Did you know there’s such a thing as an “inadvertent partnership”?

The basic definition of a partnership, under both the original Uniform Partnership Act (1914) and the most recent version of the Revised Uniform Partnership Act (1997), is “an association of two or more persons to carry on as co-owners a business for profit.” The later Act, in Section 202 (a), adds a caveat not found in the original: “whether or not the persons intend to form a partnership.”

An unintentional partnership? The official comment to Section 202 explains it’s one that can be created inadvertently and even contrary to one’s “subjective” intentions. It also tells us that it’s a universally accepted concept:

The addition of the phrase, “whether or not the persons intend to form a partnership,” merely codifies the universal judicial construction of UPA Section 6(1) that a partnership is created by the association of persons whose intent is to carry on as co-owners a business for profit, regardless of their subjective intention to be “partners.” Indeed, they may inadvertently create a partnership despite their expressed subjective intention not to do so. The new language alerts readers to this possibility.

In other words, it’s what the putative co-owners do in furtherance of a profit-seeking business — rather than what they think or say they’re doing — that evidences intent and determines the existence of a partnership. Hence, in the absence of a written partnership agreement, one or both of two putative co-owners can call it a partnership and refer to each other as partners without it being a legally recognized partnership while, conversely, they can affirmatively disavow a partner relationship yet be found by a court to have created a partnership with enforceable partner rights and obligations.

In the modern era of closely held business entities dominated by S corporations and LLCs, both of which feature limited liability along with pass-through taxation, general partnerships are rarely chosen as vehicles for multi-owner business enterprises (with the exception of professional firms organized as limited liability partnerships). Nonetheless, what we do see with some frequency are lawsuits in which the plaintiff alleges and seeks to enforce an oral partnership agreement where, after an initial period of business collaboration — usually measured in months not years — and before the parties are able to formalize the proposed business entity, the defendant calls it off. Hammond v Smith, decided last summer by the Appellate Division, Third Department, is the latest example.

Continue Reading Calling an Organization a Partnership Doesn’t Make it One, But Not Calling it a Partnership Doesn’t Make it Not One. Got It?

In 1981, three partners formed a general partnership to own and operate a rental property. Their partnership agreement fixed a 30-year term, to 2011. In 2003, the partners formed a new LLC maintaining the same ownership percentages as the partnership, to which the partnership transferred the property for purposes of refinancing the existing mortgage loan.

In 2016, after failing to secure a buy-out agreement, the holder of a 45% interest sued to dissolve the LLC under New York LLC Law § 701 (a) based on the 2011 expiration date in the partnership agreement.

But wait, you say, didn’t the LLC supersede the partnership and, if so, how can the LLC’s duration be governed by the termination date in the partnership agreement? Unless there’s an LLC agreement that provides otherwise, isn’t the LLC’s existence perpetual by default? And how can the owners hold themselves out to the world as an LLC while acting as partners among themselves? After all, it was the mortgage lender that likely required the transition from partnership to LLC as a condition of the loan, among other reasons, precisely to avoid the risk associated with a general partner’s unfettered right to dissolve the partnership at any time for any reason.

An interesting set-up, indeed, for a decision last week by Manhattan Commercial Division Justice Saliann Scarpulla in Golder v 29 West 27th Street Associates, LLC, 2017 NY Slip Op 31527(U) [Sup Ct NY County July 17, 2017], in which she denied a motion to dismiss the dissolution petition upon finding “a material issue of fact exists as to whether a written operating agreement exists as to the LLC’s term of duration.” Continue Reading It’s a Partnership! No, It’s an LLC! No, It’s Both!

Pay attention to your K-1s or they may come back to bite you, is the lesson of Bruder v Hillman, Docket No. A-5055-15T1 [N.J. Super. Ct. App. Div. June 27, 2017], decided last week by a New Jersey appellate panel which rebuffed a limited partner’s attack on the validity of the partnership’s conversion to a limited liability company.

The court’s opinion describes the plaintiffs as “sophisticated real estate investors”  who in 1984 formed a New Jersey limited partnership to own and operate a large apartment complex in Virginia which some years later filed for bankruptcy.

The bankruptcy case settled in 1992 with a restructure agreement and an amended partnership agreement under which the defendants invested almost $12 million and took control of the partnership as general partner, with the plaintiffs retaining limited partner interests. Continue Reading In Dispute Over Partnership’s Conversion to LLC, Court Finds No Duty to “Spoon-Feed” Sophisticated Investor

litigiousThe U.S. reportedly has the world’s highest number of lawyers per capita (1 for every 300 people) and the 5th highest number of lawsuits per capita (74.5 for every 1,000 people, topped only by Germany, Sweden, Israel, and Austria).

