I don’t need to tell you that New York lies at the center of the universe.  But did you know that you can be a part of it by choosing New York law to govern your business contracts and New York courts to decide upon any conflicts arising from your business contracts, even if the transaction, you, or the other party to the contract have no relation to New York?

Choosing New York law and New York courts may be desirable, because

  • you and the other contract party are from different states or countries and you wish to agree on a neutral law and a neutral place for dispute resolution; or
  • you wish to take advantage of New York law and New York courts which are known to address the most complex financial and commercial transactions.

Choosing New York Law

You can choose New York law to govern your contract – whether or not the contract has any relation to New York – if your contract provides for consideration of at least $250,000.  (General Obligations Law Section 5 1401).

How do you choose New York law to govern your contract?  You agree to it with your contract partner by including a provision in your contract similar to this one:

This Contract shall be governed by and construed in accordance with the laws of the State of New York.

Some lawyers add “without regard to New York’s choice of law statutes” or something similar, but I believe that is unnecessary.

Choosing New York courts

Now, in order to ensure that your choice of law provision will be enforced when you find yourself in court over the contract, you are well-advised to choose New York courts in addition to New York law.  If you have chosen New York law in your contract and your contract relates to an obligation of at least $1,000,000, you can have New York courts decide upon your contract disputes.  New York General Obligations Law Section 5 1402 provides that you can sue a foreign corporation or non-resident where the dispute arises out of a contract for which a choice of New York law has been made and which is a contract with consideration covering at least one million dollars.

How do you choose New York courts?  You agree to it with your contract partner by including a provision in your contract similar to this one:

Each of the parties to this Contract hereby irrevocably consents and agrees that any legal action, suit or proceeding with respect to this Contract may* be brought in a federal or state court located in [_______, New York], and each of them hereby irrevocably accepts and submits to the jurisdiction of such courts with respect to any such action, suit or proceeding.

*Note that this provision makes the selection of New York courts optional.  You could also agree that the selection of New York courts is mandatory.  In that case it would read “must be brought exclusively in a federal or state court located in…”.

Consider Consenting to Special Service

If both parties are not present in New York, it is advisable to agree in advance what constitutes service for the purpose of starting a lawsuit in New York courts.  For this reason, you could agree to a provision similar to this one:

Each of the parties to the Contract hereby irrevocably designates, appoints and empowers [insert name and address of an agent in New York], as its authorized agent to receive for and on its behalf service of summons or other legal process in any action, suit or proceeding in the State of New York.  Each of the parties to the Contract further irrevocably consents to the service of process out of any New York court by mailing copies thereof by registered United States air mail postage prepaid to each of the parties of the Contract at its address specified in this Contract.

Don’t hesitate to contact me if you have any questions about this topic.

“Should I sue my business partner?” you are asking yourself. You are fuming right now about what your business partner is doing to you and/or the business, and you are wondering if you should sue your business partner. Before pulling the trigger, understand what lies ahead:

Is there a way to negotiate yourself out of this before suing your business partner?

Going to court should always be the last resort. Court actions are costly and time-consuming (years, not months) and can destroy what is left of your business and your sanity. While your attorneys will do most of the heavy lifting, you will have to spend a lot of time cooperating with them and gathering relevant evidence. So try your best to come to the table with your partners to negotiate a good outcome before going to court. Give a little, take a little.  And even if you are already well into a lawsuit, consider settling before trial.

What do the Agreements say?

Your decision to sue your business partner or settle begins with your business agreement. You, or preferably your attorney, should check whether you have a written agreement with your partners and what it might say about your dispute. If your business is a corporation, there may be bylaws, a certificate of incorporation, and a shareholder agreement. If it is a limited liability company, there may be an operating agreement. Each of these documents, and others, may have relevant provisions.

Even if you have no formal documents, other writings could act as agreements between you and your partners. Do you recall all the promises made in email correspondence or phone texts – or on cocktail napkins? Any document showing some sort of consent may be helpful.

If you do not have anything in writing (like many small businesses, unfortunately), you need to look to the New York laws dealing with your specific entity: for LLCs, the New York Limited Liability Company Law (NYLLC), and for corporations, the New York Business Corporation Law (BCL). These laws also apply if you have a written agreement that says nothing about the issues behind your dispute.

What are my Remedies if I sue my business partner?

Your next step is to consider what you might get in court or through negotiation. Obviously, the cure depends on the problem.  But certain remedies often come up in partnership disputes.

Access to Books and Records

You can demand to see the books and records of the business.  If needed, an expedited legal proceeding (meaning it takes months, not years) can enforce this right.  The governing law is set forth in BCL 624 and  NYLLC 1102.  Inspection rights of members and business owners are not absolute, but any legitimate purpose will likely satisfy the court.  In any event, a demand can signal to your partners that you mean business and may force them to choose good faith negotiation over digging in their heels.

