LLC Law § 407(a) Permits Freeze-Out Mergers to be Approved on Written Consent

On October 30, 2014, Justice Kornreich of the New York County Commercial Division issued a decision in Slayton v. Highline Stages, LLC, 2014 NY Slip Op. 24333, granting a partial motion to dismiss.

In the underlying special proceeding, the petitioner was (upon this decision) a 13.33% member of Highline Stages, LLC, a New York LLC. In August 2013, she was informed by written notice that every other member of Highline Stages had approved a freeze-out merger by written consent, whereby Highline Stages would be merged into a new entity, HS Merger Partner, LLC, and Slayton would be tendered fair value for her equity in Highline Stages. She was offered $50,000, which she refused.

Petitioner commenced a special proceeding, bringing causes of action for declaratory judgment and money damages on the basis that the merger was void because no members’ meeting was held to approve the merger as required by section 1002(c) of the New York LLC Law. (Highline Stages had no LLC agreement.) Alternatively, the petition also sought a judicial determination of fair value, and attorneys’ fees.

The respondents moved to dismiss the first two causes of action, arguing that LLCL § 407(a) allows mergers on written consent. The court agreed:

LLCL § 407(a) provides:

Whenever under this chapter members of a limited liability company are required or permitted to take any action by vote, except as provided in the operating agreement, such action may be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action so taken shall be signed by the members who hold the voting interests having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all of the members entitled to vote therein were present and voted.

(Emphasis added by the court.)

Although no appellate court has construed LLCL § 407(a), the court rejected the petitioner’s policy argument that mergers were “extraordinary and required a meeting before a member can be frozen out,” finding that the LLCL provisions were unambiguous on their face, and that a meeting required to approve a merger does not come “with greater attendant rights than any other meeting required by the LLCL.”

Accordingly, because the necessary written consents were obtained, and the “prompt notice” required by LLCL § 407(c) was provided to the petitioner, the freeze-out merger was valid. The first two causes of action were dismissed, and further proceedings were scheduled to resolve the fair value dispute.

Defendants’ Indirect Connections to New York Insufficient to Establish Personal Jurisdiction

On November 6, 2014, the First Department issued a decision in Bluewaters Communications Holdings, LLC v. Ecclestone, 2014 NY Slip Op. 07600, affirming a trial court’s dismissal of foreign defendants for lack of personal jurisdiction.

In Bluewaters Communications Holding, the First Department affirmed the holding that there was not jurisdiction over defendants in New York, explaining:

Plaintiff maintains that the personal jurisdiction defendants committed a tort outside the state that caused injury within the state (see CPLR 302[a][3][ii]), i.e., its loss of New York-based customers, nonparties Apollo Management, L.P. and King Street Capital Management, L.L.C. However, the complaint does not refer to Apollo and King Street as plaintiff’s customers; rather, it refers to them as plaintiff’s financiers. Contrary to plaintiff’s argument, the complaint does not allege tortious interference with plaintiff’s economic relations with Apollo and King Street.

In any event, the event that gave rise to the injury did not occur in New York. That event occurred when Ecclestone persuaded defendant Gerhard Gribkowsky (a German), via the promise of money, to steer the sale by defendant Bayerische Landesbank Anstalt des Öffentlichen Rechts (BLB) (a German bank) of its shares of nonparty Speed Investments Limited (a Jersey company) to defendant CVC Capital Partners Ltd. (an English company) instead of plaintiff’s predecessor in interest (a Jersey company with offices in Jersey and London).

Plaintiff argues that the personal jurisdiction defendants are subject to New York jurisdiction because they conspired with CVC, which transacted business in the state (see CPLR 302[a][1]) by buying the Speed shares owned by nonparty Lehman Commercial Paper, Inc., which had an office in New York. However, plaintiff does not meet the requirements for establishing conspiracy jurisdiction. For example, CVC’s purchase of Lehman’s Speed shares was not a tort, and the complaint does not allege that CVC bought those shares at the direction, under the control, at the request, or on behalf of the personal jurisdiction defendants. The mere conclusory claim that an activity is a conspiracy does not make it so.

