Snell & Wilmer L.L.P.
1200 17th Street, Suite 1900
Denver, CO 80202
Byeongsook Seo is a member of the Snell & Wilmer L.L.P.’s commercial litigation practice. He represents clients in handling complex and, often, heated disputes related to failed business ventures and disputes among business partners, executives, owners, and directors. Byeongsook is a member and Vice-Chair of the Business Divorce Subcommittee of the ABA Business Law Section Committee on Business and Corporate Litigation. His honors include Colorado Super Lawyers and The Best Lawyers in America. Byeongsook graduated from the United States Air Force Academy and obtained his law degree from the University of Denver, Sturm College of Law.
Heyman Enerio Gattuso & Hirzel LLP
300 Delaware Avenue, Suite 200
Wilmington, DE 19801
Melissa N. Donimirski is an attorney with Heyman Enerio Gattuso & Hirzel LLP in Wilmington, Delaware. She concentrates her practice in the area of corporate and commercial litigation in the Delaware Court of Chancery and has been involved with many of the leading business divorce cases in that Court. Melissa is Co-Chair of the Business Divorce Subcommittee of the ABA Business Law Section, Business and Corporate Litigation Committee. She received her undergraduate degree from Bryn Mawr College and her law degree from the Delaware Law School of Widener University. Melissa has also co-edited and co-authored a treatise on business divorce, which is published by Bloomberg BNA.
Janel M. Dressen
Anthony Ostlund Louwagie Dressen & Boylan P.A.
90 South 7th Street
3600 Wells Fargo Center
Minneapolis, MN 55402
Janel Dressen is a lawyer and shareholder with the litigation boutique firm Anthony Ostlund Baer & Louwagie P.A., located in Minneapolis, Minnesota. Janel has 19 years of experience as a trial lawyer and problem solver. She assists her clients to avoid and prepare for business and employment-related disputes in and outside of the courtroom. Janel spends a significant amount of her time resolving family-owned and privately held business disputes for owners that are in need of a business divorce. In 2019, Janel was selected by her peers to the Top 50 Women Minnesota Super Lawyers list by Super Lawyers. In 2017, Janel was honored as one of Minnesota’s Attorneys of the Year.
One North Wacker Dr.
Chicago, IL 60606
John Levitske, CPA/ABV/CFF/CGMA, ASA, CFA, CFLC, CIRA, MBA, JD, is a Senior Managing Director in the disputes and economics practice of Ankura, a global business advisory and expert services firm. He serves as a business valuation, forensic accounting and damages expert witness, arbitrator, and advisor. John is frequently consulted regarding business disputes, shareholder disputes and post-acquisition transaction disputes. In addition, he is the current Chair of the Dispute Resolution Committee of the Business Law Section and a Member at Large of the Standing Committee on Audit of the American Bar Association.
Neschis & Tolitano, LLC
311 West Superior Street
Chicago, Illinois 60654
Samuel Neschis is a member of Neschis & Tolitano, LLC in Chicago, Illinois. He concentrates his practice in business and commercial litigation and regularly represents parties in complex litigation including shareholder disputes, disputes involving claims of unfair competition, and contractual disputes. He is the former chair and current co-newsletter editor of the Illinois State Bar Association’s Business and Securities Law Section Council.
John C. Sciaccotta
330 N. Wabash Ave.
Chicago, IL 60611
John C. Sciaccotta is a Member at Aronberg Goldgehn. He focuses his practice on litigation, arbitration and business counseling matters with a special emphasis on complex civil trial and appellate cases brought in federal and state courts throughout the United States. John has also been appointed by the American Arbitration Association as an Arbitrator and Lawyer Neutral to adjudicate various claims and disputes in arbitration. For many years he has advised public and privately held businesses, lenders, employers and individuals in business transactions and disputes. He is experienced in dealing with numerous industries and business activities and has a specialty focus on representing entities in business divorce and complex ownership dispute resolution. John is highly active in professional associations and within his community. Among his activities, he is Co-Founder and current Chair of the Chicago Bar Association’s Business Divorce and Complex Ownership Disputes Committee. He served on the CBA’s Board of Managers from 2017 to 2019.
§ 1.1. Introduction
This chapter provides summaries of developments related to business divorce matters that arose from October 1, 2020, to September 30, 2021, from mostly nine states. Each contributor used his or her best judgment in selecting cases to summarize. We then organized the summaries, first, by subject matter, then, by jurisdiction. This chapter, however, is not meant to be comprehensive. The reader should be mindful of how any case in this chapter is cited. Some jurisdictions have rules that prohibit courts and parties from citing or relying on opinions not certified for publication or ordered published. To the extent unpublished cases are summarized, the reader should always consult local rules and authority to ensure the unpublished cases can serve as relevant and permissible precedent. We hope this chapter assists the reader in understanding recent developments in business divorces.
§ 1.2. Access to Books and Records
§ 1.2.1. California
Ramirez v. Gilead Sciences, Inc., 66 Cal.App.5th 218 (Jul. 2, 2021). Beneficial owner of corporation’s shares filed a petition for a writ of mandate seeking to compel corporation to allow him to inspect its books and records. The petition was denied. A registered owner or record holder holds shares directly with the company. A beneficial owner holds shares indirectly, through a bank or broker-dealer. The appellate court affirmed the petition’s denial because only the record owner of the shares or holders of voting trust certificates have standing to inspect a corporation’s books and records under the plain language of Corporate Code section 1601.
§ 1.3. Business Judgment Rule
§ 1.3.1. Colorado
Walker v. Women’s Prof. rodeo Ass’n, Inc., 2021 COA 105M (Sep. 9, 2021). Members brought action against women’s professional rodeo association and rodeo company for breach of fiduciary duty, breach of contract, declaratory judgment, and injunctive relief against the association. The complaint was dismissed as failing to assert plausible claims for relief, considering the business judgment rule. The members’ claims were based on allegations that the association misapplied certain of its internal rules related to how members are compensated for participating in rodeo events. The court noted that fraud, self-dealing, unconscionability, and similar conduct are exceptions to the business judgment rule, which shields the actions of directors who engage in reasonable and honest exercise of their judgment and duties. Since the members had not alleged that the association engaged in fraudulent or similar wrongful conduct, the appellate court affirmed dismissal and chose not to override the association’s interpretation and application of its rules.
§ 1.4. Dissolution
§ 1.4.1. California
Cheng v. Coastal L.B. Assocs., LLC, 69 Cal.App.5th 112 (Sep. 1, 2021). This action involved the purchase of minority interests in an LLC that was equally owned by several siblings, pursuant to Corporations Code 17707.03, subd. (c)(1). Section 17707.03, subd. (c)(1), allows members of an LLC to respond to an application for judicial dissolution by purchasing the interests of the applicant members for fair market value of their interests. The applicant members in this action appealed the trial court’s order confirming the consensus valuation of three appraisers. The applicant members asserted on appeal that the trial court’s order instructing three disinterested appraisers to (a) review each other’s initial valuation reports, (b) confer with each other, and (c) try to reach a consensus valuation violated to Section 17707.03. The appellate court disagreed because there was no statutory language that prohibited or restricted a trial court’s authority to instruct the appraisers as it did.
§ 1.4.2. Delaware
Mehra v. Teller, 2021 WL 300352 (Del. Ch. Jan. 29, 2021). The Delaware Court of Chancery ordered dissolution of a two-member, two-manager LLC due to deadlock, despite also finding that the circumstances giving rise to the deadlock were contrived. In this action, the subject LLC had two members – Mehra and Teller. Teller held a greater membership interest, but Mehra was responsible for the company’s day-to-day management. Accordingly, the two agreed that the LLC would be managed by a two-person board, consisting of Mehra and Teller, and that board action required unanimity. The LLC agreement further provided that, if Teller and Mehra deadlocked, the company would be automatically dissolved.
After facing a series of business setbacks, Teller became critical of Mehra’s management and wished to exit the business partnership. Teller thus devised a plan in which he called a meeting of the board, and proposed a resolution that would remove Mehra from his role as CEO. When Mehra refused to vote on the resolution, Teller declared deadlock and sought to dissolve the company. The Court held that Teller proved that the parties have an irreconcilable disagreement concerning Mehra’s continuing management of Holdco and was sufficient to result in dissolution of the company. In so holding, the Court noted that, where unanimity is the voting threshold, either an abstention or a “no” vote may result in deadlock.
§ 1.4.3. New York
Garcia v. Garcia, 187 A.D.3d 859 (N.Y. App. Div. 2020). As part of a judicial dissolution proceeding, an LLC member appealed a special referee’s finding that he was lawfully expelled. The Appellate Division affirmed the Supreme Court’s interpretation of the operating agreement to allow for expulsion even without a listed mechanism for expulsion in the operating agreement. The court found that expulsion was valid using the general action procedure in the operating agreement, which was a majority vote of members.
§ 1.5. Jurisdiction, Venue, and Standing
§ 1.5.1. Delaware
Lone Pine Res., LP v. Dickey., 2021 WL 3211954 (Del. Ch. Jun. 7, 2021). In an action alleging breach of fiduciary duty for usurpation of corporate opportunities, theft of trade secrets and unjust enrichment, the Delaware Court of Chancery held that it did not have jurisdiction over defendant w entities under the conspiracy theory of jurisdiction where the only jurisdictional hook in Delaware was the formation of plaintiff Delaware entities, which action the Court held was not related to the conspiracy the Complaint sought to rectify relating to the Colorado entities.
