Earlier this year, to honor the retirement of former Manhattan Commercial Division Justice Shirley Werner Kornreich, we published a special retrospective of some of her most notable business divorce decisions. This month, two of her former colleagues, Manhattan Commercial Division Justices Eileen Bransten and Charles E. Ramos, are themselves retiring. Justice Bransten concludes 25 years a jurist; Justice Ramos, 35 years on the bench.

With the departure of these two judicial titans, we here at New York Business Divorce thought it fitting to take another stroll down memory lane with a retrospective of some of their most significant contributions to New York’s business divorce jurisprudence. As Justice Ramos is senior career-wise, he will go first.

Three Memorable Decisions from Justice Ramos

For Justice Ramos, we focus on three LLC cases.

In the first, Roni LLC v Arfa, Mem. Decision, Index No. 601224/2007 [Sup Ct, NY County Apr. 14, 2009], Justice Ramos considered the important, first-impression question of whether LLC “promoters” or “organizers” (those who form the entity) owe fiduciary duties to investors / future LLC members. Continue Reading A Fond Adieu to Two Giants of the Manhattan Commercial Division Bench

The roller-coaster ride known as Pappas v. Tzolis came to an end last week when New York’s highest court threw out a lawsuit by two disappointed sellers of LLC membership interests who accused the third, purchasing member of not disclosing at the time of sale that he already had lined up a buyer for the LLC’s sole asset at a huge premium. Pappas v. Tzolis, 2012 NY Slip Op 08053 (Ct App Nov. 27, 2012).

The Court of Appeals’ decision, enforcing a fiduciary waiver provision in the membership transfer agreement, follows in the wake of the same court’s rulings last year in the Centro and Arfa cases, likewise rejecting fiduciary breach claims between business co-owners in the face of releases given in connection with the challenged transactions. (Read here my post on the Centro and Arfa cases.) The Centro-Arfa-Pappas trilogy sends a clear message that, at least where the co-owners’ relationship is no longer one of unquestioning trust, a fiduciary’s assertions surrounding the challenged transaction cannot be blindly relied upon to overcome a contractual release or waiver of fiduciary duty. Continue Reading Pappas Saga Ends, Court of Appeals Upholds Fiduciary Waiver in LLC Buy-Out Agreement

Three-member LLC’s sole asset is long-term commercial lease. 40% Member A buys out 60% Members B and C for $1.5 million. Six months later, Member A sells lease to third party for $17.5 million. Members B and C bring damages suit against Member A for breach of fiduciary duty of disclosure, alleging that Member A secretly was negotiating sale of lease when he bought out Members B and C. Member A defends suit based on express waiver of fiduciary duty in buy-out agreement and on operating agreement’s provision permitting members to engage in competitive business ventures. Who wins?

That’s the question confronting the New York Court of Appeals, the state’s highest court, in Pappas v. Tzolis, No. 193. Earlier this month, the Court of Appeals heard oral argument of the defendant member’s appeal from a split decision by the Manhattan-based Appellate Division, First Department, permitting the complaining members’ lawsuit to proceed after it had been dismissed by the trial court.

The Pappas appeal presents the latest chapter in the ongoing, doctrinal clash of two, fundamentally different notions of the relations and duties among co-owners/fiduciaries of closely held business entities when they enter into buy-out agreements and otherwise formally reconstitute ownership and management rights. The outcome in Pappas also may mark the dénouement of a running debate between the Court of Appeals and the First Department, in which the inferior appellate court more often than not has come down on the side of fiduciary enforcement notwithstanding contractual outs, while the superior court in recent decisions has shown a greater willingness to enforce releases and other contractual waivers of fiduciary duty negotiated by sophisticated business partners with the assistance of counsel. Continue Reading Does Waiver Trump Fiduciary Duty? Court of Appeals Hears Argument in Pappas v. Tzolis

In Memoriam: Professor Larry Ribstein (1946-2011)