Claim against Partners who damaged you or the Business

You may have a claim against fellow business owners for misbehaving toward you or the business.  Managers and managing members of New York LLCs owe fiduciary duties to the other members (while non-managing members of manager-managed LLCs do not).   Officers and directors of a corporation owe fiduciary duties to the corporation and the shareholders.  Shareholders do not owe fiduciary duties to each other – except in very small corporations or where the shareholders are essentially managing the corporation.

A fiduciary duty is an obligation to act in good faith, to treat co-owners fairly and in accordance with the deal struck, to act in the best interest of the business and its owners, and to refrain from fraud, taking assets for one’s own benefit, wasting assets, competing with the business or diverting clients away from it. If your partner violates this duty, you may be able to sue the partner directly or on behalf of the LLC or corporation.

If there is a breach of those duties, you may be able to sue the person committing the breach directly or, if the breach was more towards the business, you could sue on behalf of the LLC or corporation, a so-called “derivative” action.

Forced Break-Up of the Business

Under certain circumstances, you may be able to take your dysfunctional business family to court and have a judge dissolve the business and order it to liquidate its assets.  You will first need to ask yourself if this drastic step is really the best outcome. The value of a business lies in its operations and goodwill as a going concern. But sometimes, it can be a good idea to bring such a lawsuit anyway because it may force your partners to consider a buyout – and the court may even order one.

Forced Dissolution of a Corporation

If you (alone or together with other owners willing to go into battle with you) own 50% of the shares in a corporation, you can have a judge order dissolution by showing that management is hopelessly deadlocked (Section 1104 of the BCL).

If you own at least 20%, you can have a judge order dissolution by showing that management is guilty of illegal, fraudulent, or oppressive actions toward the complaining shareholders or that the corporation’s assets are being looted, wasted, or diverted for non-business purposes by the directors or officers or others in control.  In deciding over such a case, a judge has some options under the law and could conclude that liquidation of the corporation is too harsh a remedy and that there less painful means, such as a buyout, to give you what you are owed and protect your rights (Section 1104-a).

So a shareholder with 50% or more has two options, under 1104 and 1104-a.  But the choice needs to be carefully considered since 1104-a petitioners can be forced to accept a buyout. 1118 BCL gives your opponents the option to buy you out for the fair value of your ownership share. What is fair value? Unless you agree on an amount, a battle will commence between experts who follow complicated rules and methods established over time.

Forced Dissolution of a Limited Liability Company

Many LLC owners are surprised to learn that their break-up rights and remedies are much less defined than in a corporation.  Dissolution of an LLC is codified in Section 702 of the New York Limited Liability Law.   Under 702, you need to show that management is not willing or is unable to pursue the stated purpose of the LLC, or that continuing the entity is financially unfeasible.   Easy in theory but difficult in practice.  That management may be hopelessly deadlocked or guilty of misconduct is not always enough to justify a dissolution under Section 702.

Equitable Buyout

In connection with this proceeding or standing on its own, a court may decide to grant an “equitable buyout,” meaning it is not provided for in the written law, but the court thinks it is a good idea to protect the business owners.  An equitable buyout consists of one member being forced to sell his/her ownership interest to the other member.  But don’t rely on this since this equitable remedy is very new and the requirements a little murky.  It seems that a prerequisite for the equitable buyout is that you can show that you also have a good case for dissolution under Section 702 and that a buyout is really the “most equitable method of liquidation.”  So it all depends on the individual facts.

Do you need legal action immediately?

Many people are anxious to bring injunctive relief as soon as the dispute hits the fan.  Injunctive relief means that a court will relatively quickly stop the rogue business owner’s shenanigans without waiting for a trial, which can take years.  Injunctive relief requires that you can show a high likelihood that you would win after trial, and there would be irreparable injury without this expedited relief.  An example would be any action that significantly affects the control and management of the LLC or corporation.  Courts have held that such misconduct can have irreparable consequences.  Anything that can be fixed with money damages is less likely to be a candidate for injunctive relief.   However, bringing an action for injunctive relief rather than waiting for the wheels of justice to turn can make or break your litigation strategy.  Even if you have a good case, a lost injunctive relief petition may shift the balance in favor of your opponent.

Call me if you have any questions about the above topic.  And also see “Business Partnerships Gone Bad.”

Easy Money or Debt Trap?

Merchant Cash Advances are often the small business owner’s last resort for cashflow. When an SBA loan or any other business loan is out of reach, Merchant Cash Advance businesses are eager to give the business owner money. It only takes a couple of days, minimal paperwork, and the money flows into the account. However, it is often a slippery slope into a debt spiral with no return.