In this action, plaintiff entities together operate a crude oil purchasing business. Together, they brought an action alleging that one of their co-founders leveraged his insider positions and the parties’ established structure to operate a secret side business, operated through Colorado entities formed by defendant Dickey, which he fed with the plaintiffs’ business opportunities and property. While the Court held that it had jurisdiction over Dickey for certain claims, it determined that it had no basis to exercise conspiracy theory jurisdiction over the Colorado entities, who had no well-pled contacts with Delaware. The Court held that Dickey’s actions forming Plaintiffs in Delaware was not reasonably related to the conspiracy by which the Colorado defendants were allegedly usurping business opportunities belonging to Plaintiffs. The Court additionally held that it did not have jurisdiction over Dickey for claims related to breaches of fiduciary duty to an LLC for which Dickey was not a manager.
United Food & Commercial Workers Union & Participating Food Indus. Emp’rs Tri-State Pension Fund v. Zuckerberg, 2021 WL 4344361 (Del. Sept. 23, 2021). The Delaware Supreme Court streamlined the standard for determining whether demand upon a board of directors is excused. The Court determined, as an initial matter, that exculpated care claims cannot establish that demand is futile. The Court further adopted the Court of Chancery’s three-part test for determining, on a director-by-director basis, whether demand should be excused as futile:
- whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;
- whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand; and
- whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.
§ 1.5.2. Florida
Rappaport v. Scherr, 322 So. 3d 138 (Fla. Dist. Ct. App. 2021). In a dispute between a minority shareholder and a majority shareholder arising out of the majority’s shareholder’s self-interested conduct during negotiations for the sale of the business to a third party, the court addressed the requirement that a shareholder make a demand to institute litigation on the corporation’s board of directors prior to filing a derivative action. The Florida District Court of Appeal reversed a judgment entered in favor of the minority shareholder in his derivative action because the minority shareholder had not made a pre-suit demand to institute litigation on the board of directors.
The minority shareholder alleged that the majority shareholder breached his fiduciary duty during the sale of the business by concealing information from the minority shareholders and negotiating with the buyer of the business in a manner that furthered his own interests at the expense of the other shareholders. The defendant moved to dismiss the complaint as the plaintiff had not alleged that he had made a demand on the board of directors to institute the action as required by section 607.07401(2) of the Florida Business Corporation Act, which was in effect in 2017 when the complaint was filed. The trial court denied the motion to dismiss and subsequently entered judgment in favor of the plaintiff after a bench trial. However, the appellate court reversed, holding that, as it was undisputed that the plaintiff had not filed a pre-suit demand, the complaint should have been dismissed. The court noted that the plaintiff had made a demand after the filing of the suit but held that this post-filing demand did not comply with the statutory requirement.
The court also rejected the plaintiff’s argument that his failure to make a demand was excused because the demand would have been futile. The court noted that some jurisdictions do provide for a futility exception to the demand requirement. However, in 2017, when the complaint was filed, section 607.07401(2) of the Florida Business Corporation Act was in effect and governed the requirements for the filing of derivative actions by shareholders of corporations. That section did not contain a futility exception to the demand requirement making Florida, at that time, a “universal-demand” jurisdiction.
The court did note that, in 2019, the Florida legislature amended the statute, (now renumbered as section 607.0742). The amended statute, which became effective January 1, 2020, does contain a futility exception to the demand requirement.
Yarger v. Convergence Aviation Ltd., 310 So. 3d 1276, 1281 (Fla. Dist. Ct. App. 2021). In a suit brought by a corporation against a non-resident director, the court examined the issue of whether Florida’s long arm statute provides a court with personal jurisdiction over a non-resident director of a Florida corporation or non-resident manager of a Florida limited liability company for actions that the director or manager took within Florida on behalf of the corporation or LLC.
Orval Yarger, a resident of Illinois, was a director of Convergence Aviation, Ltd. (“Convergence”), a Florida corporation, as well as a manager of Convergence Aviation & Communications, LLC (CACL), a Florida limited liability company that Convergence had formed to purchase and manage property that would be used to house aircrafts that Convergence owned. Yarger was involved in an airplane accident involving an airplane owned by Convergence. The accident occurred in Kentucky while Yarger was returning to Illinois. Yarger kept certain parts that he purchased for the airplane and Convergence sued him for conversion in Florida state court. Yarger moved to dismiss the complaint for lack of personal jurisdiction. The trial court denied the motion to dismiss and Yarger appealed.
Convergence argued that Florida courts had jurisdiction over Yarger pursuant to Florida’s long arm statute (Fl. Stat. § 48.193(1)(a)), which provides, in pertinent part, that a person submits to the jurisdiction of Florida courts for any cause of action arising out of the person’s operating, conducing, engaging in, or carrying on a business or business venture in Florida or having an office or agency in the state. Convergence argued that Yarger was subject to personal jurisdiction under the long arm statute as he carried on activities on behalf of Convergence and CACL in Florida and as the conversion claim arose out of those actions. However, the appellate court held that, because Yarger’s actions within Florida were conducted as an agent of Convergence and CACL rather than for his personal benefit, the long arm statute did not provide a basis for Florida courts to exercise jurisdiction over him personally.
§ 1.5.3. Illinois
Tufo v. Tufo, 2021 IL. App. 192521 (1st Dist. March 24, 2021). This was a business divorce case between two brothers who operated the very successful Discount Fence Co. The Appellate Court affirmed the Circuit Court’s decision finding that the Plaintiff lacked standing under Illinois law to bring a derivative action because of his personal animosity toward the Defendant, and that therefore, he was not qualified to serve in a fiduciary capacity as a representative of the class of shareholders whose interests rests on the fair and impartial prosecution of the action. The Court recognized a conflict between the Plaintiff’s interests and the interests of the parties he purported to represent. The Court also disqualified the Plaintiff for lack of standing based upon the fact that the Plaintiff knew of the wrongdoing before he became a shareholder.
The Court, although having found that the Plaintiff proved the Defendant’s breaches of fiduciary duty by usurping corporate opportunities, also rendered that the Plaintiff failed to present clear and convincing evidence that the Plaintiff’s breach caused any damages.
§ 1.5.4. Massachusetts
Mullins v. Corcoran, 488 Mass. 275, 172 N.E.3d 759, 763 (2021). In a dispute between owners of a real estate development business, the court addressed the issue of whether the doctrine of issue preclusion bars a party from litigating the same issue in separate actions, where the party filed one action individually and the other action derivatively on behalf of an entity.
The case arose out of a dispute between Joseph Mullins, Joseph Corcoran and Gary Jennison, who jointly owned Corcoran, Mullins, Jennison, Inc. and indirectly owned Cobble Hill Center, LLC. Both entities engaged in real estate development and management. The parties’ dispute centered around plans that Corcoran and Jennison had generated for the development of a property known as the Cobble Hill Center site. Mullins initially consented to the plans, but then withdrew his consent. In 2014, Mullins sued Corcoran and Jennison for breach of an agreement that parties had entered into governing the operation of their business and for breach of fiduciary duty for proceeding with the development of the property after his withdrawal of consent (the “2014 Action”). Corcoran and Jennison counterclaimed against Mullins for breach of the agreement and breach of fiduciary duty for initially consenting to the development plans but then withdrawing consent. At the trial, Mullins introduced alternate plans for the development of the site as evidence that Corcoran and Jennison could have mitigated the damages on their counterclaim. The trial court entered judgment against Mullins on both his complaint and on the counterclaim but found that Corcoran and Jennison could have mitigated their damages through one of the alternate plans introduced by Mullins, and, therefore, reduced the damages awarded to them on the counterclaim.
In 2017, while the 2014 Action was still pending, Mullins filed a separate action in which he alleged breaches of the agreement and breaches of fiduciary duty that he alleged occurred after the filing of the 2014 complaint (the “2017 Action”). In the 2017 Action, Mullins also asserted derivative claims on behalf of Cobble Hill Center, LLC. The allegations in the 2017 action centered on Corcoran and Jennison’s refusal to proceed with any of the alternate plans for the Cobble Hill Center site presented by Mullins. Corcoran and Jennison moved for judgment on the pleadings based on the doctrine of issue preclusion. The trial court stayed the case until after the judgment in the 2014 Action had been entered, at which point, the motion for judgment on the pleadings was granted. Mullins appealed that decision and the Massachusetts Supreme Court then transferred the case to itself on its own motion.
The court observed that “[t]he doctrine of issue preclusion provides that when an issue has been actually litigated and determined by a valid and final judgment, and the determination is essential to the judgment, the determination is conclusive in a subsequent action between the parties whether on the same or different claim.” With regard to Mullins’ individual claims, the court held that they were barred by issue preclusion because he had been presented about the alternate plans for development of the property at the trial in the 2014 Action.
