Almost always there are elements of acrimony and intense emotion in litigation between co-owners of closely held business entities. The degree of toxicity can vary widely from case to case, although it tends to show up more conspicuously in litigation involving family-owned ventures.

Claims by non-controlling shareholders accusing controlling shareholders and directors of financial or other managerial abuses frequently are styled as derivative claims seeking recovery on the corporation’s behalf for harm to the corporation. In such suits, under the right circumstances the accused may challenge the accuser’s standing to pursue derivative claims based on conflict of interest.

Conflict of interest usually entails some tangible pecuniary interest held or asserted as a direct claim by the accuser that is adverse to the corporation or otherwise at odds with the claims asserted on behalf of the corporation. But a number of court decisions in New York also have cited as a factor in the analysis the accuser’s “animus” or “retaliatory” motive directed against the accused. The legal theory, akin to that applied in class actions, is that the accuser’s personal hostility and the resulting acrimony undermine the accuser’s ability to fairly and adequately represent the interests of the shareholders and the corporation.

Last year I posted about the decision in Pokoik v Norsel Realties in which a trial judge dismissed for lack of standing derivative claims brought by individuals holding an aggregate 11% interest in a realty-holding limited partnership. Among the reasons cited by the judge was that the plaintiffs “failed to demonstrate on this record that they are free from personal animus” as evidenced by the lead plaintiff’s “litigious nature” including several prior lawsuits against the defendants (including family members) alleging similar mismanagement claims, leading the court to conclude that the lawsuit was being wielded by the plaintiffs as “‘a weapon in the total arsenal’ so as to gain leverage in the other disputes.”

If, based on that decision, anyone thought freedom from personal animus is now part of the required showing by a derivative plaintiff, think again. Last week, the Manhattan-based Appellate Division, First Department, reversed the lower court’s decision and reinstated the derivative claims against some (but not all) of the named defendants. Continue Reading Appeals Court Reinstates Derivative Claims Dismissed for Conflict of Interest Where Parties’ Relationship Not “Especially Acrimonious”

litigiousThe U.S. reportedly has the world’s highest number of lawyers per capita (1 for every 300 people) and the 5th highest number of lawsuits per capita (74.5 for every 1,000 people, topped only by Germany, Sweden, Israel, and Austria).

If, as it appears, litigation has become a national pastime in the U.S., then why, when we describe someone as having a “litigious nature,” does that label carry such opprobrium? Is there an unspoken assumption that anyone who brings a multitude of lawsuits must not have meritorious claims, or has ulterior motives to sue? Then again, we recently awarded the presidency to someone who, according to a USA Today analysis, has sued or been sued in 3,500 cases over the last 3 decades.

These observations are spurred by a recent court decision in Pokoik v Norsel Realties, 2017 NY Slip Op 50459(U) [Sup Ct NY County Apr. 12, 2017], in which Manhattan Commercial Division Justice Jeffrey K. Oing cited the plaintiff’s “litigious nature” among the factors supporting dismissal of his derivative lawsuit brought against the fellow members of a real estate partnership, some of whom are relatives of the plaintiff, Leon Pokoik. Granted, it was not cited as the primary factor, but it’s one of those atmospheric factors in a litigation whose impact is hard to measure. Continue Reading Suing on Behalf of People You’re Suing Can Sink a Derivative Lawsuit — Especially If You Have a Litigious Nature

The derivative lawsuit is commonly defined as a lawsuit brought by a shareholder of a corporation against the directors, management, or controlling shareholders of the corporation seeking recovery on the corporation’s behalf for breach of duty involving self-dealing, looting, waste or other wrongful conduct causing injury to the corporation. Derivative lawsuits also can be brought on behalf of alternative entities, including limited partnerships (LP) and limited liability companies (LLC).

Since the claims belong to the corporation (or LP or LLC) the governing statutes and decisional law, applicable to public and private companies alike, impose standing criteria for would-be derivative plaintiffs, including the contemporaneous and continuous ownership requirements. In addition, the claim’s proponent must plead and prove either (a) the making of a pre-suit demand upon the corporation’s directors to bring the suit directly in the corporation’s name and right or (b) that such demand would have been futile and therefore is excused. Litigation over the plaintiff’s satisfaction of the demand requirement more often than not centers on demand futility.

Because many New York-based businesses are formed in Delaware, and because the ability to seek judicial dissolution of a Delaware entity in a New York court is virtually non-existent, when litigation among co-owners of privately-owned Delaware entities takes place in New York, such cases typically feature derivative claims, the standing requirements for which are governed by Delaware law including a large and well-developed body of Delaware case law concerning demand futility.

