In the end, it wasn’t much of a fight.

The case of Huggins v Scott, decided last month by Justice W. Franc Perry of the Manhattan Supreme Court, illustrates anew the well-nigh insurmountable hurdle faced by a minority member seeking judicial dissolution of an economically viable LLC carrying on its business in conformity with its intended purpose.

The case tells the story of two longtime friends who became romantically involved and then became business partners before both relationships fizzled.

The Respondent is a female, registered amateur boxer and certified boxing coach who, in 2007, started a boxing club known as Women’s World of Boxing (WWB) to offer boxing workshops to teenage girls in under-served communities in Manhattan, Brooklyn, and the Bronx. Over the next decade, the unincorporated WWB had no permanent home and operated out of other boxing gyms.

Respondent organized WWB as a single-member New York limited liability company in 2014. In 2017, with financing help from Petitioner, who also personally co-guaranteed the lease, WWB constructed and opened its own boxing gym. Petitioner and Respondent entered into a written operating agreement under which they respectively held 40% and 60% membership interests. Continue Reading LLC Member’s Petition to Dissolve Boxing Club Dealt First Round KO

I’ve lost track of how many lawsuits I’ve seen between co-owners of New York City restaurants. It’s not surprising given the high percentage of restaurant failures in an intensely competitive market with high rents, high labor costs, and high everything else.

Another significant factor is the heavy initial investment required for start-up restaurants in the city. Aspiring restaurant entrepreneurs long on ideas and talent but short on cash and credit often will bring in friends and family as silent partners to provide the capital required to lease, build, equip, get regulatory approval, open, and carry the restaurant until it reaches profitability. The allure of owning a share of a restaurant managed by a friend or family member, especially for those with no experience in the industry, can dull awareness of the high risks involved. It also can mask the need for independent counsel to vet organizational agreements and the ongoing need to closely monitor restaurant finances.

I can only guess those factors were at play in Berman v Jankelowitz, 2019 NY Slip Op 32439(U) [Sup Ct NY County Aug. 15, 2019], a lawsuit brought by inactive, minority members of several LLCs formed to create and operate a pair of bistro-style restaurants known as Jack’s Wife Freda, located in Manhattan’s Soho and West Village neighborhoods. The lawsuit accused the managing majority members of “theft and waste of corporate assets, including valuable trademarks.”

In a decision early this year, the court ruled in defendants’ favor, upholding their separate ownership of the restaurants’ trademarked name and other intellectual property and their right to license it for use at a third location without plaintiffs’ participation. In that instance, the plaintiffs argued unsuccessfully that the critical language in the operating agreements’ purpose clause was ambiguous.

In its most recent decision, however, it was the defendants who unsuccessfully raised an ambiguity argument when the court adopted the plaintiffs’ construction of provisions in the LLC agreements requiring the defendant managing members to provide audited financial statements. Continue Reading Court Takes Ambiguity Off the Menu of Restaurant’s LLC Agreement

My last post on the subject of advancement and indemnification summarized the basic rules by which closely-held business owners, officers, directors, managers, and members may be entitled to use company funds to pay their legal fees.

This article considers the flip side of the coin: some common-law and statutory limits on the ability of businesses to advance and indemnify legal fees.

At first blush, advancement and indemnification rights may seem broad in business divorce disputes, but the doctrine of “unmistakably clear” fee-shifting agreements, the distinction between first- and third-party disputes, and the general prohibition on recovery of “fees on fees” all provide significant restrictions on advancement and indemnification rights. Continue Reading Can the Company Pay My Legal Fees? – Part Two

In 2018, two members of a realty holding LLC sought judicial dissolution based on the death of one of the other members. The operating agreement defines a member’s death as an event of “Dissociation.” A member’s Dissociation automatically triggers dissolution unless all the remaining members consent to continue the company within 180 days after the dissolution event.

The dissolution petition alleged — and it was not disputed, at least insofar as any manner of formal consent — that no member consent was given to continue the company within 180 days of the member’s death. Sounds like a slam dunk for an order of dissolution, right?

