BUSINESS DIVORCE 50 Ways to Leave Your Lover . . . err, Business Partner - PowerPoint Presentation

Slide1

BUSINESS DIVORCE50 Ways to Leave Your Lover . . . err, Business Partner

Moderator

Kurt M. Heyman; Partner; Proctor Heyman Enerio LLP; Wilmington, DE

Speakers

Hon. Donald F. Parsons, Jr.; Vice Chancellor; Delaware Court of Chancery

Melissa N. Donimirski; Associate; Proctor Heyman Enerio LLP; Wilmington, DE

Peter B.

Ladig

; Partner; Morris James LLP; Wilmington, DE

Eric C.

Milby

; Partner; Lundy

Beldecos

&

Milby

P.C.; Narberth, PA

Michaela L.

Sozio

; Partner;

Tressler

LLP; Los Angeles, CASlide2

Signs You Have a Business Divorce on Your H

ands

Definition: The legal separation of business partners in a

privately held business

Closely held

Few owners

At least one owner no longer wants to work with the other owner(s)

Tends to be acrimonious and/or emotional

“[T]

hese

two parties ... don't trust each other at all … which … in a business divorce is often the case.”

Schwartz v. Chase

, 2010 WL 2601608, *9 n.77 (Del. Ch.)

May be protracted and expensive given the business’ bottom lineSlide3

Slip Out the Back, JackRight and Wrong Ways to Leave and Related Claims

Multidisciplinary

Corporate

L

aw/LLC Law/Fiduciary Duties

Employment Law/Non-Competes

Trade Secrets & Related ClaimsSlide4

Make a New Plan, StanDissolution

Corporations & Alternative Entities

Statutory v. Common Law v.

Contractual

Corporations & Alternative Entities

Types of DissolutionSlide5

No Need to Be Coy, RoyForced Buyouts

Corporate Transactions

Majority v. Minority RemediesSlide6

Drop Off the Key, LeeProtective Measures

Shareholder Agreements

Operating Agreements

Exit Mechanisms/Buyout AgreementsSlide7

Slip Out the Back, JackCommon Claims

Eric C. Milby

Lundy Beldecos & MilbySlide8

Background“The acute vulnerability of minority shareholders in the closely-held corporation is well recognized. It stems principally from two factors. Because of its controlling interest, the majority is able to dictate to the minority the manner in which the corporation shall be run. In addition, shares in closed corporations are not publicly traded and a fair market for these shares is seldom available

.”

Orchard v.

Covelli

, 590 F. Supp. 1548, 1557 (W.D. Pa. 1984

)

Lundy Beldecos & MilbySlide9

Common Factual ComplaintsWithholding of distributionsRestricting or precluding employment in the

company

P

aying

excessive salaries to majority

or controlling stockholders

W

ithholding

information relating to the operation of the

company

A

ppropriation

of

company assets

Failure

to hold

meetings

E

xclusion

from a meaningful role in the corporate decision-making

Lundy Beldecos & MilbySlide10

Common Legal ClaimsBreach of ContractBreach of Fiduciary DutiesUsurpation of Corporate OpportunitiesOppressionAccess to Books and Records and Accounting

Violation of Restrictive Covenants

Trade Secrets and Confidentiality

Lundy Beldecos & MilbySlide11

Levels of Judicial Scrutiny1. Business Judgment RuleThe Business Judgment Rule expresses a judicial policy of deferring to the reasonable judgment of an independent and disinterested Board of Directors rather than attempting to substitute their own judgment. The Rule places the burden of proof on a Plaintiff challenging the Board’s action.

2. Enhanced

Scrutiny

The Court will apply an “enhanced scrutiny” standard of review in limited circumstances such as when a Board is confronted with takeover decisions or changes in control – i.e., decisions that inherently confront the directors with a conflict of interest.

3. Entire

Fairness Doctrine

The Entire Fairness Doctrine applies where the directors approving a transaction are not independent or disinterested. The Entire Fairness Doctrine places the burden on the Board to prove that the decisions of the Board were both procedurally and substantively fair.

Lundy Beldecos & MilbySlide12

Common RemediesMonetary DamagesDisgorgementAccountingConstructive TrustFair Value DeterminationInjunctionsDissolution

Lundy Beldecos & MilbySlide13

Direct vs. Derivative ClaimsA litigant must consider whether his or her claims are Direct or Derivative. The Delaware Supreme Court explained that you should ask two questions to determine whether claims are direct or derivative: (1) Who suffered the alleged

harm, and

Who would receive the benefit of any recovery or other remedy?

