The Business Divorce Law Report

October 17, 2011

Shareholder Dispute Settlement Barred by Accidental Shooting

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.

May 27, 2011

Oppressed Shareholders Avoid Key Person Discounts

by Jay R. McDaniel, Esq.

This case goes into the “be careful what you say” category – particularly when it’s under oath, and particularly when you are involved in an oppressed shareholder action, or any other type of business divorce, for that matter.

Oppressed Shareholder Litigation

Oppressed shareholder actions almost invariably involve the purchase of the interests of some of the principals based upon valuations prepared by experts. One of the issues that the valuation expert will consider is whether a discount (or reduction in value) should be applied for the loss of a key person.

The inclination of the oppressed shareholder is to insist that they were absolutely critical to the success of the business, while the controlling shareholders insists that the shareholder who was forced out or frozen out was of no use anyway.

There is no bonus for being important to the business in valuation proceedings. In fact, the opposite is true. It runs contrary to the emotions of the parties and is completely counterintuitive to non-lawyers. For example, the big rainmaker who accounts for 80 percent of his professional firm’s business, but has somehow gotten frozen out of the enterprise, should keep his opinion about the extent of the contribution to himself or herself. The fact is that the enterprise is worth a lot less without them around, and that decrease in value may be reflected in a lower price for the purchase of their interests.

Key Person Discounts

There is surprisingly little case law on this topic in either New York or New Jersey and I am surprised that the issue does not come up more often between feuding principals. Yet you can have the unexpected situation in which a controlling shareholder fires key sales people and then asserts that they were absolutely critical – i.e., “key persons” – to the success of the business.

That was the case recently when the Supreme Court of New York County reviewed an application of this discount, which revealed an interesting point of the very personal nature of business divorce. Matter of Abraham (Elite Techonology NY, Inc.), 2010 NY Slip Op 33225(U) (Sup. Ct. NY County Nov. 10, 2010), (opinion here) (Thanks to Peter Mahler’s NY Business Divorce blog for finding the decision and publishing the referee’s report).

The key person discount, in the context of business valuation, is defined by….

May 5, 2011

Minority and Marketability Discounts in Oppressed Shareholder Cases

by Jay R. McDaniel, Esq.

The important battle in an oppressed shareholder lawsuit most often is the battle of the valuation experts. And almost inevitably, the parties will litigate the minority discounts and discounts for lack of control that may or may not be applied to the minority interest.

As we previously discussed here, business valuation in a shareholder dispute involving a closely held business is a thorny issue. The shareholders that remain in the closely held business scramble for discounts that reduce the minority’s interest and the departing shareholders try to avoid them as much as possible. What are the rules for application of discounts? Well, there are some litigators who can’t help but smile when the say this, it depends.

Minority Interest

April 12, 2011

LLC Does Not Distribute Clients on Dissolution

by Jay R. McDaniel, Esq.

When a limited liability company dissolves, it pays its creditors and distributes the remaining assets in the winding-down process. Many professional practices are organized as LLCs, and their principal assets are the clients they serve. That does not mean, however, that the professional limited liability company in dissolution has to divide up the clients.

This is an important holding for lawyers, accountants, doctors and other professionals that are practicing in New Jersey as a limited liability company. According to a New Jersey appeals court, the clients that the professionals, such as an accountant, bring to the LLC represent personal goodwill that belongs to the individual professional, rather than goodwill belonging to the enterprise. Thus, clients of professional limited liability companies are not considered assets of the LLC and on dissolution are not subject to distribution.

Accountants Seek Dissolution of Firm

March 14, 2011

Fiduciary Duties in Unfair Competition Case

by Jay R. McDaniel, Esq.

You just learned that an employee secretly formed and operated a competing business while employed by you. Is there a claim against the competing business or just the employee? Most likely there are viable claims against both. The fiduciary duties of the employee are likely to be imputed to the company he or she formed.

Breach of Fiduciary Duties

Similar facts were before the court recently in an unfair competition and breach of fiduciary duty case, Vibra-Tech Engineers, Inc. v. Kavalek, Civil Action No.: 08-cv-2646, in the United District Court for the District of New Jersey. (opinion here) A vice president and director of Vibra-Tech, along with his wife, formed two businesses. One of the businesses sold equipment to Vibra-Tech; the other competed directly for the same customers. Vibra-Tech, of course, had no idea that one of their executives was involved in the two businesses.

