A nearly four-decade feud between the former co-owners of two New York limited liability companies (LLCs) serves as a cautionary tale for all owners of closely held businesses. The latest decision in Rosenblum v. Rosenblum, Index No. 654177/2015 (Sup.Ct., NY. County, 2024)citing Rosenblum v. Rosenblum, 214 AD3d 440 (N.Y.A.D., 1st Dep't 2023), involved a fair value appraisal proceeding to determine the parties' interests in the LLCs — a proceeding that was necessary because the parties failed to execute operating agreements for either business. This story of the Rosenblum case serves as a fair warning to all closely held business owners that it is always best to observe corporate formalities no matter how closely related the principals of a business are or how good their relationships appear at the onset. In this case and many others, it's always best to consult with a knowledgeable attorney to prepare the proper Bylaws, Operating Agreements, or Partnership Agreements to set forth the owner's interests in the business assets, or corporate principals run the risk of a lengthy and costly dispute later-on over ambiguities that could have easily been resolved when the entity was first formed.
The Epic New York LLC Dispute
The New York LLC dispute at the center of Rosenblum decision has been ongoing since 1996. Prior to the Supreme Court Justice, Melissa Craine's latest decision, the litigation involved dozens of motions and court hearings, several appeals, and two trials. In the latest chapter of , Justice Melissa A. Crane described the bitter feud follows:
This case is notable for being a particularly acrimonious, multi-generational family dispute. It has also been lengthy. The parties have been fighting since 1996. They agree on practically nothing, are uncompromising, and change legal positions as it suits them in the moment. This court is confident this decision will only foster further litigation, both here and on the appellate level. There appears to be no real interest in resolving this matter.
According to court documents, Kenneth Rosenblum and his mother, Bernice Rosenblum, formed two LLCs to serve as real estate holding companies. 132 Realty LLC and Village Realty LLC own several properties in New York City's West Village. 132 Realty owns a property located at 132 Thompson Street, while Village Realty owns two properties, which are located at 35 Christopher Street and 37-39 Christopher Street.
In 2013, the Rosenblums entered into a settlement agreement to resolve allegations by Bernice that Kenneth, her son, had improperly transferred funds out of their partnership, Standard Realty Associates, LLC ("Standard"), for his personal use and deprived Standard of certain business opportunities due to his actions. Prior to Kenneth making full payment in accordance with the terms of the settlement agreement, he filed an action seeking to dissolve the parties' joint businesses, including the two LLCs at issue in this case. Bernice filed several counterclaims, including a breach of contract claim related to the settlement agreement. Bernice passed away while the litigation was pending, and her estate is now the named defendant.
Following a 2022 bench trial, the court granted judgment to Kenneth on his withdrawal claim and determined that his withdrawal date from the two LLCs was September 20, 2019. The Appellate Division, First Department affirmed the lower court's Decision. The next step was a valuation hearing to determine the "fair value" of Kenneth's interests in each LLC as of the valuation date.
New York LLC Valuation
In most cases, an LLC's operating agreement will outline what happens if a member seeks to withdraw, including the process for distributing his or her share of the business. In the absence of an operating agreement, New York's Limited Liability Company Law controls. Pursuant to Section 509:
[U]pon withdrawal as a member of the limited liability company, any withdrawing member is entitled to receive any distribution to which he or she is entitled under the operating agreement and, if not otherwise provided in the operating agreement, he or she is entitled to receive, within a reasonable time after withdrawal, the fair value of his or her membership interest in the limited liability company as of the date of withdrawal based upon his or her right to share in distributions from the limited liability company.
In her decision, Justice Crane addressed four issues upon which the parties (and their experts) disagreed. Each one is briefly discussed below:
Net Operating Income
Justice Craine found that the rent projections offered by Kenneth's expert were "inflated and speculative," because instead of using the rent rolls the units actually collected, the expert used amounts that he believed demonstrated fair market value for a reasonable investor. By contrast, the Estate's net operating income calculation relied on actual contract rents, which the court found to be more reliable in calculating net operating income and more properly demonstrated the fair market value of the units.
