Stock Transfer Restrictions

When you want to sue to dissolve a business in New York on behalf of the estate of a deceased shareholder, to which court should you go: Supreme or Surrogate’s Court?

For many practitioners, the Commercial Division of the Supreme Court, a specialized court in New York focusing on complex business-related disputes, is the venue of choice. Most types of disputes have a minimum monetary threshold for eligibility in the Commercial Division. Manhattan’s threshold is the highest – $500,000.  The rules of eligibility for cases to be heard in the Commercial Division, which you can read here, have three exceptions to the monetary threshold – one of which lists “[d]issolution of corporations, partnerships, limited liability companies, limited liability partnerships and joint ventures — without consideration of the monetary threshold.” In part because there is no monetary threshold for dissolution proceedings, practitioners in the several New York counties that have a Commercial Division usually litigate business dissolution disputes in the Commercial Division.

But once in a blue moon a dissolution case will wind up in the Surrogate’s Court. Continue Reading Surrogate’s Court Declines to Order Demise of Fashion Business

Freeze-out2Unless otherwise provided in the operating agreement, majority members of LLCs formed under New York law — and under the LLC laws in most other states — effectively can expel a minority member by implementing a merger with another company owned by the majority members. The so-called freeze-out merger (a/k/a cash-out merger) compels the minority member to accept cash for his or her membership interest in lieu of equity in the surviving entity. The statutes generally protect the frozen-out member to the extent of providing the right to dissent from the merger and to demand a fair-value judicial appraisal.

As best as I can tell, until last month there were exactly four reported court decisions in New York involving challenges to LLC freeze-out mergers, each of which I’ve covered on this blog. In three of them — the Stulman case, the Alf Naman case, and the Slayton case — trial judges rejected various procedural and substantive objections to the mergers by the minority members. In the fourth case (SBE Wall), the trial judge denied a motion to dismiss an action seeking to invalidate a freeze-out merger, but the merger was never enjoined or rescinded and the case eventually settled.

Along comes a fifth case decided last month by Manhattan Commercial Division Justice Charles E. Ramos — who also decided the Stulman case — in which he denied the frozen-out minority members’ preliminary injunction motion seeking to enjoin the merger’s implementation after finding no basis for the minority members’ claim that the merger breached the operating agreement. Huang v Northern Star Management LLC, 2016 NY Slip Op 32194(U) [Sup Ct NY County Oct. 24, 2016]. Continue Reading Court Finds No Breach of Operating Agreement, No Basis to Enjoin LLC Freeze-Out Merger

4CThe case I’m about to describe involves an unusual clash of two fundamental principles of corporate governance for closely held corporations:

Principle No. 1:  Stock transfer restrictions may be used to preserve continuity of ownership and management within a family or other control group, without violating the common law rule against unreasonable restraints on alienation of property.

Principle No. 2:  Controllers owe a fiduciary duty to treat all shareholders fairly and evenly when authorizing and issuing new shares, and must have a bona fide business purpose for any departure from precisely uniform treatment.

The clash came to a head in a decision this month by Brooklyn Commercial Division Justice Lawrence Knipel involving 4C Foods, a well-known, fourth generation, family-owned business that manufactures and markets under the 4C® brand grated Italian cheeses, bread crumbs, iced tea, and drink mixes. The suit pits Nathan Celauro, a non-managing, minority owner holding directly or beneficially about 22% of 4C’s voting and non-voting shares, against his cousin John Celauro, the managing majority shareholder who controls or has aligned with him the remaining 78%. (Disclosure: Farrell Fritz represents the minority shareholder in the case.)

The case and Justice Knipel’s decision in Celauro v 4C Foods Corp., 2016 NY Slip Op 31917(U) [Sup Ct Kings County Oct. 12, 2016], is the latest in a series of litigations and court rulings between two factions of the Celauro family beginning around 2005, following the death of Nathan’s father the year before. About 20% of the father’s voting and non-voting shares passed to his wife either directly or to trusts under her control, with the remaining 2% going directly to Nathan. Continue Reading Too Clever By Half? Court Permits Suit Challenging Share Increase Tied to Transfer Restrictions

bananasAs Thomas Hoey, Jr., the formerly wealthy, self-proclaimed “Banana King,” sits in his prison cell serving lengthy sentences for beating up his mistress and for what the New York Post describes as “his callous attempt to cover up a wild coke orgy in a Manhattan hotel room that ended with one woman dead of an overdose,” and as he awaits sentencing for his subsequent conviction for stealing from the employee pension fund of his bankrupt, wholesale banana company, I suppose the least of his concerns is a civil court ruling last month throwing out his lawsuit seeking to enforce his assignment to his estranged wife of his membership interest in two real estate holding LLCs.

