Appearances can be deceiving.

That, essentially, was the argument made in two recently decided cases involving claims for judicial dissolution. In one, an LLC member with bad credit assigned her 50% interest to the other 50% member who then, representing herself as the 100% owner, secured a mortgage loan from a bank from which the assignor and assignee concealed a written side agreement stating their intent to remain “equal partners” in the LLC.

In the other, the buyer under a stock purchase agreement assigning a 75% share in a restaurant business claimed that he actually acquired a 100% interest. According to the buyer, he acquired and paid for the other 25% in the form of a contemporaneous no-show employment agreement done for tax purposes.

In the first case, the court denied summary judgment and left for trial the determination whether enforcement of the side agreement was permissible. In the second case, the court refused to treat the employment agreement as a disguised vehicle for conveyance of the remaining 25% and granted the dissolution petition.

Continue Reading Disguised Agreements and Dissolution

The harried realities of modern life are such that business entity organizational documents, like LLC operating agreements, sometimes do not get drafted or executed until long after the entity’s initial formation with the filing of articles of organization.

In other cases, particularly where an LLC has many members, the operating agreement may not even reach a state of total execution, with some members signing, others not, but the parties behaving as if they had agreed to the written document.

In Abraham 2008 Family Trust v 391 Broadway LLC, Decision and Order, Index No. 653460/2021 [Sup Ct, NY County Oct. 5, 2021], Manhattan Supreme Court Justice Arthur F. Engoron considered a challenge to enforceability of a written operating agreement raising two related issues of due execution of an operating agreement:

  • Can a court find potentially enforceable a written operating agreement signed by just a handful of the entity’s large roster of members?
  • Does Section 417 (c) of the Limited Liability Company Law (the “LLC Law”), which states that an operating agreement “may be entered into . . . within ninety days after the filing of the articles of organization,” render unenforceable operating agreements dating many months or years after filing of the articles?

Continue Reading Cooked or Raw? Enforceability of Partly Signed Operating Agreements

Valuation discounts can and often do play an outsized role in contested appraisal proceedings involving the valuation of equity interests in closely held business entities for which there is no public market. This is certainly true in appraisal contests applying the fair market value (FMV) standard generally used in gift and estate tax matters and matrimonial cases, under which accredited business appraisers must consider applicable discounts including the two most common and potentially largest discounts for lack of control (a/k/a minority discount a/k/a DLOC) and lack of marketability (a/k/a marketability discount a/k/a DLOM). See ASA Business Valuation Standards BVS-VI, Part IV; Statements on ASA Business Valuation Standards, SBVS-1, Part VI, SBVS-2, Part VI; ASA Procedural Guidelines PG-2.

In most states, the merger statutes granting appraisal remedies to dissenting equity owners and the judicial dissolution statutes authorizing buyouts dictate the use not of the FMV standard but, rather, the legislative construct known as the fair value (FV) standard. At the risk of oversimplification, the difference between FMV and FV is that, unlike FMV, the FV standard either statutorily or under judge-made law prohibits DLOC and DLOM, although New York’s version of FV prohibits DLOC and allows (but does not compel and sometimes disallows on a case-by-case basis) DLOM. The philosophy underlying the disallowance of one or both DLOM and DLOC under the statutory FV standard was expressed as well as anywhere by the Delaware Supreme Court in its 1989 ruling in the Cavalier Oil case, where it wrote:

Discounting individual share holdings injects into the appraisal process speculation on the various factors which may dictate the marketability of minority shareholdings. More important, to fail to accord to a minority shareholder the full proportionate value of his shares imposes a penalty for lack of control, and unfairly enriches the majority shareholders who may reap a windfall from the appraisal process by cashing out a dissenting shareholder, a clearly undesirable result.

