equityWhen it comes to LLC jurisprudence, equity’s on a roll.

A few major examples come to mind: the recent Carlisle case in which the Delaware Court of Chancery enforced “equitable dissolution” of an LLC upon the petition of the assignee of a membership interest who lacked standing under the dissolution statute; the Mizrahi case in which a New York appellate panel ordered an “equitable buy-out” of a 50% LLC member upon petition by the other 50% member in the absence of a statutory buy-out remedy; the Gottlieb decision in which another New York appellate panel gave birth to common-law “equitable accounting” claims.

Add to the growing list of equity-driven rulings for these contract-centric creatures of statute an unpublished decision last week by a New Jersey intermediate appellate court in All Saints University of Medicine Aruba v Chilana, No. A-2425-13T1 [N.J. Super. Ct. App. Div. Oct. 27, 2015], directing the lower court on remand to consider ordering a forced sale of a dissociated LLC member’s interest as a “common law equitable remedy” for “common law breaches of duty” notwithstanding the appellate court’s recognition that neither the applicable dissociation statute nor the LLC’s operating agreement authorized a compulsory sale. Continue Reading Dissociated LLC Member Faces “Equitable” Forced Buy-Out

ExpulsionPresently fourteen states and the District of Columbia have enacted the Revised Uniform Limited Liability Company Act (2006). RULLCA legislation is pending in three other states. Regrettably, New York is not one of them.

One of RULLCA’s innovative features, carried over from the original Uniform LLC Act (1996), is its provision in Section 602(6) authorizing judicial expulsion (“dissociation”) of a member who:

(A) has engaged, or is engaging, in wrongful conduct that has adversely and materially affected, or will adversely and materially affect, the company’s activities;

(B) has willfully or persistently committed, or is willfully and persistently committing, a material breach of the operating agreement or the person’s duties or obligations under Section 409; or

(C) has engaged in, or is engaging, in conduct relating to the company’s activities which makes it not reasonably practicable to carry on the activities with the person as a member.

New Jersey adopted RULLCA effective March 2013 for all new LLCs and made applicable to all existing New Jersey LLCs as of March 2014. However, even before adopting RULLCA, New Jersey’s previous LLC Act included a provision substantially mirroring RULLCA’s Section 602(6). Continue Reading Involuntary Member Dissociation Under RULLCA

pushLong Island’s dense population and surfeit of privately owned businesses small, medium, and large assure the Commercial Division judges of the Nassau County Supreme Court more than their fair share of disputes between business co-owners. What’s amazing is the range of business divorce cases heard by that court, from AriZona Iced Tea involving a multi-billion dollar, internationally known brand to the smallest mom-and-pop shops where you wonder how the fight can be worth the legal bills.

One thing in common between the high-stakes AriZona Iced Tea case and, on the other end of the spectrum, the pending fight between two co-owners of the Gusto Latino Bar & Restaurant, a neighborhood watering hole located in Hempstead, New York, is that both cases took about five years to resolve. There the similarity ends. And, again, you have to wonder how the Gusto Latino case, in which the invested dollar amounts cited in the court’s decision wouldn’t even qualify as a rounding error in the AriZona Iced Tea case, possibly has justified five years of litigation expense.

So why am I writing about it? Not because there’s anything particularly compelling about its facts or the parties’ claims. Essentially it’s a garden variety case where parties go into business together without a shareholders’ agreement after which there’s a falling out and one side claims the other either is not a shareholder or, at most, holds a minority interest. We’ve all seen dozens of similar cases.

Rather, the Gusto Latino case is noteworthy because of the novel remedy devised by the presiding judge. For those who read this blog regularly, you’ve already guessed correctly that when I mention a novel remedy in a Nassau County Commercial Division business divorce case, chances are I’m referring to a decision by that court’s senior member, Justice Stephen A. Bucaria, who, as I’ve noted before, is not afraid to think outside the box when it comes to creative solutions to intractable shareholder disputes. Continue Reading First a Judicial Nudge, Then a Push to the Buy-Out in Shareholder Dispute

BuybackIf you’ve got an owner-operated, closely held business entity that pays no dividends, and it features controlling and non-controlling ownership interests, generally it’s a good idea to include in the owners’ agreement provisions for the compulsory buyback of the non-controlling owner’s interest upon termination of employment.

The reasons are fairly obvious. The last thing anyone needs is an outside owner with trapped-in capital, possibly having to go out-of-pocket for taxes on phantom income, who may feel compelled to challenge the controller’s financial and management decision-making, possibly through a books-and-records demand and/or a lawsuit asserting derivative claims or seeking judicial dissolution, as the only means available to pressure the controller into a reasonable buyout.

While I’m a fan of such forced buybacks, I’m less wild about buyback provisions that reduce the amount to be paid for the equity interest of a non-controlling owner whose termination is for cause. I get the idea — to incentivize an owner/employee to keep to the straight and narrow — but too many times I’ve seen trumped-up terminations for cause by a financially incentivized controller followed by litigation brought by the financially penalized, expelled owner who contests cause, especially when the alleged misconduct is claimed to fall within a broad, catch-all category such as violation of company policy or failure to perform duty.

