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

C’mon, New York lawyers, do you really want to spend your time, your client’s money, and bother the court litigating a dead-end claim that your client rightfully expelled his or her LLC co-member for alleged misconduct, however egregious, when you don’t have an operating agreement that says your client can do it?

Despite clear law on the subject, some have not gotten the word as made evident by Justice O. Peter Sherwood’s ruling last month in Matter of Goyal (Vintage India NYC, LLC), 2018 NY Slip Op 31926(U) [Sup Ct NY County Aug. 7, 2018].

First, some background: Over ten years ago, in one of my earliest posts on this blog, I observed that, in contrast to states whose LLC statutes authorize judicial expulsion a/k/a dissociation of a misbehaving member, New York’s LLC Law does not authorize a judicial expulsion remedy, and that non-judicial member expulsion can only occur if and under the circumstances specified in the operating agreement.

Two years later, a far more consequential observer, namely, the Appellate Division, Second Department, in Chiu v Chiu specifically held that courts lack authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy. Continue Reading Repeat After Me: You May Not Expel a Member of a New York LLC Unless the Operating Agreement Says So

Very few and very far between are cases in which the holder of a minority membership interest in a New York LLC — with or without a written operating agreement — prevails in an action brought under section 702 of the New York LLC Law for judicial dissolution. Mainly that’s because the statute’s “not reasonably practicable” standard as interpreted by the courts is limited to a showing of the LLC’s failed purpose or financial failure, and thus excludes as grounds for dissolution oppression, fraud, or other overreaching conduct by the majority directed at the minority.

Last week, in one of the rare exceptions to the general rule, Nassau County Commercial Division Justice Timothy S. Driscoll handed down a post-trial decision granting the judicial dissolution petition of two individuals holding a collective 42% membership interest in an LLC that operates a gymnastic facility. In Matter of D’Errico (Epic Gymnastics, LLC), Decision & Order, Index No. 610084/2016 [Sup Ct Nassau County Aug. 21, 2018], Justice Driscoll held that dissolution under section 702 was warranted where, after dissension arose, the majority members formed a new, similarly named entity to collect the subject LLC’s revenues and to dole them out to the subject LLC if, as, and when the majority members saw fit, thereby reducing the subject LLC to a “marionette to be manipulated at will by [the new LLC].”

The decision deserves attention, not only in respect of its navigation of the prevailing dissolution standard articulated by the Appellate Division, Second Department, in the 1545 Ocean Avenue case, but also as a cautionary lesson for business divorce counsel about the potential backfire of overly aggressive self-help measures undertaken by controllers in response to perceived acts of disloyalty or abandonment by minority members. Continue Reading Gymnastics Business Falls Off the Beam in LLC Dissolution Case

Douglas K. Moll, Professor of Law at the University of Houston Law Center, is well known to business divorce aficionados for his many scholarly articles examining minority oppression and fiduciary duty in close corporations and LLCs, and as co-author with Robert Ragazzo of one of the leading treatises on closely held business organizations. He’s also familiar to regular readers of this blog, having been featured previously in an online interview and in Episode #8 of the Business Divorce Roundtable podcast.

Professor Moll recently published yet another, terrific article entitled Judicial Dissolution of the Limited Liability Company: A Statutory Analysis (19 Tennessee Journal of Business Law 81 [2017]) in which he brings some much-needed perspective to the statutory landscape of the diverse grounds for judicial dissolution of LLCs found among the fifty states, the District of Columbia, and the several uniform and model acts promulgated since the 1990s. From the article’s abstract:

This article, prepared for the Business Law Prof Blog 2017 Symposium, examines the statutory grounds available to members who seek judicial dissolution of an LLC in all fifty states plus the District of Columbia. I also examined the judicial dissolution grounds in five model statutes: the 1992 Prototype LLC Act, the 2011 Revised Prototype LLC Act, the 1996 Uniform LLC Act, the 2006 Revised Uniform LLC Act, and the 2013 Revised Uniform LLC Act. Two charts are provided – one that provides the judicial dissolution grounds for each statute, and one that tabulates the different approaches.

Part I summarizes the methodology used and highlights the frequency of various statutory provisions. Part II analyzes two particular provisions—dissolution if it is not reasonably practicable to carry on the LLC’s business in conformity with its governing documents, and dissolution as a result of oppressive conduct by those in control. With respect to the “not reasonably practicable” language, the article argues that the impracticability of carrying on the business in conformity with either the certificate or the operating agreement should result in dissolution, but there is confusion over which statutory articulation is consistent with this result. With respect to the oppressive conduct ground, this article provides some possible explanations for why oppression-related dissolution statutes are less common in the LLC setting than in the corporation context.

Happily, Professor Moll accepted my return invitation to the podcast to discuss his findings. In the interview, a link to which appears below, Professor Moll highlights some surprising variations among the statutory expression of the prevailing not-reasonably-practicable dissolution standard. He also discusses some of the reasons for the relative scarcity — compared to close corporation statutes — of minority oppression as ground for judicial dissolution of LLCs, and the competing forces of freedom of contract and judicial paternalism that continue to shape the evolving statutory and common-law jurisprudence governing internal relations among LLC members.