Plaintiff alleges that Ecclestone and Bambino bribed Gribkowsky in U.S. dollars and that the payments went from nonparties First Bridge Holding Limited (a Mauritius company) and Lewington Invest Limited (a British Virgin Islands company) to nonparty GG Consulting (an Austrian company). Plaintiff contends that, because the payments were made in U.S. dollars, they must have gone through New York banks. However, Ecclestone’s and Bambino’s indirect use of the New York banking system does not constitute the transaction of business in New York pursuant to CPLR 302(a)(1). Nor does it constitute the commission of a tort within New York pursuant to CPLR 302(a)(2). Unlike the third-party defendants in Mashreqbank PSC v Ahmed Hamad Al Gosaibi & Bros. Co. (2010 NY Slip Op 33909[U], *12 [Sup Ct, NY County 2010], revd on other grounds 101 AD3d 1 [1st Dept 2012], revd on other grounds 23 NY3d 129 [2014]), Ecclestone and Bambino — the alleged payors of the bribe — did not fraudulently gain funds for their own benefit. Nor does American BankNote Corp. v Daniele (45 AD3d 338 [1st Dept 2007]) avail plaintiff with respect to its CPLR 302(a)(2) argument, since that case dealt with jurisdictional discovery and involved a greater connection to the New York metropolitan area than the instant action.

(Internal quotations and citations omitted).

Separate Entity Rule Prevents Garnishment of Assets in Foreign Bank Through its New York Branch

On October 23, 2014, the Court of Appeals issued a decision in Motorola Credit Corp. v. Standard Chartered Bank, 2014 NY Slip Op. 07199, upholding the “separate entity rule” to prevent a judgment creditor from ordering a garnishee bank operating branches in New York to restrain a judgment debtor’s assets held in foreign branches of the bank.

The Motorola decision arose from Motorola Credit Corp.’s efforts to enforce a judgment of the United States District Court for the Southern District of New York, awarding it $2.1 billion in compensatory damages, and an additional $1 billion in punitive damages, against members of the Turkish Uzan family who had “perpetuated a huge fraud” against Motorola relating to the financing of a telecommunications company. The federal “District Court entered an order pursuant to Federal Rules of Civil Procedure 65 and 69 and CPLR 5222 restraining the Uzans and anyone with notice of the order from selling, assigning or transferring their property,” which Motorola served on the New York branch of Standard Chartered Bank (SCB). Although the Uzans had no assets at SCB’s New York branch, the bank seized approximately $30 million in assets held by the bank in the United Arab Emirates. When regulatory authorities in the UAE quickly intervened by unilaterally debiting the frozen account, SCB sought relief from the District Court’s restraining order, contending that, “under New York’s separate entity rule, service of the restraining order on SCB’s New York branch was effective only as to assets located in accounts at that branch and could not freeze funds situated in foreign branches.” Motorola countered that the judge-made “separately entity rule” was abrogated by the Court of Appeals’ decision in Koehler v. Bank of Bermuda Ltd., 12 N.Y.3d 533 (2009), which held that a judgment creditor could seek the turnover of stock certificates located outside the country so long as the court had personal jurisdiction over the garnishee. The District Court held that the separate entity rule precluded Motorola from restraining assets at SCB’s foreign branches. On appeal, the Second Circuit certified the issue to the Court of Appeals.

In a decision by Judge Graffeo (joined by Chief Judge Lippman and Judges Read, Smith and Rivera), the Court of Appeals held that the separate entity rule applied and precluded enforcement of the restraining order against assets at SCB’s foreign branches. First, the Court rejected the argument that the separate entity rule had been overturned by Koehler. The Court noted that the doctrine was not raised by the parties, or discussed by the Court, in that decision, and that the rule was, in any event, inapplicable in Koehler because the case did not involve “bank branches” or “assets held in bank accounts.” The majority also “decline[d] Motorola’s invitation to cast aside the separate entity rule”:

[T]he doctrine has been a part of the common law of New York for nearly a century. Courts have repeatedly used it to prevent the post judgment restraint of assets situated in foreign branch accounts based solely on the service of a foreign bank’s New York branch. Undoubtedly, international banks have considered the doctrine’s benefits when deciding to open branches in New York, which in turn has played a role in shaping New York’s status as the preeminent commercial and financial nerve center of the Nation and the world.

In large measure, the underlying reasons that led to the adoption of the separate entity rule still ring true today. The risk of competing claims and the possibility of double liability in separate jurisdictions remain significant concerns, as does the reality that foreign branches are subject to a multitude of legal and regulatory regimes. By limiting the reach of a CPLR 5222 restraining notice in the foreign banking context, the separate entity rule promotes international comity and serves to avoid conflicts among competing legal systems. And although Motorola suggests that technological advancements and centralized banking have ameliorated the need for the doctrine, courts have continued to recognize the practical constraints and costs associated with conducting a worldwide search for a judgment debtor’s assets.

* * *

We believe that abolition of the separate entity rule would result in serious consequences in the realm of international banking to the detriment of New York’s preeminence in global financial affairs.