Many articles have been written about how Merchant Cash Advances work, for example this one by nerdwallet.

But, as the nerdwallet article points out, the contracts underlying these transactions can be complicated and are certainly not standardized. The rules for default are all over the place and it really pays to know your rights under the Merchant Cash Advance agreement before you default and are faced with sometimes very aggressive debt collectors who will go after your business accounts, personal assets (if you gave a guaranty) and enter a judgment against you without you even knowing (if you signed a confession of judgment). The industry is not regulated and there are lenders out there who are engaged in what can only be described as predatory lending practices. New York has recently outlawed confessions of judgment against out of state borrowers.

Usurious Loan or Sale of Receivables?

When faced with out of control lenders trying to enforce under the Merchant Cash Advance, many borrowers have tried to characterize the merchant cash advance as a usurious loan. If you do the math, many of these transactions cost more than 100% interest. The nerd wallet article actually has a calculator how to really determine the cost of this kind of financing.

In New York, it is considered a criminally usurious loan if a lender charges more than 25% interest. If one succeeds on that argument, the entire agreement would be void and the borrower would not have to pay any interest or principal on the loan.

Unfortunately, many New York courts have now decided that a merchant cash advance is not a loan, but a sale of your future receivables. Therefore, the rules about usury do not apply and Merchant Cash Advance lenders can get away with highway robbery. How do you make the distinction between a loan and a sale of receivables?

Courts have explained that there are certain factors that a court should look for to see if repayment is absolute or contingent. Does the merchant lender have the risk of the merchant’s business going down, i.e. no receivables to collect? Or does the lender have a right to repayment no matter what?
Courts named three factors that should be present in any MCA agreement in order not to be a usurious loan: (1) a reconciliation provision that allows the merchant to adjust the fixed daily ACH payments to the amount of its actual daily receipts (answer should be yes); (2) an indefinite contract term, which is consistent with the contingent nature of each and every collection of future sales. . (answer should be yes).; and (3) whether the merchant financing company has recourse if the merchant declares bankruptcy (answer should be no).

Every Agreement must be Analyzed

Of course, every merchant lender out there, if smart enough, will now draft their agreements so that all these factors are present. But still, not everybody is skilled, and many of the other protections merchant lenders may want to put into their agreements to protect themselves may convince a court otherwise. Every agreement needs to be analyzed whether it is a usurious loan or a sale of receivables.

Every once in a while, a judge will still entertain the idea that such a transaction is a loan. In McNider Marine, LLC v. Yellowstone Capital, LLC, a judge ruled on a motion to dismiss by the lenders:

 “In determining whether a transaction is usurious, the law looks not to its form, but to its substance, or real character”

“After analyzing specific MCA agreements, many New York courts have found that they constitute legitimate purchases of accounts receivables instead of loans with usurious interest rates. Courts that found otherwise, that MCA agreements were usurious loans disguised as purchases of accounts receivable, typically found no provisions for forgiveness or modification of the loans, such as viable and enforceable reconciliation provisions, in the event that the funding companies could not collect the daily amounts required”

“Focusing on the reconciliation provision in a given merchant agreement is appropriate because it often determines the risk to the funding company. If the funding company truly is collecting a specified percentage of accounts receivable, then the funding company bears the risk of a downturn in the merchant’s business. The specified percentage typically is replaced by a fixed payment (as it was here), but if that payment is reconciled when accounts receivable drop below the merchant’s original estimation, then it may take the merchant far longer to repay the amount advanced than the funding company had anticipated.”

If, however, the merchant is unable to adjust fixed payments in the event of a reduction of its accounts receivable, and the funding company can collect the amount due and owing by way of a personal guarantee and confession of judgment, there is far less risk to the funding company. Therefore, whether the merchant may reconcile its fixed payment amount when there is a reduction of accounts receivable is often determinative of whether repayment is absolute or contingent. If repayment is absolute, then the arrangement must be considered a loan as opposed to a purchase of accounts receivable.
In this case, the court finds that plaintiffs have demonstrated that the reconciliation provisions contained in the addenda to the July and October agreements were illusory. First, the court cannot find from the language in the agreements that Yellowstone had any duty to reconcile. In fact, Yellowstone likely could refuse to even consider reconciliation if it contended that McNider Marine failed to sufficiently document a basis for it. Furthermore, even if Yellowstone was required to reconcile, there was no time to do so because McNider could request reconciliation only within five business days following the end of a calendar month. McNider Marine defaulted on December 16, 2016, so it could not request reconciliation until the first week of January 2017. Yellowstone filed for a judgment by confession on December 22, 2016 and obtained that judgment on December 28, 2016.”
The notion of reconciliation for McNider Marine appears particularly futile because the fixed daily payment in the October agreement was not a good faith estimate of 15% of its receivables to begin with inasmuch as there was no evidence that the receivables had increased over 40% from the July estimate. Without the right to effectively reconcile the fixed dollar amount, the agreement resulted in a loan payable over a fixed term with a criminally usurious interest rate in excess of 285%.”

