New York Business Divorce

No Exception to Arbitration for Deadlock Dissolution Petition, Court Rules

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 06 Jul 2009 18:23:38 -0500

As I've previously pointed out (read here), when shareholder disputes arise, including corporate dissolution contests, courts will readily stay litigation proceedings in favor of arbitration where the parties' shareholders' agreement provides for mandatory arbitration. There is no exception for dissolution cases arising from 50-50 deadlock, as the unsuccessful petitioner recently learned in Matter of Brooks (Aqua Shield Inc.), Short Form Order, Index No. 1572/09 (Sup Ct Nassau County June 5, 2009).

Aqua Shield Inc. was formed in 2000 to market a patented telescopic swimming pool enclosure invented by co-founder and petitioner Bob Brooks who, along with his wife, holds 50% of the company's shares. The other 50% is held by investor Igor Korsunsky and his wife.

The October 2001 shareholders' agreement has a broad arbitration clause requiring arbitration of "any controversy or claim arising out of or relating to [this] Agreement or its breach . . .."

In November 2008, the Korsunskys commenced an arbitration proceeding with the American Arbitration Association (AAA) against the Brookses who interposed an answer. The AAA issued an order on motions and scheduling orders in February 2009, and scheduled a preliminary hearing for April 2009.

Meanwhile, in late January 2009, the Brookses filed a judicial proceeding to dissolve Aqua Shield based on deadlock pursuant to Business Corporation Law Section 1104. The Korsunskys moved to dismiss the petition or, alternatively, to compel arbitration and stay the judicial proceeding.

The Brookses argued that arbitration should not be compelled because the matter is "unique in that there is a 50%/50% deadlock among the shareholders." The argument carried no weight with Nassau County Commercial Division Justice Ira B. Warshawsky, who wrote that "the Court does not consider this unique, or, in fact, even unusual." He then elaborated:

The arbitration proceedings appear to be well underway, and it is reasonable to expect a determination in the near future. The Court declines to dismiss the current action, since jurisdiction of the Court is appropriate for a motion to confirm or disaffirm the findings of the Arbitrator. The Brooks have not sought to stay arbitration, and in fact have actively participated in the process. The commencement of a proceeding in this Court, approximately two months after the Notice of Intent to Arbitrate, is not a motion to stay arbitration, and even if it were interpreted as such, it would be untimely and inappropriate.

. . . The agreement to arbitrate is clear, the parties have participated in the arbitration proceeding, and the arbitrator has determined that the issues presented are arbitrable. Under these circumstances it is appropriate to defer further action to the agreed-upon arbitration process.

The arbitration clause in the Aqua Shield shareholders' agreement is lifted almost verbatim from the AAA-approved form. As this case teaches anew, lawyers should not assume that corporate dissolution of any type falls outside the scope of the clause.

Appellate Court Affirms Caplash Ruling Rejecting Authority of 50% LLC Member to Hire Company Counsel in Proceedings Against Other 50% Member

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 29 Jun 2009 04:00:00 -0500

The fascinating case of Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC, involving a multi-faceted litigation between 50-50 members of a dental surgery practice, was fodder last year for several appellate and trial court decisions which in turn were fodder for several posts on this blog (see here, here and here). In what likely is the case's last hurrah, the Appellate Division, Fourth Department, earlier this month affirmed a series of trial court rulings by Monroe County Commercial Division Justice Kenneth R. Fisher including orders upholding the plaintiff's standing to seek dissolution and granting dissolution based on deadlock.

The threshold issue in the case was whether an attorney hired by the defendant 50% member, Dr. Mohammed Salahuddin, had authority under the operating agreement (a) to accept on the company's behalf a letter of resignation from the plaintiff Dr. Jolly Caplash, and (b) to assert counterclaims in the LLC's name against Dr. Caplash. If the attorney had authority to accept the resignation letter, which in turn depended on which of the two doctors held the office of President in the aftermath of a June 2007 member meeting, Dr. Caplash's membership was terminated and he lacked standing to seek dissolution.

In February 2008, the Fourth Department ruled that the issue could not be resolved without a trial of disputed factual issues. In a May 2008 mid-trial decision, Justice Fisher dismissed the counterclaims brought against Dr. Caplash in the LLC's name, concluding that even if Dr. Salahuddin was President of the LLC with general authority to hire company counsel, he had no authority to hire company counsel to prosecute an action against a co-equal 50% member. Justice Fisher's June 2008 post-trial decision found that Dr. Caplash held the President's office and, therefore, the attorney hired by Dr. Salahuddin had no authority to accept Dr. Caplash's resignation letter on the company's behalf which left intact the latter's entitlement to judicial dissolution of the deadlocked company.

On June 12, 2009, the Fourth Department issued a memorandum decision and order reported at 2009 NY Slip Op 04810 batting down all of Dr. Salahuddin's arguments on appeal. In upholding the dismissal of the counterclaims brought against Dr. Caplash in the LLC's name, the court quoted case precedent involving closely held corporations as follows:

" [W]here there are only two stockholders each with a 50% share, an action [or counterclaim] cannot be maintained in the name of the corporation by one stockholder against another with an equal interest and degree of control over corporate affairs; the proper remedy is a stockholder's derivative action' " (Stone v Frederick, 245 AD2d 742, 744-745).

The Fourth Department also upheld Dr. Caplash's standing as a member to seek judicial dissolution, although its analysis differed from Justice Fisher's. Whereas Justice Fisher concluded that the operating agreement effectively created a manager-managed LLC, with management authority vested in the President subject to override by (unanimous) action of the members, the Fourth Department saw the company as member-managed and, therefore, the question was whether Dr. Salahuddin's hiring of company counsel was within the agency authority of a member under Section 412 of the LLC Law. Here's what the court said:

[W]e conclude that the court did not err in concluding that plaintiff has standing to seek dissolution pursuant to Limited Liability Company Law § 702 (see generally Matter of Roller [W.R.S.B. Dev. Co.], 259 AD2d 1012), despite his submission of a letter of resignation. In our view, the company was a "member-managed LLC," rather than a "manager-managed LLC" (see generally § 412 [a]). Our analysis thus turns on the issue whether Salahuddin was authorized to appoint as company counsel an attorney who accepted plaintiff's resignation letter transmitted to him by plaintiff before plaintiff cross-moved for dissolution. "An act of a member . . . that is not apparently for the carrying on of the business of the limited liability company in the usual way does not bind the limited liability company unless authorized in fact by the limited liability company in the particular matter" (§ 412 [c]). Since the appointment of company counsel by Salahuddin was neither for carrying on the usual business of the company, i.e., dental surgery, nor, as required by the terms of the operating agreement, sanctioned by majority vote of the company's members, the company counsel allegedly appointed by Salahuddin was not authorized to represent the company and thus could not have accepted plaintiff's purported resignation letter.

Even assuming, arguendo, that the company counsel was properly appointed by Salahuddin, we conclude that he was neither retained to address general business matters on behalf of the company nor authorized by the operating agreement to act on behalf of that entity (see Limited Liability Company Law § 102 [c]). . . . Moreover, there is no indication that the attorney in question in fact accepted plaintiff's purported resignation before plaintiff cross-moved for dissolution (see Siegel, NY Prac § 249 [4th ed]), or that the purported resignation letter concerned plaintiff's membership in the company, as opposed to his employment with the company.

The different approaches of Justice Fisher and the Fourth Department raise interesting issues of statutory construction and interplay with the operating agreement's management provisions. In this case they both lead to the same result, but I suspect there will be other cases where the analyses and results could diverge.

Appellate Ruling in Stock Valuation Case Further Muddies the Marketability Discount Waters

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 22 Jun 2009 06:00:00 -0500

In determining the fair value of corporate shares, should the discount for lack of marketability (DLOM) apply only to the company's good will value, or to the entire enterprise value including tangible assets? Court decisions in New York tend to apply DLOM in the 25% range, so the answer can make a big difference in the ultimate award, particularly when the business is asset-heavy.

I've written before (read here) about conflicting case precedents in the Manhattan-based First Department (DLOM applies to enterprise value) and the Brooklyn-based Second Department (DLOM applies to good will value). Permit me to quote from that prior post, where I wrote:

With locked horns in the two downstate appellate departments, and no decisions on the subject from the two upstate appellate departments, it'll likely take some yet-to-be-born big-money valuation case to wend its way up to New York's highest court, the Court of Appeals, before we get a definitive answer.

Well, we still don't have a definitive answer from the Court of Appeals, but we do have a new decision on the subject from one of the upstate departments. The result aligns the Rochester-based Fourth Department with the First Department (DLOM applies to enterprise value), but the decision offers no analysis and, if anything, further muddies the DLOM waters.

The Fourth Department's decision in Matter of Rateau (DAPA Communications, Inc.), 59 AD3d 1037, 2009 NY Slip Op 00890 (4th Dept 2009), took an unusual path. DAPACom, founded in 1989 and based in Allegany, New York, manufactures and installs tower and antenna systems. The case started as a petition by 34% shareholders to dissolve the company under the minority shareholder oppression statute, Section 1104-a of the Business Corporation Law (BCL). The majority shareholders then caused DAPACom to elect to purchase the petitioner's shares for fair value under BCL Section 1118. At the valuation trial, the petitioner's expert valued the company between $728,000 and $755,000 using the adjusted net asset value method. This method, which basically adopts the company's book value as adjusted for fair market value of assets and liabilities, normally undervalues an operating business and therefore is rarely given much if any weight by either side, and even less so by the party being bought out. In any event, using this method the petitioner's expert computed the pro rata value of petitioner's 34% interest around $250,000. DAPACom's expert, using the income and market approaches to value the company as a going concern, testified that the petitioner's shares had zero value, reflecting the company's cumulative losses of $1.9 million in the four years prior to the valuation date. He alternatively valued the shares at $26,000 using the adjusted net asset approach after applying a 25% minority discount a/k/a discount for lack of control (DLOC) and a 30% DLOM.

In the first of two lower court decisions leading to the appeal, Cattaraugus County Judge Larry M. Himelein noted the three basic methods used to determine the going-concern value of a company: market value, investment or income value, and net asset value. The problem with DAPACom's expert's income and market approaches, observed Judge Himelein, was that "if the business were truly worth nothing, it would not continue to operate." Therefore, he went on, "based on the information provided, the court has no choice but to ascertain the company's net asset value." Judge Himelein criticized the petitioner's valuation of the company's equipment because it was based, at least in part, on advertised prices without any indication of what the actual selling prices of the items were. Based on the court's review of the testimony and the exhibits, Judge Himelein arrived at a "liquidation value" of the company of $180,000.

Judge Himelein then tackled discounts. First, citing numerous case authorities, he found "inappropriate" DAPACom's expert's application of a 25% minority discount (DLOC). He next addressed DLOM, writing as follows:

[Respondents' expert] also applied a 30% lack of marketability discount, which is appropriate for an operating business. However, a lack of marketability discount may or may not be appropriate when talking about selling hard assets. On the other hand, there would be significant costs involved in selling off the equipment, i.e., advertising, auctioneers and the like. Therefore, whether deemed a lack of marketability discount or a cost of sale discount, the court will apply a discount of thirty percent. [Citations omitted.]

With a 30% discount, the value of the petitioner's 34% interest was computed at $42,840.

The case took another turn pre-appeal, when the petitioners made a post-trial motion challenging the court's valuation including its consideration of a cost-of-sale discount. In the second of his two written decisions, Judge Himelein expressed his "discomfort" using net asset value to value the company, but he went on to say that he had no choice but to use it given his rejection of DAPACom's expert's zero valuation of the company "as a going concern." Judge Himelein rebuffed the petitioner's critique of his valuation of the company's equipment based on the conflicting trial testimony, but he agreed with the petitioners that he should not have considered cost-of-sale discount, writing as follows:

The court noted that it was not clear that a lack of marketability discount was appropriate when selling off hard assets but there clearly would be costs associated with such a sale. However, petitioners are correct in their contention that no proof of an appropriate discount was introduced, and theoretically, if the company sold its assets, there might be little, if any, costs associated with the sale.

On that basis Judge Himelein vacated the 30% discount and increased the petitioner's valuation award to $61,200.

DAPACom appealed from the modified award. It argued that (1) the case authorities require application of marketability discount; (2) the lower court should have valued DAPACom as a going concern and not based on its liquidation value; and (3) the lower court's $180,000 net asset valuation was "arbitrary and capricious". It did not argue for application of a cost-of-sale discount as postulated in Judge Himelein's original order. (See bottom of page for links to all the appellate briefs.)

In their brief opposing the appeal, the petitioners cited Second Department case law, including Matter of Cinque, 212 AD2d 608 (1995), Matter of Whalen, 234 AD2d 552 (1996), and Cohen v. Cohen, 279 AD2d 599 (2001), to argue that the lower court properly excluded DLOM since the company's valuation based on adjusted net asset value did not include any good will. They also argued that the lower court's use of the adjusted net asset value was proper because (1) DAPACom's expert acknowledged that the company had a "tangible net value" even if it was losing money from its operations, and (2) liquidation value generally is lower than going concern value, so DAPACom had no basis to complain.

DAPACom's reply brief argued that under the Court of Appeals' decision in a matrimonial valuation case, Amodio v. Amodio, 70 NY2d 5 (1987), the court must apply DLOM in valuing the shares of a closely held corporation. The brief did not directly respond to petitioner's Second Department cases, nor did it refer to the First Department's decision in Hall v. King, 265 AD2d 244 (1999), which affirmed a lower court ruling that applied DLOM to net asset value and expressly disagreed with the Second Department cases. (DAPACom's initial appeal brief cites Hall v. King but without any discussion of it.)

The Fourth Department's decision on the appeal is disappointingly brief, devoting only one sentence to the DLOM controversy which it decided in DAPACom's favor as follows:

We agree with DAPACom, however, that the court erred in failing to apply a discount for the lack of marketability of petitioners' shares in DAPACom (see Seagroatt Floral Co., 78 NY2d at 445-446; Amodio v Amodio, 70 NY2d 5, 7 [1987]; Hall, 265 AD2d 244 [1999]; cf. Matter of Whalen v Whalen's Moving & Stor. Co., 234 AD2d 552, 554 [1996]; Matter of Quill v Cathedral Corp., 215 AD2d 960, 963 [1995], lv dismissed 86 NY2d 838 [1995]).

Note how the decision cites both Hall v. King and Matter of Whalen even though the two cases disagree on the very issue before the court. The cite to Whalen is preceded by the "cf." signal which means the case cited supports by analogy the stated proposition. I find that very hard to fathom given Whalen's express limitation of DLOM to the good will component of a company's value of which there was none in the case at hand. Go figure.

DAPACom did not fare as well on its argument that the lower court failed to value the company as a going concern. Here's what the Fourth Department said:

Contrary to DAPACom's contentions, we conclude that the court properly valued DAPACom " 'as an operating business' " and that the court properly used the net asset valuation method. We further conclude that the court's valuation of DAPACom falls "within the range of testimony presented" and should not be disturbed. [Citations omitted.]

I'm advised by case counsel that, on remand following the appeal and without a written decision, Judge Himelein entered amended judgment using a 20% DLOM (down from 30%) to value the petitioner's shares.

No doubt about it, Matter of Rateau is a quirky case that not only fails to shed new light on an important facet of New York stock valuation proceedings, but only confuses the matter by its reliance on contradictory precedent. I wish the lower court decisions, and the appellate briefs, had focused more directly on the issue whether DLOM applies to entire enterprise value or only good will. I wish the Fourth Department had written a decision that acknowledged the split between the downstate departments and that offered a reasoned explanation for its seeming agreement with the First Department's position in Hall v. King.

