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Commercial Division Resolves Madoff-related Dispute Pursuant to LLC Law

The reverberations from the collapse of Bernie Madoff’s massive Ponzi scheme continue to be felt in Manhattan’s Commercial Division.  On May 20, 2020, Judge Joel M. Cohen issued a decision in Matter of FGLS Equity LLC, No. 157170/2019, 2020 WL 2557877, 2020 NY Slip Op 31476(U) (Sup. Ct., N.Y. Ctny., May 20, 2020), approving the liquidation plan of FGLS Equity LLC, which was founded by accountant Steven Mendelow as a feeder fund to Bernard L. Madoff Investment Securities (BLMIS).  Mendelow, who passed away in 2016, was allegedly instrumental in funneling investors to the scheme.  The decision is notable, not least because it may be the first New York case in which a court has been asked to pass judgment on an LLC plan of liquidation proposed by a liquidator appointed by the LLC’s members pursuant to its operating agreement. 

The case was brought in the Commercial Division by Steven Turchin, managing member of FGLS.  Turchin, who had also been an investor in FGLS, sought approval of FGLS’s proposed plan of liquidation, which had been objected to by a number of the fund’s members, including the two respondent-counterclaimants, Sajust LLC and Larry Warshaw as the sole Trustee of Carol Ann Enterprises, Inc. Pension Plan (the “Objectors”).  The pair’s core objections to the plan were that it provided that FGLS would not sue the estates of the late Mendelow and his wife, and that the Mendelow Foundation would receive a distribution from FGLS.  The Objectors argued that Turchin was not entitled to the protections of the business judgement rule with regards to these decisions, as he lacked impartiality due to his association with Mendelow and Konigsberg, Wolf & Co. (K&W), the accounting firm at which Turchin and Mendelow worked and that did considerable business with BLMIS.

After Turchin and the Objectors were unable to resolve their differences, Turchin filed an order to show cause and a verified petition on July 23, 2019, asserting that there were various objections to his liquidation plan and seeking both a judicial resolution of the dispute pursuant to LLC Law § 703 and a declaratory judgment approving the plan.  The Objectors filed a timely answer setting forth their objections, as well as a counterclaim.

Considering the Court’s jurisdiction, Judge Cohen noted that the Court’s power to grant relief in this case was governed by New York’s LLC Law, read in conjuncture with FGLS’s operating agreement.  New York Ltd. Liab. Co. Law § 703(a) (“LLC Law”) provides that in the event of a dissolution, the members of an LLC may wind up its affairs unless the operating agreement provides otherwise.  FGLS’s operating agreement states that upon its dissolution, which was triggered by the Mendelows’ deaths, its members shall elect a person to serve as a liquidator by a majority vote.  Turchin received the votes of 91% of FGLS’s members with positive capital, including the proxy votes of the Objectors. 

Section 703(a) further provides that the court may “wind up the limited liability company's affairs upon application of any member,. . . and in connection therewith may appoint a receiver or liquidating trustee.”  While Judge Cohen stated that the Court could not here appoint a receiver or trustee because it would conflict with the operating agreement, it was nonetheless free to “fashion remedies to speak to the omissions in the LLC statute,” including common law and equitable remedies not specifically enumerated.[1]  Based on this, the Court determined it had jurisdiction to consider and resolve the issues raised by the parties.

After detailing some of the evidence presented by the Objectors, Judge Cohen ultimately held that the Objectors did not meet their evidentiary burden to defeat Turchin’s reliance on the business judgment rule.  While the Objectors sought to portray Turchin as one of Mendelow’s cronies and an active participant in Madoff’s fraud, the court found this was not supported by the evidence.  Instead, it suggested that Madoff’s scheme was a closely-guarded secret within K&W, known only by the highest level partners, and that Turchin was a low-level staff accountant who did not have a good relationship with Mendelow and who had limited involvement in servicing BLMIS accounts. 

Moreover, the Court found that there were colorable arguments on both sides whether it was feasible or merited to bring suit against the Mendelow parties.  New York LLC Law § 409 (b) provides that a manger shall be entitled to rely on counsel in making decisions, and Turchin had consulted with counsel when deciding whether bringing claims was appropriate.  As Judge Cohen noted, there was support in the record for Turchin to have concluded that, even if it could clear potential statute of limitations hurdles, the litigation could delay distribution to the members for years, which could also be consumed by attorneys’ fees. 

By Jeff Kinkle, Ph.D. and Muhammad U. Faridi

[1] Citing LNYC Loft, LLC v. Hudson Opportunity Fund I, LLC, 154 A.D.3d 109, 114 (1st Dep’t 2017).