Tooley

v. Donaldson, Lufkin & Jenrette, Inc.

, 845 A.2d 1031,

1035

(Del. 2004)

“If the corporation alone, rather than the individual stockholder, suffered the alleged harm, the corporation alone is entitled to recover, and the claim in question is derivative. Conversely, if the stockholder suffered harm independent of any injury to the corporation that would entitle him to an individualized recovery, the cause of action is direct.”

Feldman

v. Cutaia

, 951 A.2d 727, 732 (Del. 2008

)

Lundy Beldecos & MilbySlide14

Requirements for Derivative ClaimsIn order to sustain a derivative claim, a plaintiff must:Demonstrate that he or she was a shareholder or member at the time of the alleged wrong,Remain a shareholder or member throughout the litigation,

D

emand that the Board or equivalent governing body take the action they desire before filing suit

or

describe the reason

for not making the effort (futility of

demand),

Describe the Plaintiff’s failure to obtain the desired action, and

Attest that he or she has not received, been promised and will not accept any compensation for maintaining the action except that which the court might award.

Further, any dismissal or compromise of the matter (except without prejudice or only with prejudice to the Plaintiff) must be approved by the court with notice given to all shareholders or members.

Lundy Beldecos & MilbySlide15

Derivative claims in Closely Held CompaniesIn closely held corporations, some states permit derivative claims to be asserted as direct claims rather than dismissed if certain conditions are met:

In

the case of a closely held corporation [§ 1.06], the court in its discretion may treat an action raising derivative claims as a direct action, exempt it from those restrictions and defenses applicable only to derivative actions, and order an individual recovery, if it finds that to do so will not (

i

) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors of the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons.

Hill v.

Ofalt

, 2014 PA Super 17, 85 A.3d 540,

553 (citing ALI

Principles of Corporate Governance § 7.01(d) (1994

)).

Lundy Beldecos & MilbySlide16

Breach of ContractCo-ownership of a business is inherently the product of an agreement.Agreement is usually written in the form of a Shareholder Agreement, Operating Agreement, or Partnership Agreement, but occasionally verbal.Agreement is the first place the courts look and the most important evidence in any business divorce.

In a recent Pa case, one of two 50/50 shareholders complained that the other was operating the company to his exclusion. The Court held that the failure of the company to operate in accordance with the Operating Agreement was grounds for judicial dissolution notwithstanding that the business was operating profitably.

Staiger

v.

Holohan

, 100 A.3d 622 (Pa. Super. 2014)

Common breaches claimed are (

i

) failure to contribute required time to the partnership, (ii) failure to make distributions, (iii) exclusion from management, (iv) paying excess salaries to the controlling parties, and (v) failing to abide by restrictive covenants or confidentiality agreements.

Lundy Beldecos & MilbySlide17

Restrictive CovenantsRestrictive covenants such as Non-Competition and Non-Solicitation Agreements are powerful tools in Business Divorce Litigation. The typical covenants are:Non-Competition: a covenant that restricts a shareholder, member, partner, or employee from competing with the company within a designated geographical region and for a specified time frame, and

Non-Solicitation: a non-solicitation covenant might preclude a party from soliciting customers, employees, vendors, or any combination thereof.

The covenants may be found in the shareholder, operating or partnership agreement, or they may be found in ancillary employment contracts

. It is important to define the nature of the business from which the party to the covenant is precluded from

engaging.

Disgruntled business owners who believe themselves to be responsible for the success of the business, or believe that the clients or employees are loyal to them, often leave and set up a competing business. The existence of Restrictive Covenants can force an owner to obtain an involuntary or judicial dissolution in order to terminate the covenants before setting off on their own. In most states, restrictive covenants are enforceable but are strictly construed and must be carefully drafted to be enforced as written. California is perhaps the most restrictive state, prohibiting restrictive covenants as a restraint of trade except in certain narrowly defined circumstances.

See

Cal

. Bus. & Prof. Code § 16600

et seq.

