Summer Shorts: Equitable Contribution, Stock Redemption, and Other Recent Decisions of Interest
July 31, 2023
Welcome to the 13th annual edition of Summer Shorts. This year’s edition features brief commentary on five recent decisions by New York courts in a variety of business divorce cases involving equitable contribution among partners; preferred shareholder redemption rights; LLC manager indemnification rights; shareholder books-and-records access; and statute of frauds defense to equity ownership claims. Click on the case names to read the decisions.
Court Denies Equitable Contribution Claim Against Former Partners
Esterson v Spring, 2023 NY Slip Op 32219(U) [Sup Ct NY County June 30, 2023]. This interesting case falls in the category of post-business divorce disputes. The winding down of an architectural and engineering firm organized as an LLP initially went smoothly, with the three partners agreeing to complete existing jobs and collect receivables to pay off the firm’s bank loan which the three had personally guaranteed jointly and severally. After some months, with the consent of all three, two of the partners voluntarily withdrew for no consideration while continuing to assist with collections, leaving the third partner (Mr. Spring) in sole control.
Things went awry when Mr. Spring, instead of winding down the business, used firm funds in what the court described as “an expensive and ill-fated effort to resuscitate [the firm] which ultimately led to bankruptcy and and default” under the bank loan. When the bank filed suit on the personal guarantees, Mr. Spring through a shell company bought the debt and filed legal action against his former partners to enforce their guarantees.
In an initial round of litigation, the lower court ruled, and the Appellate Division affirmed, that Mr. Spring could not enforce the guarantees and that his sole recourse was a claim for contribution.
The contribution claim proceeded to a 4-day bench trial after which the court ruled against Mr. Spring based on his failure to provide evidence that he used personal funds to pay the bank debt; that had he followed the partners’ agreed plan to collect receivables rather than attempting to revive the firm, the partnership would have been able to pay back the loan and avoid bankruptcy; and because it would be “inequitable to permit him to recover in contribution from [his former partners]” due to his “unilateral and quixotic actions to revive [the firm] for his own economic benefit, in contravention of his agreement with [his former partners].”
Right to Redeem “All, But Not Less Than All” Shares Yields Nothing for Preferred Stockholders
Luxor Capital Group LP v Altisource Asset Management Corp., 2023 NY Slip Op 03196 [1st Dept June 13, 2023]. This is one of those cases bearing out the adage, be careful what you wish for. The plaintiffs acquired 250,000 preferred shares in the defendant asset management firm. The governing certificate of designations included a provision drafted by plaintiffs giving them the right to redeem at certain times “all, but not less than all” of their shares “out of funds legally available therefor . . . at an amount equal to the Redemption Price.”
The plaintiffs timely submitted a redemption demand at an approximate Redemption Price of $250 million. The defendant demurred, stating that it did not have $250 million in legally available funds, i.e., surplus funds within the meaning of Section 513 of the Business Corporation Law. The plaintiffs sued, arguing that they were entitled to partial payment out of the available surplus and full payment out of surplus as it becomes available.
On appeal from the lower court’s dismissal of the complaint, the Appellate Division agreed with defendant, holding that plaintiffs’ argument “cannot be reconciled with the all-or-nothing nature of the parties’ agreement” providing that “all Shares must be redeemed ‘for cash,’ on a specific date, for a specific price, out of legally available funds.” The court further commented that plaintiffs effectively sought to “add terms to the contract” that would “undermine the purpose of Section 513 by effectively converting shareholders to creditors.”
Too Clever By Half: Court Shoots Down LLC Managing Member’s Indemnification Agreement as Inconsistent with Operating Agreement
Shatz v Chertok, 2023 NY Slip Op 03443 [1st Dept June 27, 2023]. Here’s a twist on another adage: If you don’t succeed at first, don’t try again if doing so squarely conflicts with prior court order. In this case, the defendant managing member of an LLC suffered adverse lower and appellate court rulings in 2020 dismissing his counterclaim for indemnification as barred by contrary provision in the operating agreement. The defendant subsequently appointed an “Officer of Legal Affairs” for the LLC with whom defendant entered into an indemnification agreement requiring the LLC to indemnify and advance attorneys’ fees,
The lower court denied defendant’s motion to dismiss plaintiff’s claim to invalidate the indemnification agreement. Not surprisingly, the Appellate Division affirmed the ruling, noting its 2020 ruling denying indemnification under the operating agreement and writing that “[t]he indemnification agreement conflicts with section 14.7 [of the operating agreement], which requires each party to bear its own legal costs in disputes among the LLC and its members.” The court also noted that any attempt to modify section 14.7 required that all members consent to amendment, which never happened.
Adding bite to its ruling, the appellate court denied defendant’s effort to overturn the lower court’s award of sanctions requiring defendant to reimburse 90% of plaintiff’s legal costs opposing defendant’s “frivolous” dismissal motion.
Books-and-Records Petitioner Ordered to Commence Declaratory Judgment Action to Establish Shareholder Status
Catalanotto v Central Station Groceries Corp., 2023 NY Slip Op 32315(U) [Sup Ct NY County July 7, 2023]. Did the petitioner jump the procedural gun by filing a summary proceeding to obtain access to books and records when his standing as a shareholder was in dispute? The court in this case concluded that he did, and dismissed the petition without prejudice to filing a plenary action seeking a declaratory judgment concerning his status as a shareholder and, if successful, to be followed by a new books-and-record proceeding.
The case involves the ownership of several corporations by three brothers, two of whom denied the petitioning third brother’s ownership even though in certain years they filed corporate tax returns with K-1s identifying him as a shareholder. The court denied the respondents’ dismissal motion, finding a “sharp dispute” as to the petitioner’s stockholder status. But it also dismissed the petition without prejudice, noting the “dilemma” that “much of the proof of whether the petitioner is a shareholder . . . is contained within the very books and records that he seeks to inspect, and which respondents seek to withhold.”
The court seemingly resolved the dilemma by inviting petitioner to file a new declaratory judgment action “in which the full panoply of disclosure devices is available to the parties” as the “proper vehicle” for determining the dispute over petitioner’s stock ownership before addressing (depending on the outcome of the plenary action) his entitlement via summary proceeding to obtain access to books and records.
Complaint Alleging Oral Acceptance of Email Offer of Equity Stake Survives Statute of Frauds Challenge
Bardy v Bonnem, Decision and Order, Index No. 55909/2023 [Sup Ct Westchester County May 26, 2023]. The statute of frauds pops up as a frequent defense in cases brought by putative equity owners of business entities who rely on handshake agreements and/or informal email or text communications as evidence of ownership. In this case, the plaintiff sued to enforce an “option” to acquire in two stages a 25% ownership interest in an LLC formed to develop and launch a chain of drive-thru coffee shops.
The plaintiff offered as proof an email from the defendant owner of the LLC that offered a 25% stake to be acquired 18% “upfront at a nominal valuation for the whole company of $1 million” and an additional 7% “after the third year at a valuation of $5 million.” The plaintiff alleged that he orally accepted the offer and thereafter provided certain services for the company’s benefit.
The defendants, focusing on the email’s contemplated option to convey a 7% interest “after the third year,” sought to dismiss the action based on the statute of frauds in General Obligations Law section 5-701(a)(1), which voids agreements by their terms not to be performed within one year from the date made unless in writing.
The court denied the dismissal motion, finding that the orally accepted email satisfied the statute and that, based on the complaint’s allegations, plaintiff’s acquisition of the 18% interest could have been performed within one year of the alleged agreement. The decision does not comment on the additional 7% in the third year.