Ask a trial lawyer what he or she would give to have an expert witness as effective as Mona Lisa Vito, the third-generation mechanic/out-of-work hairdresser whose testimony on positraction saved the day in Judge Chamberlain Haller’s courtroom. Their answer will tell you everything you need to know about the importance of expert witnesses.

In business divorce litigation, the expert appraisers often are the key witnesses. There are many different ways that owners of a closely-held business can find themselves litigating a special proceeding in which the sole question before the court is the appraised value of the business: 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—of course—the cash-out merger. And all these valuation proceedings turn largely on the testimony of the expert appraiser hired to value the business.

Continue Reading Challenges to Expert Appraisers in Valuation Proceedings

King Solomon, to whom authorship of Ecclesiastes 3 traditionally is attributed, unlikely had in mind the life cycle of limited liability companies when he wrote, “To every thing there is a season, and a time to every purpose under the heaven,  A time to be born, and a time to die . . ..”

It’s a bit of a stretch to suggest that King Solomon prophesied the standard for judicial dissolution of LLCs, but there it is: under New York’s judicially construed standard for involuntary dissolution under Section 702 of the LLC Law, an LLC whose management “is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved,” is destined for the chopping block.

The standard’s focus on the achievement or not of the LLC’s “stated purpose” has taken center stage in many an LLC dissolution case (and many a post on this blog, e.g., here, here, and here). A good number of these cases involve real estate holding companies whose operating agreements state the LLC’s purpose to acquire, own, develop, manage, lease, and sell (or other, similar terms) a specified real property.

Chernomordik v Ocean Sand Development, LLC, decided earlier this month by Brooklyn Commercial Division Justice Leon Ruchelsman, presents one of the more intriguing examples of a dissolution case highlighting the centrality of the purpose clause in a realty holding LLC’s operating agreement.

Continue Reading And a Time to Every Purpose Under . . . the Operating Agreement?

Food trucks have become as ubiquitous on the streets of Manhattan as pigeons in Central Park. Unsurprisingly, the New York City food truck business is highly regulated, requiring licensure of those participating in the enterprise.

For one hapless food truck investor, his hopes of securing a legal remedy for loss of his alleged equity interest in a food truck general partnership foundered on his alleged failure to obtain a vendor’s license, for which the Court found the alleged partnership “unenforceable as an unlawful contract.”

The decision, Bakr v Shaker (Decision and Order [Sup Ct, NY County Oct. 31, 2022]), is a fitting springboard to consider the common-law “illegality” defense to partnership formation and enforcement.

Continue Reading The “Illegality” Defense to Partnership Formation

Our federal courts by and large are not hospitable to business divorce litigation. The two mainstays of the federal courts’ limited subject matter jurisdiction — federal question and diversity of citizenship — typically are not present in disputes among co-owners of closely held businesses. That’s because such disputes generally feature only state law claims (e.g., breach of fiduciary duty, breach or enforcement of the owners’ agreement, judicial dissolution, dissenting shareholder appraisal proceedings, common-law business torts) between at least two citizens of the same state.

Diversity of citizenship is even more elusive in cases involving unincorporated entities such as LLCs and partnerships which, when named as parties, take on the citizenship of each of their members or partners. And even when diversity exists, courts in most if not all eleven federal Circuits routinely abstain from hearing judicial dissolution claims under the Burford abstention doctrine.

There nonetheless are the occasional business divorce cases that make it into federal court, among other scenarios, by omitting as defendants persons or entities that are not necessary parties whose inclusion otherwise would destroy diversity jurisdiction, or by including federal claims that can only pursued in federal court (e.g., copyright), or as an adversary proceeding in bankruptcy court.

Following are two recent federal court decisions of interest featuring claims among co-owners of closely-held firms. The first involves a law firm organized as a Florida limited liability partnership, the second a Delaware limited partnership that funds litigation-related financing ventures. Both were decided by judges sitting in the Southern District of New York.

