Business Divorce in the Divorce Courts | Farrell Fritz, P.C.

Individuals hearing the phrase “business divorce” for the first time are likely to target unconsciously on the word “divorce,” tuning out the phrase “business.” The irony is that most small business divorce circumstances have practically nothing to do with matrimonial disputes.

But that’s not often the situation. From time to time, we produce about matrimonial disputes that spill about into the professional courts, and vice versa. Previous tumble, I wrote about a matrimonial-turned-organization dispute concurrently playing out in Delaware Chancery Courtroom and Manhattan’s Matrimonial Division between truth television persona Julia Haart and her previous paramour, billionaire Silvio Scaglia, over possession of modeling agency Elite Entire world Team, Inc.

It’s not popular at all, although, to see business dissolution proceedings perform out in matrimonial court, which is why a new final decision from Manhattan Supreme Court docket Justice Kathleen Waterman-Marshall is so intriguing.

The Issues

In a wonderfully-created final decision, N.F. v J.D. (2022 NY Slip Op 51294[U] [Sup Ct, NY County Dec. 21, 2022]), Justice Waterman-Marshall considered several intriguing queries:

The electrical power of New York’s matrimonial courts to judicially dissolve intently-held business entities viewed as “marital assets”

The ability of matrimonial courts to order a wife or husband to non-judicially dissolve an entity

The electricity of matrimonial courts to appoint temporary receivers of company entities, like receiverships around non-party controllers of marital asset company entities

The energy of matrimonial courts to order a non permanent receiver to make your mind up whether to seek out dissolution

The Marriage and the Hedge Fund Shaped with Marital Property

In 2010, Spouse and Wife have been married. Spouse worked in the finance marketplace masking rising markets. Partner and Spouse had significant securities property, jointly investing in a few separate brokerage accounts really worth concerning $2 and $3 million.

In 2018, Spouse and Spouse fashioned a hedge fund, a Delaware-integrated minimal legal responsibility business (the “Company”), to maintain and deal with their investments, funding the Organization with belongings transferred from their 3 brokerage accounts.

Husband and Wife entered into a Confined Liability Enterprise Arrangement (the “LLC Agreement”) stating that Husband and Spouse have been 50% customers of the Firm. “Ostensibly,” wrote the Court docket, “the addition of Spouse as a member of the Organization was in recognition of the truth that it is a marital asset.”

The Firm invested in emerging marketplaces — “specifically, China and Russia” — known for higher volatility, together with potentially superior returns but also hefty losses.

Running the Enterprise was a separate, New York-incorporated LLC owned and managed exclusively by Spouse (“Management”).

Husband’s Violation of the Automatic Orders

In 2020, Spouse filed for divorce.

Beneath Domestic Relations Regulation (“DRL”) § 236 B, the submitting of a matrimonial lawsuit effects in what are recognised as “automatic orders,” giving that neither bash may well, amid other points:

offer, transfer, encumber, conceal, assign, get rid of or in any way dispose of, with out the consent of the other bash in writing, or by purchase of the court docket, any property . . . independently or jointly held by the parties, apart from in the standard class of enterprise, for customary and usual home bills or for affordable attorney’s expenses in relationship with this motion.

Unbeknownst to Wife, in 2021, Husband executed quite a few amended and restated LLC Agreements for the Company, in part to provide interests in the Company to more than a dozen third-bash investors as part of a previously-agreed-to approach involving Partner and Spouse, but in the course of action eliminating Wife’s membership fascination without having her know-how or consent.

In the words of the Court, “The stop outcome of the 2021 LLC Agreements is simply just this: Husband disposed of Wife’s membership fascination in the Organization and took finish possession and handle of the Corporation and its assets for himself.”

Spouse allegedly did not master of the loss of her membership curiosity in the Company, nor Husband’s sale of membership pursuits in the Enterprise to traders, right up until well into the matrimonial litigation as part of the pre-demo discovery system.

Meanwhile, the Company was closely uncovered to Russian securities, which the Court docket wrote “are locked up and might be dropped for good,” seemingly thanks to world wide sanctions from the war in Ukraine. “Consequently,” wrote the Courtroom, “the Company’s worth decreased from $6.7 million to $1.6 million, a decline of approximately $5.1 million.”

The Movement for Dissolution and/or Appointment of a Receiver

Quickly soon after Wife figured out of the $5.1 reduction in the Company’s value, she moved, pursuant to DRL § 234, for an buy dissolving the Organization, liquidating and distributing its property, or, in the substitute, appointing a momentary receiver to handle the Business all through the litigation.

The Court framed the concern as follows:

This case consists of an assessment of the breadth, and the restrictions, of the Court’s equitable ability less than DRL § 234 to difficulty preliminary injunctive reduction to protect martial property topic to equitable distribution. The electricity is not so wide as to allow this court docket to judicially dissolve a overseas minimal legal responsibility enterprise which is a marital asset. Even so, it is wide ample to let the court to manner a cure to preserve the business where by a person get together has improperly disposed of the other party’s curiosity therein, refused to comply with court docket orders, and allegedly mismanaged the enterprise such that it suffered significant losses to its value.

Under the principle that New York courts lack issue make a difference jurisdiction to dissolve overseas entities (study about this doctrine in this article and here), the Court declined to dissolve the Company. Nor did the Courtroom appoint a receiver of the Corporation for the reason that of language in the Company’s LLC Agreement permitting receivership only in the occasion of liquidation.

