Family-Owned Businesses

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Much digital ink has been spilled on this blog (here, here, here, and here) and elsewhere (Tom Rutledge’s terrific article can be read here) concerning the ability of LLC controllers to adopt or amend an operating agreement without the consent of all members.

In New York, Shapiro v Ettenson kicked things off, holding that the majority members of an LLC validly adopted a post-formation operating agreement without the minority member’s consent. The agreement in that case eliminated the minority member’s salary, authorized dilution of a member interest for failing to make mandatory capital contributions (the majority members issued a capital call promptly after the amendment), and member expulsion (the majority members expelled the minority member soon after the court upheld the LLC agreement).

Next came Ho v Yen where the court denied interim injunctive relief to a minority member who challenged the majority members’ adoption of a post-formation LLC agreement that authorized member expulsion and buy-out at book value (the majority members expelled the minority member within days after the amendment).

The appellate panel in Shapiro rested its holding on LLC Law § 402 (c) (3) which speaks to the majority’s right not only to adopt an operating agreement but also to amend it subject, of course, to any contrary provision in the operating agreement and certain statutory carve-outs in LLC Law § 417 (b). But since the vast majority of operating agreements that I’ve seen expressly require the consent of all members to amend, I figured I’d have a long wait before seeing a case that tests the limits of the non-unanimous amendment power.

My wait wasn’t nearly as long as I expected. Last month, in Yu v Guard Hill Estates, LLC, 2018 NY Slip Op 32466(U) [Sup Ct NY County Sept 28, 2018], Manhattan Commercial Division Justice Saliann Scarpulla denied a motion to dismiss a minority LLC member’s claims against the majority members for breaching their fiduciary duty by adopting, without the minority member’s consent, amendments authorizing mandatory capital calls and foreclosing upon the interest of a member who fails to contribute. What makes the case even more interesting is that the pre-existing operating agreement signed by all the members included a provision generally authorizing amendment by vote of members holding 51% of the member interests.  Continue Reading Does This Decision Put the Brakes on Non-Unanimous Amendments to Operating Agreements?

What’s a weaponized LLC? It’s one whose operating agreement gives the controlling majority members the authority to dilute, remove from management, or expel a non-controlling minority member, typically for failing to satisfy a mandatory capital call or engaging in conduct the majority determines to be a breach of specified standards of conduct.

Weaponization can occur openly or stealthily. Openly, the dilution, removal, or expulsion powers are spelled out explicitly in the operating agreement signed by all the members. Stealthily, the operating agreement authorizes amendment of the operating agreement by the majority, i.e., without minority consent, effectively allowing such powers to be added at a later time of the majority’s choosing.

Few tears normally are shed when a minority member is diluted, removed from management, or expelled under the express provisions of an operating agreement to which the minority member knowingly subscribed. As the saying goes, you made your bed, now lie in it.

Does the minority member hit with the stealth variety via an amendment to which he or she never consented deserve any greater sympathy? More importantly for litigators, does the majority’s adoption and implementation of such measures for the purpose of squeezing out the minority member, or otherwise gaining leverage in a dispute not necessarily related to the LLC’s governance and business affairs, provide the minority member with grounds to seek judicial dissolution of the LLC? Continue Reading Judicial Dissolution and the Weaponized LLC

In the judicial dissolution case that John (“Jake”) Feldmeier brought after resigning as the highly paid president of the family-owned business, the central issue over which he and his opposing siblings fought was whether the siblings’ subsequent refusal to issue shareholder distributions, as Jake claimed, was the discontinuation of a longstanding practice of awarding de facto a/k/a disguised dividends to shareholders in the form of bonuses or, as the siblings contended, was the continuation of a company policy over which Jake himself presided for many years whereby the owners and managers made good-faith business judgments to award merit-based bonuses to officers and employees.

In support of his claim, and in opposition to his siblings’ summary judgment motion, Jake invoked the granddaddy of all New York minority shareholder oppression cases, Matter of Kemp & Beatley, Inc., in which the state’s highest court upheld an order of judicial dissolution in favor of terminated employee-shareholders who similarly complained about the non-issuance of dividends where the evidence showed, prior to their departures, that the company historically awarded de facto dividends based on stock ownership in the form of “extra compensation bonuses.”