While not strictly speaking involving a business divorce, I’m also throwing in for all you LLC mavens a third decision in an unusual case filed in the Eastern District of New York involving a constitutional claim against the New York Secretary of State after it declined to dissolve an LLC fraudulently filed under the plaintiff’s name.

Continue Reading Federal Courts Wade Into Business Divorce: Recent Decisions of Interest

In last week’s New York Business Divorce, we wrote about an important decision from New York’s highest court, Sage Sys., Inc. v Liss (___ NY3d ___, 2022 NY Slip Op 05918 [Ct App Oct. 20, 2022]).

In Sage, the Court of Appeals overturned a line of case law starting with Crossroads ABL LLC v Canaras Capital Mgt., LLC (105 AD3d 645 [1st Dept 2013]). Crossroads announced a judge-made presumption that in the absence of language in an LLC operating agreement expressly “limiting” an indemnity provision to third-party claims, an otherwise broadly-worded indemnification provision applies to all claims, including those between the parties to the agreement itself (so-called “direct actions” or “intra-party” disputes).

Jettisoning the presumption of Crossroads, Sage announced the opposite presumption: in the absence of express language that an indemnity agreement applies to disputes between the contracting parties, the indemnity agreement applies only to third-party claims.

The Kao Case

Continuing our exploration of the law of advancement and indemnification, we consider this week a recent decision from Manhattan Commercial Division Justice Margaret Chan, Kao v Onyx Renewable Partners L.P. (2022 NY Slip Op 33117[U] [Sup Ct, NY County Sept. 15, 2022]).

Continue Reading The Contract is King: Advancement and Indemnification Under Delaware Law

The universe works in mysterious ways. Four days ago, when I sat down to write this article, my plan was to feature a decision from Manhattan Commercial Division Justice Andrea J. Masley denying dismissal of a closely-held business owner’s complaint challenging his co-owner’s contractual indemnification under a pair of LLC operating agreements for $2.5 million in legal fees defending a separate lawsuit the same plaintiff brought and mostly lost in Delaware Chancery Court.

The Mehra Case

In the decision, Mehra v Teller (Decision and Order, Index No. 657027/2020 [Sup Ct, NY County Oct. 17, 2022]), Justice Masley held that it was not “unmistakably clear” from the language of two exceedingly broadly worded indemnification provisions that the parties intended to indemnify one another for disputes between the contracting parties (so-called “intra-party” disputes or “direct actions”), as opposed to claims by non-parties to the contract (so called “third-party” claims).

At the time, my intention was to question if Justice Masley’s holding was consistent with a burgeoning line of appellate case law starting with Crossroads ABL LLC v Caneras Capital Mgt. (105 AD3d 645 [1st Dept 2013]).

The Crossroads Line of Cases

In Crossroads, the Court ruled that where closely-held business owners “use highly inclusive language in their indemnification provision, which they chose not to limit by listing the types of proceedings for which indemnification would be required” – in Crossroads, the contract said “any and all claims, demands, actions, suits or proceedings” – the indemnification provision must be read not to “preclude intra-party claims,” entitling the parties to advancement or indemnification of legal fees in disputes between themselves.

The simplest expression of this rule is in In re Part 60 RMBS Put – Back Litig. (195 AD3d 40 [1st Dept 2021]), the Court writing that “where the indemnification is broad, in the absence of limiting language, both intra-party and third-party claims are covered.”

As best I can tell, there are now exactly seven appeals court decisions from three of the four Departments of the Appellate Division explicitly adopting this rule of construction of contract indemnification provisions to cover intra-party disputes unless otherwise specified in the agreement:

  • In re Part 60 RMBS Put – Back Litig.
  • Crossroads ABL LLC v Canaras Capital Mgt., LLC

Serendipity Strikes with Sage

Sure enough, just as I was about to start writing my article, Peter Mahler passed along a brand new decision from New York’s highest court, the Court of Appeals, issued three days after Justice Masley decided Mehra, overruling the line of case law I planned to make the focus of my article. Back to the drawing board.