Lundy Beldecos & MilbySlide18

Fiduciary DutiesJustice (then Judge) Benjamin Cardozo is widely cited for his description of fiduciary duties in Meinhard

v. Salmon

. There, Salmon failed to inform his partner

Meinhard

about a profitable opportunity offered by a 3d party and took the opportunity for himself. Justice Cardozo found that Salmon breached the duty to inform and the duty of loyalty. Justice Cardozo explained:

“A

trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior… the level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd

.”

Meinhard

v. Salmon

,

164 N.E. 545 (N.Y. 1928

)

“At the core of the fiduciary duty is the notion of loyalty – the equitable requirement that, with respect to the property subject to the duty, a fiduciary must always act in a good faith effort to advance the interests of his beneficiary”

Dweck

v. Nasser

, 2012 WL 161590 (Del. Ch.)

Lundy Beldecos & MilbySlide19

Fiduciary Duties - Usurpation of Corporate Opportunity

The doctrine of corporate opportunity is one aspect of the fiduciary duties owed by a corporate officer or director to the entity.

A corporate officer or director

may not

take a business opportunity for his or her self if:

the corporation is financially able to exploit the opportunity,

the opportunity is within the corporation’s line of business;

the corporation has an interest or expectancy in the opportunity; and

(4)

by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position

inimicable

to his duties

to the corporation.

Broz v. Cellular Info. Sys., Inc.

, 673 A.2d 148, 155 (Del. 1996

) (citing

Guth

v. Loft

, 5 A.2d 503, 509 (Del. 1939)).

Lundy Beldecos & MilbySlide20

Fiduciary Duties - Usurpation of Corporate OpportunityConversely, a “director or officer may take a corporate opportunity if:

`

t

he opportunity is presented to the director or officer in his individual and not his corporate capacity;

t

he opportunity is not essential to the corporation;

t

he corporation holds no interest or expectancy in the opportunity; and

(4) t

he director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity.

Broz v. Cellular Info. Sys., Inc.

, 673 A.2d 148, 155 (Del. 1996) (citing

Guth

v. Loft

, 5 A.2d 503, 509 (Del. 1939)).Slide21

Fiduciary Duties - Minority Oppression

Many states specifically recognize a cause of action for minority oppression.

Under Pennsylvania law “majority

shareholders have a duty not to use their power in such a way to exclude minority shareholders from their proper share of benefits accruing from the

enterprise”. They may “act

in their own interest, but when they do act in their own interest, it must also be in the best interest of all shareholders and the corporation.”

[A]n

attempt by a group of majority shareholders to “freeze out” minority shareholders for the purpose of continuing the enterprise for the benefit of the majority shareholders constitutes a breach of the majority shareholders' fiduciary duty to the minority shareholders.

Viener

v. Jacobs

,

834 A.2d 546, 556

(Pa. Super. 2003)

Where a majority shareholder stands to benefit from his decisions as a controlling stockholder, the law requires that the majority's action be “intrinsically fair” to the minority interest.

A

policy of corporate governance which has as its objective the denial of benefits to the minority interest runs afoul of this fairness

standard . . . .

Orchard v.

Covelli

, 590 F. Supp. 1548, 1556 (W.D. Pa. 1984

)

This cause of action makes it much easier for a minority interest to challenge certain actions such as a reverse stock split or squeeze out merger when the objective is to cash out a minority interest.

Lundy Beldecos & MilbySlide22

Books and RecordsAny stockholder, in person or by attorney or other agent, shall have the right: upon written demand under

oath,

stating

the purpose thereof,

during

the

business’ usual hours

for any proper purpose (reasonably related to the stockholder’s interest as such)

to

inspect

and

to make copies and extracts from

:

The

corporation's stock ledger,

a

list of its stockholders, and

its

other books and records

If the company refuses to permit the inspection or does not respond to the demand within 5 business days after the demand, the stockholder may apply to the Court of Chancery for an Order to compel the inspection.

See Del

. Code Ann. tit. 8, §

220.

Lundy Beldecos & MilbySlide23

Trade Secrets and ConfidentialityTrade Secret and Confidentiality claims are often directed at preventing a director, officer, owner, or employee from using company secrets to compete unfairly with its current or former company.

Trade Secret claims are usually statutory whereas Confidentiality claims are usually contract based. Confidentiality claims can, however, fall under a fiduciary duty claim.

Almost all of the states and territories have adopted the Uniform Trade Secrets Act with few if any modifications.

As expressed in Delaware, a court may enjoin misappropriation of trade secrets when necessary to:

1. “protect

the secrecy of the misappropriated

information”,

2. “eliminate

the unfair advantage obtained by the

wrongdoer”,

and

“reinforce

the public policy of commercial morality

.”

