Disguised Agreements and Dissolution
November 15, 2021
Appearances can be deceiving.
That, essentially, was the argument made in two recently decided cases involving claims for judicial dissolution. In one, an LLC member with bad credit assigned her 50% interest to the other 50% member who then, representing herself as the 100% owner, secured a mortgage loan from a bank from which the assignor and assignee concealed a written side agreement stating their intent to remain “equal partners” in the LLC.
In the other, the buyer under a stock purchase agreement assigning a 75% share in a restaurant business claimed that he actually acquired a 100% interest. According to the buyer, he acquired and paid for the other 25% in the form of a contemporaneous no-show employment agreement done for tax purposes.
In the first case, the court denied summary judgment and left for trial the determination whether enforcement of the side agreement was permissible. In the second case, the court refused to treat the employment agreement as a disguised vehicle for conveyance of the remaining 25% and granted the dissolution petition.
Sisters at War Over Inherited Apartment Building
In 2007, sisters Loraine Kinyk and Darlene Hart, each as a 50% member, formed a member-managed LLC to take ownership of a 10-family multiple dwelling located in Manhattan’s East Village. They inherited the property from their father’s estate.
In 2013, the sisters decided to refinance the property’s existing mortgage with a new lender. The attorney they hired to assist submitted to the new lender an Assignment of Ownership Interest and Amended Operating Agreement, both signed by the two sisters. The former document assigned Hart’s 50% interest to Kinyk. The latter document named Kinyk as the LLC’s sole member.
The attorney also prepared a side Agreement reciting that “because of her poor credit,” Hart assigned her 50% interest to Kinyk “[f]or the purpose of securing a mortgage” and that:
Notwithstanding the Assignment of Ownership Interest dated November 19, 2013, and the Amended Operating Agreement dated November 19, 2013, the parties agree that they remain equal partners in the LLC sharing equally any profits or loss from the operation of the LLC.
The side Agreement, which both sisters admitted at deposition they signed although neither produced a signed copy, was not given to the lending bank which thereafter closed a $1,575,000 mortgage loan personally guaranteed by Kinyk.
In 2018, Kinyk filed suit against Hart seeking dissolution of the LLC under LLC Law § 702 and $475,000 damages against the LLC and Hart for unjust enrichment. Her complaint identified Hart as a 50% member and made no mention of the 2013 Assignment or Amended Operating Agreement.
With the suit still pending, in 2019 the sisters agreed to sell the LLC’s realty for $5.25 million. Their stipulation provided for equal distribution of the net proceeds except for $1.25 million which was deposited in escrow with Hart’s lawyer at Kossoff PLLC pending the outcome of the litigation. I mention the law firm’s name because, as if a law suit between sisters isn’t bad enough, earlier this year name partner Mitchell Kossoff absconded with over $8 million of the firm’s clients’ money, apparently including the $1.25 million in escrow from the building sale. According to news reports Kossoff hasn’t been seen or heard from since.
In early 2021, following discovery Kinyk filed a motion for summary judgment in which she contended, contrary to her own complaint’s allegations naming Hart a 50% member, that the side Agreement is a “nullity,” that since 2013 Kinyk has been the sole member of the LLC pursuant to the Assignment and Amended Operating Agreement, and that she therefore is entitled to 100% of the proceeds from the sale of the realty, 100% of the (now missing) escrow funds, and 100% of the LLC’s net revenues since 2013. Kinyk’s brief in support of her motion argued that Hart’s reliance on the side Agreement amounted to “residential mortgage fraud” in violation of New York Penal Law and, quoting case precedents, that the court may not accord the side Agreement legal validity elsewise the court would be helping Hart to “carry out an illegal object” or “serv[ing] as paymaster of the wages of crime or referee between thieves.” In addition to her illegality argument, Kinyk contended that the side Agreement was void under the Statute of Frauds and Parol Evidence Rule.
Hart’s opposing brief contested each of the points raised in Kinyk’s motion, arguing primarily that the Penal Law cited by Kinyk was inapplicable to the side Agreement and that the mortgage lender “suffered no harm in that the loan was repaid in full.”
The court’s decision unfortunately did not address the motion’s merits. Instead, it denied it solely on procedural grounds for Kinyk’s failure to include in her papers a Statement of Material Facts and a certification of compliance with the applicable word count limits.
