LLC enabling legislation swept the country in the late 1980s through the mid 1990s. By the turn of the century we saw a trickle of litigation working its way through the courts involving disputes among LLC co-owners. A decade later, as the popularity of LLCs blossomed, the trickle became a steady stream. Fast forward to the present, when LLCs have thoroughly upstaged the closely held business corporation as the entity of choice, the stream has become a river.

Within what has become a vast body of case law over the last two decades stemming from LLC internal disputes, I see two fields of member conflict that not only quantitatively occupy large swaths of that body, but also qualitatively distinguish LLC litigation from its counterpart litigation involving disputes among shareholders of close corporations.

One is judicial dissolution. Although the Revised Uniform LLC Act adopted in many states has partially reduced the dissimilarity between grounds for judicial dissolution and available remedies compared to prevailing forms of corporate dissolution statutes, there remains in New York and many other states an unbridgeable, substantive gap between the dissolution standards and remedies in the two statutory schemes. As New York’s leading appellate decision on LLC dissolution opined ten years ago, “since the Legislature, in determining the criteria for dissolution of various business entities in New York, did not cross-reference such grounds from one type of entity to another, it would be inappropriate for this Court to import dissolution grounds from the Business Corporation Law or Partnership Law to the LLCL.”

The other is the validity and effect of membership interest transfers and other dispositions of membership interests. There are few if any statutory default rules constraining lifetime or post-mortem transfer of shares–with all their attendant voting, economic, and other rights–by a shareholder of a close corporation. Any constraints that do exist will be found in the shareholders’ agreement or by-laws and, even then, case precedent holds that any such limitations may not cross mandatory rules in the business corporation law and may not otherwise impose “unreasonable” restraints on alienation. Continue Reading Turmoil Follows Involuntary Transfers of LLC Membership Interests

We’ve written from time to time, including here and here, about the need to allege pre-suit demand or demand futility where a shareholder seeks to sue derivatively on behalf of a corporation for whom the court has appointed a receiver. Pre-receivership, the board of directors is entitled to decide whether to bring a lawsuit on the corporation’s behalf. Under Section 626 (c) of the Business Corporation Law, a shareholder seeking to sue derivatively on behalf of the corporation must allege (i) pre-suit demand upon the board to commence a lawsuit on behalf of the corporation or (ii) that a demand upon the board of directors to commence suit would be “futile.”

Things change when a receiver is appointed. In an order appointing a receiver, the court typically gives to the receiver, and takes from the board, the power to decide whether to commence suit on the corporation’s behalf. In that situation, the putative shareholder derivative plaintiff must allege pre-suit demand or demand futility upon the receiver. The concept is straightforward, but putative derivative plaintiffs often overlook it.

Take, for example, a recent decision by Manhattan Commercial Division Justice Andrea J. Masley in Culligan Soft Water Co. v Clayton Dubilier & Rice, LLC, 2020 NY Slip Op 30828(U) [Sup Ct, NY County Mar. 19, 2020]. Culligan did not involve a closely-held business, but it did contain a particularly useful explanation of the applicable law in New York on the subject of alleging pre-suit demand upon a court-appointed receiver, or in that case, “liquidator,” including the subject of a pre-suit demand relating back to a prior-filed pleading. Continue Reading The Pre-Suit Demand Requirement for a Corporation in Liquidation or Receivership

The proverb “All for the want of a horseshoe nail” aptly describes the possibly mortal blow dealt by the Appellate Division’s recent decision in Favourite Ltd. v Cico, 2020 NY Slip Op 01463 [1st Dept Mar. 3, 2020], to a lawsuit initiated by non-managing members of a manager-managed Delaware LLC whose certificate of formation was cancelled for the ministerial failure to designate a new registered agent within 30 days after its old one resigned.