Agilent

Technologies, Inc. v. Kirkland

,

2010

WL 610725,

*

31 (Del. Ch

.)

Further a Court may award compensatory damages to the victim of the misappropriation, typically measured by lost profits. Where the damage is difficult to measure, the Court may award damages as measured by the gain accruing to the defendant as a result of the misappropriation.

Lundy Beldecos & MilbySlide24

Uniform Trade Secrets ActAdopted in all but a couple of states.Defines “Trade Secret” as “information including a formula, pattern, compilation, program, device, method, technique, or process, that:

(

i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and

(ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

(§1 (4)) Note – relying on the broad provisions of the UTSA alone is risky. Subparagraph (ii) (reasonable efforts) suggests that having confidentiality agreements in place with all directors and employees, with a subjective definition of the company trade secrets, is an important factor in persuading the court to grant relief in favor of the party seeking protection of the trade secrets in a business divorce.

Permits a court to enjoin “actual or threatened misappropriation” for such period of time as would “eliminate commercial advantage that otherwise would be derived from the misappropriation”. (§2(a))

Lundy Beldecos & MilbySlide25

Uniform Trade Secrets Act“In exceptional circumstances an injunction may condition future use upon payment of a reasonable royalty for no longer than the period of time for which use could have been prohibited. Exceptional circumstances include, but are not limited to, a material and prejudicial change of position prior to acquiring knowledge or reason to know of misappropriation that renders a prohibitive injunction inequitable.” (§2(b))

Provides for monetary damages measured by actual loss and unjust enrichment “not taken into account in computing actual loss”. Court may alternatively award “a reasonable royalty”. Court may also award exemplary damages for willful and malicious misappropriation.” (§3)

Court may award attorney’s fees for certain bad faith conduct, by the claimant or defendant, or for willful misappropriation. (§4)

Intended

to preempt common law claims. (§7)

Lundy Beldecos & MilbySlide26

Injunctive ReliefPlaintiff may obtain a preliminary injunction if it establishes:a

reasonable likelihood of success on the merits,

imminent

, irreparable harm will result if an injunction is not granted

and

the

damage to Plaintiff if the injunction does not issue will exceed the damage to the defendants if the injunction does

issue.

The

elements are not necessarily weighted equally.

A

strong showing on one element may overcome a weak showing on another element. However, a failure of proof on one of the elements will defeat the application.

Cantor

Fitzgerald, L.P. v. Cantor

, 724 A.2d 571, 579 (Del. Ch. 1998

).

Irreparable harm is harm for which there is no adequate remedy at law. It is often said that there can be no irreparable harm when the injury can be compensated by monetary damages. Hence, irreparable harm is usually the most difficult element to establish in a commercial dispute where money is often the heart of the matter. However, “[

i

]t is not necessary that the injury be beyond the possibility of repair by money compensation’ but only that it ‘be of such a nature that no fair and reasonable redress may be had in a court of law and that to refuse the injunction would be a denial of justice

.”

T

. Rowe Price Recovery Fund, L.P. v. Rubin

, 770 A.2d 536, 557 (Del. Ch. 2000

)

Lundy Beldecos & MilbySlide27

Case Study: Dweck v. Nasser - How not to effectuate a split

Nasser, a resident of Switzerland, owned 100% of Kids, an apparel company, after being tapped by

Dweck

to purchase from her family who lost a key customer (Wal-Mart) after pleading guilty to criminal charges relating to customs regulations.

Per the agreement,

Dweck

ran the company and became a 27.5% owner after Nasser was repaid his investment plus interest. Later her share increased to 30%.

Eventually

Dweck

wanted to be controlling shareholder, feeling she was responsible for Kids’ success, but Nasser refused to sell any portion of his shares.

Further, Nasser decided the owners should not receive salaries and declared himself a bonus to equalize the distributions.

So,

Dweck

started a new company, Success Apparel, to take advantage of “new opportunities” without disclosing this to Nasser.

Lundy Beldecos & MilbySlide28

Case Study: Dweck v. Nasser, cont’dDweck operated Success out of Kids’ premises

Dweck

operated Success with Kids’ employees

Dweck

caused Success to pay Kids a grossly inadequate 1% of sales administrative fee disguised on the financial statements as “Due from affiliates”.

