Pennsylvania has adopted specific provisions relating to a shareholder’s right to inspect the books and records of a corporation duly organized under the laws of the Commonwealth.  The Business & Corporations Law clearly provides for a shareholder’s inspection of corporate records, including the share registry, books of account and records of proceedings upon written notice stating a proper purpose.  However, when the legislature adopted the Limited Liability Company Law of 1994 (the “LLC law”) no similar provision was made relating to a member’s right to review company books and records, and no reference was made to the right of inspection applicable to corporations.

The absence of a specific reference in the LLC law does not mean that a member in a Limited Liability Company does not have the right to inspect business records.  The statute approaches that right from a different direction through the application and incorporation of partnership law.  Section 8904 of the LLC law incorporates by reference provisions relating to general partnerships in the case of a member managed LLC and additional provisions related to limited partnerships in the case of a manager managed LLC.  In either case, the provisions of Chapter 83 relating to general partnerships are rendered applicable.

Section 8332 provides that “the partnership books shall be kept, subject to agreement between the partners, at the principal place of business of the partnership, and every partner shall at all times have access to and may inspect and copy any of them”.  While partnership law does not define the types of records which are to be maintained in the same manner as the provisions relating to corporations, the statutory intent appears to be the same and thus the types of records subject to inspection are arguably similar in scope.           

There are material differences between the right applicable to corporations and partnerships/ LLC’s.  One major difference is that the partnership/LLC provision does not reference a requirement that the partner seeking an inspection state a “proper purpose” for the inspection.  The right as stated appears to be absolute as to partnerships/LLCs whereas in a corporate setting the shareholder must identify and communicate the purpose.  In addition, the provisions relating to corporations specifically provide for a cause of action for review of corporate records and for the recovery of attorney fees associated with the enforcement of that right.  No provision in the partnership law applicable to LLCs provides a specific similar right, nor the recovery of attorney fees.  A practitioner is left to argue the applicability of the provisions relating to corporations and the similarity of purposes served by the two statutory provisions.  

By Thomas P. Donnelly, Esquire

Reprinted with permission from the November 23, 2015 issue of The Legal Intelligencer. (c) 2015 ALM Media Properties. Further duplication without permission is prohibited.

A high business “tide” does not necessarily float all boats.  Often, when business is good and profits increasing, a business owner’s desire to avoid sharing those increasing profits with an underperforming partner can create an irreconcilable divide; particularly in the case of a partner not intimately involved in the day to day operations of the business.  Similarly, more difficult economic times stress cash flow, and may motivate a performing partner to explore options to decrease or eliminate that portion of the business income flowing to those performing at a lower level.  Of course, the lesser performing partner generally adopts a contrary perspective.  In either case, the divergence between two or more partners can render the status quo unacceptable and threaten the business as a going concern.

In approaching disputes among shareholders several factors must be considered.  First, does the attorney represent the company, the majority interest, or the minority interest?  The practitioner’s potential strategies must be informed by the relative position of the parties.  Second, what are the respective goals of the parties?  Certainly, the long term goal of extracting the most gain in income or the value of the investment is the goal of all the parties, but short terms strategies can have a dramatic and sometimes unintended consequence.  Third, what is the impact of the potential short term strategies, not only on the business, but also on the individuals?   Financing arrangements and personal guarantees must be considered.  Finally, the respective rights and obligations of the shareholders post dissolution must guide the process.

When approached by a client considering business divorce, the attorney must consider potential conflicts of interest.  Often, the majority owner’s first call is to corporate counsel.  However, Rules of Professional Conduct 1.7, 1.8 and 1.9 bear upon whether corporate counsel can represent the interests of only one shareholder/member.  In summary, representation of the “company” in the same or substantially related matter, or receipt of confidential information which may bear upon the representation of the party not seeking to be represented by corporate counsel, would preclude corporate counsel from undertaking the representation of a single shareholder/member. In some circumstances, it may be appropriate for the company to have separate counsel, such as where the company is a potential defendant in litigation commenced by either a third party or a shareholder.  However, such representation is complicated by divergence among board members and can present difficult issues in corporate governance and communication between counsel and the corporate client.

