Business Divorce Nation: A Cross-Country Tour of Recent Decisions of Interest

Farrell Fritz, P.C.
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There’s tremendous diversity from state-to-state when it comes to statutory and judge-made law in business divorce cases. The basic fact patterns one sees in cases from across the country, however, don’t vary nearly as much. This juxtaposition of divergent law and convergent fact patterns makes it all the more interesting to follow case law developments from outside my home state of New York, to see how the outcomes and rationales differ from, or resemble those, of New York courts.

To illustrate the point, as I did several years ago, below I summarize five, recent appellate rulings in business divorce cases from around the country addressing issues of universal interest to business divorce practitioners. They include a Massachusetts decision in which a member left to compete against his own LLC; a Maryland case deciding whether a request for receivership triggers buy-out rights; a Mississippi decision allowing a dissolution complaint to go forward based on an alleged “lowball” buy-out offer; a District of Columbia ruling in a dispute following the death of a 50% LLC member; and a Nebraska decision in a contested fair value appraisal case.

Massachusetts Court Holds that LLC Agreement’s Permissive “Other Activities” Provision Trumps Member’s Fiduciary Duty  

In Butts v Freedman, 96 Mass. App. Ct. 827 [2020], the Massachusetts appellate court affirmed a post-trial judgment dismissing a lawsuit brought by one of two members of a Massachusetts LLC against the other member who, while still a member, left their investment banking firm to start up a competing firm. While agreeing with the plaintiff that the defendant, “as a member of a closely held corporation [sic],” owed a fiduciary duty to the plaintiff and their jointly-owned LLC, the court upheld the defendant’s position that his alleged wrongful conduct nonetheless was permitted by the “Other Activities” provision of the LLC’s operating agreement, stating:

Other Activities. The Members, Managers and any of their Affiliates may engage in and possess interests in other business ventures and investment opportunities of every kind and description, independently or with others, including serving as directors, officers, stockholders, managers, members and general or limited partners of corporations, partnerships or other LLCs with purposes similar to or the same as those of [the LLC]. Neither [the LLC], nor any other Member or Manager, shall have any rights in or to such ventures or opportunities, or the income or profits therefrom. [Italics added.]

The appellate panel agreed with the trial judge that the defendant “had no duty to disclose or share the opportunity of joining or merging with [defendant’s competing start-up firm], a corporate opportunity that might belong to [the LLC] absent the provision.” Based on the “plain language” of the Other Activities provision, the court also rejected plaintiff’s argument that the word “other” used in the provision means business opportunities and ventures “which are different from or outside the business of [the LLC].”

It strikes me as odd to include such a provision in an agreement governing an investment banking firm. I’ve seen similar provisions in shareholder, partnership, and LLC agreements permitting owners to engage in competitive operations, but almost always involving realty-holding firms.

Maryland Court Rules Complaint Seeking Appointment of Receiver Does Not Trigger Statutory Buy-Out Election 

Creative lawyering and pushing the boundaries of statutory construction and legal doctrine are commendable, even when they don’t succeed. Bartenfelder v Bartenfelder, Nos. 0934, 2052 [Ct. Sp. App. Md. July 2, 2020], is an example of such creative but unsuccessful boundary pushing. The Maryland appellate court’s opinion’s opening paragraph compactly frames the issue:

This is a dispute between two stockholders of two close corporations. One sought the appointment of a receiver to take charge of the companies to prevent the continued alleged wrongdoing of the other. The alleged wrongdoer sought to leverage the demand for the appointment of a receiver into a statutory right to buy-out the complaining stockholder. The issue we must decide is whether a complaint seeking the appointment of a receiver but not the dissolution of the company, triggers the statutory right of another stockholder, under Section 4-603(a) of the Corporations and Associations Article of the Maryland Code Annotated (“CA”) (1975, 2014 Repl. Vol.), to purchase the complainant’s stock in the subject company. We hold that, in the absence of a petition for dissolution, the request for a receiver does not trigger the statutory purchase right.

The opinion, which reversed a lower court ruling, takes a deep dive into the controverted statute authorizing an elective buy-out and its companion Maryland statute authorizing petitions for involuntary dissolution, including the legislative history. Ultimately, the court concludes that the reference to receivership in the controverted statute, which authorizes a respondent shareholder to “avoid the dissolution of the corporation or the appointment of a receiver by electing to purchase” the petitioner’s stock for fair value (emphasis added), must be construed as limited to a request for appointment of a receiver made in a petition for judicial dissolution, which was not sought in Bartenfelder. As summed up in the opinion’s closing paragraphs:

