedings.

The theory supporting the prohibition, as articulated over 50 years ago in Matter of Clemente Brothers, 19 AD2d 568 [3d Dept], aff’d, 13 NY2d 963 [1963], is that the statute authorizing dissolution proceedings “grants to the corporation as a separate entity no authority to determine whether a proceeding shall be initiated to dissolve itself,” thus making the corporation a proper jural party “for the limited and passive purpose of rendering it amenable to the orders of the court” and barring it from assuming a “militant alignment on the side of one of two equal, discordant stockholders.”

The principles animating Clemente and its progeny such as Matter of Rappaport, 110 AD2d 639 [2d Dept 1985], and Matter of Boucher, 105 AD3d 951 [2d Dept 2013], involving deadlock dissolution proceedings between 50-50 shareholders, have been extended to cases brought under the separate statute enacted in 1979 providing a dissolution remedy for oppressed minority shareholders. Continue Reading The Prohibition Against Using Company Funds for Legal Fees in Dissolution Proceedings


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Stratospheric real estate values in New York City have bestowed great wealth on those lucky or wise enough to have invested before or in the early stages of the city’s demographic, cultural, and commercial renaissance over the last 25 or so years.

The dramatic rise in property values also has spawned more than its fair share of business divorce litigation by exacerbating the divergence of interests among co-owners, between those who desire to sell and take their profit and those who prefer to hold and/or develop the property. This phenomenon is especially observable in family-owned real estate holding companies where the potential for intra- and inter-generational conflict is more pronounced.

Take the case of the Kassab brothers, who co-own through two holding companies a nondescript, outdoor parking lot also home to a flea market near downtown Jamaica, Queens. The property consists of three contiguous parcels with a footprint of about 42,000 square feet. Under existing zoning the properties are buildable as of right to about 380,000 square feet. Recent valuation estimates for the undeveloped properties, which were acquired by the Kassabs between 1992 and 2001 at a small fraction of current value, start over $14 million.

In 2013, the younger brother owning 25% sued to dissolve the holding companies — one organized as a corporation, the other as a limited liability company — claiming oppression and freeze-out by his elder brother owning the other 75%. The younger brother claims the freeze-out tactics are designed to force him to sell his interest to his elder brother for a pittance. The elder brother counters that he has no desire to deprive his younger brother of his ownership rights and that his younger brother is attempting to force him to sell the properties due to the younger brother’s supposedly dire financial straits.

Last week, the case produced not one, not two, but three separate appellate decisions addressing a potpourri of rulings on issues of vital interest to business divorce counsel. Summaries follow after the jump. Continue Reading One Parking Lot, Two Brothers, Three Decisions

pizzaA self-described “world-renowned Neapolitan pizza chef” won a round in court earlier this month in a dispute with his business partner over control of a popular pizzeria located in Manhattan’s Greenwich Village. The court’s opinion by Manhattan Commercial Division Justice O. Peter Sherwood in Manzella v Caporuscio, 2015 NY Slip Op 31870(U)[Sup Ct NY County Oct. 6, 2015], granted summary judgment for the chef/majority member on his counterclaim against the minority member for breach of fiduciary duty and modified a prior Consent Order to authorize termination of the minority member’s employment for cause.

The case involves a Greenwich Village restaurant called Keste Pizza and Vino founded in 2009 by pizza chef Roberto Caporuscio. Since 2012 the business is co-owned by Caporuscio and Sandra Manzella as 55% and 45% members, respectively, of Keste Group LLC. Keste has a fairly standard operating agreement for member-managed LLCs, giving Caporuscio as majority member the controlling vote with a few exceptions requiring unanimous consent such as the admission of a new member.

Keste’s operating agreement (read here) doesn’t mention much less guarantee a member’s “employment” by the LLC. What it does say — which apparently stiffened spines on both sides in the lead-up to litigation — is that “[n]otwithstanding anything to the contrary contained in the provisions of this Agreement, the Members agree that Caporuscio and Manzella shall have primary responsibility for running the day-to-day operations of the Company” (¶ 4.1). Continue Reading Pizza Chef with Bigger Piece of LLC Pie Allowed to Terminate Minority Member’s Employment

shutterstock_255587932If familiarity breeds contempt, does family breed contempt of court? Apparently so, at least in the recent case of Kassab v Kasab involving a corporate dissolution battle between two brothers, one of whom was held in contempt of court for using company funds to pay legal fees in violation of the court’s prior order prohibiting transactions “except in the ordinary course of business.”

We all know that, when it comes to the litigation of disputes between co-owners of a closely held business, the ability of one side to use company funds to pay their legal fees — in effect requiring the other side, which is paying its own legal fees out of pocket, to subsidize their opponent’s litigation expenses  — can provide a critical financial and psychological advantage as the case slowly and expensively wends its way through the judicial process.

The issue usually surfaces in one of two ways: (1) the majority owners named as defendants use their voting control to approve the company’s advancement and indemnification of their legal expenses or (2) when the company also is named as a respondent or defendant, even if only nominally, they use their control of the company checkbook to pay whatever portion of defense costs they decide to allocate to the company, which may be 100%. The PFT Technology and Borriello cases, which I wrote about here and here, are examples of the former. An example of the latter, featuring an appellate decision in which the court explained the general parameters of when corporate funds can and cannot be used in a dissolution proceeding, is Matter of Levitt (read here). Continue Reading Court Holds Shareholder in Contempt for Using Company Funds to Pay Legal Fees

Think of it this way: At every negotiation of a shareholder buyout involving an S corporation or other passthrough entity, there are three parties at the table — the seller, the buyer, and the IRS.