Representation of the majority interest provides for the implementation of whatever remedies may be available under the terms of written agreements among the shareholders or by means of corporate action as to a non-performer.   Significantly, there is no statutory right or method for the involuntary removal of a shareholder (arguably, such a remedy may be available in a partnership or Limited Liability Company setting).  Potential courses of action include severance of employment or reduction in employment benefits for the non-performer, voluntary dissolution if provided and appropriate pursuant to the agreements between the parties, and modification of corporate governance.  Of course, such potential courses of action do not come without risk, and the potential for litigation alleging minority oppression should be anticipated.  In such a case, documentation of non-performance and job duties is compelling.           

Representation of the minority owner is more difficult.  Many times, the minority owner is left with litigation alternatives such as actions for the appointment of a custodian or liquidating receiver pursuant to 15 Pa.C.S.A. Sections 1767 or 1985, respectively.  While these litigation remedies can be compelling, it should not be expected that litigation would result in continuation of the status quo indefinitely. Litigation rarely restores a broken relationship. Further, as recently noted by the United States District Court in Spina v. Refrigeration Service and Engineering, Inc. 2014 WL 4632427, a shareholder seeking the appointment of a receiver or a custodian bears a heavy burden and such appointment is at the discretion of the Court.

In addition, litigation alternatives necessarily incorporate business risk.  Can the company survive the appointment of a custodian? By definition, a custodian is designed to continue the business as opposed to liquidation.  The impact of a custodian on customer relationships, the entity’s capacity to contract and the willingness of business partners to engage in long term planning or projects may render liquidation inevitable. Certainly, the appointment of a custodian or receiver results in a loss of control on the part of the shareholders.  All policy and management decisions fall within the purview of the court appointee.  Such loss of control can be particularly problematic as it pertains to the case of tax reporting. 

That same loss of control must be considered in a liquidation scenario.  Liquidation contemplates an orderly winding down and distribution of assets which should be anticipated to include intellectual property and customer lists in addition to any fixed or hard assets possessed by the entity.  As noted in Spina, liquidation is generally carried out by public auction so as to ensure fairness among shareholders.  In the event of a liquidating receiver, a marketing campaign designed to enhance the value of the assets and maximize the selling price should be anticipated.  In such circumstance, neither party may be in a position to acquire the liquidated assets or may be forced to over-pay, thereby rendering such acquisition economically unfeasible.  Accordingly, while the goal at the outset of a liquidation proceeding may be to force a buy out of a shareholder, the end result may be that no party is in a position to acquire assets and engage in continued business operations.

The impact of a custodian or receivership on the individual business owners must also be considered.  Business owners frequently guaranty corporate debt.  The commencement of an action for the appointment of a custodian or receiver is almost always defined as an event of default with regard to the entity’s financing arrangements and could also trigger liability under the personal guaranty.

Finally, post liquidation obligations, or the lack thereof, should also be considered.  It should be anticipated that former partners would compete post liquidation.  The liquidation of the entity by definition precludes any claim for breach of fiduciary duty on the part of the company to the extent based on post liquidation acts or omissions and any right to enforce a post termination of employment restriction against competition.  However, arguably, the sale of the entity’s assets, including confidential information such as customer lists, may implicate the Uniform Trade Secrets Act and preclude use of information known to the shareholders in competition with the buyer.  While no case decided under Pennsylvania law addresses the application of the Act to such circumstance, the Act appears to be applicable where a shareholder retains possession of information which was subject to transfer in liquidation.
The complexities of business divorce through litigation mandate that the parties consider and pursue all avenues of amicable dissolution and consider all proposals for voluntary consolidation of ownership before pursuing litigation with uncertain results. 

Tom Donnelly is a Partner with Antheil, Maslow & MacMinn. His practice focuses primarily on commercial litigation and transactions, employment disputes and personal injury.  

By Thomas P. Donnelly, Esquire Reprinted with permission from the May 29, 2015 issue of The Legal Intelligencer. (c) 2015 ALM Media Properties. Further duplication without permission is prohibited.

