Robert Flannigan (Saskatchewan), has an article, The Legal Status of the Joint Venture, 46 Alberta L. Rev. 713 (2009) (SSRN), that criticizes the use of the term “joint ventures” in opinions (elegantly referred to as the “judicial lexicon”) and the mistaken impression by courts that a joint venture is a”a distinct legal form”.
Gary Rosin
Earlier, I noted the decision in In re Ravitz v. Gerard Furst and Marjorie Ravitz, DPM, P.C., 2009 NY Slip Op 06437 (N.Y. App. Div. Sept. 8, 2009), in which one shareholder of a professional corporation sought to have the court determine the value of the corporation’s two offices, and to take that into account in distributing the assets of the corporation in the course of liquidation. Part of the rationale for refusing the relief sought was the Court’s two-sentence conclusion that goodwill can only be an asset of the corporation when the shareholders so agree. Slip Op., at 2. The basis for that holding can only be gleaned from a four-case string cite.
The primary authority is Dawson v. White & Case,88 N.Y.2d 666, 672 N.E.2d 589 (1996), which does not stand for that propostion. In Dawson v. White & Case, an expelled partner of a law partnership sought to have goodwill included in determining the value of his interest in the partnership. The basis for the court’s holding was that the partners had, by express agreement, ande by prior practice, excluded goodwill as an asset of the partnership:
[N]ew White & Case partners never paid anything for goodwill; departing partners never received a payment for goodwill; and goodwill was not listed as an asset in the firm’s financial statements. * * * The White & Case partnership agreement contained the following provisions:
“It is expressly understood and agreed that no consideration has been or is to be paid for the Firm name or any good will of the partnership, as such items are deemed to be of no value” (art fourth [c]);
and
“The computation of the amount with which a Former Partner shall be charged or credited … shall exclude any value for the good will of the partnership or the Firm name, as such items are deemed to be of no value” (art sixth [d]).
88 N.Y. 2d at 672. The court expressly limited its holding:
We note that the holding in this case is based on the specific facts presented, and should not be construed as a prohibition against the valuation, in the appropriate case, of law firm goodwill. In addition, the existence of law firm goodwill has been recognized in conjunction with the recent promulgation of Code of Professional Responsibility DR 2-111 (A), which authorizes the sale of “a law practice, including good will,” by a “lawyer retiring from a private practice of law, [or] a law firm one or more members of which are retiring from the private practice of law with the firm.”
To the extent that dictum in [an earlier case] stands for the proposition that a professional business, as a matter of law, cannot have any goodwill apart from the goodwill of its constituent members, we note that this rationale has been rejected by this Court in a different context (see, Spaulding v Benenati, 57 NY2d 418, 422-424, [enforcing sale of dentistry practice goodwill]…) and has been superseded by the economic realities of the contemporary practice of law, illustrated by attorney advertising, internationalization of law firms, and other professional developments. In short, the ethical constraints against the sale of a law practice’s goodwill by a practicing attorney no longer warrant a blanket prohibition against the valuation of law firm goodwill when those ethical concerns are absent.
Id. at 672-73 (citations omitted) (emphasis added).
In Kaplan v Shachter & Co., 261 A.D.2d 440, 690 N.Y.S.2d 91 (1999), the Court did begin by noting the lack of an express agreement to make goodwill a partnership assets, but also noted facts supporting the trial court’s determination that good will was not a partnership asset:
Here, the partnership agreement did not specify that goodwill was a firm asset. Furthermore, insofar as no consideration was paid for goodwill on the admission of partners, no amounts had been paid or given on account of goodwill, and the firm’s financial statements did not reflect any goodwill, it is clear that the partners did not otherwise view goodwill as a firm asset.
261 A.D.2d at 440. In Saltzstein v Payne, Wood & Littlejohn, 292 A.D.2d 585, 740 N.Y.S.2d 95 (2002), the Court perfunctorily parroted the language in Kaplan.