Far from it. Between the fact that the deceased member died 11 years earlier and a provision in the operating agreement effectively allowing a deceased member’s interest to be passed to a family member by inheritance without the other members’ written consent, the dissolution petition more closely resembled an out-of-bounds Hail Mary pass than a slam dunk. The lower court summarily dismissed the petition and last week, in Sternlicht v Daniel Z. Rapoport Associates, L.P., 2019 NY Slip Op 08141 [1st Dept Nov. 12, 2019], the appellate court unanimously upheld the lower court’s ruling.

As usual, the story behind the story points to the pressures that build over time when the LLC agreement leaves members with no assured path to liquidity, ultimately leaving litigation as a last and sometimes futile resort for a member seeking to be bought out.  Continue Reading LLC Survives Member’s Death. Dissolution Petition Doesn’t.

330 West 85th Street is a prime location on Manhattan’s Upper West Side. At that address sits an elegant, pre-war, 48-unit rental apartment building known as The Rexmere. A 4th floor one-bedroom apartment currently is available for $2,950 per month, if you’re interested. I get no commission.

330 West 85 also is the name of the limited liability company that owns the building. The LLC in turn is owned by two gentlemen, Harvey Rubin and James Baumann. Rubin and Baumann’s father acquired the building in the late 1970’s as partners in a general partnership.

Baumann subsequently succeeded to his father’s partnership interest. In 1996, he and Rubin converted the partnership to a manager-managed LLC in which each holds a 50% membership interest and each is a designated manager. The building today undoubtedly is worth exponentially more than its 1978 purchase price.

The business relationship between the two owners apparently went smoothly until around 2014 when Rubin, by then a widower in his 80s, decided to “retire” and approached the younger Baumann about a buy-out. Thus began a chain of events that ruptured their relationship and sees them currently entering their fifth year of litigation marked by two round trips to the appellate court.

The first appellate decision in 2017 pronounced Baumann the winner in a dispute over the construction of the operating agreement’s provisions governing the lifetime sale of a member’s interest.

The second appellate decision last week pronounced Rubin the winner in a dispute centering on the application of LLC Law § 408(b)’s default rule for manager decision-making, to the parties’ dispute over Baumann’s refusal to give up his longtime position as the building’s managing agent.

In both appeals, it’s fair to say that shortsighted drafting of the operating agreement sowed the seeds of dispute. I’ll offer some more thoughts about that at the bottom of this post. Continue Reading Operating Agreement Spawns Multiple Disputes Between 50/50 Members of Realty Holding LLC

The title of this post describes not an army maneuver, but the outcome of a recent lawsuit in Delaware Chancery Court for advancement of litigation expenses in which:

  1. A company sued its ex-CEO in New Jersey federal court for pre-termination breach of fiduciary duty and post-termination breach of the non-compete and non-solicitation clauses of his employment agreement, in the process allegedly using purloined confidential information.
  2. The ex-CEO sued in Delaware Chancery Court for contractual indemnification and advancement of his defense costs in the federal court action.
  3. Chancery Court ordered advancement.
  4. The company amended its federal court complaint by removing all allegations of post-termination misuse of confidential information, following which it moved in Chancery Court to modify the advancement order.
  5. Chancery Court modified its prior order to eliminate advancement for the post-termination contract breach claim.

Vice Chancellor Glasscock’s ruling last week in Carr v Global Payments Inc. underscores important lessons both for both public and private companies about the interpretive interplay between statutory and contractual provisions governing rights to officer and director indemnity and advancement, the breadth of advancement doctrine, the need for company counsel to analyze closely the impact of proposed pleadings on advancement rights, and, most importantly, the company’s need to anticipate and choose between the benefits of bringing claims that trigger advancement rights versus the strategic and financial costs of advancement.

Continue Reading Advance! Amend! Retreat!

Under the so-called “American Rule,” litigants usually must pay their own lawyer fees. But in business divorce and other private company disputes between business co-owners, there are a variety of ways for individual defendants to have the business assume payment of their legal fees in defense of a lawsuit. How? The answer depends on several factors – what kind of entity; what kind of claim; in what capacity is one being sued. In this article, we take a close look at the basics of New York’s law of indemnification and advancement.

Advancement Versus Indemnification

“Indemnification and advancement of legal fees are two distinct corporate obligations” (Crossroads ABL LLC v Canaras Capital Mgt., LLC, 105 AD3d 645 [1st Dept 2013]).