The seemingly neat distinction between the application of DLOC and DLOM, on the one hand, under the FMV standard derived from appraisal doctrine in non-statutory appraisal proceedings (allowed) and, on the other hand, the FV standard derived from legislative/judicial edict in statutory buyout proceedings (generally not allowed), came under attack in a recent California intermediate appellate court’s 2-1 decision in Pourmoradi v Gabbai.

The case involves an LLC judicial dissolution proceeding in which the respondent 50% member elected to purchase the interest of the 50% petitioning member in lieu of dissolution, as permitted by the governing statute. The two-judge majority reversed the trial court’s valuation insofar as it rejected aggregate DLOC/DLOM discounts of 25% proposed by the respondent’s appraiser and 20% proposed by a court-appointed neutral appraiser. The dissenting judge would have upheld the trial court’s determination on fairness grounds reminiscent of those articulated in Cavalier Oil. Let’s take a closer look. Continue Reading Statutory Buyouts and Discounts Under the Fair Market Value Standard: An Awkward Pair?

If ever there was a ticking time bomb of a family-owned, closely held business more likely to result in business divorce litigation than the one in Matter of Brady v Brady, 2021 NY Slip Op 02705 [4th Dept Apr. 30, 2021], I haven’t seen it.

In Brady, the explosive mixture included:

  • A family patriarch in his late 80s who owns and tightly controls highly valuable farmland held in corporate entities.
  • Sibling rivalry among the three sons brought into the family farming business.
  • A pending matrimonial divorce between the patriarch and his second wife and the mother of the youngest of his three sons.
  • No shareholder or buy-sell agreements.
  • No apparent succession plan.
  • No apparent master plan coordinating the father’s lifetime gifting of land and the sons’ stock ownership.
  • No adherence to corporate formalities.
  • Commingling of business and personal finances.
  • Poor recordkeeping.
  • Lack of transparency.

Don’t get me wrong. Lack of formalities, lack of shareholder agreements, lax accounting, and poor or absent succession planning are common among family-owned businesses and don’t inevitably lead to dissension much less litigation when family bonds and trust remain strong. Likewise, whether and to what extent these shortcomings benefitted some or all of the various stakeholders in the Brady case before things went wrong, I can’t say. But once relations soured, they went predictably wrong, leading to the Appellate Division, Fourth Department’s recent decision affirming the lower court’s order summarily granting the youngest son’s petition for judicial dissolution of Brady Farms, Inc., which owns over 400 acres of valuable farmland in upstate Livingston County, New York. Continue Reading This Is Not Your Father’s Brady Bunch

We often cover preliminary injunctions on the pages of this blog because they are a powerful tool in the business divorce litigator’s toolbox: they force court action early in the case, they can protect rights that are difficult to monetize, and they set the tone for the litigation going forward.  Requests for preliminary injunctions generally come early in the case, and they seek to impress upon the court the need for immediate action in order to maintain the status quo.

When a closely-held business threatens to reorganize its ownership to the exclusion of one owner, courts are receptive to requests for preliminary injunctions enjoining the restructuring until the ownership dispute can be sorted out in litigation.  See this court’s enjoining dilution of an LLC member’s interest, or this court’s enjoining a freeze-out merger cancelling an owner’s shares.

Both of these cases featured, to some degree, a race between the parties.  The company notified the owner that the dilution or freeze-out would occur on a certain date, and the owner scrambled to request a preliminary injunction enjoining that action before that effective date.  While it can seem trivial, that race is critical.  Because a preliminary injunction is designed to maintain the status quo, courts are far more likely to enjoin action before it happens than undo it after the fact.  That’s the tough lesson that an LLC member facing termination of his membership status learned in Costello v Molloy et al., 73 Misc 3d 1206(A) [Sup Ct 2021].

Continue Reading Too Little, Too Late: Court Sides with Ousted Member, but Denies Preliminary Injunction Undoing Termination

Ownership status in a closely-held business is the first and most vital box almost every business divorce petitioner must check.

