Winter Case Notes: Dissolution of Not-For-Profit Corporation and Other Decisions of Interest

Farrell Fritz, P.C.
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Here in the New York metro area, for the first time in years winter is living up to its name. The snow-plowed streets and sub-freezing temperatures are a natural setting for this sixth annual edition of Winter Case Notes in which I highlight a collection of recent court decisions of interest to business divorce aficionados by way of brief synopses with links to the decisions for those who wish to dig deeper.

This year’s synopses feature three noteworthy decisions by New York courts and one from Iowa:

  • dismissing a rare deadlock dissolution petition involving a not-for-profit corporation;
  • dismissing a petition to dissolve a limited liability company after the company and one of its two 50% members were indicted for tax fraud;
  • dismissing claims for breach of fiduciary duty surrounding the break-up of a law firm; and
  • affirming a post-trial decision dismissing claims by son against father for breaches of fiduciary duty involving a farm property held by an LLC as part of the parents’ estate plan.

Court Dismisses Petition to Dissolve Not-For-Profit Corporation

Judicial dissolution cases triggered by disputes between co-directors of not-for-profit corporations (NFP) — as opposed to dissolution petitions brought by the state’s Attorney General such as the one currently pending against the National Rifle Association — are few and far between. Last year’s decision by Manhattan Supreme Court Justice Carol R. Edmead in Siegel v Eisner is only the second time in this blog’s 13-year history that I’ve had occasion to feature a dissolution case involving an NFP (here’s the first time).

In Siegel, the petitioner Barbara Siegel and her sister Karen Eisner serve as sole directors and officers of The Manfred & Anne Lehmann Foundation since the deaths of their parents who established the Foundation as an NFP in 1977 to create, among other educational and philanthropic purposes, a repository for the Foundation’s Judaica collection accessible to students, scholars and others.

Siegel filed a petition seeking judicial dissolution of the Foundation under N-F-P Law § 1102(a)(2)(B), (C), and (E) alleging that she and her sister were deadlocked on filling the Board’s third seat vacant since their mother’s death, on the Foundation’s banking,  and on Eisner’s alleged scrutiny of some credit card charges and supposed resistance in continuing donations to long-standing charitable organizations. The petition proposed dividing the Foundation’s assets ratably between successor foundations designated by each of the sisters.

Eisner opposed dissolution, accusing Siegel of manufacturing the appearance of a deadlock in order to “secure half of the Foundation’s assets for herself,” alleging a “history of fiduciary abuse” by Siegel, and proposing as alternative relief either removing Siegel as director or appointing additional directors.

Justice Edmead denied the petition under each subdivision of § 1102(a)(2), finding (i) no board meeting was ever called for the purpose of electing a third director; (ii) insufficient evidence of unresolved internal dissension; (iii) dissolution and the division of the Foundation’s Judaica collection would not be beneficial to either the Foundation or the siblings; (iv) the availability of less drastic remedies including presenting the issue of the third director seat to the Attorney General; and (v) the Foundation remained able to carry out its purposes.

The case docket shows no activity subsequent to the decision, so hopefully the sisters have put aside their differences, with or without the assistance of a third director, and continue to advance the Foundation’s educational and philanthropic missions.

Court Dismisses Petition to Dissolve Criminally Charged LLC

Some years ago I wrote about the Zafar case, citing it as a rare example of a court granting judicial dissolution of an LLC based on allegations of looting and diversion of income, grounds specified in the dissolution statute for oppressed minority shareholders of close corporations but not in LLC Law § 702 which requires a showing that “it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” The court in Zafar grounded the petition’s allegations within the statute by finding that the wrongdoing member’s concealment and diversion of income effectively “ceased operation of the respondent LLC in favor of his own competing interests.”

The petitioner in Matter of Cedano [F&B Car Service LLC], did not fare as well with his dissolution petition likewise alleging financial and tax fraud by his 50% co-member in an LLC that operated a taxi service. The petition alleged, apparently without contradiction, that respondent, who was responsible for the LLC’s financial operations, was indicted along with the LLC for tax fraud; pled guilty to failure to file company returns; made unauthorized withdrawals from the company’s bank account over $200,000; was the target of a report by a municipal school district’s Inspector General finding that the company had charged the district for non-existent services for years; and had allowed a default judgment against the LLC by the State Insurance Fund. The petitioner alleged that the respondent’s financial and criminal misconduct had destroyed the LLC’s commercial viability and irreparably damaged its business reputation.

The court, in a decision last December by Westchester County Supreme Court Justice Sam D. Walker, disagreed and granted the respondent’s dismissal motion, writing:

In this case, the petitioner’s allegations, if true, would not establish that continuing the entity is not financially viable and in fact the respondent has submitted evidence to show that the company is still operating and is financially feasible. The petitioner has failed to establish that the company is presently unable to fulfill it stated purpose.

Cedano is the latest in a line of cases illustrating the higher hurdle for petitioners seeking judicial dissolution of LLCs compared to close corporations.