Appellant's Brief (Part 1)

Appellant's Brief (Part 2)

Respondent's Brief (Part 1)

Respondent's Brief (Part 2)

Appellant's Reply Brief

Appellate Rulings Clash Over Subject Matter Jurisdiction to Dissolve Foreign Business Entities

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 15 Jun 2009 06:00:00 -0500

The Appellate Division, Second Department, last week issued a decision in a dissolution proceeding involving a New York-based Delaware limited liability company (LLC) in which it broadly pronounced that New York courts lack subject matter jurisdiction in such cases. The decision in Matter of HMS Venture Management Corp. (UtiliSave, LLC), 2009 NY Slip Op 04906 (2d Dept June 9, 2009), agrees with an appellate ruling two years earlier by the Third Department, also involving the requested dissolution of a Delaware LLC, in Rimawi v. Atkins, 42 AD2d 799, 840 NYS2d 217 (3d Dept 2007).

HMS and Rimawi both rely on precedents in which New York courts dismissed petitions seeking dissolution of foreign business corporations based on the hoary internal affairs doctrine under which courts traditionally declined to exercise jurisdiction where the determination of the rights of the litigants involves regulation and management of the internal affairs of a foreign corporation. What makes things particularly interesting, however, is a 1994 appellate decision by the Manhattan-based First Department, in Matter of Hospital Diagnostic Equipment Corp., 205 AD2d 459, 613 NYS2d 884 (1st Dept 1994), where that court expressly rejected the argument, made by no less a personage than the state Attorney General, that New York courts lack subject matter jurisdiction to dissolve foreign corporations.

Let's first look at HMS. The subject Delaware LLC, called UtiliSave, operates in New Rochelle, New York, where it audits utility bills and usage of corporate clients. Its only connection to Delaware is its legal formation there. In 2007, 40% member and co-manager MHS Venture filed a petition to dissolve UtiliSave in Westchester County Supreme Court. Its petition sought dissolution under the terms of the operating agreement, allegedly based on the company's failure to make certain distributions, and on the statutory ground that it was no longer reasonably practicable to carry on the business in conformity with the operating agreement. It's unclear whether the petition invoked statutory dissolution under Section 702 of the New York LLC Law or under Section 18-802 of the Delaware LLC Act or both.

In April 2008, Westchester County Commercial Division Justice Kenneth W. Rudolph sua sponte issued an order dismissing the dissolution petition for failure to demonstrate prima facie that UtiliSave is unable to function as intended or failing financially. Then something unusual happened, as described in the Second Department's decision:

MHS then moved to vacate the order entered April 21, 2008, asserting that, subsequent to the court's denial of the petition for failure to make a prima facie case, it learned that the court lacked subject matter jurisdiction over a proceeding to dissolve a foreign limited liability company. Desirous of bringing a dissolution proceeding in Delaware, but concerned that it would be bound by the order denying the petition for failure to make a prima facie case, MHS moved to vacate the order entered April 21, 2008, and requested that the proceeding instead be dismissed for lack of subject matter jurisdiction.

In other words, after losing the case, the petitioner challenged the court's jurisdictional basis to hear its own petition! Justice Rudolph denied MHS's motion in an August 2008 order, writing as follows:

Having filed an admittedly sparse and factually incorrect pleading, and having filed the petition upon a good faith belief that this Court had subject matter jurisdiction, petitioner's attorneys now contend that this Court has no jurisdiction to dissolve a Delaware limited liability company. The Court notes that its [prior] decision did not dissolve UtiliSave but dismissed the petition for its failure, prima facie, to demonstrate that UtiliSave was unable to function as intended or failing financially or unable to reasonably operate as a going concern.

MHS's appeal from the two orders contended that, under the Third Department's Rimawi decision and Second Department case law dismissing petitions to dissolve foreign corporations, the court lacked subject matter jurisdiction to entertain a petition to dissolve a foreign LLC. The respondent countered that any possible limitation on the court's subject matter jurisdiction was never implicated because the court did not actually dissolve the LLC, and that the court's power to dismiss the petition for failure to state a valid claim was within permissible bounds of the internal affairs doctrine.

The Second Department's decision accepted MHS's argument without elaboration and vacated the order dismissing the petition, writing as follows:

A claim for dissolution of a foreign limited liability company is one over which the New York courts lack subject matter jurisdiction (see Rimawi v Atkins, 42 AD3d 799; Matter of Porciello v Sound Moves, 253 AD2d 467; Matter of Warde-McCann v Commex, Ltd., 135 AD2d 541). "[A] court's lack of subject matter jurisdiction is not waivable, but may be [raised] at any stage of the action, and the court may, ex mero motu [on its own motion], at any time, when attention is called to the facts, refuse to proceed further and dismiss the action'" (Matter of Fry v Village of Tarrytown, 89 NY2d 714, 718, quoting Robinson v Oceanic Steam Nav. Co., 112 NY 315, 324).

"A judgment or order issued without subject matter jurisdiction is void, and that defect may be raised at any time and may not be waived" (Editorial Photocolor Archives v Granger Collection, 61 NY2d 517, 523). As such, the order entered April 21, 2008, which denied the petition on the merits is void, the motion to vacate that order should have been granted, and the proceeding must instead be dismissed for lack of subject matter jurisdiction.

The court's citations to Warde-McCann and Porciello are Second Department rulings from 1987 and 1998, respectively, dismissing dissolution petitions involving New York-based foreign corporations. Neither one expressly refers to the court's subject matter jurisdiction. Indeed, Warde-McCann seems to predicate its holding on the internal affairs doctrine which assumes jurisdiction but declines to exercise it in the interests of interstate comity. The Third Department's Rimawi decision, also cited in the above passage, does state explicitly that New York courts lack subject matter jurisdiction to dissolve foreign LLCs, however, Rimawi's support for the statement consists of citations to Warde-McCann and Porciello. In addition, Rimawi (but not the MHS decision) expressly acknowledges the First Department's contrary ruling in the Hospital case.

Hospital involved a petition for dissolution of a Delaware corporation based on shareholder dissension under BCL Section 1104(a)(3). The respondent shareholders successfully moved in the trial court to dismiss the case on the ground of forum non conveniens, based on the corporation's lack of substantial contacts with New York. The New York Attorney General, undoubtedly sensitive to how courts in sister states might treat dissolution disputes involving New York corporations, also had moved for dismissal of the petition insofar as it sought dissolution, but on the different ground that the court lacked subject matter jurisdiction to dissolve a foreign corporation. The losing petitioner appealed to the Manhattan-based Appellate Division, First Department. The Attorney General filed a brief in which it argued that the trial court should have dismissed the dissolution claim based on lack of jurisdiction rather than on forum non conveniens grounds, since the latter assumes the court's subject matter jurisdiction in the first instance. The First Department's decision upheld the dismissal based on forum non conveniens, adding that the Attorney General's position, "that the courts of New York lack subject matter jurisdiction to dissolve a foreign corporation" is "without merit."

In the 15 years since Hospital was decided, I'm aware of only one case in which a lower court within the First Department issued a ruling refusing to dismiss a petition for dissolution of a foreign entity. So, is there any practical significance here, or is it just an academic exercise to determine the borderline between subject matter jurisdiction and the internal affairs doctrine, where the application of either generally will result in the dismissal of a petition to dissolve a foreign business entity?

It's hard to say. There are a number of New York cases holding that the court can adjudicate a dissolution dispute involving a foreign entity insofar as it can grant remedies short of dissolution, e.g., a compelled buy-out of a minority shareholder. Matter of Dohring (CVC Products, Inc.), 142 Misc 2d 429, 537 NYS2d 767 (Monroe County 1989), and Sokol v. Ventures Education Systems Corp., 10 Misc 3d 1055(A) (Sup Ct NY County 2005), are the best known of these cases. A court that deems itself without subject matter jurisdiction is unlikely to keep the case to consider lesser remedies.

Finally, last March I wrote about a recent New Jersey state court decision in which the court asserted its jurisdiction not only to hear a dissolution petition involving a New Jersey-based Delaware corporation, but also to apply New Jersey's dissolution statute to the Delaware entity. The contrast in judicial philosophy between that case and HMS could not be starker.

Court Grants 50% LLC Member's Petition for Judicial Dissolution of Passive Holding Company

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 08 Jun 2009 06:30:00 -0500

A recent decision by New York County Commercial Division Justice Bernard J. Fried addresses issues of interest concerning (a) the standing of an assignee of a member's economic interest to seek judicial dissolution of an LLC, and (b) grounds for dissolution of a two-member, 50-50 LLC that functioned as a holding company for a non-managing minority interest in another company.

The memorandum decision in Matter of Cline (Private Capital Management, LLC), Index No. 650117/09 (Sup Ct NY County May 29, 2009), grows out of a mega-lawsuit started by Ficus Investments, Inc. (Ficus) against Thomas Donovan, Lawrence Cline and Private Capital Management, LLC (PCM). PCM, a New York LLC co-owned 50-50 by Donovan and Cline, was the managing 20% member of a Florida LLC called Private Capital Group, LLC (PCG) that purchased, managed and sold non-performing mortgages. Ficus, which invested $300 million in the venture, held the remaining 80% interest. In 2007, Ficus terminated PCM as PCG's manager and brought suit against it along with Donovan and Cline allegedly for misappropriating over $20 million.

Early on Cline settled with Ficus and entered into a cooperation agreement as part of which he conveyed to a Ficus-owned entity called PCM Interest Holding, LLC (Holding) all of Cline's economic interest in PCM and his irrevocable voting proxy. Meanwhile, amidst burgeoning litigation proceedings between Donovan and Ficus, in April 2008 Justice Fried ruled that Donovan was entitled to advancement of his legal expenses under PCG's operating agreement. Ficus's appeal from that ruling was rejected in January 2009 (read here my post on the appellate ruling). In February 2009, Justice Fried also granted PCM's motion for advancement of its legal expenses. As part of the same ruling, Justice Fried denied without prejudice a procedurally defective cross-motion by Ficus and nominal defendant Cline seeking judicial dissolution of PCM (read here my post on that ruling).

In March 2009, Cline and Holding responded by filing a separate, new proceeding seeking judicial dissolution of PCM pursuant to Section 702 of the New York LLC Law under which dissolution is warranted "whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement." Their petition (read a copy here) alleged that PCM was formed solely to hold Donovan's and Cline's 20% interest in PCG; that since the Ficus litigation began, in which Donovan and Cline became adverse parties, the direction and control of PCM is "hopelessly deadlocked"; that Donovan is "misusing PCM for his own tactical advantage" in the litigation; that Donovan and Cline had ceased speaking to one another; and that the plethora of extremely hostile litigations between the two doomed any possibility of restoring the relationship. Notably, the petition also alleged that PCM lacks a written operating agreement.

Donovan moved to dismiss the petition. First, he contended that Holding, as transferee solely of Cline's economic interest in PCM, was not a member and therefore lacked standing to petition for dissolution. Second, citing the Delaware Chancery Court's 2008 decision in Seneca Investments LLC v. Tierney (read here my post on Seneca), he contended that deadlock between two 50% managing members of an LLC cannot provide a basis for dissolution where the LLC's sole purpose is to be a passive investor in another company. (Read here Donovan's counsel's affirmation in support of dismissal of the petition.)

In response, Cline and Holding argued that Section 702 does not require a showing that it is impossible to carry on the LLC's business, only that it is not reasonably practicable; that the petition's allegations set forth a "bitterly hostile, intractable and litigious battle" between the two sides; that PCM was formed for the specific purpose of doing business with Ficus; and that such purpose no longer was viable due to the irreconcilable split between Donovan and Ficus. They also argued that, even though Holding as assignee of Cline's economic interest was not a member and could not bring a dissolution proceeding on its own, it nonetheless could join Cline's dissolution petition. (Read here the opposition memorandum of Cline and Holding).

Interestingly, the issue whether PCM had a valid written operating agreement was raised subsequently, after Justice Fried requested the parties to provide him with copies of PCM's organizational documents. Donovan submitted an operating agreement allegedly signed by him and Cline, in which the company's purpose was stated as "managing the purchase, and resolution of non-performing mortgage as agreed from time to time by the Managers." Cline denied signing the operating agreement which he called "fraudulent".

Addressing first the issue of Holding's standing, Justice Fried agreed with Donovan that Holding lacked standing to join the petition for dissolution. Sections 603 and 604 of the LLC Law make it clear that, except as provided in the operating agreement, the assignee of a membership interest does not become a member of the LLC without the consent of the remaining members and is entitled only to the economic rights of the assignor to the extent assigned. Under Section 702, only a member has standing to seek dissolution.

Justice Fried nonetheless granted the dissolution petition, holding that Cline -- whose standing as a member was not contested -- had established

that it is not reasonably practicable to carry on PCM's business in conformity with the articles of organization or operating agreement thereby warranting dissolution. That Cline and Donovan dispute whether there exists an operating agreement for PCM, and Cline asserts that the purported operating agreement for PCM that Donovan submitted is fraudulent, is indicative of the litigious nature of their relationship. Dissolution is warranted regardless of the validity of PCM's purported operating agreement. [Citation omitted.].

According to Cline, in addition to the absence of a PCM operating agreement, PCM never followed corporate formalities, and it is merely an alter ego for Cline and Donovan. PCM's sole function is to hold their 20% interest in PCG. Thus, because of the acrimonious nature of the parties' business relationship, and the fact that dissolution will not interfere with an on-going business, dissolution is justified.

Even were he to find the operating agreement submitted by Donovan valid, Justice Fried added, it would further support dissolution in that the purpose clause (quoted above) "is inconsistent with Donovan's assertion that PCM was formed merely as a passive investment entity, and it would entail even more cooperation between the members as would be the case under Cline's characterization of PCM's purpose. Either way, dissolution is warranted."

In the Seneca case relied upon by Donovan, the Delaware Chancery Court dismissed a dissolution petition brought by a minority member of a Delaware LLC who asserted that the company had ceased all active business operations. The company retained passive investments worth over $2 million. The Chancery Court looked to the operating agreement's broad purpose clause, which included "any lawful act or activity," and concluded that the company's status as a passive investment holding company was consistent with its stated purpose.

Are Seneca and Cline reconcilable? One can argue they are, based on the fact that Cline was a deadlock petition brought by a 50% member whereas Seneca was brought by a non-controlling member who therefore was forced to make the harder argument that, even with effective majority control, the company could no longer operate consistent with its broad purpose clause. In addition, if it is assumed that PCM's operating agreement is valid, its narrow purpose clause ("managing the purchase, and resolution of non-performing mortgage as agreed from time to time by the Managers"), subsequently rendered unattainable by Ficus's expulsion of PCM as manager of PCG, is materially different from Seneca's broad purpose clause. If, on the other hand, PCM's operating agreement is deemed invalid, and therefore by statutory default the company's purpose is deemed to be "any lawful business activity" (LLC Law Section 201), it becomes a closer argument, but only if it is further assumed that the antagonism between Cline and Donovan would not interfere with PCM's reduced, passive role as the recipient of distributions and profit and loss allocations as 20% member of PCG.

One final note on procedure. In opposing dissolution, Donovan opted as permitted by CPLR Article 4 (governing special proceedings) to make a motion to dismiss the petition for failure to state a valid claim for dissolution, and requested leave to file an answer in the event the court denied his motion. Such leave is discretionary (CPLR 404[a]) and therefore always entails some risk that the court will grant the petition summarily, particularly when the respondent does not submit client affidavits or other evidentiary materials contesting the petition's factual allegations.