Favourite involves the alleged mismanagement of a Delaware LLC by its former managing members in connection with the financing, operation, and sale of a Manhattan residential apartment building acquired by the LLC to provide short-term rentals for international leisure and corporate travelers. The business was decimated in 2012 by anti-Airbnb legislation, leading to a mortgage default, foreclosure action, and distress sale. The managers used the net sale proceeds as a down payment made by a newly formed LLC to purchase another building, but the purchase never materialized.

In 2015, non-managing members holding more than 50% of the membership interests, as permitted by the operating agreement, voted to remove the managers and then brought suit against them. The suit initially named the LLC (along with some of the non-managing members) as plaintiff but it was dropped in the first amended complaint after losing its legal representation. Continue Reading Unauthorized Certificate of Revival Dooms Delaware LLC’s Claims Against Former Managing Members

The Comic Strip is the oldest stand-up comedy showcase club in New York City. Its co-founders Robert Wachs and Richard Tienken opened the club in 1975 on Manhattan’s Upper East Side. Over the last 45 years a veritable who’s who of the comedy world has performed on its stage, including George Carlin, Eddie Murphy, Richard Pryor, Chris Rock, Jerry Seinfeld, Robin Williams, and the list goes on.

Off stage, however, things are not so funny.

In the wake of co-founder Robert Wachs’ death in 2013, litigation broke out over the club’s finances and management between Tienken and Wachs’ widow, Tess Wachs, who succeeded to her husband’s 50% ownership of the corporation, Comic Strip Promotions, Inc. Over a four-year span, a half dozen or so legal proceedings have bounced back and forth between arbitration and court, much of which is omitted in the following description. Continue Reading No Laughing Matter: Deadlock Dissolution Petition Targets Legendary NYC Comedy Club

I’m always disappointed by appellate opinions that decide novel or unsettled issues in business divorce cases with little or no analysis. It seems like a lost opportunity to provide guidance in future cases. The Appellate Division, Second Department’s opinion last week in PFT Technology, LLC v Wieser, 2020 NY Slip Op 01942 [2d Dept Mar. 18, 2020], is one of those.

PFT is a case I’ve previously featured on this blog three times over it’s eight-year life span, addressing Nassau County Commercial Division Justice Stephen A. Bucaria’s novel rulings in an LLC dissolution case:

  • ordering the LLC to advance all parties’ legal fees to “level the playing field” (read here);
  • fixing the valuation date for a buyout of the defendant 25% member’s interest on the day before the LLC filed suit in July 2012 (read here); and
  • rejecting the LLC’s subsequent request to withdraw its dissolution claim in connection with its unsuccessful bid to enjoin the minority member from operating a competing business (read here).

The trial of the case yielded rulings on a number of important issues concerning fair value appraisals generally, one of which was the subject of my recent article entitled Post-Valuation Date Distributions: Should They Be Credited Against Fair Value Awards? The article summarized the few and arguably conflicting lower court cases addressing whether an award to the exiting shareholder of his or her pro rata share of post-valuation date distributions made during the proceeding’s pendency, i.e., prior to consummation of the buyout, constitutes “double dipping.”

Having already written extensively on the case background and the court’s pretrial rulings in my prior posts, I won’t do it again here. If you’re not inclined to read the prior posts, what you need to know is:

  • The subject LLC, in the business of detecting gas and fluid leaks in power networks for public utilities, had four 25% members.
  • In 2011, either three of the members froze out the fourth or the fourth “abandoned” the business, depending which side’s story you accept.
  • In 2012, the three members brought suit in the name and right of the LLC asserting claims against the fourth and also seeking the LLC’s dissolution or “reconstitution” without the fourth.
  • The fourth counter-sued for a buyout of his 25% interest.
  • Notwithstanding the absence of any buyout authorization in the LLC Law’s provisions governing judicial dissolution, the court ordered a fair value appraisal and “equitable” buyout of the fourth’s interest, apparently without objection by the other three members.