(Citations and internal quotation marks omitted.)

Judge Abdus-Salaam dissented in a decision joined by Judge Pigott. The dissent urged the rejection of the separate entity rule on four grounds:

(1) The rule is inconsistent with the text of Article 52 of the CLPR, which provides no special exemption for “third parties that are banks, or branches of banks, from complying with [a] restraining notice.”

(2) The rule is obsolete “[i]n this day of centralized banking and advanced technology, [when] bank branches can communicate with each other in a matter of seconds.”

(3) A “blanket rule” shielding foreign bank branches from complying with restraining notices served on a New York branch is not necessary to promote international comity, as there will not always be a conflict between New York law and the law of the foreign forum; considerations of comity can be taken into account on a case-by-case basis.

(4) “Although the Koehler court did not address the separate entity rule, Koehler’s interpretation of CPLR article 52 and its holding that article 52 has extraterritorial reach cannot be reconciled with . . . the separate entity rule.”

Client’s Failure To Appeal Adverse Decision Bars Legal Malpractice Claim Only Where The Client Was Likely To Have Succeeded On Appeal

On October 21, 2014, the Court of Appeals issued a decision in Grace v. Law, holding that a client’s failure to pursue an appeal in an underlying action does not bar a malpractice action arising from that action, unless the client was likely to have succeeded in the appeal.

In Grace, the plaintiff, whose medical malpractice claim had been dismissed on statute of limitations ground, brought a legal malpractice claim against his attorneys for failing to timely pursue the lawsuit. The attorneys argued that any malpractice claim against them was barred because the plaintiff had failed to pursue a “nonfrivolous” appeal of the dismissal of the underlying action. The plaintiff countered that the failure to pursue an appeal should not bar a malpractice claim unless the appeal was “likely to succeed.” The Court of Appeals agreed:

On balance, the likely to succeed standard is the most efficient and fair for all parties. This standard will obviate premature legal malpractice actions by allowing the appellate courts to correct any trial court error and allow attorneys to avoid unnecessary malpractice lawsuits by being given the opportunity to rectify their clients’ unfavorable result. Contrary to defendants’ assertion that this standard will require courts to speculate on the success of an appeal, courts engage in this type of analysis when deciding legal malpractice actions generally. We reject the nonfrivolous/meritorious appeal standard proposed by defendants as that would require virtually any client to pursue an appeal prior to suing for legal malpractice.

(Internal citations omitted).

Court Applies Rules of Common Law Dissolution to Shareholder Dispute

On October 28, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Cortes v. 3A N. Park Ave Restaurant Corp., 2014 NY Slip Op. 24329, discussing the process of common law dissolution.

In Cortes, the plaintiff brought an action relating to his investment in a restaurant. The court wrote a comprehensive decision after trial addressing many interesting issues; it is worth reading in its entirety. This post focuses on the court’s discussion of common law dissolution. The court explained that:

the remedy of common-law dissolution is available only to minority shareholders who accuse the majority shareholders and/or the corporate officers or directors of looting the corporation and violating their fiduciary duty. These grounds parallel, to some degree, the statutory grounds for judicial dissolution set forth in BCL §1104-a, which is unavailable to plaintiff because he does not reach the threshold criteria of owning at least 20% of the corporation. However, the equitable remedy of judicial dissolution at common law remains available where the shareholders in control have been looting the company’s assets at the expense of the minority shareholders, continuing the corporation’s existence for the sole purpose of benefitting those in control, and have sought to force and coerce the minority shareholders to sell and sacrifice their holdings to those in control. As explained by the Court of Appeals in Matter of Kemp & Beatley[Gardstein](64 NY2d 63 [1984]), historically, minority shareholders were granted standing in the absence of statutory authority to seek dissolution of corporations when controlling shareholders engaged in certain egregious conduct. Predicated on the majority shareholders’ fiduciary obligation to treat all shareholders fairly and equally, to preserve corporate assets, and to fulfill their responsibilities of corporate management with scrupulous good faith, the courts equitable power can be invoked when it appears that the directors and majority shareholders have so palpably breached the fiduciary duty they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by statute.

(Internal quotations and citations omitted) (emphasis added). The court went on to hold that the plaintiff had met the high standard to justify common law dissolution. However, it went on to explain that Continue reading

Forum Selection Clause Not Enforced When Neither Parties Nor Agreement Connected to Chosen Forum

On November 5, 2014, the Second Department issued a decision in U.S. Merchandise, Inc. v L&R Distributors, Inc., 2014 NY Slip Op. 07495, refusing to enforce a forum selection clause.

