NewYorkCourtofAppealsIn a controversial ruling last year in Congel v Malfitano, the Appellate Division, Second Department, affirmed and modified in part a post-trial judgment against a former 3.08% partner in a general partnership that owns an interest in a large shopping mall, and who unilaterally gave notice of dissolution, finding that

  • the partnership had a definite term and was not at-will for purposes of voluntary dissolution under Partnership Law § 62 (1) (b) based on the partnership agreement’s provisions authorizing dissolution by majority vote, notwithstanding a 2013 ruling by the Court of Appeals (New York’s highest court) in Gelman v Buehler holding that “definite term” as used in the statute is durational and “refers to an identifiable terminate date” requiring “a specific or even a reasonably certain termination date”;
  • the former partner’s unilateral notice of dissolution therefore was wrongful; and
  • having wrongfully dissolved the partnership and upon the continuation of its business by the other partners, under Partnership Law § 69 (2) (c) (II) the amount to be paid to the former partner for the value of his interest properly reflected a 15% reduction for the partnership’s goodwill value, a 35% marketability discount, a whopping 66% minority discount, and a further deduction for damages consisting of the other partners’ litigation expenses over $1.8 million including statutory interest.

The Appellate Division’s decision, which I wrote about here, and the former partner’s subsequent application for leave to appeal to the Court of Appeals, which you can read here, reveal, to say the least, a remarkable result: the former partner, whose partnership interest had a stipulated topline value over $4.8 million, ended up with a judgment against him and in favor of the other partners for over $900,000.

But the story’s not over. Last week, the Court of Appeals issued an order granting the former’s partner’s motion for leave to appeal. Sometime later this year, the Court of Appeals will hear argument in its magnificent courtroom pictured above and issue a decision in the Congel case which likely will have important ramifications for partnership law whatever the outcome. Continue Reading Court of Appeals to Decide Controversial Partnership Dissolution Case

 

I’m pleased to present my sixth annual list of picks for the past year’s ten most significant business divorce cases. This year’s selections, featuring seven appellate decisions, include significant rulings on a variety of issues in dissolution and appraisal cases involving closely held corporations, partnerships and limited liability companies. All ten were featured in this blog previously; click on the case name to read the full treatment. And the winners are:

 

  1. Holdrum Investments, N.V. v. Edelman, 2013 NY Slip Op 30369(U) (Sup Ct NY County Jan. 31, 2013), in which Manhattan Supreme Court Justice Anil C. Singh followed a 1994 First Department precedent in rejecting the argument that a New York court lacks subject matter jurisdiction to dissolve a foreign entity, in that case a Delaware limited partnership.
  2. Doyle v. Icon, LLC, 103 AD3d 440, 2013 NY Slip Op 00797 (1st Dept Feb. 7, 2013), where the First Department dismissed a complaint seeking judicial dissolution of an LLC, holding that allegations by a minority member of systematic exclusion by the controlling members, without more, fail to state adequate grounds for relief under LLC Law § 702.
  3. Sullivan v. Troser Management, Inc., 104 AD3d 1127, 2013 NY Slip Op 01634 (4th Dept Mar. 15, 2013), a 10-year litigation over a stock buy-out where the parties never updated the called-for Certificate of Value, in which the Fourth Department rejected the purchasing shareholder’s contention that the buy-out price should be based on book value.
  4. Gelman v. Buehler, 20 NY3d 534, 2013 NY Slip Op 01991 (Ct App Mar. 26, 2013), in which the Court of Appeals construed the phrases “definite term” and “particular undertaking is specified” as used in Section 62 of the Partnership Law in dismissing a complaint for wrongful termination of an oral partnership agreement.
  5. Mizrahi v. Cohen, 104 AD3d 917, 2013 NY Slip Op 02056 (2d Dept Mar. 27, 2013), where the Second Department ordered a buy-out of the defendant 50% member by the plaintiff 50% member as an equitable remedy in an LLC dissolution case.
  6. Born to Build LLC v. 1141 Realty LLC, 105 AD3d 425, 2013 NY Slip Op 02193 (1st Dept Apr. 2, 2013), in which the First Department ordered dismissal of a complaint for judicial dissolution of an LLC, brought by a party who purportedly acquired an undocumented membership interest at a judgment execution sale, where the LLC agreement negated the existence of the membership interest at issue.
  7. Matter of Sunburst Associates, Inc., 106 AD3d 1224, 2013 NY Slip Op 03368 (3d Dept May 9, 2013), an unusual case in which the Third Department dismissed a deadlock dissolution petition brought by a putative 50% shareholder on the ground that he had transferred his stock to the other 50% shareholder, notwithstanding evidence that, even after the transfer, the respondent shareholder had signed corporate tax returns reflecting the two of them as 50/50 shareholders. 
  8. Breidbart v. Wiesenthal, 108 AD3d 492, 2013 NY Slip Op 05040 (2d Dept July 3, 2013), where the Second Department held that a retired partner, or the estate of a deceased partner, who elects to receive post-withdrawal profits in lieu of interest under Section 73 of the Partnership Law is not entitled to recover appreciation on the value of the partnership assets.
  9. Ruggiero v. Ruggiero, 2013 NY Slip Op 31955(U) (Sup Ct Suffolk County July 29, 2013), in which Suffolk County Justice Emily Pines opted for one appraiser’s income approach over the other appraiser’s market approach in a stock valuation contest involving a family-owned kosher deli.
  10. Feinberg v. Silverberg, Decision and Order, Index No. 3120-11 (Sup Ct Nassau County Sept. 6, 2013), a decision by Nassau County Justice Vito DeStefano in which the court ruled that the petitioner’s alleged bad faith and creation of feigned deadlock is a cognizable defense in a proceeding for judicial dissolution under Business Corporation Law § 1104.

