The Business Divorce Law Report

January 6, 2012

Business Divorce: Five Considerations You Should Consider

It’s the Wednesday afternoon before Thanksgiving and the phone rings with a new client. The situation in the office has become an emergency. Either someone has been locked out or someone needs to be locked out, or someone is walking out the door with a key client. Many of our cases begin as emergencies.

The dispute between LLC members, shareholders or partners erupts into a lawsuit without warning, or so it seems, and without planning. Here are five considerations that are important to success in a litigated business divorce.

1. Understand the Statutory Framework.

January 3, 2012

Fiduciary Duties Change With Time

by Jay R. McDaniel, Esq.

Partnership Failed to Keep Inactive Partner Informed

The fiduciary duties owed among partners can change with time and circumstances, and the disclosures that were appropriate when all of the partners worked together in the business may become inadequate when one of the partners has ceased to take an active role.

This is the lesson of Munoz v. Perla, Docket No. A-5922-08T3 (App. Div. Dec. 20, 2011) in which the Appellate Division affirmed a trial court decision holding that the members of a partnership had failed to make adequate disclosure of the terms of the leases held by the engineering firm, of which the parties had all once been partners.

Although the case involved the now-repealed Uniform Partnership Act, and thus not all of the holdings may be applicable to partnerships formed under later law, the decision is instructive as to how the fiduciary relationships between partners my evolve as time passes and circumstances change. (For another reason decision involving fiduciary duties among partners, see our blog post here.)

December 27, 2011

Limited Liability Co Founders May Have Disclosure Duties

by Jay R. McDaniel, Esq.

Promoters of LLC Subject to Breach of Fiduciary Duty Claims

Limited liability companies are clearly the vehicle of choice for new, closely held businesses. That means that more often than not the principals have some existing relationship before they take up their new business together. Can that prior relationship create fiduciary duties even before the company has begun operations?

A decision out of the New York Court of Appeals indicates that there may be fiduciary duties in such a relationship, in particular duties of full disclosure and fair dealing. Moreover it appears that these duties may exist before the limited liability company is formed or membership interests are acquired. In Roni LLC v. Arfa, 2011 N.Y. Slip Op. 09163 (Dec. 20, 2011), The court held that the existence, or not, of a fiduciary relationship depends up the relationship of the parties and whether it meets the traditional criteria necessary to create fiduciary obligations.

Real Estate Investments by LLC

This case involved the conduct of promoters, the individuals who organize a new business and seek out other participants or investors. The defendant promoters organized seven limited liability companies under New York law for the purpose of buying and renovating buildings in the Bronx and Harlem for resale. The plaintiffs were a number of Israeli investors who acquired interests in the LLCs.

November 22, 2011

Canyon Creek Development LLC Member Fails to Meet the Capital Call

by Jay R. McDaniel, Esq.

Small business owners sometimes run into difficulties with their business partners after much time has passed since they first set up the business. They come to discover that the operating agreement either does not address their problem or the result is not what they intended. Small business owners should take care to draft their controlling documents by considering as many scenarios as possible.

Members of limited liability companies are given considerable leeway to craft a management and business structure as they see fit. This control is one of the reasons why the LLC form is attractive to those engaged in new business ventures. The LLC’s operating agreement is the contractual means by which the members will determine the business structure – and courts continuously warn parties that failure to craft the operating agreement carefully will sometimes force unintended results.

November 1, 2011

Chancery Court Rejects ‘Inconceivable’ Value in Shareholder Buyout

by Jay R. McDaniel, Esq.

Sometimes an expert valuation opinion, however well documented, leads to a conclusion that just doesn’t square with reality. That was the case with an expert opinion in Rughani-Shah v. Noaz, Docket No. A-4943-08T2 (Sept. 16, 2011) that valued a one-third interest in a medical practice at just $25,000. The trial court’s decision was affirmed by the Appellate Division of New Jersey Superior Court.

The trial judge didn’t buy it – not when the practice was grossing $1.7 million a year and not when the buy-in for the shareholder seeking the buyout had been eight times that amount. Common sense said the number was just too low, and the expert’s opinion was rejected.

October 26, 2011

Partnership Accounting Not Available from Deceased Partner’s Heirs

by Jay R. McDaniel, Esq.

Uniform Partnership Act Limits Remedy

If a partner dies after having allegedly misappropriated partnership funds, do the other partners have a right to pursue his estate? The answer appears to be no, according to a recent Chancery Court decision.

The decision in In re Genet, Docket No.: ESX-C-44-11 (Oct. 13, 2011) was decided under the now repealed Uniform Partnership Act – yet another warning to partnerships formed before December 2000 that if they want the newer law to apply, they should amend the partnership agreement to say so.

In granting a motion to dismiss the claim of the surviving partner seeking to require his nieces to account for the misappropriations of their father, Chancery Judge Walter Koprowski held that the statutory language that created an obligation of the partnership to account to the estate of a deceased partner was not reciprocal. It did not create a similar obligation of the estate to account to the partnership for the wrongful acts of the deceased partner.

October 24, 2011

Contract’s Plain Meaning Voids Parties Understanding

by Jay R. McDaniel, Esq.

A contract means what it says, even if the two parties who came to the agreement may have understood something different. This can be a trap for the business that is not careful to ensure that the contract that it signs at the end of negotiations accurately reflects exactly what it thinks it has agreed to.

It is not particularly unusual that, at the end of a period of negotiations, the contract that is finally written up does not exactly fit the terms the parties thought they had negotiated or that it does not contain all of the terms that the parties thought were relevant. A court, however, is unlikely to read those terms into the agreement, or even permit one of the parties to argue that they should have been there – at least not when the meaning of the agreement is plain from its terms.

