Business Divorce, Brooklyn Style
July 05, 2022
The pictured architectural rendering of the sunlit Kings County Supreme Courthouse at 360 Adams Street, completed in 1957, doesn’t quite capture the reality of its dour, hulking presence in downtown Brooklyn. Its design features — the long rows of identical, small, horizontally paned windows set in a monolithic, from-here-to-forever concrete façade — always struck me as more suggestive of a prison than a courthouse.
But behind its stolid exterior, the business of dispute resolution is conducted with no less rigor and integrity than any more architecturally uplifting courthouse in the state. For Manhattan-based business litigators like myself, the expansion of New York’s Commercial Division initiative to Kings County in 2002, and the appointment to that bench of judges with business law backgrounds, made the prospect of a trip across the East River to litigate an important commercial case one that could be taken with confidence of getting a fair shake from an interested, experienced, thoughtful, judge supported by highly competent staff.
There’s been some changes on the Brooklyn Commercial Division bench in recent years, following the retirement of the long-serving, former Justice Demarest and former Justice Ash’s forced departure. With Justice Knipel splitting his time as Brooklyn’s Administrative Judge for Civil Matters as well as taking on a commercial foreclosure caseload, it appears that the lion’s share of new Commercial Division assignments are landing with Justices Leon Ruchelsman and Reginald Boddie. Of those two, at least based on the volume of published decisions I’ve seen since his appointment, Justice Ruchelsman appears to have taken on the heftier share of business divorce cases.
Whether or not I’m right about that, I thought it worthwhile to highlight some of Justice Ruchelsman’s recent decisions in business divorce matters for the benefit of practitioners and business owners who face the prospect of litigating such disputes in Brooklyn Supreme Court’s Commercial Division. So without further ado, I give you summaries of four of his recent decisions, with the recommendation that you read the decisions to capture the full flavor of Justice Ruchelsman’s approach to problem solving.
Feuding Optometrists Dispute Threshold Ownership Issues
In Androschuk v Khersonsky, 2022 NY Slip Op 30833(U) [Sup Ct Kings County Feb. 24, 2022], the plaintiff alleged that she and the defendant co-own two firms providing optometry services in multiple locations — one a corporation and the other an LLC — and that the defendant essentially froze out her ownership interests in both companies. Her complaint asserted direct and derivative causes of action for breach of fiduciary duty, waste and misappropriation of company assets, and for other relief. The defendant moved to dismiss the complaint primarily on the ground the plaintiff has no ownership interest in either company and therefore lacks standing to sue.
Justice Ruchelsman denied the motion as to the corporation, citing its 2016 tax return listing plaintiff as the 90% shareholder and finding that the discrepant omission of plaintiff’s name in the shareholders agreement “merely raises questions that must be explored.” The judge also noted that the other shareholder listed in the shareholders agreement was not listed as a owner on the corporation’s tax return.
As to the LLC, however, the plaintiff struck out. In resisting dismissal, the plaintiff relied on the LLC’s articles of organization, a statement signed by her as the organizer, and an EIN form issued by the IRS, none of which, Justice Ruchelsman noted, “demonstrate the plaintiff is an owner at all or raises any questions sufficient to permit the claims to proceed.” On the other hand, the LLC’s operating agreement did not identify the plaintiff as a member, prompting Justice Ruchelsman to conclude,
the operating agreement establishes, as a matter of law, the plaintiff has no standing to bring any derivative claims. Therefore, the motion seeking to dismiss all the derivative claims as to [the LLC] only is granted.
The Case of the Vague Virgule
Lengyel-Fushimi v Rothfus, 2022 NY Slip Op 30809(U) [Sup Ct Kings County Mar. 10, 2022], a case this blog previously featured here, involves a multi-faceted dispute among the non-managing Class B and Class C members and the Class A managing members of a successful Brooklyn beer brewery and taproom. In this phase of the case, the defendants sought dismissal of the intervenors’ complaint which alleged direct and derivative claims concerning the defendants’ dilutive issuance to themselves of Class C treasury shares without consideration and awarding themselves distributions without member approval. Justice Ruchelsman dismissed the derivative claims sounding in breach of fiduciary duty as duplicative of the intervenors’ claims for breach of the operating agreement.