Have your Situation checked by a Lawyer

So, many things can go wrong. Lenders may not draft their agreements properly and it could actually turn out to be a usurious loan. Lenders may try to enforce the agreements against the terms of the agreement and in the process freeze your entire business. Lenders may fail to properly enforce their rights against you. For example, many of the predatory lenders try to bully you and your third-party debtors into paying them directly, despite the fact that they have not properly entered the judgment in your home state and have no right to demand direct payment.

If you are under the squeeze of a merchant lender gone wild, it pays to run your contract and the events by a lawyer. The worst case scenario is that your lawyer can help you to savely negotiate a way out of debt.

Most litigations reach a point, sooner or later, when the parties discuss settlement.  When should you discuss settlement in your litigation?  There is no precise rule.  It could be right after you file the complaint or after the parties has the chance to look at each other’s evidence (discovery).  There are some other things to know re settlement in litigation:

Nothing Said can be Used as Evidence

New York’s civil procedure code (CPLR 4547) provides very useful protection for settlement talks: nothing said in them can be used as evidence against a party later; for example, you cannot tell a judge or jury that a defendant acknowledged liability by offering a settlement. It is a good practice to head emails or correspondence “Confidential–for settlement purposes only”, or similar wording.

There are three things an experienced attorney will take into account: when to initiate settlement discussions, what to say, and how much to ask for.

Timing of Settlement Discussions

As far as timing is concerned, usually, a plaintiff must put in a certain amount of work before the defendant is willing to have a serious discussion. Most cases don’t settle simply because the plaintiff sent a demand letter or even filed a complaint; the most common time for discussions to begin is after the discovery phase when the parties have a more comprehensive idea of what the evidence will show at trial and the strengths and weaknesses of their respective positions. Some cases do not settle until the eve of trial. When you are suing an entity that litigates frequently (or has an insurance company that does), you may be able to find out what their usual practice is. For example, the insurance company on a slip and fall case may settle early, while a medical malpractice insurer is likely to make you go to trial.

What to say in Settlement Discussions

A typical settlement conversation is conducted amicably, with a minimum of adversarial rhetoric. “You know your client has some exposure on this. If I win, damages are likely to be $xxxx. My client would be willing to take $xxx now”. Without the tone becoming negative, you can describe what you think are the highlights of your case: the defendant sent your client an ill-advised email acknowledging responsibility for a problem, or your client will be much more sympathetic to a Brooklyn jury than the defendant. Don’t be offended or shaken when opposing counsel replies similarly, that she thinks your case is a loser because your client behaved recklessly, made his own ill-considered statement about getting rich from the lawsuit, etc. She is doing her job. If you believe there are weaknesses in your case, part of the game may be sounding more confident in conversations than you feel. In other situations, a good tactic may be to acknowledge a weakness while explaining how you will work around it. You may be showing your tactical hand here, but sometimes what you are describing is an approach the other side has already predicted, so you are just illustrating your own expertise. Sometimes an exchange of evidence may take place during discussions, and, less often, an exchange of case law supporting your position. As a general rule, anything you can think of which will keep the conversation going and overcome obstacles, is worth considering.

How much to ask for

Settlement in your litigation usually begins with the plaintiff making a demand, based on your realistic view of the damages (which may be less than the sum you asked for in the complaint), discounted by some amount as a sign of good faith. A logical explanation for the discount is helpful but not required (“if we settle this week we will agree to forego the interest”). Since the defendant’s offer will be much lower, you want to discount your initial demand only by an amount which still gives you room to move.

There is a large client relations component involved. You should be patient with your own client and take the needed time. Clients tend to be angry at the other side, and can easily feel as if their own lawyer is overly eager for them to take a relatively modest amount to avoid doing more work on the case. If you don’t take the time to check in with the client frequently, to talk through all concerns, and to get the client’s repeated endorsement of the numbers under discussion, you may wind up getting a great deal for a client who thinks its a bad one.

Frequently, discussions with your own client are more time-consuming than negotiating with the other side. It may even feel like psychotherapy. Clients who insist on unrealistic numbers or say they would rather go to trial are not guaranteed calmly to accept the results if they lose (or win a smaller amount).