Some months later, Kinyk gave summary judgment another shot, styled as a motion to renew her prior motion for summary judgment, this time accompanied by the required Statement of Material Facts and word count certifications.
The court, by Manhattan Acting Supreme Court Justice Francis A. Kahn III, last week handed down its decision in Kinyk v Hart, this time denying the motion on the merits. As to Kinyk’s § 702 claim for judicial dissolution, Justice Kahn found that
Kinyk does not address the elements of this cause of action in any respect, much less establish entitlement to summary judgment. Similarly, Kinyk offers no argument specifically addressing a summary winding up of [the LLC] (see LLCL § 703) and, more importantly, the provisions of [LLCL § 704] concerning distribution of [the LLC’s] assets.
Justice Kahn gave equally short shrift to Kinyk’s summary judgment position on her claim for unjust enrichment.
From what I see in the court record, it appears that Kinyk’s counsel did not submit a memorandum of law addressing the merits of Kinyk’s claims for which she sought summary judgment, instead limiting her brief to a discussion of the standard for granting leave to renew. This may explain the court’s disappointing (for us outsiders) silence on the key issue whether the 2013 Assignment and Amended Operating Agreement identifying Kinyk as 100% member of the LLC, prepared for purposes of the mortgage loan and submitted to the bank, prevails over the side Agreement. We’ll just have to wait for the outcome of trial.
Was Employment Agreement a Disguised Stock Transfer?
The second dissolution case is one I’ve written about twice previously, here and here, stemming from a 2012 Stock Transfer Agreement (“STA”) under which the plaintiff, Ismail Kocak, sold to the defendant, Ayhan Dargin, 75% of the capital shares of Baba’s Restaurant, Inc. which operated a Turkish restaurant in midtown Manhattan. The STA’s stated purchase price was $281,250 with installment payments through the end of 2012. According to Kocak, during the negotiations he and Dargin agreed that if, in the future, Dargin wanted to buy the remaining 25% and Kocak wanted to sell, they would perform a valuation of the company at the then-present value to determine the price.
In Dargin’s contradictory version of the transaction, he purchased from Kocak all of his shares for $375,000, with $281,500 of the purchase price allocated to the STA and the remaining $93,500 allocated to the simultaneously executed Employment Agreement at the rate of $2,500 per month. Dargin claimed that the Employment Agreement was a “legal fiction” created by Kocak’s lawyer at the time “to conceal” for “tax purposes” the actual purchase price of $375,000 for 100% of the capital shares.
Kocak and Dargin came to legal blows in 2016, after Dargin transferred all of Baba’s revenues, bank accounts, and assets, including the restaurant’s lease, to other entities under his ownership and control, leaving Baba’s an empty shell. Kocak filed two actions against Dargin, one seeking damages for breach of fiduciary duty and fraudulent conveyance, and the other for judicial dissolution of Baba’s under § 1104-a of the Business Corporation Law alleging shareholder oppression and looting. Dargin counterclaimed for a declaratory judgment that Kocak had conveyed all of his shares and is not an owner of Baba’s.
In a ruling last year, the lower court granted summary judgment for Kocak on his claims for fiduciary breach, fraudulent conveyance, and dissolution of Baba’s. The court also dismissed Dargin’s counterclaim.
Last week, the Appellate Division, First Department, in Kocak v Dargin, 2021 NY Slip Op 06084 [1st Dept Nov. 9, 2021], rejected Dargin’s appeal and affirmed the lower court’s summary judgment rulings. The court held improper Dargin’s reliance on parol evidence to contradict the “plain, unambiguous terms of the Baba’s stock transfer agreement and the employment contract.” The court stressed the Employment Agreement’s “unambiguous” provision stating, “As compensation for the services rendered, [Kocak] shall receive a net monthly salary of $2,500,” and that “[c]onsequently, Dargin may not rely on parol evidence to show that the $2,500 monthly payment was actually to buy additional shares not already transferred in the stock purchase agreement.”
It’s worth noting that neither the lower court nor the appellate court made a specific finding that Kocak in fact provided services under the Employment Agreement or, as Dargin contended, Kocak received $2,500 per month for a “no-show” job as disguised consideration for the additional 25% stock interest.
Which, perhaps, is the main takeaway from cases like Kinyk and Kocak involving transfers of ownership interests in closely held business entities, namely, that courts with rare exception will summarily enforce unambiguous, signed agreements entered into by competent parties without regard to claims that the agreements don’t reflect the parties’ true intent.