Two years ago, we wrote about a bitter rivalry between two brothers, James and Vincent Cortazar, over their ownership and management of a single-asset real estate enterprise, 47th Road LLC, which owned an apartment building in Queens. In our last article, Queens County Justice Timothy J. Dufficy issued an order dissolving the LLC under Section 702 of the Limited Liability Company Law. The Court concluded that the brothers were so badly divided, and the LLC so mismanaged by James (the apartment building was in foreclosure), that the company was unable to function as intended, leaving dissolution the only option. The Court appointed a receiver to wind down the LLC’s affairs. Pursuant to a later order, the receiver sold the building for a purchase price of $2.5 million, subject to certain credits for outstanding code violations at the building, which became important in the trial to come.

Last month, after a seven-day bench trial, Justice Dufficy issued a lengthy Bench Trial Order and Judgment, a whopper of a follow up to his earlier dissolution ruling. In the dissolution decision that preceded it, the Court ruled that the evidence cast James, the brother in exclusive control of the business, in a decidedly unfavorable light. Did he fare any better after a full-blown trial on the merits? Let’s take a look. Continue Reading The Brothers Cortazar Wage War Once Again

  1. Business divorce cases more often than not include claims against the controlling owners for diversion or waste of company assets,  usurpation of corporate opportunity, taking excessive compensation and the like. The party directly harmed by the claimed misconduct is the company.

Under settled law, that means the claim belongs to the company and, at least in the first instance, is to be pursued or not in accordance with the business judgment of the board of directors or, in the case of an LLC, its managers. (For the sake of simplicity, I’ll use the word “board” to refer both to a corporation’s board of directors and the collective managers of an LLC whether or not denominated a board of managers, and I’ll use the word “controller” to refer to the individual board members.)

While the effects of the claimed misconduct may have no less of an impact on the non-controlling owner, the harm is indirect and therefore not amenable to a direct claim in the name and right of the non-controlling owner. Enter the derivative action, in which a shareholder or LLC member sues some or all the controllers for recovery on behalf of the company. Continue Reading The Demanding Demand Requirement in Shareholder Derivative Actions

Normally you don’t associate the lucrative sale of a closely held business with bitter disputes among the co-owners leading to judicial dissolution proceedings. When the cake is big enough, the thinking goes, each owner walks away sated with their own, generous slice.

But if I’ve learned anything as a business divorce lawyer, it’s that when it comes to family-owned businesses, there’s no normal. Take Hanley v Hanley, 2019 NY Slip Op 50970(U) [Sup Ct Albany County June 13, 2019], in which Justice Richard M. Platkin of the Albany County Commercial Division ordered the parties to confer regarding the use of early mediation after denying a motion to dismiss a judicial dissolution petition brought following the sale of the family business to a strategic buyer in a highly lucrative deal.

The Business

The Hanley siblings co-founded with their father a successful truck driving school organized as a New York corporation with its principal place of business in Florida. The business, known as The Commercial Driver’s License School, Inc. (CDL School), started in 1991 with the father as majority owner. Eventually, the three siblings came to own 100% of the stock: Albert 50%; Andrea 25%; Michael 25%.

CDL School built its growth and profitability in large part on contracts with the military to train service members on military bases.  Continue Reading Siblings Battle Over Spoils from Sale of Family-Owned Business

It’s commonly said there are three things that matter with real estate: location, location, location. Likewise, three things matter when choosing a lawyer to set up a limited liability company: experience, experience, experience.

Tom Rutledge’s terrific blog, Kentucky Business Entity Law, last week highlighted a case in which the admitted inexperience of the lawyer who organized an LLC ultimately proved fatal to its existence and to a farming operation owned by the same family for four generations over 100 years. It’s a sobering lesson for anyone contemplating forming a new LLC for a start-up business or to serve as the ownership vehicle for an existing business.

Felt v Felt, No. 18-0710, 2019 WL 2372321 [Iowa Ct App June 5, 2019], involved a dissolution lawsuit among the three children of Richard Felt, the third-generation owner of an Iowa farm. One of the children, David, worked and lived on the family farm for decades when his father was diagnosed with cancer in 2013 and died in 2015. Richard’s will left his property equally to David and his two siblings, Susan and Daniel. Continue Reading Trouble Down on the Farm: The Importance of Using Experienced Counsel When Forming an LLC

Often business owners enter into arbitration agreements because they hope it will result in a speedier, less expensive resolution than litigation to disputes with their co-owners. Arbitration agreements often achieve that result. But sometimes, epic disputes arise over the scope of arbitration agreements and the power of arbitrators to decide controversies under them.

