Category: Corporations, Partnerships, and LLCs
When Can an Outside Attorney Serve as a Special Litigation Committee in an LLC Derivative Suit? When the Parties’ Contract Says So, Says First Department
In a decision handed down on August 15, 2017, by the New York Appellate Division First Department, the court endorsed the practice of the appointment of a Special Litigation Committee (SLC) by a limited liability company (LLC) “at least where explicitly contemplated” by the LLC’s operating agreement. However, where the operating agreement does not explicitly provide for such an appointment or otherwise evince intent to delegate core governance functions to a nonmember, the LLC cannot appoint an SLC that has authority over a major decision of the LLC.
The Second Department Suggests That “Any Lawful Business” Clauses May Be Effectively Meaningless in LLC Dissolution Cases
In actions brought by minority members to dissolve an LLC, a key inquiry is whether the LLC’s managers are unable or unwilling to permit or promote the LLC’s “stated purpose.” In many cases, an LLC’s operating agreement provides that the LLC’s “stated purpose” is “any lawful business.” As a result, one might think that the central question in many judicial dissolution cases would end up being whether the LLC is engaged in lawful business. Not necessarily. Recently, in Mace v. Tunick, the Second Department suggested that an “any lawful business” purposes clause is insufficient to conclusively refute an allegation that an LLC was formed for a particular purpose. Mace could therefore be read to eliminate some of the protections against litigation that would be provided for by an “any lawful business” clause.
Commercial Division Rules that U.S. Treasury Secretary’s Access to a Company’s Detailed Financial Information in His Role as a Board Member Is Insufficient to Establish Liability for Fraud
Members of a company’s board who are also investors in the company often have access to detailed information about the company’s finances and its lending facilities. But what happens when an investor-board member could, through access to the company’s financial information, potentially determine that funds from a lending facility are not being used for the purpose that the company and its agents had previously represented that they would be used for? Is the investor-board member potentially liable for fraud merely on the basis of his access to or awareness of financial information about the company? Justice Charles E. Ramos’s recent decision in RKA Film Fin., LLC v. Kavanaugh, No. 652592/2015, 2017 BL 222658, 2017 N.Y. Misc. LEXIS 2459, 2017 NY Slip Op 50846(U) (Sup. Ct. June 27, 2017), suggests that the answer may be no. According to the Commercial Division, without personal involvement in the alleged fraud itself or a special duty to disclose to the plaintiff, an investor-board member is likely not liable for fraud to a plaintiff creditor.
In PMC Aviation 2012-1 LLC et al. v. Jet Midwest Group, LLC et al., No. 654047/2015, BL221447 (Sup. Ct. Jun. 21, 2017), Commercial Division Justice Shirley Kornreich denied a motion to dismiss a fraudulent inducement claim by an LLC member against its business partner. The court found that it could not find any “controlling, on-point authority” on the issue of reasonable reliance at issue in the case. The case relates to the scope of due-diligence obligations of LLC members when they rely upon the representations of business partners concerning the affairs of a jointly owned company.
Justice Timothy J. Dufficy in the Queens County Commercial Division recently entered an order dissolving a limited liability company owned by two brothers whose disagreements regarding the management of the LLC culminated in a physical altercation. Matter of Dissolution of 47th Road LLC, No. 705060/16, 2017 BL 49187 (Sup. Ct. Feb. 16, 2017). The court applied an exception to the general rule that disputes between members are insufficient to warrant judicial dissolution, and found that the antagonism between the brothers made it impracticable for the business to carry on.
First Department Affirms the Validity of an LLC Operating Agreement Adopted by Majority Members without Minority Consent: Takeaways for New York LLCs
In Shapiro v. Ettenson, No. 2849, 2017 BL 19404 (App. Div. 1st Dep’t Jan. 24, 2017), the Appellate Division, First Department recently affirmed a decision by Supreme Court Justice Kelly O’Neill Levy upholding an LLC operating agreement that was adopted by two of the LLC’s three co-equal members without the consent of the third member. The Appellate Division rejected Shapiro’s argument that the operating agreement was unenforceable because it was not adopted unanimously. The panel affirmed the lower court’s decision that LLC Law § 402(c) “provides that the operating agreement may be adopted by ‘the vote of a majority in interest of the members entitled to vote thereon.’” Because the First Department agreed that the operating agreement was enforceable, the court further affirmed the lower court’s ruling upholding the majority members’ reliance on a provision of the agreement to issue a capital call and reduce the voting interest of any member who fails to make the requested capital contribution.
On January 6, 2017, Justice Charles E. Ramos of the Commercial Division issued an order enjoining two corporations from taking action in violation of a shareholders agreement of a third company. The case, Ciment v. SpanTran, Inc., involves a contentious shareholder dispute in which it was alleged that the shareholders agreement of one company covered governance issues concerning two other companies. Justice Ramos ruled that the third company’s shareholders agreement contemplated the acquisition of additional entities, and was thus likely to apply to the other two corporations—which had subsequently come under the ownership of the same shareholders.
On January 10, 2016, the New York Court of Appeals decided to hear a case that has significant consequence in the field of partnership dissolution. The case, Congel v. Malfitano, concerns the allegedly wrongful dissolution of a shopping mall partnership under Partnership Law § 69. In 2016, Justice Thomas A. Dickerson, writing for a unanimous Second Department panel, held that a former partner’s unilateral notice of dissolution was wrongful because under Partnership Law § 69(2)(1)(b) the partnership was not “at-will” given that the written agreement contained a “definite term.” The Second Department also ruled that it is appropriate to apply minority and goodwill discounts in determining the value of a defendant’s interest in a partnership. Finally, the Second Department concluded that an award of attorney’s fees was proper because the expenditures are only incurred because of the former partner’s wrongful conduct.
On October 24, 2016, Justice Charles E. Ramos of the New York Commercial Division denied a motion by minority members of a limited liability company (“LLC”) to enjoin a freeze-out merger that would cash out the minority members’ interests. Huang v. N. Star Mgmt. LLC, 652357/2016, 2016 NY Slip Op 32194(U), at *4 (N.Y. Sup. Ct. Oct. 24, 2016). The court rejected the minority members’ argument that the majority members had violated the LLC’s operating agreement by transferring their membership interests to another LLC to effect the merger.