Court Takes Ambiguity Off the Menu of Restaurant’s LLC Agreement

Farrell Fritz, P.C.
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I’ve lost track of how many lawsuits I’ve seen between co-owners of New York City restaurants. It’s not surprising given the high percentage of restaurant failures in an intensely competitive market with high rents, high labor costs, and high everything else.

Another significant factor is the heavy initial investment required for start-up restaurants in the city. Aspiring restaurant entrepreneurs long on ideas and talent but short on cash and credit often will bring in friends and family as silent partners to provide the capital required to lease, build, equip, get regulatory approval, open, and carry the restaurant until it reaches profitability. The allure of owning a share of a restaurant managed by a friend or family member, especially for those with no experience in the industry, can dull awareness of the high risks involved. It also can mask the need for independent counsel to vet organizational agreements and the ongoing need to closely monitor restaurant finances.

I can only guess those factors were at play in Berman v Jankelowitz, 2019 NY Slip Op 32439(U) [Sup Ct NY County Aug. 15, 2019], a lawsuit brought by inactive, minority members of several LLCs formed to create and operate a pair of bistro-style restaurants known as Jack’s Wife Freda, located in Manhattan’s Soho and West Village neighborhoods. The lawsuit accused the managing majority members of “theft and waste of corporate assets, including valuable trademarks.”

In a decision early this year, the court ruled in defendants’ favor, upholding their separate ownership of the restaurants’ trademarked name and other intellectual property and their right to license it for use at a third location without plaintiffs’ participation. In that instance, the plaintiffs argued unsuccessfully that the critical language in the operating agreements’ purpose clause was ambiguous.

In its most recent decision, however, it was the defendants who unsuccessfully raised an ambiguity argument when the court adopted the plaintiffs’ construction of provisions in the LLC agreements requiring the defendant managing members to provide audited financial statements.

The Restaurants

According to their complaint, plaintiffs Asaf and Ayelet Berman were invited by their friends, Dean and Maya Jankelowitz, initially to invest seed money for a bistro-style restaurant concept in Manhattan.

The concept took shape with the opening in 2012 of the first Jack’s Wife Freda restaurant in Soho, operated by an LLC owned 60% by the Jankelowitzes as Class A managing members and by the Bermans, who made a $100,000 capital contribution, as 15.65% Class B non-managing members. A half dozen other investor Class B non-managing members held the remaining equity interests in the Soho LLC.

The Soho restaurant apparently met rapid success. The Jankelowitzes, Bermans, and the other investors then formed and capitalized a second, similarly structured LLC to establish a second Jack’s Wife Freda restaurant in the West Village. It too was successful.

According to the complaint, the same ownership group then formed a third company called MayaDean LLC “intended to serve as a holding company for the restaurants and the valuable ‘Jack’s Wife Freda’ trademarks.”

Also according to the complaint, the West Village LLC had no written operating agreement but was “understood” to be governed by the terms of the Soho LLC agreement. The complaint further alleged that MayaDean LLC was governed by an unexecuted, draft operating agreement that was “ratified by the actions of the various members.”

The Lawsuit

In April 2018, the Bermans sued the Jankelowitzes claiming a “pattern of misconduct and fraudulent behavior.” The complaint’s allegations centered on the claimed misuse of company funds to pay their personal expenses, taking excessive salaries and management fees,  and secretly and without member approval assigning to their own, separate company the Jack’s Wife Freda trademark originally registered in the name of MayaDean LLC.

The complaint included derivative claims for breach of fiduciary duty, conversion and fraud, and direct claims for breach of contract and accounting. The complaint also sought declarations that the West Village LLC is governed by the Soho LLC operating agreement and that MayaDean LLC is governed by the unsigned draft agreement as “ratified” by the members.

Court Dismisses Trademark-Related Claims, Finding No Ambiguity in the Purpose Clause 

In late 2018, the Bermans requested leave to file an amended complaint adding a claim for diversion of corporate opportunity and intellectual property. The new claim alleged that, prior to the litigation, the Bermans and Jankelowitzes discussed expanding the business to a third location in Manhattan’s Chelsea neighborhood, but that after the Bermans sued, the Jankelowitzes went ahead without them and opened a third  Jack’s Wife Freda restaurant in Chelsea through their separately owned company.

The Jankelowitzes opposed the proposed amendment and cross-moved for partial summary judgment dismissing all trademark-related claims.

In support, the Jankelowitzes relied on language in the purpose clauses of the Soho LLC operating agreement and the unsigned MayaDean LLC agreement, in both instances referring to a restaurant “concept developed by the Managing Member and licensed to [Soho LLC/MayaDean LLC] under the name [Jack’s Wife Freda].” The Jankelowitzes explained that the original trademark registration for Jack’s Wife Freda, designating MayaDean LLC the owner, was done “in error” and subsequently corrected by assignment to their separately owned company.