One of the benefits of writing a law blog is getting to know and exchange ideas, case notes and legal tidbits with other lawyers and academics. I am grateful that in this fashion I got to know Professor Larry Ribstein, who passed away unexpectedly last weekend at the peak of his prolific, dazzling career as a leading academic voice and mentor to many in diverse fields of business law and particularly in the area of unincorporated business entities. He had a giant intellect and a forceful style that pulled no punches. He was, as I described him to others, scary smart. Two years ago, on the occasion of the publication of his brilliant book, The Rise of the Uncorporation, he graciously agreed to be interviewed for this blog (read here). His last message to me was an email forwarding a post he wrote about the New York Court of Appeals’ decision last week in the Roni LLC v. Arfa case discussed below, in which with typical and well-earned bravado he credits his amicus brief filed in that case with influencing the outcome. Undoubtedly, his influence and legacy of provocative scholarship will be felt and carried forward by many for a long, long time.

Last week the judges of the New York Court of Appeals unanimously affirmed the Appellate Division, First Department’s interlocutory order in Roni LLC v. Arfa denying a motion to dismiss investors’ claim for breach of fiduciary duty against the organizers or “promoters” of a series of real estate holding limited liability companies allegedly for failing to disclose, prior to formation of the LLCs, millions of dollars in brokerage commissions to be paid to the promoters. Roni LLC v. Arfa, 2011 NY Slip Op 09163 (Ct App Dec. 20, 2011).

The First Department’s controversial ruling held, by analogy to 19th century cases imposing fiduciary obligations on stock corporation promoters, that promoters of LLCs by virtue of their status as such also take on fiduciary duties of disclosure to prospective investors. Before reaching the issue, the court specifically found that the complaint failed to allege, as an alternative basis for finding a fiduciary duty, that the defendants possessed superior expertise or knowledge about the real estate transactions coupled with false representations concerning that subject, or that defendants’ personal connections with the plaintiffs established a fiduciary relationship. (Read here my account of the First Department’s decision.)

Continue Reading With a Whimper, Not a Bang: New York’s Top Court Rules on LLC Promoter Liability

On November 15, 2011, the spectacular Albany courtroom pictured at left was the setting for oral argument before the New York Court of Appeals in Roni LLC v. Arfa, No. 228, in which the court is poised to decide whether pre-formation limited liability company “promoters” have a fiduciary duty of disclosure to potential investors. The outcome could have a significant impact on investment structure and investor solicitation, especially in the real estate industry where the LLC, for tax and other reasons, is the preferred form of business organization.

The case involves claims by a group of Israeli real estate investors who purchased membership interests in a series of LLCs formed to acquire, renovate, manage and eventually re-sell multi-family residential properties in New York City. The complaint’s gravamen is that the defendants, who identified the properties, solicited investors, organized the LLCs, negotiated the acquisitions and obtained mortgage financing, concealed from the plaintiffs certain “brokerage” fees of up to 15% that the defendants were to receive from the property sellers and mortgage brokers, eventually exceeding $6.5 million. The plaintiffs alleged that the defendants as “promoters” of the to-be-formed LLCs had a fiduciary duty to disclose the brokerage arrangement to the plaintiffs as prospective investors, and that the fees inflated the purchase prices paid for the properties to plaintiffs’ financial detriment.

Continue Reading NY’s Top Court Hears Argument on LLC Promoter Liability

In the clash between the “punctilio of an honor the most sensitive” and the “morals of the marketplace” (Benjamin Cardozo in Meinhard v. Salmon), marketplace beat out punctilio.    

That’s one way to think about last week’s important rulings by New York’s highest appellate court in two cases testing the efficacy of releases as a defense against fraudulent inducement claims in litigation between co-owners and fiduciaries of closely held businesses.  Another way to think about it: New York judges will not substitute their ex post judgment based on fluid notions of equity and fairness for contractual undertakings freely arrived at through arm’s-length bargaining between sophisticated business partners.

