The heyday of common-law dissolution — if it ever had one — is long past, largely displaced by a statutory dissolution remedy for oppressed minority shareholders paired with an elective buy-out option for the respondent majority shareholders.

New York’s version of the statutory remedy, section 1104-a of the Business Corporation Law enacted in 1979, authorized shareholders holding at least 20% of the voting shares in an election of directors to petition for judicial dissolution based on “oppressive actions” and other misconduct by the majority including illegality, fraud, looting, waste, and diversion of corporate assets. Courts subsequently interpreted the undefined term “oppressive actions” as meaning conduct that defeats the minority shareholder’s “reasonable expectations” upon joining the enterprise, such as termination without cause of one’s employment and positions as an officer and director.

A “special solicitude toward the rights of minority shareholders of closely held corporations” was how the New York Court of Appeals in Matter of Kemp & Beatley subsequently described the legislature’s motivation for enacting section 1104-a, the implication being that common-law dissolution didn’t sufficiently protect the locked-in minority shareholder against majority abuse and overreach. Common-law dissolution’s remedial reach simply was too short.

Since section 1104-a’s enactment in 1979, common-law dissolution’s utility effectively is limited to actions by shareholders with less than 20% of the voting shares.

Under the case law, common-law dissolution requires the minority shareholder to show, as articulated by the Court of Appeals in Leibert v Clapp, that “the directors and majority shareholders . . . so palpably breached the fiduciary duty they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by statute.” In other words, to prevail under the common-law standard the minority shareholder essentially has to show that a rogue majority is operating the company as their personal fiefdom for their sole benefit. Not an easy undertaking.

With that background, let’s take a look at two recent court decisions in which the plaintiffs’ common-law dissolution claims suffered setbacks.

Continue Reading Common-Law Dissolution Hits Speed Bumps in Recent Decisions

In an earlier post, we wrote about a fascinating law firm limited liability partnership dispute culminating in a thoughtful post-trial decision by Erie County Commercial Division Justice Timothy J. Walker. Capizzi v Brown Chiari LLP involved two separate, full-blown litigations and bench trials more than a decade apart on the same issue: whether the law firm’s named partners were true “equity” partners of the firm. The legal significance of this issue was that if the firm’s named partners were true “equity” partners, then each had the power to unilaterally withdraw from and dissolve the partnership under Section 62 (1) (b) of the Partnership Law because the partnership lacked an agreement otherwise prohibiting withdrawal.

What made the Capizzi litigation unconventional was that Capizzi took essentially opposite positions as defendant in the first lawsuit and plaintiff in the second. In the prior lawsuit, Frascogna v Brown, Chiari, Capizzi & Frascogna, LLP, Capizzi opposed the position of his former law partner, Frascogna, who argued that he was true equity partner and dissolved the law firm as a matter of law when he formally withdrew from the firm. Capizzi lost that lawsuit, the Court concluding that all four of the original partners including, including Capizzi, were equity / general partners of the firm with the power to dissolve it unilaterally. After losing that lawsuit, the three remaining partners, including Capizzi, re-formed the firm under the same terms as the original.

Years later, Capizzi took the opposite position he took and lost in the first litigation, arguing that he was a true equity / general partner of the firm, and that his unilateral withdrawal from the firm caused its dissolution under Partnership Law § 62 (1) (b). In support of his position, Capizzi relied upon years of tax returns filed by the law firm and its name partners which he said showed that all three were general partners of the firm.

This unique fact pattern was the perfect setup to implicate multiple legal “estoppel” doctrines at once, namely, collateral estoppel, judicial estoppel, and tax estoppel. As we noted in our prior article, Justice Walker’s post-trial decision relied upon two of these doctrines – collateral estoppel and tax estoppel – to rule that Capizzi’s former partners, Brown and Chiari, were estopped from contesting Capizzi’s status as an equity / general partner of the firm due to the post-trial holding in the original Frascogna partnership litigation and the filing of tax documents stating that Capizzi was a general partner.

Last week, in Capizzi v Brown Chiari LLP, ___ AD3d ___, 2021 NY Slip Op 02956 [4th Dept May 7, 2021], a Rochester-based appeals court issued a decision affirming Justice Walker’s post-trial decision. Interestingly, though, the appeals court affirmed on different grounds that those relied upon by the lower court, suggesting that the higher court may have had some concerns with the lower court’s collateral and tax estoppel holdings. With Capizzi as a springboard, we’ll take a closer look at the doctrines of collateral estoppel, judicial estoppel, and tax estoppel as applied in business divorce cases. Continue Reading Battle of the Estoppels

Anyone who keeps up with the public equity markets knows that the volume of IPOs generated by Special Purpose Acquisition Companies, better known as SPACs, has exploded over the last two years. Writing for his Wealth Matters column (5/7/21), Matt Sullivan of the NY Times reports that “[s]o far this year, nearly 300 SPACs have been created and taken public, more than the 248 offerings in all of last year and up from 59 in 2019.”

