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The distinction between direct and derivative claims pervades business divorce litigation.  Whether a dissident owner’s claim against his or her co-owners is a direct claim (one that the owner can assert in their individual capacity) or a derivative one (one that seeks to redress injury to, and therefore must be asserted on behalf of the business) factors into almost every claim we litigate, and it is one of the most common grounds for a pre-answer motion to dismiss, as this post demonstrates.    

Given the choice, most owners would prefer to assert their claims directly.  Derivative claims beget a host of prerequisites and considerations: has the pre-suit demand requirement been complied with? Can the corporation take the litigation out of a shareholder’s hands by appointing a special litigation committee?  If successful on the claims, what assurances does the shareholder have that the corporation’s recovery will be passed on to the shareholders? 

For that reason, we sometimes see shareholders or LLC members utilize artful pleading strategies to cast their claims as direct ones.  But the Tooley test—the standard, under both Delaware and New York law to determine whether a claim is direct or derivative—is a good one.  By considering (1) who suffered the alleged harm (the corporation or the stockholders); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually), Courts and attorneys usually can spot the differences between a direct claim and a derivative one.

A recent decision from the Southern District of New York, Miller v Brightstar Asia, 20-CV-4849 (SDNY Sept 11, 2023) considers a shareholder’s reliance on the implied covenant of good faith and fair dealing inherent in the corporation’s shareholders agreement in an attempt to plead what otherwise would be derivative claims as direct ones.

Continue Reading Derivative into Direct and Waived into Preserved: The Transformative Power of the Implied Covenant of Good Faith and Fair Dealing

With the growing prevalence of limited liability companies, notable general partnership decisions become fewer and further between with each passing year.

A common fact pattern in which increasingly rare general partnership decisions continue to arise is family general partnerships founded decades ago by prior generations, with the current younger generation of partners, often siblings or cousins, finding themselves unwilling or unable to agree either upon a new entity structure (i.e., conversion to an LLC), or to disposition of the entity’s assets (i.e., sale to a third party).

In the absence of an agreement to the contrary, New York law imposes a requirement of unanimity upon either decision.

Inability to Achieve Unanimity Begets Conflict

Section 1006 (c) of the Limited Liability Company Law provides that a general-partnership-to-LLC-conversion “must be approved by all of the partners of the partnership. . . .” Noncompliance with the statute renders an attempted conversion “ineffective” (Miller v Ross, 43 AD3d 730 [1st Dept 2007]).

Likewise, Section 20 (c) (3) of the Partnership Law provides that “less than all the partners have no authority” to “[d]o any . . . act which would make it impossible to carry on the ordinary business of the partnership.” Cases applying Partnership Law § 20 (c) (3) hold that sale of a single real estate asset owned by a general partnership would make it impossible to carry on the business of the partnership, causes the partnership’s dissolution by operation of law, and therefore, requires unanimity, lack of which renders the attempted sale “null and void” (Camuso v Brooklyn Portfolio, LLC, 164 AD3d 739 [2d Dept 2018]).

The unanimity requirement for either of these important strategic transactions can make it exceedingly difficult to find a path forward if just one general partner withholds consent. It is, in fact, a recipe for deadlock.

The flipside of the unanimity requirement is that – at least in theory – partners of a general partnership at-will are free to disassociate from one another at any time without liability, which causes the entity’s dissolution by operation of law, after which the entity is supposed to liquidate its assets as part of its wind up.

I say “in theory” because in a lawsuit resulting in a recent decision by Brooklyn Commercial Division Justice Leon Ruchelsman, three sibling partners of a New York general partnership without a partnership agreement have found it exceedingly difficult – despite many years of litigation – to disassociate themselves from their antagonistic brother over their disagreement about what to do with the entity’s sole asset, an apartment building in Brooklyn.

All partners but one wanted to sell. The lone holdout, Arthur, refused. Litigation ensued. As the majority partners have learned to their immense frustration, breaking up – even in a general partnership at-will – can be hard to do.

Continue Reading A General Partnership in Perpetual Enmity

Earlier this year, using as a springboard the Maryland intermediate appellate court’s decision in Eastland Food Corp. v Mekhaya, I posted about a topic on which there’s little or no New York law, viz., whether a complaint for minority shareholder oppression stated a valid claim centered on allegations that the directors/majority shareholders, instead of declaring profit distributions for all shareholders, were taking disguised distributions in the form of excessive compensation and year-end bonuses.

The appellate court answered the question in the affirmative. The plaintiff, a frozen-out 28% shareholder of a family-owned business founded by his father, also won on appeal reinstatement of his complaint’s direct claims for breach of fiduciary duty and unjust enrichment.

