Here in the New York metro area, for the first time in years winter is living up to its name. The snow-plowed streets and sub-freezing temperatures are a natural setting for this sixth annual 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 three noteworthy decisions by New York courts and one from Iowa:

  • dismissing a rare deadlock dissolution petition involving a not-for-profit corporation;
  • dismissing a petition to dissolve a limited liability company after the company and one of its two 50% members were indicted for tax fraud;
  • dismissing claims for breach of fiduciary duty surrounding the break-up of a law firm; and
  • affirming a post-trial decision dismissing claims by son against father for breaches of fiduciary duty involving a farm property held by an LLC as part of the parents’ estate plan.

Court Dismisses Petition to Dissolve Not-For-Profit Corporation

Judicial dissolution cases triggered by disputes between co-directors of not-for-profit corporations (NFP) — as opposed to dissolution petitions brought by the state’s Attorney General such as the one currently pending against the National Rifle Association — are few and far between. Last year’s decision by Manhattan Supreme Court Justice Carol R. Edmead in Siegel v Eisner is only the second time in this blog’s 13-year history that I’ve had occasion to feature a dissolution case involving an NFP (here’s the first time).

Continue Reading Winter Case Notes: Dissolution of Not-For-Profit Corporation and Other Decisions of Interest

It’s not unusual to find buy-out provisions in shareholder and operating agreements that commit the pricing of the buy-out to the “final and binding” determination of one or more appraisers. The same agreements also may include broad arbitration clauses.

So what happens when a dispute erupts over the appraisal process and the resulting appraisal? Does an arbitrator’s authority begin and end with a determination whether the appraisal process adhered to the agreement? Or can the arbitrator take it a step further, notwithstanding the agreement’s assignment of finality to the appraiser’s determination, by taking valuation evidence and awarding a buy-out price that differs from the one challenged?

These questions may ring a bell for regular readers of this blog. Last year, I wrote about the Yakuel v Gluck case in which Andrew Gluck challenged the $4.7 million appraisal by PricewaterhouseCoopers (PwC) of his 35% membership interest in a digital marketing agency called Agency Within LLC. The 65% member, Joseph Yakuel, engaged PwC under the provisions of a Repurchase Option in an amendment to the LLC agreement mandating “an appraisal of the Fair Market Value by engaging a third party appraisal firm, whose appraisal will be final and binding on all parties.” Gluck essentially claimed that Yakuel rigged the appraisal by feeding PwC false financial projections designed to depress company value while at the same time excluding Gluck from participation in the appraisal process.

In his May 2020 decision that I wrote about last year, Manhattan Commercial Division Justice Joel M. Cohen denied Yakuel’s and Gluck’s dueling petitions, respectively, to confirm and to vacate the PwC appraisal award, finding that “the record is not sufficiently clear at this stage to permit a decision on this question one way or the other” whether Gluck had “a fair opportunity to present his case” to PwC.

My prior post did not mention the broad arbitration provision in the LLC agreement or the arbitration proceeding commenced by Yakuel in November 2018 in which he sought an award enforcing the Repurchase Option. In that proceeding, Gluck counterclaimed to rescind the amendment to the LLC agreement based on allegations of fraudulent inducement and, alternatively, for an award of damages resulting from Yakuel’s allegedly improper exclusion of Gluck from the PwC appraisal process.

We now know the outcome of the arbitration, thanks to another pair of dueling petitions before Justice Cohen to confirm or vacate the arbitrator’s 26-page written award issued last July. Between the award and Justice Cohen’s December 2020 decision confirming in part and vacating in part the award, let’s just say, it’s a doozy. Continue Reading Who Decides Disputed Valuation Under LLC Agreement’s Buy-Out Provision: Arbitrator or Appraiser?

One of the more attractive features of LLCs as a business organization is that they are, in large part, creatures of contract.  Most provisions in the NY LLC Law are default rules, and members are free to adopt those or almost any other rules governing the ownership and management of the LLC.  They can also agree to modify the rules, or they can make new agreements that affect the same interests as those covered by the LLC operating agreement.