Court Finds Law Firm “Partner” is Not a Partner, Dismisses Fiduciary-Breach Claims

The liberal manner in which the title “partner” is used at law firms, often given to lawyers who are not equity owners of the firm, has generated more than its fair share of litigation following an expulsion or a break-up of the firm, e.g., herehere, and here. The outcome in these cases  usually turn on a mix of factors, including the terms of written agreement, profit and loss sharing, management roles, and tax reporting.

In Epstein v Cantor, decided last December by Brooklyn Supreme Court Justice Larry D. Martin, the plaintiff Epstein filed suit “individually and as a Partner of Cantor, Epstein & Mazzola, LLP” for breach of contract and breach of fiduciary duty against defendants Cantor, Mazzola, and others, according to the complaint, for “the unilateral break up of a law firm partnership effectuated by defendant [Cantor] in coordination with a competitive law firm and its members who raided partnership assets, rendering it insolvent. . . . causing Epstein millions in damages.” The defendants moved to dismiss all but the contract claim, asserting that Epstein, even though he had been a name “partner” of the firm for 20 years, was not a partner as defined by law and therefore was owed no fiduciary duty.

Justice Martin agreed with the defendants, relying primarily on a 1995 agreement between Epstein and Cantor which, although referring throughout to the two of them as “partners,” specified in Section 7.2:

At any time after twelve (12) months from the date of this Agreement Epstein may serve upon Cantor written notice advising that he has elected as of a date not less than three (3) months from the date of the notice to devote all of his normal business time to the Partnership and to become a foil [sic] and equal partner with Cantor in the Partnership, with each having an equal say in the management, operations and running of the Partnership.

It was undisputed that Epstein never made the specified election. Justice Martin also noted that Epstein never made any capital contribution to the firm and did not share in the profits and losses of the firm all of which were allocated to Cantor under Section 6.1 of the agreement, instead receiving a percentage of income from certain clients and payment for services actually rendered at an hourly rate. Epstein also “lack[ed] control and responsibility for the ongoing operations of the firm,” the court wrote in concluding that “the court cannot find that the relationship between Epstein and Cantor was a partnership or joint venture.”

Court Resolves “Painful Dispute Between Family Members” Over LLC-Owned Farm

Erwin v Erwin, in which the Court of Appeals of Iowa for the most part affirmed post-trial rulings dismissing fiduciary-breach claims by son against father as LLC co-owners, caught my eye as a powerful illustration of the court’s power of equity in business divorce cases to avoid what otherwise would be a harsh and unjust result upon strict application of the law.

Husband and wife Michael and Janet Erwin owned a farm. In 2012, as part of their estate plan, they transferred a portion of the land to an LLC by warranty deed, without the deed reciting the transfer was subject to any mortgage. In fact, the farm was encumbered by a mortgage to secure notes given by the parents in connection with the farming operation and/or the purchase of the land. The court’s opinion states that it was “clear that the Erwins used the farm income as a source for payments” for the notes and that it “also was obvious the Erwins intended the farm to continue to be a source for payments toward the obligation.”

After the LLC’s formation and the deed transfer, the Erwins gifted 500,000 non-voting membership units to their adult son Richard and retained 500,000 Class A voting and Class B non-voting units for themselves.

Over the following years the father, as the LLC’s manager, used income from the LLC to pay off the mortgage indebtedness and to reimburse himself and his wife for their personal funds used to pay the debt which remained in their personal names. According to the court, the father “like many farmers, often handled the farm operation with little attention to paperwork details” and commingled farm and personal income and expenses without realizing they should be kept separate.

After demanding but not receiving the LLC’s financial records, the son sued his father for breach of fiduciary duty and breach of the LLC agreement and to remove him as LLC manager, primarily based on his use of LLC funds to pay personal debts related to the farm. The trial court denied the claim.

On appeal, the son argued that the LLC never incurred liability to pay the mortgage debt on the farm, which was undisputed. Nonetheless, stating that “a court, sitting in equity, has considerable flexibility in resolving a dispute among members and managers of limited liability companies” and that “courts must be careful when determining relief to avoid giving the minority a foothold that is oppressive to the majority,” the court ruled that the father was not liable, stating:

[The father] paid the mortgage on the Turner Farm to maintain ownership of the property and, eventually, leave it to [the son] with a minimal tax liability. The facts of the case establish that [the father’s] conduct reinvesting financial assets by paying the Turner Farm mortgage was done in good faith and for the benefit of [the LLC] and [the son]. In effect, [the son’s] complaint is that if [the LLC] was paying the mortgage and other debt associated with the Turner Farm, he did not receive as much value from the Turner Farm as he thought he was gifted or should have been gifted. Given the undisputed facts of the history of the Turner Farm and the creation of [the LLC], we find no inequity in the Turner Farm income being used to pay the debts arising out of the Turner Farm purchase and operating loans.

Translation: Don’t look a gift horse in the mouth.

[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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