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

Last month, seasoned business appraiser Andy Ross of Getty Marcus CPA, P.C., and I made a presentation at the Nassau County Bar Association about appraisal proceedings in business divorce cases. With the subject of business valuations front of mind, this article – the first in a three-part series – is a treetops summary of the rules governing how business owners may wind up in an appraisal proceeding. Later articles will address the legal and accounting principles that apply in the valuation proceedings.

But before we get started, some context. What exactly is a valuation proceeding? A valuation proceeding is a special kind of lawsuit in which the owners of a business litigate the “value” (the relevant standard under New York’s Partnership Law) or “fair value” (the standard under the New York Business Corporation Law and Limited Liability Company Law) of a partnership, stock, or membership interest in a business for the purpose of a potential buyout or liquidation of that owner’s interest. Appraisal proceedings may be forced, or they may be voluntary. They may involve a variety of different accounting approaches or methodologies to value an ownership interest. They are always heavily dependent upon expert testimony of accountants. For that reason, the “determination of a fact-finder as to the value of a business, if it is within the range of testimony presented, will not be disturbed on appeal where the valuation rests primarily on the credibility of the expert witnesses and their valuation techniques” (Matter of Wright v Irish, 156 AD3d 803 [2d Dept 2017]).

What are the ways in which a business owner can wind up in a valuation proceeding? The statutory paths, or routes, to a litigated appraisal depend on the kind of entity involved. This article discusses three basic entity forms: partnerships, corporations, and LLCs, and provides a non-exhaustive list of the most common ways to get to a valuation proceeding. Continue Reading Basics of Valuation Proceedings – Litigating an Appraisal from Start to Finish – Part 1

How can majority business owners legally rid themselves of a problematic minority owner? Not by transferring the business’s assets to another entity for no consideration. That was the conclusion of Manhattan Commercial Division Justice Shirley Werner Kornreich last month in a lawsuit over a minority shareholder’s stake in Bareburger, Inc., owner of its namesake restaurant chain.

The Bareburger Litigation

In Stavroulakis v Pelakanos, 2018 NY Slip Op 50180(U) [Sup Ct NY County Feb 13, 2018], Bareburger had no written shareholders agreement. Stavroulakis owned 16% of the corporation. He and his co-owners were friends before founding the business. After Bareburger took off, Stavroulakis’ co-owners complained that he was not involved enough to justify his ownership so, as related by Justice Kornreich, they did something rather drastic:

Unbeknownst to him and without his consent, after plaintiff moved to Greece, the defendants, who collectively owned the rest of the Company, transferred all of the Company’s assets to other entities in which defendants (but not plaintiff) have an interest. They did so for no consideration either to plaintiff or the Company, rendering the Company an empty shell.

Continue Reading The Cash-Out Merger Solution to the Problem Minority Owner

There’s a wrinkle in New York’s LLC Law still being ironed out by the courts when it comes to the necessity for member meetings to approve certain actions such as mergers.

On the one hand, under LLC Law § 407(a)’s default rule, whenever LLC members “are required or permitted to take any action by vote,” such action may be taken “without a meeting, without prior notice, and without a vote” so long as signed written consents are obtained from members holding the number of votes required to approve the action had there been “a meeting at which all of the members entitled to vote therein were present and voted.” When consents in lieu of meeting are used, § 407(c) requires “prompt notice” thereafter be given to any members who did not execute consents. In other words, any excluded, non-consenting member is presented with a fait accompli.

On the other hand, LLC Law § 1002(c) provides that any proposed agreement of merger or consolidation “shall be submitted” to the members for a vote “at a meeting called on twenty days’ notice or such greater notice as the operating agreement may provide.” In addition, § 1002(e) echoes the meeting requirement by providing that any member entitled to vote on the proposed transaction “may, prior to that time of the meeting at which such merger or consolidation is to be voted on, file . . . written notice of dissent from the proposed merger or consolidation.”

The question is, does § 407(a)’s written consent trump § 1002(c)’s meeting mandate, or the other way around? Continue Reading No Meeting, No Vote Required for LLC’s Freeze-Out Merger Approved by Majority’s Written Consents

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

Shareholder derivative actions play an important role in monitoring abuses by corporate managers, by giving those with an indirect stake in the corporation’s welfare (the shareholders) an incentive and vehicle to seek judicial redress on the corporation’s behalf for managerial misconduct that the corporation’s board of directors fails to pursue because of conflicted interests or other circumstances impairing the board’s business judgment.