If, as it appears, litigation has become a national pastime in the U.S., then why, when we describe someone as having a “litigious nature,” does that label carry such opprobrium? Is there an unspoken assumption that anyone who brings a multitude of lawsuits must not have meritorious claims, or has ulterior motives to sue? Then again, we recently awarded the presidency to someone who, according to a USA Today analysis, has sued or been sued in 3,500 cases over the last 3 decades.

These observations are spurred by a recent court decision in Pokoik v Norsel Realties, 2017 NY Slip Op 50459(U) [Sup Ct NY County Apr. 12, 2017], in which Manhattan Commercial Division Justice Jeffrey K. Oing cited the plaintiff’s “litigious nature” among the factors supporting dismissal of his derivative lawsuit brought against the fellow members of a real estate partnership, some of whom are relatives of the plaintiff, Leon Pokoik. Granted, it was not cited as the primary factor, but it’s one of those atmospheric factors in a litigation whose impact is hard to measure. Continue Reading Suing on Behalf of People You’re Suing Can Sink a Derivative Lawsuit — Especially If You Have a Litigious Nature

Brothers1Like most civil cases, the vast majority of business divorce disputes get resolved before trial, which is disappointing for us voyeurs since only at trial with live witnesses undergoing cross examination does one get the full flavor of the case’s factual intricacies, credibility issues, and the emotional undercurrents.

Even rarer are written post-trial decisions by judges with detailed findings of fact and conclusions of law, which is why I was so pleased recently to come across a trio of expansive post-trial decisions by Queens County Justice Timothy J. Dufficy in three business divorce cases involving family-owned businesses.

One of them, Shih v Kim, was featured in last week’s post on this blog, in which a romantically-involved couple started a business while engaged and continued as business partners even after the engagement broke off — until the defendant went rogue by diverting cash to himself and diverting business to a competing company.

The two other cases form interesting bookends, metaphorically speaking. Both involve businesses run by brothers. Both involve challenges to the documented ownership of the business. In one case, Justice Dufficy rejected a bid to establish an undocumented, de facto partnership interest and dismissed the case. In the other, Justice Dufficy upheld the documented, 50/50 ownership of an LLC, granted dissolution, and appointed a receiver. Let’s take a closer look. Continue Reading A Pair of Unbrotherly Business Altercations Go to Trial

Lady Justice

Welcome to another edition of Winter Case Notes in which I clear out my backlog of recent court decisions of interest to business divorce aficionados by way of brief synopses with links to the decisions for those who wish to dig deeper.

And speaking of digging deeper, if you don’t already know, New York’s e-filing system has revolutionized public access to court filings in most parts of the state. The online e-filing portal (click here) allows searches by case index number or party name. Once you find the case you’re looking for, you’ll see a chronological listing with links allowing you to read and download each pleading, affidavit, exhibit, brief, decision, or other filing. No more trips to the courthouse basement to requisition paper files!

This year’s synopses feature matters that run the gamut, from a claimed de facto partnership, to several disputes pitting minority against majority shareholders, to an LLC case in which the court resolved competing interpretations of a somewhat murky operating agreement. Continue Reading Winter Case Notes: De Facto Partnership and Other Recent Decisions of Interest

NewYorkCourtofAppealsIn a controversial ruling last year in Congel v Malfitano, the Appellate Division, Second Department, affirmed and modified in part a post-trial judgment against a former 3.08% partner in a general partnership that owns an interest in a large shopping mall, and who unilaterally gave notice of dissolution, finding that

  • the partnership had a definite term and was not at-will for purposes of voluntary dissolution under Partnership Law § 62 (1) (b) based on the partnership agreement’s provisions authorizing dissolution by majority vote, notwithstanding a 2013 ruling by the Court of Appeals (New York’s highest court) in Gelman v Buehler holding that “definite term” as used in the statute is durational and “refers to an identifiable terminate date” requiring “a specific or even a reasonably certain termination date”;
  • the former partner’s unilateral notice of dissolution therefore was wrongful; and
  • having wrongfully dissolved the partnership and upon the continuation of its business by the other partners, under Partnership Law § 69 (2) (c) (II) the amount to be paid to the former partner for the value of his interest properly reflected a 15% reduction for the partnership’s goodwill value, a 35% marketability discount, a whopping 66% minority discount, and a further deduction for damages consisting of the other partners’ litigation expenses over $1.8 million including statutory interest.