Equity ownership is the sine qua non of many essential legal rights in the business divorce litigant’s toolkit, including standing to sue for dissolution, to sue derivatively on behalf of the entity, to bring a books and records proceeding, etc.

Evidence of Ownership in Business Divorce Cases

Proof of ownership status comes in many forms. It is surprising to some that the absence of stock certificates, on its own, “does not preclude a finding that a particular individual has the rights of a shareholder” (Zwarycz v Marnia Const., Inc., 130 AD3d 922 [2d Dept 2015]). Aside from stock certificates, courts may consider any and all “other available evidence” to determine “whether a putative shareholder in fact and law enjoys that status” (Kun v Fulop, 71 AD3d 832 [2d Dept 2010]).

What evidence do courts consider to determine ownership status? Courts look at many factors, including the exchange of consideration to acquire equity either in the form of cash or provision of labor, issuance of ownership certificates, corporate resolutions, meeting minutes, internal financial documents, loan documents and guarantees of corporate debt, the holding out to the public of individuals as owner or non-owner, etc. A wonderfully thorough treatment of these various “indicia” of ownership status is found in the post-trial, lower court decision in Matter of Pappas v Corfian Enters., Ltd., 22 Misc 3d 1113 [A] [Sup Ct, Kings County 2009], affd 76 AD3d 679 [2d Dept 2010].

And then there are tax returns, which have spawned an ever-expanding universe of litigation on the issue of the extent to which a tax return alone can prove whether an individual is, or is not, an owner of a closely-held business. This article will focus on two competing strands of New York case law, each rooted in a single New York Court of Appeals decision, one strand holding that tax returns are not determinative of ownership status in a closely-held business, the other holding that they are dispositive. Continue Reading The Doctrine of Tax Estoppel in Ownership Status Disputes

Any shareholder, partnership, or LLC agreement that doesn’t include a well-crafted buy-sell provision triggered by an owner’s death, withdrawal, expulsion, disability, or other separation event is an agreement asking for trouble. Put otherwise, the absence of a public market for equity interests in a closely held business virtually assures that a poorly conceived or non-existent buy-sell agreement is a dissension and litigation breeder. The potential for hostilities exists both before and after a trigger event when the buy-sell provision fails to offer fair value, or fails to include the necessary parameters for an appraisal process, or imposes grossly unfair payment terms.

To the rescue comes estate planner and buy-sell agreement maven Paul Hood with his new book, Buy-Sell Agreements: The Last Will & Testament for Your Business. Paul’s background as a tax lawyer and estate planner, as well some family history involving a buyout of his grandfather when Paul was a boy, drew his interest to buy-sell agreements which became a major focus of his long career.

Contrary to its morbid subtitle, Paul’s book lays out in carefully organized fashion a detailed, comprehensive set of the practical, financial, tax, insurance, and other considerations that go into the drafting of a buy-sell agreement designed to allow business continuity and liquidity for a departing owner. The book is a terrific resource for lawyers and other professional business advisors. But it’s also written for business owners as an educational tool allowing them to have informed discussions with their professional advisor engaged to draft the business’s organizational documents including the buy-sell.

I recently interviewed Paul about his book and some of the issues surrounding buy-sell agreements for the Business Divorce Roundtable podcast. I guarantee you’ll find his commentary as sparkling as it is informative. I invite you to give it a listen by clicking the below link.

 

 

Business divorce has a way of drawing quick and often lopsided battle lines. Many disputes in closely-held companies feature one outspoken owner feuding with a united group of the remaining owners over management or participation in the company. Depending on the ownership percentages held by each faction, corporate shareholders on either side of those battle lines have at their disposal a broad range of potential remedies under both the BCL and the common law—freeze outs, dissolution proceedings, claims for money damages, and bids for injunctive relief, to name a few.