In U.S. Merchandise, the Second Department reversed a trial court decision dismissing an action because the parties’ contract contained a forum selection clause providing for “the exclusive jurisdiction of the courts of the State of Delaware and the Federal Courts therein.” It explained:

A party seeking dismissal of a complaint under CPLR 3211(a)(1) must submit documentary evidence that conclusively establishes a defense to the asserted claims as a matter of law. A contract provision may constitute documentary evidence under CPLR 3211(a)(1), and a forum selection clause contained in a contract may provide a proper basis for dismissal of a complaint under CPLR 3211(a)(1). A forum selection clause is prima facie valid and enforceable unless it is shown by the challenging party to be unreasonable, unjust, in contravention of public policy, invalid due to fraud or overreaching, or it is shown that a trial in the selected forum would be so gravely difficult that the challenging party would, for all practical purposes, be deprived of its day in court. Accordingly, a forum selection clause will be given effect in the absence of a strong showing that it should be set aside.

Here, the plaintiff has made the requisite strong showing that the forum selection clause in the nondisclosure agreement was unreasonable. Specifically, the plaintiff has contended, without contradiction, that neither the parties nor the agreement has any connection to the State of Delaware: none of the parties is located in Delaware, the nondisclosure agreement was not executed in Delaware, and performance of the agreement was not to take place in Delaware. Accordingly, the prima facie enforceability and validity of the forum selection clause has been rebutted and, therefore, that clause does not conclusively establish a defense to the asserted claims as a matter of law. Thus, the Supreme Court should have denied that branch of the defendants’ motion which was to dismiss the amended complaint pursuant to CPLR 3211(a)(1).

(Internal quotations and citations omitted) (emphasis added). That there are situations in which forum selection clauses will not be enforced is not a new legal principle. It is a bit surprising to see it applied to these facts.

CLE Program: Commercial Division Practice: What You Need to Know

On December 5, 2014, Schlam Stone & Dolan partners Jeffrey Eilender and John Lundin will co-chair the New York State Bar Association CLE program: Commercial Division Practice: What You Need to Know. Among the panelists will be Justice Bransten of the New York County Commercial Division.

Second Circuit Asks Court of Appeals to Clarify Power of New York City to Regulate Law Firms Engaged in Debt Collection

On October 29, 2014, in Eric M. Berman, P.C. v. City of New York, 13-CV‐598, the Second Circuit certified two questions to the Court of Appeals regarding the power of the City of New York to regulate law firms engaged in debt collection activities.

In Eric M. Berman, P.C., the plaintiff law firms, which “attempt to collect debts,” brought an action “seeking, among other remedies, a declaratory judgment that Local Law 15,” which regulates law firms that engage in debt collection, “violates Article IX of the New York Constitution, the New York Municipal Home Rule Law, the New York Judiciary Law, and the New York City Charter.” The EDNY granted the plaintiffs partial summary judgment, holding that “Local Law 15 conflicted with the State’s authority to regulate attorneys,” and “violated a provision of the New York City Charter by purporting to provide the City with the effective authority to grant or withhold licenses to practice law, which is a function reserved to the State.”

The Second Circuit reserved decision and certified the following questions to the Court of Appeals:

Does Local Law 15, insofar as it regulates attorney conduct, constitute an unlawful encroachment on the State’s authority to regulate attorneys, and is there a conflict between Local Law 15 and Sections 53 and 90 of the New York Judiciary Law?

If Local Law 15’s regulation of attorney conduct is not preempted, does Local Law 15, as applied to attorneys, violate Section 2203(c) of the New York City Charter?

Transcripts and Videos of Arguments in the Court of Appeals for the Week of October 20, 2014, Now Available

On October 20, 2014, we noted three cases of interest from the oral arguments for the week of October 20, 2014:

  • No. 197Kimso Apartments, LLC v. Gandhi (considering whether Supreme Court improvidently exercised its discretion in permitting the defendant to “conform the pleadings to the proof” by amending his answer to assert an “intrinsic,” but formally unasserted, counterclaim). See the transcript and the video.
  • No. 216: Sierra v. 4401 Sunset Park, LLC (considering whether insurance company complied with disclaimer requirements of Section 3420(d)(2) of the Insurance Law by providing notice of disclaimer of insurance to insured’s primary insurer, but not directly to the insured). See the transcript and the video.
  • No. 203: Strauss Painting, Inc. v. Mt. Hawley Insurance Company (considering whether an insured satisfied the policy’s notice requirement by notifying its broker of the claim with the expectation that the broker would notify the carrier). See the transcript and the video.