In the last two months, the Manhattan-based Appellate Division, First Department, handed down three decisions in derivative lawsuits examining challenges to satisfaction of the demand futility requirement: one involving a Delaware corporation, another involving Delaware LPs and LLCs, and the third involving a New York LLC. While none of them addresses claims seeking judicial dissolution, it is the exceptional dissolution petition that doesn’t include a derivative claim against the other owner alleging misappropriation of company assets or business opportunity. It’s therefore important for business divorce practitioners to stay current on the state of the law concerning the standing requirements for derivative claims. Continue Reading Recent Appellate Rulings Address Demand Futility in Derivative Lawsuits

One of the most frequently encountered preliminary skirmishes in shareholder litigation involving closely held business entities focuses on whether the plaintiff’s claims are properly classified and brought either as direct claims for individual relief or as derivative claims for recovery on behalf of the entity. This duality — direct or derivative — has major consequences at the pleading stage and beyond.

Yet, as the Appellate Division, First Department, recently observed in Yudell v. Gilbert, where it expressly adopted Delaware’s formulation for distinguishing between the two based primarily on who suffers the alleged harm, “[s]ometimes whether the nature of the claim is direct or derivative is not readily apparent.”

The line between direct and derivative gets especially blurry when the only two shareholders involved are the aggrieved plaintiff and the defendant whose alleged misconduct results in the wholesale transfer of the corporation’s assets to the defendant or the defendant’s affiliate. Such cases may give rise to direct claims that, in other contexts, might be classified as derivative.

Take, for example, the case of Barmash v. Perlman, 2013 NY Slip Op 31518(U) (Sup Ct NY County July 3, 2013), decided earlier this month by Manhattan Commercial Division Justice Melvin L. Schweitzer. In Barmash, Justice Schweitzer denied a motion to dismiss a complaint brought by a minority shareholder where the claimed breaches by the controlling shareholder, constituting what the court labeled the “de facto liquidation” of the corporation, resulted in harm to the corporation to be pursued derivatively, but also caused injury “uniquely and individually” to the plaintiff minority shareholder permitting direct recovery.  Continue Reading Minority Shareholder’s De Facto Liquidation Claim: Direct, Derivative, or Both?

Note to Readers:

This month marks the 5th anniversary of the New York Business Divorce blog. Every Monday morning, without fail for five years, I’ve posted a new article highlighting a new court decision or other development of interest to lawyers, business owners, business appraisers, and anyone else concerned with broken relationships among owners of closely held business entities.

When I started the blog, my greatest fear was running out of things to write about. After five years of blogging, I can say with great confidence that, the human condition and human relations being what they are, there is an endless stream of business partners falling out of love and into court. Of course, I’m also very grateful to the many judges in New York who take the time and care to write informative decisions in cases involving dissolution and other disputes among business partners.

The most rewarding part of blogging has been the many new relationships it’s led to over the last five years with business owners, other lawyers, other bloggers, accountants, appraisers, and academics. I’ve learned from them that education can be a wonderful, two-way street.

I appreciate the feedback I get from readers. If you’d like to share thoughts about anything I write about, please post a comment, it’s quick and easy to do. If you’re a lawyer (or a judge!) with an unpublished decision that might be of interest to other readers, send it to me. If there’s anything else you’d like me to write about, let me know.

And now, let’s start the next five years.

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I doubt Mark Twain had litigation in mind when he offered the advice, “Always tell the truth. That way, you don’t have to remember what you said.” For litigants, though, failing to remember or, worse yet, negating what was said in a prior lawsuit can have drastic consequences when a judge in a subsequent lawsuit concludes that the same litigant, having succeeded in the prior case by taking one position, is now taking a contrary position simply because his interests have changed.

I’ve previously written several posts on shareholder disputes in which, as it’s known, the doctrine of judicial estoppel against inconsistent positions has been raised successfully as a defense to a corporate dissolution petition or other shareholder suit:

  • In Light v. Boussi (read here), Justice Carolyn Demarest invoked judicial estoppel to dismiss a dissolution petition by a putative 50% shareholder who failed to disclose his alleged stock ownership in his prior bankruptcy proceeding.
  • In Glatzer v. Webster (read here), also decided by Justice Demarest, the court applied judicial estoppel to defeat a claim of ownership in an LLC by an ex-spouse who, in prior divorce proceedings, disclaimed an ownership interest.
  • In Watkins v. J C Land Development, Ltd. (read here), Justice Emily Pines dismissed a shareholder derivative action by a putative 50% shareholder who, in prior federal sentencing proceedings, failed to disclose his alleged stock holding.