Disputes of this variety are often resolved with a buyout of the outspoken owner. Other times, the parties agree that the dissident owner remains an owner, but forfeits any right to an active role in the company and agrees to stay away from company operations. For instance, a corporation agrees to some schedule of regular payments (whether salary, distributions, or some mix of the two) to the dissident shareholder, and in return, the complaining shareholder butts out of company business; he agrees to have no role in the company’s management and foregoes his right to sue the company or other shareholders for anything other than non-payment of his regular due. When his vote as a shareholder is required, he agrees to simply vote his shares in accordance with the recommendation of the board of directors.

“Stay away” settlement agreements like this one have some obvious appeal: they satisfy (and silence) the outspoken shareholder without requiring the company to immediately come up with the cash that a buyout would require. But there are downsides: disputes may arise over the payments, flaws in the settlement documents may be leveraged by either side, and, ultimately, the fighting factions remain joint owners.

This week’s post considers one potential pitfall to stay away settlement agreements: what happens when the outspoken shareholder dies? In Stile v C-Air Customhouse Brokers-Forwards, Inc., Index No. 656575/2020 [Sup Ct, New York County 2021], the New York County Supreme Court declined to dismiss a suit by the estate of a shareholder subject to a stay away settlement agreement on the grounds that the stay away obligations did not expressly apply to the shareholder’s successors.

Continue Reading Stay Away Settlement Between Closely-Held Corporation and Dissident Shareholder Goes Away Upon Shareholder’s Death

Who says email is more efficient and cheaper than regular mail?

Not the manager of the McGuire family real estate business after winning a lower court ruling only to see it reversed on appeal last month in a decision agreeing with his siblings that his issuance of dilutive capital calls, notice of which he emailed to them, was ineffective because the governing LLC agreement required all notices to be sent by first class mail.

The case and the decision by the Appellate Division, Fourth Department in McGuire v McGuire is not as simple as it sounds. Permit me to explain.

According to the complaint filed by three of the six McGuire siblings (referred to collectively by their first name initials, JKM) against their brother James, in the 1990s all six obtained equal membership interests in a number of holding companies originally formed by their father that owned dozens of commercial real properties as well as health care businesses and skilled nursing facilities. In 2006, James formed a real estate development and property management company, McGuire Development Co., LLC (MDC), also owned in equal percentages by all six siblings, to manage the McGuire family business empire. Continue Reading Court Cancels Capital Call For Want of a Postage Stamp

Most folks associate beer with pleasure. Beer brings the happy, and many craft brewers will tell you they went into business for that very reason. But an investor in a Bushwick, Brooklyn beer brewing company and taproom startup was anything but happy after his co-members began taking steps to dilute his membership interest in the limited liability company, resulting in fast and furious litigation and an immediate injunction motion to halt the alleged “freeze out.”

According to his complaint, Peter Lengyel-Fushimi (“Peter”) was a molecular biologist by training who decided to pursue his passion for craft beer making and “dedicate his life to beer.” Peter “committed himself to his new goal of opening a brewery,” took a series of apprenticeships in local breweries to learn the trade, and ultimately partnered with Anthony Bellis (“Anthony”) and Zachary Kinney (“Zachary”) to form Kings County Brewers Collective, LLC (the “Brewery”).

In 2014, Peter, Anthony, and Zachary entered into an Operating and Subscription Agreement, according to which each became a manager and 25.33% “Class A” membership interest holder, collectively owning 76% of the Brewery. The remaining 24% membership interests were sold to investors denominated “Class B” and “Class C” interests, the Class B member having limited voting rights, and the Class C members no voting rights only an economic interest. Peter held the title of Head of Beer Production / Operating Manager.

Important for his later injunction application, a standard merger and no-oral-modification provision in Section 10.1 of the Operating Agreement provided, “This agreement constitutes the whole and entire agreement of the parties with respect to the subject matter of this agreement, and it shall not be modified or amended in any respect except by a written instrument executed by all of the Members.”

Continue Reading Court Enjoins Dilution of Brewing Company LLC Membership Interest