The Appellate Division’s decision, which I wrote about here, and the former partner’s subsequent application for leave to appeal to the Court of Appeals, which you can read here, reveal, to say the least, a remarkable result: the former partner, whose partnership interest had a stipulated topline value over $4.8 million, ended up with a judgment against him and in favor of the other partners for over $900,000.

But the story’s not over. Last week, the Court of Appeals issued an order granting the former’s partner’s motion for leave to appeal. Sometime later this year, the Court of Appeals will hear argument in its magnificent courtroom pictured above and issue a decision in the Congel case which likely will have important ramifications for partnership law whatever the outcome. Continue Reading Court of Appeals to Decide Controversial Partnership Dissolution Case

limited partnershipNotwithstanding the ascendency of the limited liability company, the Delaware limited partnership continues to serve as an important, tax-advantaged vehicle for certain capital-intensive ventures — especially in the energy sector — featuring centralized management and limited liability for large numbers of passive investors.

Late last month, the Delaware Supreme Court handed down two noteworthy decisions springing from suits by limited partners challenging the fairness of conflicted transactions by general partners that were approved by conflicts committees. In one, the high court affirmed Chancery Court’s order rejecting a claim based on the implied duty of good faith and fair dealing where the transaction’s approval by the conflicts committee complied with the agreement’s safe harbor provision and thus contractually precluded judicial review. Employees Retirement System v TC Pipelines GP, Inc., No. 291, 2016 [Del. Sup. Ct. Dec. 19, 2016].

In the other, Supreme Court reversed Chancery Court’s post-trial decision holding the general partner liable in damages owed directly to limited partners for a conflicted, over-priced  “dropdown” transaction by the general partner. The high court disagreed with Chancery Court’s application of the Tooley standard, instead finding that the claims were exclusively derivative and that the post-trial, pre-judgment acquisition by merger of the partnership extinguished the plaintiff limited partner’s standing to seek relief. El Paso Pipeline GP Company, LLC v Brinckerhoff, No. 103, 2016 [Del. Sup. Ct. Dec. 20, 2016].

Together, the two decisions re-affirm the primacy of contract in the realm of alternative entities including limited liability companies, limited partnerships, and master limited partnerships. Continue Reading Limited Partners Take a Licking in Two Delaware Supreme Court Decisions

Goodwill

This is a story about a recent case involving a fight over the inclusion or exclusion of goodwill in valuing the interest of a retired partner in a medical practice organized as a limited liability partnership, and how it easily could have been avoided. But first, it helps to understand the legal framework for valuing such an interest and the type of goodwill at issue.

The limited liability partnership or LLP is a highly popular form of business association for professional practices including law firms and medical groups. As its name suggests, the LLP combines the attributes of a partnership with the limited liability traditionally associated with corporations, except that professionals in LLPs generally remain personally liable for their own misconduct or negligence.

In New York, the formation and registration of LLPs is governed by Article 8-B of the Partnership Law. In all other respects, as to both their internal and external affairs, the New York LLP is governed by the same provisions governing general partnerships codified in Sections 1 through 82 of the Partnership Law based on the ancient Uniform Partnership Act promulgated in 1914. Continue Reading How to Avoid Bad Blood Over Goodwill in Professional Partnership Valuations

66discountTalk about playing your cards wrong.

A partner with a 3.08% interest worth $4.85 million in a partnership that owns a major shopping mall likely will walk away with only a few hundred thousand dollars after a court decision finding that he wrongfully dissolved the partnership and deducting from the value of his interest the other partners’ damages including legal fees, a 15% discount for goodwill, a 35% marketability discount, and a whopping 66% minority discount.

Last week’s decision by the Brooklyn-based Appellate Division, Second Department, in Congel v Malfitano, 2016 NY Slip Op 03845 [2d Dept May 18, 2016], rejected the partner’s appeal from the trial court’s determination of wrongful dissolution and also upheld its valuation determination with one major exception: the appellate court held that the trial court erred by failing to apply a minority discount and that it should have applied a 66% minority discount based on the “credible” expert testimony “supported by the record.”

The defendant partner’s fateful decision took place in 2006, when he sent his fellow partners a written notice unilaterally electing to dissolve the partnership due to what he described as a “fundamental breakdown in the relationship between and among us as partners.” The other partners quickly responded with a damages lawsuit claiming that he had wrongfully dissolved in violation of the partnership agreement in an effort to force the partnership to buy out his interest at a steep premium. The defendant, arguing that the partnership was at-will and of indefinite duration, denied wrongful dissolution and counterclaimed for his full, pro rata share of the partnership’s value upon dissolution. Continue Reading Partner Who Wrongfully Dissolved Partnership Hit With Whopping 66% Minority Discount