tie-breakerThe New York Business Corporation Law offers the 50% shareholder of a close corporation two avenues to judicial dissolution: deadlock at the board or shareholder level or internal dissension under BCL § 1104, and oppressive actions by the directors or those in control of the corporation under BCL § 1104-a.

The 50% petitioner faces an important strategic decision whether to invoke one or the other (or both) of the statutes. That’s because § 1104-a — but not § 1104 — triggers the respondent’s elective right under BCL § 1118 to acquire the petitioner’s shares for fair value. As I’ve written previously, often a 50% petitioner may gain greater negotiating leverage by proceeding solely under § 1104 based on deadlock, thereby depriving the other 50% faction of a statutory buy-out opportunity.

I can only speculate whether a strategic decision of that sort was at work in Matter of Hudson (Pure Lime USA, Inc.), Short Form Order, Index No. 600127/16 [Sup Ct Nassau County June 16, 2016], in which Nassau County Commercial Division Justice Stephen A. Bucaria dismissed the 50% shareholders’ § 1104 dissolution petition that superficially asserted director deadlock, but where the governing shareholders agreement authorized one of the respondent’s designees on the four-member board to cast the deciding vote in case of a tie vote. How can there be deadlock, the winning argument went, when the parties had a tie-break provision specifically designed to avoid deadlock? Continue Reading Tie-Breaker in Shareholders Agreement Defeats Deadlock Dissolution Petition

OppressionNew York and most other states have judicial dissolution statutes protecting minority shareholders in close corporations against “oppressive actions” by controlling shareholders and directors. In many of those states, including New York, courts define oppression as conduct that defeats the minority shareholder’s “reasonable expectations.” The reasonable-expectations standard necessarily is a flexible one that allows courts to address the myriad circumstances under which minority shareholders, who generally lack exit rights and whose shares have no public market, face squeeze-out or freeze-out by the majority.

If I had to describe the classic case of minority shareholder oppression, it would be (1) an owner-operated business (2) that pays no stock dividends (3) in which the majority shareholder terminates the minority shareholder’s employment (4) thereby cutting off the minority shareholder’s sole source of economic benefits in the form of salary and bonus (5) while also removing the minority shareholder from the board of directors (6) thereby depriving the minority shareholder of any voice in company management.

I’ve pretty much just described the circumstances present in Matter of Digeser v Flach, 2015 NY Slip Op 51609(U) [Sup Ct Albany County Nov. 5, 2015], a post-trial decision handed down earlier this month by Albany County Commercial Division Justice Richard M. Platkin in which the court concluded that the petitioning minority shareholder established grounds for dissolution of two affiliated construction companies. Continue Reading A Classic Case of Minority Shareholder Oppression

limited partnershipA post I wrote two years ago referred to the limited partnership as “the dinosaur of business forms in New York” destined for “virtual extinction” due to New York’s outmoded partnership laws coupled with the meteoric rise of the limited liability company. As the years roll by, the limited partnership’s obsolescence is especially pronounced for those governed by New York’s Uniform Limited Partnership Act of 1922 (“NYULPA”) codified in Article 8 of the New York Partnership Law, applicable to limited partnerships formed prior to, and exempted from, the New York Revised Uniform Limited Partnership Act of 1991 (“NYRULPA”) codified in Article 8-A of the Partnership Law.

The rarity of new business divorce cases involving NYULPA-governed limited partnerships makes it all the more intriguing when one comes along, as happened earlier this month in a case called Doppelt v. Smith, 2015 NY Slip Op 31861(U) [Sup Ct NY County Oct. 1, 2015], decided by Manhattan Commercial Division Justice Eileen Bransten.

Doppelt doesn’t disappoint, thanks to its holding that a provision in a limited partnership agreement, authorizing voluntary dissolution upon the majority vote of the limited partners, precluded the plaintiff’s claims seeking judicial (involuntary) dissolution. Although neither the court nor the parties labeled it as such, and while the defendant in his briefs referred to plaintiff’s lack of “capacity” to seek judicial dissolution, I believe a more apt description of the court’s holding is that, effectively, it enforced a contractual waiver of the limited partner’s statutory right to seek judicial dissolution. Continue Reading Court Enforces Waiver of Limited Partner’s Right to Seek Judicial Dissolution — Or Did It?

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

Unclean HandsJudicial dissolution of a business entity, whether pursuant to statute or common law, is an equitable remedy subject to equitable defenses, including the doctrine of “unclean hands.”

As described a few years ago by Justice Emily Pines in the Kimelstein dissolution case, the unclean hands doctrine “bars the grant of equitable relief to a party who is guilty of immoral, unconscionable conduct when the conduct relied on is directly related to the subject matter in litigation and the party seeking to invoke the doctrine was injured by such conduct.”