At the same time, statutory and case law impose rigorous standing requirements in derivative actions. In addition to making a pre-suit demand on the board (or alleging demand futility), the derivative plaintiff must own shares at the time of the alleged wrongdoing (the contemporaneous ownership requirement) and throughout the course of the litigation (the continuous ownership requirement).

Particularly in closely held corporations, the contemporaneous and continuous ownership requirements incentivize controlling owners to utilize a cash-out merger (a/k/a freeze-out merger) to defeat shareholder standing to assert derivative claims, leaving the would-be derivative plaintiff with the exclusive remedy of an appraisal proceeding if not satisfied with the board-determined share price, and arguably leaving the corporate managers unaccountable.

Have the courts been able to reconcile the conflicting interests at stake in the two bodies of law governing standing in derivative actions and mergers? Not according to a recently published article by one commentator who, examining Delaware law, concludes that “the existing framework of overlapping rules and exceptions [are] both structurally and doctrinally unsound.” S. Michael Sirkin, Standing at the Singularity of the Effective Time: Reconfiguring Delaware’s Law of Standing Following Mergers and Acquisitions (available on SSRN).

Which brings me to a most interesting court decision late last month by a Manhattan judge in a shareholder derivative action in which, almost literally on the eve of trial in a four-year litigation, the defendant controlling shareholders initiated a cash-out merger openly designed to convert the derivative lawsuit into an appraisal proceeding. Continue Reading Court Permits Freeze-Out Merger on Eve of Trial of Shareholder Derivative Action

In his post-trial opinion issued last week in Grove v. Brown, CA No. 6793-VCG (Del Ch Aug. 8, 2013), Vice Chancellor Sam Glasscock, III of the Delaware Chancery Court begins with a spot-on observation about the risk of failure faced by small, start-up businesses — including those that fail when business partners resort to misbehavior and are driven apart by the very success of their co-venture. Here’s what he wrote:

It requires a certain kind of courage to forgo a salary and strike out on one’s own. When individuals launch a small business with little equity beyond their own sweat and dreams, what follows is often a long, hard struggle leading, ultimately, to failure. When that happens, the results should evoke admiration for their efforts and sympathy for their misadventure. This matter involves a rarer bird altogether: here, four individuals launched a small and poorly capitalized business and were, from the outset, wildly successful. Unfortunately, those individuals were unable to cooperate to enjoy the fruits of that success, choosing instead acrimony and, ultimately, this litigation.

The parties in Grove who chose acrimony over cooperation are two married couples, Marlene and Larry Grove and Melba and Hubert Brown. In 2010, the Groves and Browns started a home-care staffing agency in Newark, Delaware, organized as a member-managed Delaware limited liability company called Heartfelt Home Health, LLC (“Heartfelt”) in which each of them held a 25% membership interest. At inception they entered into an operating agreement providing that each member was to make an initial $10,000 capital contribution.

Heartfelt became an instant financial success when it snagged a contract to provide home care staffing for a major hospice provider. Each of the four members was actively involved in running the business, and they worked well together in the first year, until early 2011 when discussions began about possibly expanding into Maryland and southern Delaware. Continue Reading LLC’s Quick Success Breeds Mutual Misbehavior in Delaware Case

There are many reported decisions addressing the rights of dissenting minority shareholders in merged corporations to receive cash payment for the fair value of their shares pursuant to an appraisal proceeding (e.g., see last week’s post on the Barasch case). Dissenters’ rghts, embodied in statutes enacted over 100 years ago, protect minority shareholders from majority actions that fundamentally change the nature of their investment without their consent, while abrogating the ancient common-law rule that permitted a single shareholder to block a merger.

There’s also ample statutory and case law addressing the rights of the controlling shareholders to compel the cashing out of a minority shareholder for fair value subject to appraisal, in what’s known as a “freeze-out merger.”

But what about that relatively recent invention, the limited liability company? Do minority members of LLCs have a statutory right to demand payment for their interest if the LLC is merged into another entity? Can the majority members force a minority member to cash out his or her interest in a freeze-out merger? Is there any case law on the subject?

Yes, the LLC laws in New York and some other states make provision for dissenters’ rights.

Yes, the majority can effectuate a freeze-out merger.

Yes, there is decisional law but the cases are few and hard to find.

Continue Reading Freeze-Out Merger and the Limited Liability Company