Welcome to our 18th annual edition of the Top 10 business divorce cases featured on this blog over the past year.
This year's selections include a split decision by the New York Court of Appeals in a fascinating case involving a Delaware LLC, along with Appellate Division and trial court opinions addressing stock valuation, estate voting rights in LLCs, anti-dissolution provisions in operating agreements, and additional topics of interest to practitioners and business owners.
All ten decisions were featured on this blog previously; click on the case name to read the full treatment. And the winners are:
Behler v Tao When the Court of Appeals decides a case by 4-3 majority vote affirming the Appellate Division's 3-2 majority vote affirming the trial court's order dismissing an action, both of which featured forceful dissenting opinions, you know this one was a difficult call. And for good reason. At issue was the enforceability of an oral agreement made in 2012 between longtime business associates whereby the plaintiff invested $3 million for a 24.14% interest in a Delaware LLC that served as a holding company for shares in a publicly traded company controlled by the defendant, in consideration of the defendant's personal guarantee that if the publicly traded shares hit $50 per share, defendant would cause the LLC to sell its shares and distribute the proceeds pro rata to plaintiff, and if the shares didn't hit $50 within five years, defendant would cash out plaintiff's interest in the LLC based on the then-value of the LLC's share holdings. Long story short, the shares never hit $50; after five years the plaintiff demanded payment; the defendant allegedly admitted his guarantee but never paid. The plaintiff sued in New York Supreme Court which dismissed the case based on the merger provision in the LLC's 2014 amended operating agreement that the plaintiff never signed. The key factor in all three decisions throwing out the case was the LLC's original, 2012 single member operating agreement which gave the defendant the unilateral right to amend the operating agreement. The dissenting judges at the Appellate Division and Court of Appeals took umbrage at what they saw as the fundamental unfairness at the pleading stage of allowing the defendant to unilaterally amend the operating agreement to deprive plaintiff of any remedy. The takeaway: Before acquiring a non-controlling interest in an existing LLC, be sure to review the in-place operating agreement including any provision concerning its amendment.
Rosenblum v Treitler When determining the discount for lack of marketability (DLOM) in fair value appraisal proceedings, should courts consider dysfunctional or non-existent governance provisions, and discord including litigation between the existing owners, or only look to factors affecting illiquidity at the enterprise level. The Court of Appeals' seminal decision in Friedman v Beway Realty Corp., and the Appellate Division's later Giaimo decision, point toward a focus at the enterprise level as seen through the eyes of a hypothetical buyer, but other trial and appellate court decisions have muddied the DLOM waters by taking into consideration discord among the existing owners. In Rosenblum, the Appellate Division arguably muddied the waters further in affirming the trial court's application of a 15% DLOM to the subject realty holding company based on, as the court wrote, “protracted litigation between the parties, the lack of an operating agreement setting forth a process for withdrawal and the amount of time and money spent on ‘an unwillingness to compromise,' all of which highlights the difficulties a third-party investor would risk in purchasing the LLCs and supports the DLOM applied.” The takeaway: Until there's more definitive appellate guidance, be prepared to argue DLOM at both the enterprise and existing ownership levels.
Bodenchak v 5178 Holdings LLC The First Department's Bodenchak decision is the latest in a string of appellate decisions in the First and Second Departments (Crabapple [1st Dept 2017], Andris [2d Dept 2023], Weinstein [2d Dept 2024]) confirming the powers of estate fiduciaries under LLC Law § 608 to exercise the rights of deceased LLC members. In Bodenchak, a one-third member who petitioned for judicial dissolution died shortly after filing his petition. His widow subsequently moved in the dissolution proceeding to be substituted as the named petitioner in her capacity as executor of her late husband's estate. The respondent members opposed on the ground that the decedent's membership terminated upon his death and that the executor of his estate, as an “assignee” holding only an economic interest, lacked standing to seek judicial dissolution under LLC Law 702. The trial court granted the executor's motion to be substituted and, upon the respondents' appeal, the First Department affirmed, holding that “the dissolution proceeding is necessary to settle [the decedent's] estate and distribute the proceeds from the sale of the apartment owned by [the LLC].” The takeaway: The appellate decisions seem to be applying § 608 as a mandatory statute that overrides conflicting provisions in the operating agreement.