Can Corporate Dissolution Proceedings Be Brought in Federal Court?

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 01 Jun 2009 07:00:00 -0500

This month's Business Valuation Update includes a lengthy analysis of a recent stock valuation decision in a high-stakes corporate dissolution case, Kaplan v. First Hartford Corp., 2009 WL 737681 (D. Me. Mar. 20, 2009), brought by an oppressed minority shareholder of a Maine corporation that developed, owned and operated strip malls. The court, which had to contend with three different expert appraisals that came in $9 million at bottom and $48 million at top, valued the entire enterprise at $15 million based on "Pink Sheets" market trades adjusted -- as required by Maine's buyout statute -- to exclude any minority and marketability discounts. The decision is well worth the read for students of the art of stock valuation, but that's not what I want to address here. Rather, what I find most interesting about the case is who decided it: a federal judge.

Why is that interesting? The federal courts have two basic sources of subject matter jurisidiction: (1) the case involves a federal question, meaning the complaint asserts claims arising under federal statute or the U.S. Constitution, and (2) diversity of citizenship, meaning in most cases that the plaintiffs and defendants are citizens of different states. The typical case seeking judicial dissolution of a state-chartered corporation seeks state law remedies solely, which leaves diversity of citizenship as the only possible avenue to bring a corporate dissolution case in federal court.

In the U.S. Second Circuit, which encompasses New York, Connecticut and Vermont, the federal courts uniformly have abstained, i.e., refused to hear a case over which they otherwise have jurisdiction, from hearing corporate dissolution cases where jurisdiction is based on diversity of citizenship. Abstention doctrine is a highly complex area of federal (and sometimes state) law with several different strains. One of those strains, called Burford abstention after a U.S. Supreme Court case of that name, holds that a federal court sitting in diversity jurisdiction should abstain to avoid needless disruption of state efforts to establish coherent policy in an area of comprehensive state regulation. In Friedman v. Revenue Management, Inc., 38 F3d 668 (2d Cir. 1994), the Second Circuit Court of Appeals applied Burford abstention to dismiss a complaint seeking judicial dissolution of a New York corporation under Section 1104 of the Business Corporation Law based on shareholder deadlock. The plaintiff-50% shareholder resided in Indiana. The other shareholder was an Illinois corporation. The appellate court determined that abstention was appropriate because it

would avoid needless interference with New York's regulatory scheme governing its corporations. New York has a strong interest in the creation and dissolution of its corporations and in the uniform development and interpretation of the statutory scheme regarding its corporations. Moreover, to exercise jurisdiction over a dissolution of a state corporation would allow “the possibility of federal dissolution actions, based on [state statutes], being commenced in a number of different districts in which a particular ... corporation was subject to service, thereby placing an onerous burden on the corporation.” In addition, every federal court that has addressed the issue of dissolving state corporations has either abstained or noted that abstention would be appropriate, assuming jurisdiction existed. [Citations omitted.]

The federal District Court judges in the Second Circuit have rigorously followed Friedman, to the point of dismissing diversity-based corporate dissolution cases sua sponte, meaning, of their own accord, even when not asked by the defendant to do so, as in Boucher v. Sears, 1999 WL 736532 (NDNY Nov. 21, 1997).

I haven't done a comprehensive search of federal decisions outside the Second Circuit. A 2002 decision by the Sixth Circuit Court of Appeals, which covers Michigan, Ohio, Kentucky and Tennessee, agreed with Friedman. See Caudill v. Eubanks Farms, Inc., 301 F3d 658 (6th Cir. 2002). I haven't come across any decision on the subject by the First Circuit Court of Appeals which includes Maine where Kaplan was decided. There is, however, a 2008 decision by the U.S. District Court for the District of New Hampshire, which also is within the First Circuit, abstaining from deciding a corporate dissolution case brought under the court's diversity jurisdiction. See Neary v. Miltronics Manufacturing Services, Inc., 534 F Supp2d 227 (DNH 2008).

It does not appear that the defendants in Kaplan ever raised abstention as grounds to dismiss the case. In 2006, the federal judge held a trial of the plaintiff's state law claims for oppression, fraud and breach of fiduciary duty. The Court's April 2007 decision merely recites that the court has jurisdiction based on diversity of citizenship, and then goes on to uphold the oppression claim.

I can't close without noting that the Second Circuit's Friedman decision was in 1994, the year before the Commercial Division was established in the New York Supreme Court, initially in Manhattan and Rochester and later in many other counties throughout the state. The judges of the Commercial Division hear most of the corporate dissolution cases and, over the years, have developed great expertise and understanding of the special needs and dynamics of these cases. Therefore, and apart from the fact that diversity of citizenship among the co-shareholders and the corporation is infrequent, I don't think that the closing of the federal courthouse door to would-be dissolvers of New York corporations is a significant detriment anymore.

Fiduciary Breach Can Result in Shareholder Oppression, But Is Shareholder Oppression a Breach of Fiduciary Duty?

pmahler@FarrellFritz.com (Peter A. Mahler) — Tue, 26 May 2009 19:44:23 -0500

A recent Northern District New York federal court decision (HT Eric Fryar) caught my eye when I read a passage explaining the court's reasons for denying a motion to dismiss a plaintiff's claim against fellow shareholders for breach of fiduciary duty. The court in Rusyniak v. Gensisi, 2009 WL 1269911 at *14 (NDNY May 5, 2009), starts off simply enough, with the observation that the relationship between shareholders in closely held corporations is a fiduciary one. In the next sentence, the court writes:

More specifically, it "is the fiduciary duty owed by . . . majority shareholder[s] in a closely held corporation to a minority shareholder, not to engage in oppressive actions toward minority shareholders." (Italics added.)

The internal quote is from McCagg v. Schulte Roth & Zabel LLP, 20 Misc 3d 1139(A) (Sup Ct NY County Aug. 1, 2008). Both Rusyniak and McCagg cite the New York Court of Appeals' seminal decision in Matter of Kemp & Beatley, 64 NY2d 63, 73 (1984), construing the term "oppressive action" as used in the judicial dissolution statute, Section 1104-a of the Business Corporation Law, to mean "majority conduct [that] substantially defeats expectations [of the minority shareholder] that, objectively viewed, were reasonable under the circumstances and were central to the petitioner's decision to join the venture."

There are many cases in which courts have found that majority shareholder conduct constituting breach of fiduciary duty -- be it self dealing or theft of corporate opportunity or other "classic" violations of the duties of loyalty and care meant to squeeze out the minority shareholder -- satisfies the reasonable-expectations test of oppression. But, is the opposite true? Does proof of oppression constitute breach of fiduciary duty, as Rusyniak suggests?

The most common allegation of oppression by minority shareholders involves termination of employment by the controlling shareholders. The Court of Appeals in Matter of Kemp & Beatley noted that obtaining employment is often the main reason for becoming a shareholder in a closely held company that typically pays no shareholder dividends. As I've pointed out before, case law holds that the majority's termination of the minority's at-will employment does not give rise to a wrongful termination remedy under either a contract or tort theory, but it may be oppressive for purposes of seeking judicial dissolution where the shareholder joined the venture with the reasonable expectation of getting and keeping a job. In other words, the terminated minority shareholder can establish oppression for purposes of BCL 1104-a without the ability to, or needing to, establish breach of fiduciary duty.

Does McCagg support Rusyniak's equation of oppression with breach of fiduciary duty? Like Rusyniak, McCagg is not a judicial dissolution case. In pertinent part, McCagg involves a claim against a law firm for aiding and abetting breach of fiduciary duty by the plaintiff's co-shareholder arising out of an aborted business venture. I regard McCagg's statement quoted in Rusyniak ("the fiduciary duty owed by a majority shareholder in a closely held corporation to a minority shareholder, not to engage in oppressive actions toward minority shareholders") as dicta, mainly for the reason that the court in McCagg found that the alleged misconduct in that case did not involve "oppressive conduct that flows from any hegemonic abuse of [the defendant's] status as majority shareholder." I would also point out that the McCagg decision cites no precedent for its statement about a fiduciary duty to avoid oppressive conduct.

Oppression is not a free-floating, common law concept. It was created by the legislature in 1979 as part of a new, statutory judicial dissolution remedy against freeze-out and squeeze-out of minority shareholders of closely held corporations. Equating oppression with fiduciary breach may be doing a disservice to both.

Court Orders Hearing On Minority Shareholder's Petition for Common Law Dissolution

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 18 May 2009 07:00:00 -0500

UPCOMING CLE PROGRAM ON LIMITED LIABILITY COMPANIES

On Thursday, May 21, 2009, I'll be speaking about LLC dissolution at a CLE program sponsored by the Queens County Bar Association. I'll be joined by attorney and author Michele Santucci who'll speak on LLC origins, choice of entity and organizational issues. It's a two-hour evening program (6 p.m. to 8 p.m.) with light dinner available starting at 5 p.m. For more details and registration, click here. Hope to see you there!

Minority shareholders in closely held New York corporations, unlike many other states, must hold at least 20% of the corporation’s voting shares to petition for judicial dissolution on grounds of oppression under Section 1104-a of the Business Corporation Law. There’s little if any legislative history to explain the arbitrary 20% threshold. I imagine it was included as a compromise to satisfy legislators opposed to judicial interference with traditional corporate majority rule.

Shareholders with less than 20%, and without any claim for breach of shareholders' agreement, have limited options to right perceived wrongs by the controlling shareholders. They may bring a derivative action under BCL Section 626 for corporate waste, diversion of assets or other wrongs causing injury to the corporation, but first they either must make proper demand upon the board of directors or demonstrate demand futility. BCL Section 627 also requires a derivative plaintiff-shareholder with less than a 5% interest to give security for the corporation's costs including legal expenses. Furthermore, depending on the circumstances, commencing a plenary action for breach of shareholders' agreement or asserting derivative claims for recovery on the corporation's behalf may not provide sufficient leverage to induce a buy-out of the plaintiff's shares, assuming the plaintiff is pursuing an exit strategy.

The below-20% shareholder has one other option: common law dissolution. It carries no minimum ownership percentage. It's harder to establish than statutory oppression under BCL 1104-a, and rarely successful, but under the right circumstances it may give such a shareholder at least a toe-hold toward dissolution, which also may be enough to induce serious buy-out negotiations.

A recent decision by Queens County Commercial Division Justice Orin R. Kitzes presents one of the relatively rare instances in which a claim for common law dissolution successfully advances past the pleading stage. The case, Matter of Mouzakitis (Pearl Nightlife, Inc.), Index No. 28420/08 (Sup Ct Queens County Feb. 24, 2009), was previously featured on this blog when the court initially dismissed without prejudice a common law dissolution petition because the plaintiff's husband, who co-owned the shares as tenants by the entirety, was not a party to the action. Husband and wife thereafter filed a new action as co-plaintiffs, again suing for common law dissolution.

In his decision addressing the new petition, Justice Kitzes lays out the petition's allegations as follows:

Petitioners are wife and husband, and they jointly own fifteen shares in Pearl Nightlife, Inc., the operator of a restaurant located at 45-30 Bell Boulevard, Bayside, New York. According to a shareholder's agreement executed on or about October 9, 2007, the petitioners own their shares as tenants by the entirety. The corporation has issued a total of one hundred shares, and the Mouzakitis allegedly contributed approximately $125,000.00 for their fifteen per cent interest. Nicholas Kiriakis, the holder of thirty shares and the corporation’s president, serves as the manager of the restaurant. The restaurant opened for business on or about March 1, 2008, only about six months ago. The petitioners allege that those in control of the corporation have failed to make required contributions to the business, have failed to pay salaries and dividends, have refused to permit an inspection of corporate books and records, and have diverted corporate funds and assets. The amount of liquor purchased by the restaurant allegedly does not match sales, and Kiriakis has allegedly diverted food supplies to his other restaurants, claiming that the food spoiled. On May 4, 2008, the other shareholders allegedly had the petitioner arrested at the restaurant.

After noting that the petitioners do not meet the 20% threshold for statutory dissolution, Justice Kitzes sets forth the standard for common law dissolution as established in Leibert v. Clapp, 13 NY2d 313 (1963):

In Leibert, the Court of Appeals recognized a common-law right to dissolution of a corporation where the officers or directors of the corporation are engaged in conduct which is violative of their fiduciary duty to shareholders. Dissolution is appropriate if the directors or those in control of the corporation are looting the corporate assets to enrich themselves at the expense of the minority shareholders; continuing the corporation solely to benefit those in control; or that the actions of the directors or those in control has been calculated to depress the capital of the corporation in order to coerce the minority shareholders to sell their stock at a depressed price.

Justice Kitzes further notes that "the proof required to establish a common law dissolution is greater than is required to sustain a shareholder derivative action for waste" because, while the latter seeks to strengthen the corporation, the former seeks to "'end the corporate life'" (quoting from Fontheim v. Walker, 282 AD 373 (1st Dept 1953), aff'd, 306 NY 926 (1954)).

Justice Kitzes concludes that the petitioners "have set forth sufficient allegations and support to raise an issue that the majority shareholders are enriching themselves at the expense of the minority" and that the "sworn statements of the petitioners are sufficient to warrant a hearing to determine the validity of these allegations." His order also preliminarily enjoins the defendants from transferring or encumbering any corporate assets outside the normal course of business, and directs that petitioners be given access to all corporate books, including those for construction costs and operating the business.

In Leibert v. Clapp, the minority shareholder alleged that the majority had accumulated a large surplus which it then diverted to a parent company as part of a squeeze-out scheme. The Court of Appeals found that the alleged misconduct by the majority, if proven, "so palpably breached their fiduciary duties they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by the statute." The allegations in Mouzakitis sound somewhat more garden variety than those in Leibert, but then again, the Leibert court's pronouncement is broad enough to encompass a wide range of alleged majority shareholder misconduct.

Mediation and Business Divorce: Interview with Mediator Leona Beane

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 11 May 2009 07:00:00 -0500

UPCOMING CLE PROGRAM ON LIMITED LIABILITY COMPANIES

In last week's post, entitled "Winning the Dissolution Battle, Losing the War," I wrote about two cases in which business partners remained locked in protracted litigation even after one side's gambit for dissolution failed. I was very pleased to get an email from Leona Beane who read the post and commented, "Your ending statements refer to both situations with utter gloom and despair. It's a perfect segue-way into describing the benefits of mediation as an alternative."

Leona Beane, you see, is a former law professor turned full-time mediator/arbitrator based in New York City. I first met her when she was assigned by the court as mediator in a difficult business divorce case of mine pitting sibling against sibling. Much to my surprise, the case settled after a long day of candid dialog led by Leona.

I've long thought that mediation is under-utilized in business divorce matters. So inspired by Leona's email, I decided to ask her some questions about mediation in general, and about mediating business divorce cases in particular. I think you'll find her answers enlightening.

PM: I find that many people are unfamiliar with mediation. How do you describe it?

LB: Mediation is an informal, voluntary, confidential process whereby a neutral impartial third party (the mediator) assists the parties to resolve their dispute by means of facilitating discussions to consider different options so that both parties can craft an agreement that will be acceptable and agreeable to them.

PM: How does it differ from arbitration?