With all the freedom of contract available to LLC members, it is not difficult to imagine how things can get messy quickly.  Members sign an LLC operating agreement, then bury it in a file cabinet while they run the business.  Years later and without consulting the operating agreement, they make another deal regarding their respective interests in the LLC.  When a dispute arises, how do the operating agreement and the subsequent deal interact?

A recently filed case in the Manhattan Commercial Division promises to shed some light on the issue.  In the first round—the plaintiff’s application for a preliminary injunction—a subsequent email buyout deal trumped any provisions in the parties’ operating agreement that might have given the defendant an out.  At this stage, therefore, the case reminds us that the LLC operating agreement may give way to a subsequent, less formal agreement when both LLC members manifest their intent to be bound by the latter.

Continue Reading A Shotgun Buy-Sell Agreement and an Email Deal Walk into a Beachside Bar . . .

Three weeks ago, I wrote about the Bak v Rostek case in Brooklyn Supreme Court addressing the duty to disclose third-party offers amidst buy-out negotiations between co-owners. In the classic scenario such as the one played out in Bak involving a single-asset realty holding company, co-owner #1 buys the shares of co-owner #2 at a negotiated price and soon afterward sells the company’s realty at a much higher price to an outside buyer who was waiting in the wings unknown to co-owner #2.

In my post, I commented on the dearth of such cases in the wake of the Centro-Arfa-Pappas trilogy of opinions in which the Court of Appeals rejected reliance on any categorical rule that the seller may “blindly trust” the buyer’s representations concerning value or that the buyer owes a non-releasable fiduciary duty to disclose to the seller all material information concerning the buy-out.

So much for dearth. Days after publishing my piece on Bak, I stumbled across another pending Brooklyn Supreme Court case involving a realty-holding LLC with a similar fact pattern, but with an interesting twist: instead of member #1 buying out member #2, member #1’s son, who helped his father manage the realty but was not himself a member, bought out member #2’s interest and, on the same day the buy-out was completed, the LLC sold the realty to an outside buyer at a much higher price.

The twist gets even twistier. Not only did member #2 sue member #1 and the son, he, or more precisely, his wife as executor of his estate, also brought a separate lawsuit with a claim for aiding and abetting breach of fiduciary duty against the lawyer who handled both the buy-out transaction as well as the LLC’s concurrent sale of the realty to the outside buyer.

Both cases feature decisions denying summary judgment motions. Absent settlement, the two cases are destined for separate trials. (A defense motion seeking a joint trial was denied.) Each case raises interesting issues surrounding fiduciary duties owed, or not, between the parties arising, or not, under the LLC’s operating agreement or common law. Continue Reading Re-Revisiting The Duty to Disclose Third-Party Offers Amidst Buy-Out Negotiations

In last week’s New York Business Divorce, Peter Mahler wrote about an important new decision with far-reaching implications for New York LLC owners. In Farro v Schochet, ___ AD3d___, 2021 NY Slip Op 00150 [2d Dept Jan 13. 2021], Peter and I persuaded a Brooklyn appeals court to rule, based upon Sections 1002 (f) and (g) of the Limited Liability Company Law, that a limited liability company member forced out of a business in a lawful cash-out a/k/a “squeeze-out” or “freeze-out” merger lacks (with limited exceptions) any legal right to attack the validity of the merger, or to have it set aside or rescinded, including based upon alleged grounds of “illegality” or “fraud.”

The Farro merger holding conclusively distinguishes – and places in a different category entirely – LLC mergers from corporation mergers. The latter preserves for dissenting shareholders a post-merger right under Section 623 (k) of the Business Corporation Law (the “BCL”) to maintain an “appropriate action” (construed by the courts to mean one for “equitable relief”) to challenge a merger based upon alleged “unlawful” or “fraudulent” conduct.