“Advancement is a species of loan—essentially simply a decision to advance credit—to a [corporate official] pending later determination of that person’s right to receive and retain indemnification. The corporation maintains the right to be repaid all sums advanced, if the individual is ultimately shown not to be entitled to indemnification” (In re Adelphia Comms. Corp., 323 BR 345 [Bankr SD NY 2005]). Continue Reading Can the Company Pay My Legal Fees?

In general, federal courts have subject matter jurisdiction to hear cases in which the opposing litigants have diverse citizenship or the suit involves claims arising under federal law.

Lawsuits seeking judicial dissolution of incorporated and unincorporated business entities arise under state law, leaving diversity jurisdiction as the only possible entrée to federal court in such cases.

The rules dictating the citizenship of incorporated and unincorporated entities differ. A corporation is deemed a citizen of its state of formation and its principal place of business. An unincorporated entity, including a limited liability company, is deemed a citizen of every state of which a member of the entity is a citizen.

Thus, if the shareholder-petitioner seeking judicial dissolution of a corporation is a citizen of State X, the corporation is a citizen of State Y, and a named respondent shareholder is a citizen of State Z (or any state other than X), there is complete diversity of citizenship and the federal court has subject matter jurisdiction.

At that point, even with jurisdiction secured, a possible, further impediment to a federal venue in dissolution cases is the so-called Burford abstention doctrine. Some but not all federal courts have applied Burford abstention to dismiss the case without prejudice to re-filing in state court, in deference to state court primacy in an area of comprehensive state regulation. (Read here,  here, and here prior posts about Burford abstention in dissolution cases.) Continue Reading LLCs as Nominal Parties in Dissolution Cases: An Uncertain Portal to Federal Court Jurisdiction

Here we go again — and again and again.

On numerous prior occasions I’ve written about judicial dissolution cases and other infighting among LLC members featuring disputes over membership percentages. The disputes may involve voting rights, management rights, profit shares, buyout, or distributions upon liquidation.

In some cases, the parties fail to document properly — or at all — their respective membership interests. In others, the operating agreements state initial membership percentages but make them subject to future adjustment based on changes in the members’ capital accounts.

In the latter instance of indeterminate or floating interests, the operating agreement can become a curse if eligible capital contributions aren’t adequately defined and/or it establishes no reliable mechanism for recording them, especially non-cash contributions such as services or property. It becomes a double curse when the parties opt to forego legal counsel and use one of the notoriously unreliable, free or cheap, one-size-fits-all, online operating agreements.

The double curse was at work in Roy Food and Wine LLC v Meregalli, 2019 NY Slip Op 32875(U) [Sup Ct NY County Sept. 25, 2019], decided last month by Manhattan Commercial Division Justice O. Peter Sherwood, in which the parties litigated among other issues their respective membership interests, including a claim that the managing member misrepresented his capital contributions. Continue Reading The Perils of Indeterminate LLC Membership Interests

In my business divorce travels occasionally I encounter instances in which shareholder distributions are made in the period between the valuation date for an elective buyout of a minority shareholder who sued for dissolution and the consummation of the buyout following a contested fair value appraisal proceeding.

With that setup, there are two questions you might ask yourself:

  • Why would the controllers of a closely held corporation voluntarily make shareholder distributions benefitting the soon-to-be-removed minority shareholder whose petition accuses them of oppression, looting, or other misdeeds?
  • Since the petitioner’s shares are to be valued based essentially on the risk-adjusted value of future cash flows, do such post-valuation date distributions constitute double dipping and thus should they be credited against the fair value award?

There’s no single answer to the first question. It can happen where the company’s owners for whatever reasons historically have distributed substantially all profits as dividends rather than as salary or bonus, and feel compelled to continue the practice out of economic necessity. It also can happen where a company with a longstanding dividend policy has a number of non-petitioning minority shareholders who likely would object loudly if their dividends were suspended indefinitely by reason of  a dissolution and valuation proceeding brought by another shareholder.

As for the second question, I’ve not seen any appraisal literature that addresses the double-dipping issue. Nor does the sparse case authority provide a clear answer. Continue Reading Post-Valuation Date Distributions: Should They Be Credited Against Fair Value Awards?