Two years ago, I blogged about a decision in a case called Stulman v. John Dory LLC which, as far as I knew at the time, was the sole decision by a New York court in which a dissenting member of a limited liability company (LLC) sought to block an allegedly unlawful freeze-out merger. The court gave the merger a green light after finding that the ousted minority member in a restaurant business failed to establish that the merger was procedurally improper or “tainted with fraud, illegality, or self dealing.”

Since Stulman, there was one other reported New York case that I blogged about last year involving an LLC freeze-out merger, Alf Naman Real Estate Advisors, LLC v. Capsag Harbor Management, LLC, but that case focused almost entirely on the minority member’s challenge to the offered price for his membership interest and only peripherally on the merger’s technical compliance with the operating agreement, i.e., there was no claim of underlying fraud or misconduct.

Recently I came across a third, new decision in an LLC merger case more akin to Stulman, in which Manhattan Commercial Division Justice Melvin L. Schweitzer examined a disputed LLC freeze-out merger involving a realty management company. Unlike in Stulman, Justice Schweitzer’s decision in SBE Wall, LLC v. New 44 Wall Street, LLC, 2013 NY Slip Op 32104(U) (Sup Ct NY County Aug. 29, 2013), found that the dissenting plaintiffs’ allegations of misconduct by the controlling member, including misrepresentation, concealment, and use of a pretextual capital call in furtherance of a “sham” merger to deprive plaintiffs of their equity stake, fell within an exception to the LLC Law’s provision mandating appraisal as the dissenting members’ exclusive remedy, and enabled them to proceed with their claims seeking to invalidate and set aside the merger.

The combination of Stulman and SBE Wall raise an interesting question about the interplay of the LLC Law’s two, separate provisions that address the dissenting member’s exclusive appraisal remedy. But first let’s look at what happened in SBE Wall.

Continue Reading Action to Enjoin LLC Freeze-Out Merger Goes Forward

Legal scholars have noted that “[f]rom ancient Roman times until the end of the nineteenth century, the partnership was the dominant form for organizing jointly owned business firms.” (H. Hansmann, et al., The New Business Entities in Evolutionary Perspective [Feb. 2005]). Since then, at least in the United States, the general partnership has been largely supplanted by other, statutorily enabled business forms providing limited liability, namely, corporations and, more recently, limited liability companies.

The dearth of business firms organized as general partnerships helps explain the dearth of case law in recent decades addressing partnership rights and duties (the exceptions being cases dealing with limited partnerships and limited liability partnerships which, in New York, continue to be governed to varying degrees by the general Partnership Law).

Thus I was pleasantly surprised when, last month, up popped a new decision by the New York Court of Appeals — the state’s highest appellate court — addressing a core issue under Section 62 of New York’s ancient Partnership Law permitting a partner to dissolve the partnership unilaterally if “no definite term or particular undertaking is specified.”

