After two years, 300+ docket entries, and 12 motions, a lawsuit among members of a Delaware LLC that owned a 5-story apartment building on Manhattan’s Upper East Side (the “UES Building”) acquired to provide short-term rentals for international leisure and corporate travelers, and whose business was decimated by anti-Airbnb legislation, is barely past the pleadings stage and likely can look forward to years more litigation.

Manhattan Commercial Division Justice Jennifer G. Schechter’s recent decision in Favourite Ltd. v Cico, 2018 NY Slip Op 32781(U) [Sup Ct NY County Oct. 30, 2018], permitting the LLC and some of its members to file an amended pleading against the LLC’s former managing members, addresses several issues of interest including whether the legislature’s action automatically triggered dissolution under the operating agreement’s arguably conflicting provisions, and whether the former managers’ attempted reinvestment of proceeds from the UES Building’s sale in another property violated the operating agreement’s purpose clause.

According to the Second Amended Complaint ultimately allowed by the court, the two defendants as sole managing members of Upper East Side Suites, LLC, formed in Delaware in 2007, solicited investors from Italy’s business community who contributed $4.75 million to buy the UES Building to operate a short-term rental business. What allegedly followed is a scheme by the defendants of “self-dealing, mismanagement, waste of assets, fraud, and forgery that resulted in the loss of every cent of the $4.75 million invested.” Continue Reading Outlawing of LLC’s Short-Term Rental Business Brings Long-Term Litigation

Let me say up front, I don’t claim to know the answer to the question posed in this post’s title, or pretend there’s a simple yes-or-no answer. It very well may be that the answer depends on the unique facts and circumstances in any given case, including the one discussed below.

Having said that, take a look at a Schedule K-1 in the tax return of a limited liability company. I’ll make it easy; click here for the 2017 K-1 form available on the IRS’s website. Now tell me, in the Part II “Information About the Partner” section of the form, do you see a check box for a taxpayer who is a non-member/assignee/holder of an economic interest in an LLC?

That’s right, you don’t. As pertains to LLCs, the only choices are “LLC member-manager” or “other LLC member.”

I’m not a tax expert, but I’m fairly confident it makes no difference whether one or the other of those boxes is checked for a non-member assignee of an LLC interest, at least for tax purposes. But it can make a night-and-day difference for state law purposes to a litigant seeking to enforce rights as the assignee of a membership interest — be it to secure judicial dissolution, to enforce management, voting or inspection rights, or to prosecute derivative claims — and who relies solely on a K-1 as proof of his, her, or its member status.

It makes a difference because, under New York statutory and case law, absent provision in an operating agreement to the contrary, an assignee, non-member holder of an economic interest in an LLC has no standing to assert any of those rights or to obtain any of those remedies.

I’ve encountered the issue a number of times in my business divorce travels, almost always involving LLCs with no written operating agreement and that don’t observe governance formalities. It’s also an issue that surfaced in a recent decision in which the court held that the plaintiff, whose complaint asserts both direct and derivative claims for breach of fiduciary duty, and who was not an original member of the subject LLC and acquired his interest by undocumented assignment, established his member status based on his K-1, apparently in the absence of any written agreement with the other members or other evidence of any formal consent to his admission as a member. Rosin v Schnitzler, 2018 NY Slip Op 32320(U) [Sup Ct Kings County Sept. 4, 2018]. Continue Reading Is a Schedule K-1 By Itself Enough to Prove LLC Membership?

It’s no surprise that the quorum requirements found in close corporation by-laws and LLC operating agreements rarely step into the limelight in business divorce disputes. After all, the typical quorum provision for meetings of shareholders, directors, and LLC members and managers requires attendance by a bare majority of voting shares or membership interests or, at the board or managerial level, a bare majority of the board of directors or managers. In other words, it’s usually not the holding of the meeting that generates the dispute, it’s the action taken at the meeting by the control faction that generates the dispute.

In the case of closely held entities with two owners having equal interests and control, a quorum provision requiring majority attendance effectively requires attendance by both owners. If owner #1 doesn’t attend the meeting, not because of some benign reason but due to a disagreement with owner #2 over the action proposed by the latter to be voted upon at the meeting, that produces a deadlock the same as if both owners attended the meeting and cast conflicting votes. Deadlock is deadlock, meeting or no.

Now imagine a closely held entity that has three or more voting shareholders or members, or three or more members of the board of directors or managers, with a quorum provision requiring the presence at a meeting of all the shareholders or members, or of all the directors or managers. With such an entity, a dissenter with minority voting power who couldn’t otherwise defeat a proposed action requiring majority approval, nonetheless can block the action simply by not showing up at the meeting. So much for majority rule.

Actually, we don’t have to imagine the scenario because that’s what happened in Casilli v Natan, 2018 NY Slip Op 32621(U) [Sup Ct NY County Oct. 12, 2018], recently decided by Manhattan Commercial Division Justice Andrea Masley. In her decision, Justice Masley was invited to substitute the statutory default rule under LLC Law § 404, requiring the presence at meetings of a majority in interest of the members, for an “unworkable” quorum provision in the LLC’s operating agreement requiring the presence of all. Not surprisingly, at least to this writer, Justice Masley declined the invitation. Continue Reading Think Twice Before Putting 100% Quorum Requirement in By-Laws or LLC Agreement

Consider the following hypothetical: The operating agreement of an LLC vests management authority in its two members. In practice, and by informal mutual consent, only one of the members actively manages the LLC’s business and financial affairs. (Not an altogether unusual arrangement, by the way.) When things go awry between the two members, and the active member accuses the inactive member of engaging in misconduct violating fiduciary duties owed to the LLC and to the active member, can the inactive member disclaim those fiduciary duties on the ground he owes no such duty as a de facto non-managing member?

A disclaimer of the sort was raised and rejected in a ruling earlier this month by Manhattan Commercial Division Justice Barry Ostrager in Marcus v Antell, 2018 NY Slip Op 32527(U) [Sup Ct NY County Oct. 5, 2018], where the court relied on a strict application of New York’s LLC Law § 401 (b) (ii) providing that any member of a member-managed LLC “shall have and be subject to all of the duties and liabilities of a manager provided in this chapter.”

It’s not quite as simple as it sounds. Continue Reading Does an Inactive Member of a Member-Managed LLC Owe Fiduciary Duties?

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