The third Appellate Division case cited by the In re Ravitz Court, In re Leslie & Penny for Penny Preville, 303 A.D.2d 508, 757 N.Y.S.2d 302 (2003) stands for the opposite proposition than the conclusion in In re Ravitz. Penny Preville, Inc. engaged in the business of designing jewelry. Its initial shareholders were Penny Siskin (formerly Penny Preville). When a second shareholder was brought into the business, the parties entered into a Shareholder Agreement providing that, on dissolution of the corporation, the Siskins would have the exclusive right to the use of the trade name ‘Penny Preville.” 303 A.D.2d at 508-09. The Court rejected the claim by the Siskins that the Shareholder Agreement excluded the good will of the corporation, especially that asscoiated with the trade name, from ownership by the corporation:
We agree with the Supreme Court that this clause only gives the Siskins the exclusive right to use the trade name “Penny Preville” upon dissolution. The Agreement does not explicitly give the Siskins the right to the value of the Corporation’s goodwill associated with the trade name “Penny Preville,” nor does it except such goodwill or the trade name from the Corporation’s assets distributable upon dissolution. * * *
In adjudicating the rights of the parties under the Agreement, this Court may not read any additional provisions into that agreement. The Court, therefore, cannot accept the Siskins’ invitation to read into the Agreement an additional provision giving them continued ownership of the trade name or of its associated goodwill. Thus, the Siskins are entitled only to the exclusive rights of continued use of the name “Penny Preville” upon dissolution,but the value of the Corporation’s goodwill, including that associated with the trade name “Penny Preville,” … should be distributed along with its other assets upon dissolution.
Id. at 509 (emphasis added). While the action for judicial dissolution in that case was under Section 1104-a of the NY GCL (oppression), rather than under Section 1104 (deadlock), Section 1117, which incorporates Section 1005 (relied on in In re Ravitz), applies to all judicial dissolutions.
As noted by Peter A. Mahler (New York Business Divorce blog), most written agreements among professionals engaged in a joint practice expressly address the treatment of professional goodwill. Or at least, well-drafted agreements do.
Gary Rosin
What happens after after a judicial dissolution of a corporation on the grounds of deadlock? What usually happens in a dissolution. The corporation winds up its business, pays its creditors, and distributes assets to its shareholders. But if there’s a deadlock, there’s a good chance that the directors (and shareholders) won’t be able to agree on those matters, either. What happens then? In re Ravitz v. Gerard Furst and Marjorie Ravitz, DPM, P.C., 2009 NY Slip Op 06437 (N.Y. App. Div. Sept. 8, 2009), tells us what does not happen, at least under New York law.
The corporation in question was a podiatry practice with two equal shareholders, three offices. The two agreed that one office should be closed. They agreed that they would split the two remaining offices. The problem was that one office was more profitable than the other. The shareholder who would take the less profitable office proposed a valuation of the goodwill of each office, and a cash settlement to equalize the distribution of assets. When the other did not agree, the first asked the court to supervise the liquidation for the purpose of valuing the practices. Both the trial and appellate courts held that such a procedure was not permitted under the pertinent provisions of the New York Business Corporation Law.
Section 1008(a) of the New York General Corporation Law (NY GCL) authorizes a court to
continue the liquidation of the corporation under the supervision of the court and may make all such orders as it may deem proper in all matters in connection with the dissolution or the winding up of the affairs of the corporation
The Court held that Section 1008(a) did not authorize the appointment of a referee. Under Section 1005(a)(2), assets can only be sold at “public or private sale.” In re Ravitz, Slip Op. at 1-2. If the parties cannot agree on a private sale, the only recourse is a public sale. Id.
The appointment of a referee (special master) to mediate a possible sale, and to value the businesses, should be within the power of the court. If one of the parties is intransigent, and refuses to pay full value, should the only recourse seems to be a referee to conduct the public sale?
The Court also held that, in the absence of an agreement, goodwill was not a distributable asset. More on that later.
Hat tip to Peter A. Mahler (New Business Divorce blog), who represented the prevailing party.
Gary Rosin
In Wilson v. Paine, 288 S.W.3d 284 (KY 2009), the Kentucky Supreme Court adopted the “adverse domination” doctrine. Under that doctrine, the statute of limitations on claims of misconduct against a corporation’s officers and directors does not begin to run until the corporation “knows” of the misconduct giving rise to the claim. Taking off from the “adverse agent” exception to the rule that the knowledge of agents is ‘attributed” to the principal, the adverse domination doctrine does not impute to the corporation the knowledge of the offending officers and directors. The Court adopted the “majority” domination variant of the doctrine, under which the knowledge of an innocent corporate “agent” will not be attributed to the corporation so long the offenders control the Board of Directors.
The Court also held that the doctrine does not apply when a majority of the directors are merely negligent. Instead there must be “intentional wrongdoing of some kind, which would include fraud”. Slip Op. at 12. The rationale of the court was two-fold. First,
To [allow a negligence standard] would effectively eliminate the statute of limitations in all cases involving a corporation’s claims against its own directors . . . . [I]t could almost always be said that when one or two directors actively injure the corporation, or profit at the corporation’s expense, the remaining directors are at least negligent for failing to exercise “every precaution or investigation.” (Internal citation omitted.) If adverse domination theory is not to overthrow the statute of limitations completely in the corporate context, it must be limited to those cases in which the culpable directors have been active participants in wrongdoing or fraud, rather than simply negligent.