Miller v 22 Ericsson Owner, LLC Miller presented the highly unusual question, whether an LLC member who (1) petitions to dissolve nine LLCs, (2) two years and eight months later amends the petition to name dozens of additional respondents, (3) three months later files a new lawsuit in a different county asserting derivative claims against the other member, and (4) two months later moves to discontinue the dissolution proceeding without prejudice, should be required to pay the other side's legal fees and expenses incurred in defense of the dissolution proceeding as a condition of its discontinuance? In the face of respondents' accusation that the petitioner was guilty of forum shopping, plus the petitioner's sparse explanation for his change of litigation strategy three years into the lawsuit, the court found that the respondents' request was proper and granted discontinuance conditioned upon either the parties stipulating to an amount to be paid to respondents or, failing that, respondents submitting a proposed order granting costs and expenses with an accompanying bill of costs and attendant affidavits. The respondents subsequently submitted a fee request for a little over $400,000. Petitioner opposed the fee request, arguing for various reasons that the fee request should be denied in its entirety. As of this writing the court has not decided the fee application. The takeaway: Absent some truly compelling reason (not including unfavorable rulings by the presiding judge), if you need to discontinue a dissolution proceeding without prejudice in favor of some alternative litigation, don't wait years to do it unless you're prepared to pay a steep price in the form of opposing counsel's legal fees.
Martin v Abrams Family Trust I found Martin of interest as a lesson for business planners and particularly corporate counsel responsible for drafting agreements among working co-owners of closely held companies. The case addresses the not uncommon scenario in which a shareholder who plays an important role in company operations decides to retire after decades of service. The plaintiff 25% shareholder in Martin had worked for the company for 43 years and rose to co-CEO, when she decided to retire. Buyout negotiations ensued without a deal, at which point the plaintiff maintained that she had the right to retire and maintain her 25% equity interest. The other shareholders contended that if plaintiff retired without an agreement to sell her shares, under the extant shareholders agreement she forfeited her shares. The plaintiff sued for a declaratory judgment that upon retiring she kept her 25% equity and profits interest. In opposition the defendants relied on the shareholder agreement's provision stating that “for as long as [plaintiff] is a shareholder of the Corporation, [plaintiff] shall serve as Chief Executive Officer-East Coast Office, Vice-President and Treasurer of the Corporation.” The trial court granted summary judgment in plaintiff's favor, finding that the shareholder agreement was silent on retirement and forfeiture and that the section upon which defendants relied does not say that plaintiff is a shareholder as long as she is CEO. Defendants' appeal fared no better, with the Appellate Division likewise finding that the section relied upon did not contain “clearly expressed” language of forfeiture. The takeaway: When a working shareholder voluntarily retires and keeps their shares, it can breed resentment among the remaining, working co-owners who have to share profits with someone who's no longer contributing to the company's success. Absent unusual circumstances, a shareholder agreement should contain mandatory buyout provisions for all exit scenarios including voluntary retirement, not just death and disability.
Loreti v Lorcress Enterprises, Inc. At first glance, one would think the outcome in Loreti was a slam dunk: the corporation's certificate of incorporation authorized only 200 shares, hence the claim by one of three shareholders in a dissolution proceeding, acknowledging that all 200 shares were issued — 100 to her, 50 apiece to the other two shareholders — while simultaneously claiming that she owned an additional 100 shares pursuant to a corporate resolution where she as sole director awarded 100 shares to herself, was destined for dismissal. Dismissed it was, not as a matter of destiny, but rather as a matter of proof. As the Appellate Division pointed out in its decision affirming the lower court's order, the issuance of the additional 100 shares was not necessarily void. Rather, shareholder agreements may overcome the presumption that the certificate of incorporation controls over any contradictory corporate document “when there is clear and unambiguous evidence that a later agreement was meant to override the certificate.” That kind of evidence was lacking, the court found, hence the shareholder's claim to own two-thirds rather than one-half of the corporation's shares was properly dismissed. The takeaway: There's no excuse for failing to file with the Secretary of State a duly authorized certificate of amendment of the corporation's certificate of incorporation, increasing the number of authorized shares.
TZ Vista, LLC v Helmer The extremely sparse case law addressing whether a provision in an operating agreement waiving the right to seek judicial dissolution of the LLC is enforceable, or is void as against public policy, at best is confusing (compare Matter of Youngwall with Advanced 23, LLC v Chamber House Partners, LLC). Thus any new decision that involves an anti-dissolution provision merits attention, even if, as in the TZ Vista case, it does little to clarify the state of the law. The trial court's decision dismissing the dissolution claim didn't mention the operating agreement's two anti-dissolution provisions, merely noting that the petitioner's showing was “fraught” with conclusory allegations “without evidentiary support.” On appeal to the Second Department, neither side addressed the issue whether the anti-dissolution provision was void as against public policy. Nor did the Second Department in its decision affirming the lower court's order. However, without citing any case authority, the appellate panel's decision found that the LLC members in the operating agreement “waived their right to seek judicial dissolution of TZ Vista” and, specifically, “waived their right to ‘file a complaint, or to institute any proceeding at law or in equity, to cause the termination, dissolution, or liquidation of [TZ Vista].'” On the heels of that finding, the panel added, “[i]n any event, even if the members of TZ Vista had not waived their right to seek judicial dissolution of TZ Vista, the defendants failed to demonstrate, prima facie, that the purpose of TZ Vista had been frustrated or that continuing TZ Vista had become financially unfeasible.” The takeaway: Does the TZ Vista court's finding concerning the anti-dissolution provisions' enforceability, arguably relegated to dicta, move the doctrinal needle? We'll have to wait to see how it's treated in some future case involving anti-dissolution provisions in an LLC agreement.
