Accounting Unchained: Is the Closely Held Business Owner’s Right to an Accounting Absolute?
October 29, 2018
Let’s face it. In business divorce, the accounting cause of action doesn’t get a lot of love. It’s not as sexy as the torts (conversion, breach of fiduciary duty, waste, etc). It lacks the oomph of judicial dissolution.
Nonetheless, accounting claims are ubiquitous in business divorce litigation, pleaded practically as a matter of course. Sometimes the claim is tacked on as if by rote, perhaps simply to beef up a petition, complaint, or counter complaint. But other times, like the books and records proceeding, the accounting cause of action can be a vital tool in the closely-held business owner’s litigation toolbox.
The accounting cause of action has its roots in a basic, ancient principle of partnership law: partners owe one another fiduciary duties, including the duty to account. The common-law duty of partners to account to one another and to the partnership is codified in Sections 42, 43, and 44 of the New York Partnership Law. Although there are not any quite comparable statutes in the Business Corporation Law (Section 720 provides a narrower right to sue a director or officer for an accounting) or the Limited Liability Company Law, it is well-settled that the obligation of business owners to account to one another is fully applicable to closely-held corporations and LLCs.
Doctrinal Limits on the Accounting Remedy
Over the years, though, some judge-made limitations on the accounting claim have developed.
First, some courts hold that a plaintiff cannot state a viable claim for an accounting in the absence of a viable accompanying “substantive” cause of action – like a tort, breach of contact, judicial dissolution, etc. For example, just a couple of months ago, in Feldmeier v Feldmeier Equip., Inc., 164 AD3d 1093 [4th Dept 2018], written about on this blog here, a Rochester-based appeals court held, “Inasmuch as plaintiff’s substantive causes of action for breach of fiduciary duty and dissolution were properly dismissed,” the court also correctly dismissed the accompanying claims for “constructive trust and accounting.”
Second, logically at odds with the principle that a plaintiff must have a viable substantive claim to be able to sue for an accounting, courts often hold that to be entitled to be entitled to an accounting, “a claimant must demonstrate that he or she has no adequate remedy at law” (Unitel Telcard Distrib. Corp. v Nunez, 90 AD3d 568 [1st Dept 2011]).
The notion is that if a plaintiff can obtain the relief it seeks via an accounting through some other form of action, like a claim for breach of fiduciary duty, then the plaintiff is not entitled to an accounting. Courts often, though not always, deny dismissal of accounting claims on this ground, at least at the pleading stage, based upon the rule that plaintiffs are entitled to sue for legal and equitable claims “in the alternative.”
Third, based upon the Court of Appeals’ decision in Gramercy Equities Corp. v Dumont, 72 NY2d 560 , some courts have expressed a disinclination to engage in “piecemeal adjudications” of disputes among “squabbling” business partners and require them, as stated by the Court of Appeals, to either “settle their own differences amicably or dissolve and finally conclude their affairs by a full accounting.” We wrote about this phenomenon in earlier posts, including this one.
The notion of Gramercy Equities, which certainly applies, but was not limited to, accounting, is this: disputes among owners of closely held businesses should not be resolved as an interim matter. If a court is to decide a controversy, then it should be final, and should resolve the affairs of the business owners. In short, all controversies presumably should be resolved at the conclusion of the business relationship as part of a single, final accounting.
The Webster Case
The preceding discussion was a roundabout way of arriving at the inspiration for, and focal point of, this week’s post: a recent appellate decision which, if taken literally and out of context, suggests the impotency of all three of the doctrinal limitations described above.
Webster v Forest Hills Care Ctr., LLC (2018 NY Slip Op 06289 [2d Dept Sept. 26, 2018]), was an appeal of a decision by Nassau County Commercial Division Justice Stephen A. Bucaria, which you can read here, in which Justice Bucaria in effect granted re-reargument of an earlier decision dismissing a claim for an accounting among other claims brought by a minority owner of two LLCs operating nursing homes. Justice Bucaria’s two earlier Webster decisions are here and here. One of the earlier Webster decisions was the subject of a post three years ago.
In the first Webster decision, Justice Bucaria, relying upon Gramercy Equities‘s principle of avoidance of “piece-meal adjudications,” ruled that because plaintiff did not assert a claim for judicial dissolution it was appropriate to dismiss her claim for accounting “without prejudice to plaintiff’s commencing a proceeding for judicial dissolution.” In the second Webster decision, the court, ruling that a “non-managing member of a limited liability company may pursue . . . a breach of fiduciary duty claim without seeking dissolution,” reinstated the accounting claim. In the third Webster decision, the court, relying again upon Gramercy Equities, re-dismissed the accounting claim:
As the court noted in its original order, it is reluctant to engage in piece-meal adjudication of plaintiff’s request for distributions, absent a request for dissolution and a final accounting . . . . Plaintiff has clearly elected not to seek dissolution . . . . Having elected to forego dissolution, plaintiff is barred from seeking an accounting. Accordingly, defendants’ motion to dismiss is granted to the extent of dismissing the first and second causes of action for an accounting for failure to state a cause of action.
The Appellate Decision
Fast forward two-plus years to the Appellate Division’s decision in Webster, where the Court held, with no further explanation or analysis:
[T[he Supreme Court should have denied that branch of the defendants’ motion . . . to dismiss the causes of action for an accounting. Generally, to be entitled to an equitable accounting, a plaintiff must demonstrate that he or she has no adequate remedy at law . . . . However, where, as here, there is a fiduciary relationship between the parties, there is an absolute right to an accounting notwithstanding the existence of an adequate remedy at law . . . .
The Court’s holding, that a closely-held business owner has an “absolute right” to an accounting based on the presence of a fiduciary relationship, is hardly self-evident. The only prior appellate decision to characterize the right to an accounting in similar terms is a First Department decision over three decades earlier in Koppel v Wien, Lane & Malkin, 125 AD2d 230 [1st Dept 1986], cited in the Webster decision.
Oddly, a month before the Appellate Division’s decision in Webster, the parties discontinued the lawsuit.
A Better Reading of Webster
In business divorce litigation, absolutes are few and far between. Does an “absolute right” to an accounting, as stated in Webster, literally mean available in all cases? Likely not. Justice Bucaria’s underlying decision in Webster makes clear that the plaintiff alleged defendants’ breach of fiduciary duty. The appellate rulings in Webster and Koppel, when read in context, both seem to use the term “absolute” to underscore the availability of the accounting remedy even when there may be other, adequate legal remedies, and not to undermine the other essential elements of an accounting claim including allegations that the defendant breached fiduciary duty.
Indeed, it is hard to envision a scenario in which a partner, shareholder, or member could successfully allege a standalone cause of action for accounting unaccompanied by at least some allegation of wrongdoing. Perhaps the appeals could have expressed its holding a bit more subtly, given all the recent case law about whether accounting claims must be accompanied by viable “substantive” claims, whether the claim might involve “piecemeal” litigation, etc.
Finally, an interesting coincidence: thirty years ago, a young lawyer, Alan D. Scheinkman, Esq. represented the appellant in Gramercy Equity. The very same Alan D. Scheinkman is now Presiding Justice (though not on the panel) of the Appellate Division, Second Department, which, in Webster, implicitly rejected the notion that courts may refrain from adjudicating accounting claims based on Gramercy Equities‘s disfavor of piecemeal litigation.