His loss is our gain, at least to those interested in the law governing transfer of LLC interests.

New York LLC Law § 603 sets forth the basic default rules governing assignment of LLC membership interests. Except as provided in the operating agreement:

  • membership interests are assignable in whole or in part;
  • assignment does not entitle the assignee to become a member or to exercise any membership voting or management rights; and
  • the assignment’s only effect is to entitle the assignee to receive distributions and allocations of profits and losses to which the assignor would be entitled.

Under LLC Law § 604 (a), except as provided in the operating agreement, an assignee can become a member only upon the consent of at least a majority in interest of the members excluding the assignor. Continue Reading How Good is Your Operating Agreement’s Anti-Assignment Clause?

A Manhattan appellate panel’s two-page decision in Gartner v Cardio Ventures, LLC, 2014 NY Slip Op 07423 [1st Dept Oct. 30, 2014], offers a dry account of a disputed transfer of an LLC membership interest, in which the court held that the terms of an LLC subscription agreement did not bar the transfer otherwise permitted under the LLC Law’s default rules.

But the story behind the decision is anything but dry. As revealed in papers filed in the lower court proceedings, the suit was brought by the ex-husband of the transferee in an attempt to frustrate a Florida court’s final judgment of divorce, requiring him to transfer to his wife one half of his membership interest in a company that operates physical therapy offices at multiple New York locations. The judgment further provided that if the transfer couldn’t be done, the wife would receive the net economic benefits of the half-interest.

Soon after the divorce judgment was entered, the husband signed a court-approved transfer document instructing the LLC to transfer half his 4% interest to his wife. The other LLC members promptly executed a consent to the transfer, admitting the wife as a 2% member.

The now ex-husband, who had fiercely resisted the transfer in the Florida divorce proceedings and had signed the transfer directive under the court’s threat of contempt, subsequently filed suit in Manhattan Supreme Court against the LLC, its managers, and his ex-wife, claiming that the transfer was “unauthorized” and “illegal,” and should be rescinded, because of language in his LLC Subscription Agreement purportedly barring the transfer of membership interests. Continue Reading LLC Subscription Agreement No Bar to Transfer of Membership Interest

Shifting alliances. Pacts made and broken. Territorial disputes. Sounds like nations at war, but it also describes an unusual, three-way battle over a real estate partnership being waged in Brooklyn Supreme Court in which Commercial Division Presiding Justice Carolyn E. Demarest (pictured) recently dealt with the fundamental question: Can someone become a partner absent compliance with the partnership agreement’s transfer restrictions?

Justice Demarest answered “yes” in a decision earlier this month, in Camuso v Brooklyn Portfolio LLC, 2014 NY Slip Op 50940(U) [Sup Ct, Kings County June 9, 2014]. Essentially, she found that each of the two 50% partners separately had validated the transfer of a 25% interest by one of them to his ex-wife, by means of stipulations in prior legal proceedings and in partnership tax returns identifying the ex-wife as a partner, resulting in a three-way, 50/25/25 partnership.

The ultimate issue in the case is the validity of a $5.9 million contract, executed on the partnership’s behalf solely by the remaining 50% partner, for the sale of the partnership’s realty to a third-party buyer. The court’s ruling didn’t resolve the contract’s enforceability, instead finding an issue of fact whether other provisions in the partnership agreement and the Partnership Law require unanimous partner approval for the sale.

Continue Reading Divorce Settlement, Tax Returns Trump Partnership Agreement’s Transfer Restrictions

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

When one of a handful of shareholders in a close corporation decides to sell his shares to another shareholder, is the buying shareholder obligated to offer the other remaining shareholders the opportunity to participate in the purchase on an equal basis? In the absence of a shareholders’ agreement regulating such transfers, is there a common law fiduciary duty to share the shares with the remaining shareholders?