Tarro v Amadei In Tarro, the trial court granted summary judgment for the plaintiff on his equitable accounting claim brought as a 10% member of an LLC that operates a Manhattan restaurant. Nothing special about that ever since the First Department's 2009 ruling in Gottlieb v Northriver Trading Co. recognizing an LLC member's common law right to an equitable accounting. What was special, as more fully developed in the defendant's appeal to the First Department, was the appellate court's consideration of the defendant's argument for reversal on the ground the accounting claim should have been dismissed because plaintiff did not satisfy the pre-suit demand requirement. That argument by the defense is standard in cases involving derivative actions, as is the counterargument in such cases that any demand made upon the controllers would have been futile. In Tarro, citing exclusively case authorities involving derivative actions, the First Department agreed with the plaintiff that any demand would have been futile based on the complaint's allegations of self-dealing and misconduct. The takeaway: Tarro appears to be a first-impression ruling applying the demand futility rule to an LLC member's equitable accounting claim. It nonetheless remains good practice to make a demand for an accounting, keeping in mind that, unlike in the context of derivative lawsuits, the demand does not request company management to bring suit in the company's own name and right.
Gurewitsch v Korff In what appears to be another first impression ruling, the trial court in Gurewitsch held that the LLC's controller was estopped from seeking to enforce against the non-controlling members a $4.4 million capital call made for the purpose of repaying a series of insider loans unilaterally made by the controller to the LLC. At the time the controller made the capital call, the LLC's real estate development project was deeply in the red. The controller relied on the operating agreement's provision stating that the members “shall make such Capital Contributions . . . as the [Manager] deems appropriate from time to time. If the Company requires additional funds in connection with the business of the Company, then the Members shall . . . make additional Capital Contributions in accordance with their Membership Interests.” The trial court observed that when the Company required financing throughout the development of the project, the Manager chose not to make a capital call, but instead to finance the Company via loans from entities under his control and that, when he made that choice, he charted his path. “Years later,” the court wrote, “he made a hindsight asymmetrical demand for reflective repayment. At this later date and for this purpose, this simply can no longer be said to be a legitimate capital call made pursuant to terms of the Operating Agreement. At this later date, the ‘capital call' was to share the loss of his unilateral investment decision. As such, it is impermissible.” Stated simply, now that the real estate project hasn't the funds to repay his loans, the Manager cannot use his capital call rights to saddle the plaintiffs with a pro rata share of the debt. The takeaway: Broadly authorized capital calls by LLC controllers are susceptible to abuse. On the right facts, the estoppel defense recognized in Gurewitsch can serve as a powerful counterweight.
P.J. Restaurant, Inc. v Dauber “Except as otherwise set forth herein” and other formulations to the same effect are typically found throughout contracts of all sorts, including agreements among co-owners of closely held business entities be they corporations, LLCs, or partnerships. In Dauber, the quoted language made all the difference in a fight for control of a famous red-sauce Italian restaurant in lower Manhattan, following the death of its majority shareholder and sole director. The minority shareholders invoked Section 8.2 of the shareholders agreement, stripping management and voting rights from the shares of a deceased shareholder and by which the minority shareholders elected a new board and appointed new officers. The deceased shareholder's wife, acting as administrator of her late husband's estate, relied on Section 5.1(b) of the shareholders agreement providing that upon there being a board vacancy, “a replacement Direcor shall be elected to fill each vacancy pursuant to the affirmative vote of the holders of the majority of Shares issued by the Company at a special meeting organized in accordance herewith for such purpose.” The opposing positions were advanced in the context of the wife's motion to dismiss a lawsuit against her late husband's estate brought in the name and right of the company under the putative authority of the new board. The trial court sided with the minority shareholders primarily based on the proviso, “Except as otherwise set forth herein,” contained in Section 5.1(b), which therefore was trumped by Section 8.2. The takeaway: I've described the proviso found in Section 5.1(b) and others of its ilk as a wolf in sheep's clothing. Each such proviso in a draft agreement of any sort must be carefully analyzed to determine its impact on any other provision in the agreement.
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