Business Divorce on the Menu

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The restaurant business is on the skids amid the COVID-19 pandemic. Yelp reports that 60% of closed restaurants won’t re-open.

Apart from the pandemic, the success rate for new restaurants is dauntingly low. Surveys show a 60% failure rate for new restaurants within the first year and 80% within five years of opening. High rents and labor costs, especially in urban centers. High food costs. Byzantine health and safety regulations. Stiff competition. Low profit margins. It’s a tough business by any measure.

It can be even tougher when co-owners of a restaurant have a falling out, as seems to happen with disproportionately high frequency in the restaurant business. With the exception of real estate holding companies, I can’t think of any business category that, over the last 13 years that I’ve been publishing this blog, has racked up more posts about litigation between co-owners than the restaurant business. The reasons are many: divergent interests between outside investors and inside managers and talent, opportunity for siphoning cash receipts, sloppy accounting, poorly drafted or no owner agreement, an owner opening a competitive business, and more.

In the last few months, unrelated to the pandemic, there’s been a mini-surge of reported court decisions in business divorce cases among restaurant owners. Below you’ll find summaries of five such cases — four decided by judges in the Manhattan and Brooklyn Supreme Courts, and one from Delaware Chancery Court. Bon appétit!

Court Grants Dissolution Petition Against Majority Shareholder Who Transferred Manhattan Restaurant’s Assets to His Separate Company for No Consideration

Kocak v Dargin, 2020 NY Slip Op 33121(U) [Sup Ct NY County Sept. 23, 2020]. In this case involving a Turkish restaurant located in midtown Manhattan, which I first wrote about in 2017, the court granted summary judgment of liability in favor of a 25% shareholder on his statutory claim for dissolution, common law breach of fiduciary duty, and violation of the Debtor and Creditor Law. The court found it undisputed that the 75% controlling shareholder, who in 2012 purchased his shares from the petitioner for about $280,000 to be paid in installments, subsequently diverted essentially all of the restaurant corporation’s assets including its lease and revenues to other entities owned by him and his sister.

The court rejected under the parol evidence rule the majority shareholder’s contention that payments made to the petitioner under a separate employment agreement made contemporaneously with the stock purchase agreement in reality represented a buyout of petitioner’s 25% interest. As the court wrote, “Defendants specifically argue that the employment contract was the method through which [respondent] paid for the remaining shares owned by [petitioner], a position that is unsupportable as both agreements are complete on their faces.”

In Case Involving Celebrity Chef Gordon Ramsay, Chancery Court Approves Receiver’s Liquidation Plan to Assign Derivative Claims to LLC Members in Lieu of Auction

In re GR Burgr, LLC, Letter Opinion [Del. Ch. Oct. 13, 2020]. I wrote about this case three years ago on the occasion of Vice Chancellor Slights’ scholarly opinion granting dissolution of a deadlocked Delaware LLC formed by celebrity chef Gordon Ramsay and investor Rowen Seibel to develop and operate first-class burger-themed restaurants. The LLC succeeded in opening one burger restaurant at a Las Vegas casino, under a set of licensing agreements with an affiliate of Caesars Entertainment Corp., before things skidded to a halt after Seibel pled guilty to a federal tax-related felony and after Caesars, in order to maintain its compliance with Nevada gaming regulations, terminated the license agreements when Seibel refused its (and Ramsay’s) demand that he dissociate from the LLC.

Following the order of dissolution, the court appointed Wilmington attorney Kurt Heyman as Receiver to assess the LLC’s assets and liabilities and to report with recommendations for the wind-down of the entity. In his initial report and supplemental submission, Mr. Heyman recommended in lieu of an auction to the highest bidder, the assignment to Seibel of his derivative claims against Ramsay and Caesars, and the assignment to Ramsay of his derivative claims against Seibel, with each case to be litigated at the assignee’s expense and limiting the award to 50% of the recovery. Mr. Heyman reported finding no guidance in reported cases, treatises, or law review articles on what approaches the court might take to deal with derivative claims as assets of a dissolved entity.

VC Slights’ letter opinion adopted Mr. Heyman’s recommendation and rejected Ramsay’s argument that Seibel should not be permitted to pursue meritless claims. The court found that “the auction approach is neither feasible nor appropriate” for disposing of the LLC’s “litigation assets” and that “the better approach is to assign all of [the LLC’s] litigation assets to its Members, in line with their respective interests in pursuing them, and then allow the Nevada courts to separate the wheat from the chaff.”