It was conservatively estimated that Kids employees spent 20% of their time on Success business.

Success reimbursed Kids rent of about $14,500 whereas they paid $437,000 after moving to its own space.

Success’ marketing materials

used Kids’

logo, cited awards won by Kids and cited Kids’ success record.

Lundy Beldecos & MilbySlide29

Case Study: Dweck v. Nasser, cont’dThe operations were so intertwined that Clients were confused by the operations:

Several clients drafted license agreements with Kids as licensee

Dweck

requested that the licensee name be changed to Success

One client issued a press release describing its licensee as “Success Apparel Group, LLC

also known as Kids International . . .

”

Kids was the only name on the office.

The operation was so surreptitious that the employees just thought it was a brand and not a separate company.

Lundy Beldecos & MilbySlide30

Case Study: Dweck v. Nasser, cont’dDweck forms

another

company, Premium, to take advantage of another apparel licensing agreement.

Like Success, Premium uses Kids’ offices, employees,

etc

To add insult to injury,

Dweck

charged over $450,000 in personal expenses to Kids including Club Med vacations and luxury goods from Armani, Prada, Gucci, and Bergdorf Goodman on top of her $850,000 to $1.3 million annual salary.

Dweck

stopped sending quarterly financials to Nasser.

Nasser became concerned and was tipped off by an employee that “something was going on

”.

Lundy Beldecos & MilbySlide31

Case Study: Dweck v. Nasser, cont’dIn a January 5th

meeting, the first formal meeting ever, Nasser appointed a relative and the employee who tipped him off to the Board tasking the relative to find out what was going on.

Dweck

, unhappy with the new oversight, prepared to leave, found new office space for Success and Premium,

and began diverting all of Kids’ future orders to

Success.

Nasser called a March 11 meeting. As a result of confusion over the meeting location,

Dweck

showed up at Nasser’s lawyer’s office while Nasser showed up at Kids. Nasser was placed in the conference room where Success and Premium samples adorned the walls. As

Dweck

raced back, she called and instructed an employee go into the conference room and remove the samples. Nasser sat in the conference room and watched this bungled attempt at concealment firsthand.

Lundy Beldecos & MilbySlide32

Make a New Plan, StanDissolution and the Business DivorcePeter B. LadigMorris James LLPSlide33

Dissolution and Other Judicial RemediesCommon LawCorporations8 Del. C. §

273

8

Del. C.

§

291

Limited Liability Companies

6

Del. C.

§ 18-802

Limited Liability Partnerships

6

Del. C.

§ 17-802

Court-Implemented DissolutionSlide34

Common LawVery limited right to dissolve a solvent entity under common law“[O]nly upon a showing of gross mismanagement, positive misconduct by corporate officers, breach of trust, or extreme circumstances showing imminent danger of great loss to the corporation which, otherwise, cannot be prevented

.”

Carlson v.

Hallinan

, 925 A.2d 506 (Del. Ch. 2006)Slide35

8 Del. C. § 273Dissolution of joint venture corporation having 2 stockholders, each owning 50%Under Section 273(a), if the stockholders are unable to agree upon the desirability of discontinuing the joint venture and disposing of its assets, either stockholder may (unless otherwise provided in the certificate of incorporation or a stockholder agreement), file a petition in the Court of Chancery stating that it desires to discontinue the joint venture and dispose of the assetsSlide36

8 Del. C. § 273 (cont.)Under Section 273(a), the petition shall: (1) attach a copy of the proposed plan of discontinuance and distribution; and (2) a certificate stating that copies of such petition and plan have been transmitted in writing to the other stockholders and any officers or directionsSlide37

8 Del. C. § 273 (cont.)Under Section 273(b), unless both stockholders file with the Court of Chancery:Within 3 months of the date of the petition, a certificate similarly executed and acknowledged stating they have agreed on such a plan, or a modification thereof, and

Within 1 year from the date of the petition, a certificate similarly executed and acknowledged stating that the distribution provided by such plan is completed, the Court of Chancery may dissolve the corporation and may appoint 1 or more trustees or receives under 8

Del. C.

§ 279 to administer and wind up the affairs.Slide38

Talking Points re: Section 273Section 273 doesn’t define “joint venture,” but the Delaware Supreme Court has defined it as: “(1) a community of interest in the performance of a common purpose, (2) joint control or right of control, (3) a joint proprietary interest in the subject matter, (4) a right to share in the profits

, [and (

5) a duty to share in the losses which may be

sustained.”