In Matter of Capital Enters. Co. v Dworman, 2019 NY Slip Op 04494 [1st Dept June 6, 2019], a Manhattan appeals court, after three years of litigation and multiple appeals, decided the novel question of whether an arbitrator has the power to order dissolution of a New York partnership, and if so, the extent of the arbitrator’s discretion to fashion a remedy for winding up the partnership’s affairs.

The Partnership

Capital Properties Company (the “Partnership”) was a New York general partnership formed in the 1960s. The Partnership owned three residential apartment buildings in Manhattan. Alvin Dworman and Michael Palin (through another entity, Capital Enterprises Company), were the two, equal general partners of the Partnership. In 1981, Dworman and Palin entered into a written partnership agreement. Continue Reading Can an Arbitrator Order Extra-Judicial Dissolution?

If you’re a member of a multi-member LLC, and especially if it’s manager-managed, here’s a reason you might want to check under the hood of your LLC agreement: if the business goes belly up amidst squabbling or worse among the members and managers, to whom does the LLC agreement give authority to file for bankruptcy? The members? The managers? A majority of the managers or just one?

These are not just theoretical questions, having been the focus of a very recent decision by a federal district court, affirming a bankruptcy judge’s dismissal of a Chapter 11 bankruptcy filing on behalf of an LLC made by one of three managing members over the objection of the other two, in Catalyst Lifestyles Sport Resort, LLC v Sherrard, Opinion and Order, 2:18-CV-302-HAB [U.S. Dist. Ct. N.D. Ind. May 22, 2019].

The Catalyst case lies at the intersection of business divorce and bankruptcy law. The court’s opinion doesn’t describe the nature of Catalyst’s business, only that it is a member-managed Indiana LLC formed in 2015; that it has one 50% member (Tony) and two additional members (Josh and Todd) holding the remaining 50%; and that Catalyst’s downfall was due “at least in part” to conflict among the members that eventually resulted “in a flurry of court filings” beginning in 2017.

Tony filed the first state court lawsuit for injunctive relief after he was removed from the company’s bank account. Todd then filed a state court petition for judicial dissolution of Catalyst in which he alleged that the company was insolvent and could no longer operate because Tony refused to work with the other managers. Continue Reading Who Gets to Play the Bankruptcy Card Under Your LLC Agreement?

I’ve long been intrigued with the frequency of litigation — especially in Delaware Chancery Court — over advancement of legal fees of a corporate director or officer or LLC manager who’s the target of a lawsuit by the entity with which he or she is or was affiliated.

After all, advancement rights are straightforward, at least in concept:

  • The company’s organizational documents either do or do not require the company to advance a director’s or officer’s or manager’s attorney’s fees during the course of the litigation.
  • If they do, the target of the company’s claims either is or is not within the category of persons entitled to seek advancement.
  • If the target’s status qualifies him or her for advancement, either the claims asserted against the target are or are not the type of claims for which advancement is required, that is, arising “by reason of the fact” that the target is or was a director, officer, or manager.

The frequency of advancement litigation surely is influenced by its high stakes, both dollar-wise and leverage-wise, especially when the company is closely held and the adverse parties are co-owners. From the dissident owner’s perspective, he or she not only could be paying crippling legal fees to defend the claims, but as an equity owner he or she may also be paying indirectly the company’s legal fees, creating great pressure to settle absent advancement. It’s the opposite for the controlling owners: if advancement is required, indirectly they are financing the majority of all legal fees on both sides while incentivizing the dissident owner to litigate to the hilt. Continue Reading Ambiguous Advancement Provision Favors Former Officer and Director

This is the story of a deadlock resolution provision that backfired. It is a long story — 94 pages long to be exact. That is the length of Chancellor Bouchard’s characteristically detailed and thorough post-trial opinion issued last week in Acela Investments v DiFalco, C.A. No. 2018-0558-AGB [Del Ch May 17, 2019], in which he ordered the dissolution of a deadlocked start-up developer of abuse-deterrent opioid pain medications after finding that the LLC agreement’s deadlock resolution provision had planted the seeds of its own demise.