LB: Arbitration is another informal process to resolve disputes, but it is very different from mediation. The concepts underlying each are entirely different. With arbitration, the arbitrator renders a decision based on sworn testimony and evidence presented at a hearing. The arbitrator’s decision (referred to an “award”) is binding on the parties. There is also “non-binding” arbitration which is not utilized very frequently. Arbitration conducted pursuant to a court rule is generally non-binding, and the losing party generally has a right to a trial de novo. In many respects, arbitration is more similar to litigation as it is adversarial; the formal rules of evidence are relaxed, there is no absolute right to discovery, and no right to appeal. Arbitration awards can be reviewed by a court, and sometimes (although very seldom) may be vacated, but only on very limited grounds.

PM: In mediation, who dictates the outcome?

LB: The parties. In mediation the parties have the opportunity to craft their own agreement with the assistance of a trained mediator. The end result may not always be exactly what all parties want, but they will each have had input in the end result, as the process requires give and take from all parties. If one of the parties is not satisfied with the final agreement, he/she is not forced or pressured to sign it. Mediation is a confidential process; whatever is discussed in mediation is inadmissible.

PM: Does the mediator tell the parties what the settlement should be?

LB: No. Mediators in general should not. There are several different mediation styles; the one that has gained the widest acceptance as being most effective is the facilitative form of mediation (which I utilize). The mediator does not render any decision. The mediator does not decide who’s right or wrong. The mediator assists the parties in resolving their dispute by encouraging discussions, considering options, problem solving, and creative solutions. It’s the parties' dispute and the ultimate decision should be that of the parties with the assistance of the mediator.

PM: Most cases in litigation also settle before trial, often with the assistance of the judge or other court personnel. What's different about mediation?

LB: A settlement conference in court is not the same as mediation. In a settlement conference, generally only the attorneys appear, and they are on guard not to fully reveal aspects of their case. In mediation, the parties themselves must be present in order for the mediation to be effective, and the parties are encouraged to fully participate. There are different advocacy skills for attorneys in mediation as opposed to traditional litigation. A well trained mediator encourages the parties to consider creative options and solutions, to think ‘outside the box’. Mediation allows for a broader range of solutions than does litigation, which is limited to traditional remedies. Thus creative solutions are encouraged and entertained during the mediation process. In mediation, it’s possible for all parties to win. In contrast, by the time of the settlement conference in court, a great deal of litigation expense has generally already been incurred. In a settlement conference, many times the judge (or court personnel) put pressure on the attorneys to settle, as the court is primarily interested in reducing a case from the judge’s docket. In mediation, nobody is pressured to settle.

PM: Let's talk about business divorce cases. Can they be mediated?

LB: Definitely. Practically all disputes and litigation are suited to mediation. In addition, disputes within the closely held business almost always involve inter-personal disputes, which are particularly well suited to mediation.

PM: What are some of the special problems you see in business divorce cases, and how do you as a mediator deal with them?

LB: Because of the inter-personal disputes between the partners that may have been festering for years, it’s necessary for the parties to have the full opportunity to “vent” and voice complaints. There is a benefit and value to venting -- at least someone finally hears and listens to what a party has been complaining about all these years, and hopefully others will be able to better understand that party’s complaints. Some of the important attributes of a good mediator are being able to actively listen, and to have patience and perseverance. Disputes within the closely held business require the mediator to utilize those attributes in addition to others.

PM: Most business divorce cases involving viable companies lead to a buyout of one side by the other. Is a valuation dispute, which may require the involvement of appraisers, suitable for mediation?

LB: Definitely. Many times after a few hours of mediation, the parties realize they need additional information from experts such as appraisal reports. Thus, the mediation is adjourned a few weeks for the parties to obtain appraisal and other expert reports. Sometimes, each of the parties obtains a separate appraisal report, and sometimes they agree to utilize one common appraisal. Before the parties can seriously discuss settlement, they need to have the actual information so they know what they are each agreeing to.

PM: Can the court divert a business divorce case to mediation?

LB: Yes. In the Commercial Division (Rule 3, Practice for the Commercial Division; and Rule 202.70(g)), a judge can order the matter to mediation. There are additional local court rules. In the federal court, the court may direct most cases to mediation (Local Rule 83.11 & 83.12).

PM: Is mediation something lawyers should be thinking about when putting together a shareholders or operating agreement?

LB: Definitely. It’s important to set the framework in advance of what the parties should do if and when a major dispute arises; include provisions requiring mediation in the shareholders or partnership or LLC agreement. Also, any time there is a settlement agreement resolving a dispute or litigation, think of incorporating a contingency for mediation should a later dispute arise.

* * * * * * *

For those of you who'd like to learn more about mediation, a good place to start is the resources page on the website of the Dispute Resolution Section of the American Bar Association.

Winning the Dissolution Battle, Losing the War

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 04 May 2009 07:00:00 -0500

UPCOMING CLE PROGRAM ON LIMITED LIABILITY COMPANIES

Most business divorce litigation involving closely held companies results either in a buyout of one party by the other, or the two sides dividing the remaining assets and going their separate ways.

The biggest problem getting to the buyout is the absence of a public market to establish the value of the interest being acquired, particularly when dealing with a non-controlling interest in a sales or services-based operating company. The buyer and seller, even when advised by qualified business appraisers, can be light years apart on price due to different assumptions about a host of valuation inputs some of which necessarily require subjective analysis.

Splitting up the business can be very easy or very difficult, depending on the specifics of the business. It tends to be more difficult when there is value associated with the defunct company's name or other such intangible good will value at the enterprise level (as opposed to personal good will that follows the individual business partner wherever he or she goes).

Litigation means time, expense and uncertainty, all of which can jeopardize the potential benefits of an eventual buyout or business split-up. It is difficult for the controlling owner to invest and make business plans while under the cloud of a prospective buyout of uncertain magnitude. The risks can be even greater in a split-up scenario for business partners who, perhaps as a matter of business survival, begin taking unilateral and sometimes surreptitious steps at odds with each other, designed to retain for themselves the loyalty and business of key customers and vendors.

These ruminations, and the title of this post, are inspired by recent decisions in two cases in which business partners remain locked in protracted and undoubtedly expensive litigation even after one side's initial attempt to achieve judicial dissolution became moot.

The first decision is Mouhlas Realty, LLC v. Koutelos, 2009 NY Slip Op 30893(U) (Sup Ct Queens County Apr. 7, 2009). If the party names sound familiar, that's because I highlighted a prior decision in this LLC dissolution case in a post last year (read here). In the prior decision, Queens County Supreme Court Justice Patricia Satterfield held that the petitioner, who owned a minority membership interest in the LLC, failed to establish grounds for judicial dissolution under LLC Law Section 702, and also held that the controlling members had no right to compel an "equitable" buyout of the petitioner's interest -- thereby leaving the litigants locked in a relationship neither wants. The decision also left unresolved a series of counterclaims brought by the controlling members against the petitioner, including one seeking imposition of a judicial lien on her membership interest on account of an unsatisfied demand for capital contribution.

Justice Satterfield's recent decision addresses the controlling members' motion for summary judgment on those unresolved claims. The controlling members argued, based on the "law of the case" doctrine, that the court's prior rejection of the minority member's grounds for dissolution, including her objection to a mandatory capital contribution, entitled them to judgment against her for specific performance enforcing the capital contribution requirement and imposing a lien. Justice Satterfield disagreed, stating that her prior decision did not determine the propriety of the capital call, only that there was no statutory prohibition against it, and that the petitioner failed to show that the LLC is unable to function in accordance with its operating agreement or that the business is failing financially.

So here it is, over a year after the minority member sued for dissolution, and even though the issue of dissolution has been taken out of the case, the parties seemingly are not one step closer to resolving their broken relationship. Have the parties been discussing a buyout? I don't know, I can only assume that they have and, if so, that the demand and offer are too far apart due to different views of the business value and/or the impact on price of the capital call.

The second case is Stack v. O'Higgins, 2009 NY Slip Op 30874(U) (Sup Ct NY County Apr. 2, 2009), decided by the newest member of the Commercial Division of the New York County Supreme Court, Justice Shirley Werner Kornreich. The plaintiff, Lawrence Stack, and the defendant, Michael O'Higgins, are 50-50 members of an LLC called Stack's Sales East Coast LLC ("SSEC") which buys and sells rare coins, medals, paper currency and other numismatic items. In September 2006, Stack brought an action for judicial dissolution of SSEC due to disagreement regarding the proposed transfer of Stack's membership interest. It appears from the court's docket that the case got bogged down in discovery for the next year and a half. Again, I don't know if any buyout negotiations took place in the interim.

What we do know from the court's decision is that in May 2008, Stack changed course by sending O'Higgins a written notice purporting to exercise his right under the operating agreement to cancel SSEC's license to use the word "Stack" in its company name or otherwise. The relevant section of the operating agreement expressly conditioned the license termination on Stack's withdrawal from SSEC or SSEC's dissolution, so O'Higgins responded with a letter demanding confirmation of Stack's withdrawal, which Stack gave by written notice in September 2008. Soon thereafter, O'Higgins filed a certificate of amendment changing SSEC's name to "Steib's Sales East Coast LLC."

Did Stack's withdrawal from SSEC, which effectively mooted his claim for dissolution, end the hostilities? Not by a long shot. Even after the formal withdrawal, O'Higgins apparently continued to use Stack's name to market and advertise his business, as evidenced by certain trade journal ads and online directories. This prompted Stack to file a motion to amend his complaint to add claims for breach of contract, a declaratory judgment and a permanent injunction. O'Higgins opposed the motion on the grounds that Stack's withdrawal from SSEC mooted the entire action and that, in any event, his company's official change of name met any obligation under the operating agreement to cease using Stack's name. Justice Kornreich rejected O'Higgins' contentions and, for the most part, granted Stack leave to amend his complaint.

Stack, as Stack's Rare Coins, and O'Higgins, as Steib's Sales East Coast, are now business competitors fighting each other for customers, sources and for the good will they spent years developing jointly. Dissolution is out of the picture. Yet they are still locked in a three-year old litigation that drains their financial resources, places in the public record matters that most business owners prefer to keep private, and distracts from time better spent building their business.

In both of these cases, Koutelos and Stack, the defendants avoided dissolution and were able to carry onward in control of the business. In that narrow sense they won the dissolution battle. But in both cases the war goes on to an uncertain end as they continue to litigate their unresolved business and financial differences.

Pay Attention to the Latent Power of Corporate Bylaws

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 27 Apr 2009 07:00:00 -0500

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The lead-up to business divorce litigation is a tense pas de deux in which, once the dispute reaches critical mass, the two sides "lawyer up" and begin tactical maneuvers to best position themselves for the coming court battle. Sometimes the maneuvering consists of a series of back-and-forth letters between the lawyers staking out their positions and attacking the other's. Especially when one faction owns a controlling interest in the company, the maneuvering also may include formal meetings of the shareholders or the corporation's board of directors (or members/managers in the case of an LLC) to authorize actions adverse to the non-controlling faction.

Never mind that the owners never once held a formal meeting or kept minutes or adopted written resolutions since the day the corporation was formed. Never mind that the corporate kit, containing the organizational documents, stock ledger and certificates, has been sitting untouched, gathering dust since day one.

Among the likely neglected documents in the corporate kit are the corporation's bylaws. Bylaws are to be distinguished from the shareholders' agreement. The latter typically sets forth the stock interests of the individual shareholders, designates directors and officers, and contains restrictions on the transfer of shares, among other provisions. In contrast, think of bylaws as the corporation's operating system, consisting of internal rules not specific to any named individuals, governing such matters as quorum and notice requirements for meetings of the shareholders and board of directors; procedures for the election and replacement of directors; the number and term of directors; and the titles and duties of the corporation's officers. Section 601 of the Business Corporation Law mandates the adoption of bylaws by the incorporators at the initial organization meeting required under BCL Section 404.

I can't say whether all the parties and counsel in Matter of McDaniel (162 Columbia Heights Housing Corp.), 2009 NY Slip Op 29047 (Sup Ct Kings County Feb. 3, 2009), were cognizant of the bylaws as they maneuvered prior to commencement of dissolution proceedings. I can say that the bylaws played a dispositive role in the court's determination of their preliminary dispute over a certain stock transfer involving shares of a residential co-operative corporation.

McDaniel involves a 5-unit co-op occupying a landmarked brownstone building in Brooklyn. In May 2004, one of the units was vacated as part of a settlement with a former shareholder. A dispute arose among the remaining shareholders regarding the disposition of the vacant unit and its appurtenant shares which petitioner McDaniel contended were owned by her and the others believed were owned by the corporation. In June 2005, McDaniel resigned her positions as president and as one of the board's two directors.

McDaniel apparently hoped that by resigning as director she effectively would disable the corporation, now with a one-member board, from taking any action contrary to her claimed ownership of the disputed unit. In August 2005, the other shareholders gave written notice of a shareholders meeting the following month to elect a new board of directors. McDaniel's attorney appeared at the meeting with his client's proxy. A vote was taken to place the disputed unit on the market for sale, to which all parties, except McDaniel through her attorney, agreed. A process server then interrupted the meeting to serve a complaint by McDaniel to recover certain monies owed her by the corporation. The shareholders meeting was adjourned to October 2005 on which date the other shareholders -- McDaniel did not attend personally or by proxy -- elected two of their number as directors. At subsequent directors meetings the board approved the sale of the disputed unit to an outside buyer for $850,000. The sale was completed in May 2006.

A year later, in May 2007, McDaniel petitioned for judicial dissolution of the corporation under the oppressed minority shareholder statute, BCL Section 1104-a. The corporation elected to purchase McDaniel's shares for fair value under BCL Section 1118. This set the stage for the initial skirmish over the interest to be valued, i.e., 25% as claimed by McDaniel versus 20% as claimed by the remaining shareholders, with the outcome dependent on the validity of the two-member board elected in October 2005.

The decision by Kings County Commercial Division Justice Carolyn Demarest hinges primarily on the corporation's bylaws, starting with Article III, Section 4 stating as follows:

Newly created directorships resulting from an increase in the number of directors and vacancies occurring in the board for any reason except the removal of directors without cause may be filled by vote of the board. If the number of the directors then in office is less than a quorum, such newly created directorships and vacancies may be filled by vote of a majority of the directors then in office . . . .

McDaniel argued that the remaining director could not alone constitute a "majority" with the power to appoint an interim replacement director. Justice Demarest disagreed, calling such analysis "illogical" since "any decision taken by the only authorized director would necessarily be unanimous and thus exceed the required 'majority.''' McDaniel's argument also would contradict the clear intent of the bylaws "to provide a mechanism to overcome the paralysis arising from the lack of sufficient directors to act on behalf of the Corporation." Justice Demarest further noted that "petitioner deliberately resigned knowing that her absence would impede the functioning of the board."

McDaniel next contended that under Article II of the bylaws and BCL Section 605, all actions taken by the corporation following her resignation were void based on the failure to give written notice of the October 2005 meeting at which the new board was elected. Justice Demarest again disagreed, holding that both the bylaw and statute permitted the adjournment of the properly-noticed September 2005 meeting without further written notice. Not only did McDaniel receive written notice of the September 2005 meeting, her attorney attended the meeting and was present when it was adjourned to October after his process server showed up. Justice Demarest also found that McDaniel waived any objection to defective notice based on Article II, Section 3 of the bylaws stating as follows:

The notice [of shareholder meetings] provided for in the two foregoing sections is not indispensable but any shareholders' meeting whatever shall be valid for all purposes if all the outstanding shares of the Corporation are represented thereat in person or by proxy . . ..

The bylaws also contradicted McDaniel's argument that authorization for the contract of sale of the disputed unit required a shareholders' meeting and vote. "A perusal of the By-Laws for the Corporation indicates that such authority is vested in the Corporation's Board of Directors," wrote Justice Demarest.