Warren v.

Goldinger

Bros., Inc.

, 414 A.2d 507 (Del. 1980)

Whether or not a corporation is a “joint venture” is an element of the claim that can also be litigated.

See

In re McKinney-

Ringham

Corp.

, 1998 WL 118035 (Del. Ch. Feb. 27, 1998)Slide39

Talking Points re: Section 273Section 273 proceedings are narrow in scope (usually no counterclaims). In re Arthur Treacher’s Fish & Chips of Ft. Lauderdale, Inc., 386 A.2d 1162 (Del. Ch. 1978)

The Court has held that a Section 273 proceeding is not the appropriate vehicle to seek damages or the imposition of a constructive trust for breach of fiduciary duty.

In re Data Processing Consultants, Ltd.

1987 WL 25360 (Del. Ch. Nov. 25, 1987)Slide40

Talking Points re: Section 273However, the Court will consider allegations by the respondent regarding the possibility of a conspiracy or bad faith in connection with the petition for dissolution. Id.For Example, the Court has stated that the only basis upon which it may refuse to dissolve is if the actual foundation for the action is something other than a genuine inability to agree upon the desirability of discontinuing the joint venture.

Arthur

Treacher’s

; In re McKinney-

Ringham

Corp.

, 1998 WL 118035 (Del. Ch. Feb. 27, 1998)Slide41

Talking Points re: Section 273The word “may” in Section 273(b) clearly indicates that the remedy is discretionary, but the Court’s discretion not to grant dissolution should be applied sparingly. In re McKinney-Ringham Corp., 1998 WL 118035 (Del. Ch. Feb. 27, 1998)

Moreover, there is no specific time period of disagreement that must exist before the Court may order dissolution.

Matter of

Bermor

, Inc.

, 2015 WL 554861 (Del. Ch. Feb. 9, 2015)Slide42

Talking Points re: Section 273The Court may also order one 50% holder to sell to the other in lieu of dissolution. Fulk v. Washington Service Assoc., Inc., 2002 WL 1402273 (Del. Ch. June 21, 2002)Note: If the stockholders are in agreement, they may proceed with a voluntary dissolution under 8

Del. C.

§ 275Slide43

Talking Points re: Section 273Can be used to dissolve a corporation that is part of a larger joint venture, even if not seeking dissolution of other entitiesMcKinney-Ringham and

Bermor

both involved requests to dissolve corporations serving as general partners of limited partnerships

In each case, court rejected arguments that petitioner was acting in bad faith by seeking dissolution of general partner as part of plan to dissolve limited partnershipsSlide44

8 Del. C. § 291Receivers for Insolvent CorporationsUpon the application of any creditor or stockholder of an insolvent Delaware corporation, the Court of Chancy may, in its discretion, appoint one or more persons as receivers for the corporationReceiver obligated to manage the assets, business and affairs of the corporation and collect outstanding debts, claims and propertySlide45

Talking Points re: Section 291Petitioner bears the burden of establishing that insolvency existed at the time of the filing of the petition. Banks v. Cristina Copper Mines, Inc., 99 A.2d 504 (Del. Ch. 1953)Insolvent for purposes of Section 291 if either: (1) liabilities exceed assets; or (2) unable to meet its currently maturing obligations in the ordinary course of business.

Production Resources Group, L.L.C. v. NCT Group, Inc.

, 863 A.2d 772 (Del. Ch. 2004)Slide46

Talking Points re: Section 291Court will exercise discretion if it is shown that the appointment is required by “special circumstances of great exigency” and would benefit stockholders or creditors. In re Townsend Acres, Inc., 1977 WL 2571 (Del. Ch. May 3, 1977)A receiver will not be appointed where such appointment will not benefit the petitioning creditor and will cause injury to other creditors.

Boggs v. Bellevue, Inc. of Washington, D.C.

, 156 A. 202 (Del. Ch. 1931)

“Creditor” includes judgment creditors, contract creditors and creditors at large.

Velcut

Co. v. United States Wrench Mfg. Co.

, 140 A. 801 (Del. Ch. 1928)Slide47

Talking Points re: Section 291Appointment of a receiver does not result in dissolutionThe Court may subsequently discharge the receiver and return the assets to the corporation, may order the assets reduced to cash for distribution to creditors and stockholdersSlide48

6 Del. C. §18-802Judicial Dissolution of an LLC: “On application by or for a member or manager the Court of Chancery may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.”

