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Litigating Closely Held Business Disputes: Breach of Fiduciary Duty, Breach of Contract and Shareholder Oppression

Identifying Causes of Action; Pursuing Emergency Injunctions, Partition and Dissolution; Tackling Valuation Issues

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WEDNES DAY, MAY 21, 2014

Presenting a live 90-minute webinar with interactive Q&A

Michele Lorbieski Anderson, Managing Associate, Frost Brown Todd, Indianapolis Alison G. Greenberg, Counsel, Fensterstock & Partners, New Y

• rk

Aaron Chausmer, Member, Chausmer Law, Atlanta

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Litigating Closely Held Business Disputes

Michele Lorbieski Anderson manderson@fbtlaw.com May 21, 2014

Today’s Topics:

• Causes of Action
• Remedies
• Valuation Issues
• Derivative vs. Direct Claims

6

Shareholder Oppression

• Commingling of Funds
• Restrictions on Dividends
• Reduced Repurchase Price
• Waste

7

Causes of Action

• Compel Inspection
• Breach of Fiduciary Duty
• Fraud
• Breach of Contract

8

Breach of Fiduciary Duty

• Duty of Loyalty

Usurpation of Corporate Opportunities Self Dealing

• Duty of Care

Business Judgment Rule Entire Fairness

9

• Duties in Corporations
• Duties in Partnerships
• Duties in Limited Liability Companies
• Duties in Closely Held Businesses

10

Breach of Fiduciary Duty

Minority Shareholder Rights

• Inspection of Corporate Records
• Shareholder Meetings
• Repurchase of Shares
• Direct or Derivative Claims

11

Inspection of Corporate Records

• Limited Access

Statute Partnership Agreement Articles of Incorporation Bylaws Operating Agreement

• Proper Purpose

Whether the request for inspection is reasonably related to the plaintiff's interest as a shareholder.

• Confidentiality Agreements

12

Shareholder Meetings

• Annual Meeting
• Special Meeting
• Notice Requirement
• Shareholder Consent

13

Fraud

• Fraudulent Inducement
• Securities Fraud
• Pleading Requirements
• Evidentiary Issues

14

Breach of Contract

• Governing Documents
• Shareholder Agreement
• Implied Covenant of Good Faith

and Fair Dealing

15

CLOSELY HELD BUSINESS DISPUTES

REMEDIES

MAY 21, 2014

Alison G. Greenberg

Fensterstock & Partners LLP 100 Broadway New York, New York 10005

• Tel. (212) 785-4100

Fax (212) 785-4040 agreenberg@fensterstock.com www.fensterstock.com

Preliminary and Permanent Injunction- Temporary Restraining Orders

• Where to file in consideration of ultimate relief.
• Jurisdictional amount at issue and nature of claim.
• Commercial Division, New York County - monetary threshold is

$500,000 and look to nature of claim.

• Temporary Restraining Order
• Whether ex parte or notice required, and type of notice.

17

Preliminary and Permanent Injunction

• New York CPLR 6301 “Where it appears that immediate and

irreparable injury, loss or damage will result unless the defendant is restrained before the hearing can be held.”

• Is client prepared to post a bond.
• Fact affidavit from party required in New York.
• Seek expedited discovery.

18

Injunctive Relief - Preliminary and Permanent Injunction

• Account for official conduct
• Set aside conveyance, assignment or transfer where

transferee knew of unlawfulness

• Enjoin actions.
• Appoint receiver pending new election where directors are

acting fraudulently or in bad faith.

Welcke v. Trageser, 131 A.D. 731, 116 N.Y.S. 166 (1st Dep’t 1909)

• Where appraisal not available, injunctive relief to stockholders

may be appropriate.

Goldberg v. Meridor, 567 F.2d 209 (2nd Cir. 1977) 19

Partition

• Physical division by sale and distribution of net proceeds.
• Sale of a co-owner’s interest by another co-owner.
• Partition by appraisal.
• Action for partition with appointment of referee.
• Claims for accounting, breach of lease or breach of fiduciary duty to

be filed in separation action.

• Referee with additional capacities.

20

Partition

• Article 9 of New York Code
• Interlocutory judgment – N.Y. RPA Law §915
• Venue – County where property situated
• Challenge to referee final report.
• Koniosis v. Tsororos, 83 A.D.3d 665, 920 N.Y.S.2d 403 (2nd Dep’t 2011)
• Partition is equitable in nature.
• Fee award to referee.
• Partition and other relief denied where based on oral agreement.
• Razavi v. Shackelford, 260 Ga. App. 603, 580 S.E.2d 253 (2003)

21

Dissolution

• Limited Liability Companies

Whenever it is not reasonably practicable (New York)

In re 1545 Ocean Ave., LLC, 72 A.D.3d 121 (2nd Dep’t 2010)

• Partnerships and Corporations

Oppressive conduct against a limited partner or minority shareholder.

Horning v. Horning Constr. LLC, 12 Misc.3d 402, 413, 816 N.Y.S.2d 877 (N.Y. Sup. Mar. 21, 2006)

• Disagreements between partners with regard to an accounting,

without more, are insufficient to warrant dissolution.

