Litigated business breakups are often highly intense and emotional for the participants. The intensity and emotion multiply when the litigants are close family members.

If you add to the mix several years and more than ten rounds of motion practice, a successful judicial dissolution and winding up, an appeal, a remand, a motion for summary judgment, and another motion for summary judgment, lawyers and clients can become exceedingly close through the experience.

This week, we’re pleased to feature a story about two longtime favorite clients and the Homerian odyssey of litigation they endured, resulting in a recent victory in the form of total dismissal of what remained of a complaint filed by a son against his own father and stepmother for dissolution of a landscape and masonry supply business and accompanying damages claims related to six parcels of real property on which the business operated based upon a theory of “misappropriation of corporate opportunity.”

The Company, its Ownership Structure, and the Six Parcels of Real Estate

Joseph founded Jos. M. Troffa Landscape and Mason Supply, Inc. (the “Company”) as sole shareholder in the 1970s. Over time, Joseph grew the Company into a very successful business.

In the 1990s, Joseph gifted his son from his first marriage, Jonathan, shortly after he graduated high school, half the shares of the Company for no consideration.

The Company operated on six adjacent parcels of real estate in East Setauket, New York, five of which Joseph and his second wife, Laura, acquired over a period of decades through two real estate holding companies, NIMT Enterprises, LLC (“NIMT”) and L.J.T. Development Enterprises, Inc. (“LJT”).

The sixth parcel – a 1.78 piece of unimproved land known as the “Compost Yard” – Joseph acquired in his own name in March 2013. According to Joseph and Laura, Jonathan always knew and agreed that NIMT (of which Jonathan was a 1% member), LJT, and Joseph were to be the owners of the properties; it was only after lawyers got involved that Jonathan devised a scheme to sue Joseph, Laura, and their real estate companies in connection with those properties.

Continue Reading A Litigation Odyssey
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Having spent the better part of my career litigating disputes between minority and majority owners of closely-held businesses, I can comfortably say that all else equal, I would prefer to be a minority shareholder of a New York corporation than a minority member of a New York LLC.

With share ownership comes the protections specifically enumerated in the Business Corporation Law and a rich body of caselaw concerning shareholders’ rights and the need for courts to protect shareholders from majority overreach.

LLCs, by contrast, we often describe as “creatures of contract,” and courts tend to focus less on protection of the minority members and more on determining and enforcing the parties’ intent at the outset of their relationship. That focus sometimes puts too much faith in the belief that members enter into a thoughtful, ex ante agreement governing their relationship and any potential fallout. It takes minutes to create an LLC and execute a fill-in-the-blank operating agreement, and that is exactly what many business owners do. Then when a dispute arises, a court’s first instinct is to scrutinize the same document that the owners may not even have read when the LLC was formed. 

Those observations explain why I thoroughly enjoyed reading Professor Megan Wischmeier Shaner’s recent article in the Columbia Business Law Review, Corporate Resiliency and Relevancy in the Private Ordering Era (available on SSRN here). Professor Shaner, the Arch B. & Jo Anne Gilbert Professor of Law at University of Oklahoma College of Law, presents her compelling observations that the contract-based focus often associated with LLCs is migrating to corporations, producing unintended consequences. 

Continue Reading The Corporation is Becoming More Contract Focused, But Don’t Call it an LLC Just Yet

De facto dividend. Disguised dividend. Constructive dividend. They all refer to the same thing: monies in excess of reasonable compensation taken by owners of closely held companies, booked as deductible employment compensation rather than as a non-deductible distribution from profits. For companies taxed as C corporations — as opposed to S corporations and other pass-through entities taxed as partnerships — because they are paid from after-tax income, declared dividends effectively are subject to double taxation at the company and shareholder levels.

The tax laws thus provide no small incentive for owners of closely held companies to pay themselves, shall we say, generous compensation in lieu of declaring and paying dividends. This being a blog about disputes between business co-owners, I approach the topic not from the standpoint of tax compliance but, rather, to address how de facto dividends can surface in business divorce litigation as fodder for allegations of oppressive conduct by majority shareholders against minority shareholders.

De Facto Dividends as Potential Tools of Oppression

There are a number of scenarios that give rise to disputes over real or imagined de facto dividends.

One of the most common ones occurs with companies all of whose owners are employed in the business. Often because of the above-mentioned tax incentives, the companies declare no dividends while the owners take salaries plus periodic or year-end bonuses of any excess cash as employment compensation. The problem arises when one or more of the owners is forced out by the others without any recourse or buyout rights under a shareholders agreement. The ousted shareholder no longer receives a salary and the company continues its no-dividend policy while the remaining owners split among themselves the ousted shareholder’s former compensation and/or use it to hire a replacement worker if needed. The ousted shareholder (or LLC member) is left high and dry financially, with no income from a company he or she still owns and, if it’s a pass-through entity, having to go out of pocket to pay personal income taxes on any phantom income reported on their K-1s.