Dissolution is an “extreme remedy”Slide49

Talking points re: 18-802“Member” under 18-101(11) means a person who is admitted to a limited liability company as a member ….“Manager” under 18-101(10) means a person who is named as a manager of a limited liability company in, or designated as a manger of a limited liability company pursuant to, a limited liability company agreement or similar instrument under which the limited liability company is formedSlide50

“Reasonably Practicable” Under 18-802What is the defined purpose of the LLC?If the purpose is broad (such as “any lawful activity”), difficult to establish impracticability. Wiggs v. Summit Midstream Partners, LLC

, 2013 WL 1286180 (Del. Ch. Mar. 28, 2013);

In re Arrow Investment Advisors, LLC

, 2009 WL 1101682 (Del. Ch. Apr. 23, 2009)

If the purpose is narrow, it is easier to establish impracticability if the ability to achieve the limited purpose of the LLC is impaired.

Vila v.

BVWebTies

LLC

, 2010 WL 3866098 (Del. Ch. Oct. 1, 2010);

In re Silver Leaf, LLC

, 2005 WL 2045641 (Del. Ch. Aug. 18, 2005)Slide51

“Reasonably Practicable” Under 18-802Deadlock – Court will typically look to availability of exit mechanisms before ordering judicial dissolution based on Deadlock, but will not rule out deadlock if the exit mechanisms are not viable. Lola Cars Intern. Ltd. v. Krohn Racing, LLC

, 2009 WL 4052681 (Del. Ch. Nov. 12, 2009)

Court will also look to case law interpreting Section 273 and 17-802 for interpreting “reasonably practicable.”

Haley v. Talcott

, 864 A.2d 86 (Del. Ch. 2004

);

In re Silver Leaf, LLC

, 2005 WL 2045641 (Del. Ch. Aug. 18, 2005

)Slide52

“Reasonably Practicable” (cont.)Insolvency – While a common basis for dissolution of corporations, it is not always relevant when considering the purpose of an LLC. However, insolvency may go hand in hand with an LLC losing its key asset. In re Silver Leaf, LLC, 2005 WL 2045641 (Del. Ch. Aug 18, 2005) Slide53

Talking Points re: 18-802Waiver: The Court of Chancery has held that Sections 18-802, 18-803 (Winding Up) and 18-805 (Trustees) are not mandatory provisions of the LLC Act that cannot be modified by contract. A waiver of judicial dissolution in the LLC Agreement is valid and enforceable under the statute. R & R Capital, LLC v. Buck & Doe Run Valley Farms, LLC

, 2008 WL 3846318 (Del. Ch. Aug. 19, 2008);

Huatuco

v. Satellite Healthcare

, 2013 WL 6460898 (Del. Ch. Dec. 9, 2013)Slide54

6 Del. C. § 17-802Judicial Dissolution of an LP: “On application by or for a partner the Court of Chancery may decree dissolution of a limited partnership whenever it is not reasonably practicable to carry on the business in conformity with the partnership agreement”Slide55

Talking Points re: Section 17-802“Reasonably practicable” interpreted the same way as for LLC’s. In re Silver Leaf, LLC, 2005 WL 2045641 (Del. Ch. Aug. 18, 2005)Court has held that insolvency can be a basis for dissolving LP when the stated purpose of the LP was to operate for profit. PC Tower Center, Inc. v. Tower Center Development Assoc.

, 1989 WL 63901 (Del. Ch. June 8, 1989)Slide56

6 Del. C. § 17-802However, if the limited partnership is still operating under its stated purpose, and is still producing returns for its investors , even if not performing as expected, Court will not grant dissolution. Cincinnati Bell Cellular Sys. Co. v. Ameritech Mobile Phone Serv. Of Cincinnati, Inc., 1996 WL 506906 (Del. Ch. Sept. 3, 1996)Slide57

Court-Ordered DissolutionWhat happens next?In re Interstate General Media Holdings, LLC, 2014 WL 1697030 (Del. Ch. Apr. 25, 2014)Deadlocked LLC whose managing members agreed judicial dissolution was needed, but disagreed on the type of auction process to use.Court held that dissolution should happen via a private, English-style, open outcry auction among the membersSlide58

Court-Ordered DissolutionBut, in The EB Trust v. Information Management Services, Inc., C.A. No. 9443-VCL (Del. Ch. June 16, 2014) (TRANSCRIPT), the court rejected proposal of private auction among existing stockholders, finding that the proponent of the plan had not proven why situation was so unique that general tenets of auction theory did not apply Slide59

No Need to Be Coy, RoyForced Buyouts in the Business Divorce

Melissa N.