In Sage Sys., Inc. v Liss (___ NY3d ___, 2022 NY Slip Op 05918 [Ct App Oct. 20, 2022]), the Court brought a climactic end to twelve bruising years of litigation, reversing an intermediate appeals court’s affirmance of a motion court’s decision granting the plaintiff, Sage Systems, Inc. (“Sage”), summary judgment for indemnification under a partnership agreement.

The Prior Proceedings

Two years ago, Peter Mahler wrote about some of the extensive prior proceedings in Sage.

In 2006, Robert Liss (“Liss”), a co-partner with Sage of a general partnership named S-L Properties (the “Partnership”), sued to dissolve the Partnership. After three years of litigation, Manhattan Supreme Court Justice Debra A. James dismissed Liss’ dissolution proceeding, holding that Liss had “unclean hands” and lacked “any evidence” to warrant dissolution.

In 2010, Sage sued Liss, alleging in its complaint a single cause of action for recovery of its legal fees defending against Liss’ unsuccessful dissolution proceeding under Section 13.02 (b) of a partnership agreement providing, in broad language:

The Partnership and the other Partners shall be indemnified and held harmless by each Partner from and against any and all claims, demands, liabilities, costs, damages, expenses and causes of action of any nature whatsoever arising out of or incidental to any act performed by a Partner which is not performed in good faith or is not reasonably believed by such Partner to be in the best interests of the Partnership . . . . (emphasis added).

A decade later, Manhattan Supreme Court Justice Barbara Jaffe, relying in her decision upon Crossroads, Crown Wisteria, WSA Group, and Healthnow, held that the indemnity provision did not “limit the types of proceedings covered by it,” and, therefore, “applies to direct claims between the partners.”

The Appellate Division affirmed, ruling in just two terse sentences, citing Crown Wisteria, that the indemnity agreement’s “broad language encompasses the recovery or attorneys’ fees” and is “not limited to third-party claims.”

The Court of Appeals Decision

Sage moved for, and was granted, permission to appeal to the Court of Appeals. Those interested can read the parties’ merits briefs here, here, and here. You can also watch the oral argument at this link.

In Sage, the Court began with a familiar principle victorious litigants love to hate: “Under the American Rule, a prevailing party” in a breach of contract dispute “may not recover attorneys’ fees from the losing party” unless the agreement contains “express language or indicia of the parties’ ‘unmistakably clear’ intent to indemnify each other for attorneys’ fees in an action between them on the contract” (quoting Hooper Assoc., Ltd. v AGS Computers, Inc., 74 NY2d 487 [1989]).

The Court noted that while the American Rule is “straightforward enough,” in the “context of private agreements” courts must often “determine the intent of vague fee-shifting language and broad indemnification provisions that do not explicitly allow for the prevailing party in an action between contracting parties to collect attorneys’ fees.”

Overturning the nearly decade-old, common-law default rule of Crossroads and its progeny that broad contract indemnification provisions apply to intra-party disputes “in the absence of limiting language” (In re Part 60 RMBS Put – Back Litig.), the Court held:

To the extent that some of these decisions presume that broadly worded indemnification provisions by their nature are intended to cover attorneys’ fees in direct party actions, they deviate from this Court’s exacting standard that the agreement must contain “unmistakably clear” language of the parties’ intent to encompass such actions.

After announcing its abrogation of the Crossroads line of cases, the Court found that “the indemnification provision makes no explicit mention that partners may recoup attorneys’ fees in an action on the contract” and “nothing in the provision nor the agreement as a whole makes ‘unmistakably clear’ that the partners intended to permit recovery for attorneys’ fees in an action between them on the contract.”

As a result, the Court reversed the lower courts’ award of attorneys’ fees and dismissed Sage’s complaint.

Business Owners, Controllers and Corporate Transactional Lawyers Take Heed

Clients always ask, “Can the company pay my legal fees?

Sage is an abrupt wake-up call to closely-held business owners and controllers, and especially to the lawyers who draft their partnership, shareholder, or operating agreements that the answer may be “no.”