McDaniel also argued unsuccessfully that, even assuming a properly constituted board, she nonetheless held a 25% interest because the shares appurtenant to the disputed unit were cancelled upon reacquisition by the corporation at the time of the 2004 settlement with the former shareholder. Citing BCL Section 515 governing reacquired shares, Justice Demarest found that the disputed shares were not cancelled but were retained as treasury shares and were subsequently sold for fair consideration.

The court accordingly determined that McDaniel is entitled to receive only 20% "of the fair value of the assets of the Corporation, including the market value of the building . . . and any other Corporate assets, less the Corporation's liabilities." The case appears to have gone to trial last month; I'll be sure to report on any written decision on valuation.

What's the Difference Between Marketability and Minority Discounts?

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 20 Apr 2009 07:00:00 -0500

The following testimony was given by an accredited business appraiser, testifying on behalf of the purchasing majority shareholders in a buy-out valuation proceeding under Section 1118 of the Business Corporation Law, to determine the "fair value" of the petitioner's 45% interest in two related companies:

Q:     . . . I see that for the [first] appraisal there was no separate marketability discount analysis, but there is one for the [second] appraisal. Could you explain the basis of that?

A:     After the issuance of both reports, . . . we were asked to come up with a value on a fully enterprise, the value of both entities. After the second report, [the majority shareholders' lawyer] asked me to address it because the case had become a 1118 case, and in that case the definition of value is fair value, and under that definition of value for the minority interest, what other considerations would one take into consideration, and I said, well, you would address the marketability discount of that specific block of stock under that statute. And he asked me then could I quantify what the marketability discount would be applicable to the stock.

Q.     Applicable to the minority interest?

A.     To the block of stock, the 45 percent interest.

The same expert, in a written report, wrote that "[a] minority equity holder of [the two companies] owns an equity interest for which no market exists. . . . It is our opinion that no less than a 30%-to-35% discount for lack of marketability is appropriate for the equity interest in [the two companies] to derive the fair value of the specific fractional interest in each company . . .."

The judge in that case rejected the expert's position and refused to apply the proposed discount. Can you guess why?

The answer, according to the judge, is that in actuality the expert was applying a minority discount a/k/a discount for lack of control (DLOC) dressed up as a discount for lack of marketability (DLOM). Why does it matter? Because New York case law holds that under the "fair value" standard applicable in valuation proceedings under Section 1118, as well as under the statute governing dissenting shareholder appraisals (BCL 623), application of a minority discount is prohibited.

The International Glossary of Business Valuation Terms gives the following definitions for DLOC and DLOM:

Discount for Lack of Control--an amount or percentage deducted
from the pro rata share of value of 100% of an equity interest in
a business to reflect the absence of some or all of the powers of
control.

Discount for Lack of Marketability--an amount or percentage
deducted from the value of an ownership interest to reflect the relative
absence of marketability.

DLOM is deducted from the value of the entity as a whole, i.e., it applies to all shares, not just the minority stake being valued, to reflect the relative illiquidity of the shares compared to those of publicly traded companies. DLOC is deducted from the proportionate share of the value of the minority stake being valued, to reflect the affect on cash flows of the absence of control attributes.

Leading valuation expert Shannon Pratt, at page 69 of his standard reference book, "Valuing a Business" (5th Ed.), writes that "[l]ack of control is reflected in the projected cash flows; that is, whether or not control adjustments have been made to the cash flows." In contrast, he writes, "[m]arketability, or lack thereof, is the ability to sell the interest and obtain cash quickly without loss of value."

The seminal New York case upholding the use of DLOM and rejecting DLOC under the fair value standard is Matter of Blake decided in 1985 by the Appellate Division, Second Department (107 AD2d 139, 486 NYS2d 341). The Blake court reasoned that the oppressed minority shareholder statute was enacted for the protection of minority shareholders, and that "the corporation should not receive a windfall in the form of a discount because it elected to purchase the minority interest pursuant to [BCL ] 1118." The New York Court of Appeals (New York's highest court) in Matter of Penepent Corp., 96 NY2d 186 (2001), offered a somewhat different rationale for the prohibition:

To impose upon petitioning minority shareholders a penalty because they lack control would violate two "central equitable principles of corporate governance." First, a minority discount would deprive minority shareholders of their proportionate interest in the corporation as a going concern. Second, it would result in shares of the same class being treated unequally.

The Blake decision also endorsed use of DLOM in determining fair value, stating as follows:

A discount for lack of marketability is properly factored into the equation because the shares of a closely held corporation cannot be readily sold on a public market. Such a discount bears no relation to the fact that the petitioner's shares in the corporation represent a minority interest.

The New York Court of Appeals later placed its imprimatur on DLOM in fair value proceedings in Matter of Seagroatt Floral Co., 78 NY2d 439 (1991), where it wrote:

Valuing a closely-held corporation is not an exact science. Accordingly, courts in such proceedings confront a variety of evidence and methods aimed at determining the price of minority interests in closely-held corporations--legal entities that by their nature contradict the concept of a "market" value. The 1979 amendments to the Business Corporation Law were motivated, in part, by recognition of the fact that shareholders in closely-held corporations, as contrasted with shareholders in public companies, are unlikely to find prospective buyers for their shares. It follows that, whatever the method of valuing an interest in such an enterprise, it should include consideration of any risk associated with illiquidity of the shares. [Citations omitted.]

It's important to note that New York's proscription against DLOC under the "fair value" standard does not carry over to other types of valuation proceedings under the "fair market value" standard, such as matrimonial valuation proceedings. (See my prior piece on fair value vs. fair market value here.)

By the way, the testimony quoted at the top of the post is from an unpublished decision in Matter of O'Brien (Academe Paving, Inc.), Index No. 99-2594 (Sup Ct Broome County Sept. 25, 2000). It's a noteworthy case in which the majority shareholders took some serious lumps by presenting expert valuation testimony by the same appraiser who, before hostilities broke out, valued the combined companies at $7.6 million for purposes of an unconsummated sale to a third party but who later, on behalf of the majority shareholders, re-valued the companies for litigation purposes at a substantially lower number.

Nominee Agreement Trumps Corporation Records in Fight Over Stock Ownership

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 13 Apr 2009 07:00:00 -0500

I recently did a series of postings on challenges to standing in corporate dissolution cases where the petitioners lacked stock certificates or other conclusive evidence of their share ownership (see here, here and here). I didn't expect to return to the topic so soon, but a new decision out of the Appellate Division, Second Department, reversing a lower court's order denying injunctive relief, warrants another visit.

The case, Yemini v. Goldberg, involves a fight over the ownership of a New York corporation called ANO, Inc. which is an acronym for Ari N Oded, Ari being plaintiff Ari Yemini and Oded being defendant Oded Goldberg.

ANO was formed in June 1999 to purchase an interest in another company called Candlewood Holdings, Inc. The only ANO stock certificate ever issued was issued on June 22, 1999, to Yemini who also was identified as sole director and shareholder in corporate resolutions adopted the same date.

On July 1, 1999, ANO acquired a 50% interest in Candlewood (later increased to two-thirds). On that same date, Yemini and Goldberg entered into a "Nominee Agreement" denominating Goldberg as "Principal" and Yemini as "Nominee". The Nominee Agreement contains the following two recitals:

WHEREAS, the Principal is the true owner of fifty (50%) percent of the common stock of ANO, Inc., a New York corporation (the "Corporation");

WHEREAS, the Nominee shall act as nominee for the Principal in connection with said Corporation and in connection with the Stock Acquisition Agreement by and between ANO and Candlewood Holdings, Inc.("Candlewood"), dated as of July 1, 1999 (the "Stock Acquisition Agreement".

The Nominee Agreement contains provisions authorizing the Nominee to take all actions required to purchase the Candlewood interest; requiring the Nominee to provide the Principal with all documents concerning ANO; prohibiting the Nominee from taking any action with regard to the Principal's interest in ANO without the Principal's express instructions; and appointing the Principal the Nominee's attorney-in-fact with the power to execute all agreements, instruments, etc. required to be signed by the Nominee.

In 2005, Yemini sued Goldberg for the latter's alleged failure to make certain capital contributions for a separate business venture. Apparently, by this time Yemini refused to acknowledge Goldberg as owning any interest in ANO, prompting a countersuit by Goldberg and an application by him for preliminary injunction with regard to a meeting of the shareholders of Candlewood.

The matter proceeded to an 11-day evidentiary hearing before Nassau County Commercial Division Justice Leonard B. Austin (recently elevated to Associate Justice of the Second Department), who denied Goldberg's injunction motion in a decision reported at 15 Misc 3d 1142(A), 2007 NY Slip Op 51117(U) (Sup Ct Nassau County 2007).

Justice Austin found that, other than the Nominee Agreement and ANO's name, there were "no indicia of ownership of ANO or any interest therein" by Goldberg. In addition to the stock certificate and resolutions mentioned above, Justice Austin pointed to a Candlewood shareholders agreement and employment agreement that identified Yemini as sole shareholder, both of which agreements Goldberg knew about when they were executed in July 1999, and to ANO's tax returns which, with Goldberg's knowledge, also identified Yemini as sole shareholder. Justice Austin further noted that, until the litigation, Goldberg never asserted rights as a shareholder of ANO or demanded a turnover of the ANO stock.

Justice Austin also held that Goldberg was unlikely to succeed on the merits because he lacked "clean hands" and was estopped from taking inconsistent positions. This arose primarily from Goldberg's involvement in legal proceedings with his ex-wife in 2002, in which he filed a net worth affidavit that omitted mention of ANO as an asset. "A party, such as Goldberg", Justice Austin wrote,

who has hidden an interest in ANO from his wife in a matrimonial action, has failed to disclose this interest to a lender and repeatedly failed to disclose the interest in ANO to the tax authorities, has unclean hands and cannot obtain relief.

Not so fast, says the Second Department in a decision on Goldberg's appeal ordering that he be granted a preliminary injunction based on the Nominee Agreement. Yemini v. Goldberg, 2009 NY Slip Op 02353 (2d Dept Mar. 24, 2009). Here's the key passage from the appellate decision:

Parties are free to make their own arrangements regarding beneficial ownership of securities as definitive between them (see UCC § 8-207[a], Official Comment 3; Delaware v New York, 507 US 490, 505). This nominee agreement "constituted a declaration of trust" (Brotman v Meyers, 41 AD2d 547, 547). It is irrelevant that Yemini at all times retained ownership of the ANO stock certificates (see Matter of Benincasa v Garrubbo, 141 AD2d 636, 638).

The appellate decision does not comment on the issue of unclean hands relating to Goldberg's non-disclosure of his ANO stock interest in his matrimonial case. It does state, however, that judicial estoppel does not apply because there is no evidence that Goldberg "secured a judgment in his favor in the proceeding in which he allegedly took an inconsistent position".

The lower court and appellate decisions do not relate Goldberg's reasons for wanting the Nominee Agreement, or refer to any testimony from Yemini explaining his reasons for executing it. In my experience, such arrangements usually are driven by tax considerations. In other cases courts have refused to uphold undocumented stock ownership claims in the face of contradictory tax or other official filings. This case is different because the lawyer-prepared Nominee Agreement contains the adverse shareholder's explicit, signed recognition of the disputed stock interest.

Court Enjoins "Squeeze-Out" Capital Call by Controlling Members of LLC

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 06 Apr 2009 07:00:00 -0500

Baseball has the squeeze play. Majority owners of closely held companies have the squeeze out. It's only fitting, then, that I refer to what happened in the recently decided case, Cooperstown Capital, LLC v. Patton, 2009 NY Slip Op 02277 (3d Dept Mar. 26, 2009), involving a dispute between majority and minority owners of a baseball camp, as the "squeeze-out play."

Martin and Brenda Patton owned land in upstate New York about 20 miles from the Baseball Hall of Fame in Cooperstown. In 2004, they entered into agreements with Cooperstown Capital, LLC to build and operate a baseball camp and hotel on the Patton land. The Pattons contributed the land to Abner Doubleday, LLC ("Abner") in exchange for 35% membership interests in Abner and a second company formed to operate the baseball camp, called Cooperstown All Star Village, LLC ("CASV"). Cooperstown Capital paid $400,000 and gave a $1 million promissory note for 35% interests in the two companies. A third investor, Marco Lionetti, acquired the remaining 30% interests.

The $1 million promissory note was made payable to the Pattons, but the operating agreements designated the payments as operating expenses of the companies and treated Cooperstown Capital's additional capital contributions as credits against the Patton note.

The baseball camp opened under the name Cooperstown All Star Village, but relations among the owners soon deteriorated over various financial disputes which erupted in a pair of lawsuits centering on Cooperstown Capital's obligations for capital contributions and payments on the Patton note. In December 2007, in a suit commenced by the Pattons against Cooperstown Capital demanding payment of the note, the Appellate Division, Third Department, upheld the denial of the Pattons' summary judgment motion, stating that "[b]ecause the note requires defendants to pay, but the operating agreements include payments under the note as operating expenses of Abner and CASV, questions of fact exist concerning the breach of the agreements and the amount, if any, due under the note." (Read decision here.)

Now comes the "squeeze-out play." Apparently not content to await trial, in February 2008, the Pattons with the support of the other 30% member, Lionetti, called a meeting of Abner's members to vote upon and approve a capital call upon Cooperstown Capital alone, demanding that it contribute over $450,000 for operating expenses consisting of amounts allegedly due under the Patton note. Under Abner's operating agreement, the other members may make a capital contribution if a requested party fails to do so, and such action is treated as a loan for a period of 90 days. Thereafter, if the loan is not repaid, the defaulting member's interest may be decreased and the contributing member's interest increased accordingly.

Cooperstown Capital quickly sought to enjoin implementation of the February 2008 capital call, contending that when it refused to make the demanded contribution, the Pattons purported to loan Abner the funds (to pay themselves) and were threatening to dilute Cooperstown Capital's membership interest so as to give the Pattons absolute control of the business.

LLC member disputes usually turn on the express provisions of the operating agreement, and Cooperstown is no exception. Section 5.2 of Abner's operating agreement governing additional capital contributions provides:

The Members shall contribute such additional capital on a pro rata basis in proportion to their respective "Membership Interests", as hereinafter set forth in Section 6 hereof, as such amount is determined in good faith by the consent of Members holding a majority in interest.

In support of its injunction application, Cooperstown Capital argued that Section 5.2 does not authorize a selective capital call upon one member, and that by diluting its membership interest the Pattons effectively would wrest over two-thirds control of the LLC giving them the unchecked power to sell major LLC assets and dissolve the LLC. In a Memorandum Decision and Order dated April 21, 2008, Oneonta County Supreme Court Justice Kevin M. Dowd agreed with Cooperstown Capital and granted the injunction, stating:

Plaintiff has shown a probability of success on the merits. The operating agreement for Abner states in Section 5.2, "The Members shall contribute such additional capital on a pro rata basis in proportion to their respective 'Membership Interest,'…" Section 5.8 further states that in determining the amount of any additional capital contribution the members shall consider all the operating expenses. Operating expenses are defined by Section 13.13 of the Operating Agreement to include payments of principal and interest due under the Patton notes. Based upon these sections, there appears to be no basis to make a capital call on Plaintiff alone.