The decision in Gelman v. Buehler, 2013 NY Slip Op 01991 (Ct App Mar. 26, 2013), involved a claim for breach of an oral partnership agreement between two individuals. The complaint (read here) alleged that Gelman and Buehler were recent business school graduates who decided to form a 50/50 partnership in 2007 to raise $600,000 capital for the purpose of establishing a “search fund” to research and identify for acquisition an operating business with growth potential. A second capital raise was contemplated to purchase the targeted business which was then to be managed by the two partners for “approximately” four to seven years before selling it at a profit for themselves and their investors. Continue Reading New York’s High Court Rules on Unilateral Dissolution of Partnerships

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

It’s among the most common scenarios seen by business divorce lawyers:  A minority shareholder of a non-dividend paying close corporation — let’s call him Joe the Shareholder — for years has been a full-time employee, officer and director of a company he co-founded.  Joe the Shareholder’s salary and occasional bonus are the sole source of return on his investment in the company.  Without any advance notice, the majority shareholders fire Joe the Shareholder, remove him from the payroll, cut off his access to the company computer and change the office locks.  Joe the Shareholder can’t believe that, as a company owner, he can be fired and thrown out by his business partners just like that.  Joe the Shareholder wants to know what his remedies are and, in particular, whether he can sue for wrongful termination of his employment to recover lost salary and other damages.

Joe the Shareholder has a standard shareholders’ agreement that gives a majority of the Board of Directors control of all company business affairs.  The shareholders’ agreement does not fix any definite term of employment for any of the company’s shareholders, and it has no language limiting the Board’s authority to terminate an officer or employee with or without cause.  Joe the Shareholder has no separate employment agreement with the company.

So what’s the answer to Joe the Shareholder’s question?  In New York, without any agreement for employment of a definite duration, Joe the Shareholder is considered an at-will employee of his own company who can be fired for any or no reason (except for reasons made illegal under federal and state workplace anti-discrimination laws), and therefore he has no claim for wrongful termination of his employment.  If Joe the Shareholder has any remedy, he must look to his statutory right to seek judicial dissolution for shareholder oppression under Section 1104-a of the Business Corporation Law

Continue Reading Dissolution May Be Sole Remedy When Minority Shareholder’s At-Will Employment is Terminated

On March 18, 2008, the New York Court of Appeals, which is New York’s highest court, decided Appleton Acquisition, LLC v. National Housing Partnership (read decision here).  The decision holds that a limited partner may not bring an action seeking damages or rescission based on allegations of fraud by the general partner in connection with a merger transaction, and that the statutory appraisal proceeding is the exclusive remedy for such claims.  As a result, the plaintiff in Appleton, which acquired partnership interests post-merger from limited partners who did not exercise appraisal rights, was out of court and out of luck.

The limited partnership known as Beautiful Village (“BV”) owned and managed a New York City apartment complex which received federal financing under HUD’s Section 8 affordable housing program.  By 2002, BV owed over $1.5 million to the corporate General Partner’s parent company.  Rather than foreclosing, the General Partner proposed that BV merge into a new limited partnership owned by the parent company, with each limited partner receiving $100 or 2.5 common units of the parent company for their BV shares.  The limited partners received proxy statements disclosing the conflict of interest between the General Partner and its parent company, and advising that rejection of the merger would likely lead to foreclosure resulting in adverse tax consequences for the limited partners.  The proxy also notified the limited partners of their alternative right to institute a judicial appraisal proceeding to receive the fair value of their partnership interests.  None of the limited partners exercised their appraisal rights.  In September 2002, the merger was approved and the limited partners’ interests in BV were extinguished.

Three years later, plaintiff Appleton Acquisitions, LLC (“Appleton”), which had no prior involvement with BV, purchased from the former BV limited partners their equitable or partnership shares together with any legal claims they had against BV, the General Partner and its parent company.  Appleton then filed a lawsuit against the latter entities asserting three causes of action for rescission of the merger and ancillary money damages on the grounds of fraud, breach of fiduciary duty and negligent misrepresentation.  Appleton alleged that the proxy statement contained false and misleading statements and that the General Partner had depressed the value of the BV partnership interests by failing to enroll in a certain HUD program that would have provided BV with additional Section 8 rent subsidies.  These allegations were also used to support two additional claims seeking monetary damages for breach of contract and aiding and abetting breach of fiduciary duty.

Continue Reading High Court Restricts Remedies of Limited Partner Alleging Fraud by General Partner in Merger Transaction

The New York Court of Appeals (the state’s highest court), in a split decision with a vigorous dissent by three of the court’s seven judges, today resolved the hotly debated question whether members of New York limited liability companies may bring derivative suits on the LLC’s behalf.  Answer:  they may.  Here’s the decision in Tzolis v. Wolff, 10 NY3d 100 (2008). 