Case in point: last week’s appellate ruling in Matter of Bonamie, 2015 NY Slip Op 06191 [3d Dept July 16, 2015]. Bonamie involves a company called Ongweoweh Corp. which, according to its website, was founded in 1978 by Frank Bonamie in upstate New York and is “a Native American-owned, pallet management company providing pallet & packaging procurement, recycling services and supply chain optimization programs.” According to this trade publication, in 2010 Frank’s son Daniel became the company’s CEO and president. Continue Reading The Hidden Cost of a Devalued Buyback Upon Termination for Cause

ValuationIf you’ve studied New York dissolution law, you know that, unlike proceedings involving close corporations, there’s no statutory authority for a court-ordered buy-out when a member of a limited liability company petitions for judicial dissolution under LLC Law § 702.

You also know, especially if you follow this blog, that notwithstanding the absence of such authority, on a few occasions New York courts have invoked their common-law powers of equity to compel buy-outs in LLC dissolution cases, or have reached the same result by characterizing the buy-out as a form of liquidation.

The selected valuation date can make a critical difference in determining the value of an equity interest in the business. In dissolution proceedings involving close corporations, the statute authorizing a buy-out election, Business Corporation Law § 1118, stipulates valuation as of the day before the filing of the petition. We don’t have similarly definitive guidance on the LLC side because there’s no enabling statute, but the few LLC cases decided so far suggest some answers. Continue Reading Court-Ordered LLC Buy-Outs: What’s the Valuation Date?

The statutes and judge-made law governing dissolution and other claims among co-owners of closely held business entities can vary significantly from state to state. Depending on the states, there also can be much in common, which is why I like to keep an eye on developments outside New York, and not just Delaware which tends to have the most advanced business-law jurisprudence.

Below are five business divorce cases decided by appellate courts outside New York that made a splash in 2014. As you might expect, four of the five involve that relatively new business entity form, the limited liability company. The one involving a traditional business corporation, however, likely made the biggest splash.

Ritchie v Rupe, 2014 WL 2788335 [Tex. Sup Ct June 20, 2014]. The Lone Star State takes the prize for the most controversial business divorce decision in 2014, thanks to the Texas Supreme Court’s decision in Ritchie which, as one commentator put it, effectively “gutted the cause of action for shareholder oppression in Texas.” A Texas intermediate appellate court ruling in 1988, which had been followed ever since, recognized a compulsory buyout remedy for oppressed minority shareholders under a broad test for oppression mirroring New York’s reasonable-expectations standard. No more. The Ritchie court, in a 6-3 decision, narrowly defined oppressive conduct by majority shareholders as “when they abuse their authority over the corporation with the intent to harm the interests of one or more of the shareholders, in a manner that does not comport with the honest exercise of their business judgment, and by doing so create a serious risk of harm to the corporation.” The Ritchie majority then applied the coup de grâce by construing the applicable Texas statute as limiting the remedy for oppressive conduct to the appointment of a “rehabilitative receiver.” Bye bye buyout. For a more detailed analysis of Ritchie‘s impact on Texas business divorce litigation, check out my friend Ladd Hirsch’s posts here, here, and here on his Texas Business Divorce blog.   Continue Reading Round-Up of Recent Business Divorce Cases From Across the Country

The under-reporting of cash receipts a/k/a skimming by restaurant owners and other cash-intensive businesses costs many billions of dollars in lost tax revenues each year and, when detected by audit, can lead to stiff penalties and even criminal prosecution. When the business has multiple owners, not all of whom are in on the skimming, it also can constitute grounds for judicial dissolution, as illustrated in a fascinating post-trial decision last week by Brooklyn Commercial Division Presiding Justice Carolyn E. Demarest in Cortes v 3A N. Park Ave. Rest Corp., 2014 NY Slip Op 24329 [Sup Ct, Kings County Oct. 28, 2014].

Any publicly aired business divorce involving allegations of looting can be a nasty affair. Throw into the litigation mix the specter of under-reported taxes and it becomes positively toxic, which is the flavor I got from reading Justice Demarest’s detailed findings of fact and conclusions of law in her 24-page ruling which, ultimately, found that the controlling shareholders skimmed about $3.7 million and conditionally ordered dissolution of the corporation, contingent upon the controllers’ buy-out of the plaintiff’s shares for over $1.2 million.