Donimirski

P

roctor

H

eyman

E

nerio

LLPSlide60

Effectuating the Forced Buyout – Majority Owner

Several options when the party that wants the divorce has a majority voting interest

Reverse stock split DGCL § 155

Squeeze out merger

Short form squeeze out merger DGCL § 253

90%+ interest

Appraisal is cashed out stockholder’s only recourse

Long form squeeze out merger DGCL § 251

Majority vote

BoD

and majority of shares

Subject to entire fairness review

Not available in alternative entitiesSlide61

Effectuating the Forced Buyout –Minority Owner

In corporate context, New York stockholder may seek dissolution for minority oppression under BCL § 1104-a

Must have right to vote 20% of outstanding shares

Must state a claim of fraudulent, oppressive, wasteful or illegal action by majority owner

Majority owner may avoid dissolution by opting to purchase minority shares under BCL § 1118(a) Slide62

Effectuating the Forced Buyout –Minority Owner cont’dConcept of ‘equitable buyout’ permits New York Courts to equitably apply § 1118(a) in the alternative entity context

Mizrahi v. Cohen

, , 961 N.Y.S.2d 538 (N.Y.A.D. 2013)

In re Superior Vending, LLC

, 898 N.Y.S.2d 191 (N.Y. A.D. 2010)

Permitted LLC majority member to avoid dissolution by buying out

minority memberSlide63

Effectuating the Forced Buyout –Minority Owner

Fewer options in Delaware corporate context where minority owner wants to be bought out

No minority oppression claim in Delaware

No right to dividends

No right to be bought out by majority

“[A] controlling stockholder generally does not have a fiduciary duty to buy back a minority stockholder's shares.”

Blaustein v. Lord Baltimore Capital Corp

., 2013 WL 1810956, *16

(Del. Ch.)

In alternative entity context, rights governed by contractSlide64

Effectuating the Forced Buyout –Minority Owner

Thus, minority shareholders instead agitate to attempt to convince majority to effectuate a buyout

Books and records actions

DGCL § 220

DE RULPA § 17-305

DE LLCA § 18-305

Expensive

Only awarded documents

Must file another action for breach of fiduciary duty once have documentsSlide65

Effectuating the Forced Buyout –Minority OwnerDerivative action for breach of fiduciary duty

Crude tool to force buyout

Recovery goes to the corporation

If majority cashes out minority, derivative claims may be considered an asset of the corporation and used to determine fair value of shares.

Zutrau

v.

Jansing

, 2014 WL 3772859 (Del. Ch.)

Settlement must be approved by the courtSlide66

Michaela L. SozioDrop off the Key, Lee

Protective MeasuresSlide67

Drop off the key, Lee …The inevitable has occurred. We just can’t get along …67Slide68

Do we have an agreement that:Avoids as many disputes as possible?Has a mechanism in place to efficiently handle the dispute?Provides for multiple exit strategies for dissatisfied shareholders?Removes subjectivity from valuation?

68Slide69

Model Business Corporations Act § 7.32 – Shareholder AgreementsExpansive re the types of issues that can be contracted for in shareholder agreementsPrimary focus: protection of minority shareholder rights

69Slide70

Thinking ahead: The Operating or Shareholder AgreementIssues to Consider:Employment statusPayment of dividendsBuyout AgreementsValuation FormulasAlternative Dispute Resolution strategies

70Slide71

Other Issues Requiring Contemplation:Voting requirements for certain actionsVeto arrangementsIssuance of additional shares of stock

71Slide72

The Buyout AgreementModel Bus. Corp. Act § 6.27 - Restriction on Transfer of Shares and Other SecuritiesHelps control future ownershipProvides liquidity upon occurrence of certain events:Death or disabilityRetirementTermination of employment

72Slide73

Valuation ProvisionsUseful in contemplating:Purchase of shareholder’s stockBuy-Sell AgreementsStock-Purchase AgreementsJudicially-ordered purchaseAppraisal proceeding

73