However, the more complicated issue was whether issue preclusion barred Mullins’ derivative claims on behalf of Cobble Hill Center, LLC as, in order for issue preclusion to a bar a claim, the party against whom preclusion is asserted must have been a party or in privity with a party to the prior adjudication. The 2014 Action had been filed by Mullins individually not derivatively on behalf of the LLC. The court observed that, because corporations are treated as distinct from their shareholders, ordinarily the parties to direct actions by shareholders and derivative actions filed by shareholders on behalf of their corporations are not considered to be the same. Therefore, ordinarily, a direct action by a shareholder should not be preclusive of a separate derivative action brought by a shareholder on behalf of the corporation. However, the court recognized an exception to that rule for closely held entities where ownership and management are in the same hands. Because Cobble Hill Center, LLC had only three members, all of whom participated in the 2014 Action, the Court held that the LLC’s interests were adequately represented in the 2014 Action. Therefore, the court held that issue preclusion barred Mullins from asserting the same claims in the 2017 Action derivatively on behalf of the LLC that he had asserted individually in the 2014 Action.
§ 1.5.5. New York
Durst Buildings Corp. v Edelman Family Co., No. 652036/2021, 2021 WL 2910316 (N.Y. Sup. Ct. Jul. 8, 2021). An equal member of a Delaware LLC sought judicial dissolution in New York pursuant to a jurisdiction and venue clause selecting New York County in the LLC operating agreement. The Supreme Court dismissed the claim for lack of subject matter jurisdiction, citing that New York courts do not have the subject matter jurisdiction over judicial dissolutions of foreign entities.
§ 1.5.6. Minnesota
Poultry Borderless Co., LLC v. Froemming, No. 20-CV-1054 (WMW/LIB), 2021 WL 354087 (D. Minn. Feb. 2, 2021). The plaintiff, a Texas LLC, sued one of its co-owners, a Minnesota LLC, and its members in federal court invoking 28 U.S.C. § 1332 diversity jurisdiction. The plaintiff and defendant LLCs are both equal owners of TFC Poultry LLC. The court determined that the company, TFC Poultry, was an indispensable party because the plaintiff LLC’s claims were derivative claims alleged on TFC Poultry’s behalf. The plaintiff argued that the claims were direct, not derivative because the board’s composition directly injured the plaintiff. The court concluded that LLC members only have derivative standing when an alleged wrongdoer controls an entity, making TFC poultry an indispensable party. Once the court found TFC Poultry to be an indispensable party, the court dismissed the case for lack of subject-matter jurisdiction because TFC Poultry is a corporate citizen of both Mexico and Minnesota and therefore, there was not proper diversity jurisdiction.
Ross v. Dianne’s Custom Candles, LLC, No. A20-1543, 2021 WL 3852272 (Minn. Ct. App. Aug. 30, 2021). Plaintiff, a member of a Minnesota LLC, brought an action for oppressive conduct seeking judicial dissolution or buyout under Minn. Stat. § 322C.0701 against the LLC and its majority member. Alternatively, the plaintiff sought damages from the defendants for the breach of the duty of good faith and fair dealing. The plaintiff argued that he uniquely suffered losses from not receiving any salary or distribution to offset his tax liability from his ownership interest. As alleged, this injury was partly due to the LLC’s excessive compensation to the majority member. The Court of Appeals agreed with the district court that the claims were derivative, not direct, claims because improper use of corporate funds injures the corporation directly, not the member. The injury is the improper diversion of corporate funds, which requires a derivative action to remedy.
§ 1.5.7. Texas
Cooke v. Karlseng, 615 S.W.3d 911 (Tex. 2021). The Texas Supreme Court reversed and remanded the judgment of the Texas Court of Appeals that Texas courts lack jurisdiction to hear derivative claim asserted directly. In this case, a limited partner sued his business partners for looting the partnership of which he was a member by moving partnership assets to new business entities with which he was not associated without compensating him. The Texas Court of Appeals held that the claim for damages properly belonged to the partnership, not to plaintiff, and that, because the claim was not pleaded derivatively, the court lacked jurisdiction to decide the matter. Citing to Pike v. Texas EMC Mgmt., LLC, 610 S.W.3d 763 (Tex. 2020), the Texas Supreme Court reversed, holding that the authority of a partner to recover for injury to his partnership interest is not a matter of constitutional standing that implicates subject-matter jurisdiction. The Court additionally noted that statutory provisions “define and limit a partner’s ability to recover certain damages.” However, those provisions go to the merits of the claim and do not strip a court of subject-matter jurisdiction to render a judgment in such a case.
§ 1.6. Claims and Issues in Business Divorce Cases
§ 1.6.1. Accounting
§ 188.8.131.52. Colorado
Sensoria, LLC v. Kaweske, 2021 WL 2823080 (D. Colo. Jul. 7, 2021). Investor in a holding company for various cannabis-related entities, on its own behalf and derivatively on behalf of holding company, brought action seeking to recover its investment in holding company against holding company, its subsidiaries, its owner, its managers, its law firm, and other, separate entities that were in competition with holding company allegedly created by holding company’s owner and manager to siphon off assets and cash of holding company. The cannabis-related businesses were legal under Colorado state law. However, Defendants moved to dismiss all claims because the underlying illegality of the business under federal law (Controlled Substances Act, 21 U.S.C. §§ 802, et seq. (“CSA”)), which prevented the federal court from granting any relief that would endorse or require illegal activity or that would impose a remedy paid from assets derived from criminal activity. Since many of the forms of the sought-after remedy would require the court endorsing or implementing criminality, the court dismissed several of the investor’s claims. But one of the few claims that did survive was a claim for accounting. The court determined that the accounting claim was not subject to an illegality defense.
§ 1.6.2. Alternative Entities
§ 184.108.40.206. Delaware
Pearl City Elevator, Inc. v. Gieseke, 2021 WL 1099230 (Del. Ch. Mar. 23, 2021). The Delaware Court of Chancery construed limitations on the transfer of membership interests the subject LLC Agreement in deciding a Section 18-110 action to determine the proper makeup of the company’s Board of Governors. The Court determined that plaintiff Pearl City had complied with the requirements of the LLC Agreement and had acquired sufficient equity to change the composition of the Board. The LLC in question was owned 50% by plaintiff Pearl City and 50% by a disaggregated group of “General Members.” Both Pearl City and the General Members were each entitled to appoint three members to the LLC’s Board of Governors. The LLC Agreement permitted either party to appoint an additional member to the Board of Governors upon accumulation of more than 56% of the LLC’s units.
Pearl City subsequently initiated a campaign to cross the 56% threshold, doing so by engaging in private purchases of membership interests from disaggregated General Members. Members of the Board of Governors elected by the General Members refused to acknowledge such acquisition for purposes of appointing an additional board member, arguing that Pearl City failed to comply with the terms of the LLC Agreement when obtaining additional membership units. In construing the LLC Agreement, the Court held that the Agreement requires Board approval for membership transfers only where the transfer is to a non-Member. The Court further held that the Board may require a legal opinion relating to certain considerations set forth in the LLC Agreement and may defer recognition of any transfer until such opinion is obtained, and that advance notice of a transfer is not required before effectuation of a transfer of membership interests, but that the LLC Agreement provided that notice to the Board was required before such transfer would be deemed effective. The Court found that Pearl City complied with the foregoing requirements and was entitled to add an additional board member to the Board of Governors, thereby obtaining control of the company.
§ 220.127.116.11. New York
Eikenberry v. Lamson, No. 516653/20, 2021 WL 722837 (N.Y. Sup. Ct. Feb. 19, 2021). The plaintiff sued her alleged partner and various limited liability companies, claiming that the partnership oversaw the entities. The Supreme Court held that a plaintiff could demonstrate that a partnership operated a limited liability entity, but only if the plaintiff alleged facts showing that the partnership intended to survive the creation of the entity and that the entity was created to serve a specific purpose. The plaintiff did not meet that factual burden, and the Supreme Court dismissed all the plaintiff’s claims related to alleged corporate activity.
Farro v. Schochet, 190 A.D.3d 689 (N.Y. App. Div. 2021). The plaintiff, previously a 50% LLC member, commenced direct and derivative claims against the LLC, the other 50% LLC member, and a lender after a cash-out merger eliminated his interest. The Appellate Division found that appraisal is the exclusive remedy under New York’s Limited Liability Company Law § 1005. The plaintiff also could not seek recission of the merger on the grounds of fraud under § 1005, repeating that appraisal was a member’s sole and exclusive remedy under New York’s LLC Law. The plaintiff also could not maintain a derivative action for breach of fiduciary duty, removal of a manager, or equitable request for accounting because he lacked a membership interest, and his only remedy was appraisal.
Compare to Johnson v. Asberry, 190 A.D.3d 491 (N.Y. App. Div. 2021). The defendant LLC member appealed the denial of their motion to dismiss. The Appellate Division affirmed the denial because the plaintiff LLC member properly alleged fraud by omission that resulted in a freeze-out merger. The Appellate Division found that equitable relief would be an available remedy for the alleged fraud, citing New York’s Business Corporation Law § 623[k].