The more interesting part of the decision concerns the plaintiffs’ direct, contract claim alleging that the issuance of the treasury shares without payment violated the operating agreement’s provision stating that the Class C treasury units “will only be issued as Class C Units, unless purchased/assigned to Class A Member(s).” The plaintiffs argued that “purchase/assigned” requires the purchase of the units before assignment, i.e., the backslash or “virgule” must be read as conjunctive, whereas the defendants argued that “purchase/assigned” must be read as disjunctive, allowing them to assign the units to themselves without payment. Finding that the “use of the virgule or the backslash and its precise meaning is the crux of this issue,” and that “a backslash can mean either ‘and’ or ‘or’”, Justice Ruchelsman held that “since there is a question as to the correct interpretation of the agreement the motion seeking to dismiss this claim is denied.”
Court Rejects Dual Representation of Company and Individual LLC Members
Just a few days after the above-described decision, Justice Ruchelsman issued another decision in the Lengyel-Fushimi case granting the intervenor plaintiffs’ motion to disqualify the defendants’ counsel from dual representation of the LLC and the individual defendants based on a non-consentable conflict of interest under the Rules 1.13(d) and 1.7 of the Rules of Professional Responsibility. In Lengyel-Fushimi v Rothfus, 2022 NY Slip Op 30862(U) [Sup Ct Kings County Mar. 15, 2022], Justice Ruchelsman held, based on the primary complaint’s and the intervenors’ complaint’s derivative, non-frivolous allegations of malfeasance by the defendants, that the “interests of the [nominal defendant LLC] and the interests of the individual defendants cannot possibly be aligned to permit the same counsel to represent them.” The decision permitted defense counsel to continue representing the individual defendants and directed the LLC to secure “new and independent” counsel.
Inconclusive Formation and Tax Records Preclude Summary Judgment in Shareholder’s Derivative Action
Famous Family LLC v Kutsyk, 2022 NY Slip Op 31155(U) [Sup Ct Kings County Apr. 5, 2022], is another case in which Justice Ruchelsman was called upon to address a threshold issue of the plaintiff shareholder’s contested ownership interest in the subject close corporation known as New York City Fish, Inc. The plaintiff alleged that it held a 60% stock interest versus the defendants’ combined 40%, and asserted derivative claims accusing the defendants of engaging in improper and illegal activities which caused an injunction closing the company’s facility causing damages.
The defendants moved for summary judgment arguing that the plaintiff has no ownership interest and lacks standing to bring a derivative action. Justice Ruchelsman denied the motion, finding that none of the evidence offered was conclusive and that “there are still questions of fact whether the plaintiff is an owner of the corporation.” The inconclusive evidence relied upon included:
- the incorporator’s statement electing one of the defendants as a director, but which does not indicate any ownership interests of any party;
- the corporation’s certificate of incorporation and bylaws, neither of which identifies the owners;
- a directors’ resolution to sell all of the corporation’s capital stock to one of the defendants, which was contradicted by that defendant’s testimony in a prior, related lawsuit affirming plaintiff’s 60% ownership; and
- an unsigned stockholders agreement listing plaintiff as one of the corporation’s owners.
The defendants also relied on the corporation’s tax return whose Form K-1 identified one of the defendants as the sole owner. Given the frequency with which K-1s are cited as a basis for arguing “tax estoppel,” I’ll close with the following quotation from Justice Ruchelsman’s decision, explaining why the K-1 was not dispositive:
However, there is scant authority whether the existence of Schedule K-1’s or even complete tax returns conclusively establish ownership as recorded in those documents. The cases that have dealt with this issue have held they do not establish ownership but create an ”unsubstantiated claim” (Beacher v. Estate of Beacher, 756 F.Supp2d 254 [E.D.N.Y. 2010)). Further, as noted in Royal Communications Consultants Inc. v. Iviz LLC, 40 Misc3d 1217(A), 975 NYS2d 712 [Supreme Court Kings County 2013] Schedule K-1′ s do not constitute “incontrovertible proof of ownership” (id). Nevertheless, they are surely evidence of ownership and certainly questions of fact have been created which must be presented to a trier of fact.