Shareholders A and B are the sole shareholders of a real estate holding corporation. Their shareholders’ agreement includes provisions that:

  • guarantee each of them a seat on the two-member board of directors and appoint each as co-president;
  • prohibit their removal from the board with or without cause;
  • in the event of death, disability, or resignation, authorize the vacant board seat to be filled by the departing shareholder’s child;
  • require majority (i.e., effectively unanimous) board consent for all board actions;
  • require 55% (i.e., effectively unanimous) shareholder consent for all actions needing shareholder approval.

Under these provisions, neither A nor B can take any action at the board or shareholder level without the other’s consent. Sounds like a perfect set-up for a deadlock dissolution petition in the event A and B reach impasse on some critical issue jeopardizing the corporation’s viability, doesn’t it?

What if I now add that Shareholders A and B own 49% and 51%, respectively, of the corporation’s common shares? Can Shareholder A still bring a deadlock dissolution petition?

Not according to a recent decision by Manhattan Commercial Division Justice Saliann Scarpulla in Balkind v Nickel, 2018 NY Slip Op 31703(U) [Sup Ct NY County July 16, 2018], in which she dismissed a deadlock dissolution petition filed under Section 1104 of the Business Corporation Law brought by a 49% shareholder, despite his co-equal board and shareholder control. Continue Reading 49% Shareholder Can’t Seek Deadlock Dissolution Despite Shareholders’ Agreement Granting Co-Equal Control

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

You know there’s something unusual going on in a case involving a dispute between co-members of an LLC — a form of business entity that didn’t exist in New York until 1994 — when the key legal precedents cited in the parties’ briefs date from the nineteenth and early twentieth centuries.

By any measure, Horowitz v Montauk U.S.A., LLC, No. 16-3912 [2d Cir. Apr. 20, 2018], is an unusual case, stemming from a fiercely contentious battle between 50/50 co-owners for control of a highly successful restaurant and night spot called The Sloppy Tuna located on the beach in Montauk, New York, a popular summer resort on the eastern tip of Long Island. The dispute, which is still going strong after four years, has spawned at least a half dozen lawsuits in state and federal courts in New York and Georgia, and landed operational control of The Sloppy Tuna in the hands of a court-appointed receiver.

Horowitz is a lawsuit brought in federal court by one of The Sloppy Tuna’s 50% members (Member #1) seeking injunctive relief and damages against the restaurant entity, a New York LLC (Restaurant), for trademark infringement based on the alleged unauthorized use of various trademarks and domain names related to The Sloppy Tuna that Member #1 registered in the name of his solely-owned company (Montauk).

The threshold issue teed up for the court in Horowitz — this post won’t address the several other issues addressed in the court’s opinion — and the reason I call the case unusual, is whether the Restaurant’s other 50% member (Member #2), who was not named as a party to the trademark action and who did not move to intervene in the action personally, under governing New York law has the right to defend the suit derivatively on behalf of the Restaurant. Continue Reading Court Grants 50% LLC Member Derivative Right to Defend Action Brought by Other 50% Member’s Solely Owned Company

In business divorce litigation, petitioners / plaintiffs often want to start the case with a bang. A common tactic is to file a petition / complaint simultaneously with an injunction motion. Often there is a real need for an injunction – the respondent / defendant may be engaging in activities that could cause real, irreparable harm.

But often another objective is that if the injunction motion succeeds, it will be an early win in the case, set the stage favorably for the litigation to come, put significant leverage on the respondent / defendant by restricting its freedom to operate the business, and possibly result in a speedier resolution of the case. If the injunction motion or complaint itself has vulnerabilities, however, a case meant to start with a bang may end with an unceremonious whimper. That is just one lesson from a recent decision by Manhattan Commercial Division Justice Saliann Scarpulla in Pappas v 38-40 LLC, 2018 NY Slip Op 30329(U) [Sup Ct NY County Feb. 22, 2018]). Continue Reading Operating Agreement Dooms Derivative Claims by Deceased LLC Member’s Estate

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”

This winter forever will be remembered in the Northeast as the winter of the “bomb cyclone,” which gets credit for the 6º temperature and bone-chilling winds howling outside as I write this. So in its honor, I’m accelerating my annual Winter Case Notes synopses of recent business divorce cases, which normally don’t appear until later in the season.