The Rubio Lawsuit

Justice Pines had another opportunity to apply judicial estoppel in her decision last month in Rubio v. Rubio, 2012 NY Slip Op 52218(U) (Sup Ct Suffolk County Nov. 26, 2012), involving a shareholder dispute over a family-owned auto dealership. In Rubio, it was the plaintiff’s inconsistent disavowal of a stock ownership interest in prior litigation with his ex-wife that proved fatal to his shareholder derivative claims against his brother and others in the suit before Justice Pines. Continue Reading Court Dismisses Shareholder Derivative Action Due to Inconsistent Stock Ownership Claim in Prior Lawsuit

Last February, in Tzolis v. Wolff, 10 NY3d 100 (2008), the New York Court of Appeals ruled that members of limited liability companies may bring derivative actions on behalf of LLCs notwithstanding the legislature’s deliberate omission of statutory authorization for derivative actions when it enacted the LLC Law in 1994.  (Read my post on Tzolis here).

The dissenting judges in Tzolis objected that the majority had created a common law right of derivative action "unfettered by the prudential safeguards against abuse that the Legislature has adopted when opting to authorize this remedy in other contexts," namely, the statutory provisions imposing demand, contemporaneous ownership, security, attorney fees and settlement restrictions on derivative suits brought on behalf of business corporations and limited partnerships.

The majority responded to this charge, stating that "the right to sue derivatively has never been ‘unfettered’"; that "the limitations on it are not all of legislative origin"; and most importantly:

What limitations on the right of LLC members to sue derivatively may exist is a question not before us today. We do not, however, hold or suggest that there are none.

In Tzolis‘s aftermath, lower courts have taken their cue from the majority’s response by imposing prior demand and contemporaneous ownership requirements on putative LLC derivative plaintiffs.

Continue Reading Post-Tzolis Rulings Address Demand and Contemporaneous Ownership Requirements for LLC Derivative Actions

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?

Sections 706 (d) and 716 (c) of the Business Corporation Law (the “BCL”) both contain a “for cause” standard for judicial removal of corporate directors and officers. Complaints with claims for judicial corporate director and officer removal are common. Decisions actually ordering removal are rare. Very rare. Over the past two decades, there have been less than a dozen appeals court decisions to even cite BCL 706 or 716, and not one involved actual removal on the merits of an officer or director.

The closest to reach the merits of a removal claim, Colucci v Canastra (130 AD3d 1268 [3d Dept 2015]), ruled that four shareholders of a corporation that owned and operated a golf course “submitted prima facie evidence” warranting a trial whether “there was cause for defendant’s removal due to his use of Hillcrest’s profits to pay for clubhouse operations that only benefitted him.”

Last month, in Gam v Dvir (___ AD3d ___, 2024 NY Slip Op 00181 [2d Dept Jan. 17, 2024]), a Brooklyn-based appeals court became the first in a generation to consider the merits of a lower court’s decision ordering judicial removal of a corporate officer or director.

Continue Reading The Flexible “For Cause” Standard for Director and Officer Removal

Parallel business divorce proceedings in the same or different courts alleging overlapping or duplicative claims are common.

When it occurs, judges must often determine whether to dispose of one so the other may proceed in the first instance under the “another action pending” ground for dismissal in CPLR 3211 (a) (4), whether to consolidate or join the two lawsuits in a single proceeding under CPLR 602, or whether to simply allow the two cases to proceed concurrently.

Parallel business and matrimonial divorce proceedings? Not so common. But that is exactly what happened in Malick v 302 East 105th St. LLC (2023 NY Slip Op 34417(U) [Sup Ct, NY County Dec. 12, 2023]).

Continue Reading Parallel Business and Matrimonial Divorce Proceedings

I recently had the privilege of speaking to an audience of judges of the New York Supreme Court Commercial Division at Fordham Law School’s Eileen Bransten Institute on Complex Commercial Litigation. Naturally, the topic was business divorce litigation. My co-panelists Chris Mercer (Mercer Capital) and William Savino (Woods Oviatt Gilman LLP) respectively spoke about the marketability discount in fair value appraisal proceedings and caselaw developments concerning closely held business corporations.

My segment offered what I labelled a “semi-critical retrospective” assessment of the state of New York law concerning LLC business divorce. First, I discussed how tax considerations dictated key elements of the original design and subsequent amendment of New York’s LLC Law. I also observed how those developments have hobbled the ability of New York courts to resolve disputes among co-owners of LLCs and especially in dissolution cases, at least compared to the majority of states that have adopted the Revised Uniform LLC Act or otherwise have similarly updated their LLC statutes, unlike New York.

Next, I gave a chronological, verbal travelogue of court decisions I selected as the “greatest hits” of New York case law since the LLC Law’s enactment in 1994. I highlighted those that have shaped business divorce litigation involving LLCs, showcasing both the statute’s limitations and how courts have achieved some workarounds.

I thought it might be useful to share with a wider audience the substance of my presentation. What follows is adapted from the handout material I prepared for the Commercial Division judges.

Continue Reading New York LLC Caselaw’s Greatest Hits