Two years ago, we wrote about a bitter rivalry between two brothers, James and Vincent Cortazar, over their ownership and management of a single-asset real estate enterprise, 47th Road LLC, which owned an apartment building in Queens. In our last article, Queens County Justice Timothy J. Dufficy issued an order dissolving the LLC under Section 702 of the Limited Liability Company Law. The Court concluded that the brothers were so badly divided, and the LLC so mismanaged by James (the apartment building was in foreclosure), that the company was unable to function as intended, leaving dissolution the only option. The Court appointed a receiver to wind down the LLC’s affairs. Pursuant to a later order, the receiver sold the building for a purchase price of $2.5 million, subject to certain credits for outstanding code violations at the building, which became important in the trial to come.
Last month, after a seven-day bench trial, Justice Dufficy issued a lengthy Bench Trial Order and Judgment, a whopper of a follow up to his earlier dissolution ruling. In the dissolution decision that preceded it, the Court ruled that the evidence cast James, the brother in exclusive control of the business, in a decidedly unfavorable light. Did he fare any better after a full-blown trial on the merits? Let’s take a look.
The Dispute
Before we get to the trial itself, a quick recap. James and Vincent were equal 50% members of an LLC. The LLC’s sole asset was an 8-unit apartment building. The building was encumbered by several mortgages. The origins of the dispute dated back to 2011, when the brothers borrowed $1.2 million secured by a mortgage on the building. According to Vincent, $1 million of the loan proceeds was intended for a 100-acre real estate investment in rural California, to be titled equally in the names of the two brothers. James handled the investment. Unbeknownst to Vincent, James acquired the property solely in his own name. When Vincent found out, he confronted James and the two had a physical altercation. After their fight, Vincent was “locked out of the Company’s day-to-day operations.”
The Claims
In his complaint, Vincent alleged that James grossly mismanaged the property, failing to collect rents and pay debts, resulting in the building’s foreclosure. He alleged that the building was subject to numerous outstanding code violations, which were reduced to money judgments against the LLC, based on an illegal apartment in the basement James leased to his employee and sole corroborating witness at trial. Vincent alleged claims individually and derivatively on behalf of the LLC for breach of fiduciary duty, fraud, waste, conversion, unjust enrichment, and negligence.
The Pre-Trial Contempt Order
As a prelude of things to come, a few months before the trial commenced, the Court issued an order finding Vincent in contempt for refusing to provide financial documents and information to the receiver. Not a good start for James.
Damages Sought
As Justice Dufficy noted in his post-trial decision, Vincent sought six different forms of damages:
1) The principal amount of money (approximately one million dollars) that was received from [the] mortgage taken from the property by respondent James Cortazar and invested in the property in California wholly owned by James Cortazar.
2) The default amount of interest when the mortgage was not paid by respondent due to his failure to pay the mortgage and subsequent foreclosure (approximately seven hundred thousand dollars.)
3) Rents and profits of the Company pocketed into his own name since respondent failed to pay any taxes nor did he pay the mortgage or bills.
4) Building Violations that the petitioner contends that he took all reasonable steps to correct, but once he was removed from control the violations mushroomed to an astronomical amount (approximately one half million dollars.)
5) Legal fees for the breach of respondents fiduciary duties to be determined by the Court by attorney’s affidavit.
6) Contempt for failure to comply with the Court’s Order to turn over rents, records and security deposits to the Receiver.
Credibility Findings
At the trial, Vincent and the receiver testified against James. The court found both their testimony “credible.” In contrast, the Court found the testimony of James “not generally credible, as well as that of his only witness, Jose Guadalupe Escudero.” The Court ruled that James’ “lack of credibility was compounded by his lack of cooperation” with the receiver, his “systematic failure, even in the face of the Contempt Order, to transfer and transmit” to the receiver “the Company’s books, records, bank accounts, securities, and collected rent.” The Court found particularly important that James’ bookkeeper, whom James “attempted to call as a witness at trial,” “refused to testify or appear on [his] behalf.” Not a good look. In a searing rebuke, the Court found that James’ “constant refrain” at trial “that he would ‘have to check his records’ when asked questions about compliance with the Court’s directives, confirm his total lack of regard for these proceedings, this trial and the Court’s directives.”
Conclusions of Law
After trial, the parties submitted proposed and counter-proposed findings of fact and conclusions of law. As one can see from the final decision, the Court adopted large portions of Vincent’s submission in full. Ultimately, the Court held:
The Court finds that the petitioner Vincent Cortazar sustained his burden to prove that respondent James Cortazar breached his fiduciary duties owed to his brother as a 50% owner/member of the Company . . .
1) by diverting the sum of $714,420.21 from the Company to the Rio Dell Project, on August 25, 2009, and not sharing same with the Company or Vincent Cortazar despite his representations to the contrary;
2) by permitting the sum of $548,521.50 to be docketed as Judgment liens against the premises during his control of the Company;
3) by failing to pay and allowing the mortgage on the premises to go into default by refusing to recognize Vincent Cortazar as a member of the Company, causing default interest to become due with bank attorney’s fees, in the sum of $625,721.94, as paid at the closing of June 29, 2018;
4) in failing to disburse and properly share with Vincent Cortazar 50% of the rents and profits of the Company, from May 1, 2013 through June 29, 2018, in the sum as more specifically set forth in Appendix No. 1 herein;
5) in failing to provide the Receiver with the sum of $6,227.76 in rent securities ($7,414 received of $13,641.76 outstanding); and
6) in failing to pay water and sewer rents to the City of New York in the sum of $16,936.21.
On top of these damages, of which the Court awarded 50%, totaling $1.2 million, directly to Vincent for his pro rata share of the LLC, the Court imposed costs in the form of legal fees against James for contempt, and ordered him to pay Vincent’s legal bill for the entire case to be determined based on future submissions. In other words, the Court threw the book at James.
Lessons
For litigants, it often feels like remedies for a business co-owner’s wrongdoing are elusive and painfully difficult to achieve. Cortazar is a reminder that the fiduciary duties of loyalty, good faith, and to refrain from self dealing that LLC owners owe one another are quite real, and that breach of those duties can have terrible financial consequences for those in the wrong. For James, the end result of his fiduciary breaches was the total erasure of all equity he once had in the LLC’s real estate, the payment of the proceeds of the sale of the property directly to his brother, an excess judgment against him, and the looming specter of an additional massive future judgment against him for Vincent’s legal fees.
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