Give it a listen. I guarantee you’ll be glad you did.

 

A few weeks ago, this blog – in the first of a three-part series about business valuation proceedings – addressed the various statutory triggers by which owners of New York partnerships, corporations, and limited liability companies can wind up in a contested business appraisal proceeding.

So you, or your client, have found yourself in an appraisal proceeding. The question then becomes: What are the legal rules, principles, and standards that apply in the valuation proceeding itself? That is the subject of today’s article.

“Value” Versus “Fair Value”

The ultimate purpose and objective of an appraisal proceeding is to determine the correct “value,” the term found in the Partnership Law (i.e. Sections 69 and 73), or “fair value,” the term used in both the Business Corporation Law (i.e. Sections 623 and 1118) and Limited Liability Company Law (i.e. Sections 509, 1002, and 1005), of an owner’s interest in a business for the purpose of a buyout of liquidation of that ownership interest.

The interplay of the “value” and “fair value” standards raises a trio of threshold questions. Continue Reading Basics of Valuation Proceedings – Litigating an Appraisal from Start to Finish – Part 2

Last month, seasoned business appraiser Andy Ross of Getty Marcus CPA, P.C., and I made a presentation at the Nassau County Bar Association about appraisal proceedings in business divorce cases. With the subject of business valuations front of mind, this article – the first in a three-part series – is a treetops summary of the rules governing how business owners may wind up in an appraisal proceeding. Later articles will address the legal and accounting principles that apply in the valuation proceedings.

But before we get started, some context. What exactly is a valuation proceeding? A valuation proceeding is a special kind of lawsuit in which the owners of a business litigate the “value” (the relevant standard under New York’s Partnership Law) or “fair value” (the standard under the New York Business Corporation Law and Limited Liability Company Law) of a partnership, stock, or membership interest in a business for the purpose of a potential buyout or liquidation of that owner’s interest. Appraisal proceedings may be forced, or they may be voluntary. They may involve a variety of different accounting approaches or methodologies to value an ownership interest. They are always heavily dependent upon expert testimony of accountants. For that reason, the “determination of a fact-finder as to the value of a business, if it is within the range of testimony presented, will not be disturbed on appeal where the valuation rests primarily on the credibility of the expert witnesses and their valuation techniques” (Matter of Wright v Irish, 156 AD3d 803 [2d Dept 2017]).

What are the ways in which a business owner can wind up in a valuation proceeding? The statutory paths, or routes, to a litigated appraisal depend on the kind of entity involved. This article discusses three basic entity forms: partnerships, corporations, and LLCs, and provides a non-exhaustive list of the most common ways to get to a valuation proceeding. Continue Reading Basics of Valuation Proceedings – Litigating an Appraisal from Start to Finish – Part 1

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

With a genuine sense of loss, we bid adieu to Manhattan Commercial Division Justice Shirley Werner Kornreich, who retired at the end of May after more than three decades of service on the bench, including nearly ten years as a Justice of the Commercial Division. Her accomplishments are many and varied. She is a detailed and scholarly writer. She ran an orderly and efficient part. Invariably well prepared, she asked probing questions at oral argument, arriving quickly at the “nub” of the issue. It was a pleasure and a luxury to be a litigant in her part.

Justice Kornreich also knew and understood as well as any judge the complexities and dynamics of business divorce cases.

As a testament to Justice Kornreich’s quality as a jurist, this blog has written about her opinions on many an occasion, with some of her decisions receiving repeat treatment. Rather than quantify her massive body of work, this week’s post will summarize a half dozen or so of Justice Kornreich’s more memorable decisions in the area of business divorce. You can click on the case name to read the earlier post. Continue Reading A Trip Down Business Divorce Lane with Recently Retired Justice Shirley Werner Kornreich

Mediation, as commonly understood in the context of alternative dispute resolution, employs a neutral third party to facilitate negotiation and voluntary agreement between the parties. Unlike arbitration, the mediator does not conduct an evidentiary hearing, is able to “caucus” separately with each side, and does not impose a solution or issue a legally binding award.

Or so I thought, until I came across last week’s appellate ruling in Korangy v Malone, 2018 NY Slip Op 03767 [1st Dept May 24, 2018], in which the court affirmed an order dismissing claims by one 50% LLC member against the other 50% member based on the outcome of a prior, “binding mediation” conducted pursuant to a provision in the LLC’s operating agreement addressing member deadlock.

When I did a little online research, I found commentary about binding mediation — in which mediators usually impose a legally enforceable resolution only after they fail to produce a voluntary settlement — both negative (“a trap for the unwary”) and positive (“more cost effective than arbitration”). I also got the sense that the inclusion of mandatory, binding mediation clauses in commercial contracts, insofar as it has achieved any significant level of acceptance, mostly is confined to standardized transactions such as construction and reinsurance contracts.

Whatever their utility in those contexts, does it make sense to include an ex ante provision for binding mediation as a deadlock-breaking device in a shareholders or operating agreement, such as the one in Korangy v Malone? I doubt it, but let’s first take a look at the case. Continue Reading Anyone Think Binding Mediation to Break Deadlock Is a Good Idea?