Welcome to this 14th annual edition of Summer Shorts. This year’s edition features brief commentary on three recent decisions by New York courts in business divorce cases. The featured cases involve a suit pitting three siblings against their aunt and uncle over a realty holding LLC initially co-owned by the siblings’ deceased mother; the grant of a large bonding requirement in a fair value appraisal proceeding that landed the subject company in Bankruptcy Court; and a dispute between former partners in a dissolved law firm over the post-dissolution allocation of cases and fees. Click on the case names to read the decisions.
Did These Alleged One-Third LLC Members Need an LLC Law § 608 Rescue?
In the last year there have been significant court decisions in business divorce cases seemingly expanding the rights of representatives of the estates of deceased LLC members. Last year, in Andris v 1376 Forest Realty LLC, New York’s Appellate Division, Second Department, condoned without discussion a judicial dissolution petition by the executor of a deceased LLC member under § 608 of New York’s LLC Law, which confers upon the estate representative “all of the member’s rights for the purpose of settling his or her estate or administering his or her property” (read here).
Last month, the Delaware Court of Chancery in the Goldman case held under Delaware’s similarly worded counterpart statute that “[b]ecause handling an estate requires administering its assets before the ultimate settlement of the estate’s affairs, an executor must have the ability to do both” and that the statute “authorizes a personal representative to exercise full governance rights for a proper purpose.” In that case the court left to further proceedings the scope of the executor’s governance rights (read here).
Two weeks after Chancery’s decision, the Brooklyn Commercial Division issued an unusual decision in Hartill v Nunziata denying dismissal of a lawsuit brought by three siblings. In 2007, they allegedly succeeded to their deceased mother’s one-third membership interest in a realty holding LLC co-owned by an aunt and uncle who denied that their nephews and niece ever attained member status.
The lawsuit alleged various breaches of fiduciary duty by their aunt and uncle including withholding distributions. The complaint primarily demanded access to the LLC’s financial records and an accounting. The defendants denied that the plaintiffs were ever admitted as members and therefore lacked standing to assert their claims. The plaintiffs relied on a hodgepodge of documents supporting their alleged membership.
One might have expected the court to deny the pre-answer dismissal motion based on the familiar rule requiring it to assume the truth of the complaint’s well-pleaded factual allegations and on the absence of any conclusive documentary evidence negating plaintiffs’ claims.
Instead, in denying the dismissal motion the court went in a completely different direction — one neither sought nor addressed by either side’s submissions–by invoking § 608 in support of the finding that the estate of the plaintiffs’ mother, who died 17 years earlier, “maintains an interest in the entity, . . . is not a new member and does not need to be voted upon as a new member” under the operating agreement.
Never mind the three children of the long-ago deceased mother claim membership for themselves and sued in their own names to enforce their own alleged rights as members. Never mind the complaint does not identify the plaintiffs as suing in a fiduciary capacity on behalf of their mother’s estate. Never mind the court record doesn’t include any evidence concerning the administration or settlement of the mother’s estate. Never mind the court does not analyze whether the plaintiffs have standing in their own name and right.
Time will tell if the court’s novel approach stands.
Be Careful What You Wish For When Demanding a Bond Under BCL § 1118
When a minority shareholder alleging oppression petitions for judicial dissolution under Business Corporation Law § 1104-a, the respondents have the option under BCL § 1118 to convert the case to an appraisal proceeding by electing to purchase the petitioner’s shares for fair value. When that happens, BCL § 1118(c)(2) enables the petitioner to request, and the court to order in its discretion, that the electing party post a bond “or other acceptable security in an amount sufficient to secure petitioner for the fair value of his shares.”
In what is perhaps the most commonly cited precedent construing the bonding provision, the court in In re Kastleman cited as factors the likelihood of the waste and mismanagement rendering the corporation worthless, the electing party’s financial capability to purchase the petitioner’s shares, financial exposure from other pending lawsuits, and drastic differences in opinion on the value of the shares.
The case of Mestousis v Titan Concrete, Inc. is a powerful be-careful-what-you-ask-for reminder to any petitioner who seeks to have the potential fair value award bonded. Titan Concrete is a Bronx-based concrete supplier to the construction industry. One of its two 50% owners sued for judicial dissolution; the company elected to purchase under § 1118; the petitioner asked the court to require a $10 million bond based on his $6 million investment, $2 million loan, and the company’s $88 million gross income in the period 2018-2021.