If you answered these questions “no,” you’ll take comfort in a decision issued last week by Kings County Commercial Division Justice David Schmidt in a case called Varveris v. Zacharakos, 2012 NY Slip Op 50947(U) (Sup Ct Kings County May 24, 2012), turning down a bid by a disappointed shareholder to require equal participation in the purchase of a departing shareholder’s shares.

Varveris involves a real estate business known as Jarc Realty Co. formed in 1986 to own and operate a residential apartment building in Brooklyn. Upon incorporation, Jarc’s 200 shares were issued and distributed equally among four shareholders: Zacharakos, Sichenze, Kristiansen and Varveris. After Zacharakos transferred his shares to his wife in 1999, he continued to serve as president. A company initially owned by Zacharakos, and later transferred to his daughter, manages the property.

Continue Reading There’s No Fiduciary Duty to Share and Share Alike for Shares of Stock

The P.C., as in professional service corporation, has been called a “strange creature.”  The strangeness stems mainly from the statutory restrictions on the voluntary or involuntary transfer of ownership in a P.C. to persons who are not licensed members of one of the regulated professions permitted to utilize the P.C. business form under Title 8 of the Education Law, including lawyers, doctors, dentists, accountants and miscellaneous others.

In New York, P.C.s are governed by the same general provisions of the Business Corporation Law (BCL) applicable to all for-profit business corporations, including Articles 10 and 11 of the BCL governing voluntary and judicial dissolution.  The P.C. ownership transfer restrictions, along with other provisions specific to the formation, operation, limited liability and disposition of P.C.s, are collected in Article 15 of the BCL.  The somewhat obscure interplay between the general dissolution provisions in BCL Articles 10 and 11 and the P.C. ownership transfer restrictions in Article 15 can create havoc for the professional in a multi-member P.C. who fails to appreciate those provisions or, worse yet, fails to enter into a shareholders’ agreement that protects the professional’s financial interests under various exit scenarios including death.

It’s hard to imagine a more painful illustration of such havoc than the case decided last week by a Brooklyn appellate court involving a P.C. dental practice in which the majority shareholder died without a shareholders’ agreement, called Matter of Bernfeld (Michael Bernfeld, D.D.S. and Yakov Kurilenko, D.D.S., P.C.), 2011 NY Slip Op 05071 (2d Dept June 7, 2011).  The deceased dentist’s widow, who had found a buyer for the practice’s assets for over a half million dollars, now stands to walk away empty handed as a result of the statutory default provisions that prevent her both from seeking judicial dissolution and from resisting the surviving shareholder’s right to have the P.C. purchase her late husband’s interest possibly at negative book value.

Continue Reading Case Illustrates How Not to Plan for the Death of a Shareholder in a Professional Corporation

I’m pleased to present my third annual list of the year’s top ten business divorce cases.  This year’s crop includes some very important decisions concerning the standard for LLC dissolution, expulsion of LLC members, buyouts triggered by dissolution petitions, stock valuation, and much, much more.  All ten were featured in this blog previously; click on the case name to read the full treatment.  And the winners are: 

1.  Matter of 1545 Ocean Avenue, LLC, 72 AD3d 121, 2010 NY Slip Op 00688 (2d Dept Jan. 26, 2010), in which the Second Department differentiated dissolution of LLCs from business corporations and pronounced a contract-based standard for judicial dissolution of LLCs giving primary weight to the terms of the operating agreement.

2.  Jain v. Rasteh,  Decision and Order, Index No. 109920-09 (Sup Ct NY County Feb. 1, 2010), where the court upheld the right of the LLC’s majority member to expel a minority member for breach of the operating agreement.

 

3.  Chiu v. Chiu, 71 AD3d 646, 2010 NY Slip Op 01768 (2d Dept Mar. 2, 2010), holding that courts have no statutory authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy. 

 

4.  Matter of Superior Vending, LLC, 71 AD3d 1153, 2010 NY Slip Op 02801 (2d Dept Mar. 30, 2010), in which the court upheld as an "equitable method of liquidation" the return of the petitioner’s capital contribution in exchange for his membership interest in the LLC.

  

5.  Matter of Eklund Farm Machinery, Inc., 73 AD3d 1319, 2010 NY Slip Op 04097 (3d Dept May 13, 2010), in which the court construed BCL Section 1217 to limit the commission payable to receivers in corporate dissolution cases.

 

Continue Reading Top 10 Business Divorce Cases of 2010