Lawsuit Pits Father Against Son Over Family Businesses

This was originally posted on the SGR Blog.

Did Son [Im]properly Divest Father of Interests in LLCs?

Battles between fathers and sons are found in Greek mythology (Zeus and Cronus). And, as a recent case illustrates, continue to this day in a somewhat different manner.

Jacob Harounian owned and operated a rug business called J. Harounian Oriental Rug Center. Jacob eventually asked his son, Mark Harounian, to help him run JHORC. Jacob thereafter gave Mark a 40% ownership interest in JHORC. In addition, Jacob formed a partnership with Mark and Mark’s two sisters called JAM Realty Co. to take title to a property located on 25th Street in Manhattan. Jacob had a 76% ownership interest in JAM Realty, while Mark’s two sisters had 5% each, and Mark had 14% (10% plus a 4% “equity kicker”) in light of the active role Mark would be taking in JAM Realty. 

Jacob, Mark, and Mark’s two sisters decided to purchase and manage investment properties in Manhattan. JAM Realty purchased two more buildings, and then the family formed another partnership called United Nationwide Realty. The ownership interests in United Nationwide Realty were divided: (1) Jacob 40%, Mark’s sisters 14% each, and (3) Mark 32% (28% plus a 4% “equity kicker”). Mark eventually converted JAM Realty to a limited liability company called Jam Realty NYC, LLC, and formed three new limited liability companies, United Flatiron, LLC, United Seed, LLC, and United Square, LLC, to own the three properties formerly owned by JAM Realty. Mark converted United Nationwide Realty to a limited liability company called United Nationwide Realty, LLC.

Over the course of the next several years, the family formed multiple companies to acquire a number of properties, including United Hay, LLC, 3M Properties, LLC, United West, LLC, United Chelsea, LLC, United Village, LLC, and United East, LLC. The family acquired a building located on 32nd Street for use as a showroom for the rug business and as the business headquarters, using funds from JAM Realty for the purchase and renovation of the building. It was agreed that Mark or an entity owned by Mark would take title to the family headquarters and hold the family’s interests therein in trust for the family. The ownership interests would be divided as follows: (1) Jacob 40%, (2) Mark’s sisters 14% each, and (3) Mark 32% (28% plus a 4% “equity kicker”). In addition to showroom and office space, the building also had a living space for Jacob.

Jacob asserted 13 causes of action in a personal and derivative suit against Mark and the various limited liability companies, as nominal parties. And sought to recover damages for breach of fiduciary duty and unjust enrichment, and for an accounting and injunctive relief. The complaint alleged, among other things, that Mark amended the operating agreements or had new operating agreements drafted to reduce or eliminate Jacob’s ownership interests in JAM Realty, United Nationwide Realty, and the United LLCs, and to permit payment of “reasonable compensation” to Mark for managing the JAM LLCs and the United LLCs. The complaint further alleged that Mark caused the family headquarters to be vacated, including, but not limited to, the rug showroom and Jacob’s living space. Mark moved to dismiss the complaint. Jacob opposed the motion. Supreme Court denied the motion. Mark appealed.

Members of a limited liability company may bring derivative suits on the LLC’s behalf. In a derivative suit, the remedy sought is for a wrong done to the corporation; the primary cause of action belongs to the corporation, and recovery must enure to the benefit of the corporation. In the context of a corporation, the standing of the shareholder is based on the fact that he is defending his own interests as well as those of the corporation. Where the plaintiff voluntarily disposes of the stock, his rights as a shareholder cease, and his interest in the litigation is terminated. Being a stranger to the corporation, the former stock owner lacks standing to institute or continue the suit. The same is true of a limited liability company. In order to maintain a derivative cause of action, a plaintiff must be a member of the LLC.

Here, the United LLCs’ operating agreements conclusively established that Jacob was not a member of the United LLCs. As a nonmember of the United LLCs, Jacob lacked standing to bring derivative causes of action on their behalf Accordingly, Supreme Court should have granted those branches of Mark’s motion to dismiss the third, fifth, and seventh causes of action alleging derivative causes of action.

To prevail on a cause of action for an accounting, in addition to being a shareholder, a party must show that he or she demanded an accounting and that the demand was refused by the corporation, or that such demand would have been futile.

Pursuant to the JAM LLCs’ operating agreements, members are entitled to inspect the JAM LLCs’ books and records for the immediately preceding three-year fiscal period upon 10 days’ written notice. Here, the complaint failed to allege that Jacob made a demand to inspect the books and records of the JAM LLCs, and that Mark refused his demand, or that such demand would have been futile. Additionally, the thirteenth cause of action, which is a derivative cause of action for an injunction, is vague in that it fails to indicate upon which limited liability companies the cause of action was being litigated, and failed to specify the conduct which it sought to enjoin. Accordingly, Supreme Court should have granted that branch of Mark’s motion to dismiss the sixth cause of action, which was for accounting with respect to the JAM LLCs, and the thirteenth cause of action.

The usual elements of a constructive trust are (1) a confidential or fiduciary relationship, (2) a promise, (3) a transfer in reliance thereon, and (4) unjust enrichment. However, those factors should be applied flexibly and serve only as a guideline. And a constructive trust may still be imposed even if all four elements are not established. The ultimate purpose of a constructive trust is to prevent unjust enrichment and, thus, a constructive trust may be imposed when property has been acquired in such circumstances that the holder of the legal title may not in good conscience retain the beneficial interest. Here, the complaint did not allege that Jacob provided any personal funds or made any personal guarantees towards the purchase or renovation of the property on 32nd Street. And the complaint did not allege that Jacob made any transfer of property in reliance upon a promise by Mark. Accordingly, Supreme Court should have granted that branch of Mark’s motion to dismiss the eighth cause of action, seeking to impose a constructive trust.

The eleventh cause of action sought a judgment declaring that Jacob was a 40% owner of the JAM LLCs and United Nationwide Realty, LLC. The complaint alleged that Mark “unilaterally” converted JAM Realty and United Nationwide Realty into limited liability companies, and “unilaterally” and “without any authority whatsoever” filed paperwork reducing Jacob’s 40% ownership interests therein to 28%. However, Jacob executed operating agreements which expressly stated that his ownership interest in each resulting limited liability company was 28%. 

A contract is to be construed in accordance with the parties’ intent, which is generally discerned from the four corners of the document itself. Consequently, a written agreement that is complete, clear, and unambiguous on its face must be enforced according to the plain meaning of its terms. The language in the operating agreements was sufficient to place Jacob on notice that his ownership interests would be reduced from 40% to 28%. Accordingly, Supreme Court should have granted that branch of Mark’s motion for a judgment declaring that Jacob was not a 40% owner of the JAM LLCs or United Nationwide Realty, LLC.

The complaint also alleged that Mark falsely or mistakenly reported capital distributions to the Internal Revenue Service over the course of four years. The operating agreements for the JAM LLCs and the United LLCs provided that for any intentional misconduct by a manager of the limited liability companies, the sole remedy was money damages. Thus, pursuant to the operating agreements, Jacob would not be entitled to injunctive relief. Accordingly, Supreme Court should have granted that branch of Mark’s motion to dismiss the twelfth cause of action, seeking a mandatory injunction.

Finally, the operating agreements prohibited Jacob from seeking punitive damages. Accordingly, Supreme Court should have granted that branch of Mark’s to strike the demand for punitive damages.

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