Red Sail Easter Ltd. Partners, L.P. v. Radio City Music Hall Prods., Inc., 1992 WL 251380 (De. Ch. Sept. 29. 1992). 22

Other Relief

• Money Damages
• Lost profits
• Punitive damages
• Attorneys’ fees (if contractual term)
• Accounting
• Ultimate relief sought
• Constructive Trust
• Confidential relationship or fiduciary duty owed

23

Forced or Amicable Buy-Out

• Buy- Out
• Valuation

Marketability Discount

Balsamides v. Protameen Chems., Inc., 160 N.J. 352 (1999)

• Indemnification

24

CLOSELY H ELD BUSINESS DISPUTES

Derivative or Direct Claim s

• and-

Valuation Concerns

May 21, 20 14

Three Ravinia Drive, Suite 1875 · Atlanta, GA 30346 404.856.3992 P · 404.478.8494 F · chausmerlaw.com

Aaron B. Chausmer

26

Derivative

• r Direct?

KNOW the Applicable Law!

Is the entity a dom estic or foreign entity?

◊ Many entities may operate solely in one jurisdiction, but have been incorporated in a different jurisdiction, such as Delaware. ◊ See, e.g., O.C.G.A. § § 14-2-747 and 14-11-807 (“In any derivative action in the right of a foreign [corporation or limited liability company], the matters . . . shall be governed by the laws of the jurisdiction of organization of the foreign limited liability company . . .”).

27

Derivative

• r Direct?

Is the Entity a Form al “ Close” Corporation?

If so, claimant may be able to proceed directly. Statutory “close” corporations often have special statutory considerations. See, e.g., O.C.G.A. § 14-2-940 (“a shareholder of a statutory close corporation may petition the superior court” for relief); see also Grace Bros., Ltd. v. Farley Indus., Inc., 264 Ga. 817, 819, 450 S.E.2d 814, 816 (1994) (“outside the context of a close corporation, a shareholder must be injured in a way which is different from the other shareholders or independently of the corporation to have standing to assert a direct action”)

28

Derivative

• r Direct?

Is the Claim Direct or Derivative?

To determine if claim is direct or derivative, look at the nature of the alleged wrong. ◊ Who was harmed? ◊ Is the claim an asset of the Entity? ◊ Who needs to be protected?

29

Derivative

• r Direct?

Is the Claim Direct or Derivative?

For a direct claim, Owner must generally allege a separate and distinct injury or a right that exists independent of any right

• f the Entity.

For a derivative claim, the Owner acts on behalf of the Entity because the Entity was harmed. ◊ Conversion or misappropriation

• f Entity assets

◊ Breach of Fiduciary Duty by Officers and Directors ◊ Corporate waste

30

Derivative

• r Direct?

Is the Claim Direct or Derivative?

Reasons for to require derivative suit: ◊ prevents multiple lawsuits ◊ protects corporate creditors by putting proceeds back in the Entity ◊ protects all Owners, instead of benefitting only one Owner ◊ Owner is compensated by increasing value of interest

See Thom as v. Dickson, 250 Ga. 772, 301 S.E.2d 49 (1983)

31

Derivative

• r Direct?

Derivative Claim s Have Special Conditions

◊ There is generally a pre-litigation demand requirement. ◊ See, e.g., O.C.G.A. § 14-2-742 (shareholder must make written demand for “suitable action” and Entity has 90 days to act, unless demand would be futile or irreparable injury would result) ◊ Because claim belongs to Entity, Owner must give the Entity a chance to act on the claim.

32

Derivative

• r Direct?

Derivative Claim s Can Face Early Dism issal

◊ Courts may defer to the Entity’s “business judgment” and dismiss the derivative case if exercised in good faith and by independent decision-makers. ◊ See, e.g., O.C.G.A. § 14-2-744 (may be dismissed if action is “not in the best interests of the corporation” as determined by independent directors or persons). ◊ Is because the Claim belongs to the Entity, not the Owner

33

Derivative

• r Direct?

Derivative Claim s Rem ain Subject to Court Oversight

◊ Because the Claim belongs to the Entity, the Owner cannot unilaterally dismiss or settle the Claim without Court approval. ◊ And Court may require notice to non-party shareholders or members. ◊ See, e.g., Fed. R. Civ. P. 23.1(c) (“derivative action may be settled, voluntarily dismissed, or compromised

• nly with the court's approval”); see also

O.C.G.A. §§ 14-2-745 and 14-11-804.

34

Valuation

What is the Valuation For?

◊ Different Claims May Have Different Items being Valued. ◊ Is minority interest contesting treatment or bring a claim? ◊ What state or statute applies? ◊ “Fair Value” is not “Fair Market Value” ◊ Valuing Interest at Issue or Entity as a Whole (then pro rata value)

35

Valuation

Different Valuation Methodologies ◊ Income or Capitalized Earnings Method ◊ Market Approach Method ◊ Cost Approach Method ◊ Others? Valuations May Be More Art Than Science.

36

Valuation

Know Thy Entity

Valuation methodology may be influenced by Entity-specific factors: ◊ Professional Services ◊ Financial Services or Banks ◊ Agricultural/ Farming ◊ Manufacturing ◊ Real Estate

37

Valuation

Minority Interests are Routinely “ Discounted” as Part of Valuation Discount is because a bona fide purchaser would not likely pay full price for interest: ◊ Interest May Have Limited Marketability or Transferability ◊ Lack of Control over Entity (dividends, policies, etc.) ◊ Cannot Force Sale of Corporate Assets or Dissolution

38

Valuation

Other Potential Areas of Valuation Inform ation ◊ Divorce Cases ◊ IRS Matters