UturnIn a post last year entitled “Squabbling Partners with Piecemeal Adjudications Need Not Apply,” I wrote about Nassau County Commercial Division Justice Stephen A. Bucaria‘s creative adaptation of the ancient common-law principle of partnership law, forbidding actions at law between partners prior to dissolution and a final accounting, to cases involving close corporations and LLCs.

Essentially, in a series of cases involving claims among co-owners of close corporations and LLCs for breach of fiduciary duty and the like, Justice Bucaria likened these cases to partnership disputes and either conditioned relief on one side bringing a dissolution claim or dismissed the complaint with leave to replead including a claim for dissolution or buy-out.

The squabbling-partners rule applicable to corporations and LLCs now has a corollary, also courtesy of Justice Bucaria: if you do bring a claim for dissolution, don’t expect you’ll be able to withdraw it later for the purpose of gaining interim injunctive relief against your adversary.

The corollary appears in a recent decision by the judge in PFT Technology LLC v Wieser, Short Form Order, Index No. 8679/12 [Sup Ct Nassau County Apr. 13, 2015]. The case, commenced in 2012, involves a four-member LLC in which the three majority members brought suit in the LLC’s name against the fourth seeking judicial dissolution of the LLC and also asserting claims for breach of fiduciary duty. The defendant member opposed dissolution, demanded a fair-value buy-out of his membership interest, and counterclaimed against the three majority members for breach of fiduciary duty. Continue Reading Court Rebuffs Dissolution Withdrawal in Denying Enforcement of Non-Compete

I recently came across a fascinating article in which the authors, two prominent professors of law and economics, rely on experimental evidence to argue that courts should utilize the “shotgun” mechanism to resolve business divorce cases involving deadlock between two, 50/50 owners. The shotgun basically involves one owner setting a buyout price and the other owner opting to buy or sell at that same price, the theory being that the one setting the price, uncertain whether he or she will end up buyer or seller, effectively will be forced to offer a reasonable price for a business whose “true” market value otherwise may be very difficult to ascertain.

I’ll be posting more about this important and thought provoking article in the near future. (For those who can’t wait, here’s a link to the article by Professors Claudia Landeo and Kathryn Spier available on SSRN.) The topic for today is inspired by one particular court decision cited in the article, in which the judge not only ordered the sale of a deadlocked service business as a going concern using a shotgun mechanism, but also imposed a limited duration non-solicitation injunction upon whichever of the two shareholders ended up the seller.

The case, decided over 10 years ago by then-Vice Chancellor Jack B. Jacobs of the Delaware Court of Chancery (currently serving as a Justice of the Delaware Supreme Court), is Fulk v. Washington Service Associates, Inc., 2002 WL 1402273 (Del. Ch. June 21, 2002) (read here). It’s a case that deserves more attention than evidenced by the paucity of citations to it in subsequent case law. It’s a case that puts to the forefront questions about the appropriate reach of the judicial power in dissolution cases, to maximize shareholder value for both sides in winding up a 50/50 company with substantial good will that one of the two owners is threatening to walk off with. Continue Reading How Should Courts Maximize Shareholder Value When Dissolving Deadlocked Companies?

Shareholder agreements for closed corporations frequently prohibit lifetime stock transfers, except pursuant to a right of first refusal (RFR) that gives the corporation and the remaining shareholders the option to acquire the selling shareholder’s interest at the same price and on the same terms of any bona fide purchase offer by a third party. Such RFRs have limited  practical value for the simple reason that, generally speaking, there are few if any outside buyers for a non-controlling interest in an owner-operated, non-dividend paying close corporation.

A recent post-trial decision by Suffolk County Commercial Division Justice Elizabeth Hazlett Emerson in M.H. Mandelbaum Orthotic & Prosthetic Services, Inc. v. Werner, 2012 NY Slip Op 32080(U) (Sup Ct Suffolk County May 30, 2012), addressed an interesting twist on the usual RFR scenario: Does a provision in the RFR, requiring that any third-party buyer agree to be bound by the shareholders’ agreement, also require the third-party buyer to assume the selling shareholder’s job duties specified elsewhere in the shareholders’ agreement?

The case involves a company located in Port Jefferson, New York, that sells orthotic and prosthetic devices. The company, called M.H. Mandelbaum Orthotic & Prosthetic Services, was founded in 1987 by Martin Mandelbaum as 100% owner. In 1991, Mandelbaum hired Marc Werner. Three years later, Mandelbaum sold Werner a 5% stock interest in the company with an option to acquire an additional 25%. According to Mandelbaum, his intention was to eventually offer the corporation for sale to Werner upon Mandelbaum’s retirement.

Continue Reading Court Invalidates Father-Son Stock Transfer Under Right of First Refusal

The cringe-worthy phrase, “legal equivalent of a proctology exam,” gained notoriety about ten years ago when its use by an attorney in a pre-litigation demand letter was cited by a federal judge as partial justification for a $50,000 sanction award which was later reversed on appeal. The phrase involuntarily leapt to mind when I read the recent post-trial decision by Suffolk County Commercial Division Justice Emily Pines in Suffolk Anesthesiology Associates, P.C. v. Verdone, 2012 NY Slip Op 50728(U) (Sup Ct Suffolk County Apr. 25, 2012), a bare-knuckles contest pitting an expelled physician-shareholder of a large Long Island anesthesiology practice against the 11 other physician-shareholders.

