Some years are easier than others to select the most significant business divorce cases. In this, the 16th year I’ve published this top-10 list, the task is made especially difficult by a veritable flood of court decisions involving novel issues in business divorce cases. But select I must.
The cases I’ve selected for this year’s list include decisions by New York courts and a couple of out-of-state courts at the trial and appellate levels, involving mostly limited liability companies but also a few close corporations. All ten decisions were featured on this blog previously; click on the case name to read the full treatment. And the winners are:
Doeblin v MacArthur Case law is clear that designated managing members of New York LLCs owe fiduciary duties whereas non-managing members do not. In Doeblin, Commercial Division Justice Andrea Masley was tasked with deciding whether a non-managing member who nonetheless allegedly acted in a managerial capacity owes a fiduciary duty to the company. Upon her review of applicable precedent, Justice Masley concluded that a fiduciary duty is imposed on a non-managing member who shares management duties or takes control of management duties where management duties are not shared. The facts alleged in the plaintiff’s complaint, Justice Masley held, did not make the cut. Case dismissed.
Andris v 1376 Forest Realty, LLC Section 702 of the LLC Law expressly confers standing to seek judicial dissolution on members. Section 608 provides that a deceased member’s executor “may exercise all of the member’s rights for the purpose of settling his or her estate.” Does Section 608 confer on the executor standing to seek judicial dissolution? Cases denying executors as non-members standing to pursue derivative claims suggest not. But in Andris, quoting Section 608’s language without further analysis, the Appellate Division, Second Department, affirmed the lower court’s denial of the executor’s motion for a summary judgment of dissolution based on disputed issues of fact concerning the grounds for dissolution. Given that the respondent in the lower court proceedings did not contest the executor’s standing to pursue dissolution, whether or not Andris made new law will need to be tested in future litigations.
Srivatsa v Rosetta Holdings LLC Can an “equity interest” in an LLC exist separate and apart from a membership interest? The plaintiff in Srivatsa claimed that it can — notwithstanding the Delaware LLC’s operating agreement naming one of the defendants its 100% member — based on an alleged oral agreement to give him a one-sixth ownership interest and the operating agreement’s reference to both “Interest Holders” and “Members.” The Appellate Division, First Department, affirming Commercial Division Justice Jennifer G. Schecter’s order, found that plaintiff’s alleged “equity interest” did not accord with the operating agreement’s use of the term “Interest Holders” or Section 18-702 of Delaware’s LLC Act concerning the interim period before and until an assignee of an LLC interest becomes a member.
Eastland Food Corp. v Mekhaya Eastland, decided by Maryland’s Supreme Court, addresses a frequent issue in New York business divorce cases but on which there is little case-law guidance: Do allegations that the controlling shareholders are taking disguised distributions in the form of salary and bonus (a) support a claim for minority shareholder oppression, and (b) support a direct claim for breach of fiduciary duty or unjust enrichment? All seven of the Court’s Justices agreed with the former, but split 5-2 on the latter, with the majority nixing the direct claims on the ground that the alleged injury is incurred directly by the corporation and therefore any damages claim must be pled derivatively. The scholarly majority and minority opinions totaling 85 pages are well worth the read as regards both issues.
Tsai v Lo Section 620 of New York’s Business Corporation Law authorizes with certain limitations written voting agreements among shareholders. New York’s LLC Law has no such provision. In Tsai, the plaintiff 50% member filed suit to foreclose on the defendants’ 50% membership interests in their realty holding LLC based on nonpayment of a $6 million loan made to fund the defendants’ capital contribution. The defendants counterclaimed to enforce the plaintiff’s alleged oral agreement that, upon defendants’ request, the LLC would sell the property so that the loan could be repaid. The Appellate Division, First Department, reversing the order below, in a first-impression decision held that the counterclaim “sufficiently pled that the oral agreement was effectively an LLC voting agreement under which plaintiff agreed to vote her membership interest in favor of defendants’ sale of their membership interests or a sale of the property.”