The Pattons appealed, arguing that the injunction was inconsistent with the Third Department's December 2007 decision in which it found questions of fact concerning whether Abner and CASV or Cooperstown Capital was obligated to pay the Patton note. In its March 26, 2009 opinion, the appellate court rejected this argument and upheld the injunction, writing:

While both Supreme Court and this Court previously determined that questions of fact preclude summary judgment in the parties' related case (Patton v Ferrara, 46 AD3d at 1205), plaintiff has still established a likelihood of success here. Abner's operating agreement permits capital calls, but specifies that the "[m]embers shall contribute such additional capital on a pro rata basis in proportion to their respective '[m]embership [i]nterests.'" Under the operating agreement and the promissory notes, the Patton notes are payable as operating expenses of Abner and CASV rather than the individual members, and capital calls "shall" be shared pro rata by the "members" plural. Hence, despite questions of fact, it is at least likely that plaintiff will succeed in proving the impropriety of Abner's notice requiring a capital contribution only from plaintiff to pay the Patton note.

An opportunity for defendants to shift the balance of power and wrest complete control over the company can constitute irreparable injury (see Vanderminden v Vanderminden, 226 AD2d 1037, 1041 [1996]; Casita, LP v Maplewood Equity Partners [Offshore] Ltd., 17 Misc 3d 1137A, *8 [2007]; see also Matter of Brenner v Hart Sys., 114 AD2d 363, 366 [1985]). If plaintiff does not pay the capital contribution, the operating agreement permits the remaining members to meet the capital contribution on plaintiff's behalf as a loan, then repay the loan with plaintiff's equity interests in Abner. In that scenario, plaintiff would lose not only its shares of Abner, but also its ability to block certain actions which require a two-thirds vote. Those actions include selling major LLC assets and dissolving the LLC. The possibility of plaintiff losing any real say in Abner, as opposed to maintaining the status quo where defendants suffer no actual harm, suggests that the equities balance in plaintiff's favor. Thus, Supreme Court did not abuse its discretion in granting the preliminary injunction (see Matter of Kalichman, 31 AD3d 1066, 1067 [2006]).

The occasional need for additional capital contributions is a fact of life for many closely held businesses. A business organized as a New York limited liability company must pay attention to Section 502 of the LLC Law which sets forth certain default rules surrounding member liability for contributions. Section 502 does not, however, mandate any consequences to the membership interest of the defaulting member, leaving this entirely to the operating agreement. Here's what it says in Section 502(c):

The operating agreement may provide that the membership interest of any member who fails to make any required contribution shall be subject to specified consequences of such failure. Such consequences may include, but are not limited to, reduction or elimination of the defaulting member's interest, subordination of the defaulting member's interest to that of nondefaulting members, a forced sale of the defaulting member's interest, forfeiture of the defaulting member's interest, the lending by the other members of the amount necessary to meet the defaulting member's commitment, a fixing of the value of the defaulting member's interest by appraisal or by formula and redemption or sale of such member's interest at such value, or other consequences

In other words, if the operating agreement does not expressly authorize dilution, forfeiture, or other adverse consequences to the non-contributing member's interest, the LLC has no immediate recourse beyond seeking to enforce the payment obligation. This was not the problem for the Pattons in Cooperstown. Rather, their problem was adopting a selective capital call designed to bring down the operating agreement's "hammer" provisions upon only one member, contrary to the operating agreement's pro rata formula for additional member contributions.

New Jersey Courts Apply State's Dissolution Statute to Foreign Corporations: Can it Happen in New York?

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 30 Mar 2009 07:00:00 -0500

Many New York businesses are incorporated in other states, Delaware being the traditional favorite. In most instances these corporations are foreign in name only, i.e., their offices, assets, employees, shareholders and directors all are located in New York. Can a shareholder sue for dissolution of a New York-based foreign corporation in a New York court under New York's dissolution statutes?

The lead article in this month's online newsletter published by Drinker Biddle highlights two recent, unpublished New Jersey court decisions in which that state's dissolution statute was applied to foreign corporations based in New Jersey. In Krzastek v. Global Resource Industrial and Power, Inc., No. A-1815-06T2 (App. Div. Sept. 11, 2008), the New Jersey appellate court upheld application of the state's oppressed minority shareholder dissolution statute in a suit brought by a minority shareholder of a Massachusetts corporation. In Conway v. DialAmerica Marketing, Inc., No. BER-C-116-08 (Super.Ct. Sept. 30, 2008), the trial court did the same in a case brought by a minority shareholder of a Delaware corporation. In both cases, the courts applied New Jersey law based on an interests-based conflict of laws analysis. In both cases, the New Jersey dissolution statute afforded the plaintiffs rights and/or remedies (especially in regard to buyout) broader than those available under the laws of the states of incorporation. In both cases, the defendants unsuccessfully argued for dismissal based on the the "internal affairs doctrine" under which courts traditionally refused to exercise jurisdiction where the determination of the rights of the litigants involves regulation and management of the internal affairs of a foreign corporation.

Could it happen in New York? Case precedent suggests not, although the issue is not fully settled.

The leading New York precedent on the internal affairs doctrine is Langfelder v. Universal Laboratories, Inc., 293 NY 200 (1944), decided by the New York Court of Appeals (the state's highest court). The case was brought in New York by dissenting shareholders objecting to the terms of a merger involving two Delaware corporations. Here's the court's description of the internal affairs doctrine under which the case was dismissed:

There are cases in which our courts will entertain jurisdiction in suits against foreign corporations where suitors, even stockholders, are entitled to some relief which the State court is competent to grant. But it is well settled that jurisdiction in any case will be declined either in the absence of jurisdiction in the strict sense or where a determination of the rights of litigants involves regulation and management of the internal affairs of the corporation dependent upon the laws of the foreign State or where the court in which jurisdiction is sought is unable to enforce a decree if made or where the relief sought may be more appropriately adjudicated in the courts of the State or country to which the corporation owes its existence.

Although the doctrine generally has fallen out of favor in the ensuing decades (see former Justice Herman Cahn's highly informative discussion of the issue in Matter of Topps Co., Inc. Shareholder Litigation, 19 Misc 3d 1103(A), 2007 NY Slip Op 52543(U)), it has retained vitality in the realm of judicial dissolution proceedings brought under Article 11 of the New York Business Corporation Law.

This is due in large part to a pair of rulings by the Appellate Division, Second Department, in Warde-McCann v. Commex, Ltd., 135 AD2d 541 (2d Dept 1987), and Matter of Porciello, 253 AD2d 467 (2d Dept 1998), where, with virtually no discussion, the court invoked the internal affairs doctrine in dismissing proceedings to dissolve Delaware and Florida corporations. These cases have been followed in numerous lower court decisions within and outside the Second Department. (A recent example is Justice Bucaria's Schneck decision about which I wrote last year.)

The First Department's decision in Matter of Hospital Diagnostic Equipment Corp., 205 AD2d 459 (1st Dept 1994), arguably points in a different direction. There, the court upheld the dismissal of a deadlock dissolution proceeding involving a Delaware corporation on the discretionary ground of forum non conveniens due to the corporation's lack of substantial contacts with New York. The New York Attorney General also had moved for dismissal on the ground the court lacked jurisdiction to dissolve a foreign corporation. In its decision the First Department expressly rejected the Attorney General's argument that, whatever the court's authority to grant other forms of relief, under principles of comity it lacks jurisdiction to order dissolution of a foreign corporation.

There's been little, subsequent case activity putting Hospital Diagnostic's jurisdictional view to the test. In Sokol v. Ventures Education Systems Corp., 10 Misc 3d 1055(A) (Sup. Ct. NY County 2005), the court held that it could not entertain a request to dissolve a New York-based Delaware corporation but that it had jurisdiction to grant remedies short of dissolution. Here's how New York County Commercial Division Justice Richard B. Lowe III navigated the cross currents created by the First and Second Department precedents:

"It is well settled that 'a foreign corporation is controlled, as to its dissolution, by the laws of its domicile, and is not affected by laws which are intended to govern the dissolution of corporations created under local laws' " (Matter of Warde-McCann v Commex, Ltd., 135 AD2d 541, 542 [2d Dept 1987], quoting 17A Fletcher's Cyclopedia of the Law of Private Corporations § 8579, at 516 [Perm ed] [now, at 454-55 (1998 rev ed)]; Matter of Porciello v Sound Moves, Inc., 253 AD2d 467 [2d Dept 1998]; Mook v Berger, 26 AD2d 925 [1st Dept 1966], appeal granted 19 NY2d 581 [1967]; see BCL § 1104-a). A corporation is domiciled only in the state where it is incorporated (Sease v Central Greyhound Lines, Inc., of New York, 306 NY 284 [1954]). VESC is incorporated under the laws of Delaware and, therefore, may be dissolved only by order of a Delaware court.

For these reasons, the branches of Sokol's cross motion for dissolution of VESC and appointment of a liquidating receiver are denied.

However, this court may exercise subject matter jurisdiction over the other issues raised by the parties. Subject matter jurisdiction over the internal affairs, short of dissolution, of a foreign corporation may be found, in the court's discretion, to exist in equity where the corporation's sole connection to a foreign state or country is its place of incorporation and the corporation has significant and substantial ties with New York (Matter of Dissolution of Hospital Diagnostic Equip. Corp. [Klamm], 205 AD2d 459 [1st Dept 1994]; Broida v Bancroft, 103 AD2d 88 [2d Dept 1984]; Tosi v Pastene & Co., 34 AD2d 520 [1st Dept 1970]). Where jurisdiction exists, "the fact that the relief nominally sought (i.e., dissolution and forfeiture of the corporate charter) is not technically within the power of the Court does not bar the award of lesser or alternative relief in this action . . . which will attain substantial justice between the parties" (Matter of Dohring for the Dissolution of CVC Prods., Inc., 142 Misc 2d 429, 433 [Sup Ct, Monroe County 1989]).

Significantly, in Sokol Justice Lowe rejected the plaintiff's request to apply New York's substantive law to the plaintiff's claim of minority shareholder oppression. Rather, Justice Lowe held that the claim had to be decided under the more demanding standards of Delaware statutory and common law because the corporation's charter and bylaws demonstrated that the founders (including the plaintiff) "agreed to govern VESC's internal affairs in accordance with the laws of Delaware." In this regard, Sokol seems incompatible with the New Jersey courts' analysis in Krzastek and Conway.

I did not find in the two New Jersey opinions any acknowledgment of the "technical" barrier to dissolution of a foreign corporation noted in the New York cases, namely, the inability of a court in one state to order the secretary of state in another state to dissolve a corporation. The practical answer may lie in New Jersey's strong policy in favor of buyouts, as reflected in the New Jersey dissolution statute's express provisions authorizing the court to compel the respondent shareholders to purchase the petitioner's shares or vice versa. New York courts have rarely compelled buyouts and, to my knowledge, never in the form of a compelled buyout of a respondent by a petitioner.

Perhaps some day one of the other Appellate Division Departments will unequivocally split with the Second Department, requiring the New York Court of Appeals to decide once and for all the scope of judicial authority to entertain a petition for judicial dissolution of a foreign corporation. Until then, New York shareholders of closely held foreign corporations who seek the remedy of judicial dissolution must do so in the state of incorporation. In the case of a minority shareholder of a Delaware corporation, this can be a daunting challenge given Delaware's lack of a minority shareholder oppression statute (except for statutory close corporations) and given Delaware case law that is generally more hostile to oppression claims than New York's.

Shareholders unwilling to sue for dissolution in the state of incorporation alternatively may consider bringing a derivative action, e.g., for breach of fiduciary duty, in New York state court as specifically authorized by Section 1319 of the New York Business Corporation Law. As explained by Justice Kenneth Fisher in Potter v. Arrington, 11 Misc 3d 962, 2006 NY Slip Op 26062 (Sup. Ct. Monroe County 2006), in such an action the court is still required to apply New York's conflict of laws rules, which likely will result in application of the foreign state's substantive law.

My thanks to Brian Waters at Drinker Biddle for providing copies of the Krzastek and Conway decisions.

Undocumented Stock Interests Invite Challenges to Standing in Corporate Dissolution Cases: Part Three

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 23 Mar 2009 06:30:00 -0500

[This is the third in a three-part series on challenges to standing to petition for judicial dissolution where the petitioner lacks a stock certificate or other definitive evidence of shareholder status. Part One looked at a recently decided case where the court ordered an evidentiary hearing to resolve the parties' contradictory factual contentions. Part Two discussed a dissolution case involving two contested corporations, in which the court rendered a split decision after an eight-day evidentiary hearing to determine whether the petitioner owned any shares. This week's highlighted case adds a family dimension to the problem of inadequate documentation of share ownership.]

If a corporate dissolution contest could be re-imagined as a TV game show, I'd call the case of Rodriguez v. Estevez, "Who Wants to be a Shareholder: Family Feud Edition".

In many instances, the same bonds of kinship and trust that give life and success to family-owned businesses can lead to the most bitter of courtroom disputes when the family members/business partners have a falling out. In Rodriguez, the dilution of family ties as control passed to the second generation, combined with a dramatic increase in the value of the business assets, created conditions rife for dissension. The resulting legal conflagration over the question of share ownership was made even more predictable by the family members' traditional aversion to the use of "outsider" lawyers and accountants to maintain proper corporate records.

The Rodriguez saga starts with two first generation immigrants to the United States, Rafael Rodriguez and Joaquin Estevez, who became successful retail business owners in New York City. Rafael owned and operated a liquor store. Joaquin went into the retail grocery and food trades. Rafael married Joaquin's sister. Joaquin had two daughters and five sons, several of whom became involved in their father's businesses.

In 1989, the Estevez family took over a supermarket business located in what was then a crime-ridden section of East Harlem, in a building on East 110th Street (the "Building"). Because the business needed a license to redeem food stamps, and because Joaquin and some of his sons previously were convicted of felonies relating to the food stamp program, Joaquin initially placed ownership of the supermarket in a new corporation ("D&R") owned 100% by Rafael's brother, Juan Rodriguez. Eventually Juan dropped out and his D&R shares were transferred to Estevez family members.

The Building's owner later landed in financial trouble and contemplated bankruptcy which would have threatened the supermarket's lease. In 1992, the supermarket's supplier proposed that the Estevez family acquire the Building and offered to finance its acquisition 100% conditioned on the purchaser's advancing of $100,000 cash for "closing costs." Lacking the funds, Joaquin asked Rafael to put up the $100,000 which he did out of unreported cash receipts from his liquor store. Neither Joaquin nor any of his sons invested any cash or other monies for the Building, the ownership of which was placed in a newly-formed corporation called EB 110 Realty Corp. ("EB 110"). Rafael and Joaquin's son, Ramon, attended the closing and executed the note and mortgage as President and Secretary of EB 110, respectively. Both also executed personal guarantees.

Now that you know the case involves Manhattan real estate bought in the early 1990s, you've probably guessed correctly that the Rodriguez case centers on the disputed ownership of the EB 110 shares. As observed by the trial judge, Justice Lewis Bart Stone, in his 42-page decision (19 Misc 3d 1116[A], 2008 NY Slip Op 50732(U) [Sup Ct NY County 2008]):

The economic change which led to this dispute was the reduction of crime and the resulting enormous escalation of real estate values in the East Harlem area where the Building is located. The Building, acquired in late 1992 for no more than the transactional costs of the acquisition over a mortgage, i.e. with effectively no equity, now has an equity of over $8 million. Obtaining a share of this jackpot has now overwhelmed the strength of family ties.

Rafael brought his lawsuit asserting his ownership of 50% of EB 110's shares and seeking its dissolution under Business Corporation Law Section 1104-a. Rafael alleged that his nephews Dennis and Jose Estevez together owned the remaining 50% although he took no position as to the breakdown between the two. Rafael's suit also asserted derivative claims on EB 110's behalf against D&R and Dennis arising out of inter-company loans, shortfalls of rental payments and for reimbursements of tax and/or mortgage payments.