§ 1.6.3. Breach of Fiduciary Duty
§ 18.104.22.168. Florida
Taubenfeld v. Lasko, 324 So. 3d 529 (Fla. Dist. Ct. App. 2021). In a case arising out of a dispute between two fifty percent shareholders of a corporation, the court addressed the pleading requirements for claims of breach of fiduciary duty and aiding and abetting breach of fiduciary duty. The plaintiff, who had been the president of the corporation, alleged that the defendant usurped the position of president and assumed sole control over the company. The plaintiff further alleged that the mother of the defendant then established a separate limited liability company that provided the same services as the corporation. The defendant, with the assistance of his mother, father, and brother, transferred assets of the corporation including its business relationships, customer list, and vehicles to the new company. The plaintiff filed a derivative action on behalf of the corporation alleging that the defendant had breached his fiduciary duties of loyalty and care by wasting the corporation’s assets through causing them to be transferred to the new company. The plaintiff’s complaint also included claims of aiding and abetting breach of fiduciary duty against the defendant’s mother, father, and brother.
The trial court dismissed the complaint finding that the allegations lacked sufficient factual support regarding the specific duty that the plaintiff was alleging that the defendant owed and because the nexus between the defendant’s conduct and the damage to the corporation was unclear and speculative. However, the appellate court reversed, holding that the allegations that the defendant had mounted a takeover of the company, diverted the corporation’s relationships and revenues to the new company, and executed documents to transfer the corporation’s assets to a competitor were sufficient to state a claim that the defendant had breached his fiduciary duties as an officer of the corporation. The court further held that the plaintiff had stated claims for aiding and abetting breach of fiduciary duty against the defendant’s mother, father, and brother as he had alleged that each of these family members knew of the defendant’s breaches and assisted those breaches by, among other things, helping him divert assets to the new company.
§ 22.214.171.124. Minnesota
Clintsman v. Gervais, No. 62-CV-19-8677, 2021 WL 3417833 (Minn. Dist. Ct. Mar. 23, 2021). Two sibling plaintiffs commenced an action against their five siblings involving their family real estate business, which consisted of various Minnesota limited liability companies. Plaintiffs’ claims included oppression, breach of the duty of good faith and fair dealing, and breach of statutory and common law fiduciary duties. The district court granted summary judgment for the plaintiffs on their claims of oppression, breach of the duty of good faith and fair dealing and breach of fiduciary duties. The court found that undisputed evidence of multitudes of derogatory comments made by the defendants along with intentional exclusion from material communications and secret recordings supported finding that the defendants were liable for at least one act of unfairly prejudicial conduct constituting oppression and breach of fiduciary duties. The court then granted the plaintiffs’ motion for a fair value buyout from the family LLCs.
§ 126.96.36.199. Texas
Straehla v. AL Glob. Servs., LLC, 619 S.W.3d 795 (Tex. App. 2020). The Court of Appeals of Texas held that Plaintiff AL Global Services established a prima facie case that defendant Jorrie breached his fiduciary duty of loyalty and duty not to usurp corporate opportunities. In so holding, the Court noted that, while the Texas Business Organizations Code does not directly address the duties a manager or member owes to their LLC, the Court of Appeals has previously held that the Code “presume[s] the existence of fiduciary duties.” In this case, defendant Jorrie, a member and manager of AL Global diverted opportunities owned by the company to his own business, which had originally served as a subcontractor to AL Global. Among other things, Jorrie encouraged and exploited a personal relationship between his business partner and one of AL Global’s clients to move related business opportunities into his own, competing business. The Court additionally held that a prima facie case had been plead for knowing participation in breach of fiduciary duties against employees of the client, one of whom was engaged in the personal relationship with Jorrie’s business partner.
§ 188.8.131.52. New York
John v. Varughese, 194 A.D.3d 799 (N.Y. App. Div. 2021). The plaintiff brought a derivative breach of fiduciary duty claim against the managing member of the LLC. The Supreme Court entered judgment after a nonjury trial in favor of the managing member because of the operating agreement’s exculpatory clause, which exculpated the managing member from breach of fiduciary duty liability, except for actions or omissions that were “in bad faith or involved intentional misconduct or a knowing violation of law or that he personally gained in fact a financial profit or other advantage to which he was not legally entitled.” Id. at 801. The Appellate Division reversed the Supreme Court as to one act and found that the managing member intentionally breached a fiduciary duty by transferring $50,000 from the LLC to an unrelated entity that he then used for his personal attorney’s fees not authorized by the LLC’s operating agreement. The court entered judgment in favor of the plaintiff on that claim.
Celauro v. 4C Foods Corp., 187 A.D.3d 836 (N.Y. App. Div. 2020). Celauro, a minority shareholder of a family-owned, closely held corporation, 4C Foods Corp., filed suit against the majority shareholders for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing. The Supreme Court awarded summary judgment for the defendants regarding these claims. The Appellate Division affirmed, finding that the defendants did not breach a fiduciary duty or an implied covenant of good faith and fair dealing by following a valid stock transfer restriction that required majority consent for any transfer of shares. The defendants acted appropriately to avoid disrupting the corporation’s operations. The transfer of shares would have given the plaintiff more than 20% of voting shares, allowing the plaintiff to pursue a judicial dissolution proceeding under N.Y. Bus. Corp. Law § 1104-a. The Appellate Court also found that the plaintiff did not suffer damages by increasing the authorized amount of non-voting shares and issuing a non-voting share dividend because the defendants adopted an amendment to the shareholder agreement that appraised the non-transferable shares at pre-dilution value.
Shilpa Saketh Realty, Inc. v. Vidiyala, 191 A.D.3d 512 (N.Y. App. Div. 2021). A minority shareholder sued the other shareholders of a pharmaceutical corporation for fraud, breach of fiduciary duty, and unjust enrichment in connection with the sale of the corporation. The plaintiff alleged that it relied on the defendants to negotiate on its behalf. Before the sale, a stock purchase agreement reduced only the plaintiff’s percentage of shares, which the plaintiff alleged was misrepresented by the defendants. The plaintiff signed the stock purchase agreement, which included a general release of claims against the corporation and its equity holders. The Supreme court dismissed the plaintiff’s claims as barred by the release as a matter of law. The Appellate Division reversed, finding that plaintiff’s claims were not barred as a matter of law by the release because the plaintiff may have reasonably relied on the defendants to act on its behalf. The court noted the plaintiff alleged a united relationship at the time of negotiations. The court also excused the plaintiff from reading the agreements, though the court did not explain its reasoning.
CIP GP 2018, LLC v. Koplewicz, 194 A.D.3d 639 (N.Y. App. Div. 2021). An investment company sued its business partners from a cannabis laboratory venture for breach of contract, promissory estoppel, unjust enrichment, breach of fiduciary duty, minority oppression, and misappropriation of trade secrets. The plaintiff appealed the Supreme Court’s dismissal of its claims of promissory estoppel, unjust enrichment, breach of fiduciary duty, minority oppression, and misappropriation of trade secrets. The Appellate Division found that the plaintiff adequately alleged an oral partnership and then reversed the Supreme Court’s dismissal of the plaintiff’s unjust enrichment and promissory estoppel claims. The court found these claims not to be duplicative because a plaintiff may pursue both quasi-contract theories and breach of contract. The Appellate Division affirmed the dismissal of the breach of fiduciary duty and minority oppression claims as duplicates of the breach of contract claim. The court further affirmed the dismissal of the misappropriation of trade secrets claim because the plaintiff failed to allege that business methods it shared willingly were trade secrets.
§ 1.6.4. Breach of Contract and Breach of Covenant of Good Faith and Fair Dealing
§ 184.108.40.206. Delaware
In re Cellular Telephone P’ship Litig., 2021 WL 4438046 (Del. Ch. Sept. 28, 2021). The Delaware Court of Chancery held that a majority partner did not breach the subject partnership agreement by “manag[ing] the Partnership however it wished” because a Management Agreement executed by the Partnership delegated broad authority to manage the business and affairs of the Partnership to AT&T, despite the efforts of the minority partner to demonstrate that AT&T exceeded the scope of authority delegated in the Management Agreement. The Court noted that, because the Management Agreement was between AT&T and the Partnership, a derivative claim for breach of the Management Agreement might have succeeded. This was because AT&T’s failure to comply with the provisions of the Management Agreement would give rise to a breach that is cognizable only derivatively, while Plaintiffs’ direct claim was focused on AT&T exceeding the scope of its delegated authority.
The action involved a general partnership between AT&T, which held 98.119% of the partnership interest, and the minority partners, who collectively owned the remaining 1.881% partnership interest. The partnership agreement provided that governance of the partnership was delegated to an Executive Committee. The Partnership Agreement provided for a three-member Executive Committee, with two representatives appointed by the majority partner and one by the minority partners. In practice, however, AT&T only acted through the Executive Committee on formal matters, such as authorizing a distribution to the partners, and generally ran the business of the Partnership as it pleased.
Plaintiffs sought to prove a direct claim for breach of the Partnership Agreement under Section 15-405(b)(1) of the Delaware Partnership Act by demonstrating that AT&T exceeded its delegated authority under the Management Agreement. The Court held that the delegation of authority was expansive and ruled in favor of AT&T on the direct claim. The Court noted, however, that AT&T’s failure to comply with its contractual commitments regarding how AT&T would exercise its delegated authority could support a claim for breach of the Management Agreement, a claim that could only be brought derivatively. Because plaintiffs failed to assert such a claim, the Court ruled in favor of AT&T.