The company denied any waste or mismanagement and alleged that it was in the red, faced substantial third-party lawsuits and judgments, owed the government unpaid sales tax, was in default of rent obligations, and reported millions in negative equity on its tax return.
The court found that that there was “some evidence of waste and mismanagement which could render Titan “worthless”; that Titan “is less than financially solvent”; that the petitioner “is entitled to some measure of protection given the uncertainty of Titan’s financial status and respondent’s representation that petitioner’s shares are worthless”; and that “a bond in the amount of $8 million is not unreasonable.”
You can probably guess what happened after the Appellate Division turned down Titan’s application to stay pending appeal the lower court’s bond order. That’s right, Titan filed a Chapter 11 bankruptcy petition, thereby automatically staying the dissolution/appraisal proceeding.
That was almost a year ago. The Chapter 11 case remains pending. There’s an official committee of unsecured creditors and, I imagine, a hefty number of lawyers, accountants, and other professionals bleeding Titan’s bank account. Will there be anything left for the petitioner? Who knows.
If You Think Lawyers Know Better When Doing Their Own Partnership Agreements, Think Again
Whether you’re a business owner or a lawyer for one, beware when someone suggests including in the co-owners’ agreement a provision requiring periodic updates affecting buyout, equity percentages, or anything else with economic consequences.
The most common example is the infamous Certificate of Value annexed to a shareholder, partnership, of LLC agreement fixing per-share value for buyout purposes upon disability, death, retirement, etc., with a provision requiring annual updates and, in many instances, reverting to the last such certificate no matter how outdated it may be. The problem is, the updates are rarely done. If the business grows in value significantly over the years preceding a buyout event and the certificate was never updated, the probability of litigation skyrockets.
Partership agreements among lawyers, whom you think would know better, are not immune from the phenomenon, as illustrated in the trial court’s decision which was affirmed on appeal in Law Office of J Bacher v Safter.
The case involves a dispute between former law partners over entitlement to fees after the partnership’s dissolution. The operating agreement (the firm was organized as a PLLC) included in Section 3.04 what sounds like an easily implemented provision addressing which case goes with which partner upon the firm’s dissolution, stating that “[a]ll cases revert to the partner who brought said case into the partnership upon dissolution.” The agreement included a Schedule A listing the files at the firm’s inception and identifying “who would retain said file if the firm dissolves.”
Section 3.04 also required Schedule A “to be revised yearly” which, naturally, the partners never did, prompting one of the partners to sue the other concerning cases never listed on Schedule A that he worked on regardless they may have been originated by the other partner.
The lower court denied each side’s bid for summary judgment, finding that
Because section 3.04 plainly states that all the cases revert back to the originating partner and only the cases on Schedule A go back to the originating partner, there is an issue of ambiguity that cannot be resolved by the Operating Agreement. This ambiguity in section 3.04 compels this Court to deny both parties’ motions.
The defendant partner appealed. The Appellate Division, First Department, affirmed the lower court’s order, agreeing that, in light of the partners’ failure to revise Schedule A,
neither party established its entitlement to the relief it sought, as the contested language is ambiguous as to the circumstances under which cases would revert to the originating partner upon the firm’s dissolution. . .. Thus, Supreme Court properly concluded that a trial on these issues, among others, was needed to determine the parties’ intent in drafting or negotiating the disputed terms.
We’ll never know how the dispute might have been resolved at trial. The parties recently informed the trial court that they reached a settlement and last week–five years after the case began–filed a stipulation discontinuing the action.
The partnership in Bacher was a small plaintiffs personal injury firm. Such practices can differ greatly in how they originate and staff cases, so I’m in no position to opine on what was a better way for those two partners to allocate cases (and contingent fees) upon dissolution. If there’s little or no collaboration on cases, that is, one partner working on cases originated by the other, and assuming overhead share is not an issue, a provision simply allocating cases (and fees net of the dissolved firm’s disbursements) upon dissolution to the originating partner might make some sense. On the other hand, if as intended and in practice there is significant collaboration, it makes more sense to incentivize the desired collaboration with some sort of a fee-sharing arrangement in the event of dissolution.
[View source.]