Confidentiality agreements have become commonplace in commercial litigation.  The purpose of a confidentiality agreement as the protection from disclosure of either private personal or sensitive business information which gives a party a competitive advantage is certainly a noble one and one which mandates an agreement against such disclosure in a wide variety of circumstances.  Often, the parties seek the imprimatur of the court by requesting the court adopt the agreement of the parties as an order thereby incorporating the court’s power to impose sanctions in the event of breach.  The entry of such an order, whether intentionally or as an unintended consequence,  may change the nature of a third party, foreign to the dispute with respect to which the confidentiality order was entered, to obtain information produced in the prior litigation.  

By Thomas P. Donnelly, Esquire, Reprinted with permission from the November 24, 2014 issue of The Legal Intelligencer. (c) 2014 ALM Media Properties. Further duplication without permission is prohibited.

I do not generally characterize myself as a fan of arbitration.  While proponents argue arbitration is a superior form of dispute resolution and more efficient than litigation, my personal experience in the representation of privately held businesses and individuals is otherwise.  In many situations, the sheer cost to initiate an arbitration proceeding may be prohibitive.  For a claimant, even if that initial cost is not an effective deterrent, the budget of ongoing hourly fees required of a qualified arbitrator in addition to the parties’ own anticipated legal fees, can quickly impair the potential recovery. For a Respondent, many times the cost of proceeding was not considered at the time of execution of an agreement which compels arbitration; thus the obligation to make payment for a service technically rendered by the courts without cost comes as a surprise. In either case, the parties must realize that at arbitration each is compensating not only its own lawyer, but, at least partially, another lawyer and a private dispute resolution industry as well. While arguably profitable for the legal profession, the realities of proceeding can result in difficult client discussions.

The above being said, there are situations where arbitration clauses can be of substantive, procedural and, consequently, financial benefit.  In such cases, even a skeptic of arbitration must recognize the benefits of the bargained for exchange which is an arbitration agreement.  Under the current state of the law, and given the trends in the enforcement of the right to contract, a carefully considered and artfully drafted arbitration agreement can be an essential aspect to certain business relationships and an important term of negotiation.

Employers should almost always include the broadest possible arbitration clause in any employment agreement and, generally, as a term of employment.  In most cases, an action arising in an employment situation concerns a claim raised by an employee, or worse, a class of employees against the employer.  The employer is generally a defendant.  In such cases, arbitration clauses can serve several functions.  First, an employee initiating the action must satisfy the initial fee if mandated by the prevailing agreement. As such fees are often determined by the amount at issue, the larger the claim, the higher the fee, and the greater deterrent toward commencement of the action.  As of November 1, 2014, the filing fee for the commencement of an American Arbitration Association claim involving more than one million but less than ten million dollars was $7,000.00.  Note there is no refund of the filing fee should the matter resolve.  Certainly, the requisite fee is a deterrent to the filing of a border line claim, but could also be a deterrent to a claimant’s joinder of additional even less viable claims which include different damage components.  Under any circumstances, the employee faces an early branch to the decision tree.

The flexibility of arbitration clauses within employment agreements may prove even more critical.  With careful drafting, an employer can effectively insulate itself from certain employment related class actions.   In Quillion v. Tenet HealthSystem Philadelphia, Inc. the United States Court of Appeals for the Third Circuit compelled arbitration of a Fair Labor Standards Act claim and, more importantly, declined to strike down a provision of an employment agreement requiring such claims be brought on an individual basis precluding proceedings as a class.  The Quillion Court indicated that such a class action waiver was consistent with the Federal Arbitration Act and suggested in the strongest of terms that Pennsylvania’s preclusion of class action waiver in the employment context was preempted by Federal Law.  Certainly, the equities of any such situation, including preservation of remedies and additional recovery of fees and costs are important to the court’s inquiry, but the current trend is to support the rights of the parties to contract, even to their own peril.

