Welcome to this 15th annual edition of Summer Shorts. This year's edition features brief commentary on a trio of recent decisions by New York courts in business divorce cases, all involving LLCs, including:
- A relatively infrequent example of a court appointing a temporary receiver at the behest of a dissident LLC member.
- A decision highlighting some basic rules for pleading business tort claims in LLC member disputes.
- A decision in an unopposed LLC dissolution case parsing the plaintiff's claims for damages at an inquest following the majority member's default.
(Dis)Band of Brothers: Court Appoints Temporary Receiver of Realty LLCs Due to Waste and Self-Dealing
Suits by minority interest owners of realty holding companies alleging mismanagement and financial abuse by the majority controllers are a dime a dozen. What I haven't seen are many successful attempts by plaintiffs to win court appointment of a temporary receiver in such cases. It's great leverage if you can get it, but the applicable standard for the "extreme remedy" of pre-judgment receivership, requiring a clear and convincing evidentiary showing of irreparable loss or waste to the realty, is a very high bar, especially when the property is collecting the rent and paying the bills.
Malekan v Malekan, decided earlier this year by Manhattan Commercial Division Justice Andrea Masley, is one of the relatively few examples of a successful application for appointment of a temporary receiver in a case involving commercial realty held by LLCs, in that case pitting brother against brother. The plaintiff brother (MM) sued the defendant brother (AM) alleging mismanagement of two fully rented commercial properties in downtown Manhattan. The brothers had a falling out starting in 2019 when MM left the family apparel business and started a competing business.
In 2023 MM brought suit against AM alleging a host of direct and derivative claims seeking monetary and equitable remedies for misappropriation of company assets, mismanagement, and withholding MM's proper share of profits. In 2024, MM moved for appointment of a temporary receiver after the two LLCs defaulted on their mortgages, prompting AM to make a capital call. At a hearing in early 2025, Justice Masley conditionally granted MM's motion, subject to AM's submission of a plan to refinance the properties.
After further jostling for position by the parties, Justice Masley held an evidentiary hearing, writing in her subsequent decision that "[a]lthough MM's documentary evidence of corporate waste and self-dealing is more than sufficient to satisfy the clear and convincing standard, the court scheduled a hearing primarily to hear from AM," whom she found "not credible." For instance, she found that AM's own documents contradicted his testimony that no bank would refinance the mortgages unless MM withdrew his lawsuit. Justice Masley also found that AM engaged in self-dealing, with proof that he took unexplained management fees and hundreds of thousands of dollars in repayment of loans he claimed to have made but could not substantiate. Among other evidence of financial abuse, the Court cited AM's improper use of the LLCs' funds to pay his legal fees in the action.
Justice Masley's decision observed that AM and other family members "clearly remain upset" about MM's departure from the family apparel business in 2019 and establishment of a competing firm. She also noted their insistence that "MM is responsible for the current financial woes" of the two LLCs even though he had no involvement with the real estate for years. All of which is to say, the maxim that "the best defense is a good offense" sometimes can backfire.
Court Crops Complaint Alleging Menu of Claims by Restaurant Investor
Over-pleading in a complaint in commercial litigation — that is, asserting a laundry list of aggressive sounding causes of action, each seeking the same remedy based on the same facts — may please a client and seem harmless enough, until you consider the high likelihood that opposing counsel will make a pre-answer dismissal motion attacking the legal viability of the questionable claims, delaying the case potentially for many months or longer, and costing the plaintiff hefty legal fees.
See, for example, Fitterer v Carone, brought by an aggrieved investor in a restaurant venture organized as an LLC, in which Manhattan Commercial Division Justice Joel Cohen was tasked with separating the wheat from the chaff in a ten-count complaint, each count seeking the identical money damages, that essentially presented straightforward claims for the managing member's breach of an LLC operating agreement's provisions governing distribution of net cash flow and a major decisions provision requiring the plaintiff's consent for certain debt transactions.
Instead, the complaint was packed with claims for various and sundry business torts, including breach of fiduciary duty against non-managing members (dismissed), breach of fiduciary duty against the LLC (dismissed), accounting by non-managing members (dismissed in part), breach of contract (dismissed in part), unjust enrichment (dismissed in part), conversion (dismissed), conspiracy to commit fraudulent conveyance (dismissed), fraudulent inducement (dismissed), and negligent misrepresentation (dismissed).
The initial round over the legal adequacy of the over-ambitious complaint set the case back almost a full year, during which there was no discovery and no progress toward resolving the merits. Was it worth it?
Court Denies Recovery of Capital Investment and Other Expenses in Failed Cannabis Venture
When a defendant in a lawsuit defaults, i.e., fails to appear in the case and answer the complaint, and the court orders an inquest to determine damages, you may think that the undefended inquest is tantamount to shooting fish in a barrel, that is, assume that with no opposition or contrary proof, the plaintiff will be awarded whatever it seeks.
It's a credit to our courts that they take very seriously their job to weigh the evidence at an undefended inquest, and to do so through the same lens of burdens of proof and legal sufficiency of claims as in a fiercely defended action.
That's what happened in HR Holdings, LLC v Horstmann, decided by Brooklyn Commercial Division Justice Reginald A. Boddie, in a case brought by a member of a short-lived, failed cannabis venture organized as an LLC. The plaintiff minority member sued the majority member seeking judicial dissolution, plus damages for breach of the operating agreement and fiduciary duty. The defendant failed to answer. The court entered a default and ordered an inquest hearing.
At the hearing, the plaintiff testified that he carried out his responsibilities buying and planting seeds and cultivating the cannabis, but received little in return because the majority member never developed an account for the business as legally required and plaintiff couldn't sell product because the defendant would not allow the use of his license, as was previously agreed.
In support of a damages award, the plaintiff offered proof of his initial capital investment of $31,000, out-of-pocket expenses over $100,000, and another $100,000 worth of spoliated product. He also sought about $45,000 in legal fees.
Justice Boddie took care to look at the operating agreement and other factors in assessing the plaintiff's damages claims:
- First, he denied recovery of plaintiff's initial $31,000 investment, citing a provision in the operating agreement denying members the right to demand a return of their capital contribution.
- Second, he denied recovery of plaintiff's approximately $100,000 outlay for other business expenses under another section of the operating agreement denying members compensation for services provided to the LLC without the approval of a majority in interest, finding that plaintiff "voluntarily took on these tasks and expenses since no one else stepped forward." Awarding plaintiff his total investments as well as the alleged lost profits, Justice Boddie wrote, "would result in a double recovery in a transaction that Plaintiff understood from the outset to be merely an investment venture."
- Third, the court awarded plaintiff his legal fees under the operating agreement's fee-shifting provision.
- Fourth, he awarded plaintiff damages for the approximately $100,000 value of the spoliated product "which was specifically designated as his share" and was ruined by the defendant's refusal to assist him selling it by utilization of his license.
- Lastly, Justice Boddie ordered the dissolution and winding up of the LLC, with a credit for plaintiff's initial capital investment in the (unlikely sounding) event a profit is realized.
Now comes the hard part: collecting the judgment.
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