The math you must do with your client involves starting from the value of the realistic damage claim, which is then discounted, by the present-day value of money which might not be recovered for several years; by the strength or weakness of the case; and, of course, by the legal fees your client would have to pay you to see the case through trial.

It is a good idea to begin a settlement conversation with two numbers in mind: the demand you are making and the secret number which is the least your client would accept. In the ensuing negotiation, you should move downwards as slowly as possible, while trying to achieve a better result than your client’s bottom line number.

In some cases, a settlement for fifty percent of your demand is a good number; in a stronger case, you may achieve eighty percent of your demand. Every case is different. When you make a demand and the other side listens carefully and then comes back with an offer that bears a certain relationship to your demand (typically, a third or more of what you asked), you are probably in the end game and a settlement is possible.

When to end Settlement Discussions in your Litigation

There is also the art of knowing when to end discussions. While some relatively honest adversaries will just decline to discuss settlement, others will respond frivolously. Two very common examples are the offer of a nominal amount (you asked for $500,000 and the other side counters with $20,000), and the particularly notorious request that you negotiate against yourself (“That demand is too high. If you come back with a more realistic number, we will talk”). In these situations, continuing the conversation may make you appear weak, over-eager or inexperienced. It is sometimes best to end the conversation in the hope it can be restarted later. Often a good way to sign off is simply by not making the next phone call (nothing communicates confidence in your case more than simply letting a fruitless discussion drop and getting back to making motions or demanding discovery).

In our experience, three or four litigations eventually settle for every one which proceeds to trial. Timing varies. In the past few years, we settled one case for 80% of the demand, very soon after filing the complaint, and another one for about 40% on the eve of trial. Both were good settlements, and because we did the necessary hand-holding, both clients were satisfied.

Many small business contracts provide that any dispute arising from the contract must be arbitrated rather than litigated in a state or federal court.  Unfortunately, these provisions are often included without a second thought to their practical meaning and whether small business arbitration is beneficial.  Before agreeing to arbitrate your small business dispute know this about arbitration:

What is Arbitration?

Litigation of disputes normally takes place in the various courts of New York State.  As an alternative, people can agree to resolve their disputes outside of the traditional courts and authorize arbitrators to hear and decide their case.  Technically, one could authorize any third party to be an arbitrator.  Such an arbitrator would then decide your dispute based on his or her understanding of justice and fairness.  However, most contracts provide that disputes are to be arbitrated by specified arbitration associations, such as the American Arbitration Association or JAMS.  Most arbitration associations have arbitrators ready to spring into action and provide for a set of rules to be applied by the arbitrators in deciding the case.

Cost of Small Business Arbitration

Small Business Arbitration can be pretty expensive.  If your claim against your adversary is rather small, the cost of arbitration may be too steep.  To get the arbitration going, you have to pay the arbitration association’s fees, which can be quite costly.  Look at the fee structure of the American Arbitration Association here.  The filing of a complaint in supreme court will cost you a “mere”  $210 and might be all you need for now to get serious settlement negotiations going.    On the other hand, litigation can quickly get very expensive in the long run.  The parties in litigation may spend huge sums of money on discovery (production and review of evidence) and motion practice.  An arbitrator may be able to control such expenses by only allowing limited discovery and motion practice.

Small Business Arbitration is Non-Public

The public has no access to your arbitration dispute, whereas civil and supreme court litigation is a matter of public record.  The court papers can be seen by anyone with a rudimentary knowledge of the court system and court databases.  Anybody can appear to a hearing or trial in your small business dispute.  Depending on your outlook on publicity, this may play for or against you.

Discretion of Arbitrators

An arbitrator has much more discretion on how to lead the dispute proceedings, what evidence to allow and what law to follow.  Arbitrators are more inclined to let “fairness” and equity rule, even if not entirely within the constraints of prior case law.   This can make your arbitration case rather unpredictable.

No Appeal

An arbitration award is usually final.   There are only very limited possibilities of appealing an arbitration award.

We can help you with your small business arbitration.

How do you evaluate small business litigation; whether to bring a law suit or not?

Metaphysical Overview

The small business owner considering litigation, or being sued, should at the outset take what I refer to as a “metaphysical” overview of the problem. The two constants of litigation are that it is time-consuming, expensive and the outcome is uncertain (any lawyer who guarantees you will win a case is exaggerating or inexperienced).

A civil law suit can easily take over a year and has to go to various lengthy stages.  There will be initial court papers, answers from the defendant, investigation of each party’s evidence (discovery), pre-trial testimony (depositions), special pre-trial requests to the court to make decisions about the case (motions), numerous appearances and conferences and finally the trial.  This takes a lot of time and legal fees.