ANO, Inc. v Goldberg ANO is a 15-year litigation saga that, along the way, yielded a determination that the two litigants were 50/50 shareholders in the subject corporation and later granted a petition for deadlock dissolution under Section 1104 of the Business Corporation Law. The lower court appointed a receiver and ordered a closed, sealed-bid auction sale between the two shareholders of the corporation’s indirect interest in a real property which was encumbered by a $600,000 mortgage guaranteed by one of the two shareholders. The non-guarantor shareholder appealed to the Appellate Division, Second Department, which reversed the lower court’s order, holding that unless the shareholders agree otherwise, “the only authorized disposition of corporate assets is liquidation at a public sale.”
Han v Kwak This case is a poster child for the importance of choice of remedy in business divorce cases. Pursuant to a Subscription Agreement, the plaintiff invested $1 million for 20% membership interest in an LLC formed to develop and own a chain of poke restaurants. The plaintiff eventually brought suit claiming she was defrauded by the principal of the managing member, itself an LLC. Her claim alleged a single common-law claim for fraud against the principal, seeking rescission of the Subscription Agreement, and a series of derivative claims for damages on the LLC’s behalf. After Commercial Division Justice Schecter warned plaintiff of the inconsistency between the rescission and derivative claims, the plaintiff withdrew her derivative claims and proceeded to a bench trial on the one direct fraud claim seeking rescission. The court found that the plaintiff proved fraud, but in the end recovered nothing. Why? Because the plaintiff sued the principal, not the LLC on whose behalf the principal signed the Subscription Agreement. Wrote Justice Schecter, “While plaintiff could have elected to proceed with her legal claim for damages against Kwak, the ship sailed on that long ago.”
Gallagher v Crotty In Gallagher, the plaintiff 25% member claimed that the defendants squeezed him out of several LLCs involved in affordable housing development. The LLC agreements had a broad authorization provision for amendment by majority consent, and a second, narrower majority-consent provision specific to member distributions, except “if the effect on [a non-consenting] Member is disproportionate to such Member as compared to the effect on all other Members.” Without plaintiff’s consent, the majority members amended the agreements to authorize payment to themselves of management fees which necessarily reduced the excess cash available for distribution under the agreement’s waterfall provisions, allegedly depriving plaintiff over $450,000 in distributions. In granting plaintiff’s motion for summary judgment of liability, the court found that the amendment disproportionately and adversely affected the plaintiff by diminishing his distributions while paying fees to the defendants for work they already were doing.
Owen v Hurlbut Owen is a relatively rare example of the powerful convergence of two common-law doctrines in the same business divorce case: misappropriation of corporate opportunity and faithless servant. In this suit between two siblings, the court granted summary judgment for the plaintiff sister on her derivative misappropriation claim, finding that the defendant brother essentially gutted their co-owned business that provided administrative and bookkeeping services for nursing homes, by setting up his own, separate company that hired all its employees to provide the same services and acquired its assets for a nominal price. The court left to further proceedings a damages determination for the misappropriation. It did not wait, however, to grant summary judgment and assess damages of almost $1.7 million against the brother under the faithless servant doctrine, equal to the compensation he received as an officer and employee of the co-owned company during the period of his wrongdoing.
Flor v Greenberg Farrow Architectural Inc. Flor is a one-of-a-kind case as far as I can tell, in which a New Jersey intermediate appellate court affirmed a jury’s damages award and the trial court’s order dissociating (expelling) a 49% LLC member that abandoned the venture after about two months. The damages over $900,000 for breach of contract consisted of monies the defendant had agreed to pay for plaintiff’s salary and the LLC’s start-up expenses. The expulsion was based on its voluntary withdrawal and both pre- and post-termination wrongful conduct that frustrated the purposes of the LLC and adversely and materially affected its business operations. Of perhaps greater interest to business divorce mavens, the court rejected the defendant’s alternative arguments, either that it was inconsistent to require it to pay contract damages and not allow it to retain its 49% interest, or to require plaintiff to pay defendant for the value of its terminated membership interest.
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