Continue Reading When Do Disguised Dividends Add Up to Minority Shareholder Oppression?
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One of the most difficult periods in the lifecycle of a closely-held company is the period following the death of an owner.  Apart from having to fill whatever business responsibilities the deceased owner left behind, the surviving owners often find themselves amid prime conditions for dispute: they wish to continue the business without interruption from the deceased owner’s estate, while the estate is interested in liquidating the deceased owner’s interest at any cost.

In New York, the rights of the estate of a deceased LLC member are codified in Section 608 of the LLC Law.  That section provides:

The member’s executor, administrator, guardian, conservator or other legal representative may exercise all of the member’s rights for the purpose of settling his or her estate or administering his or her property, including any power under the operating agreement of an assignee to become a member.

Two important takeaways from this language.  First, for the purpose of settling the estate, the executor can exercise whatever rights that the deceased member had.  And second, upon the death of a member, the estate does not automatically become a member; it can choose to exercise any power under the operating agreement of “an assignee to become a member.”  The reference to the rights of an assignee invokes Section 603 of the LLC law, under which the assignee of a member’s interest becomes an “economic interest holder,” but not a full-fledged member, unless the remaining members consent or it is expressly authorized by the operating agreement.

Continue Reading Who Died and Made You a Member?  Second Department Resurrects LLC Dissolution Petition Brought by Deceased Member’s Estate.

Notwithstanding that the pictured snow globe is the only snow I’ve seen in my neck of the woods this balmy winter, I’m pleased to present my annual Winter Case Notes collection of recent court decisions of interest.

This year’s collection features a relatively rare example of a court awarding punitive damages against a company controller for breach of fiduciary duty; a decision denying enforcement of allegedly promised “equity” in an LLC; and a decision dismissing untimely fraud claims against co-members of a realty holding LLC.

Shareholder Derivative Action Yields $1 Million Punitive Damages Award Against Company Controller

Clients complaining of fiduciary breaches by their business partners often ask whether they can recover punitive damages. I usually answer yes but add, it’s a high bar to get them and the success rate is low. Here’s one of the success stories.

In 2019, Reggie Middleton, the founder/CEO of a fintech company named Veritaseum, Inc., got into hot water with the SEC which accused him of raising millions of dollars through an initial coin offering without registering with the SEC while misleading investors to attract more funds with false information. The SEC action culminated with a settlement agreement requiring Middleton to pay disgorgement and prejudgment interest over $8 million plus a civil penalty of $1 million.

Continue Reading Winter Case Notes: Punitive Damages Awarded for Breach of Fiduciary Duty and Other Recent Decisions of Interest

Nine months ago, we wrote about a 20% shareholder, Alvin Clayton Fernandes, whose bare bones petition Manhattan Supreme Court Justice Frank P. Nervo found stated sufficient grounds to judicially dissolve a seemingly successful modeling agency, Matrix Model Staffing, Inc.

Fernandes’ primary ground for dissolution was that his 80% co-shareholder, Jacquelyn Willard, named Fernandes without his knowledge as the entity’s “responsible person” for withholding and remitting employee income and payroll taxes. Willard allegedly failed to pay employment taxes, saddling Fernandes with personal liability for a $210,000 Trust Fund Recovery Penalty.

“Failing to pay tax liabilities is corporate mismanagement,” ruled the Court in Fernandes v Matrix Model Staffing, Inc. (2022 NY Slip Op 31317(U) [Sup Ct, NY County 2022]), “which defeats a petitioner’s reasonable expectations sufficient to constitute oppression” under Section 1104-a of the Business Corporation Law (the “BCL”).

Because the record was bereft of evidence, though, the Court declined to grant the petition, instead referring the matter to a special referee under BCL § 1109 to conduct an evidentiary hearing on three issues:

  • the “underlying facts of the petition for dissolution;”
  • the “merits of the petition;” and
  • the “appropriate remedy.”

This article picks up 13 days after Justice Nervo issued his decision, when Willard, Matrix’s majority shareholder — hoping to stop dead in its tracks any further litigation over dissolution or an “adequate alternative remedy” to dissolution — filed with the Court a Notice of Election to purchase Fernandes’ stock for “fair value” under BCL § 1118.

Continue Reading The Worst of Both Worlds: Untimely Buyout Election Yields Full Merits Hearing and Huge Bond
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This blog frequently covers cases considering a shareholder’s request to dissolve a corporation under New York’s oppression-based corporate dissolution statute, BCL 1104-a.  That statute allows a shareholder to petition for dissolution of a corporation on the grounds that those in control of the corporation have engaged in “illegal, fraudulent or oppressive actions,” (BCL 1104-a[a][1]), or that the “property or assets of the corporation are being looted, wasted, or diverted for non-corporate purposes by its directors, officers or those in control of the corporation” (BCL 1104-a[a][2]).

But even upon a showing of oppression or other misconduct satisfying the requirements of BCL 1104-a, dissolution is not a given.  That is because BCL 1104-a(b) requires the court to consider “whether liquidation is the only feasible means whereby the petitioners may reasonably expect to obtain a fair return on their investment.”  Dissolution should be a remedy of last resort, and a court has broad discretion to fashion a less-drastic, alternative remedy to dissolution.  Consider, for example, this post about a case ordering a compelled buyout of the complaining shareholder (Zulkofske v Zulkofske, 2012 NY Slip Op 51210(U) [Suffolk Co., 2012]), or this post about a case finding money damages sufficient to remedy the oppressive conduct (Hammad v Jamal Kamal Corp., 68 Misc 3d 1227(A) [Queens Co., 2020]). 