§ 220.127.116.11. Florida
Triton Stone Holdings, L.L.C. v. Magna Business, L.L.C., 308 So. 3d 1002, 1005 (Fla. Dist. Ct. App. 2020). In a case arising out of negotiations between the members of a struggling limited liability company for the sale of some of the members’ interests to another member, the court addressed the requirements for enforceability of an agreement for the transfer of membership interests. After a two-day meeting between the representatives of the four members of Lotus, a Florida limited liability company, the parties handwrote a document containing certain agreed upon terms for the sale by three of the members to the fourth member. The agreed upon terms memorialized in the handwritten document included the purchase price, term, governing law, identity of personal guarantors, and costs and fees in the event of default. The handwritten document referenced future contracts and promissory notes to be drafted; however, no future contracts or promissory notes were ever drafted. The purchasing member made some of the payments identified in the handwritten document but failed to make all of the payments. The selling members filed suit to enforce the handwritten document, which they alleged constituted an enforceable agreement for the sale of their membership interests. The purchasing member argued that the handwritten document was not enforceable because it lacked essential terms.
The trial court found that the handwritten document was enforceable and entered judgment for the selling members. However, the appellate court reversed, holding that the handwritten document was unenforceable as it lacked essential terms. The court looked to the company’s operating agreement, which provided that no transfer shall be valid unless the transferee signs the operating agreement as appropriately amended to take account of the terms of the transfer. The court further held that, while certain terms were contained in the handwritten document, essential terms regarding the transfer of the interests were not included. Among the missing material terms were a closing date, provisions for the issuance and transfer of certificates, releases, indemnification provisions, and any provision for mandatory execution of the operating agreement or amendment. As the handwritten document lacked essential terms and as the parties had failed to follow the mandatory procedure for a transfer of membership interests set forth in the operating agreement, the court held that the handwritten document was not enforceable.
§ 18.104.22.168. Texas
Adam v. Marcos, 620 S.W.3d 488 (Tex. App. 2021). The Court of Appeals of Texas upheld the trial court’s refusal to find breach of an oral partnership agreement where the agreement was between an attorney and his client. Plaintiff Adam – a businessman – and defendant Marcos – had a long-standing attorney/client relationship by which Marcos provided legal services for Adam’s various business ventures. The two subsequently orally agreed to form a partnership for future joint ventures, sharing costs and profits evenly. Marcos would provide legal services, while Adam would run the day-to-day operations. The agreement was purportedly seal with a celebratory “fist bump,” but no agreement was ever reduced to writing. Marcos provided Adam with startup funds in the amount of $250,000 and subsequently provided all legal services free of charge. Adam denied the existence of such an agreement, instead claiming that Marcos provided funds for Adams to invest in his companies, and that the legal services were provided in barter for other de minimis services.
While the Court credited Marcos’ testimony that that an oral agreement to form a partnership existed, the Court held that such arrangement was invalid because of the attorney/client relationship between the two parties. The Court held that a presumption of unfairness or invalidity attaches to contracts between attorneys and their clients due to the fiduciary nature of the relationship. The Court further held that Marcos failed to carry his burden to prove the fairness and reasonableness of the agreement, including the burden to establish that Adam was informed of all material facts relating to the agreement, particularly where Marcos, Adam’s attorney, allowed him to agree to a “fist bump” deal without any formal writing.
§ 1.6.5. Fraud
§ 22.214.171.124. Colorado
McWhinney Centerra Lifestyle Center LLC v. Poag And McEwen Lifestyle Centers-Centerra LLC, 2021 COA 2 (Jan. 14, 2021). Financing member of LLC filed suit against managing member of LLC after a failed joint venture to build and operate a shopping center. Financing member asserted breach of fiduciary duty and breach of contract claims under an operating agreement requiring the application of Delaware law, as well as common law fraudulent concealment, intentional interference with contractual obligations, civil conspiracy, and intentional inducement of breach of contract. Following a bench trial, the court concluded managing member breached both its fiduciary duties and contractual obligations under the agreement and awarded $42,006,032.50 to financing member in damages plus interest but dismissed most of financing member’s intentional tort claims under the economic loss rule. The court of appeals first noted that the operating agreement’s choice of law provision did not govern related tort claims. Then, the appellate court reversed the dismissal of the intentional tort claims due to recent developments in Colorado precedent that ruled that the economic loss rule cannot bar statutory tort claims even if they are related to the operating agreement. The appellate court extended the precedent’s rationale to apply to common law intentional tort claims. However, the dismissal of the civil conspiracy claim was affirmed because the claim was based on an alleged conspiracy to breach the operating agreement and, thus, remained subject to the economic loss rule.
§ 1.6.6. Interference
§ 126.96.36.199. Florida
Bridge Financial, Inc. v. J. Fischer & Associates, Inc., 310 So. 3d 45, 49 (Fla. Dist. Ct. App. 2020). In a case involving a shareholder-employee’s copying of customer information for the use by a competing business, the court addressed the issue of whether a shareholder of a corporation can tortiously interfere with the corporation’s business relationships. Three former employees of J. F. Fischer & Associates, Inc. (“JFA”), a corporation that provides tax preparation services, copied and appropriated the customer list and then resigned to form a competing company. One of those employees, Adam Palas (“Palas”), was a five percent shareholder of JFA. The employees used the customer list to solicit JFA’s clients for their new business. JFA sued for violation of the Florida’s Uniform Trade Secrets Act (“FUTSA”) and tortious interference with a business relationship. A jury found for JFA. The defendants moved for a new trial, arguing that the customer list did not constitute a trade secret. The trial court denied the motion and the defendants appealed. The appellate court affirmed the denial of the motion for a new trial holding that the customer list did constitute a trade secret under the FUTSA because the JFA had spent a significant amount of time, effort, and money developing the client list, which was kept on a password protected server and was not publicly available.
However, with regard to the tortious interference claim, the trial court had entered judgment on the pleadings in favor of Palas because he was a five percent shareholder of the corporation. JFA filed a cross-appeal of this judgment. The appellate court affirmed the trial court’s entry of judgment on the pleadings, explaining that a tortious interference claim must be directed to a third party that interferes with a business relationship. Therefore, as Palas was an owner of the corporation, he was a party to the corporation’s business relationships with its clients and “could not interfere with a business relationship with himself”.
§ 1.6.7. Equitable/Statutory Relief
§ 188.8.131.52. Colorado
Sensoria, LLC v. Kaweske, 2021 WL 2823080 (D. Colo. Jul. 7, 2021). Investor in a holding company for various cannabis-related entities, on its own behalf and derivatively on behalf of holding company, brought action seeking to recover its investment in holding company against holding company, its subsidiaries, its owner, its managers, its law firm, and other, separate entities that were in competition with holding company allegedly created by holding company’s owner and manager to siphon off assets and cash of holding company. The cannabis-related businesses were legal under Colorado state law. However, Defendants moved to dismiss all claims because the underlying illegality of the business under federal law (Controlled Substances Act, 21 U.S.C. §§ 802, et seq. (“CSA”)), which prevented the federal court from granting any relief that would endorse or require illegal activity or that would impose a remedy paid from assets derived from criminal activity. Since many of the forms of the sought-after remedy would require the court endorsing or implementing criminality, the court dismissed several of the investor’s claims, including theft, fraud, negligent misrepresentation, breach of fiduciary, aiding and abetting breach of fiduciary duty, civil conspiracy, unjust enrichment/constructive trust, mandatory injunction, RICO, and securities law-based claims.
However, the court did not dismiss certain other claims because they did not directly implicate the CSA in any way. The Court permitted an accounting and recission claim to survive but dismissed all aspects of the investor’s equitable claims that would have the practical effect of transferring cannabis-related assets to the investor. As for the investor’s derivative claims on behalf of the holding company against its law firm, the Court permitted a malpractice claim to proceed because the allegations raised issues of disloyalty and conflict of interest.
§ 184.108.40.206. Minnesota
Gerring Properties Inc. v. Gerring, No. A20-0032, 2020 WL 7490729 (Minn. Ct. App. Dec. 21, 2020), review denied (Mar. 16, 2021). The parties in Gerring Properties Inc. are two equal shareholder factions of brothers and their children that reached a shareholder deadlock regarding two family corporations. One brother was terminated from the corporation and brought a claim seeking equitable relief under Minn. Stat. § 302A.751, subd. 1(b)(4). The Court of Appeals affirmed the district court’s finding that the brother reasonably expected to be continually employed by the companies. The court further supported the district court’s finding that his termination violated that reasonable expectation even with evidence of the brother’s misconduct after weighing that misconduct against evidence that the termination was meant to force the brother and his wife to transfer shares and become less than 50% shareholders. This conduct and the admitted shareholder deadlock supported the need for an equitable remedy of a buyout. After the district court evaluated equitable remedies by a special master’s report, the Court of Appeals did not find that the district court abused its discretion by not applying a marketability discount to the buyout value or ordering a dissolution after the buyout failed. The district court did not abuse its discretion by adopting the special master’s valuation or awarding attorney fees under Minn. Stat. § 302A.751 because of specific findings that the opposing faction of shareholders acted “arbitrarily, vexatiously, and in bad faith,” which included failure to hold shareholder meetings, comply with court-ordered disclosure of financial records, and unfair use of bank loan proceeds.