In opposition to Jake’s claim, and in support of their summary judgment motion, the siblings argued, on the law, that the reasonable-expectations standard for oppression formulated in Kemp, a case brought under Section 1104-a of the Business Corporation Law, did not apply to Jake’s non-statutory claim for common-law dissolution — Jake, as a 12% shareholder, lacked standing under Section 1104-a’s 20% minimum — and, on the facts, that Kemp was distinguishable because, unlike in that case, prior to Jake’s departure and with his active participation and approval as company president, bonuses were paid disproportionately to stock ownership and not at all to non-employee shareholders.

So who prevailed? Continue Reading Past is Prologue: Refusal to Adopt Dividend Policy After Petitioner Resigns Not Ground for Dissolution

The hard-fought business divorce litigation between Nissim Kassab and his brother Avraham has provided plenty of fodder for this blog over the last several years (here, here, here, and here) with more to come, as evidenced by Queens County Supreme Court Justice Timothy J. Dufficy’s decision earlier this month dismissing Nissim’s second attempt to plead a claim for judicial dissolution of the brothers’ realty-holding company known as Mall 92-30 Associates LLC (“Mall”), which owns an unimproved lot in a prime development location in downtown Jamaica, Queens, valued around $10 million.

Justice Dufficy’s ruling in Matter of Kassab v Kasab, 2018 NY Slip Op 50934(U) [Sup Ct Queens County June 11, 2018], comes on the heels of a post-trial decision last year in a related case brought by Nissim in which Justice Dufficy conditionally ordered dissolution of their corporation known as Corner 160 Associates, Inc. (“Corner”) which owned two unimproved lots adjoining Mall’s lot. Justice Dufficy’s order gave Avraham the option to buy out Nissim’s 25% interests in both Corner and Mall at fair values determined by the court, but Avraham took a pass and subsequently failed to obtain an appellate stay of the dissolution order, leading to a public auction sale of Corner’s realty two weeks ago by the court-appointed receiver for $18 million.

Nissim’s second shot at dissolving Mall, like the first unsuccessful one, illustrates anew the hurdles faced by a minority member of a solvent, realty-holding LLC, particularly when there’s no operating agreement giving the minority member additional management rights, in satisfying the prevailing standard for judicial dissolution of LLCs as articulated in the 1545 Ocean Avenue case, namely, the LLC’s management “is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved” or that “continuing the entity is financially unfeasible.” Continue Reading Court Denies Second Bite at Dissolution Cherry in Kassab Brothers Business Divorce

Article 11 of the Business Corporation Law features multiple provisions giving judges broad authority and discretion to impose interim remedies designed to preserve corporate assets and otherwise to protect the petitioning minority shareholder’s interests pending judicial dissolution and buy-out proceedings involving closely held New York corporations. They include appointment of a temporary receiver, injunction, setting aside certain conveyances, and bonding the eventual buy-out award.

As in any type of civil litigation, an application for one or more of Article 11’s interim remedies can be motivated by tactical as well as strategic goals, namely, to paint the adverse party as the “bad guy” and to gain leverage for settlement purposes.

Matter of Hammad v Al-Lid Food Corp., Decision and Order, Index No. 518406/17 [Sup Ct Kings County May 29, 2018], decided last month by Brooklyn Commercial Division Justice Sylvia G. Ash, looks like one of those cases in which tactical ambitions overshadowed strategic merit, resulting in the court’s denial of the minority shareholder-petitioner’s motion to impose multi-faceted interim, coercive remedies against the controlling shareholders, well after the corporation elected to purchase the petitioner’s shares for fair value. Continue Reading You Sued for Dissolution, They Elected to Buy You Out, What Else Do You Want?

“We are poster-boys for why family members should not go into business together.”

So says respondent Paul Vaccari in his affidavit opposing the petition of his brothers Richard and Peter seeking to dissolve their jointly owned corporation that owns a five-story, mixed-use building in Manhattan’s Hell’s Kitchen, housing the operations of Piccinini Brothers, a third-generation wholesale butcher and purveyor of meat, poultry and game established by the brothers’ grandfather and great-uncle in the 1920’s.

The family-owned business at the center of Vaccari v Vaccari, 2018 NY Slip Op 30546(U) [Sup Ct NY County Mar. 28, 2018], decided last month by veteran Manhattan Commercial Division Justice Eileen Bransten, is a classic example of fraying family bonds in the successive ownership generations caused by divergent career interests and sibling sense of injustice over disparate treatment by their parents.

