Summer Shorts: Three Must-Read Decisions
August 28, 2017
Regular readers of this blog know it’s been anything but summer doldrums in the world of business divorce, what with case law developments such as the Appellate Division’s potentially far-reaching ruling on the purposeless purpose clause and LLC dissolution in Mace v Tunick reported in last week’s post, and the astonishing story of minority shareholder oppression in the Twin Bay Village case also reported earlier this month.
This year’s edition of Summer Shorts picks up the summer pace with short summaries of three must-read decisions by New York and Delaware courts on three very different business divorce topics: use of a Special Litigation Committee to evaluate derivative claims brought by LLC members (New York); grounds for dissolution and the court’s remedial powers in shareholder oppression cases (New York); and LLC deadlock dissolution (Delaware).
Appellate Ruling Rejects Appointment of Special Litigation Committee in LLC Derivative Suit Where Not Authorized By Operating Agreement
LNYC Loft, LLC v Hudson Opportunity Fund I, LLC, 2017 NY Slip Op 06147 [1st Dept Aug. 15, 2017]. In Tzolis v Wolff, New York’s highest court recognized a common-law right of LLC members to sue derivatively on behalf of the LLC. Subsequent lower court decisions have clarified other aspects of the right by analogy to corporation law, such as requiring the plaintiff LLC member to allege pre-suit demand or demand futility. In shareholder derivative suits involving corporations, the board’s inherent authority to appoint a Special Litigation Committee composed of independent and disinterested directors to assess derivative claims is well established and, when properly implemented, can result in the court’s dismissal of derivative claims based on the SLC’s conclusion that the claims do not merit prosecution by the corporation.
LYNC Loft is the first case to address the authority of a New York LLC’s managing members to appoint an SLC to make recommendations as to the disposition of derivative claims. In a signed opinion by Justice Sallie Manzanet-Daniels, the Manhattan-based Appellate Division, First Department, reversed the trial judge’s order authorizing the appointment by the subject LLC’s conflicted managers of a nonmember, outside lawyer to serve as the sole member of an SLC. While stating that it “recognize[s] that the appointment of an SLC may serve an important purpose in the LLC context and endorse[s] the practice generally,” the court refused to extend the practice to LLCs absent authorization in the LLC’s operating agreement. The court expressed further discomfort with the composition of the one-person SLC in the case before it, consisting of a lawyer who neither was a member nor a manager of the LLC, in contravention of provision in the LLC’s operating agreement requiring the minority member’s consent to decisions to “institute and prosecute . . . or settle any material legal . . . action on behalf of the LLC.”
Thus, unless and until the Court of Appeals takes up the matter on appeal and reaches a different conclusion, drafters of LLC agreements should add to their checklist the possible inclusion of a provision authorizing an SLC and addressing its composition including the appointment of outside SLC members when the LLC’s managers who might otherwise serve are interested in the outcome.
Post-Petition Oppressive Conduct Warrants Order of Dissolution Absent Buy-Out
Kassab v Kasab, 56 Misc 3d 1213(A), 2017 NY Slip Op 50986(U) [Sup Ct Queens County Aug. 3, 2017]. The long-running Kassab case, involving a dispute between two brothers who co-own valuable, undeveloped, adjacent parcels of land in Jamaica, New York, has been featured twice before on this blog (here and here). Title to the properties is held in two entities, one a corporation and the other an LLC, each of which is owned 75% by the older brother and 25% by the younger brother. In prior decisions that were affirmed on appeal, the court dismissed the younger brother’s claims to dissolve the LLC and for equitable buy-out of his LLC membership interest, and held the older brother in contempt of court for using company funds for legal fees. Earlier this year Queens County Supreme Court Justice Timothy J. Dufficy held an eight-day bench trial focusing on the younger brother’s claim for statutory and common-law dissolution of the corporation and valuation of both entities.
Justice Dufficy’s 26-page post-trial decision is of the sort we don’t see often enough in New York business divorce cases, providing a thorough description of the case’s complex procedural history followed by detailed findings of fact, a highly useful summary of the expert testimony on valuation, and a thorough analysis of governing law and its application to the facts, all in service of a creative remedy promoting an economically sensible separation of the brothers’ business interests.