Court Review

The New Jersey Appellate Division opinion in MicroBilt Corp. v. L2C, LLC demonstrates just how difficult it can be to get a court to consider that there were important terms missing from the final document that should have been included.

MicroBilt signed a contract with L2C under which L2C would perform credit evaluations of MicroBilt’s potential customers and provide customer credit scores to MicroBilt. MicroBilt later claimed that L2C was also required to supply the underlying data used to calculate the credit score, which L2C obtained from a third party vendor. L2C claimed it could not provide the underlying data because its contract with its vendor prohibited the release.

October 19, 2011

Failure to Disclose Transfer of Partnership Not Wrongful

by Jay R. McDaniel, Esq.

Partnership Interest Secretly Transferred to Family Member

Does a partner have an obligation — separate and apart from the terms of a partnership agreement — to disclose the fact that one of the partners has transferred their interest to another member of the partnership?

The question seems to answer itself. Of course it is. After all, is there anything more material to the business of a partnership than the identities of the partners? But in a case earlier this year involving a secret transfer from a mother to one of her sons, the New Jersey Appellate Division’s came to the contrary conclusion. The narrow reading given by the court to the Uniform Partnership Act and its failure to find that there was a duty to disclose the transfer is troubling.

Fiduciary Duties under the Uniform Partnership Act

The question that is lurking in this decision, Taylor v. Taylor, Docket No. A-4363-09T1 (N.J. App. Div. July 8, 2011), is whether the adoption of the UPA fundamentally altered the relationship between the partners of a partnership, and whether precedent going back to the early 20^th Century is still good law. The Taylor decision suggests it is not.

I do need to confess my personal bias. I think the current trend of allowing parties in a business relationship to contract away basic principles of honesty and loyalty, demonstrated by statutory and occasional court approval of agreements that eliminate fiduciary duties, is a bad idea. In my opinion, it’s like the Japanese gangster who willingly cuts off his own fingertip to atone for a mistake. The fact that the Yakuza participated in the wrong done to himself doesn’t make it right. On the other hand, I appear to be in the minority and the drafters of the Uniform Partnership Act, adopted in New Jersey in 2000, and a growing number of courts seem to think otherwise.

October 17, 2011

Shareholder Dispute Settlement Barred by Accidental Shooting

by Jay R. McDaniel, Esq.

Oppressed Shareholder Settlement Void

Shareholders in New Jersey’s Wild West City cannot distribute assets to resolve an oppressed shareholder action due to an unresolved claim involving an employee’s accidental shooting. The case is a warning, perhaps, that prudence requires some due diligence before a release is signed to ensure that there is not a lurking claim that could upset the settlement.

Purchase of Minority Interest

Oppressed shareholder actions almost invariably end with the compelled purchase and sale of the minority shareholder’s interest. An unresolved claim, however, that could give a third party an interest in the company’s assets may prevent any resolution of the dispute.

Stabile v. Stabile (Stabile v. Stabile.pdf) involved a dispute between the members of several family owned businesses owning a large tract of land in rural Sussex County, New Jersey and operating Wild West City, a western theme park. The businesses also held a liquor license and owned a contiguous restaurant. The litigation among the family members began in September 2005, when James Stabile filed suit alleging various breaches of duties by the directors of the business and minority shareholder oppression. In June 2006, the Court entered an order that the plaintiff was be bought out at fair value. The real estate holdings were appraised at about $11.45 million.

August 19, 2011

Book Value is Not Fair Value in Partnership Buyout

by Jay R. McDaniel, Esq.

Socialite’s Family Partnership Interest

Book value can have a few different meanings. The best definition is simply the value of assets and liabilities that a company carries on its books. Is it different than the “fair value” standard applied in statutory buyouts? Yes– a lot different.

There are many partnership agreements and corporate buy-sell agreements still in effect with a book value buyout provision. They tend to be older entities, often involving family businesses, and I cringe whenever I look at the agreement and see the term applied to the company’s value.

Book Value Used to Buy Socialite’s Interest

A recent decision involving the estate of socialite Claudia Cohen demonstrates why. Estate of Claudia Cohen v. Booth Computers, et al., Docket No. A-0319-09T2. Estate of Cohen App Div.pdf. (Thanks also to Peter Mahler’s NY Business Divorce blog for finding the trial decision. Cohen Chancery Div.pdf.) In that decision, the Cohen’s estate argued that the book value of a successful business was just less than 2 percent of its fair value – $ 178,000 as opposed to $11.526 million – and sought to reform the partnership agreement. The effort failed and the Appellate Division affirmed the trial court’s enforcement of the agreement. The disparity between book value and fair value was not, in the court’s opinion, reason to alter an otherwise unambiguous document.

The result was a windfall for the last surviving partner, Claudia’s bother James, and the same result is likely to occur in most agreements that set the value of the business at book value rather than fair value.

The Cohen case involved a partnership formed by the late Robert Cohen, an entrepreneur who amassed a considerable fortune through various entities including the Hudson News Group. He had three children – Claudia, Michael and James. Claudia, well known in Manhattan and Hamptons social circles, was also an editor of Page 6 of the New York Post and the ex-wife of entrepreneur Ronald Perelman.

The estate, with Perelman as executor, brought suit against Booth Computers and Claudia’s brother, James, after Claudia’s interest in a family partnership was valued at a fraction of the fair value of the partnership’s holdings.