The doctrine has been employed in dissolution cases in two ways. First, it can defeat a petitioner’s standing to seek dissolution, as in Kimelstein where Justice Pines held that the petitioner’s admitted concealment from his ex-wives, creditors and federal government of his alleged, undocumented 50% equity interest in two corporations owned by his brother barred him from asserting the requisite stock holdings to seek statutory dissolution. Second, even when the petitioner’s stock ownership is conceded, the doctrine can bar the petitioner’s dissolution claim on the merits.

The doctrine’s latter use rarely has been successful. A recent exception is Sansum v Fioratti, 128 AD3d 420 [1st Dept 2015], in which the Appellate Division, First Department, ordered the dismissal of a common-law dissolution claim brought by a 6% shareholder in an art gallery based on the plaintiff’s “embezzlement” of company funds for which he pled guilty to larceny and related charges. The decision packs an even more powerful punch by virtue of the court’s summary disposition of the claim, disagreeing with the lower court that a hearing was required and invoking the doctrine of in pari delicto (Latin for “in equal fault”) to reject the plaintiff’s counter-argument, that the defendant stockholders themselves conducted illegal business operations. Continue Reading Wash Hands Before Suing

They say this summer has been unusually cool in the Northeast, but it’s been a hot one for business divorce litigation, judging from the number of recent court decisions involving various and sundry disputes among co-owners of closely held businesses. So, once again, it’s time for my annual summertime post featuring a few, short summaries of recent decisions of interest in business divorce cases.

First, we’ll look at a decision by Justice Melvin Schweitzer in a battle between 50/50 ownership factions over control of an international translation services company with over 3,000 employees. Next up is Justice Carolyn Demarest’s ruling denying a change of venue in a corporate dissolution case. Last is a decision by Justice Marcy Friedman in which she addressed an interesting statute of limitations defense in a drawn-out dissolution case.

Shareholder of Parent Corporation Has Standing to Sue Derivatively to Remove Subsidiary’s Director But Not for Dissolution

Elting v Shawe, 2014 NY Slip Op 32126(U) [Sup Ct, NY County July 24, 2014]. It’s not everyday you encounter business divorce litigation on the scale of this case, involving a firm with over 3,000 employees and revenues over $350 million. The subject company is a closely held Delaware holding corporation owned 50/50 by two individuals who also comprise its two-director board, and its wholly owned New York subsidiary providing international translation services. One owner-director sued the other for alleged financial and management abuses, asserting direct and derivative claims seeking the defendant’s removal as an officer and director of the subsidiary under BCL §§ 706 (d) and 716 (c), and also seeking deadlock dissolution of the subsidiary under BCL § 1104 (a). Continue Reading Summer Shorts: Director Removal and Other Recent Decisions of Interest

A disproportionate number of court decisions applying New York’s Partnership Law involve law firm partnerships. That’s because, while use of general partnerships in the business world at large has been eclipsed almost entirely by other closely-held business forms offering both limited liability and partnership taxation, those same features are available to law firms and certain other professional practices by organizing as limited liability partnerships under New York’s LLP statute enacted in 1994.

Other than its organizational and limited liability attributes, New York LLPs are governed by the same, arcane Partnership Law provisions applicable to all general partnerships. One of the most existentially critical of these provisions is found in Partnership Law § 62 [4] stating that dissolution of the partnership is caused “[b]y the death of any partner.” Courts in New York and elsewhere construe this provision, modeled on § 31 [4] of the 1914 Uniform Partnership Act, as a default rule, that is, subject to override in the partnership agreement.

The tragic, accidental death in 2008 of one of two partners in a Manhattan law firm called Donovan & Yee, LLP, triggered a lawsuit in which the estate of the deceased partner is contesting the surviving partner’s continuation of the firm. Earlier this month, in Le Bel v Donovan, 2014 NY Slip Op 03608 [App. Div. 1st Dept, May 20, 2014], a panel of appellate judges unanimously construed contested provisions in the partnership agreement as overriding Partnership Law § 62 [4]’s dissolution default rule, by authorizing continuation of the partnership if a new partner is admitted within 90 days after the death. At the same time, however, the panel remanded the case for trial to determine whether the newly admitted partner was actually an equity partner or, as the estate contended, was part of an alleged “sham transaction” making her a partner in name only to avoid paying the estate one-half of the law firm’s assets upon dissolution.

You have to admit, as dissolution lawsuits go, it doesn’t get much more interesting than that.

Continue Reading Court in Law Firm Dissolution Suit Must Decide, Was Partnership a “Sham”?

Here we go again.