After Farro, it is clear that BCL 623 (k)’s “illegality” of “fraud” exception to the post-merger, exclusive remedy of a “fair value” appraisal proceeding does not apply to LLC mergers, and that a fair value appraisal proceeding is the one and only legal remedy available to an LLC owner forced out of the business in an LLC merger that otherwise complies with the merger statutes and the operating agreement (if any).

Although last week’s article addressed the appeals court’s merger holdings in Farro in quite some detail, the article tells only part of the story. In fact, the Farro decision was one of four related opinions the appeals court issued that day. In this article, I’ll do my best to tell the rest of the story, focusing on two of those other decisions. In the first, which I’ll call the “Counterclaims Appeal,” the appeals court affirmed in its entirety the lower court’s decision denying Farro’s motion to dismiss our clients’ counterclaims. In the second, which I’ll call the “Direct Claims Appeal”, the appeals court affirmed in its entirety the lower court’s decision denying Farro’s motion to dismiss our clients’ claims in a separate lawsuit they brought against Farro. Continue Reading The Farro Litigation: The Rest of the Story

For law bloggers, if there’s one thing more satisfying than writing about an important new court decision, it’s writing about an important new court decision that you won for your client.

Last week, the Brooklyn-based Appellate Division, Second Department, unanimously ruled in favor of my clients, construing for the first time at the appellate level two sections of New York’s LLC Law with profound effect on the ability of controlling members of LLCs to oust minority members by means of a cash-out merger.

First, reversing in part the lower court’s order, the appellate panel held that under § 1002 (g) of New York’s LLC Law, an appraisal proceeding is the cashed-out, dissenting member’s sole remedy and that, in contradistinction to the analogous statute applicable to dissenting shareholders under the Business Corporation Law (BCL), no exception exists for alleged fraud or illegality in the procurement of the merger.

Second, affirming in part the lower court’s order, the appellate panel held that LLC Law § 1002 (c), which requires member approval of the proposed merger agreement at a meeting called on at least 20-days notice, is trumped by LLC Law § 407 (a)’s default rule providing generally for member action by written consent in lieu of meeting.

Based on those unanimous rulings, the court in Farro v Schochet, __ AD3d __, 2021 NY Slip Op 00150 [2d Dept Jan. 13, 2021], granted my clients’ request to dismiss an action brought against them by a cashed-out minority member who sought to rescind the merger on grounds of alleged fraud and breach of fiduciary, and who also argued for rescission on the ground that he was not permitted to vote on the merger at a meeting of the members called on 20-days notice. Continue Reading Groundbreaking Appellate Ruling Boosts LLC Cash-Out Mergers

In 2011 and 2012, the New York Court of Appeals decided a series of difficult cases addressing the circumstances under which a contractual waiver or release included in a buyout or other agreement between co-owners of closely held firms provides insulation from subsequent claims for breach of fiduciary duty or fraud based on an alleged failure to disclose vital information concerning the firm’s financial condition or the existence of a third-party offer to purchase the firm’s assets at a significantly higher value.

The upshot of the three cases — Centro Empresarial v America Movil, Arfa v Zamir, and Pappas v Tzolis — is that it depends not only on the particular language of the waiver or release but also on the sophistication of the complaining party and whether, at the time of the transaction, the complaining party had reason to distrust the other party such that it could not reasonably rely on the latter’s representations. Centro in particular rejected any categorical rule that the non-controlling owner may “blindly trust” the alleged fiduciary’s representations or that the controlling owner owes a non-releasable fiduciary duty to disclose to the co-owner all material information bearing on the transaction. In all three cases, which you can read about in my prior posts here and here, the complaining parties lost their claims.

I’m inclined to believe that the cumulative impact of the Centro-Arfa-Pappas trilogy is responsible for the relative dearth of reported decisions by New York courts over the last eight years involving claims of the sort, and that lawyers representing business owners on both sides of buyouts and other transactions between co-owners have applied the trilogy’s lessons in negotiating and documenting agreements.