February 16, 2011

Employer E-Mail Policy Creates Privacy Rights

by Jay R. McDaniel, Esq.

As an employer, we may assume that because we own the computer equipment, that includes any data left on there by our current or former employees. Thus, if an employee wants to use company time or our equipment for personal e-mail, then they do so at their own peril. If we’re not careful, however, we may be wrong.

Whether an employee working in New Jersey has an expectation of privacy in e-mails sent during working hours and whether the employer can read those e-mails –will depend on the policies that the company establishes, particularly those in writing, and its actual practices.To be safe, the policy should be clear and it should be in writing.

The New Jersey Supreme Court recently held that an employee had a reasonable expectation of privacy in workplace e-mails sent to her attorney through a web-based personal e-mail account, but using a company computer, largely because the company was less than clear about its policy. Stengart v. Loving Care Agency, Inc., 201 N.J. 300 (N.J. 2010). (copy of opinion here). In Stengart, employee Marina Stengart’s e-mails sent to and received by her attorney on her work laptop were viewed by her former employer, Loving Care Agency, whom she was then suing for employment discrimination. The e-mails were discovered by her attorneys when her laptop was examined by an expert during the litigation.

February 2, 2011

Indemnification of Director Despite Judgment of Wrongdoing

by Jay R. McDaniel, Esq.

Most corporations include broad indemnification provisions in their by-laws that are intended to protect directors and officers from the costs of lawsuits claiming wrongdoing. Those corporate provisions, however, as well as the statutory provisions that permit indemnification have an important caveat, an officer or director cannot be indemnified against intentional wrongdoing.

What happens when the officer or director loses a civil case, however, and a judgment is entered finding wrongdoing? According to a recent decision in New Jersey that finding of wrongdoing does not automatically deprive the officer or director a right to indemnification, nor does it require him or her to repay the costs incurred in the defense or payment of any judgment.

Advancement of Defense Costs

January 28, 2011

Partnership Agreement Disclosure to Labor Union Pending Trial Court Decision

by Jay R. McDaniel, Esq.

In some circumstances, a business may be able to claim that its organizational documents are trade secrets. That seems to be the holding of a trial court decision insulating a partnership agreement from disclosure to a labor union.

The case is interesting because non-management owners do not generally have free access to all of the records of a business, but they do have a right of access to organizational documents. This case raises the prospect that a company that in turn enters into other ventures might classify those documents as proprietary or trade secrets and avoid disclosure to parties with an interest in their contents.

The dispute actually arose under New Jersey’s Open Public Meetings Act. The lawsuit, Communications Workers of America and New Jersey Education Association v. John McCormac and Blackstone Capital Partners et al., L-3217-05 (2008), involved a complaint brought by several state workers’ groups against defendant public officials and private equity funds seeking documents which might reveal the investment strategy defendant private equity firms were utilizing to invest state worker pensions.

January 24, 2011

Court Defers to Management’s Liquidation Value in Dissenting Shareholder Value

by Jay R. McDaniel, Esq.

The Business Judgement Rule presumes that a decision made by a majority of the board of directors in business matters is entitled to deference. Courts generally will not interfere with decisions that fall under the Business Judgment Rule.
Courts disregard the Business Judgment Rule when there is evidence of bad faith, misconduct or self dealing.
Even in a case involving the fair value of the shares of a dissenting minority shareholder, a court may consider the transaction at ‘arms length’ and defer to the board’s discretion.

Oppressed Shareholder Settlement Void

Purchase of Minority Interest

Socialite’s Family Partnership Interest

Book Value Used to Buy Socialite’s Interest

Oppressed Shareholder Litigation

Key Person Discounts

Minority Interest

Accountants Seek Dissolution of Firm

Breach of Fiduciary Duties

Advancement of Defense Costs

The Business Judgement Rule presumes that a decision made by a majority of the board of directors in business matters is entitled to deference. Courts generally will not interfere with decisions that fall under the Business Judgment Rule.

Courts disregard the Business Judgment Rule when there is evidence of bad faith, misconduct or self dealing.

Even in a case involving the fair value of the shares of a dissenting minority shareholder, a court may consider the transaction at ‘arms length’ and defer to the board’s discretion.