Why the IRS? The commonly understood answer, even to those lacking tax expertise, is the seller’s liability for capital gains tax on buyout proceeds in excess of the seller’s basis in the shares.

Less appreciated, especially to those without tax expertise, but potentially of equal or even greater financial impact, is the seller’s liability for ordinary income taxes on undistributed a/k/a phantom income that may be reported on his or her Form K-1 issued by the passthrough entity after the buy-out closes for a tax period that preceded the buyout. For this type of tax liability, think of the IRS as a tax allocator which, at the direction of the remaining shareholders who control the company’s tax reporting, will reduce some portion of their personal income tax liability by allocating undistributed net income to the selling shareholder who will be forced to pay ordinary income taxes on phantom income. While this also should reduce the seller’s capital gain on the sale by increasing basis in the shares, overall the seller loses because of the significantly higher tax rates on ordinary income versus capital gains.

This is a topic I’ve written about several times before, featuring cases in which the seller’s release barred a post-buyout suit seeking reimbursement for taxes on phantom income (read here) or where the seller relied unsuccessfully on tax provisions in the buyout agreement that didn’t support indemnification of taxes on phantom income (read here and here). Add to this collection a case decided last month by the Appellate Division, First Department, which handed the selling shareholder a double defeat by finding that his release barred his claim to recover taxes on phantom income and also ordering him to pay attorneys’ fees incurred by the corporation and its majority shareholder defending the seller’s suit under the buyout agreement’s indemnification provision. Sina Drug Corp. v Mohyuddin, 2014 NY Slip Op 07757 [1st Dept Nov. 13, 2014]. Continue Reading Negotiating a Buyout? Don’t Overlook Taxes on Phantom Income

Nassau County Commercial Division Justice Vito M. DeStefano (pictured) last month handed down an important ruling in Schlossberg v Schwartz, 43 Misc 3d 1224(A), 2014 NY Slip Op 50760(U) [Sup Ct, Nassau County May 14, 2014], addressing rights of indemnity and advancement when a company brings claims against its own officer or director for alleged misconduct undertaken in a corporate capacity. The scholarly decision, which traces the convoluted history of the governing Business Corporation Law (BCL), rejects the company’s position that its bylaws and the BCL preclude advancement and indemnification for intra-company claims, i.e., claims brought directly by the company against an officer/director, as opposed to extra-company claims, i.e., claims brought by outside, third parties.

Schlossberg also is noteworthy:

  • for upholding the right to seek advancement and indemnity for expenses incurred in the defense of the company’s counterclaims, on an apportioned basis, in a suit initiated by a minority shareholder, director and former officer asserting direct and derivative claims against the controlling shareholder, inter alia, for breach of fiduciary duty, breach of contract and common law dissolution; and
  • for its numerous citations to decisions of the Delaware Chancery Court, which rightfully boasts an advanced jurisprudence in the area of indemnification and advancement.  Continue Reading Court Upholds Former Officer’s Right to Seek Indemnity and Advancement in Intra-Company Dispute

Section 420 of New York’s LLC Law authorizes an LLC, “subject to the standards and restrictions, if any, set forth in its operating agreement,” to indemnify and hold harmless, and advance expenses to, any member, manager or other person “against any and all claims and demands whatsoever.” The statute goes on to prohibit indemnification if a “judgment or other final adjudication adverse to such member, manager or other person” establishes that his or her acts were committed in bad faith or resulted from deliberate dishonesty, or that he or she gained a wrongful financial advantage.

In plain English, (1) if an LLC member, manager or other agent is successfully sued for actions relating to the LLC’s business and is hit with a damages award, so long as that person didn’t act in bad faith, dishonestly or profit illegally, when it’s all over the LLC can pay the award and reimburse the person’s legal expenses, and (2) the LLC also can fund (“advance”) the person’s legal expenses during the lawsuit, but the funds will have to be repaid if ultimately there’s a final judgment against the person and his or her conduct fails the bad-faith test.

There are few reported decisions by New York courts addressing claims for advancement in internecine lawsuits among LLC members. Best known is the 2009 Ficus decision in which the Appellate Division, First Department followed Delaware law to enforce advancement rights in litigation among members of a Florida LLC, emphasizing that rights of advancement and indemnification are “independent of one another” and that a court’s finding of misconduct for purposes of interim relief does not defeat advancement rights granted under the company’s operating agreement (read here). And then there’s the Borriello case, about which I wrote here, in which Justice Demarest enjoined an LLC from advancing the controlling members’ legal expenses in the face of the operating agreement’s provision which authorized indemnification only.

As those two cases illustrate, sometimes it’s the non-controlling member trying to use advancement to shift his or her defense costs indirectly to the controlling members, and sometimes it’s the other way around. Such cost-shifting can give one side or the other a huge and sometimes decisive litigation advantage. In a recent, novel ruling by Nassau Commercial Division Justice Stephen A. Bucaria, the court decided to “level the playing field” by ordering the LLC to advance legal expenses of both sides. PFT Technology LLC v Wieser, Short Form Order, Index No. 8679/12 [Sup Ct Nassau County Feb. 20, 2014]. Continue Reading Novel Ruling on Advancement in LLC Dissolution Case “Levels the Playing Field”