The relevant, indeed, dispositive point is that Ms. Bartenfelder’s complaint did not request a receiver vested with the one thing that separates equitable from statutory receivers: the power to dissolve the corporations. Ms. Bartenfelder’s complaint, therefore, stayed on the equitable side of the Rubicon. [¶] Accordingly, we are persuaded that because Ms. Bartenfelder’s complaint did not request a dissolution under CA § 4-602, the purchase right under CA § 4-603(a) was not triggered, and therefore Ms. Bartenfelder was not compelled to sell her stock to Mr. Bartenfelder. This result aligns with the plain language as well as the structure and context of the statute, its legislative history, and the distinction between statutory and equitable receivers. This result also has the added benefit of common sense: a stockholder who seeks equitable relief to stop alleged oppression should not have to do so at the risk of being forced to sell her stock to the alleged oppressor.

Mississippi Court Finds Shareholder Agreement’s Buy-Out Provision May be Invalid “As Applied” Due to Oppressive Conduct

In Chain v Ormonde Plantation, Inc., No. 2017-CA-01733-COA [Ct. App. Miss. Mar. 31, 2020], the Mississippi appellate court by a bare 5-4 majority reversed the lower court’s dismissal of a complaint by the spouse of a deceased 25% shareholder. The complaint sought judicial dissolution of a corporation that owns over 1,800 acres used for hunting, fishing, and other recreational activities by the shareholders and their guests.

The plaintiff (Chain) acquired her shares upon her husband’s passing in 2014. Several years later Chain requested that the other shareholders agree to an appraisal of the property for purposes of buying out her shares for “fair compensation.” At a subsequent shareholders meeting attended by Chain’s son, he advised that Chain had received a $1.5 million outside offer for her shares. Under the shareholders’ agreement, however, if Chain desired to dispose of her interest, she had to first offer to sell it to the corporation or the other shareholders at the price set at the last annual shareholders meeting.

The other shareholders claimed the $1.5 million was “more than it was worth” and refused to permit Chain’s acceptance of the offer. They then determined — not at a prior annual meeting as specified in the shareholders agreement and not by secret ballot as also required by the agreement — the value of Chain’s stock at $900,000 and later sent her meeting minutes giving Chain notice of the corporation’s intent to purchase her stock at that price. Chain then filed her dissolution lawsuit alleging oppression and a “blatant attempt” by the majority shareholders “to improperly squeeze out/freeze out” Chain.

On appeal from the lower court’s dismissal of Chain’s lawsuit, Chain argued that the majority shareholders did not comply with the shareholder agreement’s buy-out pricing procedure; that they gave “identical ‘lowball guestimates” of the value”; and that the agreement’s stock transfer restrictions are “manifestly unreasonable” in violation of Mississippi statute. The appeals court majority concluded that Chain’s complaint “properly states a claim for dissolution of the corporation under [Mississippi’s judicial dissolution statute] because the terms were oppressive to Chain,” adding:

The other shareholders offered her only $900,000 for her share, when she allegedly had been offered $1.5 million by an outsider, and there is a question of fact whether the price had been previously set at an annual meeting by secret ballot. Chain further alleges that the other shareholders colluded to set an unreasonably low price for her shares.

The dissenting judges would have affirmed the dismissal of Chain’s complaint on the grounds that shareholders do not have a right to the fair market value of shares and because the failure to receive fair market value does not constitute an unreasonable restriction on the sale of the stock. The majority judges responded:

While we do not disagree with the dissent that the Agreement may be valid on its face, Chain states a claim because the Agreement may be invalid as applied due to oppressive or fraudulent conduct, in which case she would be entitled to the fair value under [the Mississippi statute authorizing an election to purchase the petitioner’s shares in lieu of dissolution]. It is too early in the litigation process to determine. Additional facts through discovery need to be examined before a determination as to the merit of her claims is made. . . . [¶] [H]ere the $600,000 difference between the majority shareholders’ valuation of Chain’s one-quarter interest in Ormonde and the $1.5 million offer Chain allegedly received could be considered “grossly inadequate consideration”; however, Chain had no opportunity to present expert testimony as to the property’s objective value due to the dismissal. Accordingly, Chain should be allowed to present such testimony so the finder of fact can decide whether the majority shareholders offered “grossly inadequate consideration.”

D.C. Court Affirms Liability of Deceased LLC Member’s Executor for Improper Distributions

In Parker v U.S. Trust Co., N.A., Nos. 18-CV-1349, 19-CV-1225 [D.C. Ct. App. Sept. 3, 2020], the District of Columbia Court of Appeals affirmed a $1.3 million jury award against a bank acting as executor of the estate of a deceased member of an LLC that owned residential rental properties.