This year’s selections include a variety of interesting issues, including LLC dissolution based on deadlock; the survival of an LLC membership interest after bankruptcy; application of the entire-fairness test in a challenge to a cash-out merger; an interim request for reinstatement by an expelled LLC member; and a successful appeal from a fee award in a shareholder derivative action.

Deadlock Between LLC’s Co-Managers Requires Hearing in Dissolution Proceeding

Advanced 23, LLC v Chamber House Partners, LLC, 2017 NY Slip Op 32662(U) [Sup Ct NY County Dec. 15, 2017].  Deadlock is not an independent basis for judicial dissolution of New York LLC’s under the governing standard adopted in the 1545 Ocean Avenue case but, as Manhattan Commercial Division Justice Saliann Scarpulla explains in her decision, when two co-equal managers are unable to cooperate, the court “must consider the managers’ disagreement in light of the operating agreement and the continued ability of [the LLC] to function in that context.” In Advanced 23, the co-managers exchanged accusations of bad acts and omissions, e.g., one of them transferring LLC funds to an unauthorized bank account, raising material issues of fact as to the effectiveness of the LLC’s management and therefore requiring an evidentiary hearing, which is just what Justice Scarpulla ordered. Of further note, in a companion decision denying the respondent’s motion to dismiss the petition (read here), Justice Scarpulla rejected without discussion the respondent’s argument that judicial dissolution under LLC Law § 702 was unavailable based on a provision in the operating agreement stating that the LLC “will be dissolved only upon the unanimous determination of the Members to dissolve.” In that regard, the decision aligns with Justice Stephen Bucaria’s holding in Matter of Youngwall, that even an express waiver of the right to seek judicial dissolution of an LLC is void as against public policy. Continue Reading Winter Case Notes: LLC Deadlock and Other Recent Decisions of Interest

When the tsunami of LLC enabling statutes swept the U.S. in the late ’80s and early ’90s, including New York in 1994, many included a default rule authorizing as-of-right member withdrawal and payment for the “fair value” of the membership interest. The default rule was one of many designed to avoid C corporation-style “double taxation” of LLC earnings. After 1997, when the IRS adopted check-the-box regulations cementing pass-through partnership tax treatment for LLCs, New York and other states flipped the default rule, i.e., members are no longer permitted to withdraw unless authorized by the operating agreement.

When New York amended its withdrawal provision, LLC Law § 606, it included a new subsection “b” grandfathering LLCs formed before the amendment’s 1999 effective date, meaning that withdrawal under the “old” § 606 and fair-value buyout under LLC Law § 509’s default rule remain available for members of pre-1999 LLCs — so long as not otherwise provided in the operating agreement. The Chiu case, which I wrote about here, is an example of one such case resulting in a fair-value buyout of a withdrawn member.

After the amendments, some pre-1999 New York LLCs adopted new operating agreements or amended their existing ones to prohibit withdrawal. Some, as in Chiu, did not.

This is a story about one LLC that did not, but with a very different outcome than Chiu. The story’s punch line, which makes it a fascinating one, is that even though the minority member, seeking to force a fair-value buyout, was found to have properly invoked his uncontested right to withdraw under the old § 606, in the end the lower and appellate courts held that his withdrawal did not trigger a statutory buyout under § 509 because the LLC’s operating agreement included mandatory rights of first refusal — with which the minority member never complied — that displaced the buyout statute’s default rule.

The case, Matter of Jacobs v Cartalemi, was decided last week by the Appellate Division, Second Department, along with two decisions in companion appeals in related cases in which the court held that upon withdrawal the minority member also lost his standing to pursue derivative claims against the controlling member. I’ll explain all below, but before doing so I must disclose that, along with co-counsel, my firm and I represent the controlling member of the LLC in each of the cases. Continue Reading Operating Agreement Defeats Statutory Buyout Rights Upon LLC Member’s Withdrawal

I wish I could take credit for it, but I can’t. The phrase “bare naked assignee” was coined by the preeminent scholar and LLC maven Professor Daniel Kleinberger whose massive oeuvre (not to mention his guest posts on this blog here and here) includes a wonderful article published in 2009 called The Plight of the Bare Naked Assignee (available here on SSRN ). As described in the abstract, the article addresses the “new and separate opportunity for oppression” that “exists because LLC law purports to (1) recognize a species of persons holding legal rights vis-á-vis the LLC (assignees) while (2) denying those persons any remedies whatsoever in connection with those rights.”

