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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

Lawyers are famous for arguing seemingly inconsistent positions at the same time. We practitioners lovingly refer to the technique as “arguing in the alternative.” The famous Texas trial lawyer, Richard “Racehorse” Haynes, gave a vivid example:

Say you sue me because you say my dog bit you. Well, this is my defense: My dog doesn’t bite. And second, in the alternative, my dog was tied up that night. And third, I don’t believe you really got bit. And fourth, I don’t have a dog.

A litigator’s stock in trade, arguing multiple positions at once can be vital to advance the client’s interests and to preserve arguments for later appellate review. Sometimes, though, one comes across arguments so seemingly in tension that they don’t quite seem able to coexist. A recent appellate decision, Alam v Uddin, 2018 NY Slip Op 02763 [2d Dept Apr. 25, 2018], involved a rather odd array of apparently conflicting arguments on both sides. Continue Reading Corporate Frankenstein “Partnership to Form a Corporation” Lives Another Day

There’s a lot to digest in last week’s decision by the Court of Appeals — New York’s highest court — affirming and modifying in part the intermediate appellate court’s ruling in Congel v Malfitano, a “wrongful dissolution” case I previously covered here and here, in which a minority partner in a general partnership that owns a shopping mall, whose former 3% interest had a stipulated top-line, pro rata value of $4.85 million, after massive valuation discounts and a seven-figure damages award for the majority’s legal fees, ended up with a judgment against him for about $1 million.

Let’s begin with a synopsis of Judge Eugene M. Fahey’s opinion for the court:

  • Instead of focusing, as did the lower courts, on whether the partnership met Partnership Law § 62 (1) (b)’s durational criteria of “definite term” or “particular undertaking,” the court decided the wrongfulness of the minority partner’s unilateral dissolution without recourse to the statute, and instead employed a purely contractual approach in affirming the lower courts’ finding of wrongful dissolution based on the partnership agreement’s “clear and unequivocal terms” providing the exclusive means by which the partnership could be dissolved.
  • The court affirmed the lower courts’ application of 35% marketability, 66% minority, and 15% goodwill discounts, which collectively erased around 80% of the stipulated top-line valuation. As to the minority discount, based on the objectives and policies underlying the “terminological difference” between the statutes, the court refused to read into Partnership Law § 69 (2) (c) (II) — which requires the court to determine the “value” of the partner’s interest when the remaining partners elect to continue the business following a wrongful dissolution — the case law disallowing any minority discount under the “fair value” standard found in sections 1118 and 623 of the Business Corporation Law governing buyouts in shareholder oppression and dissenting shareholder cases. Two of the panel’s seven judges dissented from this part of the court’s decision and would have disallowed the minority discount as a matter of law.
  • In the one bright spot for the minority partner, the court’s opinion struck the approximately $1.6 million (plus 9% interest) damages award for the majority’s legal fees, holding that the award contravened the so-called American Rule under which each side pays its own litigation expenses absent a contractual or statutory fee-shifting provision, and that the damages recoverable under Partnership Law § 69 are only designed to compensate for legal fees or other losses “incurred in carrying out separate acts necessitated by the breach.”

The court remitted the case to the trial court to recalculate damages (I’ll explain below). As best as I can tell, the likely net effect of the rulings will be to swing the judgment from around $1 million against the minority partner to around $1 million in his favor — still a jaw-dropping reduction from the pro rata value of the partnership interest he gave up.

Continue Reading New York’s High Court Takes Fresh Approach to Wrongful Dissolution, Sustains Valuation Discounts, Limits Damages in Partnership Case

Almost always there are elements of acrimony and intense emotion in litigation between co-owners of closely held business entities. The degree of toxicity can vary widely from case to case, although it tends to show up more conspicuously in litigation involving family-owned ventures.

Claims by non-controlling shareholders accusing controlling shareholders and directors of financial or other managerial abuses frequently are styled as derivative claims seeking recovery on the corporation’s behalf for harm to the corporation. In such suits, under the right circumstances the accused may challenge the accuser’s standing to pursue derivative claims based on conflict of interest.

Conflict of interest usually entails some tangible pecuniary interest held or asserted as a direct claim by the accuser that is adverse to the corporation or otherwise at odds with the claims asserted on behalf of the corporation. But a number of court decisions in New York also have cited as a factor in the analysis the accuser’s “animus” or “retaliatory” motive directed against the accused. The legal theory, akin to that applied in class actions, is that the accuser’s personal hostility and the resulting acrimony undermine the accuser’s ability to fairly and adequately represent the interests of the shareholders and the corporation.

Last year I posted about the decision in Pokoik v Norsel Realties in which a trial judge dismissed for lack of standing derivative claims brought by individuals holding an aggregate 11% interest in a realty-holding limited partnership. Among the reasons cited by the judge was that the plaintiffs “failed to demonstrate on this record that they are free from personal animus” as evidenced by the lead plaintiff’s “litigious nature” including several prior lawsuits against the defendants (including family members) alleging similar mismanagement claims, leading the court to conclude that the lawsuit was being wielded by the plaintiffs as “‘a weapon in the total arsenal’ so as to gain leverage in the other disputes.”

If, based on that decision, anyone thought freedom from personal animus is now part of the required showing by a derivative plaintiff, think again. Last week, the Manhattan-based Appellate Division, First Department, reversed the lower court’s decision and reinstated the derivative claims against some (but not all) of the named defendants. Continue Reading Appeals Court Reinstates Derivative Claims Dismissed for Conflict of Interest Where Parties’ Relationship Not “Especially Acrimonious”

As LLCs have become the dominant form of closely-held business in New York, cases involving dissolution of partnerships have become more and more rare. Section 63 of the Partnership Law is the statute governing judicial dissolution of New York general partnerships. The last time this blog wrote about a general partnership dissolution under Partnership Law § 63 was Summer 2015, a testimonial to how uncommon they have become.

After a lengthy interlude, along comes Magid v Magid, 2017 NY Slip Op 32603(U) [Sup Ct NY County Dec. 14, 2017].

Magid involved a fact pattern familiar to this blog’s regular readers – an entity owned by siblings, an income-producing property, a rising real estate market, some family members who want to sell, others who do not. Litigation ensues. Usually, the various dissolution statutes under the Business Corporation Law (BCL) or the Limited Liability Company Law (LLC Law) provide the standards to resolve the dispute.

In Magid, Manhattan Commercial Division Justice Eileen Bransten considered the applicable standards for judicial dissolution – particularly based on deadlock – under Partnership Law § 63. Magid raises the question – is the standard for judicial dissolution based on deadlock under Partnership Law § 63 any different than under BCL § 1104, the deadlock statute for corporation dissolutions? Continue Reading Rare Partnership Dissolution Decision Applies Deadlock Standard to Dissolution Under Partnership Law

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