§ 220.127.116.11. New York
ALP, Inc. v. Moskowitz, No. 652326/2019, 2021 WL 2416509 (N.Y. Sup. Ct. June 11, 2021). As part of a history of family business conflict and litigation between the children of artist Peter Max, the plaintiff corporation and its CEO, the daughter of Peter Max, sought a preliminary injunction to enjoin a special shareholder meeting pursuant to New York’s Business Corporation Law §§ 706(d), removal of directors, and 716(c), removal of officers. The plaintiffs alleged that the son and the father’s guardian entered into an improper shareholder voting agreement. The agreement promised the guardian’s vote to re-elect the son and oust the daughter as CEO and board chair in exchange for the son’s promise to return the artwork and intellectual property currently owned by the corporation to the father. The plaintiffs provided evidence that the guardian previously supported the daughter as an officer and director of the corporation and that the son breached his fiduciary duties by improperly diverting corporate assets. The Supreme Court found that the plaintiffs demonstrated a likelihood of success on the claims and would suffer irreparable harm if the vote were allowed to take place, resulting in the significant diversion of the corporation’s assets.
§ 1.7. Valuation and Damages
§ 1.7.1. California
Cheng v. Coastal L.B. Assocs., LLC, 69 Cal.App.5th 112 (Sep. 1, 2021). In an appeal regarding the value of the plaintiff’s membership interest in a judicial dissolution action regarding a Limited Liability Company (“LLC”), the California Appellate Court concluded that the standard of value under the statute for corporate shares do not apply to membership interests in Limited Liability Companies. The Appellate Court affirmed the Trial Court decision, which relied on a majority appraisal by the panel of three appraisers it had appointed in which the appraisers used a fair market value standard of value and considered discounts. The Appellate Court considered that the parties had stipulated to an order that the standard of value is fair market value, and commented, “Fair market value includes discounts reflected in the market… had the Legislature intended to apply a ‘fair value’ standard to purchase of membership interests… it would have done so expressly in the statutory language.” Furthermore, the Appellate Court considered that the definition of “fair market value” from Internal Revenue Service, Revenue Ruling 59-60 has largely been adopted in California, “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts.”
Furthermore, the Appellate Court concluded that the Trial Court was not required to de novo determine the value when the appointed appraisers panel did not unanimously agree because the Trial Court found no error in the appraisers’ separate appraisals and acted in its authority to order the appraisers to confer to explore for a consensus on valuation.
§ 1.7.2. Delaware
In re Cellular Telephone P’ship Litig., 2021 WL 4438046 (Del. Ch. Sept. 28, 2021). In an action where the Delaware Court of Chancery found breach of a partnership agreement, the Court declined to award a dissociation remedy under the subject partnership agreement, which would have required the sale of the majority partner’s partnership interest to the minority partner, finding that such a remedy would “be unconscionably disproportionate.” Instead, to remedy the breach of the partnership agreement, the Court ordered the majority partner to pay compensatory damages equal to the pro rata value that the minority partner would have received had the partnership agreement not been breached. The Court noted that, “[i]f the plaintiffs had shown that AT&T had committed a breach that deprived the minority partners of meaningful value, and particularly if AT&T’s breach was willful or persistent, then dissociation damages could be warranted. The damages awarded were nominal.
§ 1.7.3. Illinois
Payroll Servs. by Extra Help v. Haag, 2021 IL App (5th) 200036-U. In an appeal regarding the value of the defendant’s 25 percent shareholder interest in a privately-owned corporation pursuant to the parties’ shareholder agreement, the Illinois Appellate Court affirmed the Trial Court’s decision to determine that the fair market value is the average of the valuations prepared by the plaintiff’s and defendant’s respective experts.
At trial, the Court determined that the analysis prepared by the defendant’s expert was not a “valuation” within the meaning of the shareholders agreement, and instead a “calculation analysis.” The Court considered that the defendant’s expert “’explained that a calculation analysis does not include all of the valuation procedures required for a valuation analysis,’ and that if a valuation analysis had been performed, ‘the results may have been different, and the difference may have been significant.” The defendant’s expert testified at trial that the expert and client “agreed on a calculation engagement because of a lack of reliable financial data and an inability to gain cooperation from” the company.
Regarding the shareholders agreement, the Court noted that the purchase price “shall be equal to the sum of the fair market value… determined by the Fair Market Value Determination, as hereinafter defined… Fair Market Value Deter determination shall be defined by the valuation of the Corporation by a mutually agreed upon business valuation company…. If there cannot be a mutually agreed upon business valuation company then such valuation shall be the average of two valuations (one chose by the Corporation and one chosen by the Shareholder whose shares are being sold).”
The Court considered “that the parties did not agree on the meaning of the term ‘valuation’ as used in the Agreement.” Ultimately, the Court “determined that the term ‘valuation’ should be defined in accordance with the definition of ‘valuation’ in the business valuation industry, and that the calculation analysis submitted by… [defendant’s] expert was not a sufficient ‘valuation’ under the terms of the Agreement.”
Furthermore, the Court noted that the… [defendant’s expert’s] testimony and correspondence indicated that… [defendant’s expert] was aware of ‘valuation’ in the business valuation industry. During its analysis, the Court considered that both experts were CPAs and that AICPA valuation standards contain definitions, which it quoted as stating “There are two types of engagements to estimate value – a valuation engagement and a calculation engagement. The valuation engagement requires more procedures than the calculation engagement.”
During the second round of summary judgment motions, the defendant’s supporting memorandum for the motion was accompanied by a “’Full’ Valuation” prepared by defendant’s expert which came to the same valuation quantum conclusion as the original “calculation analysis.” Defendant’s expert “stated that she conducted additional research and inquiries… conducted a comparative analysis of the company over time … and performed the valuation engagement and reached a conclusion in compliance with the AICPA Statement on Standards for Valuation Services;” that “Every piece of evidence obtained through the more in-depth review and examination of… [the company] affirmed her earlier opinion that a guideline company valuation method was the most appropriate… and that the consideration of… [the company’s recent acquisition of payroll companies supported” her conclusion and that “She uncovered nothing in the review that changed her initial opinion.”
Ultimately, the Court concluded that the “Full” Valuation “met the definition of ‘valuation’ under the terms of the Agreement” and declared “That the fair market value… was the average of the valuations” by the plaintiff’s and defendant’s respective experts.
On appeal, the plaintiff’s claimed that the defendant’s expert’s “Full” Valuation was a not a “valuation” within the meaning of the shareholders agreement. The plaintiff’s contended that the defendant’s expert did not ever perform a “valuation,” “But instead offered the same ‘calculation analysis’ and renamed it a business valuation.”
The Appellate Court noted that “’valuation is not defined in the Agreement. The Agreement does not specify the type of engagement required to estimate value,” and that “The plaintiffs, as drafters of the Agreement, could have included provisions requiring… using only a valuation engagement that complied with the standards of the AICPA, but that was not done here.” The Appellate Court found “error in the trial court’s determination that ‘valuation’ should be defined in accordance with the definition of ‘valuation’ in the ‘business valuation industry.” In absence of a definition in the Agreement, the word ‘valuation’ should be assigned its plain and ordinary meaning.”
Further, the Appellate Court considered definitions of “valuation” from popular dictionary and a legal dictionary. Nevertheless, the Appellate Court concluded that “Even if the meaning of ‘valuation,’ as defined in the [AICPA] Statement on Standards, was applicable, it would not alter the outcome of this case… it recognizes ‘two types of engagements to estimate [the] value [of a business] – a valuation engagement and a calculation engagement.” In reaching this conclusion, the Appellate Court noted that “The plaintiffs presented no evidence to rebut… [defendant’s expert’s] testimony that she complied with her obligations to perform a valuation engagement.”
§ 1.7.4. Indiana
Hartman v. BigInch Fabricators & Constr. Holding Co., 161 N.E.3d 1218 (Ind. 2021). In an appeal from a Court of Appeals decision which found that valuation discounts did not apply in a closed-market compulsory buy-back sale of shares of a minority interest, the Indiana Supreme Court determined that there is no universal rule prohibiting discounts in these situations and where the shareholders agreement suggests fair market value as the standard that discounts may be particularly applicable. The Supreme Court reversed the Court of Appeals.
The shareholders agreement specified that the company would buy the interest at “appraised market value,” determined by an independent valuator in according with generally accepted accounting principles. In this case, the independent valuator applied discounts for both lack of control and lack of marketability.
At trial, the plaintiff contended that discounts did not apply because this is a compulsory closed-market sale and that the agreement does not specify fair market value as the valuation standard. Plaintiff did not exercise his contractual right to obtain an additional third-party valuation.
The Trial Court found that as used in the agreement, the “adjective” of “appraised” modified the term “market value” and that “appraised market value” meant fair market value. However, the Appellate Court found that in a compulsory sale that discounts are not applicable and reversed the Trial Court.
As stated by the Supreme Court in its decision on this appeal, “we hold that the parties’ freedom to contract may permit these discounts, even for shares in a closed-market transaction,” and “under the plain language of this shareholder agreement – which calls for the ‘appraised market value’ of the shares – the discounts apply.”
Furthermore, the Supreme Court found that case law regarding statutory buyouts “doesn’t control” because “the valuation terms come not from a statute but from a contract.” The Supreme Court also commented that the parties’ freedom to contract may permit discounts and that the plaintiff had provided no evidence to show that the independent appraiser had not correctly quantify fair market value.
