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

We call it deadlock dissolution when a 50% shareholder of a close corporation, who claims to be at an impasse with the other 50% shareholder, asks the court to dissolve and liquidate the corporation. New York’s deadlock dissolution statute, unlike its statutory cousin for minority shareholder oppression petitions, does not give the non-petitioning 50% shareholder the right to avoid dissolution by acquiring the petitioner’s shares for “fair value” as determined by the court, nor do the courts have statutory or common-law authority to compel a buyout. Absent a settlement, the litigation outcomes are binary: either dissolution is granted, in which case the court usually will appoint a receiver to sell the corporation’s assets, or it’s denied, in which case the co-owners continue indefinitely their fractious co-existence.

There’s one particular subspecies of deadlock dissolution that may not be motivated primarily by the usual disputes over finance, personnel, owner compensation, budget, distributions, or other such operational issues. Rather, sometimes a deadlock dissolution petition is brought when the two owners disagree whether to dissolve or continue to operate a functioning business. The petitioner may need the liquidity for unrelated financial reasons, or in contemplation of retirement, or because he or she believes the optimal time to sell the business or its assets is at hand. Perhaps the two owners also discussed a buyout but couldn’t agree on terms. Over time, as resentments fester and pressures grow, one or both owners typically undertake unilateral actions affecting the business, or block management actions advanced by the other, that push the standoff to crisis mode and into the hands of lawyers and judges.

A recent decision by Manhattan Commercial Division Justice Saliann Scarpulla shows how a deadlock dissolution petition of this existential sort can play out. Continue Reading One 50% Shareholder Wants to Sell or Liquidate the Business. The Other Wants to Keep It Going. Is That Deadlock?

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

Minority shareholder oppression and deadlock are the twin pillars of most business divorce litigation. Both are codified in the vast majority of statutes authorizing proceedings for judicial dissolution of closely held corporations and, to a lesser extent, limited liability companies. Both encompass infinite permutations of  behaviors — of both the well and ill-intended variety — among business co-owners that make any working definition of the two doctrines only marginally more useful than Justice Potter Stewart’s famous “I know it when I see it” definition of obscenity.

From my casual observations over the years, I’d say the courts probably have devoted far more attention to formulating and refining the standard for minority shareholder oppression, which is of more recent vintage than deadlock as ground for judicial dissolution and typically is not defined in the statutes. Oppressive conduct is evaluated in most states under one of three judicially-created formulations: majority conduct that defeats the reasonable expectations of the minority shareholder; breach of the fiduciary duty of good faith and fair dealing majority shareholders owe minority shareholders; and burdensome, harsh, and wrongful conduct constituting a visible departure from the standards of fair dealing majority shareholders owe minority shareholders in close corporations.

I’ve not encountered comparable attempts to formulate a deadlock standard, although one might think the term deadlock needs no judicial interpretation à la oppression. After all, the dictionaries tell us that deadlock is a state of impasse or inability to progress when two opposing factions with equal control can’t come to agreement on something. But the dictionary definition doesn’t get us very far in the context of judicial dissolution proceedings. For example, 50/50 owners in an otherwise well-functioning company could be deadlocked over what shape table to buy for their conference room; no one would suggest that deadlock of this sort would warrant a judicial death verdict for the company. And what about a feigned deadlock created by one faction in pursuit of a break-up, buy-out, or other strategic objective?

In my case-law travels I’ve come across decisions that catalog prior cases granting dissolution as illustrative categories of disagreement warranting dissolution, e.g., impasse over distributions or the hiring or firing of key personnel, but I’ve seen no attempt to fashion an overall framework for evaluating claims of deadlock, that is, until last month’s opinion in Koshy v Sachdev (read here) in which the Supreme Judicial Court of Massachusetts, in its first-ever effort to construe that state’s deadlock-dissolution statute, devised a four-factor test to determine whether a “true deadlock” exists. Continue Reading Court Defines “True Deadlock”

Regular readers of this blog know it’s been anything but summer doldrums in the world of business divorce, what with case law developments such as the Appellate Division’s potentially far-reaching ruling on the purposeless purpose clause and LLC dissolution in Mace v Tunick reported in last week’s post, and the astonishing story of minority shareholder oppression in the Twin Bay Village case also reported earlier this month.