In response to the dissolution petition, Dennis elected to purchase Rafael's shares under BCL Section 1118. Dennis, however, asserted that Rafael owned only one-third of EB 110's shares and that he (Dennis) owned the remaining two-thirds.

Making matters even more complicated, Jose appeared in the action agreeing with Rafael's claim of 50% ownership and asserting, contrary to Dennis, that he (Jose) and Dennis each owned half of the other 50%.

EB 110's minute book and stock ledger were blank, although stock certificates Nos. 1 through 4 were removed. As Justice Stone noted, "[t]he ownership dispute here, therefore, cannot be resolved by the usual method of reviewing the corporate books and records, since virtually for all purposes, there are none." In a section of his decision entitled "The Social Context," Justice Stone commented on the lack of documentation as follows:

Relying instead on family bonds and trust, documentation of intra-family transactions was rare and Joaquin and Rafael assumed they could always re-shift and re-title their business assets at will for the "benefit" of the family. Lawyers and accountants were not "of" family and were used only when necessary so as to contain costs and not to reveal too much of the family's business to those outside of the family circle.

At trial one of the several lawyers who in the past represented both families produced stock certificates Nos. 1, 2 and 3 showing Rafael, Dennis and Jose each holding 10 shares. All were dated concurrent with the Building acquisition, however Nos. 1 and 2 were signed by Rafael and Ramon as President and Secretary, respectively, whereas No. 3 was signed by Dennis and Jose in the same respective positions. The first name of the holder of certificate No. 2 was whited out and the name "Dennis" was typed over the white out in a type-face different than the one used on No. 1 and on the remainder of No. 2. All typing on No. 3 was in the same type-face as the name "Dennis" on No. 2. Rafael disputed the authenticity of No. 3.

A second lawyer-witness testified that his office prepared only certificates Nos. 1 and 2 at the time of the Building acquisition, in the names of Rafael and Ramon; that his office equipment did not use the type-face used for "Dennis" on No. 2 and on No. 3; and that his office did not prepare No. 3.

Ramon testified that he received a 50% interest when the Building was acquired, and that he owned it for the benefit of the Estevez family subject to any further disposition by his father, Joaquin, who did not testify at trial. Ramon also testified that Joaquin had told him that Rafael would have a 50% interest in the Building. Ramon further testified that in 1995, he transferred his ownership position in EB 110 to his brothers Dennis and Jose equally. There was neither consideration nor documentation for the transfer.

Jose corroborated Ramon's testify concerning the 1995 transfer of Ramon's shares to Dennis and Jose equally. Jose also testified that the only time he remembered signing a certificate was on the occasion of the 1995 Building refinancing.

The Building was again refinanced in 1998 with the assistance of a lawyer who had no previous involvement with EB 110 and who "assumed" each of Rafael, Dennis and Jose held a one-third interest. The loan agreement included a reference to the three of them as guarantors each with a one-third interest.

Dennis asserted his two-thirds ownership based on the three stock certificates, the 1998 loan documents and his 2004 purchase of Jose's supposed one-third interest for $500,000 cash. Jose admitted that he agreed to sell his shares to Dennis (which Jose described as a 25% interest), but denied that Dennis ever gave him the cash and therefore claimed that he was still a 25% owner. Dennis produced documents signed by Jose acknowledging receipt of the cash and assigning his shares to Dennis. Jose testified that he did not read the documents before signing them and that he signed with the expectation that the cash would be subsequently paid. Dennis testified that he delivered the $500,000 cash to Jose in a briefcase, in a car.

EB 110's tax returns for the years 1992 through 2004 identified Rafael as 50% owner. The pre-1995 returns identified Ramon as the other 50% owner while the post-1995 returns corroborated Ramon's testimony that he transferred his interest to Dennis and Jose equally that same year. The company filed no returns after 2004. "Such failure to file," wrote Justice Stone, "coincided with this dispute, where signing a Federal Return might place Dennis between the rock of conceding Rafael's claim if the Return recited Rafael's 50% ownership and the hard place of perhaps knowingly signing a false Return, if the return did not."

Based on the evidence summarized above, Justice Stone concluded that as of the commencement of the dissolution proceeding in 2005, the shares of EB 110 were owned 50% by Rafael and 50% by Dennis. Justice Stone found that only certificates Nos. 1 and 2 for 10 shares each in the names of Rafael and Ramon were issued at the Building acquisition in 1992, and that No. 2 was modified and No. 3 was prepared and signed some time in 1995, most likely at the 1995 refinancing closing. The personal guarantees given by Rafael and Ramon for the 1993 refinancing also supported their 50%-each ownership at that time. The 1995 refinancing documents were consistent with Ramon's testimony that he transferred his 50% interest at that time equally to Dennis and Jose.

Justice Stone discounted the reference in the 1998 loan documents to Rafael, Dennis and Jose as one-third shareholders, finding that it was an "error" introduced by their lawyer "based on his uncritical reading of the Certificates, which was not caught by Claimants, who relied on documentation prepared by trusted counsel, and were instead focused on consummating the refinancing." Justice Stone also found that Rafael never knew of certificate No. 3 in Jose's name until 2004.

Finally, Justice Stone disbelieved Jose and credited Dennis' testimony that he paid the $500,000 cash for Jose's 25% interest. In this instance, the receipt and transfer documents signed by Jose were prepared by Dennis' lawyer with whom Jose had no relationship and on whom he had no basis to rely. In addition, the signed payment receipt was a simple document clear in both its substance and terms. Justice Stone also found that Jose's testimony, that he trusted Dennis by signing a cash receipt without having received payment, was inconsistent with the "bad blood" that existed between Dennis and Jose at the time.

It's hard to draw any lessons from a case like Rodriguez which exists precisely because the business owners shunned professional planning and corporate formalities in favor of home-grown family governance. The best we lawyers can do is try to sort out the mess when the family bonds break.

Undocumented Stock Interests Invite Challenges to Standing in Corporate Dissolution Cases: Part Two

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 16 Mar 2009 07:00:00 -0500

[This is the second in a three-part series on challenges to standing to petition for judicial dissolution where the petitioner lacks a stock certificate or other definitive evidence of shareholder status. Last week's post set the stage and looked at a recently decided case where the court ordered an evidentiary hearing to resolve the parties' contradictory factual contentions. This week's post discusses another recent dissolution case involving two contested corporations, in which the court conducted an 8-day evidentiary hearing to determine whether the petitioner owns any shares.]

"In the real world, particularly that in which close corporations operate, clear evidence of share ownership is often not found in the corporate books and records, for any number of reasons."

So writes Kings County Supreme Court Justice Jack M. Battaglia as he paints a vivid picture of contradictory, ambiguous and incomplete evidence in a five-year court contest over the stock ownership of two Brooklyn-based businesses in Matter of Pappas (Corfian Enterprises, Ltd.), 2009 NY Slip Op 50109(U) (Sup Ct Kings County Jan. 23, 2009).

The case began in 2004 when Theano Pappas, as executrix of the estate of her late husband, Eleftherios Pappas, petitioned under Business Corporation Law 1104-a for judicial dissolution of two corporations, Corfian Enterprises, Ltd. and Epiros Realty, Ltd. The petition named as respondents Paul Fotinos and Theodoros Kalogiannis, alleged to be the corporations' controlling shareholders. BCL 1104-a conditions the right to seek dissolution on holding a minimum 20% stock interest. Mrs. Pappas alleged that the estate, Fotinos and Kalogiannis each hold one-third of the two corporations' shares. Kalogiannis filed an answer agreeing with Mrs. Pappas as to share ownership and also seeking dissolution. Fotinos, however, claimed to be 100% shareholder of both corporations and denied that the late Mr. Pappas or Kalogiannis ever held shares in either corporation.

Three years into the legal proceedings, Fotinos moved for summary judgment on the issue of his alleged 100% stock ownership. The trial court's September 2007 decision denying the motion was affirmed on appeal in June 2008. This set the stage for what became an eight-day framed-issue hearing on the question of standing at which the court heard 14 witnesses and admitted 48 documents into evidence.

Simplifying the issues somewhat, the parties stipulated at trial that if the court found in favor of either Mrs. Pappas or Kalogiannis' stock interest, the other's shareholder interest would also be established, in which case both would be deemed one-third shareholders from inception. The parties also stipulated, however, that the ownership of each of the two corporations had to be decided separately.

The Evidence

Justice Battaglia's lengthy decision contains a detailed recitation of the evidence at trial, the full scope and nuances of which I cannot possibly replicate here. What follows is an oversimplified summary.

In 1982 Mr. Pappas, Kalogiannis and Fotinos bought a commercial building ("577 Baltic") as tenants in common, one-third each, where they operated a succession of businesses including Corfian providing marine and building maintenance and repair, and structural steel work. There was no documentary evidence such as a shareholders' agreement establishing the business relationship of the three. Fotinos testified that Mr. Pappas and Kalogiannis were salaried employees. Mrs. Pappas and Kalogiannis testified without documentary support that Mr. Pappas and Kalogiannis made capital contributions in the form of cash payments for machinery purchases and deductions from profit shares. A 1994 long-term lease between the three building owners and Corfian had no fixed rent, but instead required Corfian to pay as rent the landlord's expenses "to retain ownership . . . and to maintain and repair the building, including mortgage payments and taxes." The personal and corporate tax returns for many years were unavailable and incomplete, although Corfian's available returns (beginning in 1997) reflected Fotinos as sole shareholder. Fotinos acknowledged that he possessed Corfian's "corporate books and records" but failed to offer them in evidence because, he asserted, they "would not show ownership."

The other corporation at issue, Epiros Realty, owned a rental property ("583 Baltic") purchased in 1985. Fotinos claimed he contributed 100% of the cash required for the acquisition, whereas Mrs. Pappas and Kalogiannis testified that Mr. Pappas and Kalogiannis each put up a third. Neither side offered documentary support. The closing statement for the purchase of 583 Baltic was not introduced in evidence by any of the parties although, as Justice Battaglia noted, "it would have been expected more from Mr. Fotinos." Mr. Pappas and Kalogiannis worked on renovations to 583 Baltic. Kalogiannis testified that they received no compensation for doing do "because it was ours" whereas Fotinos testified (without supporting documents) that they were paid a salary. There were several refinancings of 583 Baltic, for each of which Fotinos was the sole personal guarantor.

Fotinos relied most heavily on documents relating to the estate of Mr. Pappas, including an asset questionnaire prepared by his attorney four months before Mr. Pappas' death, and a petition for probate and tax certification signed by Mrs. Pappas as executrix. The questionnaire's sections for stocks and interests in corporations were left blank. The attorney testified that Mr. Pappas mentioned no businesses in which he had an interest, but he also quoted Mr. Pappas as insisting that he was Mr. Fotinos' "business partner" and not his "employee." The probate petition (prepared by the same attorney) shows "-0-" for the value of Mr. Pappas' personal property and stocks and bonds. Neither the questionnaire nor the probate documents mention 583 Baltic. (Please visit the New York Trusts & Estate Litigation blog, where my partner, Eric Penzer, discusses Pappas in regard to the evidentiary issues surrounding admissions by estate fiduciaries and the possible interplay of the Dead Man's Statute.)

The Legal Framework

Justice Battaglia's analysis sets forth a number of guiding legal principals which can be summarized as follows:

Petitioners have the burden of establishing by a preponderance of the credible evidence that they hold the requisite shareholder interest to constitute standing to seek judicial dissolution.
The absence of stock certificates does not preclude a finding that a person has the rights of a stockholder.
The relationship between a corporation and its stockholders is contractual. It is the payment, or obligation to pay for shares of stock, accepted by the corporation, that creates the shares and their ownership.
Consideration for the issue of shares may take many forms besides cash, including payment in services and out of future profits.
In the first instance a court should look for evidence that consideration has been paid for a stock interest and that proceeds of the enterprise have been distributed to the putative shareholder.
A court may consider the conduct among the parties reflecting and in furtherance of status as shareholders including the managerial responsibilities borne by the putative shareholder and how non-parties understand the relationship based upon their observation of the conduct among the parties.
Among the types of documents considered probative of shareholder status are corporate and personal tax returns, bank loan documents and financial statements. Such documents, however, even when filed with government agencies, are not in and of themselves determinative.
Estate tax returns and certifications can constitute admissions of the deceased shareholder.
A party's failure to offer documentary support for his oral testimony may permit an adverse inference where it can be shown that the document exists, that it is under the party's control, and that there is no reasonable explanation for failing to produce it.

The Decision

Corfian. Justice Battaglia concluded that, despite the absence of clear and substantial documentary evidence, "it is more likely than not that Messrs. Pappas, Kalogiannis, and Fotinos were equal shareholders of the corporations formed to conduct business from 577 Baltic." The court found "particularly significant" that the three men had been shareholders in corporations conducting similar business before working at 577 Baltic which property they owned jointly and equally; that Mr. Pappas and Fotinos told non-party witnesses about joining the others in partnership; that Mr. Pappas' cash position relative to the others was consistent with the claim that he made capital contributions out of profits; that the three were similarly paid out of a non-payroll account; that all three "exercised significant executive and operational responsibility for the business at 577 Baltic"; that Mr. Pappas and Kalogiannis received no revenue from their ownership of the 577 Baltic property; that the pass-through rental terms of the lease suggested "an identity of ownership of landlord and tenant"; and that Mr. Pappas and Kalogiannis "considered the property at 577 Baltic and the business conducted there essentially as one and the same" so that the court "gives no great import" to the failure to ascribe separate value to the "stock" or business interests in Corfian in the asset questionnaire and estate documents.

Epiros. Justice Battaglia reached the opposite conclusion concerning Epiros and 583 Baltic. He noted the failure of Mrs. Pappas and Kalogiannis to produce any documentary evidence of contributions to the purchase price or other funding of 583 Baltic. He also ascribed greater significance to the omissions of any reference to Epiros and 583 Baltic in the Pappas asset questionnaire and estate documents. Justice Battaglia's careful analysis of the disparate import of these documents to the claims of stock ownership in the two corporations is worth the read:

The reasons that have been articulated for minimizing the significance of these "admissions" in the context of Corfian and 577 Baltic are not present as to Epiros and 583 Baltic. Mr. and Ms. Pappas could not have thought of the separate and substantial property at 583 to be one and the same as the property and business at 577.

Petitioners' claims as to Epiros Realty, Inc. do not benefit from the context out of which Corfian Enterprises, Ltd. grew. When in late 1982 Messrs. Pappas, Kalogiannis, and Fotinos came together to work at 577 Baltic, a property they equally owned, it was for the purpose of continuing the type of business in which they had previously been successful. There is no evidence of an agreement at that time to engage jointly in real estate investment. Indeed, the Court's conclusion as to Petitioners' shareholder status in Corfian is based in great measure on the purchase of 577 Baltic as primarily a place to conduct business, rather than an investment.

If more is needed to justify different conclusions as to Corfian Enterprises, Ltd. and Epiros Realty, Ltd., the Court notes that 583 Baltic is apparently the sole "tangible" asset of Epiros, and that for centuries the law has demanded with the Statute of Frauds (see General Obligations Law § 5-703) that there be particular proof before an interest in real property will be recognized. That stricter scrutiny has been applied to alleged oral agreements to transfer stock in a corporation whose sole asset was an interest in realty. (See Yenom Corp. v 155 Wooster Street Inc., 33 AD3d 67, 70-71 [1st Dept 2006]; Bergman v Krausz, 19 AD3d 186, 186-87 [1st Dept 2005].) Although the Statute of Frauds is not at issue here, the underlying policies demand caution in considering a claim that, at the end of the day, seeks recognition of an interest in real property.