For those not familiar with SPACs, essentially they are publicly traded, non-operating, shell companies formed to raise capital to acquire and convert to public ownership a privately-owned operating company. SPACs are also referred to as “blank check” companies because investors buy shares before any merger or acquisition opportunity is identified. The IPO process for SPACs avoids much of the burden, expense, and lengthier regulatory compliance associated with traditional IPOs.

The SPAC is controlled by a “sponsor” management company typically organized as a limited liability company. The sponsor receives a percentage of shares at the time of the offering — normally 20% — which are put in escrow pending consummation of a potential acquisition within a two-year period. Post-acquisition, the sponsor distributes shares to its members subject to certain triggers such as termination of a lockout period or the reaching of a specified share price. If no acquisition is consummated within the fixed period, the investors get their money back.

The sponsor LLC is subject to the same trials and tribulations of any LLC as far as rights, duties, and potential conflicts among the members. Or perhaps not quite the same, given that, unlike most small, owner-operated start-up sales or service companies formed as LLCs, often without any written operating agreement, the sponsor typically is formed under Delaware law by sophisticated investors/managers using experienced transactional lawyers from major law firms to prepare intensely considered operating agreements.

But, as we all know, having sophisticated investors with agreements prepared by experienced counsel is no guarantee that LLC members will not turn on each other. That brings me to a decision last month by U.S. District Judge Victor Marrero of the Southern District of New York in Vogel v Boris involving a falling out between members of a SPAC sponsor following the completion of an acquisition. The question presented to the court was whether the sponsor’s operating agreement contemplated a one-deal company and terminated upon completion of the one deal or, as the plaintiff contended, it prohibited the other members from organizing another SPAC transaction without his consent, effectively giving him an ongoing participation right in any subsequent SPAC transactions. Continue Reading It Was Only a Matter of Time: SPAC Meets Business Divorce

Under both New York and Delaware law, members of an LLC may petition for judicial dissolution on the grounds that the management is so hopelessly deadlocked that the LLC can no longer function in accordance with its purpose as defined in its governing documents.

In those cases, courts will consider whether the LLC operating agreement contains some other mechanism to break the deadlock.  If the operating agreement itself provides a fair opportunity for the dissenting member who disfavors the inertial status quo to exit and receive the fair market value of her interest, it is at least arguable that the LLC can still proceed to function, because there exists an equitable way to break the impasse.

Coequal LLC members might agree in their operating agreement to break a deadlock with a shotgun buy-sell agreement.  In the event of a deadlock, the initiating member names a price, and thereby gives the other member the option to either buy the initiating member’s interest or sell his own interest at that price.  “I cut, you choose.”

In theory, because a shotgun buy-sell agreement can equitably break an impasse, a member’s electing to initiate the shotgun buy-sell procedure should foreclose a petition for deadlock-based dissolution.  In practice, disputes over the implementation of that election might make dissolution appropriate after all.  That’s the lesson of Seokoh, Inc. v Lard-PT, LLC, CV 2020-0613-JRS [Del Ch Mar. 30, 2021], in which Vice Chancellor Slights cited the flaws in the parties’ shotgun buy-sell agreement as the basis for his refusal to dismiss a 51% member’s petition for deadlock-based dissolution.

Continue Reading Holes in Shotgun Buy-Sell Agreement Keep Deadlock Dissolution Petition Alive

Now that I’ve got your attention, relax. At least for New York LLCs, a member can be expelled from an LLC only if expressly authorized by the operating agreement.

In my experience, expulsion provisions in LLC agreements are relatively rare, arguably for good reasons. For one, prospective, non-controlling participants in an LLC generally are loathe to subject the certainty of their investment to the discretion of a controlling member or members who have an inherent self-interest when deciding whether an expulsion trigger has occurred. For another, the financial terms of expulsion provisions tend to be punitive, returning to the expelled member substantially less than the fair value of their interest in the LLC as a going concern.