A number of lower courts, in refusing to grant member standing to sue derivatively, interpreted the LLC Law’s legislative history as indicative of the legislature’s deliberate omission of statutory authority for derivative suits.  The Court of Appeals majority held otherwise, finding the legislative history "too ambiguous to permit us to infer that the Legislature intended wholly to eliminate, in the LLC context, a basic, centuries-old protection for shareholders, leaving the courts to devise some new substitute remedy" (p. 11).

Waving the separation of powers banner, the dissenters accuse the majority of "judicial fiat" by "effectively rewrit[ing] the law to add a right the Legislature deliberately chose to omit", adding: "The proponents of derivative rights for LLC members — who were unable to muster a majority in the Senate — have now obtained from the courts what they were unable to achieve democratically" (p. 20).

The availability to LLC members of derivative rights will have a substantial impact on LLC member relations and the kind of litigation that may ensue when members seek judicial recourse.  Without such rights, members holding minority interests in LLCs had little recourse against majority abuses that caused direct injury only to the LLC (e.g., taking excessive compensation or other forms of self dealing).  The LLC Law’s provision for judicial dissolution has not proved to be a potent remedy in the face of typical operating agreement provisions giving broad management control to the majority owners.  Today’s decision in Tzolis evens the playing field by providing an alternative avenue for judicial relief. 

Continue Reading LLC Members May Bring Derivative Suits

A decision last week by New York’s highest court may have registered an uptick on the public’s schadenfreude meter, at least among the portion of the public who hold the legal profession in low esteem and who therefore might enjoy the sight of internecine warfare among splitting partners of a law firm.

In Ederer v. Gursky, 9 NY3d 514 (2007), Lawyer A joined and became a 30% shareholder along with Lawyer B (who then held 70%) of a small law firm organized as a professional corporation (PC). Several years later they re-organized the firm as a registered limited liability partnership (LLP) and took in three new partners who collectively held a 15% partnership interest, leaving Lawyer A with 30% and Lawyer B with 55%. Two years later, Lawyer A decided to leave the firm – according to him, because of a falling out with Lawyer B over a firm client; according to Lawyer B, because the firm was in financial dire straits for which Lawyer A was partially responsible – following which he entered into a written withdrawal agreement with the LLP setting forth various financial and case-sharing arrangements. Six months later, Lawyer A sued the LLP and each of its four remaining partners claiming breach of the withdrawal agreement and seeking an accounting and certain profit shares.

Garden variety financial disputes among former business or law partners do not usually garner the attention of New York’s Court of Appeals. This one did, however, because of the defendant partners’ reliance on a provision in the statute governing LLPs that, in general terms, shields partners of LLPs from vicarious liability for obligations of the LLP or for the negligence of their law partners. The case thus raised a novel question of statutory construction whether Section 26(b) of the Partnership Law was meant to protect only against partner liability asserted by third parties or whether, as the defendants argued, it also encompasses liabilities among the partners.

The Court’s decision traces the highly interesting history of partnership liability laws, including the nationwide surge of LLP formations in the aftermath of the savings and loan crisis of the 1980s when regulators went after deep-pocketed law firms to recover massive bank losses. In a 5-2 majority decision, the Court handed victory to Lawyer A by concluding that Section 26(b) only addresses a partner’s vicarious liability for partnership obligations to third parties and does not extend to claims among the partners of the LLP.

The dissenting judges note that Lawyer A’s withdrawal caused the firm’s finances to deteriorate and thereby rendered the firm unable to satisfy its obligations under the withdrawal agreement. They raise two provocative questions: Under these circumstances why should a former law partner be able to collect the firm’s debt from the “innocent” individual partners where a third-party creditor could not, and why should partners of an LLP be saddled with an obligation from which they would be shielded had the firm remained organized as a PC? The majority’s decision, laying emphasis on statutory construction rather than policy, means it will be up to the legislature to amend the law if it sees the same anomaly as do the dissenters.

Update (May 2, 2008)In Kuslansky v. Kuslansky, Robbins, Stechel & Cunningham, LLP, 50 AD3d 1100 (2d Dept 2008), the Appellate Division, Second Department, under the authority of the Court of Appeals’ Ederer decision, reversed a lower court’s decision dismissing an action brought by a former law firm partner for breach of contract based on the alleged failure of the defendants to pay him the value of his interest in the subject partnership as provided for in the parties’ partnership agreement upon a partner’s withdrawal from the partnership.