My Two Cents. You really do have to read Justice Battaglia's entire decision to appreciate fully the complexity and ambiguity of the parties' business relationships. Also, Justice Battaglia's split decision necessarily casts doubt to some extent on the testimony given by both sides or, as Justice Battaglia put it, "challenge[s] the credibility of all the parties, because Ms. Pappas and Mr. Kalogiannis testified that Messrs. Pappas and Kalogiannis were shareholders of both corporations, and Mr. Fotinos testified that they were shareholders of neither."

At bottom, this case is all about the burden of proof. No one piece of the circumstantial evidence presented by Mrs. Pappas and Kalogiannis was dispositive but, at least as to Corfian, the totality permitted a finding of stock ownership that Fotinos could not overcome in large part because of his own documentary lapses including his failure to produce corporate records in his possession.

Undocumented Stock Interests Invite Challenges to Standing in Corporate Dissolution Cases: Part One

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 09 Mar 2009 07:00:00 -0500

In the world of closely held corporations, what makes a shareholder a shareholder?

Section 508 of New York's Business Corporation Law states that "the shares of a corporation shall be represented by certificates or shall be uncertificated shares." Scattered throughout the BCL are references to "shareholders of record". BCL Section 624 requires every corporation to keep "a record containing the names and addresses of all shareholders" and makes such record "prima facie evidence of the facts stated therein" in any action or special proceeding against the company, its directors, officers or shareholders.

However, ask lawyers about their experiences with small, closely held corporations and you will hear countless stories about companies that never issued stock certificates, never kept a stock ledger, never adopted bylaws, never had a written shareholders' agreement, and never held formal shareholder meetings much less kept meeting minutes.

Such widespread record keeping lapses create fertile ground for disputes over shareholder status in many different legal settings, including corporate dissolution contests. Sometimes the dispute is over the stock percentage held by an otherwise acknowledged shareholder. This kind of dispute is geared toward either supporting or defeating the specific stock-holding percentage requirements for bringing a deadlock dissolution proceeding under BCL 1104 (50%) or an oppressed minority shareholder dissolution proceeding under BCL 1104-a (20%).

Then there are the cases in which the respondent contends that the petitioner never held a stock interest. More often than not, these cases are brought under the oppression statute by putative minority shareholders who lack control of, or access to, the corporation's books and records.

This is the first of three consecutive posts on the standing challenges to be overcome by a petitioner who holds no stock certificate or other direct evidence of a stock interest. Each of the three cases highlighted in these posts presents a distinct factual scenario. All three cases remind us of the substantial additional litigation costs and time involved when an initial evidentiary hearing must be held to determine the petitioner's standing before proceeding to a hearing on the merits of the dissolution petition.

The first case is Matter of Schwartzman (First Rate Capital Corp.), 2009 NY Slip Op 30457(U) (Sup Ct Suffolk County Feb. 24, 2009) decided by Suffolk County Commercial Division Justice Emily Pines. Harlin Schwartzman brought a petition to dissolve a mortgage banking business called First Rate Capital Corp. under BCL 1104-a in which he alleged that he is one of three 33 1/3% shareholders; that the other two shareholders withheld his share of profits and diverted business to their separate mortgage company; and that when he demanded to be bought out they denied that he was a shareholder. Schwartzman's evidence of his shareholder status included a 2002 shareholders' agreement identifying him as one of four shareholders (the fourth shareholder later dropped out) and income tax K-1 statements issued to him for the years 2003-2006 listing his ownership interest at either 25% or 33.33%.

The respondents moved to dismiss the petition for lack of standing, claiming that Schwartzman did not own the requisite 20% stock interest. First, they argued that prior to bringing his petition, in May 2007, Schwartzman gave a written "resignation" of his stock ownership. Alternatively, they argued that he never acquired a stock interest because he defaulted in payment on his 2002 promissory note and stock purchase agreement. They admitted Schwartzman's receipt of the K-1s but argued that they were "erroneous" and that "K-1 statements are not proof of ownership."

Schwartzman replied that the resignation letter was a forgery, that his note payments were deducted from his share of the profits, and that, while he did tender his resignation as an officer and director, he never resigned as a shareholder.

The respondents submitted the report of a forensic document examiner who opined that the resignation letter contains Schwartzman's authentic signature.

Justice Pines' ruling cites a number of Second Department decisions for the proposition that a preliminary hearing must be held on the issue of stock ownership where the parties' affidavits create questions of fact. And that is exactly what she ordered in the case before her, stating:

In the case at bar, the conflicting assertions by the parties create questions of fact regarding petitioner's ownership interest, if any, in First Rate, which must be resolved before the Court can consider the merits of the petition. The Court notes that petitioner was receiving K-1 income tax statements reflecting a varied degree of stock ownership, which respondents merely dismiss as being either erroneous or not probative of the issue of ownership. Moreover, while the Court finds persuasive the May 21, 2007 purported resignation letter as evidence of petitioner's surrender of his shareholder interest, petitioner denies the authenticity of this document. Equally disconcerting is the disparate claims as to whether petitioner made payments on the promissory notes via deductions from his share of the profits. Although petitioner submits an affidavit from [First Rate's former controller] claiming that such payments were made, respondents similarly dismiss these allegations as the machinations of a disgruntled former employee who is currently engaged in a business venture with petitioner.

I see two noteworthy aspects of Schwartzman, beyond illustrating the need for a hearing to resolve the parties' disputed factual assertions. First, the presence or absence of K-1s supporting or refuting the petitioner's claimed stock ownership usually takes top priority in cases like this. The Marciano case I wrote about last year in my Anatomy of a Dissolution Slugfest series is another good example of this. Schwartzman presents the more unusual case in which the respondents argue against tax records that, as controlling shareholders, presumably they approved before filing.

Second, a shareholder's surrender (redemption) of his or her stock interest usually occurs under a written shareholders' agreement on specified terms or, absent such written agreement, pursuant to a voluntary tender and acceptance. All we know from the court's decision in Schwartzman is the one sentence quoted from the petitioner's alleged letter stating, "Please accept this letter as my resignation as 1/3 shareholder of First Rate Capital Mortgage Bankers effective immediately." We do not know if the parties' 2002 shareholders' agreement addresses voluntary redemption and, if so, whether the letter complies with it. Assuming the shareholders' agreement doesn't govern, we also don't know if there was an acceptance of the stock redemption by the company's Board of Directors. Of course, these issues will remain unanswered if, at the upcoming hearing, the court rejects the letter's authenticity.

Application for Judicial Dissolution of LLC Must Be Made by Complaint or Petition, Mere Motion Will Not Suffice

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 02 Mar 2009 07:00:00 -0500

For years I've been carping about the substantive and procedural inadequacies of New York's LLC judicial dissolution statute. LLC Law Section 702, which was modeled after the rarely utilized limited partnership dissolution statute, consists in its entirety of the following two sentences:

On application by or for a member, the supreme court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement. A certified copy of the order of dissolution shall be filed by the applicant with the department of state within thirty days of its issuance.

At the time of the LLC Law's adoption in 1994, the legislature's minimalist approach made some sense because of tax considerations requiring avoidance of certain corporate characteristics including continuity of life. The IRS's subsequent implementation of check-the-box regulations freely permitting partnership tax treatment of LLCs, and the 1999 LLC Law amendments restricting member withdrawal from LLCs, largely eliminated the legislative rationale for Section 702 as enacted, leaving the statute, in my view, not up to the complex task of adjudicating LLC breakups (hence the title of my June 2002 article published in the New York State Bar Journal, Vol. 74, No. 5, "When Limited Liability Companies Seek Judicial Dissolution, Will the Statute Be Up to the Task?").

These observations are prompted by a recent decision by New York County Commercial Division Justice Bernard J. Fried in a case I've previously written about called Ficus Investments, Inc. v. Private Capital Management, LLC. Ficus is a highly contentious dispute between LLC members involving accusations that the managing members misappropriated over $20 million. Last January, an appellate ruling enforced the lead defendant's right to advancement of his legal defense costs as provided by the operating agreement (see my earlier post here).

In a follow-up ruling dated February 23, 2009, Justice Fried granted a motion by the LLC's 20% member, Private Capital Management, LLC ("PCM"), also enforcing its advancement rights. According to Justice Fried's April 2008 decision, PCM is owned 50-50 by defendant Thomas Donovan and Lawrence Cline. In an apparent effort to lessen or avoid PCM's advancement rights, the plaintiff (or more likely Cline, who earlier settled with the plaintiff under a cooperation agreement) made a cross motion to dissolve PCM. This required Justice Fried to determine whether, absent a pleading containing a claim for dissolution, the court can decree dissolution on application by motion. As far as I know, this is the first decision to address the issue.

Justice Fried notes that the operative language in Section 702 (court may decree dissolution "on application by or for a member . . .") does not expressly deny the right to seek dissolution by way of motion. He also contrasts Section 702 with the detailed procedural provisions in Article 11 of the Business Corporation Law requiring the commencement of a special proceeding for judicial dissolution of closely held business corporations by way of verified petition and order to show cause. Notwithstanding the legislative omission in the LLC Law, Justice Fried concludes that

the better practice is to apply for judicial dissolution by way of a plenary action. This would provide [the dissolution proponent] the opportunity to plead a cause of action for judicial dissolution, and it would enable [the dissolution opponent] to answer this claim, rather than merely oppose the [motion]. . . . Moreover, the vast majority of the cases applying Section 702 involve an application for dissolution that is made by way of cause of action contained in the complaint, counterclaim, or plenary petition [citations omitted]. . . . Here, Plaintiffs have not sought summary judgment on a claim or counterclaim for judicial dissolution, but rather, have merely cross-moved for the relief sought. Defendant PCM has neither interposed a counterclaim for dissolution nor indicated in any way that it would favor such relief. As stated above, I believe the preferable way to proceed with this application for judicial dissolution is by way of petition, and, exercising my discretion, I therefore deny Plaintiffs' cross-motion without prejudice.

There's no question that Justice Fried's conclusion reflects the practical reality. I have brought, defended and otherwise seen any number of LLC dissolution cases commenced by summons and complaint in a plenary action, as well as by order to show cause and verified petition in a special proceeding whose accelerated procedures are governed by CPLR Article 4.

Curiously, the courts routinely accept petitions for LLC dissolution by way of special proceeding notwithstanding the absence of statutory authority for doing so, as seemingly required by CPLR 103(b) ("All civil judicial proceedings shall be prosecuted in the form of an action, except where prosecution in the form of a special proceeding is authorized.").

Court Rejects Experts' Appraisals in Fair Value Proceeding, Relies on Own Computation Using Income Approach

pmahler@FarrellFritz.com (Peter A. Mahler) — Mon, 23 Feb 2009 07:00:00 -0500

No matter how many times I see it happen, I'm always intrigued when a new stock valuation decision comes along in an oppressed shareholder buyout proceeding in which the opposing experts come up with valuations light years apart. How is it that two impeccably credentialed business appraisers, operating under the same independence principle, looking at the same data, and following the same valuation guidelines, can produce such divergent numbers? Is the court required to accept one or the other, or should it appoint its own neutral appraiser, or compute value itself?

Last December I wrote about one ill-fated valuation decision in which the lower court adopted wholesale one of the two widely divergent expert appraisals, only to be reversed on appeal and remanded for a new valuation hearing. Today I write about another valuation decision in which the trial court rejected both experts' appraisals and came up with its own computation of fair value. Matter of Beattie (PlanData Systems Corp.), 2009 NY Slip Op 30181(U) (Sup Ct Suffolk County Jan. 15, 2009).

PlanData Systems Corp., located in Huntington, New York, offers space management services to owners and facility managers of commercial buildings. The business uses a proprietary computer program called SpaceMan to design and manage the clients' commercial properties. In 2006, 40% shareholder Ronald Beattie sought judicial dissolution of PlanData under the oppressed minority shareholder statute, Section 1104-a of the Business Corporation Law. The 60% shareholder, Steven Smith, elected to purchase Beattie's shares for fair value under the buyout statute, BCL Section 1118. After the two shareholders failed to reach agreement on price, the fair value question went to a hearing before Suffolk County Commercial Division Justice Elizabeth Hazlitt Emerson.

Each side presented a valuation report and testimony by a well-credentialed expert business appraiser. The primary difference in approach stemmed from characterizing PlanData either as a software company or a services company. Beattie's expert testified that he was "instructed" to assume that PlanData is best described as a software company. His valuation relied on a separate calculation of the replacement cost of the SpaceMan software prepared by a computer consultant who also testified as an expert on Beattie's behalf. This expert based his calculation in the sum of $718,000 on "good-faith estimates" of the amount of time and labor expense it would take to recreate a program like SpaceMan, derived from "industry norms and his overall business experience" rather than specific data from PlanData's books and records.

Beattie's expert appraiser incorporated the $718,000 software replacement cost in his valuation of the company using the three common valuation methods: Asset (Cost) Approach, Market Approach and Income Approach. He testified that none of these methods alone provided an accurate assessment of fair value and that a weighted approach using data produced by all three methods was more appropriate. The court's decision does not disclose his weighting percentages or the underlying figures; it simply notes the expert's testimony that he selected the percentages based on his "business judgment and experience." Using his weighted approach the expert arrived at a value of $618,000 for Beattie's 40% interest. Beattie's expert also contended that no discount for lack of marketability should be applied.

Smith's expert also considered the Asset, Market and Income Approaches. He rejected the Market Approach due to lack of data on companies sufficiently similar to PlanData. He also rejected the Asset Approach because it is generally used for the companies "the real value of which is in assets such as real estate." In relying on the Income Approach alone he reasoned -- contrary to Beattie's expert -- that PlanData is a company that provides services for its clients using various software programs, but it is not a software company. He noted that over 83% of company revenue is derived from measuring and drafting services. Using the company's historical financial data and a 19.11% capitalization rate under the Income Approach, Smith's expert computed a value of $102,159 for PlanData, to which he applied a 25% discount for lack of marketability, resulting in a value of $30,648 for Beattie's 40% interest. He then added 40% of the company's "excess cash" to arrive at a total value of $128,829 for Beattie's shares. The difference between the two competing appraisals? Approximately 500%.

Justice Emerson did not adopt either side's valuation. She concluded that the record did not support Beattie's expert's use of a weighted average of the three methods and the percentage assigned to each. She faulted his use of the Market Approach for lack of sufficiently similar transactions. More importantly, she disagreed with Beattie's expert's "use of [software] replacement cost as a proper method of valuing PlanData" and noted that the analysis "also contains a number of important assumptions that do not relate to specific data derived from PlanData's books and records."

Smith's expert's analysis fared better insofar as Justice Emerson agreed that the Income Approach is the proper valuation method. She also agreed with his capitalization rate and some of his income adjustments. However, she declined to adopt his calculations in certain key respects and instead came up with her own "alternative calculation." The main differences in the court's calculation were: an increase in the company's average net income; an increase in the add-back of officer "perks"; and a significant decrease in the officer reasonable compensation figures. The court's calculation almost doubled Smith's expert's valuation of Beattie's 40% interest, to $245,626.39. (The last page of the court's decision is a helpful line-item chart of the court's adjustments to Smith's expert's Income Approach calculations.)

Finally, Justice Emerson also agreed with Smith's expert's application of a 25% marketability discount which, in my view, has become something of a default percentage in the Second Department. The discount is not applied against the allocation of excess cash.