I’ve previously written about cases in which New York courts enforced expulsion provisions in LLC agreements for misappropriation of company funds, for felony conviction, and for material breach of the LLC agreement. Earlier this month I came across another case, one might say, that pushes the envelope to include a member’s statements made to third parties complaining about the LLC managers’ claimed failure to provide information in breach of the operating agreement. The statements allegedly constituted ground for expulsion under an expansive provision covering “any act or omission which, in the reasonable judgment of the Managers, is in bad faith and is detrimental to the interests of the Company, its Members or its Managers.”

Earlier this month, in Jacobowitz v Gutnick, a Brooklyn Supreme Court judge found that the challenged statements were non-actionable opinion and dismissed defamation claims brought by the plaintiff LLC and its managers against the defendant expelled member. The court nevertheless refused to dismiss the plaintiffs’ claim for a declaratory judgment enforcing the expulsion, holding that the non-defamatory nature of the statements is not determinative whether, in the “reasonable judgment of the Managers,” the defendant’s statements constituted bad-faith acts detrimental to the LLC, its managers, or members. Let’s take a closer look. Continue Reading Be Careful What You Say. It May Get You Expelled From Your LLC.

Of late I’ve been ruminating on New York’s membership in the shrinking pool of states that don’t recognize oppression of an LLC minority member by the controlling members or managers as ground for judicial dissolution.

The point indirectly was brought home by Professor Daniel Kleinberger’s recent article for the ABA’s Business Law Section in which he dissects last year’s decision by a Connecticut appellate panel in Manere v Collins interpreting that state’s Revised Uniform LLC Act which expressly includes oppression as one of the grounds for judicial dissolution. As the good professor highlights, the court’s decision freely borrows from the rich body of case law construing the term “oppression” as used in judicial dissolution statutes for closely held corporations in virtually every state save Delaware.

New York continues to buck the nationwide trend toward harmonization of close corporation and LLC law governing judicial dissolution, as made clear in cases such as Doyle v Icon and Barone v Sowers explicitly holding that New York’s LLC Law § 702 neither mentions nor otherwise accommodates oppression as a basis for seeking judicial dissolution.

Coincidentally, a case decided by the Manhattan-based Appellate Division, First Department, just a few days after Professor Kleinberger posted his article, starkly illustrates the disharmony of New York’s statutory schemes and the resulting disadvantageous position of a minority member of a New York LLC as compared to a minority shareholder of a New York close corporation when confronted with similar, allegedly oppressive behavior by the controlling co-owner. Continue Reading The Money’s There But Out of Reach for the Minority LLC Member

Ten months ago, we wrote about an unusual case involving an LLC member who documented two irreconcilable membership interest transfers upon death. In Harris v Harris, 2020 NY Slip Op 31570(U) [Sup Ct, NY County Apr. 23, 2020], the deceased LLC member, Steven, had a written operating agreement conveying a life estate of his membership interest to his wife and, upon her death, to their daughter (hereinafter “Family Number One”).

Symmetrically at odds with the operating agreement (which happened to be unsigned, some provisions internally inconsistent, and loaded from front to back with handwritten comments), the deceased LLC member left an executed last will and testament conveying a life estate of his membership interest to another woman (referred to in the will as his “loving partner”), and upon her death, to their alleged out-of-wedlock daughter (hereinafter “Family Number Two”).

Last week, in Harris v Harris, ___ AD3d ___, 2021 NY Slip Op 02105 [1st Dept Apr. 6, 2021], a Manhattan-based appeals court reversed the lower court’s decision in Harris, which denied both sides’ motions for summary judgment, and granted summary judgment to Family Number One. Harris is a fascinating take on two important legal issues for closely-held business owners. Continue Reading Unsigned, Non-Final Operating Agreement Trumps Conflicting Testamentary Bequest of LLC Interest

Fine dining and business divorce crossed paths in a recently decided case featuring a lengthy battle between co-equal ownership factions of the corporation that operates Delmonico’s, the renowned Manhattan restaurant established in the early 19th century and famous for its signature dish, the Delmonico steak, among other dining firsts.

Delmonico’s can now lay claim to another first, though not of the edible kind. Last month, a New York Supreme Court judge of the Manhattan Commercial Division entered final judgment granting “equitable dissolution” of the restaurant corporation known as Ocinomled Ltd. — Delmonico spelled backwards — and ordering the respondent shareholders who were found to have engaged in oppressive conduct to forfeit their stock holdings.

What is Equitable Dissolution?