The flexibility of the arbitration agreement also allows for exclusions from the scope and reservation of certain matters for litigation.  Matters of equity such as enforcement of restrictions against competition or solicitation can be reserved for the courts, thereby preserving immediate access to judicial process for enforcement of employer remedies.  Interestingly, the reverse may not necessarily be true.  The Montgomery County Court of Common Pleas recently dismissed a complaint for declaratory judgment seeking a judicial determination voiding certain restrictions against competition determining that such equity claim was within the scope of the arbitration agreement and, therefore, for the arbitrator to decide.                 

Arbitration also plays a vital role in the ever broadening world economy.  In 2014, international business is the norm rather than the exception.  The courts of the United States and the signatories to the New York Convention on Arbitration have routinely enforced arbitration clauses establishing the parameters of dispute resolution as consistent with the parties’ right to contract.  Critically, the arbitration clause can protect a company operating in this country from the many pitfalls, incremental expenses and inconsistencies of litigating in a foreign country or even against a sovereign nation in its own judicial system by selecting a choice of law and a situs of the arbitration proceeding.  Such forum selection also provides a certain substantive component not only as to applicable law, but also in the qualification of fact finders as the roles of qualified arbitrators available for commercial disputes continue to grow.   Finally, arbitration may be preferable to litigation in the United States District Courts as the parties may be granted greater flexibility and input to the development of the schedule of proceedings rather than subject to the rule of the federal judge, who may or may not be familiar with often complex substantive issues.           Finally, arbitration may also be preferable in any relationship where confidentiality is key.  In some cases, the simple fact of a public filing is of concern.  In many others, the factual allegations of a complaint, even if eventually proven unfounded, can be damaging.  While an arbitration clause cannot prevent a claimant from filing an initial public complaint in court, an enforceable arbitration clause can bring an abrupt end to the public aspect of the dispute.

The courts remain the preferred forum for dispute resolution in many circumstances.  However, with the growing trend of contract enforcement to the terms of arbitration agreements even a skeptic must admit that the inclusion of an arbitration clause in certain circumstances can provide a substantive advantage and dramatically impact the landscape of dispute resolution to your client’s benefit.

My wife doesn’t eat fish.  Chicken is the staple of the diet in our house.  Despite careful consideration, sometimes she gets tricked into consuming what looks like a tasty morsel only to be disappointed by the taste and texture of what comes from the sea.  She promptly, but of course gracefully, extracts the fishy culprit from her mouth thereby rescinding the transaction and restoring her being to non-seafood status.  Of course, a fishy business transaction cannot be so easily unwound.

Business transactions come in all shapes and sizes.  From multi-million dollar mergers involving teams of lawyers and accountants to small asset purchases effectuated by only a bill of sale scribbled on a napkin.  Most fall somewhere in between.  Almost all involve disclosure of financial and business information in advance of closing in a “due diligence” period of evaluation and investigation.  Due diligence is the means by which a buyer attempts to verify what the seller has to sell; the ongoing revenue stream and the customer pipeline.  Sometimes the performance of the business after closing sharply contrasts the results of operations depicted in financial information exchanged in due diligence.  The new owners are left without a roadmap to ascertain the disparities in performance.  The investigation can be all consuming and require substantial attention and money at a time when the business is already in a period of transition.  The new owners must balance examination of the transaction and results of operations against the focus required to conduct the daily activities of the business which, of course, remain pressing and are likely made more complex by the unexpected performance levels. 

Hopefully, any agreements reached between the parties contain representations and warranties which could benefit the purchaser.  The terms of the agreement are the best place to start the analysis of potential legal action.  Generally, such agreements will represent and warrant the financial information exchanged in due diligence was accurate and adequately described the performance of the business. For example, often tax returns, profit and loss statements and balance sheets will be exchanged in due diligence and subject to specific representations and warranties.  Examination of what documents were specifically referenced as included in the representations and warranties is critical. Where the prevailing agreements contain integration clauses, the representations and warranties are of paramount importance as integration clauses can prohibit reliance upon statements and information not specifically incorporated into the four corners of the documents and bar claims such as negligent misrepresentation and, potentially, fraud. 