One other tidbit for those who don’t read the prior posts: If you’re wondering why the LLC’s three members holding an aggregate 75% membership interest had to seek judicial dissolution as opposed to dissolving voluntarily, the answer lies in the LLC’s operating agreement which required a super-majority in excess of 75%, i.e., unanimity, to dissolve voluntarily. Continue Reading No Double Dipping! Court Denies Post-Valuation Date Distributions in Equitable Buyout of LLC Member

Section 1104-a of the Business Corporation Law (the BCL) empowers courts to dissolve a corporation if the petitioning shareholder can establish either of two specified grounds for dissolution. Section 1104-a(a)(1) authorizes dissolution upon a showing of ” illegal, fraudulent or oppressive actions toward the complaining shareholders” by the “directors or those in control of the corporation” (emphasis added). Section 1104-a(a)(2) authorizes dissolution upon a showing that property or assets of the corporation are being “looted, wasted, or diverted for non-corporate purposes” by the “directors, officers or those in control of the corporation” (emphasis added).

At the end of the statute, the so-called “surcharge” provision, section 1104-a(d), empowers courts to “order stock valuations be adjusted” and to “provide for a surcharge upon the directors or those in control of the corporation upon a finding of wilful or reckless dissipation or transfer of assets or corporate property without just or adequate compensation” (emphasis added).

As noted with italics above, all three statutes contain an identical three-word phrase allowing courts to dissolve based upon conduct committed by, and/or impose a surcharge against, “those in control” of the corporation. What does it mean to be “in control?” As noted in a prior post, reported decisions involving a corporate dissolution petitioner seeking a surcharge against the respondent are exceedingly rare. Cases in which corporate dissolution petitioners obtain a surcharge are unicorn-like in their rarity – there is only a single case of which we are aware.

With the scarcity of case law on the subject of surcharges, a recent decision caught our eye, in which a court, apparently for the first time, considered what it means to be “in control” of the corporation for purposes of imposing a surcharge.

In Matter of Telano, Decision and Order [Sup Ct NY County Jan. 8, 2020], Manhattan Justice Joseph Risi tackled the interesting question of whether a shareholder petitioning for dissolution may sue a non-shareholder, director, or officer under the “surcharge” provision of section 1104-a(d) seeking in effect to use the statute as a substitute for an otherwise viable cause of action. Continue Reading Who Is a “Control” Person for Purposes of the Dissolution Statute’s Surcharge Provision?

Article 12 of New York’s Limited Liability Company Law authorizes the formation of professional service limited liability companies (PLLC). Eligible professions include lawyers, medical doctors, accountants, architects, and various other licensed occupations. Article 12 merely regulates the formation and the professional membership of PLLCs. Otherwise, PLLCs are governed by the same provisions of New York’s LLC Law applicable to non-professional LLCs.

I’m unfamiliar with the organizational or tax-related advantages or disadvantages, if any, peculiar to law firm PLLCs compared to the ubiquitous limited liability partnerships and professional corporations. What I can say is that, since 1994 when New York enacted its LLC Law, I’ve come across relatively few New York law firms organized as PLLCs. Nor have I seen, much less written about, any business divorce cases involving law firm PLLCs, which means either they’re out there operating flawlessly or, as I suspect, they’re few in number.

There’s always a first. Last month, Albany County Commercial Division Justice Richard M. Platkin decided Flink v Smith, 2020 NY Slip Op 50305(U) [Sup Ct Albany County Feb. 7, 2020], involving a dispute between former law partners following the collapse of their PLLC known as Flink Smith Law (FSL).

Justice Platkin’s decision, granting in part and denying in part the defendants’ pre-answer motion to dismiss the complaint, addressed interesting issues concerning the effect of the defendant members’ withdrawal from the PLLC on their undertakings in FSL’s operating agreement to buy out the plaintiff’s membership interest. It also addresses the plaintiff’s claims that his former partners conspired to unlawfully collapse FSL and divert its business to a newly created law firm. Continue Reading Forced to Buy Out Law Partner’s Interest In Defunct Firm, Years After Withdrawing? It Can Happen

Buyers of fine art must investigate the work’s provenance before closing the deal. The same holds true for anyone contemplating the acquisition by assignment of a membership interest in a limited liability company.