Thus, before you launch, it is important to know what you are trying to accomplish and if it makes financial sense.

If someone has breached a contract with you or otherwise inflicted some legally recognizable harm, as a matter of thoroughness and due diligence you should always consider the option of doing nothing.

If someone caused you $7,500 in damage, which was a one time situation and won’t repeat, it won’t encourage anyone else to do the same, and it will cost $15,000 to litigate, it may be good economics to walk away. On the other hand, legal harms which may result in the destruction of, or significant ongoing harm to,  your business, such as someone wrongfully appropriating a major project or client, may leave you no choice but to litigate.

If you are being sued, the “metaphysics” is similar. There is a subset of cases which can be settled for a few thousand dollars, would cost more to litigate, and cause no reputational or other ongoing harm if you settle, regardless of whether you believe you are liable or not.

In both situations, you owe it to yourself as a rational businessperson to know what your goals are. Litigation, as unusual or even extraordinary as it may seem, is a tactic that businesses use to achieve goals, so, just like a marketing campaign or other large expenditure, it should have an objective business reason. If you can say, “if we don’t sue, we will have no business left” or  “we will take a significant hit to revenue because our subcontractors will learn they can cut us out of the loop”, these are potentially sound business motives. If, however, the reason you arrive at is “I am angry” or “I want to teach that idiot a lesson,” you should think twice before going ahead.

Can you collect a Judgment?

Finally, you always have to have an eye on the collectibility of a judgment in your favor.  If the defendant has no assets, a judgment is worthless.  You may be able to glean some clues about the defendant’s financial affairs by searching for other law suits against it, getting a business credit report or doing some asking around in the defendant’s business circles.

See also, when and how to discuss settlement in your litigation.

Business Partnerships Can go Bad.  Picture this:

own a restaurant with three other people.  Lately, all we’ve been doing is fighting over almost everything.  Now it seems that everybody turned on me.  I have not seen any money from the business.  Meanwhile, everybody else uses the restaurant as their own piggy bank.  What can I do?

A business break-up of a business partnership can be as stressful and emotionally draining as the breakup of a marriage.  And there is always a child involved….the business.  So when your business partnership has gone bad, you really want to find out where you are standing and what rights you may have vis a vis the other business partners and the business.

The Agreements

Whatever your gripe against your business partners may be, the first question is always: What does the agreement say?  You have to check whether you have an agreement with your business partners and what it says concerning your problem.   If the business is run as a corporation, check your shareholder agreement;  if it is an LLC, check the operating agreement.

If you do not have anything in writing (like many small businesses, unfortunately), you have to look to the default rules of the respective New York laws dealing with your specific entity.     For LLCs, it is the New York Limited Liability Company Law, and for corporations, it is the New York Business Corporation Law.  These laws also apply if your agreement is silent with respect to your issues.

The following assumes that the default rules govern your relationship and that it is organized as a New York corporation or a New York limited liability company.  So always remember that your particular agreement may have different provisions.

Making Bad Business Partners Responsible for their Actions

As business partners, you owe each other and the business loyalty, honesty, and support.  Each of you is held to a higher standard than ordinary people.  This is called “fiduciary duties.”  Business partners cannot steal or embezzle from the business; they cannot grossly mismanage or withhold good deals from the business.  If this is happening, you have a court action for “breach of fiduciary duty.”  This action can take the form of asking for damages or making the bad business partners stop the offending conduct.   In most cases, the damages are being done to the business and not to you personally. Thus, such an action would be in the name of the business.  In other words, you are the plaintiff, but you are bringing the action for the benefit of the business.  So if you win the action in court, the money damages go to the business, not to you personally.  But you are entitled to get your attorneys’ fees back from the amount of money granted by the court before it goes to the business.

Forced Business Partnership Break-Up

I just want to leave this behind me.  They should buy me out and  let me go.  I am doing them a favor, because somebody will get hurt if we don’t come to a resolution soon.

Unfortunately, as a minority shareholder of a corporation or a member of an LLC, you may not be able to convince your estranged business owners to let you go and buy you out.  Unless your agreement provides for some withdrawal/buy-out remedy, you will remain a member/shareholder until the business dissolves or until the other owners agree to buy you out.

Is there a way that I can force a break-up of the business?  If they don’t want to compensate me for leaving in peace, we should just close shop and call it a day.

Under certain circumstances, you may be able to take your dysfunctional business family to court and ask the judge to dissolve the business and then distribute the assets to the owners.   If you can succeed with such a drastic step depends on the facts of your situation and whether you are a shareholder in a corporation or a member of an LLC.