Decision highlights include:
- Justice Dufficy found that the younger brother established grounds for judicial dissolution based on a freeze-out by the older brother and the latter’s misappropriation of corporate revenues, all of which took place after the original filing of the dissolution petition in 2013, and notwithstanding the younger brother’s own financial misconduct that preceded the petition’s filing.
- Justice Dufficy accepted the fair value appraisals of the corporation and of the LLC offered by the younger brother’s experts as of May 2013 when the petition was filed, excluding any separate percentage discount for lack of marketability on the theory that the real estate appraisals already incorporate exposure to market.
- Justice Dufficy ordered the dissolution of the corporation unless within 90 days the older brother purchases his younger brother’s 25% stock interest for $3.17 million representing fair value as found by the court, plus interest at the 9% statutory rate from May 2013.
- Justice Dufficy also gave the older brother the noncompulsory option to purchase his younger brother’s 25% interest in the LLC for $1.66 million, again representing fair value as found by the court, plus interest at the 9% statutory rate from May 2013, thereby preserving the older brother’s opportunity to exploit the greater development potential of the three, adjacent parcels.
The Kassab saga is not over. As of this writing the older brother has filed a notice of appeal and a post-trial motion before Justice Dufficy to vacate or modify certain portions of his decision.
Update November 14, 2017: Yesterday the court filed a decision and order denying the older brother’s post-trial motion, among other items, asking the court to reconsider its valuation based on a new appraisal submitted the last day of trial, and granting the younger brother’s post-trial motion for an upward adjustment of the valuation to account for shareholder loans. I am grateful Justice Dufficy saw fit, in a footnote on page 3 of the decision (read here), to quote from my above commentary on his August 3 decision.
Update January 18, 2018: The saga definitely continues. The older brother did not elect to purchase the younger brother’s shares in the corporation. Consequently, by Final Order dated January 5, 2018 (read here), the court ordered the corporation’s dissolution and appointed a receiver to take control and sell the corporation’s two parcels at public auction or, with the parties’ consent, at a private sale. Meanwhile, the younger brother filed a new petition seeking to dissolve the LLC (read here) which already is the subject of the older brother’s pending motion to dismiss.
Chancery Court Summarily Orders Dissolution of Deadlocked LLC
GR US Licensing, LP v Seibel, Mem. Op., C.A. No. 12825-VCS [Del Ch Aug. 25, 2017]. This case is destined to be known as the Gordon Ramsay case, after the celebrity chef whose entity as 50% member sought and obtained judicial dissolution of a Delaware LLC formed with the other 50% member, Rowen Seibel, to develop and operate first-class burger-themed restaurants. The LLC succeeded in opening one burger restaurant at a Las Vegas casino, under a set of licensing agreements with an affiliate of Caesars Entertainment Corp., before things skidded to a halt after Seibel pled guilty to a federal tax-related felony and after Caesars, in order to maintain its compliance with Nevada gaming regulations, terminated the license agreements when Seibel refused its (and Ramsay’s) demand that he dissociate from the LLC.
The 33-page decision by Vice Chancellor Slights is one of the best expositions I’ve seen from the Delaware Chancery Court on member deadlock as a basis for LLC dissolution under § 18-802 of the Delaware LLC Act. His decision granted Ramsay’s motion for judgment on the pleadings based on the court’s finding that the deadlock between the parties rendered it no longer reasonably practicable for the LLC to operate in accordance with its LLC agreement. The court observed that with 50/50 owners who do not speak, do not make decisions together, and whose relationship “is, at best, acrimonious,” “an unbreakable deadlock can form a basis for dissolution even if the company is still engaged in marginal operations,” and “the notion that the deadlock might somehow be broken in the future is simply not reasonably conceivable.” In rejecting Seibel’s “equitable” arguments against dissolution, the court emphasized that the “deadlock here is temporally related to a series of events, caused by Seibel, that have rendered [the LLC] no longer able to function.”
One of the more notable passages in the opinion is found at page 22, footnote 71, where VC Slights distinguishes between dissolution based on deadlock versus dissolution based on the business being unable to continue — a distinction resisted so far by New York courts. While agreeing with Seibel “that questions of fact remain regarding whether [the LLC] might be able to engage in some form of business in the future that preclude a ruling at this stage that dissolution is appropriate because [the LLC] is no longer in business,” VC Slights continued, “[t]his, of course, does not preclude a judgment of dissolution on the alternative ground that it is no longer reasonably practicable to carry on the business of [the LLC] given the intractable deadlock of its members.”