But the Courtroom concluded:

Husband’s violation of the automatic orders, concealment of the revised LLC Agreements, failure to give data as to the Company’s assets, refusal to abide by this Court’s get, and alleged irresponsible investment selections which triggered considerable losses, mandates preliminary injunctive aid to defend and preserve Wife’s expectancy in the Enterprise and stop its more dissipation.

Relying upon what the Court explained as its “broad equitable electrical power, under DRL § 234, to concern orders concerning the possession of marital property to avoid their disposition or dissipation in the course of the pendency of a matrimonial action,” the Court docket ruled that it “could direct” the Spouse, “in his capacity as the sole member-supervisor of Administration, a New York LLC, in excess of whom and more than which it has jurisdiction, to dissolve the Company” non-judicially.

But the Court finally declined to get Husband to dissolve the Enterprise for the reason that “the history does not build that dissolution is certainly needed or suitable at this time,” and may well harm 3rd-party buyers in the Organization.

In its place, individually relying upon what the Courtroom explained as its broad power beneath DRL § 234 to “appoint a momentary receiver for marital belongings where assets matter to equitable distribution is in risk of staying lost, ruined, or wrecked,” the Court dominated that it may well “appoint a short-term receiver for Management” – not the Business itself – “in put and in its place of Husband, which human being will believe the duties and obligations of Management during this litigation in get to guard and protect the Company’s assets.”

Recognizing that Administration was a non-party entity, the Court concluded that it even so had the energy to bind it to an injunction / receivership order due to the fact “it is a captive entity of Husband” and “does not work independently of Husband.”

The Courtroom instructed the receiver, as section of its demand, to undertake an “assessment of the Company’s belongings and liabilities, and the dangers and gains attendant to dissolution, really should that action be required.”

In other words and phrases, the Courtroom put the onus on the receiver to figure out, in the 1st instance, irrespective of whether to dissolve the Enterprise.

The Powers of Matrimonial Courts to Judicially Dissolve Domestic Entities

Is there any motive, in principle, why the Matrimonial Division of the Supreme Court docket may possibly deficiency the electrical power, in a correct case, to dissolve a domestic small business entity? I think not.

Under the New York Condition Structure, only the Supreme Court has jurisdiction to buy dissolution of a marriage. Below the Condition Constitution, the Supreme Court is a court docket of “general original” (i.e., “unlimited”) jurisdiction, that means it is “competent to entertain all triggers of motion unless of course its jurisdiction has been particularly proscribed” (Persons v Correa, 15 NY3d 213 [2010] [quotations omitted]).

Of training course, most business divorce instances are venued in the Business Division of the Supreme Courtroom, though once in a while they wind up in Surrogate’s Courtroom (study listed here and listed here). That is partly due to the fact most of the business enterprise dissolution statutes, such as for limited partnerships (see Partnership Regulation § 121-802), corporations (see Company Corporation Regulation § 1112), and LLCs (see Constrained Legal responsibility Enterprise Law § 702), provide that a proceeding for judicial dissolution shall be brought in the “Supreme Court in the judicial district in which the office” of the entity is positioned.

Based upon the policies, there does not appear to be to be any reason why the Matrimonial Division of the Supreme Court docket, in theory, would absence jurisdiction to dissolve a domestic enterprise entity if the Court docket considered it vital for the preservation of martial belongings.

In point, additional than a decade in the past, Peter Mahler wrote about Rossignol v Rossignol (82 Ad3d 1335 [3d Dept 2011]), a case in which the Court docket implied, while did not rule directly, that matrimonial courts have the ability to grant dissolution of entities owned entirely by the spouse and wife based mostly upon DRL § 234’s empowerment, in the Rossignol Court’s phrases, “to determine all problems with regard to property owned by the get-togethers.”

The Court’s summary that it had the energy to order Spouse to non-judicially dissolve the Enterprise, in distinct, was somewhat not like any ruling I have witnessed in a business divorce scenario in the business courts, wherever it can usually be frustratingly challenging, to say the the very least, to persuade courts to dissolve entities, significantly below the stringent typical governing LLC dissolution.

I requested Michael DiFalco of Yard City-dependent matrimonial boutique Aiello & DiFalco LLP, to remark on the Court’s expansive perspective of its powers, and the strange reduction it fashioned, in N.F. v J.D.

Here’s Michael’s just take:

Prior to the 2009 enactment of the Computerized Orders which now implement in all matrimonial steps, matrimonial courts relied upon DRL § 234 to restrain marital assets in buy to preserve them right up until the court docket experienced an prospect to equitably distribute the marital estate.

Whilst the Computerized Orders now prohibit get-togethers from transferring assets in get to reduce the dissipation of marital belongings, the principal cure for a violation is to keep a get together in contempt. These types of a blunt instrument would not effectively aid the wife in N.F. v J.D. As a substitute, the Court docket relied upon DRL § 234 to cautiously craft an acceptable purchase.

N.F. v J.D. demonstrates the unbelievable versatility of the very simple provisions contained in DRL § 234 to tailor an equitable treatment. The identical a single-paragraph statute that permits a courtroom to award title or exceptional use and occupancy of the marital residence to a single get together, or to claw back transfers from a joint lender account, is applied to the one of a kind established of specifics to appoint a receiver to take management about a hedge fund and perhaps dissolve the entity. Effective reduction for a partner in need to have of a remedy.

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