Forced Dissolution of a Corporation

If you (alone or together with other owners willing to go into battle with you) own  50% of the shares in the corporation, you can petition a court for dissolution of the corporation by showing either one or both of the below:

– management is hopelessly deadlocked; or

– management has been guilty of illegal, fraudulent, or oppressive actions toward you.

If your ownership is at least 20%, you can still petition under the second showing above, namely, that the other owners have engaged in illegal, fraudulent, or oppressive actions.  But in those cases, a judge has certain discretions and may conclude that the liquidation of the corporation is too harsh a remedy and that there are other feasible means to give what you are owed and protect your rights.  In that context, a judge may conclude that a buy-out may be a proper remedy for your situation.

Buy-Out Election

If you decide to sue your estranged business owners based on oppression, you may be in for a surprise because your opponents could force you to accept a buy-out of your stake in the business.  The business corporation law gives your opponents the option to buy you out for the fair value of your ownership share.  But they must make that election within 90 days after you have filed your papers.   What is the fair value of your ownership stake?  Unless you agree on such value, it will be a battle of the experts who follow specific rules and methods established over time.

Forced Dissolution of a Limited Liability Company

Many owners of a Limited Liability Company are surprised to learn that their business break-up rights and remedies are much less defined compared to a corporation.   A minority member of an LLC has limited possibilities to force a dissolution of the LLC. The majority members of an LLC are not able to force the minority member to accept a buy-out.

The only remedy for a forced dissolution of an LLC is in Section 702 of the New York Limited Liability Law. A member can force a dissolution whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or the operating agreement.   The New York Limited Liability Law does not provide a buy-out election or all the other specific rights in the business corporation laws.

However, by now, the courts have given some guidance.

For a dissolution under Section 702 Limited Liability Company Law, “the petitioning member must establish, in the context of the terms of the operating agreement or articles of incorporation, that (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible.”

If dissolution is justified, courts have now even granted a so-called “equitable buyout,” whereby an LLC member is allowed to purchase the other member’s interest in the LLC.  This is not really a dissolution, as the LLC continues its existence after the buyout.

Is a deadlock or total conflict between the members sufficient for a dissolution?  Not always.  Courts have held that dissolution is not warranted despite disagreements between the members when the limited liability company can otherwise continue to operate in furtherance of achieving its stated business purpose.

The reality is that many dissolution fights over corporations and LLCs or lawsuits for breach of fiduciary duty end in settlement.  In certain situations, a court action towards dissolution or for breach of fiduciary duty or both may be the right strategic move to convince your business partners that they have to come to the table and negotiate with you, rather than spend a fortune on litigation.

Short of dissolution, don’t they have to pay me my share of the profits? I have not seen anything in terms of money.

Right to Profits – Access to Books and Records

Before dissolution, you have a right to profit distributions.  If the other members/shareholders pay themselves, most likely, you have a right to a similar distribution based on your ownership percentage.

I don’t even know how the business is doing financially and how much they are paying themselves. How can I get access to that information?

Each shareholder of a corporation or member of an LLC has a right to inspect the books and records of the business.  Write them a letter and demand to see them.  If they don’t let you, you can take the matter to court.  The law provides an expedited proceeding giving you the right to see the books and records; sometimes, this gets the ball rolling for serious negotiations and makes the parties come to the table.

Can they make all kinds of decisions without my consent?

When it is you and one other owner, certain important decisions have to be made by consent of all owners.  For example, the other business owner in an LLC cannot just take in another member without your consent.

When it is you against more than one other business owner, there is the possibility that they can outvote you, even on certain critical issues.  But they have to follow proper procedure and notify you of all decisions made without your consent.  Finally, they can’t just decide to do whatever pleases them.  If their decision is completely lacking any business judgment or just designed to damage you and your stake in the business, you may have a claim against them based on their breach of fiduciary duties against you.

Call me to discuss your business partnership gone bad.  We help clients with business partnership disputes.

(Also see Access to LLC Books and Records)

According to New York Civil Practice Law and Rules section 3016(b), in a fraud cause of action in a complaint, “the circumstances constituting the wrong shall be stated in detail”.  Contrast this with the standard for a libel or slander pleading in 3016(a): ” the particular words complained of shall be set forth in the complaint”. Lawyers might be excused for thinking that there was a slightly less exacting standard for fraud than defamation.

