It’s been a rough couple of months for Joseph Sullivan.

First, in May the New York Court of Appeals (the state’s highest court) threw out Sullivan’s claim for wrongful termination of his employment as compliance officer of a hedge fund known as Peconic Partners. The court ruled that Sullivan’s alleged retaliatory firing, for objecting to improper trading by Peconic’s majority owner, William Harnisch, did not fall within any exception to New York’s at-will employment doctrine (read decision here).

Then, last month, an intermediate appellate court threw out Sullivan’s claim that, after Harnisch forced him out of Peconic, he was wrongfully deprived of millions of dollars of profit sharing due him as a minority member of the limited liability company. The decision by the Appellate Division, First Department, which is the focus of this article, disagreed with the trial court’s interpretation of the governing operating agreement and held that the agreement gave the majority member unbridled discretion to allocate certain profit and loss between the members even after the close of the LLC’s fiscal year. Sullivan v. Harnisch, 2012 NY Slip Op 05238 (1st Dept June 28, 2012).

Background

The case involves two New York LLCs, originally known as FLA Asset Management, LLC and FLA Advisors, LLC, that were registered investment advisors and subsidiaries of Forstmann-Leff. From 1999 through 2004, Sullivan served as Chief Financial Officer of the companies in the hedge fund business. Harnisch was Chief Executive Officer and Chief Investment Officer. In late 2004, the companies split off from Forstmann-Leff and were renamed Peconic Partners LLC and Peconic Asset Managers, LLC, with Harnisch and Sullivan as 85% and 15% members, respectively.

Continue Reading Court Upholds LLC Manager’s Broad Discretion Under Operating Agreement to Determine Member’s Profit Share

The removal of a limited partnership’s general partner for malfeasance, under the court’s general powers of equity, is a rarely exercised judicial remedy. A court’s replacement of the expelled general partner with a limited partner is even rarer. But that’s just what happened last month in Garber v. Stevens, Decision & Order, Index No. 601917/05 (Sup Ct NY County June 6, 2012), decided by Manhattan Commercial Division Justice Eileen Bransten (pictured).

It figures that Garber involves a relatively old (1974) limited partnership formed to hold ownership of a Brooklyn apartment building. This once-popular form of realty ownership involving passive investors largely has been eclipsed since the mid-1990’s by use of the limited liability company form, which is governed by a comparatively sophisticated and more flexible set of statutory default rules that may be varied or eliminated by agreement of the members.

The Garber partnership’s vintage also indicates that it is governed by the original Uniform Limited Partnership Act (ULPA) adopted by New York in 1922, which remained largely unchanged until 1991 when New York adopted the Revised Uniform Limited Partnership Act (RULPA). ULPA makes no reference to the removal power, whereas RULPA includes a provision (§121-402[c]) for removal of a general partner “as may be provided in the partnership agreement.”

Continue Reading The Court’s Equitable Power to Remove and Replace a Limited Partnership’s General Partner

The cringe-worthy phrase, “legal equivalent of a proctology exam,” gained notoriety about ten years ago when its use by an attorney in a pre-litigation demand letter was cited by a federal judge as partial justification for a $50,000 sanction award which was later reversed on appeal. The phrase involuntarily leapt to mind when I read the recent post-trial decision by Suffolk County Commercial Division Justice Emily Pines in Suffolk Anesthesiology Associates, P.C. v. Verdone, 2012 NY Slip Op 50728(U) (Sup Ct Suffolk County Apr. 25, 2012), a bare-knuckles contest pitting an expelled physician-shareholder of a large Long Island anesthesiology practice against the 11 other physician-shareholders.

The parties’ very public charges and counter-charges of improper financial dealings, conflicts of interest and potentially serious healthcare law violations, none of which ultimately swung the case outcome, if nothing else offer a compelling argument for inclusion of a binding arbitration clause in the shareholder and employment agreements, thereby ensuring that the airing of the practice’s allegedly “dirty linen” will be confined to a private, confidential setting.

The Verdone case also offers healthcare transactional attorneys a cautionary lesson on drafting mandatory buyback provisions triggered by a shareholder’s departure from the practice, to avoid a draining battle as took place in Verdone over whether the expelled shareholder was terminated with or without cause.

Continue Reading Anesthesiology Practice Undergoes “Legal Equivalent of a Proctology Exam” in Shareholder Dispute

The highly competitive and lucrative market for premium vodka has spawned some of the most creative advertising and promotional campaigns known to consumers (think Absolut). A new market entrant offering vodka imported from Holland under the brand name Medea, sold in special bottles designed with an interactive LED ticker display, has spawned a different kind of competition, of the litigious sort, involving a fight for control between an angel investor and the managing member of the company.

An appellate court decision issued last week in Lehey v. Goldburt, 2011 NY Slip Op 08670 (1st Dept Dec. 1, 2011), reinstated the managing member whom the lower court had removed and replaced with the investor on the latter’s application for interim relief. The decision reinforces the constraints lower courts face in granting provisional remedies without holding an evidentiary hearing to resolve conflicting allegations. The decision also addresses an interesting issue of contract construction arising from an arguable inconsistency between the operating agreement’s provisions for the appointment and removal of managers.