The operating agreement contemplated three co-equal members, a father and his two daughters, however one of the daughters never became a member. That left the father with a 50% membership interest and the other daughter and her husband (the Parkers) holding the other 50% as tenants by the entirety. The agreement required dissolution of the LLC upon the death of a member unless within 90 days the remaining members vote to continue the LLC, further provided that the LLC “shall not be continued by fewer than two Members.” The agreement also provided that if the remaining members continued the LLC, they were obligated to buy out the deceased member’s interest for one-third of the LLC’s assessed value minus 10%. (The decision offers no insight as to why they never amended the LLC agreement’s buy-out formula to 50% of the assessed value.)

The father died in 2003. Within 90 days of his death, the daughter transferred half her interest to her husband in order to make him a member in his own right so that the two of them could continue the LLC. They then made a demand upon the bank named as executor in the father’s will to purchase the father’s interest at the price fixed by the LLC agreement. The bank refused, precipitating a lawsuit by the Parkers to compel the buy-out and to pay the Parkers their share of the LLC’s income. In 2007, the court summarily ruled in the bank’s favor, finding that the LLC terminated upon the father’s death and ordering the winding up of the LLC. While the Parkers’ appeal from that ruling was pending, in documents describing itself as “managing member,” the bank formally dissolved the LLC and transferred the LLC’s properties to itself as trustee for no consideration.

In 2011, the D.C. appellate court reversed and remanded the lower court’s grant of summary judgment, finding that the LLC agreement was ambiguous on the issue of who is a “member” as well as other disputed issues of fact. At the eventual jury trial, the jury found that Mr. Parker was not an LLC member at the time of the father’s death but became a member after he died; that the Parkers validly elected to continue the LLC; and awarded the Parkers $1.3 million representing the amount of LLC income the bank wrongly distributed to the father’s estate.

In its decision earlier this month, the D.C. appellate court affirmed the jury’s verdict. The bank argued that the LLC agreement could not reasonably be interpreted to permit the addition of Mr. Parker as a member after the father’s death, because as soon as only one member remained, the LLC could take no action other than winding itself down. The bank also argued that the addition of Mr. Parker required the bank’s consent. The court rejected both arguments, drawing upon its ruling on the prior appeal as to the first argument and, as to the second, concluding that under the LLC agreement’s provisions, the bank never became a member of the LLC, thus its consent was not needed.

Finally, the court agreed with the Parkers that the bank was liable for prejudgment interest on the $1.3 million and that, upon remand to the trial court, the Parkers are entitled to seek to prove additional damages arising from the bank’s termination of the LLC and its transfer of the LLC’s realty assets with an approximate net value of $5 million.

Nebraska Court Affirms Fair Value Award But Vacates Judgment Against Non-Electing Party

Anderson v A&R Ag Spraying and Trucking, Inc., 306 Neb. 484 [2020], is another case in which the efforts of the spouse of a deceased shareholder to “cash out” sparked litigation. Anderson involves a trucking and crop-spraying business formed as a corporation in 1999 by two 50% shareholders. One of the owners died in 2015, leaving his shares to his wife (Cheryl) who petitioned for judicial dissolution shortly thereafter. The remaining shareholder (Rafert) elected under the Nebraska statute to purchase her shares for fair value, leading to a battle of the opposing appraisal experts at a hearing.

Cheryl’s expert relied on an asset approach to value the company between $720,000 and $1 million. Rafert’s expert used an income approach to value the company at negative $498,000 reflecting over $1.1 million debt and, alternatively, an asset approach valuing the company at $142,000 before applying a 15% marketability discount.

The trial judge rejected the asset approach because the corporation would not be liquidated. After making certain adjustments to Rafert’s expert’s income approach including his treatment of debt, the court determined the corporation’s value to be almost $640,000 with Cheryl’s share valued at almost $320,000. A judgment in that amount was entered against both the electing shareholder and the non-electing corporation. The judgment also allowed Cheryl to keep two of the corporation’s vehicles that she kept after her husband’s death.

Rafert and the corporation appealed from the trial court’s valuation as well as from the entry of judgment against the corporation and the award of the two vehicles to Cheryl. The Nebraska Supreme Court’s decision agreed that it was improper under the statute to enter judgment against the corporation because Rafert alone elected to purchase Chery’s shares. The court also agreed that the trial judge “lacked the authority to award corporate assets to Cheryl.”

As to the fair value award, however, the court rejected Rafert’s challenge and upheld the award, finding that Rafert “failed to prove that a lower valuation would be more accurate”; that both experts “‘generously included’ assumptions and limiting conditions in their opinions which made arriving at an objective valuation of the corporation difficult”; and that the trial judge “carefully considered the opinions of both experts, identified aspects of the opinions which are inconsistent with the income approach, adjusted each opinion accordingly, and determined a value based on the average of the two opinions.”

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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