Id. at 11 (quoting from FDIC v. Dawson, 4 F.3d 1303, 1310 (5th Cir. 1993)). Second, the Court believed that
[T]he danger of fraudulent concealment by a culpable majority of a corporation’s board seems small indeed when the culpable directors’ behavior consists only of negligence.”
Id. (quoting from Dawson, 4 F.3d at 1312-13) (emphasis added by Court).
Here the Court drifts off the path. First, the conduct of directors is protected by the business judgment rule, which generally requires at least gross negligence or bad faith before directors will be found liable. Second, a similar standard protects directors against liability for failures to supervise or to monitor.
Bernards v. Summit Real Estate Management, Inc., 229 Or. App. 357, 213 P.3d 1 ( Ct. App. 2009) involves a demand-refusal derivative suit by a member of two member-managed Oregon LLCs. Each LLC owns an apartment complex that is managed by Summit Real Estate Management, Inc. (apparently unrelated to any of the members). After Summit and one of its officers embezzled substantial sums from each LLC, Bernards demanded that each LLC sue them. When other members refused “without explanation,” Bernards filed a derivative suit against Summit and its officer. Later, Bernards joining the other members, alleging that breach of both contract and fiduciary duties. 213 P.2d at 360-362.
Section 63.801(b) of the Oregon LLC Act allows derivative suits on a showing of demand futility, but allows the operating agreement to change that rule. Section 5.4(d) of the operating agreement of each LLC required unanimous member consent for a derivative suit. 213 P.2d at 360-61 & 366. The Court rejected the argument that Section 5.4:
Section 5.4(d) cannot carry the freight with which defendants would load it. There is no logical connection between the premise that the consent of every member is a contractual prerequisite for legal action, and the conclusion that every member has the unfettered authority to withhold consent. That is particularly true in light of the well-settled rule that the parties to a contract are bound by a requirement of good faith and fair dealing. Even more to the point, another provision of the operating agreement, Section 5.10 (as noted above), provides that a member can be held liable for action or inaction taken in bad faith, “gross negligence, fraud, or willful or wanton misconduct.” The operating agreements, then, confirm rather than contradict the proposition that, although every member’s consent is required before another member may take legal action, that consent cannot be withheld except for a valid business reason.
Id. at 366-67 (emphasis added)(citations omitted).
As indicated by the court, Section 5.10 of the operating agreement provided that members were not liable
… for honest mistakes of judgment or for action or inaction taken in good faith for a purpose reasonably believed to be in the best interest of the Company; provided that such mistake, action, or inaction does not constitute gross negligence, fraud, or willful or wanton misconduct.
Id.at 364 ( emphasis added) (internal quotations omitted). The Court clearly saw good faith as that required of a fiduciary, rather than the contractual obligation of good faith and fair dealing.
Although the Court did not discuss this, Section 63.160 of the Oregon LLC Act limits the use of operating agreements to eliminate member (and manager) liability of damages, and uses language similar to that of Section 102(b)(7) of the Delaware General Corporation Law to do so:
However, no such provision shall eliminate or limit the liability … for …
- Any breach of the member’s or manager’s duty of loyalty to the limited liability company or its members;
- Acts or omissions not in good faith which involve intentional misconduct or a knowing violation of law;
- Any unlawful distribution …; or
- Any transaction from which the member or manager derives an improper personal benefit.
Section 63.160. Section 63.160(2) differs from DGCL Section 102(b)(7)(ii)
acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law
(emphasis added). Arguably, the omission in the Oregon statute of the word “or” limits the scope of “good faith.” That said, the Oregon statute also prohibits elimination of liability for breaches of the duty of loyalty. If it was not already clear that acts not in good faith breach the duty of loyalty, the Delaware Supreme Court has now settled that question as a matter of Delaware law (In re Walt Disney Litigation and Stone v. Ritter).
In any event, Section 5.10 of the operating agreement in Bernards arguably conditions the waiver of liability to acts taken in “good faith.” Thus, the exclusion of “gross negligence, fraud, or willful or wanton misconduct” applies only to acts taken in good faith.
The problem with complaint was that it did not plead any specific facts indicating misconduct by the members in rejecting the demand. The court rejected that argument that the misconduct by Summit and its officer was clear that a failure to sue them could only be explained by misconduct. 213 P.3d at 267-70.
Gary Rosin
In re Loomis, No. 02S00-0808-DI-422 (Ind. May 7, 2009), is a recent disciplinary case. Three lawyers in Aboite, Indiana formed “Attorneys of Aboite, LLC.” Although the three lawyers did not combine their practices, they
…used the names “Attorneys of Aboite, LLC” and “Attorneys of Aboite” in professional documents, communications, signage, telephone directory listings, numerous advertisements, and an internet website without revealing that they did not practice law as a firm.