Continue Reading Appellate Court Reinstates LLC Manager in Dispute with Investor in Vodka Venture

Reading the post-trial decision by Suffolk County Commercial Division Justice Emily Pines in Nastasi v. Carlino, 2011 NY Slip Op 30626(U) (Sup. Ct. Suffolk County Mar. 8, 2011), one can’t help but be struck by the utter futility of an intense three-year litigation between business partners over a now-defunct company in which the court finds them all at fault and sends them all home empty handed.

Aletto & Nastasi Ltd. ("A&N") was formed in 2004 by shareholders Nastasi (40%), Carlino (40%) and Aletto (20%) to operate a marble and granite sales business including warehouse and showroom in Bohemia, New York.  Nastasi managed the business until early 2008 when Carlino and Aletto held a shareholders meeting without proper notice at which they voted to remove Nastasi from management and, as described in the court’s decision, "had him thrown off the property" after they determined that Nastasi was running sales through a separate company wholly owned by Nastasi.

In May 2008, Nastasi filed a petition for judicial dissolution of A&N as an oppressed minority shareholder under Section 1104-a of the Business Corporation Law.  Carlino and Aletto responded in kind with their own suit against Nastasi and his separately owned companies seeking an accounting based on Nastasi’s alleged conversion of corporate funds for his own personal use and breach of fiduciary duty.      

Continue Reading Court Sends Everyone Home Empty Handed in Bitter Business Breakup

I’m pleased to present my third annual list of the year’s top ten business divorce cases.  This year’s crop includes some very important decisions concerning the standard for LLC dissolution, expulsion of LLC members, buyouts triggered by dissolution petitions, stock valuation, and much, much more.  All ten were featured in this blog previously; click on the case name to read the full treatment.  And the winners are: 

1.  Matter of 1545 Ocean Avenue, LLC, 72 AD3d 121, 2010 NY Slip Op 00688 (2d Dept Jan. 26, 2010), in which the Second Department differentiated dissolution of LLCs from business corporations and pronounced a contract-based standard for judicial dissolution of LLCs giving primary weight to the terms of the operating agreement.

2.  Jain v. Rasteh,  Decision and Order, Index No. 109920-09 (Sup Ct NY County Feb. 1, 2010), where the court upheld the right of the LLC’s majority member to expel a minority member for breach of the operating agreement.

 

3.  Chiu v. Chiu, 71 AD3d 646, 2010 NY Slip Op 01768 (2d Dept Mar. 2, 2010), holding that courts have no statutory authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy. 

 

4.  Matter of Superior Vending, LLC, 71 AD3d 1153, 2010 NY Slip Op 02801 (2d Dept Mar. 30, 2010), in which the court upheld as an "equitable method of liquidation" the return of the petitioner’s capital contribution in exchange for his membership interest in the LLC.

  

5.  Matter of Eklund Farm Machinery, Inc., 73 AD3d 1319, 2010 NY Slip Op 04097 (3d Dept May 13, 2010), in which the court construed BCL Section 1217 to limit the commission payable to receivers in corporate dissolution cases.

 

Continue Reading Top 10 Business Divorce Cases of 2010

If you’re the majority member of a New York limited liability company (LLC), and either you have no written operating agreement, or you have one but it’s silent on the issue, repeat after me:  I cannot make a compulsory capital call; I cannot make a compulsory capital call; I cannot make a compulsory capital call.

Alternatively, you can read a recent decision by Kings County Commercial Division Justice David I. Schmidt in Georgi v. Polanski, Decision and Order, Index No. 10406/10 (Sup Ct Kings County Sept. 22, 2010), where the court denied a preliminary injunction application by a purported majority member of an LLC who sought to expel the minority member after he failed to comply with the majority member’s unauthorized capital call.

The facts in Georgi are relatively straightforward.  In 2004, Tina Georgi and Andrew Polanski as 50-50 members formed A&T Partners, LLC to own and operate commercial realty at 60 Pulaski Street in Brooklyn.  According to Georgi, she and Polanski made initial capital contributions of $40,000 and $90,000, respectively, plus they obtained a $200,000 mortgage loan secured by an adjoining property also co-owned by the two of them.  In 2008, Georgi obtained on A&T’s behalf a $640,000 construction loan which she alone personally guaranteed.  That same year Georgi caused A&T to return $40,000 to Polanski who by that time was unemployed.

Continue Reading Not a Capital Idea: Making Unauthorized LLC Capital Calls

 Two cases do not a trend make, but I can’t shake the feeling that the Brooklyn-based Second Department appeals court has clamped down on the era of freewheeling judicial remedies in business breakup cases involving limited liability companies.