Determining whether the profit and loss statements and balance sheets contain material mis-statements of operations can be complicated.  The investigation must begin with securing all documents subject to due diligence and the verification that those documents were the same documents that were prepared in the ordinary course of business.  Ensure that any financial records or tax returns produced by the seller match financial records available from a different source such as a broker, accountant or internal revenue service.  Of course, information becomes more available after the commencement of litigation by virtue of the discovery process.

The forensic analysis involves testing the information set forth in summary form in the financial statements against whatever other information is available.  Quickbooks reports can reveal adjustments made to performance results.  The reality however, is that most business owners, and for that matter attorneys, lack the requisite expertise to effectively conduct the necessary investigation.  Accordingly, a forensic accountant skilled in fraud examination and detection is a valuable member of the analytical team.  Certainly, there is a cost associated with that service, which cost must be incurred before the results are clear, but the expertise of the investigation will often control the outcome.  The forensic accountant is trained to identify inconsistencies such as whether payroll was accurately stated, whether inventory and costs of goods sold were appropriately booked and whether income as stated on the financial records is impacted by other unspecified factors.  A preliminary forensic investigation is essential to the decision to pursue costly litigation.

A buyer must also consider the potential parties, their financial positions, and the types of claims that can be raised.  In seller financed transactions, as opposed to bank financed transactions, the buyer’s leverage is significantly enhanced.  In the former, the buyer may apply pressure to a seller by discontinuing payments.  In the latter the bank generally has no regard for any claims the buyer may possess against the seller and simply demands its’ payment each month.  Generally, no court will interfere with the bank’s rights to security and payment as same are not dependent on the result of any claims possessed by the buyer as against the seller.  The ability to recover in litigation must also be considered.   The distribution of purchase price, whether distributed to creditors or held in joint accounts in a tenancy by the entireties state can impose additional obstacles to recovery and necessarily impacts litigation strategy.  Identification of potential defendants and causes of action is also essential.  Pennsylvania recognizes the torts of negligent misrepresentation in certain circumstances including preparation of financial information for the reliance of others, aiding and abetting breach of fiduciary duty and conspiracy. Accordingly, to the extent a seller was assisted in the preparation of false financial information, those who assisted may also be appropriately identified as defendants when the facts are supportive of liability. Potential claims against a seller include breach of warranty, fraud, misrepresentation, conversion, unjust enrichment and, under the right set of fact, claims for punitive damages.  Breach of warranty claims are often the best chance of success as the issue of intent (or lack thereof) has no bearing on proof of a breach of warranty claim.  

Finally, consider the measure of damages.  Under the right circumstances, lost profits can be claimed. However, post-closing failure (or alternatively, success), management issues and other factors can complicate the damages analysis.  In the absence of a lost profits claim, the difference between the valuation of the company in accordance with the financial information presented and the financial information eventually uncovered may result is a simpler damage calculation.  Of course, any such analysis also requires the assistance of a business valuation expert in addition to the forensic accountant referenced above. A buyer must also be wary of any damage limitations internal to the agreements between the parties as well as any internal statutes of limitations which may be set by agreement. 

In contrast to the ease by which my wife can expel inadvertently consumed sea food, rescission in a business transaction is unlikely.  The very idea of rescission, placing the parties back in their respective conditions, may be impossible based on post-sale performance.  Claims for money damages are far more often the claims that proceed to conclusion.

Certainly, pursuit of litigation concerning the purchase of a business can be expensive and complicated.  Any such decision must weigh the likelihood of success and the cost of that success, against the distraction such litigation may cause and potential impact of that distraction on business operations.  That being said, sometimes a buyer simply has no choice and sometimes what smells rotten really is just that; rotten.    

Business divorce, just like traditional matrimonial divorce, can occur for many reasons.  Many times, business divorce is occasioned by underperformance and the need to separate an underperforming owner.  However, the opposite circumstance, a business that has done well, can also spur desire for change in structure.  Just like matrimonial divorce, business divorce can be a long, painful and expensive proposition.  Consideration of trigger events for dissolution and setting an exit strategy before commencing the business venture can manage the expectations of the parties and facilitate transition when it becomes necessary.  And it almost always does.