§ 1.7.5. Iowa
Guge v. Kassel Enters., 962 N.W.2d 764 (Iowa 2021). The Iowa Supreme Court ruled that in a buyout under Iowa’s election-to-purchase-in-lieu-of-dissolution statute, where both parties’ experts included transaction costs as a reduction to the value of a minority interest of stock in a corporation under a net asset value approach, that it was error for the Trial Court to not reduce value for the transaction costs on the enterprise level. However, where there was no evidence of intention to liquidate that an adjustment for built-in gains tax is not warranted. The Supreme Court reversed the Trial Court regarding the transaction costs and remanded the case.
This was the first time that the Supreme Court addressed a “fair value” determination under Iowa’s election-to-purchase-in-lieu-of-dissolution statute. The family-owned corporation held farmland which did not generate any income from operations. During its analysis, the Supreme Court considered that, in its view, the weight of authority leans towards courts not discounting values for tax consequences absent contemplation of liquidation triggering built-in gain tax consequents.
§ 1.7.6. Kentucky
Kenneth D. Parrish, DMD, Ph.D., P.S.C. v. Schroering, 2021 WL 1431604 (Ky. Ct. App. Apr. 16, 2021). In an appeal of a jury’s decision to determine its own buyout price of a professional practice partnership 50 percent ownership interest instead of an appraisal under the terms of the partnership agreement, the Kentucky Appeals Court considered that there was no evidence that the appraisers used the wrong valuation approach under the agreement. The Appeals Court reversed and remanded the case back to the Trial Court.
In this case, the agreement stated that the buyout price under the partnership agreement was to be the average of the closest of two of the three appraisal experts. The two closest appraisals when averaged resulted in a negative value. Those two appraisals were based on the net asset value approach. The appraiser retained by the partner being bought out concluded a substantially higher, positive value, than either of the other two appraisers. That appraiser used an income approach. The jury decided to make its own value determination because it believed that a demonstrable mistake of fact underlies the two closest appraisals.
On appeal, the plaintiff contended that it was improper for review of the appraisals to go to the jury. The Appeals Court considered that there was no indication that the two appraisers misinterpreted the partnership agreement’s provision regarding value and that they chose the asset approach because they deemed the partnership to have insufficient cash flow to justify use of the income approach. Consequently, the Appeals Court concluded that the two appraisers’ rationale for applying the asset approach was not a demonstrable mistake of fact and the standard that would allow a jury to review an appraisal had not been met.
§ 1.7.7. Minnesota
Ionlake, LLC v. Girard, No. CV 20-640 (SRN/BRT), 2021 WL 632605 (D. Minn. Feb. 18, 2021). Third-party defendant, Derrick Girard, is a founding member of the plaintiff, Ionlake, LLC. The third-party defendant moved to amend his counterclaim to claim punitive damages pursuant to Minn. Stat. § 549.20 against his uncle and co-founder of Ionlake, LLC, Wade Girard. Section 549.20 requires that the claimant show by “clear and convincing evidence that the acts of the defendant show deliberate disregard for the rights or safety of others,” which is statutorily defined as meaning that “the defendant has knowledge of facts or intentionally disregards facts that create a high probability of injury to the rights or safety of others.” The District Court of Minnesota found that Derrick sufficiently alleged facts to support a punitive damages claim by alleging that his uncle falsely filed a copyright application as the sole owner of a software program owned by the LLC, created a competing company to sell licenses for the software program, threatened to suspend the LLC’s access to the software, and then fulfilled that threat by terminating the LLC’s access to the software.
Mork & Assocs., Inc. v. Willow Run Partners, No. A19-1914, 2021 WL 771693 (Minn. Ct. App. Mar. 1, 2021). Willow Run Partners (WRP) was a limited partnership with the sole purpose of developing and operating a low-income residential apartment building. After initiating claims revolving around the embezzlement of WRP funds, limited partners and the managing general partner, Mork, agreed to submit the dispute to a receiver. The district court disagreed with the receiver regarding the interpretation of distribution under the Limited Partnership Agreement (LPA) and distributed funds equally between general and limited partners by rendering the repayment priority moot. According to the district court, the repayment priority was moot because the sale proceeds exceeded the initial contributions made by the general and limited partners. The Court of Appeals reversed the district court’s interpretation of the LPA that disregarded repayment, finding that the LPA required the repayment priority. The first step of the LPA repayment unambiguously referred to past distributions, not future distributions. The LPA also lists the steps in numerical order, and each step refers to the balance from the previous step. Without this priority plan, the general partners received more than they would have under the plan. Considering the language and effect of the repayment priority plan, the Court of Appeals reversed the district court’s interpretation of the LPA.
§ 1.7.8. Nebraska
Wayne L. Ryan Revocable Tr. v. Ryan, 308 Neb. 851, 957 N.W.2d 481 (2021). In this appeal, the Nebraska Supreme Court upheld all the Trial Court’s findings in a family-owned business buyout dispute regarding the value of the shares of the founder’s majority ownership interest in the corporation.
On appeal, the company contented that the Trial Court had failed to independently review all the relevant evidence because in its decision it adopted all the plaintiff’s proposed valuation findings, the plaintiff’s expert’s proposed valuation “improperly assumed synergies,” and disregarded Letters of Intent from potential buyers during an attempt to solicit bids for acquisition of the company. The Supreme Court said a Trial Court may consider a variety of material valuation factors because the “real objective is to ascertain the actual worth of what the [shareholder] loses” and listed a variety of examples of commonly considered business valuation factors. Furthermore, the Supreme Court undertook its own de novo review of the record and found that the determination of the Trial Court regarding value was based on fact, principle and reasonableness.
The Supreme Court pointed out that there was no evidence that synergies were incorporated into the valuation and that the Trial Court considered that two of the Letter of Intent bids were near the concluded value by the plaintiff’s expert which the Trial Court adopted. In addition, the Supreme Court noted that since there was not a completed or nearly completed transaction upon which to extract pricing evidence and that the attempt to solicit to solicit bids for acquisition of the company was defective, that the attempt “did not reliably reflect the market’s view regarding… [the company’s] value.”
Ultimately, the Supreme Court found that the Trial Court reviewed “each area of disagreement between the valuation expert and found [plaintiff’s expert’s] valuation to be reasonable and supported by the evidence” and that “each part of [defendant’s expert’s] analysis… reflected a downward bias which rendered his conclusions unreliable.”
§ 1.7.9. New York
Derderian v. Nissan Lift of New York, Inc., 192 A.D.3d 1021 (N.Y. App. Div. 2021). A 50% shareholder sought the judicial dissolution of the closely held corporation. The corporation elected to purchase the plaintiff’s shares, but after a valuation hearing, the Supreme Court determined that the shares had no fair market value. The Appellate Division affirmed this finding because the corporation’s valuation expert properly considered the threat of creditor judgments of more than $3 million, and the plaintiff sold inventory out of trust. Further, the plaintiff did not come forward with credible evidence to invalidate the expert’s testimony.
Derderian v. Nissan Lift of New York, Inc., 192 A.D.3d 1021 (N.Y. App. Div. 2021). A 50 percent shareholder in a corporation in a judicial dissolution of a closely-held corporation case appealed the Trial Court’s decision that the value of his shares is zero. The Supreme Court of New York, Appellate Division affirmed the Trial Court’s decision because “The determination of a factfinder as to the value of a business, if it’s within the range of testimony presented, will not be disturbed on appeal where the valuation rests primarily on the credibility of the expert witnesses and their valuation techniques” and that the Trial Court’s “determination that the fair value… was zero is supported by the evidence.”
The Appellate Division Court noted “The corporation’s expert testified that the petitioner’s stock shares had no value due to his having sold inventory out of trust, and the resulting impact upon the corporation’s assets of the petitioner having done so… [and] he factored into his valuation that at least two creditors had commenced separate actions against the corporation seeking judgments in excess of more than $3 million.” In addition, the Appellate Division Court noted “Although the petitioner’s expert prepared a report in which she opined that the value of the corporation exceeded $6 million, when cross-examined, her testimony revealed that the valuation set forth in her report was flawed since it neither accounted for the actions commenced against the corporation nor for the inventory that had been sold out of trust by the petitioner.”
§ 1.7.10. North Carolina
Finkel v. Palm Park, Inc., 2020 NCBC LEXIS 137. In a breach of fiduciary and constructive fraud dispute among members of a Limited Liability Company, the North Carolina Superior Court entered a judgment for judicial dissolution. The parties sought to avoid dissolution of the company by agreeing to purchase the interest of the plaintiff’s minority member interest at fair value and agreed that the Limited Liability Company, which held real estate, should be valued under the net asset value approach without discounts. A dispute arose regarding the valuation.
The Court issued an Amended Final Judgment allowing the majority owner to elect to purchase the minority owner’s interest. The majority owner made the election. The Court appointed “a receiver solely for the purpose of managing the operations and business… until the sale of… [plaintiff’s] membership interest to… [the majority owner defendants] is completed.” The parties jointly retained a real estate appraiser to value the real estate properties and who undertook a net asset value calculation.
The majority owner defendants objected to the jointly retained real estate appraiser’s report and a Court hearing occurred. The parties disagreed over whether the company was a real estate holding company, as the plaintiff asserted, or an investment holding company, as defendants asserted. The defendants retained an accredited business valuation expert who testified at the hearing and based his valuation an orderly liquidation premise. The plaintiff asserted that an orderly liquidation premise is not appropriate because the purpose of the buyout was to avoid a dissolution liquidation.