The defendants appealed to the Maryland Supreme Court. Last month, that court handed down a 35-page majority opinion affirming the lower appellate court’s decision upholding the oppression claim, but dismissing the claims for fiduciary breach and unjust enrichment.

Two of the court’s seven Justices, including its Chief Justice, concurred in a 50-page opinion in which they agreed with the outcome on all three counts, but disagreed with the majority’s analysis of the fiduciary breach claim, contending that the law supports a direct claim against directors for paying themselves disguised distributions, and inviting the plaintiff to pursue the claim upon remand by seeking remedies other than money damages.

Continue Reading Eastland Redux: Do Close Corporation Shareholders Have a Direct Claim Against Directors For Taking Disguised Distributions?

Do New York’s Surrogate’s Courts have jurisdiction to compel an accounting related to a non-party limited liability company in which the decedent’s estate has only a minority interest?

Do Surrogate’s Courts have the power to compel an accounting of an LLC where the party seeking an accounting is not a current member of the LLC?

New York County Surrogate Rita Mella tackles both of these questions in Matter of McKelvey (2023 NY Slip Op 32680(U) [Sur Ct, NY County Aug. 3, 2023]).

Continue Reading Surrogate’s Court Jurisdiction to Resolve Close Business Owner Disputes

Potential client sits down with business divorce lawyer and says, “I’m a minority shareholder in XYZ Corp. I’ve been completely frozen out by the majority. Can you help me?” The lawyer says, “Absolutely. New York law gives you the right to ask the court to dissolve the corporation as a remedy for minority shareholder oppression. You can also ask the court to compel a buyout even if the majority doesn’t elect to do so. Tell me, what did the majority do and when?” Potential client starts to answer, “About ten years ago they fired me, threw me off the board, took me off the K-1s, . . .” at which point the lawyer cuts in, “What? Ten years ago? Why have you waited so long?”

Potential client explains that he tried to negotiate a buyout, but when that didn’t happen he took a job in California where he lived for the next eight years while the freeze-out stayed back-of-mind, went through a difficult matrimonial divorce, and that eventually he returned to New York, saw that his old company was flourishing, and finally decided to speak with a lawyer.

The lawyer responds, “Before we go any further, I need to check out the statute of limitations to see if you still can bring an oppression action. I have some concern.”

Some concern is right. In the typical fact pattern giving rise to an oppressed minority shareholder’s petition for judicial dissolution, there’s little mystery about the occurrence and timeline of the kinds of events typically constituting oppressive conduct:

  • The petitioner’s employment is terminated.
  • The petitioner is removed as an officer of the corporation.
  • The petitioner is removed as a director of the corporation.
  • The petitioner’s shares are improperly diluted.
  • The petitioner’s distributions are shorted or cut off.

The list goes on. The point is, given the discrete, fixed-in-time nature of the oppressive acts, rare is the minority shareholder who doesn’t know they’re being oppressed when they’re being oppressed. Just as rare is the minority shareholder who doesn’t take some remedial action — whether negotiating a buyout or other out-of-court resolution, or suing — if not right away, within a reasonably short period of time.

Which partially explains the infrequency of court decisions addressing challenges by controlling shareholders to judicial dissolution petitions by oppressed minority shareholders based on the statute of limitations.

The rest of the explanation comes from the applicable six-year statute of limitations (CPLR 213[1]) under which, as the Appellate Division held in 1996 in DiPace v Figueroa, the six years runs from the “instances of alleged wrongdoing adverted to by [the petitioner] as grounds for dissolution.” If an oppressed minority shareholder hasn’t gotten satisfaction and hasn’t sued within six years of whatever misfortune befell him, her, or it, chances are there’s little or nothing worth suing over.

Or maybe not. At least, that must have been the thinking of the petitioner in Apostolopoulos v Oxford Associates Group, Inc., who, 14 years after allegedly being frozen out, sought judicial dissolution under New York’s minority shareholder oppression statute of two real estate holding corporations co-owned by herself and her co-owner. The lower court initially denied a motion to dismiss the petition as time-barred. Earlier this month, however, the Appellate Division reversed the lower court’s ruling and dismissed the petition as untimely. Let’s take a closer look.

Continue Reading When Is It Too Late to Sue for Shareholder Oppression?
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The authors of this blog have a special affinity for fair value appraisal proceedings.  The narrow hearings—where the sole issue before the court is the fair value of an owner’s interest in a business—require attorneys and appraisers to understand, convey, and advocate on both the intricacies of the business, and complex (and sometimes esoteric) valuation issues.  Any miscalculation on methodology, assumptions, normalizations, or any of the countless factors that business appraisers consider can produce a major swing in valuation. 