The parties’ very public charges and counter-charges of improper financial dealings, conflicts of interest and potentially serious healthcare law violations, none of which ultimately swung the case outcome, if nothing else offer a compelling argument for inclusion of a binding arbitration clause in the shareholder and employment agreements, thereby ensuring that the airing of the practice’s allegedly “dirty linen” will be confined to a private, confidential setting.

The Verdone case also offers healthcare transactional attorneys a cautionary lesson on drafting mandatory buyback provisions triggered by a shareholder’s departure from the practice, to avoid a draining battle as took place in Verdone over whether the expelled shareholder was terminated with or without cause.

Continue Reading Anesthesiology Practice Undergoes “Legal Equivalent of a Proctology Exam” in Shareholder Dispute

The New York Law Journal recently published, for the 9th consecutive year, my annual review of business divorce cases (read it here).  Most of the cases discussed in the article have been mentioned in previous postings.

Here’s a rundown of the article’s choices for 2007’s most interesting business divorce cases, with links provided to the cases and to previous postings:

  • Dissolution and Right of First Refusal:  Matter of Schneck (R&J Components Corp.) (discussed here) and Matter of Schwimmer (El-Roh Realty Corp.), where two judges reached opposite results on the issue of whether the petitioner’s filing of a dissolution petition triggered a right of first refusal and mandatory buyback under the shareholders’ agreement.
  • LLCs and Temporary Receivers:  At the Airport, LLC v. Isata, LLC (discussed here) in which the court held that the LLC Law does not authorize the court to appoint a temporary receiver until after dissolution is ordered.
  • Grounds for Dissolution:  Matter of Cheung (Ho Foong Shiu Realty Corp.) and Matter of Livolsi (111 Glen Street Corp.) (discussed here) in both of which the courts denied dissolution petitions brought by 50% shareholders claiming oppression by the other shareholder.
  • Restrictive Covenants:  Matter of Autz (Ronald C. Fagan, M.D. and Arthur Lutz, M.D., P.C.) (discussed here) where the court ruled that the sale in liquidation of the company’s good will is a sale "under compulsion" and therefore does not trigger an implied covenant not to solicit customers.
  • Pre-Conversion Agreements:  Matter of Hochberg (Manhattan Pediatric Dental Group, P.C.) (discussed here) in which the court compelled arbitration of a dissolution case under an arbitration clause in a partnership agreement that pre-dated the conversion of the business to a professional corporation.
  • Partner Limited Liability Shield:  Ederer v. Gursky (discussed here) where New York’s top court interpreted Section 26(b) of the Partnership Law as not shielding partners in limited liability partnerships from personal liability against claims for breach of the partnership’s or partners’ obligations to each other.

If you’d like to read some of my previously published annual reviews, look under Links on the right sidebar of this blog’s home page where you’ll find links to my articles covering the years 2003 through 2006.

Next week, New York Business Divorce returns to Anatomy of a Dissolution Slugfest, Part III.

Under the Mohawk Maintenance doctrine, named after a case decided by New York’s highest court, the seller of a business including its good will is under an implied covenant not to solicit the seller’s former customers. Yet to be decided by the same court, although it’s come close on a couple of occasions, is whether a stock buyout resulting from an election to purchase in a dissolution proceeding likewise triggers the implied covenant. The key issue in these cases in whether the sale is deemed to be one “under compulsion” and therefore not within the Mohawk Maintenance rule. Lower court decisions have been less than uniform in their approach and the results.

A dissolution case decided earlier this year raised the issue anew in an interesting context. In Matter of Autz, 16 Misc 3d 1140(A) (Sup Ct Nassau County 2008), the antagonists were minority and majority shareholders in a professional corporation that operated walk-in medical clinics. The petitioner sought dissolution as an oppressed minority shareholder under Section 1104-a of the Business Corporation Law (BCL). The majority shareholder did not elect to purchase the petitioner’s shares. Rather, he consented to dissolution and asked the court (a) to determine that the corporation is not a going concern, and (b) to order a liquidation sale of the corporation’s hard assets and the division of its receivables. The petitioner sought a sale of the corporation as a going concern, inclusive of good will, along with a determination that such a sale is voluntary and therefore imposes a restrictive covenant upon the unsuccessful shareholder-bidder.

In a decision by Justice Leonard B. Austin of the Nassau County Supreme Court, Commercial Division, the court ruled that there was evidence that the corporation had saleable good will, but that a transfer of shares resulting from an involuntary dissolution, in the absence of an election to purchase the petitioner’s shares for fair value under BCL Section 1118, is a sale under compulsion and thus does not implicate the non-solicitation covenant.

Like so many other issues that come to haunt partners who find themselves embroiled in business divorce litigation, covenants not to compete or to solicit customers and employees are most efficiently dealt with in a shareholders agreement made at the beginning of the relationship.