Until recently, I encountered only three post-2012 published decisions involving buyout-related lawsuits alleging breach of a fiduciary duty of disclosure, one decided in 2013 and two in 2015. In two of them, the court threw out the claims (read here and here). In the third, the court denied a pre-answer motion to dismiss (read here). Continue Reading The Duty to Disclose Third-Party Offers Amidst Buy-Out Negotiations, Revisited

Business divorce clients often arrive in the throes of a crisis, complaining of co-owners siphoning, diverting, depleting, or denying access to company assets and resources for their own personal use or for the benefit of a competing entity at the expense of the business and the client. We usually hear some variation of the question, “How do we stop it?” More often than not, the answer is: “An injunction.”

The Injunction Remedy

An injunction is a kind of court order. It usually comes in the form of a prohibition against a person or entity acting in a particular way (for example, in a business divorce case, from drawing funds from corporate accounts). Less frequently, it can come in the form of a mandate to do or engage in certain conduct (for example, in a business divorce case, to provide ongoing access to corporate books and records). The injunction has three species, each defined primarily by the temporal duration of the relief granted. Continue Reading The Injunction Remedy in Business Divorce Cases

I’m very pleased to present my 13th annual list of the past year’s ten most significant business divorce cases.

This year’s list includes important appellate and trial court decisions in New York and Delaware on a smorgasbord of interesting issues in lawsuits among co-owners of closely held business entities concerning contested buyouts, LLC member expulsion, LLC and limited partnership dissolution, freeze-out merger, the exercise of buy-sell agreements, and federal court abstention in a case seeking common-law judicial dissolution.

All ten decisions were featured on this blog previously; click on the case name to read the full treatment. And the winners are:

Busher v Barry  This S.D.N.Y. federal court decision was handed down in late December 2019 but I’m dragging it across the 2020 line not only because I wrote about it in 2020 but because of its first-impression ruling, applying the Burford abstention doctrine to dismiss a claim for common-law dissolution of a closely held corporation that owns the realty leased to a golf club with overlapping ownership. Citing the Second Circuit’s seminal decision in Friedman v Revenue Management, Inc., the District Court saw no distinction in the application of Burford to common-law dissolution versus statutory dissolution in its impingement upon New York’s strong interest in the uniform development and interpretation of its comprehensive system of corporate governance including the creation and dissolution of its corporations. Continue Reading Top 10 Business Divorce Cases of 2020

“I don’t get no respect” was a famous Rodney Dangerfield comedy routine. It also could be ascribed albeit less comedically to tiebreakers assigned the often thankless task of resolving deadlock between 50/50 owners or managers of closely held business entities. If the deadlock concerns a heated, major issue, the tiebreaker’s vote favoring one of the two factions is likely to alienate and sow mistrust or worse in the other. Or, if prior to putting a decision in the tiebreaker’s hands, faction #1 perceives that the tiebreaker has developed a bias favoring faction #2, faction #1 may seek to remove or otherwise disenfranchise the tiebreaker.

The latter scenario generally describes what happened in Franco v Avalon Freight Services LLC, C.A. No. 2020-0608-MTZ [Del Ch Dec. 8, 2020], in which the plaintiff, representing a 50% ownership faction of a Delaware LLC, sought a declaration that he had the right unilaterally to remove the mutually agreed tiebreaker director designated in the LLC agreement.

The novel issue presented to the court was whether the terms of the governing provision, which did not address removal of any directors,

  • as the plaintiff agued, required the continually renewed, mutual agreement of the two factions to his appointment such that either faction could at any time withdraw its agreement and unilaterally demand removal, or
  • as the defendants argued, referred only to the one-time, past event of designating and appointing the tiebreaker director without any reference to future or ongoing agreement regarding the continued service of the tiebreaker and therefore did not authorize unilateral removal. Continue Reading It Takes Two to Remove a Tiebreaker