One of the primary considerations is trust.  Consider the level of trust you place in a business partner on so many levels.  Trust ranges from the basics of whether you can trust your partner not to have a hand in the cookie jar, to more esoteric questions of whether you can trust your partner to share your long term vision.  All too often clients come to us with stories of unexplained payments for personal expenses which are only discovered by accident.  What are the rights and obligations of the company and the business partners in such event?  These  rights should be spelled out in the agreement between the parties, otherwise the company, and the innocent shareholders, are left to argue common law claims and may be without a way to specifically extract the untrustworthy owner.

Trust goes deeper than the simple situation of defalcation (misuse of funds).  Can you trust your business partner to have the same desire to grow your business and increase sales and performance metrics over an extended time?   Business entities generally have perpetual existence.  Can you trust that your partner will continue to make the requisite investments of time, energy and money that are necessary to bring the success you work so hard to achieve?  If the agreements between the parties do not provide for a mechanism to remove that partner, or at least monetarily induce that partner to voluntarily separate, what strategy is available to accomplish the necessary change? 

If extraction of a non performing owner is one side of the coin, the terms of voluntary separation are the other.  Even in the absence of material differences between owners and managers, time and circumstance often require parties to go their separate ways.  The terms of voluntary separation can be every bit as complex as forcible removal.  Often, the most problematic inquiry is the right to be compensated in consideration of separation.  Such terms of separation can vary based on valuation methodologies such as “market” or “book” values, timing of payments, reductions or additions to value based on subsequent conduct.  In the absence of advance planning, the parties are almost certain to find dispute.   

Post-employment obligations and fiduciary duties are also fertile ground for dispute.  Corporate officers and directors have fiduciary obligations to the business.  Partners, shareholders and members may have fiduciary obligations to each other.  A departing shareholder may or may not be permitted to directly compete either during or after termination of the business relationship.  Certainly, issues arise with respect to client/customer relationships and confidential information.  More substantial issues may arise when the business develops a new technology or intellectual property which one party seeks to exploit in a different way.  Agreements between the parties can address such possibilities and preserve rights by contract which might otherwise be ambiguous. 

What if it all goes wrong?  Again, business entities are generally established to have a perpetual existence, so termination must be accomplished by agreement or statutory procedure.  What kind of consent is necessary to effectuate dissolution?  Must all of the shareholders or members agree?  Agreements can specify events and effect of dissolution including specific assignments in distribution of assets according to differing methodologies or factual circumstances.  In circumstances where one party is opposed to liquidation or dissolution, the situation can become even more complex.  Occasionally, only the appointment of a receiver can effectuate liquidation or dissolution; a generally unappealing circumstance as such an appointment necessitates the loss of control.

The questions posed and circumstances described above underline the importance of careful consideration prior to establishment of business entities.  Such considerations during the business “engagement” and before business matrimony are necessary to prevent significant hardship when expectations are not managed.  Advance planning though counsel can address many of the issues potentially faced by business owners and help the parties realize their expectations when circumstances change.    

Lis pendens is a powerful tool which can be utilized in civil litigation pertaining to a claim against title to real estate.  The filing of a lis pendens and recording that lis pendens against a parcel of property puts the world on notice that the owner may not have clear title, and thus, may be unable to convey same.  A lis pendens effectively precludes transfer of the real property as any buyer must take subject to the cloud on title.  Of course, a lis pendens must be supported by a writ of summons or a civil action complaint relating to real property.

Curiously, a lis pendens is not an available tool in an Orphans’ Court proceeding.  Accordingly, a lis pendens cannot be utilized to place the world on notice of a claim against an administrator or executor where a transfer of property is made in connection with estate administration.  Nor can it be used to place the world on notice of the claim relating to that transfer or a defect in their authority to effectuate same.  Thus, the lis pendens is not an effective tool to  preclude further transfer or encumbrance by mortgage or other debt instrument. 