Under the LLC statutes in New York and most other states, except as otherwise provided in the operating agreement, LLC membership interests are freely assignable in whole or in part. As the Professor’s article explains, the bedrock “pick your partner” principle of partnership law found expression in the default rules of LLC statutes which, contrary to traditional corporation laws, require majority (or unanimous) consent of the other LLC members for an assignee to become a full-fledged member with both economic and voting/management rights. Typical of these statutes, New York’s LLC Law § 603 provides that, absent such consent, the assignee has no right to participate in LLC management “or to exercise any rights or powers of a member” and only has the right “to receive, to the extent assigned, the distributions and allocations of profits and losses to which the assignor would be entitled.”

The vast majority of written operating agreements that I’ve encountered include detailed articles addressing the rights of members to assign (or not) their membership interests and, when permitted, what if any rights non-member assignees possess other than the right to receive distributions and profit/loss allocations. Of course, absent an operating agreement, the rights of an assignee are governed by the statutory default rules.

The Professor’s article broadly discusses theory and case law surrounding the difficulties faced by non-member assignees a/k/a transferees — oftentimes the heir of a deceased member — when it comes to protecting their economic interests against managerial abuse by the LLC’s controllers. My focus here addresses only one, narrow aspect of such protection, namely, the ability of a non-member assignee to inspect LLC records in the absence of dispositive rules in an operating agreement or, as in what I believe is a small minority of states including Texas, a statute giving assignees inspection rights. Continue Reading Can the Bare Naked Assignee Demand Access to LLC Records?

The self-proclaimed entrepreneur and guiding force behind his soon-to-be ex-wife’s highly successful, multi-office pediatric dental practice known as Kiddsmiles is not smiling after the court in Savel v Savel, Short Form Order, Index No. 006375-15 [Sup Ct Nassau County May 19, 2017], dismissed his claim, among others, to impose a constructive trust upon 50% of his wife’s ownership interest in a series of professional limited liability companies.

The facts of the case, as presented in the husband’s complaint in his civil action, which he filed some months after he filed a separate divorce action against his wife, involve tawdry, self-incriminating allegations of illegal kickbacks for patient referrals from which the husband, who is not a dentist, personally benefitted through his separate consulting company that received the alleged kickbacks under the guise of phony “rental” payments.

Between the governing statute’s ironclad requirement that members of a dental practice organized as a professional service LLC be licensed dentists, and the husband’s admitted receipt of kickbacks for patient referrals in violation of the Public Health Law, it’s no wonder the court dismissed the husband’s claims seeking to enforce illegal arrangements. Continue Reading Divorcing Husband Not Smiling Over Court’s Rejection of Ownership Interest in Wife’s Dental Practice

Over the years I’ve litigated and observed countless cases of alleged oppression of minority shareholders by the majority. Oppression can take endlessly different forms, some more crude than others in their execution, some more draconian than others in their effect.

If there was an award for the crudest and most draconian case of shareholder oppression, Matter of Twin Bay Village, Inc., 2017 NY Slip Op 06024 [3d Dept Aug. 3, 2017], decided earlier this month by an upstate appellate panel, would be a serious contender.

The case involves a bitter dispute between two branches of the Chomiak family over a lakefront resort called Twin Bay Village located on beautiful Lake George in upstate New York. In 1957, the husband-and-wife founders, Stephan and Eleonora Chomiak, opened the summer resort on land they owned. They and their two sons, Leo and Vladimir, together ran the business until 1970 when they transferred ownership of the land and business to newly-formed Twin Bay Village, Inc. owned 26% by each parent and 24% by each son. Continue Reading And the Award For Most Oppressive Conduct By a Majority Shareholder Goes to . . .