No longer may they rely on a generic, broadly-worded indemnification provisions to recover advancement or indemnification of legal fees they incur defending against “intra-party” disputes a/k/a “direct actions” by another party to the contract.

But hope is not lost. A relatively quick fix for the pitfall created by Sage is to amend existing partnership, shareholder, or operating agreements to include language that the right to advancement or indemnity shall include “disputes arising out of or related to this agreement between or among the parties hereto,” or words to that effect, and to explicitly provide for “attorneys’ fees” to the prevailing party. A variety of phrases like this should do the trick.

The Court of Appeals alluded to this drafting solution in Sage, writing at the end of its opinion that “inclusion of clear language stating that the prevailing party is entitled to recover attorneys’ fees in an action between the parties would avoid potential litigation on the issue.”

The problem, of course, is that many business owners, controllers, and their lawyers barely know what’s in their contracts, nor consider amending them, until litigation ensues and it’s far too late. I suspect Sage will come as a bitter pill to many litigants in the years to come, who presumed – wrongly – that a broad indemnification provision in a closely-held entity’s agreement would provide for recovery of legal fees in a dispute under the contract.

Special thanks to my former adversary, Chris Raimondi, for discussing the case and sending me the appeal briefs in Sage.

Continue Reading Warning: If You Want Legal Fee Advancement or Indemnification, You May Need to Amend Your Partnership, Shareholder, or Operating Agreement

Unlike the vast majority of states, New York hasn’t adopted the Revised Uniform Partnership Act (1997) (“RUPA”). A recent appellate decision by a court in a neighboring RUPA state — New Jersey — highlights the very different approaches taken by that court and the New York courts in determining when a partner’s dissolution of a partnership is wrongful under RUPA versus New York’s antiquated Partnership Law.

I’ll start in New York then head over to Jersey.

New York: Congel v Malfitano

In Congel v Malfitano, a 3% partner of a general partnership that owned a large shopping mall in Poughkeepsie, New York, acting under the assumption that the partnership was at-will, gave notice of dissolution of the partnership under Section 62 (1) (b) of New York’s Partnership Law providing that a partner may cause dissolution “without violation of the agreement between the partners . . . [b]y the express will of any partner when no definite term or particular undertaking is specified.”

Under Section 62 (2), a wrongful dissolution occurs when the partner by “express will” dissolves the partnership “in contravention of the agreement between the partners.”

Continue Reading Wrongful Dissociation Under RUPA: Toto, We’re Not in New York Anymore

For most business divorce litigants, a dispositive win on the merits, even in a summary proceeding, can take years. Appraisal proceedings following a cash-out merger, for example, may involve multiple years of difficult financial and expert appraisal disclosure before the case reaches trial.

Just days ago, though, New York County Commercial Division Justice Andrew S. Borrok issued a decision in a lawsuit seeking recovery of a cash payout for an extinguished 40% minority interest in two New York limited partnerships following a merger transaction which – in what quite possibly could be a record – went from case commencement to entry of a final, colossal money judgment exceeding $35 million in exactly three months and four days. How is that even possible?

Elberg v Pewzner, Decision, Order, and Judgment, Index No. 657021/2022 [Sup Ct, NY County Oct. 3, 2022], was an offshoot of multiple prior litigations, including one we previously blogged about here, Crabapple Corp. v Elberg, all of which derived from a failed real estate development project for two hotels in Long Island City (planned to be a Crowne Plaza and Hotel Indigo) spawning many years of prior litigation in multiple courts. In Justice Borrok’s recent Decision, Order, and Judgment, the plaintiff, Ruben Elberg (“Ruben”), made a possibly unprecedented procedural maneuver with absolutely devastating results: a motion for summary judgment in lieu of complaint under CPLR 3213 based upon the prior issuance in another lawsuit of a declaratory judgment. Continue Reading Summary Judgment in Lieu of Complaint Meets Business Divorce

One of the earliest signs that a closely-held business is headed for divorce lies in how its owners treat new opportunities. When the relationship among the owners reaches a certain level of distrust, an owner presented with a potentially valuable opportunity is naturally tempted to pursue the opportunity independently, rather than through the business. That temptation explains why we business divorce litigators frequently see claims for “usurpation of corporate opportunity.”