Although lis pendens is not available, the same purpose can be accomplished under the Orphans’ Court rules, provided a Petition for Citation has been filed with respect to the administrator’s activity.  Pursuant to 20 Pa. Cons. Stat. §3359, any pleading in Orphans’ Court may be recorded in the Recorder of Deeds Office with reference to the property in question.  While little case law is available to address the impact of such filing, the practical effect of providing notice of any existing claim to title may be satisfied.

Antheil Maslow and MacMinn is experienced in matters of estate administration and litigation pertaining to estate matters. 

By Thomas P. Donnelly, Esquire, Reprinted with permission from the March 27, 2014 issue of The Legal Intelligencer. (c)
2014 ALM Media Properties. Further duplication without permission is prohibited.

It happens all the time.  A potential or existing client calls and advises they have been stiffed by a customer on a commercial contract.  Often times, your client has provided goods or services to a client business only to be advised their client, the other named party to agreements in place, has ceased business operations.  [As filing under Chapter 7 of the Bankruptcy Code does not result in a discharge of corporate obligations, a bankruptcy filing is generally not forthcoming.]  There is no event which gives the client finality as to their loss.  The client is left with only their suspicions that operations have commenced under a new corporate umbrella and whatever assets remained have simply been transferred out of the client’s reach.   

While certainly not in an advantageous position, your client’s claims may not be dead.  Under the right factual circumstance, recovery may still be had.  Claims against successors, affiliated business entities, and corporate principals are fact specific and often necessitate pre complaint development through available public information or, potentially, through the issuance of a writ of summons.  If sufficient information can be mined, causes of action for violation of the Uniform Fraudulent Transfers Act, successor liability under the de facto merger doctrine, unjust enrichment, and claims for piercing the corporate veil may have merit and be successfully pursued.

By Thomas P. Donnelly, Esquire, Reprinted with permission from October 11, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Properties. Further duplication without permission is prohibited.

Senior Judge Anita Brody of the United States District Court for the Eastern District of Pennsylvania recently presided over a non- jury trial in the matter of Lehman Brothers Holdings, Inc. v. Gateway Funding Diversified Mortgage Services, L.P. Judge Brody is expected to render a decision in the coming weeks.  Lehman Brothers represents the first occasion for the District Court to consider the legal principal of de facto merger under Pennsylvania law following the Pennsylvania Supreme Court’s landmark decision in Fizzano Brothers Concrete Products, Inc. v. XLN, Inc., 42 A.3d 951 (Pa. 2012).  In Fizzano Brothers, the Supreme Court substantially modified the application of the de facto merger doctrine allowing trial courts far greater flexibility in the application of the doctrine to a broader set of facts.

Before Fizzano Brothers, Pennsylvania courts were constrained to a mechanical application of four elements: (1) continuation of the enterprise of the seller corporation; (2) continuity of shareholders; (3) cessation of ordinary business operations on the part of the selling entity; and  (4) assumption of those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations.  In practical application, the “continuity of shareholders” requirement was nearly impossible to satisfy where sophisticated business people with legal representation structured the transaction as a sale of assets to a new entity.  Consequently, mechanical application of the continuity of shareholders element was the stumbling block in the de facto merger analysis.

The Fizzano Brothers court substantially modified the analysis by discarding the mechanical application of continuity of shareholders.  Citing public policy and recognizing the sophistication of business transactions in the current climate, the court ruled that “where the underlying cause of action is rooted in a cause of action that invokes important public policy goals, the continuity of ownership prong may be relaxed.”  Fizzano Brothers, 42 A.3d at 966.  The question of successor liability should first be viewed in light of “whether, for all intents and purposes, a merger has or has not occurred between two or more corporations, although not accomplished under the statutory procedure.”  Id. at 969.

The Supreme Court went on to hold that the shareholders of the predecessor company were no longer required to become shareholders of the successor to meet the requirements of de facto merger. The court concluded such a holding would be “incongruous” with provisions of the Pennsylvania Business Corporation Law stating; “because a de facto merger analysis tasks a court with determining whether, for all intents and purposes, a merger or consolidation of corporations has occurred, even though the statutory procedure had not been used, the continuity of ownership prong of the de facto merger analysis certainly may not be more restrictive than the relevant elements of a statutory merger as contemplated by our legislature.”  Id. at 968.