Capitalization Rates
Both parties' experts relied on comparable sales to determine their respective capitalization rates. The court determined that Kenneth's cap rate was more reliable, citing that the comps offered by the Estate were either located outside of the West Village, differently sized or had incomparable mixes of commercial use and/or rent-regulated designations. The court also found the precipitous drop in Estate's appraisals from the 2016 valuation at the previous trial to the current valuation based on 2019 numbers to be "highly suspicious."
Treatment of Loans in Connection with Valuation of the LLC's Holdings
The Court rejected the Estate's argument that the loans owed to the LLCs should be eliminated because the parties' partnership, Standard Realty, is insolvent. As Justice Crane explained, the loans are still fully collectible because Standard Realty is a partnership, and partners are personally liable for the debts of the partnership. Thus, any loan the Partnership is unable to pay would be covered half from Kenneth and half from the Estate, which Justice Crane noted, as a practical matter, should cancel each other out.
Marketability Discount
The Court agreed with the Estate's application of a discount for lack of marketability, which the Estate argued was warranted due to the protracted litigation between the parties and the lack of an operating agreement that has contributed to the protracted litigation.
"The amount of time and money that has been wasted due to an unwillingness to compromise reflects poorly on the value of these companies," Justice Crane wrote. "Compounded by the lack of an operating agreement and a set process for withdrawal, a third-party investor would be unlikely to risk buying into this business at all, much less without a discount."
In finding that a marketability discount should be applied at the holding company level, the court rejected Kenneth's argument that the LLCs should be treated as mere corporate "wrappers" for the underlying real estate and that any marketability discount is "baked in at the property level."
Key Lesson for Members of New York LLCs
Family-owned companies often forgo legal formalities because they assume any disputes will be readily resolved or because they can't foresee any disputes between the members at all. Unfortunately, disputes among family members can sometimes be even more acrimonious than dispute between unrelated business partners.
In the case of the Rosenblum's LCCs, both businesses lacked formal operating agreements and thus, lack the written guidelines for how the assets of the entities should be divided in the event that the businesses needed to be dissolved. Additionally, further complicating the dispute between the parties, the loans made between the parties' business entities were never documented in writing and thus, left the loan terms open for interpretation. Both of these oversights made the litigation between the Rosenblums even more complex, contentious, and costly. To avoid a similar fate, we strongly encourage LLCs to adopt operating agreements that address all of the following:
- Business activities: These provisions should address the purpose and scope of the LLC and any limitations on its operations.
- Contributions: These provisions should clearly establish the percentage of each member's ownership interest and their ability or obligation to make additional contributions. The circumstances surrounding future capital contributions or capital calls should be well defined, and the Operating Agreement should be amended based on those future capital contributions where warranted.
- Governance: These provisions should lay out the members' voting rights and responsibilities as well as the day-to-day management of the LLC, such as the duties and powers of officers, managers, and other employees.
- Distribution of profits and losses: These provisions should dictate the timing, type (capital v. profits), and amount of all allocations of profits and losses. There should be provisions indicating specific circumstances when profits will be disbursed to avoid disputes.
- Members: These provisions should govern how and when members may withdraw or are admitted to the LLC. They should also address whether members may transfer their interests to trusts, family members, or third parties and whether the other members will have a right of first refusal.
- Obligations of members: The agreement should contain provisions addressing the members' obligations to the LLC in terms of confidentiality, intellectual property, and non-competition.
- Dissolution: These provisions should outline when the LLC can be dissolved and what happens in the event of a dissolution, i.e., how assets are distributed. For example, if the LLC is to be dissolved upon the death of any of the members, the Operating Agreement should state such terms.
- Disputes: These provisions should establish procedures to resolve deadlocks, such as mediation or arbitration. It should also include the terms of a buy-sell agreement.
- Fee Shifting: The Operating Agreement may establish that in the event of a dispute over the terms of the Agreement itself, the loser of such dispute will be responsible for paying the prevailing parties' attorneys fees' costs and expenses.
- Indemnification: The Operating Agreement may also add provisions indemnifying the members from claims made by third parties and against claims made by each other.
As the Rosenblum case makes clear, LLCs formed to hold real property should pay particular attention to provisions addressing valuation and distribution. To avoid costly disputes, these provisions should be negotiated carefully in consultation with an attorney experienced in New York LLCs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.