The term equitable dissolution can have different meanings in different contexts. In its most generic usage, the emphasis is on the word “equitable,” describing generally the judiciary’s broad discretion sitting as a court of equity without a jury and where legal remedies (i.e., money damages) are inadequate, to fashion a just resolution of a dispute between business co-owners over the continued existence of the firm. Continue Reading On the Menu: Steak and Equitable Dissolution

In 1994, in Friedman v Revenue Management, Inc., the U.S. Court of Appeals for the Second Circuit, covering New York, Connecticut and Vermont, closed federal courthouse doors in those states to petitioners seeking judicial dissolution of close corporations under state law, even where subject matter jurisdiction exists. The court in Friedman applied the so-called “Burford abstention” doctrine to dismiss a complaint seeking statutory dissolution of a New York corporation, without prejudice to its re-commencement in state court.

The doctrine is named after Burford v Sun Oil Co., a 1943 decision in which the U.S. Supreme Court carved out a vaguely defined exception to the federal courts’ duty to exercise their jurisdiction, as one commentator put it, “allow[ing] federal courts to abstain from reviewing certain decisions of state administrative agencies or from otherwise assuming the functions of state courts in the development and implementation of a state’s public policies.”

The Friedman court held that Burford abstention was appropriate in corporate dissolution cases to “avoid needless interference with [the state’s] regulatory scheme governing its corporations” and in deference to the “strong [state] interest in the creation and dissolution of its corporations and in the uniform development and interpretation of the statutory scheme regarding its corporations.”

In 2002, in Caudill v Eubanks Farms, Inc., the Sixth Circuit Court of Appeals, covering Michigan, Ohio, Kentucky, and Tennessee, agreed with the Second Circuit and invoked Burford abstention to dismiss an action seeking statutory dissolution of a Kentucky close corporation. Quoting from one of its prior, non-precedential, unpublished opinions, the court reasoned,

The state should be permitted to exercise control over the internal affairs of its domestic corporations free from interference by federal courts, particularly where the issue is whether the corporation should be permitted to continue in existence or be dissolved. Moreover, the legislature has provided a forum with specialized competence in the areas of internal corporate matters. Jurisdiction over corporate dissolution rests exclusively with the circuit court of the county in which the registered office of the corporation is located.

Of the dozen or so reported corporate dissolution cases in the lower federal courts addressing Burford abstention, including a handful by District Courts outside the Second and Sixth Circuits, all but one dismissed the action without prejudice or remanded it to state court where the case initially was filed but then removed to federal court. In the one exceptional case decided by the Idaho District Court in 2020, entitled Zafer v Spengler, the court found that dissolution “does not present a complex question of state law, nor does it have any significant impact on state public policy, such that this Court needs to relinquish jurisdiction.”

Now, that imbalance may change. Earlier this month, the Eleventh Circuit Court of Appeals, covering Alabama, Florida, and Georgia, explicitly parted ways with Friedman and Caudill in a decision reversing the District Court’s Burford-based dismissal of a claim seeking judicial dissolution of a family-owned Georgia corporation. The case is Deal v Tugalo Gas Co., No. 19-14336 [11th Cir. Mar. 19, 2021].

Continue Reading U.S. Circuit Courts Split on Abstention Doctrine in Dissolution Cases

What do business divorce litigants have in common with the frill-necked lizard? At the outset of confrontation, they both use in terrorem tactics in an attempt to force their adversary into rapid submission. The lizard spreads its frill to appear more threatening in what’s called a deimatic display. The business divorce litigant packs the initial pleading with the most aggressive legal claims available, designed to cause the adversary maximum fear of business and economic disruption, public embarrassment, and, of course, liability.

I’ve frequently preached that most business divorce litigation is tactical, meaning the lawsuit’s ultimate objective, whether styled as one for judicial dissolution and/or asserting direct and/or derivative claims, is to pressure the adverse business partner into a buyout or other agreement achieving a separation of business interests, without having to litigate to the bitter end.

On the pressure-spectrum of claims by and against business co-owners, starting with the least aggressive, there’s breach of the firm’s constitutive documents, i.e., articles of formation, by-laws, shareholder agreements, partnership agreements, LLC operating agreements, and the like. Taking it up a notch, there’s breach of fiduciary duty and a panoply of other fault-based business torts. Taking it up yet another notch, there’s fraud which, depending on the type of business, its customers and vendors, and its public or private reporting requirements, can threaten detrimental external consequences beyond the stigma of the fraudster label. Continue Reading Civil RICO: A Blunt But Elusive Tool in Business Divorce Cases