The court then adopted a more flexible approach. After Fizzano Brothers, cases rooted in breach of contract and express warranty no longer require strict transfer of ownership.  Rather, the de facto merger doctrine now requires “’some sort of’ proof of continuity of ownership or stockholder interest. . . . However, such proof is not restricted to mere evidence of an exchange of assets from one corporation for shares in a successor corporation.” Id. at 969 (internal citations omitted).

The Fizzano Brothers factors are at issue in Lehman Brothers Holdings, Inc. v. Gateway Funding where Lehman Brothers raised claims of successor liability relating to indemnification agreements with Gateway’s alleged predecessor.  At trial, evidence was admitted indicating that  Gateway had specifically and intentionally purchased all assets that were necessary to the continuation of the mortgage origination business formerly conducted by the predecessor.  Such evidence included direct testimony on the part of Gateway’s management team that the acquisition was designed to acquire not only the current “pipeline” of loans in progress, but also the potential for continued loan origination.  Contemporaneously, Gateway also undertook to acquire debt obligations owed by the predecessor which were necessary to loan origination including securing warehouse lines of credit utilized to temporarily fund mortgage loans until sold on the secondary market.  Finally, documents related to the transaction reflected the intention that the business operations of the predecessor entity were to be “wound down”.  In that regard, restrictions against competition imposed upon the former principals of the predecessor, now Gateway employees, were permitted to “compete” only for the purpose of effectuating that wind-down.

While evidence was admitted as to each element of the de facto merger doctrine, continuity of ownership was specifically contested.  The transaction at issue was characterized by the buyer and seller as an asset transaction with no stock transfers. However, the four shareholders of the predecessor entity were provided compensation in a variety of ways which Lehman Brothers argued were illustrative of ownership.  The four shareholders received employment agreements with Gateway which included substantial severance benefits, a right to share in the profits of the same operations as had been conducted by the predecessor, and cash considerations.  One former shareholder indicated the cash component was paid, at least in part, as a result of his equity position in the predecessor.

In contrast, Gateway argued that the four shareholders were valuable and experienced revenue generating employees with corresponding compensation arrangements following the acquisition.  Objectively, the four shareholders of the predecessor were not granted stock in the acquiring entity.  Further, although certain of the agreements between the four shareholders and Gateway referenced the shareholder’s equity stake in the predecessor, no provision for consideration set forth in the language of the agreements was expressly tied to that equity position. 

The Lehman Brothers trial is the first test of the new more relaxed application of the continuity of ownership prong of the de facto merger analysis.  Judge Brody’s decision will provide guidance to both transactional practitioners in structuring transactions where liabilities may remain post-closing, and to litigators when faced with claims against a defunct entity where assets were transferred leaving a hollow shell.

The author served as local trial counsel to Lehman Brothers Holdings, Inc.

Reprinted with permission from April 5, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Properties.
Further duplication without permission is prohibited.

The Pennsylvania Supreme Court is set to hear argument on April 10, 2013 regarding the scope of the work product doctrine and the discovery of materials contained in a testifying expert’s file on April 10, 2013.    The specific issue on appeal is whether Pennsylvania Rule of Civil Procedure 4003.3 provides absolute work product protection for all communications between a party’s counsel and its testifying trial expert.  The decision may provide clarity and guidance to litigation counsel facing an otherwise clouded issue.

In Barrick v. Holy Spirit Hospital, 32 A. 3d. 800 (Pa. Super. 2011), the trial court was faced with a subpoena directed to a medical provider who was both a treating physician and an expert retained for the purpose of offering trial testimony.  The trial court, after an in camera inspection, ordered the enforcement of the subpoena and the disclosure of communications between the expert and the Plaintiff’s counsel.  Plaintiff appealed, arguing the application of the work product doctrine under Pennsylvania Rule of Civil Procedure 4003.3 and trial preparation materials under Rule 4003.5 protected the communications from disclosure.