Background

The Cortes case involves a 150-table Mexican restaurant, bar, and nightclub called Cabo, located in Rockville Center on Long Island. In 2003, the plaintiff, Porfirio Cortes, acquired for $50,000 a 16.67% stock interest in the restaurant’s operating company, in which the remaining shares were owned equally by defendants Angelo Ramunni and Domenick DeSimone. The purchase agreement gave the corporation the right to repurchase Cortes’s shares in the event he resigned his designated position as managing partner though, oddly, it did not specify a price or a pricing mechanism. Continue Reading Restaurant’s Cash-Skimming Majority Owners Forced to Buy Out Minority Shareholder or Face Dissolution

What are the current, hot topics in the law of business divorce? I’ve been thinking about this in preparation for a speaking engagement later this month, and thought I’d preview my choices for the hot-topic list in the hope that some interested readers might offer their own ideas about unsettled areas of the law governing dissolution cases and other types of disputes among co-owners of closely held business entities.

Not surprisingly, a majority of the topics I’ve come up with concern limited liability companies, which first came into being in New York in 1994. Case law applying the LLC Law got off to a tepid start — it wasn’t until 2010 that an appellate court authoritatively construed LLC Law § 702 governing judicial dissolution — but the pace of court decisions concerning LLCs has quickened in recent years as the LLC slowly but surely has supplanted the traditional business corporation as the preferred form of entity for privately-owned companies.

So, without further ado, here’s my list of hot topics in business divorce:

Equitable Buy-Out in LLC Dissolution Cases.  In contrast to oppressed minority shareholder dissolution petitions involving closely-held corporations (see Business Corporation Law § 1118), the LLC Law has no provision authorizing courts to compel a buy-out of the complaining or respondent LLC members as a remedy in judicial dissolution cases brought under LLC Law § 702. There nonetheless have been several appellate decisions affirming or ordering a compulsory buyout as an “equitable” remedy, of which the most notable is the Second Department’s 2013 ruling in Mizrahi v. Cohen where the court compelled a buy-out requested by the petitioner of the respondent member’s 50% interest. These few cases, each involving their own, peculiar set of facts, provide little guidance as to the circumstances under which courts will or won’t grant an equitable buy-out, or as to the interplay between equitable buy-out and LLC agreements that may limit dissolution remedies. It also remains to be seen whether buy-out awards in LLC cases will be based on the fair value standard used in statutory buy-outs of oppressed minority shareholders. Continue Reading Hot Topics in Business Divorce

One of three, equal shareholders in a family-owned business licensed by the state liquor authority was convicted of a felony. Under state law the felony conviction of an owner jeopardizes the company’s license and with it, the entire business. The other two shareholders therefore adopted a resolution terminating his employment and simultaneously exercised the company’s option, set forth in their shareholders’ agreement, to redeem his stock at a value to be determined by appraisal.

Problem solved? Not quite. For one thing, the termination of employment was made retroactive about three months, arguably contrary to a provision in the shareholders’ agreement requiring that the purchase option be exercised within 30 days of termination. For another, the company did not obtain the required appraisal or propose a closing until about a year after the termination, whereas the agreement required that the company close on its option to redeem the shares within 90 days of the termination.

The ousted shareholder refused to tender his shares, contending that the company forfeited its purchase option by failing to exercise it in a timely fashion. The company, under pressure of a threatened de-licensing, sued to enforce the buy-out.

Probably you won’t be surprised to learn that, last week, an appellate panel in A. Cappione, Inc. v Cappione, 2014 NY Slip Op 05230 [3d Dept July 10, 2014], affirmed the trial court’s decision in favor of the company, ordering the ousted shareholder to convey his shares but also allowing him to contest the appraised value offered for his shares. The court’s ruling is particularly important in that it ordered the conveyance even assuming the option to purchase was not timely exercised, based on the manifest intent of the shareholders’ agreement to retain managerial control within the family, and the risk to the company of losing its critical license. Continue Reading Stockholder Fired, Forced to Sell Shares After Felony Conviction

Over the years I’ve seen a boatload of crudely prepared operating agreements for New York limited liability companies. These agreements often derive from generic forms grabbed off the internet, including forms offered by paid services such as LegalZoom, or from recycled, one-size-fits-all forms used by attorneys without paying meaningful attention to the special considerations and needs attendant to the particular business being formed. Once signed, these agreements are locked away and ignored until the outbreak of hostilities among the co-members, at which point they resurface to the great dismay of one or another faction upon realizing that what they signed only provides more fodder for litigation.

The common thread for these newborn LLCs is the inability or unwillingness of the business owners to invest upfront the financial resources needed to secure a customized, well-considered and well-drafted LLC agreement that anticipates and resolves through contractual means the kinds of potential disagreements — over management, finance, compensation, distributions, sale of equity stakes, etc. — that can arise in the life cycle of a multi-member LLC.

That is not to say I haven’t seen excellent, carefully prepared, thorough LLC agreements for New York LLCs. Certainly I have, usually involving more highly capitalized ventures and particularly those structured with both managing and non-managing members. My guess, however, is that such agreements are relatively infrequent given the great preponderance of small, member managed, minimally capitalized companies formed each year in New York as LLCs. Continue Reading Waterfalls and Compulsory Buybacks: New York Courts Decide Disputes Involving Sophisticated Delaware LLC Agreements