In a 2014 decision, the Appellate Division First Department was very specific about specificity, dismissing a fraud claim “because the words used by defendants and the date of the alleged false representations are not set forth”, Gregor v. Rossi, 120 A.D.3d 447 (1st Dept. 2014). The Court in effect closed the gap between fraud and defamation pleadings, requiring that even a fraud pleading name the speaker of a misrepresentation and quote the words used. Trial courts in the First Department, which covers Manhattan and the Bronx, have since applied the new rule to dismiss fraud claims. In Board of Mgrs. of 141 Fifth Ave. Condominium v 141 Acquisition Assoc. LLC, 2015 N.Y. Misc. LEXIS 3775 (Supreme Court New York County 2015) the court held that “the amended complaint does not set forth a specific statement and, often, does not identify a specific document in which these statements allegedly occurred. Such allegations are insufficient to state a fraud claim”. In Davoli v Dourdas, 2015 N.Y. Misc. LEXIS 1345 (Supreme Court New York County 2015) the court stated that “The particularity requirement of CPLR 3016(b) requires, in general, that the complaint specify the language of the alleged misstatements and the time and place that were made”.

Experienced defense practitioners are used to seeing fraud claims included as afterthoughts in what are essentially law suits for breach of contract. By raising the bar on specificity, the Appellate Division has acted to discourage this practice, and to require plaintiffs not to make allegations of fraud unless they really have facts to back it up.

I wish every small business that all its clients and customers always pay what is owed.  Unfortunately, we know this not to be true.  At a certain point, all small businesses face the dilemma of either writing off an unpaid invoice or trying to collect it in court.  But there are measures you can take to increase the likelihood of collecting outstanding invoices. One is a written agreement, the other, less known legal weapon, is an “account stated.”

Enter into a Written Agreement

The first building block of a successful collection system is a written agreement with the customer that sets forth how much is owed, when it has to be paid and how much interest will accrue on unpaid invoices.  The agreement could also add incentive discounts for paying on time or paying early.

Establish an Account Stated

But there is something else that you can do today to make a future court action for any outstanding invoice go smoother.   Your billing practices have to make sure that every outstanding account qualifies as a so-called “account stated.”   Once you are in court, an account stated cuts off any complaints by your delinquent customer that the service or product that you sold to him or her was defective.

An account stated requires that:

You regularly send invoices to your customers detailing the amount and any interest due; If payment is not made after the first invoice, you keep sending updated invoices at regular intervals.

That’s it.   If your attorney can show the above and that the delinquent customer did not object to the invoices and/or made some partial payment on the outstanding invoice, your attorney can get a quick judgment on a so-called account stated.   The law interprets the customer’s silence in response to the invoices as his or her agreement to pay the stated amounts in the invoice.  Since he or she did not object to the invoices then, he or she should not be allowed to raise problems later.  Thus, the debtor’s only defense on an action for collection of an invoice would be that he or she actually did object to the invoices.  But general allegations are not sufficient under the law.  The debtor has to detail the specifics of when, how, and/or to whom he or she objected to the invoices sent.  A failure to do so enables your attorney to immediately move for a judgment on the amount due, which dramatically reduces the cost and time involved in ultimately collecting on the debt.

There may come a time when you have to prove what, if anything, you own of that small business corporation. Once a relationship with business partners goes sour, your fellow business owners may dispute your exact percentage of ownership, short-change you on the distribution of profits, or you may want to sue them for dissolution of the corporation or force a buyout, which requires certain percentages of share ownership.

Let me tell you in all caps:  NOTHING BEATS A SHARE CERTIFICATE .

 

A share certificate issued by the corporation is solid proof (legalese: “prima facie” evidence) that you own a piece of the corporation and how much of that piece you own.  See Business Corporation Law 624(f).

If your startup corporation follows proper coperate formalities, the issuance of share certificates should be a routine step during the formation process.  When ownership changes, a change in the records of the corporation is similarly painless.

Still, in reality, many small business owners don’t pay much attention to such formalities.  Another often encountered situation is that the business owners misrepresent share ownership for the purpose of getting a better loan or qualifying for certain licenses (for example, a liquor license).  Or a business owner might fudge his ownership in the context of divorce proceedings.  All of the above may muddy the waters when trying to show actual share ownership.

Fortunately, not all is lost when you do not have a share certificate issued to your name.

Not having a share certificate does not necessarily mean that you do not own part of the corporation.  New York Courts know how many small businesses operate and have long held that evidence other than a share certificate may prove share ownership.

Courts may look at tax returns, actual financial contributions, liquor license applications, agreements, testimony of the parties involved or third parties.  Anything that can show that you owned part of the business.

But be aware, if you are the person bringing the claim, in most cases, you have the burden of proving that you in fact own shares in the corporation.  The burden of proof means that your version of the facts has to be more believable than your opponent’s version of the facts.  Which story is more credible?  If both stories are equally believable, you lose.  If your opponent is a good liar or has other evidence against you, it may not look so good for you.  Finally, having to go through the process of proving share ownership by other means adds substantial cost to any court proceeding.