Last month, in Matter of Bianchi (Fragrance Systems International, Inc.), Short Form Order, Index No. 29627-2013 [Sup Ct, Suffolk County Apr. 22, 2014], Suffolk County Commercial Division Justice Emily Pines issued a decision dismissing a petition for judicial dissolution of a New York-based, Delaware corporation on the ground the court lacked subject matter jurisdiction.

The decision is short. Here’s the pertinent excerpt:

Although there is conflicting case law as to whether New York courts lack subject matter jurisdiction over a claim for dissolution of a foreign corporation, absent a decision from the Court of Appeals, this Court is bound to follow the decisions of the Appellate Division, Second Department (see 28 NYJur2d Court and Judges § 221). There is no decision from the Court of Appeals on this issue. The law in the Second Department is that New York courts lack subject matter jurisdiction over proceedings to dissolve foreign corporations (see Matter of Warde-McCann v Commex, Ltd., 135 AD2d 541, 542 [2d Dept 1987]; Matter of Porciello v Sound Moves, 253 AD2d 467 [2d Dept 1998]) and foreign limited liability companies (see Matter of MHS Venture Mgt. Corp. v Utilisave, LLC, 63 AD3d 840 [2d Dept 2009]). The Petitioners fail to address, or even acknowledge, the Second Department decisions on this issue in their opposition papers. Although this Court has read significant First Department decisions permitting New York Courts to hear these cases, it is constrained to follow the current rulings of the Second Department. Accordingly, the respondents’ motion is granted and the Verified Petition is dismissed. Continue Reading The Conflict Continues Over Judicial Dissolution of Foreign Corporations

Last month, in Huatuco v. Satellite Healthcare, C.A. No. 8465-VCG (Del. Ch. Dec. 9, 2013)the Delaware Court of Chancery invoked that state’s “contractarian” approach to limited liability companies in dismissing a 50% member’s complaint seeking judicial dissolution of a deadlocked Delaware LLC.

The court did so based on Section 2.2 of the LLC agreement (read here), entitled “Other Member Rights,” which addressed rights to distributions of assets upon liquidation and preemptive rights, and which also included the following sentence:

“Except as otherwise required by applicable law, the Members shall only have the power to exercise any and all rights expressly granted to the Members pursuant to the terms of this Agreement.”

The court construed Section 2.2 as “reject[ing] all default rights under the [Delaware LLC] Act unless explicitly provided for in the LLC Agreement or ‘otherwise required’ by law.” While the LLC agreement included provisions for voluntary dissolution triggered by defined events, it did not include any reference to involuntary (judicial) dissolution under § 18-802 of the Delaware LLC Act. “Since the LLC Agreement does not expressly contain a right to judicial dissolution,” the court concluded, “the members effectively opted out of the statutory default contained in 6 Del. C. § 18-802.”

Huatuco builds on Chancery Court’s 2008 ruling in R&R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, 2008 WL 3846318 (Del. Ch. Aug. 19, 2008), in which the court classified § 18-802 as permissive rather than mandatory and, citing Delaware’s strong freedom-of-contract policy codified in § 18-1101(b) of the LLC Act, enforced an LLC agreement’s provision explicitly and unambiguously waiving the right to seek judicial dissolution of the LLC. (Read here my post on R&R Capital.)

The question is, does Huatuco take contractarianism too far by finding a dissolution waiver, not based on an explicit waiver as in R&R Capital, but on a provision that generally limits member “rights” to those expressly granted in the LLC agreement? Continue Reading Contractarianism Gone Wild?

The so-called bad faith defense has been a staple in judicial dissolution proceedings brought by oppressed minority shareholders under § 1104-a of the Business Corporation Law (“BCL”) ever since the New York Court of Appeals articulated it in Matter of Kemp & Beatley, 64 NY2d 63 (1984):

The purpose of this involuntary dissolution statute is to provide protection to the minority shareholder whose reasonable expectations in undertaking the venture have been frustrated and who has no adequate means of recovering his or her investment. It would be contrary to this remedial purpose to permit its use by minority shareholders as merely a coercive tool. Therefore, 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[Citations omitted.]

In contrast, the bad faith defense has appeared sporadically and with uncertain effect in deadlock dissolution proceedings brought under BCL § 1104, which authorizes judicial dissolution at the behest of a 50% shareholder who can demonstrate one of:

  • director deadlock precluding board action;
  • shareholder deadlock precluding an election of directors; or
  • that “there is internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders.”

The great majority of deadlock cases turn on the catch-all internal dissension ground because, among other reasons, the shareholders eschew the formality of board meetings and/or the shareholders’ agreement creates permanent directorships for the two shareholders. So why has the bad faith defense fared differently in deadlock cases, and is it a viable defense at all in such cases? Continue Reading Is Bad Faith a Defense in Deadlock Dissolution Proceedings?