Business Divorce Cases of 2013

, New York Law Journal

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Peter A. Mahler and Matthew D. Donovan
Peter A. Mahler and Matthew D. Donovan

The improved economic climate last year saw no let up in the volume of business divorce litigation in New York courts. Indeed, there's an argument to be made that a bigger "pie" resulting from higher profits and rosier business prospects foster more, not less, infighting among co-owners of closely held business entities contributing to a higher incidence of legal disputes.

The most striking aspect of last year's business divorce decisions is the number of important appellate rulings concerning various forms of business entities. The cases featured in this annual review include decisions by the Court of Appeals and all four departments of the Appellate Division concerning dissolution and valuation contests involving partnerships, corporations, and limited liability companies.

Grounds for LLC Dissolution

The Second Department's landmark decision in Matter of 1545 Ocean Avenue, LLC, 72 AD3d 121 (2d Dept. 2010), distinguished the standard for dissolution of an LLC under Limited Liability Company Law §702 from that of a corporation under Business Corporation Law Article 11, adopting an approach that gives priority to the terms of the operating agreement and focuses on the business of the LLC rather than on incidents of minority oppression.

The First Department's decision last year in Doyle v. Icon LLC, 103 AD3d 440 (1st Dept. 2013), is the first New York appellate decision outside the Second Department to follow 1545 Ocean Ave. and its crucial distinction between dissolution under the LLCL and the BCL. Doyle involved a night club operated by an LLC owned equally three ways. One of the members sued for dissolution, alleging that he had been "systematically excluded" from the company's business affairs and denied his share of the LLC's profits. The LLC moved to dismiss, contending that plaintiff failed to state a cause of action. The lower court denied the motion, finding that plaintiff's allegations regarding exclusion from the business were sufficient to state a claim under LLCL §702.

On appeal, the First Department reversed and dismissed plaintiff's dissolution claim, citing 1545 Ocean Ave. in holding that plaintiff's allegations of exclusion "are insufficient to establish that it is no longer 'reasonably practical' for the company to carry on its business" and that his allegation regarding denial of profits actually "shows that the company is financially feasible."

Documentary Evidence

In Born to Build LLC v. 1141 Realty LLC, 105 AD3d 425 (1st Dept. 2013), the First Department reversed the lower court and granted a real estate holding company's motion to dismiss a dissolution petition based on documentary evidence showing that petitioner did not hold a membership interest in the company.

Born to Build involved a hotel construction project that encountered financial difficulties and delays resulting in foreclosure and lien-enforcement proceedings. The general contractor sued the developer, who ultimately was indicted on federal charges and skipped town. The contractor took a default judgment against the developer and enforced the judgment by execution sale at which it purchased the developer's purported membership interest in the LLC that owned the hotel property. The contractor then petitioned to dissolve the LLC and liquidate and distribute its assets.

The LLC moved to dismiss on the basis of an operating agreement, which the contractor did not know existed. The agreement established that the developer, whose purported membership interest was acquired at the execution sale, was never a member of the LLC. The contractor opposed the motion with affidavits averring that the developer had exhibited indications of ownership, including negotiating the sale of, and personally guaranteeing, the mortgage on the property. The lower court denied the motion, finding that the contractor raised sufficient fact issues regarding whether the developer was an owner.

The First Department reversed and dismissed the petition, holding that the contractor's affidavits merely "assert that the affiants were told by [the developer]…that he was actually an owner"; that the petition was "premised only upon information and belief"; and that the [contractor] failed to raise fact issues regarding "the authenticity of the operating agreement." In so holding, the Appellate Division emphasized the crucial distinction between a dissolution petition, which is akin to a summary judgment motion based on admissible evidence, and a dismissal motion, which turns on a lesser sufficiency-of-the-pleadings standard.

Standing and documentary evidence of ownership in dissolution proceedings also were front and center in Matter of Sunburst Associates, Inc., 106 AD3d 1224 (3d Dept. 2013), in which the Third Department, in deference to the lower court's "better position" with respect to assessing conflicting documents and weighing the credibility of witnesses, affirmed the dismissal of a dissolution petition.

The parties in Sunburst co-founded as equal owners a company that operated a chain of tanning salons. After partnering in the business for more than a decade, the parties executed a "stock certificate agreement" providing that petitioner was indebted to respondent and requiring him to deliver to respondent a certificate representing his 50 percent interest in the company to be held in escrow as security. The parties thereafter signed an unrelated "statement of corporate action" stating that respondent was sole shareholder.

Petitioner commenced a deadlock dissolution proceeding under BCL §1104. Respondent moved to dismiss on the ground petitioner had transferred his interest and lacked standing to bring the proceeding. The lower court directed the parties to a hearing solely on the issue of petitioner's ownership status.

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