The Bermans countered that the purpose clauses were “ambiguous” and “vague” in their use of the term “concept” without any reference to “trademark” or “intellectual property.” They also pointed out that the clauses did not explicitly refer to the Jankelowitzes’ ownership rights in the trademark.

By Decision and Order dated February 19, 2019, Manhattan Commercial Division Justice Andrew Borrok entered an order, “for the reasons stated on the record” at oral argument, denying the Bermans’ motion and granting the cross-motion. Unfortunately the oral argument transcript is not posted to the court’s website. We can assume that the court agreed with the Jankelowitzes, that the purpose clauses did not suffer from ambiguity and that their reference to the licensing of the trademark to the LLCs conclusively evidenced the LLCs’ non-ownership.

Court Upholds Contract Breach Claim, Finding No Ambiguity in the Agreements’ Audit Provisions

Following the dismissal of their trademark-related claims, the Bermans took the offense by moving for summary judgment on their claim for breach of contract based on the Jankelowitzes’ alleged refusal to provide audited financial statements as required by section 11.3 of the Soho LLC and MayaDean LLC operating agreements, which state in relevant part:

The Managing Member shall prepare the Company’s annual income tax return and annual financial statements which shall include a balance sheet, and the related statements of income and cash flow, which shall be audited.

In the same motion, the Bermans also sought summary judgment on their claim for a declaration that the unsigned MayaDean LLC operating agreement is valid and in effect.

The Jankelowitzes opposed both prongs of the motion. First, they argued that section 11.3 is ambiguous when read in conjunction with section 7.11 of the agreement, captioned “Compensation” and stating in relevant part:

The books, records and supporting documents of the Company shall be made available for inspection by the Members at the Restaurant during normal business hours. To confirm the accuracy of statements delivered and payments of the Management Fee made to it hereunder, Members may request an audit of such books and records by an auditing firm of its choice, but no more frequently than once annually. Any such audit shall be conducted at the Company office at the expense of the requesting Member. [Emphasis added]

The Jankelowitzes contended that sections 11.3 and 7.11 “contradict” each other in regard to the responsibility for engaging and compensating the auditor and therefore require extrinsic evidence of the parties’ intent and a trial. “If the Managing Member were required to prepare audited books and records, presumably at the company’s expense,” the Jankelowitzes argued in their brief, “there would be no need for a minority member to request and audit, let alone pay for the audit at the minority member’s expense.”

The Jankelowitzes secondarily denied that the unsigned MayaDean LLC operating agreement was binding. They also denied that any of their pleadings or positions taken earlier in the litigation showed otherwise.

This time, the court sided with the Bermans, finding no ambiguity or inconsistency between sections 11.3 and 7.11. Here’s what Justice Borrok wrote:

Section 7.11 simply permits members to inspect the companies’ records to confirm the calculation of the Management Fee which is calculated monthly once per year. It does not release or otherwise affect the Managing Member’s obligation from providing annual audited financial statements in the first instance and K-1 statements, etc. It is a well-settled principle of contract interpretation that a contract should be interpreted in a way that reconciles all its provisions, whenever possible. Here, the provisions are clear: section 11.3 requires the managing member to audit the companies’ books and records on an annual basis, and section 7.11 permits (but does not require) LLC members to further inspect the company books with respect to the Management Fee. There is no contradiction or ambiguity.

Justice Borrok also granted the Bermans summary judgment on their claim for a declaratory judgment that the MayaDean LLC agreement is valid and in effect (thereby also extending the audit requirement to MayaDean LLC) notwithstanding that neither side presented the court with a signed copy.

In so ruling, Justice Borrok pointed to the Jankelowitzes’ prior affidavit in support of their motion to dismiss the trademark-related claims, in which they affirmatively alleged that the agreement was signed by all members. “Having taken the position that the MayaDean operating agreement is enforceable,” the court concluded, “and having benefitted from this position, the Jankelowitzes cannot now take a contrary position.”

The Denouement.  With one loss and one win in each side’s column, who came out ahead? We’ll never know because shortly after the second decision, and likely without an interim audit or other forensic accounting, the parties’ counsel filed a stipulation discontinuing the action with prejudice, meaning none of the Bermans’ claims can be relitigated. I can only speculate, given the rancorous tone reflected in the case filings, that rather than pursuing an accounting and remaining business partners, the Bermans and Jankelowitzes negotiated a buyout of the former’s interests in the Soho and West Village restaurants. Sometimes the best partners are former partners.

[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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