This year’s edition of Summer Shorts picks up the summer pace with short summaries of three must-read decisions by New York and Delaware courts on three very different business divorce topics: use of a Special Litigation Committee to evaluate derivative claims brought by LLC members (New York); grounds for dissolution and the court’s remedial powers in shareholder oppression cases (New York); and LLC deadlock dissolution (Delaware).

Appellate Ruling Rejects Appointment of Special Litigation Committee in LLC Derivative Suit Where Not Authorized By Operating Agreement

LNYC Loft, LLC v Hudson Opportunity Fund I, LLC, 2017 NY Slip Op 06147 [1st Dept Aug. 15, 2017].  In Tzolis v Wolff, New York’s highest court recognized a common-law right of LLC members to sue derivatively on behalf of the LLC. Subsequent lower court decisions have clarified other aspects of the right by analogy to corporation law, such as requiring the plaintiff LLC member to allege pre-suit demand or demand futility. In shareholder derivative suits involving corporations, the board’s inherent authority to appoint a Special Litigation Committee composed of independent and disinterested directors to assess derivative claims is well established and, when properly implemented, can result in the court’s dismissal of derivative claims based on the SLC’s conclusion that the claims do not merit prosecution by the corporation. Continue Reading Summer Shorts: Three Must-Read Decisions

Food-Fight1A little over three years ago I reported on the first round of a fascinating “food fight” among four siblings, each of whom is a 25% shareholder of a Brooklyn-based, second-generation food distributor known as Jersey Lynne Farms, Inc. (the “Corporation”), and each of whom also is a 25% member of Catarina Realty, LLC (the “LLC”) which leases its sole realty asset to the Corporation.

The occasion back then was the court’s decision in Borriello v Loconte denying a dismissal motion in a derivative suit brought by Dorine Borriello on the LLC’s behalf in which she alleged that her three siblings breached fiduciary duty by leasing its realty to the Corporation at a drastically below-market rent and by imposing on the LLC certain expenses that ought to be borne by the Corporation as tenant.

In 2011 — the same year her siblings entered into the challenged lease — they ousted Dorine as a director, officer, and employee of the Corporation. In 2012 Dorine and her siblings negotiated a Separation Agreement and General Release setting forth terms for payment of compensation and benefits along with non-compete and non-disclosure provisions. The agreement left intact Dorine’s 25% stock interest in the Corporation.

Dorine’s derivative suit filed in 2013 claimed that the 2011 below-market lease rendered the LLC unprofitable while increasing the Corporation’s income used to pay salaries and other benefits to her siblings. The first round went to Dorine when the court ruled that her General Release did not encompass her derivative claim and enjoined her siblings from advancing their legal expenses from LLC funds.

In the end, however, and subject to any appeals Dorine may bring, it appears that the siblings have won the food fight’s final rounds. Continue Reading “Food Fight” Sequel Ends Badly for Ousted Sibling

SushiThe Japanese word “omakase” translates as “I’ll Ieave it up to you” and is used by patrons of sushi restaurants to leave the selection to the chef rather than ordering à la carte.

The minority member of an LLC that operates a high-end Japanese restaurant in Brooklyn featuring omakase service, and who sued for judicial dissolution, recently learned a different meaning of omakase, as in, don’t leave it up to the court to protect you from being frozen out by the majority member when you don’t have a written operating agreement, much less a written operating agreement containing minority-interest safeguards.

The hard lesson learned by the petitioner in Matter of Norvell v Guchi’s Idea LLC, 2016 NY Slip Op 32307(U) [Sup Ct Kings County Nov. 18, 2016], has been taught before, starting most prominently with the First Department’s 2013 decision in Doyle v Icon, LLC and reinforced by that court two years later in Barone v Sowers, holding that minority member claims of oppressive majority conduct including systematic exclusion from the LLC’s operations and profits, in the absence of a showing that the LLC is financially unfeasible or not carrying on its business in conformity with its operating agreement, do not constitute grounds for judicial dissolution under LLC Law § 702. Continue Reading Another Frozen-Out Minority LLC Member’s Petition for Dissolution Bites the . . . Sushi?

tie-breaker[N.B. Younger readers of this post may be forgiven for not catching the title’s play on the refrain of a certain 1976 hit song by one of the oldest and most hirsute recording groups around. Click here if you’re still stumped.]