In Centro Empresarial Cempresa S.A. v. America Movil, S.A.B. de C.V., 2011 NY Slip Op 04720 (Ct. App. June 7, 2011), the Court of Appeals affirmed the intermediate appellate court’s dismissal of a lawsuit by minority owners of a privately-held telecommunications company, in which they alleged breach of fiduciary duty and fraud by the majority owner in connection with the buy-out of their equity interests, based on a written release given as part of the buy-out agreement.  In Arfa v. Zamir, 2011 NY Slip Op 04719 (Ct. App. June 7, 2011), the Court of Appeals likewise held that a release provision in a co-management agreement between co-owners of a realty company required dismissal of breach of fiduciary duty and fraud claims based on alleged non-disclosure of major problems with a property acquisition.

In both cases, the trial courts had permitted the lawsuits to go forward citing case law from the Manhattan-based Appellate Division, First Department, seemingly indicating that a fiduciary involved in a self-interested transaction with another owner can almost never rely on a release to avoid liability against allegations of non-disclosure and fraudulent inducement.  That broad proposition is dead after Centro and Arfa.

Continue Reading New York’s Top Court Resets the Bargaining Table When Controlling Owner of Closely Held Company Buys Out Minority Partner

A limited liability company named Ocelot Capital Management, LLC made some new law last month on a narrow but interesting issue: Can the majority member of a manager-managed New York LLC bring a derivative action on its behalf when the manager position is vacant, without alleging either a prior demand upon the manager or that such demand would be futile?

The question drew a negative answer from New York County Commercial Division Justice Bernard J. Fried, who consequently dismissed the derivative claims in Eldan-Tech, Inc. v. Ocelot Capital Management, LLC, Memorandum Decision, Index No. 651101/10 (Sup Ct NY County Oct. 29, 2010).

The dispute in Ocelot begins with a $350,000 promissory note made by Isaac Hershkovitz in favor of Ocelot Portfolio Holdings, LLC (“OPH”) given in partial payment for Hershkovitz’s purchase from Holdings of the latter’s ownership interest in another real estate holding company known as OCG VI.  According to its operating agreement, OPH is a manager-managed LLC whose membership interests are held 80% by plaintiff Eldan-Tech, Inc. (“Eldan”) and 20% by defendant Ocelot Capital Management, LLC (“OCM”).  OCM, which was OPH’s sole manager, is wholly owned by Rachel Arfa and her husband.  At that time Arfa also was the sole officer and director of Eldan.

Continue Reading May Majority Member of Managerless Manager-Managed LLC Maintain Derivative Action?

This is the second of two posts analyzing two recent decisions by the Manhattan-based Appellate Division, First Department, in which the court dismissed fraudulent inducement claims by LLC members against co-member fiduciaries arising from agreements that included broad general releases.  Last week’s post examined Centro Empresarial Cempresa S.A. v. America Movil S.A.B. de C.V.2010 NY Slip Op 04719 (1st Dept June 3, 2010), which involved a dispute over a buyout between members of a Delaware LLC that owned an Ecuadorian mobile telephone company.  The second case, discussed in this week’s post, also concerns a dispute between co-members of a Delaware LLC, but this time the business operations are closer to home, involving a series of real estate acquisitions in New York City.  

The case of Arfa v. Zamir is one of those hydra-headed business partnership disputes that takes on a life of its own, generating multiple lawsuits and dozens of motions, decisions and appeals that take up years before anything seems to get resolved on the merits.  I’ve written up decisions in the Arfa family of cases on several prior occasions, most recently on the issue whether LLC promoters are fiduciaries (see here), before that on indemnification rights of LLC managers (see here), and before that on whether a general release of a LLC fiduciary given as part of an inter-member transaction bars a subsequent action for fraudulent inducement (see here). 

The last-mentioned post highlighted a December 2008 decision by Manhattan Commercial Division Justice Charles E. Ramos refusing to dismiss a fraudulent inducement claim by plaintiffs Rachel Arfa and her husband, Alexander Shpigel, as 60% members of the subject LLC, against defendant Gadi Zamir, who held the remaining 40% interest, relating to a real estate acquisition and development venture in upper Manhattan known as Academy Street.  Here’s a short summary of the factual background from my prior post:

Continue Reading Recent Appellate Rulings Clarify Standards for Challenging Releases Given to Fiduciaries of Closely Held Business Entities: Part 2