While Vaccari will not go down in the annals of business divorce litigation as a landmark case, it does add incrementally and usefully to the body of case law addressing the grounds available or not to establish minority shareholder oppression. Justice Bransten’s opinion also serves as an important reminder to counsel in dissolution proceedings of their summary nature and of the potentially high cost of noncompliance with the Commercial Division’s practice rules. Continue Reading Shareholder Oppression Requires More Than Denial of Access to Company Information

The self-proclaimed entrepreneur and guiding force behind his soon-to-be ex-wife’s highly successful, multi-office pediatric dental practice known as Kiddsmiles is not smiling after the court in Savel v Savel, Short Form Order, Index No. 006375-15 [Sup Ct Nassau County May 19, 2017], dismissed his claim, among others, to impose a constructive trust upon 50% of his wife’s ownership interest in a series of professional limited liability companies.

The facts of the case, as presented in the husband’s complaint in his civil action, which he filed some months after he filed a separate divorce action against his wife, involve tawdry, self-incriminating allegations of illegal kickbacks for patient referrals from which the husband, who is not a dentist, personally benefitted through his separate consulting company that received the alleged kickbacks under the guise of phony “rental” payments.

Between the governing statute’s ironclad requirement that members of a dental practice organized as a professional service LLC be licensed dentists, and the husband’s admitted receipt of kickbacks for patient referrals in violation of the Public Health Law, it’s no wonder the court dismissed the husband’s claims seeking to enforce illegal arrangements. Continue Reading Divorcing Husband Not Smiling Over Court’s Rejection of Ownership Interest in Wife’s Dental Practice

If you haven’t yet listened to prior episodes of the Business Divorce Roundtable (a) it’s time you did and (b) absolutely you won’t want to miss the latest episode (click on the link at the bottom of this post) featuring first-hand, real-life, business divorce stories told by business appraiser Tony Cotrupe of Melioria Advisors (photo left) and attorney Jeffrey Eilender of Schlam Stone & Dolan (photo right).

Tony’s and Jeff’s stories have a common element: both involve the contentious break-up of a poisonous business relationship between two brothers. The similarity ends there. In my interview of Tony, he puts us inside a fast-paced and ultimately successful effort by the feuding second-generation owners of a propane distributorship, guided by their respective lawyers working in collaboration, to avoid litigation by engineering a buy-out of one brother by the other based on Tony’s business appraisal as the jointly retained, independent evaluator. It’s a happy ending to what otherwIse could have turned into a drawn-out courtroom slugfest.

Courtroom slugfest aptly sums up Jeff’s story as counsel for the brother owning the minority interest in Kassab v. Kasab, a case I’ve featured on this blog several times including last month’s post-trial decision giving the other brother the opportunity to buy out the minority interest upon pain of dissolution if he doesn’t (read here, here, and here). Jeff’s insider analysis of the case provides unique insights into a multi-faceted, roller-coaster-ride of a case involving novel issues under the statutes and case law governing business corporations and limited liability companies.

If you’re a lawyer, business appraiser or business owner with a business divorce story you’d like to share for a future podcast, drop me a line at pmahler@farrellfritz.com.

 

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

Over the years I’ve litigated and observed countless cases of alleged oppression of minority shareholders by the majority. Oppression can take endlessly different forms, some more crude than others in their execution, some more draconian than others in their effect.

If there was an award for the crudest and most draconian case of shareholder oppression, Matter of Twin Bay Village, Inc., 2017 NY Slip Op 06024 [3d Dept Aug. 3, 2017], decided earlier this month by an upstate appellate panel, would be a serious contender.

The case involves a bitter dispute between two branches of the Chomiak family over a lakefront resort called Twin Bay Village located on beautiful Lake George in upstate New York. In 1957, the husband-and-wife founders, Stephan and Eleonora Chomiak, opened the summer resort on land they owned. They and their two sons, Leo and Vladimir, together ran the business until 1970 when they transferred ownership of the land and business to newly-formed Twin Bay Village, Inc. owned 26% by each parent and 24% by each son. Continue Reading And the Award For Most Oppressive Conduct By a Majority Shareholder Goes to . . .