Court Addresses Claims in Amended Complaint Following Termination of LLC’s License Agreement for Las Vegas Steakhouse

Original Homestead Restaurant, Inc. v Seibel, 2020 NY Slip Op 32149(U) [Sup Ct NY County July 1, 2020]. Yes, the defendant Seibel in this case involving the famous Old Homestead Steakhouse is the same individual who partnered with Gordon Ramsay in the GR Burgr case just discussed. If the fact patterns in both cases sound alike, they are. Seibel and the owners of Old Homestead Steakhouse as 50/50 members formed a Delaware LLC to license to Caesars the steakhouse’s name and associated intellectual property to develop a Las Vegas steakhouse. As in GR Burgr, Caesars terminated the license upon learning of Seibel’s felony conviction. The other 50% members, alleging a series of wrongful non-disclosures by Seibel, brought suit seeking damages for breach of the LLC agreement and the implied covenant of good faith and fair dealing, breach of fiduciary duty, and aiding and abetting breach of fiduciary duty.

In her decision, Manhattan Commercial Division Justice Andrea Masley rejected Seibel’s motion to dismiss the plaintiffs’ direct and derivative claims for failing adequately to allege damages. Instead, Justice Masley found that the amended complaint’s allegations satisfied applicable Delaware and New York law insofar as pleading a “reasonable basis” for damages and that it was unnecessary on a pre-answer motion to dismiss to allege “a basis for the jury to calculate such damages.” She also upheld the amended claims for breach of fiduciary duty.

On the other hand, Justice Masley dismissed the claims for breach of the implied covenant of good faith and fair dealing, finding that under Delaware law, the subject of the alleged breaches did not involve “contractual gaps” and, on the contrary, were anticipated by the LLC agreement’s express terms.

Court Orders Evidentiary Hearing on 40% Shareholder’s Dissolution Petition, Denies Motion to Appoint Temporary Receiver for Manhattan Restaurant   

Matter of Taboon Restaurant Corp., 2020 NY Slip Op 33829(U) [Sup Ct NY County Nov. 17, 2020]. In this case involving a restaurant in Manhattan’s Hell’s Kitchen neighborhood offering Middle Eastern and Mediterranean fare, a 40% shareholder sought judicial dissolution on the grounds that the two other shareholders had “engaged in a campaign to undermine petitioner’s authority over the business.” The petition alleged the respondents were taking excess compensation for themselves, had terminated petitioner’s wife as the company’s bookkeeper, and were operating the restaurant in violation of labor laws. The petitioner also sought appointment of a temporary receiver.

The decision by Manhattan Supreme Court Justice Arlene Bluth denied the receivership application and, based on the parties’ conflicting affidavits, ordered a hearing on the dissolution claim. Justice Bluth wrote that “if, as petitioner alleges, the restaurant is engaged in shady business practices, then it should be brought up at the evidentiary hearing” and that “the financial status of the restaurant, particularly in light of the ongoing pandemic, will be an important factor as the Court considers whether to grant the petition to dissolve the restaurant.”

Justice Bluth’s opinion also offered some words of wisdom, reminding the parties that “if  they work together, the hearing can be quick and efficient” but “if they act like the lawyers acted at the conference–preferring to argue every little point (the equivalent of “who gets the teapot” in a divorce proceeding), then this will drag on at great expense to the parties.”

Court Denies Summary Judgment Concerning Disputed 10% Membership Interest in Brooklyn Restaurant

Galarza v Galarza, 2020 NY Slip Op 33801(U) [Sup Ct Kings County Nov. 6, 2020]. The LLC at issue in this case operates a Brooklyn-based restaurant serving Argentinian cuisine. The plaintiff, claiming a 10% membership interest and suing for her share of profits, is the stepsister of one of the defendants and the ex-wife of the other. The defendants claimed 100% ownership of the LLC and denied that the plaintiff held an interest in the LLC since her withdrawal as a member and buyout in 2010 as evidenced by the LLC’s Form K-1s, despite defendants having subsequently filed renewal applications with the State Liquor Authority listing plaintiff as a member.

Brooklyn Commercial Division Justice Lawrence S. Knipel denied the plaintiff’s motion for partial summary judgment of liability. Justice Knipel found that there were triable issues of fact as to whether plaintiff relinquished her interest in the LLC and due to plaintiff’s failure to produce her personal tax returns. He also found that the doctrine of judicial estoppel did not apply to defendants’ listing of plaintiff in the LLC’s renewal applications to the State Liquor Authority since they do not “rise to the level of an adjudicatory proceeding.”

[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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