Two years ago, in Littman v. Magee, 54 AD3d 14 (1st Dept 2008), the Manhattan-based Appellate Division, First Department, made waves with a decision in which it reinstated a complaint for breach of fiduciary duty and fraudulent inducement by an LLC member who sold his minority interest to the majority, gave them a comprehensive release and, over a year later, after the majority sold the company at a substantial premium, claimed he had been misled as to the true value of his interest.  My write-up of the decision (read here) referred to Littman as "lowering the bar" for claims of this sort by making broad pronouncements that seemingly elevated beyond the power of release the purchaser-fiduciary’s duty to disclose to the seller all material facts bearing on the transaction.  At the time, with some degree of concern, I posed the question, "After Littman, can business owners pursue and exploit the profitable sale of their business or its assets without risk of liability to a former partner whose interest was acquired at a cheaper price?"

In a recent pair of decisions, the First Department effectively has enervated Littman‘s broad pronouncements regarding the inefficacy of releases vis-à-vis the fiduciary duty of disclosure.  In Centro Empresarial Cempresa S.A. v. America Movil S.A.B. de C.V., 2010 NY Slip Op 04719 (1st Dept June 3, 2010) (hereafter "Centro"), and Arfa v. Zamir, 2010 NY Slip Op 06070 (1st Dept July 13, 2010) (hereafter "Arfa"), lower courts had denied motions to dismiss fraudulent inducement claims by LLC members who entered into transactions which included an exchange of general releases.  In both cases, the plaintiffs argued, and the lower courts agreed, that under Littman a general release does not insulate a fiduciary from liability for failing to disclose the fiduciary’s own wrongdoing.  On appeal in both cases, the First Department reversed the lower courts’ orders and directed dismissal of the claims, finding that the plaintiffs had failed to allege facts sufficient to set aside their releases.  In both cases, the First Department expressly distinguished Littman by limiting it to its particular facts.

Interestingly, both appellate decisions were authored by Associate Justice David Friedman who was not on the panel that decided Littman as were none of the other Arfa panel members and only one of the Centro panel members.  As related below, the one Centro panel member who also decided Littman — Associate Justice Catterson — was half of a two-judge dissent in Centro.

In this Part One of a two-part series, I report on the Centro decision.  In next week’s Part Two, I’ll report on the Arfa decision.

Continue Reading Recent Appellate Rulings Clarify Standards for Challenging Releases Given to Fiduciaries of Closely Held Business Entities: Part 1

Will there be a new wave of lawsuits by disappointed investors in business enterprises organized as limited liability companies, alleging that the investors were solicited to become members by slick, fast-talking promoters who concealed their own self-dealing in violation of a fiduciary duty of disclosure that existed even before the LLC was formed?  A recent New York appellate ruling has opened the door to just such suits.  

By the beginning of the 18th century, when Daniel Defoe wrote about the "Villainy of Stock-Jobbers", the public held a contemptuous view of those who traded in the proto stock markets of the time.  In the late 19th century, the term "promoter", referring to those who organized companies and sold shares, likewise took on derogatory shades amidst an industrial boom that experienced no shortage of flim-flam artists exploiting an unprecedented wave of public investment in railroads, utilities, heavy industry and real estate development companies. 

Common-law courts in the U.S. reacted by imposing fiduciary duties on corporate promoters, thereby providing some means of civil recourse for duped investors, and some incentive for greater disclosure by corporation organizers.  For example, in Dickerman v. Northern Trust Co., 176 U.S. 181 (1900), the U.S. Supreme Court wrote that a corporate promoter, which it defined as one who "brings together the persons who become interested in the enterprise, aids in procuring subscriptions and sets in motion the machinery which leads to the formation of the corporation itself," must be "treated as standing in a confidential relation to the proposed company, and is bound to the exercise of the utmost good faith."  The promoter, the Court went on, "is the agent of the corporation and subject to the disabilities of an ordinary agent.  His acts are scrutinized carefully, and he is precluded from taking a secret advantage of the other stockholders. . . . [and] must faithfully disclose all facts relating to the property which would influence those who form the company in deciding upon the judiciousness of the purchase."

Continue Reading Are LLC Organizers Fiduciaries?