That affinity, plus all of the business divorce circumstances from which an appraisal proceeding can spawn (the death or retirement of a partner under Partnership Law § 73, a buyout election under BCL § 1118, a member’s withdrawal under LLC Law § 509, and the cash-out merger, to name a few), plus the many complex, deeply interesting issues that can dominate a valuation proceeding, stokes a healthy appetite among business divorce lawyers and appraisers for new valuation guidance from the courts.

With that appetite in mind, I’m delighted to blog about a recent decision from New York County Commercial Division Justice Jennifer Schecter, Rosenthal v Erber, No. 650771/2021 (Sup Ct, NY County 2023).  The Court’s detailed analysis of the competing business appraisals—informed by its own obvious familiarity with appraisal proceedings and their issues—promises to satisfy business divorce lawyers and appraisers alike, at least until the next course. 

Continue Reading Clash of Valuation Visions: Appraisal Proceeding Over Manhattan Eyeglass Shop Goes the Distance

That was the interesting, infrequently-litigated question addressed in a recent decision by Manhattan Commercial Division Justice Melissa A. Crane.

Simon v FrancInvest, S.A. (2023 NY Slip Op 32422[U] [Sup Ct, NY County July 7, 2023]), was a summary judgment decision in a litigation still going strong after nearly ten years over a family-owned medical practice called the French-American Surgery Center (the “Surgery Center”) operating out of a valuable, family-owned condominium adjacent to Central Park in Manhattan (the “Premises”).

Continue Reading Can a Shareholder Suing Derivatively Face Countersuit Individually?

Welcome to the 13th annual edition of Summer Shorts. This year’s edition features brief commentary on five recent decisions by New York courts in a variety of business divorce cases involving equitable contribution among partners; preferred shareholder redemption rights; LLC manager indemnification rights; shareholder books-and-records access; and statute of frauds defense to equity ownership claims. Click on the case names to read the decisions.

Court Denies Equitable Contribution Claim Against Former Partners

Esterson v Spring, 2023 NY Slip Op 32219(U) [Sup Ct NY County June 30, 2023]. This interesting case falls in the category of post-business divorce disputes. The winding down of an architectural and engineering firm organized as an LLP initially went smoothly, with the three partners agreeing to complete existing jobs and collect receivables to pay off the firm’s bank loan which the three had personally guaranteed jointly and severally. After some months, with the consent of all three, two of the partners voluntarily withdrew for no consideration while continuing to assist with collections, leaving the third partner (Mr. Spring) in sole control.

Continue Reading Summer Shorts: Equitable Contribution, Stock Redemption, and Other Recent Decisions of Interest
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MiniCorp has five shareholders, all of whom are employees.  Each shareholder’s employment agreement states that they are an at-will employee of MiniCorp, and the shareholders agreement provides that when a shareholder’s employment terminates for any reason, MiniCorp shall redeem their shares for book value.

After years of middling success, MiniCorp is on the verge of making it big: a closing competitor and well-timed celebrity endorsement are poised to send sales of its signature product through the roof.

Three of MiniCorp’s five shareholders decide that they would rather split their windfall three ways than five.  They call a shareholders meeting, vote to terminate two employee-owners, then redeem their shares at book value.  The ousted shareholders sue, alleging that the majority breached their fiduciary duties by forcing the redemption of their shares for the sole purpose of cutting them out of MiniCorp’s success.  MiniCorp moves to dismiss.  How does the court rule? 

  • Ousted shareholders win.  Shareholders in a close corporation owe each other fiduciary duties.  And it is a breach of those fiduciary duties where the majority exercises even legitimate rights, “if the sole purpose is reduction of the number of profit-sharers, or ultimately ‘to increase the individual wealth of the remaining shareholders’” (Alpert v 28 Williams St. Corp., 63 NY2d 557, 564 [1984]).  This means that where a shareholders agreement contains a redemption clause, those in control of corporation must still exercise those rights in accordance with their fiduciary duties.
  • MiniCorp wins.  “At-will employment” means what it says: subject to certain legislative exceptions, an employer can terminate an employee for any reason whatsoever—even one that would be a breach of fiduciary duty.  And the redemption clause in the shareholders agreement is simply an automatic consequence of the employment decision that MiniCorp had absolute authority to make; fiduciary duties do not extend to employees.
Continue Reading At-Will Employment Agreement Plus Mandatory Redemption Clause Leaves Minority Shareholder-Employees Out in the Cold