Not only must the assignee-to-be determine the provenance of the assignor’s membership interest, the LLC’s operating agreement also must be consulted for restrictions on transfer rights and, assuming transfer is permitted, whether an assignment conveys full membership rights or an economic interest only.

These lessons were learned painfully and too late to help the plaintiff in Behrend v New Windsor Group, LLC, in which an appellate court last month affirmed dismissal of the putative assignee’s lawsuit claiming a 50% membership interest in an LLC that owns a shopping center in Orange County, New York, allegedly acquired by assignment from someone who, as it turned out, held a contingent interest that never ripened into membership.

A Contingent Membership Interest Goes Bust

The LLC was formed by defendant Andrew Perkal in 2004 to acquire and operate a shopping center in New Windsor, New York. The operating agreement, never amended, named defendant Andrew Perkal and his wife as the sole members. It included a provision requiring prior unanimous consent of the other members to any member’s proposed transfer of his or her membership interest. Continue Reading Always Check Provenance Before Taking an Assignment of LLC Interest

Welcome to this year’s edition of Winter Case Notes in which I highlight a collection of recent court decisions of interest to business divorce aficionados by way of brief synopses with links to the decisions for those who wish to dig deeper.

This year’s synopses feature decisions by courts in New York, Colorado, and Delaware:

  • dismissing a minority shareholder’s dissolution petition brought outside the limitations period;
  • affirming a minority shareholder’s standing to sue derivatively where her stock sale to a third party was deemed invalid under the shareholders’ agreement;
  • rejecting derivative claims on behalf of a cancelled Delaware limited liability company;
  • dismissing a shareholder derivative suit alleging demand futility where the court found that a pre-suit letter to the board constituted a demand notwithstanding the letter’s explicit disclaimer; and
  • dismissing an appeal from a dissolution order brought by shareholders in the corporation’s name, on the ground that only the court-appointed receiver can act on the corporation’s behalf.

Court Dismisses Time-Barred Dissolution Petition

It’s no surprise that dissolution cases raising a statute of limitations defense are very few and very far between. When a non-controlling owner is frozen out and deprived of income, or disabling deadlock occurs, or the controller is suspected of looting, there’s powerful incentive to bring suit expeditiously. Continue Reading Winter Case Notes: Time-Barred Dissolution Petition and Other Decisions of Interest

Business Divorce 101: To be entitled to an accounting of a closely-held business, the plaintiff or petitioner must demonstrate the existence of a fiduciary relationship giving rise to a duty to account. Almost always, that requires establishing ownership status in the business — the existence of a general partnership, ownership of shares of stock in a corporation, possession of a membership interest in an LLC, etc.

Can one obtain a judicially-imposed accounting of a closely-held business in which one is not an owner? That was the question decided two weeks ago by a Brooklyn appeals court in Bonanni v Horizons Invs. Corp., 2020 NY Slip Op 00563 [2d Dept Jan. 29, 2020]. The answer may surprise you.

The MRI Business

In 2001, four investors formed MRI Enterprises, LLC (the “Company”) with the following stakes to provide magnetic resonance imaging services to local hospitals:

  • 20% – Plaintiff Bonanni, through his wholly-owned corporation, Plaintiff MRI Enterprises, Inc. (“MRI Inc.”)
  • 40% – Defendant Fernandez through his wholly-owned corporation, Defendant Horizons Investors Corp. (“Horizons”)
  • 20% – Defendant Kalish through his wholly-owned corporation, Defendant Adex Management Corp. (“Adex”)
  • 20% – Defendant Hausknecht

To comply with New York law, which prohibits the practice of medicine without a medical license, Hausknecht, a physician, formed Comprehensive Imaging of New York, PLLC (“CINY”), an entity in which Bonanni and MRI Inc. had no membership interest, to provide medical services associated with the Company’s machines. Continue Reading Bending the Rules of Standing: The De Facto Merger Doctrine