Slip Op.at 1. Unsurprisingly, they were disciplined for misleading clients as to whether they practiced as a firm. Still …
What were they thinking? I suppose that they wanted to share offices, and formed the LLC to lease or buy office space, and to share expenses.
There may be some estoppel issues here, so that the LLC may be liable for malpractice, errors and omissions committed in the course of representing clients who thought they were dealing with a firm.
Hat tip, Mike Frisch (Legal Profession Blog).
Gary Rosin
This student article looks ambitious: Tiffany A. Hixon, Note, The Revised Uniform Partnership Act–Breaking Up (or Breaking Off) Is Hard To Do: Why the Right to “Liquidation” Does Not Guarantee a Forced Sale upon Dissolution of the Partnership, 31 W. New Eng. L. Rev. 797-831 (2009). Hixon argues that
… RUPA does not require a forced sale. * * * [C]ourts should consider a buyout as an alternative to a forced sale when implementing RUPA’s dissolution provision. [The RUPA] only guarantees a partner the right to receive his interest in cash. * * * [T]he term “liquidation” as used in the statute is ambiguous at best. As a result, courts are free to defer to their equitable powers and permit a buyout.
Id. at 800.
Gary rosin
Baltimore Street Builders v. Stewart, 186 Md.App. 684, 975 A.2d 271(Md. Ct. Spec. App 2009), involves an interesting twist on pre-formation contracts. Lenkey and Kunkel were contractors, with separate businesses, each conducted through separate LLCs. Apparently, Lenkey and Kunkel also conducted business as partners under the name Baltimore Street Builders. Lenkey signed a construction contract in the name of Baltimore Street Builders, LLC. Work under the contract began in January 2006. The LLC was not organized until March 2007, shortly before the completion of the work in June 2007. When the homeowner refused to pay for the work as performed, the LLC sued to establish and enforce a mechanic’s lien on the property. The problem? Neither Lenky, who signed the conttract, nor the LLC, nor its predecessor partnership, had a home improvement license, either at the time of contracting, or before starting or completing work. No license, no lien.
The Court rejected the argument that the licensing requirement was met because work under the contract was done by Kunkel’s LLC, which did have a home improvement license. The court reasoned that the statute required “persons” acting as contractors to be licensed, and defined person to include any “partnership, firm, association, corporation, or other entity.” Slip Op., at 8-9.
Inasmuch as neither Robert Lenkey or BSB [the LLC?] of the informal partnership known as BSB ever had a home improvement contractor’s license, it cannot be said that the “person” with whom appellee contracted complied with [the licensing statute]. (sic).
Slip Op., at 9. The Court also rejected a substantial compliance argument
Because BSB’s counsel admitted at oral argument before us that it was Mr. Kunkel’s company … that had the license, we interpret the appellant’s argument to be that BSB substantially complied with the statute because at the time the contract … was signed, BSB was a partnership and Mr. Kunkel was one of BSB’s partners, and an entity controlled by Mr. Kunkel had a license. Such an attenuated relationship with a license holder can scarcely be considered “substantial compliance” in light of the requirement that the partnership [BSB] that contracts to do the home improvement work must be licensed.
Slip Op., at 12-13.
And, the mere fact that [Kunkel’s LLC], a sub contractor, was licensed does not fulfill the purpose of the Home Improvement Law insofar as [the homeowner] s concerned. After all, [the homeowner] never contracted with that entity and thus could not have successfully brought a breach contract action against [it.]
Slip Op., at 20.
Gary Rosin
“Check the Box” as Diagnostic
September 22nd, 2009Heather M. Field (UC-Hastings) argues in Checking in on “Check-the-Box,” 42 Loy. L.A. L. Rev. 451 (2009) that
It’s not just the “multi-regime system.” Partnership taxation is built on an extreme aggregate view of partnerships that was not true in 1954 (or before) and still isn’t true. Even under the UPA’s tenancy-in-partnership, partners have no meaning individual rights in, or access to, partnership property. Partnership property is dedicated to partnership purposes; all an individual partner has is the right to distributions (if, as and when approved by the partners). RUPA-based partnership statutes now vest title to partnership property in the entity, and not the partners.
It’s hard to ensure economic substance in partnership allocations when the partnership tax regime itself has no economic substance. Well, apart from the tax regime itself.
Now, if I were the Tax Czar, I’d like to see
That level would the field, both as between entities, and as between debt and equity.
Hat-tip to Paul Caron (Tax Prof blog).
Gary Rosin
Tags: Check-the Box
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