The Court noted that under the relevant statute, “The buyout of the ‘complaining member’ was to occur ‘at its fair value in accordance with any procedures the court may provide’… There exists no case law on the standards for applying this statute.” Furthermore, the Court noted that relevant case law exists that a court has flexibility in determining fair value, cited valuation factors cited in the case law, and agreed with the parties that U.S. Internal Revenue Ruling 59-60 provides useful guidance for valuation of closely-held companies such as the subject company. The Court decided that fair market value, under Revenue Ruling 59-60, was informative and quoted that definition of fair market value. In addition, the Court commented that fair market value is not focused on the specific participants in a specific transaction, rather it assumes a sale between a hypothetical buyer and hypothetical seller. It continued that according to relevant case law, “market value is not the sole determinant of fair value but is a factor to be given heavy weight. It is the starting point for any valuation.”
Regarding the real estate appraiser’s report, the Court agreed with the defendants that the report was “suspect” considering that the appraiser corrected “significant errors” in his original report, but “for some reason, was attempting to justify the values reached in the [original] Reports. However, he did so without providing a sound basis for the changes in his assumptions and methodology.” The Court accepted the real estate appraiser’s overall methodology considering that he was “highly experienced and respected” and that his methodology was generally accepted in commercial real estate appraisal. The defendant’s business valuation expert used aspects of the real estate appraiser’s values and methodology, but deducted liquidation costs, capital gains taxes and profit participation payment, under an orderly liquidation premise.
The Court used the defendant’s business valuation expert’s report as a starting point and considered that the parties agreed that discounts were not appropriate. Furthermore, it considered that, pursuant to Revenue Ruling 59-60, “there is no dispute that the orderly liquidation premise is an accepted method for determining the fair market value of holding companies.”
Ultimately, the Court decided that it could and would consider the fact of an actual dissolution would not occur in this case, but that the evidence showed that the company faced considerable business challenges and declining market conditions, and the business provided a livelihood for the defendants. The Court concluded by rejecting the subtraction of capital gains taxes, and noting that, under fair value “this does not necessarily consider the specific circumstances involved in this case in assessing the equities” and “the statue provides that flexibility.” Therefore, the Court used the orderly liquidation valuation, based upon the defendants’ business valuation expert’s valuation but with correction for subtraction of capital gains taxes.
§ 1.7.11. Utah
Armstrong v. Sabin, 2021 WL 3473256 (D. Utah Aug. 6, 2021). In this case, the defendant elected to purchase the member interests of the other two owners in a Limited Liability Company in lieu of dissolution. The defendant owned 40 percent, and the other two members, the plaintiffs, each owned 30 percent. According to the U.S. District Court for the District of Utah, “The parties were unable to agree on the value of the Plaintiff’s interests, so the court must determine the value under” the Utah statute and held a hearing “to determine the fair market value of the applicant member’s interest in the limited liability company as of the day before the petition under” the Utah statute “was filed or as of any other date the district court determines to be appropriate under the circumstances and based on the factors the district court deems appropriate.”
The Court noted that the Utah statute requires “the Court must determine (A) the appropriate valuation date” and “(B) the fair market value of Plaintiff’s 30% interests on that date.” In determining the appropriate valuation date, the Court considered that defendant had “acted in ways that devalued” the company, “but cannot ignore the Plaintiff’s part… Both of these actions subsequently lowered” the company’s “value.” It noted, “Plaintiff’s proposed valuation date would allow Plaintiff’s to avoid the consequences of their own actions would not be equitable.” Considering the date stated in the Utah statute, the Court selected the date it deemed “the most equitable valuation date… because it captures the fruits of both parties’ actions.”
In beginning its analysis of fair market value, the Court considered that the relevant section of the Utah statue did not define fair market value but noted that the definition in the International Glossary of Business Valuation Terms is consistent the with the definition in other portions of the Utah Code. It concluded therefore that the Court would use the fair market value definition from the International Glossary of Business Valuation Terms.
Next, the Court considered that the differences in the asserted valuations “are the result of differences in (1) the projections used and (2) the discounts applied.” Both parties’ experts used the discounted cash flow method to determine the value of the income of the company and the Court found that to be an appropriate methodology because the company could have rehired employees and continued operating as of the selected valuation date.
Regarding projections, the Court considered and compared the experts’ respective projections and internal company evidence regarding projections, such as sales plans and budgets. In selecting among the projections of growth, it deemed appropriate the projection which “would have been known or knowable as of the valuation date.” Furthermore, the Court considered that evidence existed “that the liquid herbal supplement industry is expected to grow more rapidly in the coming years because of an aging population and the general focus on health…. [and] enjoyed unusual growth during the COVID-19 pandemic, which was ongoing as the time of the valuation date.” It concluded, “Because of these opposing factors, the Court will rely upon the averages of the expert’s projected growth.”
Furthermore, the Court resolved the different assertions regarding projected gross profit by relying upon actual product costs applied to historical financial statements with a similar customer base, which “relies on data that was known or knowable as of the valuation date.” In resolving differences among asserted projected operating expenses, the Court selected the use of historical operating expense, which “excluded all of the disputed expenses and nonessential expenses from the calculations” and “separately calculated salaries for employees with fixed salaries and employees with variable salaries like commissions. However, the Court adjusted “for the lower revenue projected by the Court,” selected the “average of the experts’ projected depreciation and amortization,” and subtracted income taxes.
In determining terminal value beyond the forecasted period in the valuation, the Court noted “the parties had very similar capitalization rates” and the Court applied the last projected future year’s cash flow and capitalization rate.
Regarding discounts, the Court rejected the plaintiffs’ contention that their individual 30% interests should be valued as one 60% interest. The Court stated “the fair market value standard requires the Court to consider what separate hypothetical buyers would pay for each Plaintiff’s interest. To conclude otherwise would implement a different standard such as investment value, which considers who is buying the interests and the value to that specific person.” It also found that there was not oppressive conduct, that the two 30% owners could together exercise voting control, and that even if there hypothetically was oppressive conduct that both sides were similarly engaged in misconduct. The Court therefore concluded “there is not basis – legal or equitable – to exclude the discounts typical of a fair market value analysis.” Ultimately, the Court relied upon and applied the percentage discounts for lack of control and lack of marketability from the only expert’s report which had quantified such discounts.
§ 1.7.12. Virginia
Jones v. A Town Smoke House & Catering Inc., 106 Va. Cir. 168 (2020). This matter was before the Circuit Court of the City of Waynesboro, Virginia, to establish the value for the purchase in lieu of dissolution of the plaintiff’s one-third ownership interest in the shares of stock of a private corporation.
Both parties’ experts used income approaches. The plaintiff’s expert primarily used a capitalization of income method because he deemed the current income level stabilized and the defendant’s expert used, with a 100% weight, a discounted cash flow approach because he deemed that future cash flows will vary as a result of the then recently passed Tax Cuts and Jobs Act of 2017 which changed the way depreciation is calculated for income tax purposes. Each expert also considered other methodologies.
On a more detailed basis, the Court found that the plaintiff’s expert’s view that the income level was stabilized was inconsistent with his testimony that in applying the market-based approach, which was his secondary-weighted methodology, he considered that the company experienced “operational inefficiencies.” The Court viewed this inconsistency as a failure by the plaintiff’s expert to adjust in his income approach for those inefficiencies.
Regarding the market-based approach, the Court deemed it a less reliable methodology because of the lack of similarity in qualitative and quantitative characteristics of potentially comparable companies or transactions, lack of information regarding the motivation of the buyers and sellers of potentially comparable transactions, and whether the terms of potentially comparable transactions were all in cash. Furthermore, the Court considered that “income methods are utilized to value stock in a corporation as a going concern.”
In its analysis, the Court reviewed pertinent sections of the Virginia Code regarding fair value and determined that “Application of minority or marketability discounts in a corporate dissolution are therefore discretionary after consideration of all relevant facts and circumstances of the case.” Regarding minority discounts, the Court noted that “all three corporate shareholders own equal shares therefore, there is not a controlling interest by any one shareholder” and therefore a minority position discount is not applicable. The Court also found that “discounted cash flow calculations inherently incorporate the applicable discount for lack of control and all three shareholders own a minority position.” The Court did not apply a minority discount, in distinction from the discount for lack of control which it had mentioned.
Regarding marketability discounts, the Court stated, “Virginia does not follow the majority rule and instead requires the application of the marketability discount unless doing so would be unjust or inequitable.” The Court also considered that the plaintiff’s “stock is a restricted stock given the limitations imposed by the bylaws…. [the] stock is a minority interest in a corporation. No dividend has been paid on the stock, there was no pending prospects of a public offering or sale of business, and there were no prospective buyers of the stock.” In addition, the Court reviewed the parties’ contentions regarding whether oppressive conduct occurred. It found that oppressive conduct had been established and commented “Abrupt removal of a minority shareholder from positions of employment and management can be a devastatingly effective squeeze-out technique.” As a result, the Court deemed this a “squeeze-out” of a minority owner case. Accordingly, “the Court finds that application of the marketability discount would be unjust and inequitable in this case.”