The Delaware limited liability company involved in Acela is named Inspirion Delivery Services (IDS) which owns two FDA-approved drugs. The venture was co-founded by a chemical engineer (DiFalco), a pharmaceutical industry scientist (Shah), and a pharmaceutical industry executive (Aigner). IDS attracted tens of millions of private equity dollars to fund drug development and the long and taxing drug-approval process. By the time of the lawsuit, only one of IDS’s two approved drugs was in production with limited commercial success.

IDS’s “Bespoke Governance Structure”

IDS’s LLC agreement contains what Chancellor Bouchard described as a “bespoke governance structure” in which Aigner as CEO and DiFalco as President performed their duties subject to each other’s “advice and consent,” and either Aigner alone or DiFalco and Shah together can veto any action of the IDS board of managers.

Continue Reading Can a Deadlock Resolution Provision Cause Deadlock? This One Did

Over the years, we’ve written a lot about limited partnership, corporation, and LLC “fair value” appraisal proceedings. An appraisal proceeding is a statutory remedy that allows a minority business owner to “dissent” from a business transaction and/or withdraw from the business and have a court determine the “fair value” of his or her interest in the business, usually for the purpose of a buyout of that interest by the majority owners or the entity itself.

Despite all we’ve written on the subject of appraisal proceedings, we have never given extensive treatment to the procedures involved in the run-up to, and initiation of, an appraisal proceeding. In New York, the steps one must take to commence an appraisal proceeding depend on the kind of entity involved, and are set forth in various statutes contained in the Partnership Law, the Business Corporation Law (“BCL”), and the Limited Liability Company Law (“LLC Law”). The purpose of this article is to collect those various statutes in a single reference source. This article is in response to a specific reader request. You ask, we deliver.

Step One: The Triggering Event

The first step in any appraisal proceeding is the occurrence of an event giving rise to a right of appraisal. There are myriad ways business owners can wind up in an appraisal proceeding, a subject about which we gave extensive treatment in this article. Some examples include “wrongful” partner withdrawal under Partnership Law 69, death or retirement of a partner under Partnership Law 73, the filing of a buyout election under BCL 1118 in response to a petition for corporate dissolution based upon oppression, and LLC member withdrawal under LLC Law 509. Continue Reading How to Initiate a Fair Value Appraisal Proceeding – a Dissenter’s Checklist

A Plug for Cunningham on IRC 199A

Tax issues always have been an integral factor in valuing closely held business entities, whether for purposes of a court-supervised buyout or otherwise. The Tax Reform Act of 2018 added an important, new deduction for pass-through business owners, called the 199A deduction, providing business owners with federal income tax deductions of up to 20% of their net business income. I’ve started to see business appraisals that deal with the 199A deduction and, of course, the 199A deduction can provide substantial tax savings for business owners in the ordinary course, having nothing to do with appraisals or business divorce scenarios.

Taking advantage of the 199A deduction also can require a restructuring of the business, which is why I’m recommending a new book by my friend John Cunningham called Maximizing Pass-through Deductions under IRC Section 199A published by Wolters Kluwer. John has made it his mission to educate and help business owners navigate the complexities of the 199A deduction and with restructuring their businesses when required. Some of you may recognize John’s name from posts on this blog or my interview of John on my podcast on various LLC issues–a topic on which John also is a top expert and author of the leading LLC formbook and practice manual entitled Drafting Limited Liability Company Operating Agreements also published by Wolters Kluwer.

It was, as both principals of a start-up management consulting business testified at trial, a “partnership made in heaven,” which doesn’t exactly bode well for the celestial ambitions of the rest of us given that the litigation between the partners lasted longer than the partnership.

Vice Chancellor Glasscock’s recent valuation opinion in Smith v Promontory Financial Group, LLC, Mem. Op., C.A. No. 11255-VCG [Del Ch Apr. 30, 2019], tells the fascinating story of two individuals — Neil Smith, a seasoned management consultant in the profit improvement field, and Eugene Ludwig, a former U.S. comptroller of the currency and head of a financial services advisory firm — who together formed a Delaware company called Promontory Growth and Innovation, LLC (PGI), to provide management consulting services to financial services companies to enhance earnings and business performance.

Essentially, Ludwig had the rainmaking connections with CEOs of large companies while Smith had the expertise to close the deals and perform the client projects. PGI’s business model contemplated a very small number of one-shot engagements each year with large corporations, charging a contingency fee based on a percentage of the client’s increased profits. Landing an account, as Smith described it at trial, was like “finding the needle in the haystack,” requiring meeting with the right executive at the right time. Continue Reading Half-Baked LLC Agreement Yields Improvised Valuation Decision