LLC deadlock’s been on my mind more than usual of late, after interviewing LLC maven John Cunningham for a podcast and last week co-presenting with John a webinar on the subject for the ABA Young Lawyer’s Division.

During the webinar’s Q&A session, a listener asked about potential liability of an appointed deadlock tie-breaker. I mentioned that I had not seen any cases involving the issue. Lo and behold, several days later up popped a decision by Queens County Commercial Division Justice Martin E. Ritholtz presenting exactly that issue, in which the court denied the tie-breaker’s motion for summary dismissal of a claim brought against her for breach of fiduciary duty by one of two 50/50 members of a family-owned LLC. Fakiris v Gusmar Enterprises LLC, 2016 NY Slip Op 51665(U) [Sup Ct Queens County Nov. 21, 2016]. Continue Reading She’s a Tie-Breaker, She’s a Risk Taker

Bad Faith 1In New York, the bad faith defense in dissolution proceedings traces its lineage to Matter of Kemp & Beatley, 64 NY2d 63 [1984], a landmark ruling by the state’s highest court that set the standard for minority shareholder oppression under § 1104-a of the Business Corporation Law, where the court wrote in dicta that “the minority shareholder whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression should be given no quarter in the statutory protection.”

Several years ago, I gave headline treatment to Justice Vito DeStefano’s decision in Feinberg v Silverberg recognizing the bad faith defense as applicable also in deadlock dissolution cases between 50/50 shareholders under BCL § 1104 notwithstanding a line of appellate rulings indicating that the underlying reasons for dissension and deadlock are not relevant. In reconciling those seemingly contradictory cases, Justice DeStefano wrote that the “manufactured creation of the dissension . . . is the sine qua non of bad faith” which “would belie a finding that the shareholders’ dissension poses an irreconcilable barrier to the continued functioning and prosperity of the corporation.”

Has the bad faith defense similarly osmosed to LLC dissolution? While I’m not aware of any New York cases directly addressing the issue, a recent decision by Chancellor Ellen Hobbs Lyle of the Tennessee Business Court in Wilford v Coltea, Case No. 15-856-BC [Tenn. Ch. Ct. 20th Dist. May 16, 2016], echoes Justice DeStefano’s rationale in upholding a bad faith defense in a dissolution case involving a Delaware LLC whose two 50/50 members seemingly were at an alleged managerial impasse with no way out. Continue Reading Bad Faith Defense Gets Boost in LLC Dissolution Case

ExpulsionThere are arguments pro and con when it comes to the power to expel a/k/a dissociate an LLC member. On the one hand, expulsion can be viewed as a necessary measure to preserve the LLC as a going concern when faced with persistent misconduct or failure to perform by one of its members. On the other hand, depending how broadly or narrowly the expulsion criteria are drawn, the power to expel can be a tool of oppression and abuse by those wielding it for their self-advantage.

Expulsion can occur in one of two ways. First, the operating agreement can authorize member expulsion under specified circumstances by self-executing action of the other members or managers. This is not a feature I regularly come across in operating agreements of LLCs, especially those whose membership consists of founding owners actively involved in the business.

Second, in states that have adopted the Revised Uniform LLC Act — to date numbering 16 plus the District of Columbia; New York is not one of them — courts are authorized to expel an LLC member on application by the company or a member on three specified grounds, two of which entail fault-based standards based on intentionally wrongful conduct or material breach, and the third of which dispenses with the notion of wrongful conduct by authorizing judicial expulsion of a member who

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

Not surprisingly, the open-endedness of the above provision when utilized in LLC disputes has generated litigation, with New Jersey courts taking the lead. Last week, in IE Test, LLC v Carroll, 2016 WL 4086260 [NJ Sup Ct Aug. 2, 2016], that state’s Supreme Court handed down a major decision in which it reversed the lower courts’ summary judgment order expelling an LLC member and adopted a series of factors to assist trial courts in determining whether it is not reasonably practicable to operate an LLC in light of a subject member’s conduct. Continue Reading New Jersey Supreme Court Raises the Bar for Judicial Expulsion of LLC Members