As I reported here, last January the Second Department issued a major ruling in the 1545 Ocean Avenue case articulating a new, tougher standard for LLC dissolution, in line with the Delaware approach, in which freedom of contract and fidelity to the operating agreement are paramount.  Earlier this month, the Second Department issued another significant ruling in Chiu v. Chiu, 71 AD3d 646, 2010 NY Slip Op 01768 (2d Dept Mar. 2, 2010), holding that courts have no statutory authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy.  In so ruling, the court turned its back on the appellant’s argument that judicial expulsion should be recognized as a common law remedy under the reasoning of the Court of Appeals’ 2008 decision in Tzolis v. Wolff, 10 NY3d 100, where it divined a common law basis for LLC derivative actions.

Chiu arises from a bitter family dispute between older brother Winston Chiu (WC) and younger brother Man Choi Chiu (MCC) featuring multiple lawsuits over a real estate holding limited liability company called 42-52 Northern Blvd., LLC formed in 1999.  The property was purchased for approximately $5.5 million.  The LLC had no written operating agreement.  The LLC’s 1999 and 2000 tax returns identified WC and MCC as holding 25% and 75% interests, respectively.  Under a 1999 agreement, WC had certain rights to purchase the 75% interest held by his brother.

Continue Reading Tzolis No Solace for Proponent of LLC Member Expulsion

A number of valuable lessons can be learned from a recent decision by Manhattan Commercial Division Justice Melvin L. Schweitzer (pictured) in Jain v. Rasteh,  Decision and Order, Index No. 109920-09 (Sup Ct NY County Feb. 1, 2010), where the court summarily dismissed a complaint by a minority member of a limited liability company who was expelled from the LLC for breach of its operating agreement.

The last time I wrote on the subject (read here) I noted that, unlike some other states, New York’s LLC Law has no express provision authorizing or prohibiting member expulsion, although LLCL Section 701(b) mentions member expulsion in the context of various events (death, retirement, bankruptcy, etc.) not requiring the LLC’s dissolution.  Jain involved an LLC formed under Delaware’s LLC Act, which, unlike New York’s law, expressly authorizes the LLC agreement to provide for the elimination or forfeiture of a member’s interest for failure to comply with the LLC agreement, or under any other circumstances specified in the LLC agreement (see Delaware LLC Act Section 18-306 and Section 18-502(c)).

The subject of Jain is a New York based, two-member company formed in Delaware in 2008 to provide investment management and advisory services for a hedge fund.  The defendant Majority Member contributed most of the firm’s capital and held an 83% profit interest.  The plaintiff Minority Member held the balance.  Section 5 of the LLC agreement designated the two as co-managers, however it also gave the Majority Member the final say in case of disagreement on any issue with specified exceptions such as dissolution and admission of new members.

Section 12 of the LLC agreement, entitled “Withdrawal of a Managing Member,” included a subsection (a)(ii) governing involuntary withdrawal by the Minority member, authorizing the Majority Member to “require” him to withdraw at any time for “Cause” as defined.  The definition included conviction for felony or violation of securities laws, fraud, or “a material breach of this Agreement.”  Section 13 of the LLC agreement entitled the Minority Member to be paid specified percentages of the firm’s net profit over the three years following any such involuntary withdrawal, depending on the number of years of service.  For termination after less than two years — which is what happened — the Minority Member’s share of net profit goes from 4.25% in the first year down to about 1.4% in the third year.  Under Section 17 of the LLC agreement, following his termination for any reason the Minority Member is prohibited for six months from competing with the company or soliciting any of its clients or employees. 

Continue Reading The Perils of For-Cause Expulsion Provisions in LLC Agreements

In a 3-2 decision, a panel of Appellate Division, First Department judges last week upheld the removal of an LLC member-manager by majority vote of the members, notwithstanding provision in the operating agreement requiring all members to vote for the ousted member-manager in any election for managers.  The case is Ross v. Nelson, 54 AD3d 258, 2008 NY Slip Op 06504 (1st Dept 2008).

The underlying facts in Ross are described in the trial court’s decision dated October 12, 2006, written by New York County Commercial Division Justice Helen E. Freedman.  Since 1996, Dean Ross owned minority membership interests in two New York limited liability companies, each of which owned rental properties in Manhattan.  The LLCs had substantially identical operating agreements naming Ross, Eric Nelson and Gary Podell as the member-managers.  Each LLC also had a number of non-manager members.  Things went smoothly until 2001, when severe strains developed in the relationship between Podell and Nelson on the one hand and Ross on the other.   Podell and Nelson called meetings of the LLCs’ members to vote on the removal of Ross as a member-manager, and to replace him with Ross’s brother who also was a member of both LLCs.  The resolutions passed.  Ross brought suit seeking to invalidate the vote and to declare that he continued to be a member-manager of the LLCs.  He also sought to recover one-third of property management fees that were paid to a separate company owned by Podell and Nelson. 

Continue Reading Divided Appeals Court Upholds Removal of LLC Member-Manager Contrary to Voting Agreement