A species of the breach of fiduciary duty claim, a claim for usurpation of corporate opportunity is derivative—asserted on behalf of the company—and disarmingly simple to allege (“You engaged in deal X personally, in violation of your fiduciary duties to bring that deal to the company”).

Despite its frequency and apparent simplicity, a claim for usurpation of corporate opportunity often is difficult to prove, requiring the plaintiff to confront a bevy of difficult questions: What about the company and the opportunity begets the legitimate expectation that the fiduciary was required to bring it to the company before pursuing it independently? What if the company lacked the funding or legal authority to pursue the opportunity? Did the fiduciary act in bad faith to personally profit from the opportunity? What if the counterparty was unwilling to deal with the company? And, perhaps most importantly, what state’s law applies to the claim?

Two recent cases out of the Manhattan Commercial Division and the U.S. District Court for the Southern District of New York provide a fine springboard to unpack these questions and explore the bounds of the corporate opportunity doctrine under New York and Delaware law.

Continue Reading A Recurring Business Divorce Feature: Usurpation of Corporate Opportunity

The statutes authorizing judicial dissolution of Delaware LLCs (LLC Act § 18-802) and New York LLCs (LLC Law § 702) essentially are the same: the petitioner must show that it is no longer “reasonably practicable” to carry on the business in conformity with the LLC’s operating agreement. Not much guidance there.

Delaware’s Chancery Court got a head start over New York’s courts in crafting a standard for determining when the statute is satisfied. Coincidentally or not, a string of the earliest, major Chancery Court decisions construing § 802 involved 50/50 deadlock cases (Haley v Talcott [2004], Silver Leaf [2005], Fisk Ventures [2009], Lola Cars [2009], Vila v BVWebTies [2010]). Those primordial opinions crafted what has become a standard explication of the statute’s requirements — even showing up in dissolution cases pleading grounds other than deadlock! Here’s how the Fisk Ventures opinion put it:

The text of § 18-802 does not specify what a court must consider in evaluating the “reasonably practicable” standard, but several convincing actual circumstances have pervaded the case law: (1) the members’ vote is deadlocked at the Board level; (2) the operating agreement gives no means of navigating around the deadlock; and (3) due to the financial condition of the company, there is effectively no business to operate.

In each of the above-mentioned cases, the deadlock was uncontested or at least found by the court to be genuine, i.e., there was no argument and/or no finding that the petitioner had manufactured a deadlock in bad faith for the very purpose of seeking dissolution.

The closest to that I saw is then-Vice Chancellor Strine’s passing remark in the Vila case that “this is not a case in which Vila in bad faith manufactured a phony deadlock.”

The next closest to that remark that I could find involving a Delaware LLC, at least temporally (and oddly from a jurisdictional standpoint), is a 2016 Tennessee Chancery Court opinion in which the court cited that same remark in Vila in support of the court’s decision denying the plaintiff’s motion for a summary judgment of judicial dissolution of a Delaware LLC. In that case the plaintiff proffered evidence from which the factfinder could reasonably infer that dissolution based on alleged deadlock was sought in bad faith to secure for plaintiff’s sole benefit the LLC’s business opportunity.

The wait for the Delaware Chancery Court to squarely address and uphold a defense to a petition to dissolve a Delaware LLC under § 802 based on manufactured deadlock, is over. Earlier this month, in In re Dissolution of Doehler Dry Ingredient Solutions, LLC, Mem. Op., C.A. No. 2022-0354-LWW [Del. Ch. Sept. 15, 2022], Vice Chancellor Lori W. Will dismissed at the pleading stage a dissolution petition on the ground, among others, that the petition’s allegation of deadlock based on petitioner’s declared intent to withhold future consents from certain “critical” actions was a “contrived attempt to manufacture deadlock.” Let’s take a closer look. Continue Reading Contrived LLC Deadlock Doesn’t Cut the Delaware Dissolution Mustard