Based on the principle that dissolution should be a remedy of last resort, the Court of Appeals in Matter of Kemp & Beatley introduced another layer into the “available remedies” analysis of BCL 1104-a(b).  Even when dissolution is an appropriate remedy, the court must give the shareholders the option to save the corporation by buying out the complaining shareholder: “[e]very order of dissolution . . . must be conditioned upon permitting any shareholder of the corporation to elect to purchase the complaining shareholder’s stock at fair value” (64 NY2d 63 [1984]).

Against this backdrop, consider the Second Department’s recent decision in Marum v Graffeo, which affirmed an order of dissolution of a closely-held corporation entered without a hearing, despite contested allegations and apparent non-consideration of alternative remedies (179 NYS3d 621 [2d Dept 2023]).

Continue Reading Dueling Dissolution Petitions Beget Dissolution Without Consideration of Alternate Remedies

This important question of whether non-manager, minority limited liability company owners owe fiduciary duties continues to bedevil New York litigants and courts.

The prevailing state of the law remains unsettled, with no explicit appeals court guidance to be found. Peter Mahler has written about this unresolved legal question a number of times, with three articles on the subject available here.

In Doeblin v MacArthur (2023 NY Slip Op 30133(U) [Sup Ct, NY County 2023]), Manhattan Commercial Division Justice Andrea J. Masley considered a variation of the question. Do minority LLC owners owe fiduciary duties to their co-members and to the company, at least for purposes of surviving a pre-answer motion to dismiss, where the complaint alleges that the defendant, although not an official manager, in some respects “acted in a ‘managerial capacity?’”

Continue Reading Do Non-Manager, Minority LLC Owners Owe Fiduciary Duties?

Since its legislative birthing in New York in 1994, the limited liability company has become the preferred choice of entity in New York and across the country. Over the ensuing 15 years or so, New York’s lower courts struggled to arrive at a consistent interpretation of LLC Law § 702’s enigmatic provision, patterned on that found in New York’s Revised Limited Partnership Act, authorizing judicial dissolution of LLCs “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.”

As I wrote in a NYSBA Journal article many years ago, in those early days, with no meaningful appellate guidance, some courts explicitly or implicitly treated LLCs as business corporations subject to the same judicial dissolution standards and remedies specified in Business Corporation Law Article 11.

A uniform standard under § 702 didn’t appear until 2010, when the Appellate Division, Second Department, issued its landmark decision authored by former Associate Justice Leonard B. Austin in Matter of 1545 Ocean Avenue, LLC.

In the court’s lengthy opinion, Justice Austin articulated a contract-centric approach under which a § 702 petitioner must establish, “in the context of the terms of the operating agreement or articles of incorporation, that (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible.”

Continue Reading Has the Time Come for New York to Follow Delaware and Officially Pronounce Deadlock as Ground for LLC Dissolution?
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The dissolution of a company—and the winddown and liquidation that usually follow—often impacts a broad range of stakeholders beyond just the owners of the company, including creditors and potential creditors, who often are stuck awaiting the outcome of the dissolution process before they get paid.

The waiting can be doubly painful when a corporation is the subject of an involuntary dissolution proceeding under BCL 1104 or BCL 1104-a, since those proceedings can drag on seemingly indefinitely.

Last year, my co-blogger Frank McRoberts offered a construction of the Business Corporation Law that gave creditors and potential creditors an alternative: a path to insert themselves (and their claims) into a contested dissolution proceeding. It went like this:

  • BCL 1117 (a) provides that in a judicial dissolution proceeding under Article 11 (such as 1104 or 1104-a), the provisions of BCL 1005 through 1008 “shall apply.” 
  • BCL 1008 states that creditors of the to-be-dissolved corporation may petition the court for various relief, including: (a)(3) the determination of the creditor’s claims against the corporation, (a)(5) the determination of the creditor’s claims to hold the shareholders personally liable, and (a)(8) for the appointment of a receiver over the corporation.
  • Based on the above, creditor could rely upon the BCL 1117 / 1008 combination to intervene in a judicial dissolution proceeding and ask the court with jurisdiction over the dissolution proceeding for the relief specified in BCL 1008(a)(1 – 11).

Despite this apparent statutory authorization, requests from creditors to intervene in involuntary dissolution proceedings are relatively rare. I had not seen it done until a recent decision from New York County Justice Arlene P. Bluth, In re Golan Floors, Inc., Index No. 655063/2019 (Sup Ct, New York County 2023), which grants a potential creditor’s application to have a receiver appointed in a dissolution proceeding. And, as we’ll see below, it took a staggering fact pattern to get there.

Continue Reading Potential Creditor Drags Corporation in Stalled Dissolution Proceeding into Receivership