THE "DE FACTO CORPORATION" DOCTRINE

Torto Note Member, LLC v Babad, 2021 NY Slip Op 01438, Decided on March 10, 2021, Appellate Division, Second Department:

"....The appellants also failed to raise a triable issue of fact as to whether the assignment of the note to the plaintiff was a nullity on the ground that the plaintiff, a limited liability company, was not yet formed or in existence on the date of the assignment. New York has recognized that an unincorporated entity can take title or acquire rights by contract if it is a de facto corporation (see Lehlev Betar, LLC v Soto Dev. Group, Inc., 131 AD3d 513, 514). "Under very limited circumstances, courts may invoke the de facto corporation doctrine where there exists (1) a law under which the corporation might be organized, (2) an attempt to organize the corporation and (3) an exercise of corporate powers thereafter" (Matter of Hausman, 13 NY3d 408, 412; see Lehlev Betar, LLC v Soto Dev. Group, Inc., 131 AD3d at 514). The de facto corporation doctrine is equally applicable to LLCs (see Matter of Hausman, 13 NY3d 408, 412; Lehlev Betar, LLC v Soto Dev. Group, Inc., 131 AD3d at 514). Here, the plaintiff submitted affidavits that demonstrated the applicability of the de facto corporation doctrine (see Lehlev Betar, LLC v Soto Dev. Group, Inc., 131 AD3d at 514). Specifically, the plaintiff demonstrated that there was a law under which the LLC might be organized (see Limited Liability Company Law §§ 203, 209), that the plaintiff made a "colorable attempt" to comply with the statutes governing the formation of an LLC, including the filing requirement, and that the plaintiff exercised its powers as an LLC thereafter (see Lehlev Betar, LLC v Soto Dev. Group, Inc., 131 AD3d at 514-515)."

TRYING TO AVOID DEBT - SUCCESSOR LIABILITY

It may be a new name, but it's the same business trying to avoid debt.

Jack Williams Tire Co. v. The Tire Pl. of Queens Ltd., NYLJ 1/24/19, Date filed: 2019-01-15, Court: Supreme Court, Queens, Judge: Justice Robert McDonald, Case Number: 711068/2016:

"An action for continuation of successor liability requires a plaintiff to show that the corporation was a mere continuation of its predecessor (see Broadway 26 Waterview, LLC v. Bainton, McCarthy & Siegel, LLC, 94 AD3d 506 [1st Dept. 2012]). “[W]hen a successor firm acquires substantially all of the predecessor’s assets and carries on substantially all of the predecessor’s operations, the successor may be held to have assumed it’s predecessor’s…liabilities” (Aguas Lenders Recovery Group v. Suez, S.A., 585 F3d 696, 702 [2d Cir. 2009] [internal quotation marks and citations omitted]). In determining whether a successor corporation is a mere continuation of a predecessor corporation, five factors are considered: (1) all or substantially all assets are transferred to the successor corporation; (2) only one corporation exists after the transfer; (3) assumption of an identical or nearly identical name; (4) retention of the same corporation officers and/or directors; and (5) continuation of the same business (see Miot v. Miot, 897 NYS2d 670 [Sup Ct, NY Cnty 2009]).

Here, Tire Place of Queens transferred its website, phone number, customer base, and network to Tire Place. Although Ms. Lombardi contends that Tire Place merely assumed the abandoned assets of Tire Place of Queens, a successor corporation has still been found to be a mere continuation of a predecessor corporation without a formal transfer of assets when, as here, only one of the two corporations is benefitting from those (see Miot v. Miot, 897 NYS2d 670 [Sup Ct, NY Cnty 2009]). Only one corporation now exists, and the names are nearly identical. Tire Place is owned by the daughter and former co-owner of Tire Place of Queens and a former employee. Lastly, Tire Place is merely an expansion of Tire Place of Queens’ business, not a different business. As such, the five factors are met, and this Court finds that Tire Place is a mere continuation of Tire Place of Queens."

INCORPORATION BY ESTOPPEL

TY Bldrs. II, Inc. v 55 Day Spa, Inc., 2018 NY Slip Op 08345, Decided on December 5, 2018, Appellate Division, Second Department:

""Since a nonexistent entity cannot acquire rights or assume liabilities, a corporation which has not yet been formed normally lacks capacity to enter into a contract" (Rubenstein v Mayor, 41 AD3d 826, 828; see 442 Decatur St., LLC v Spheres Realty, Inc., 14 AD3d 535, 536; Farrell v Housekeeper, 298 AD2d 488, 489). However, a corporation may be deemed to exist and possess the capacity to contract pursuant to the doctrine of incorporation by estoppel (see Boslow Family Ltd. Partnership v Glickenhaus & Co., 7 NY3d 664, 668; JCL Props., LLC v Equity Land Developers, LLC, 102 AD3d 745, 746; Rubenstein v Mayor, 41 AD3d at 828). The doctrine of incorporation by estoppel, or corporation by estoppel, is based on the principle that "one who has recognized the organization as a corporation in business dealings should not be allowed to quibble or raise immaterial issues on matters which do not concern him [or her] in the slightest degree or affect his [or her] substantial rights" (Boslow Family Ltd. Partnership v Glickenhaus & Co., 7 NY3d at 668 [internal quotation marks omitted]). There is no question that the defendants, regardless of the technical status of TY Builders, LLC, or TY Builders II, LLC, at the time the lease documents were signed, agreed to enter into a lease for certain premises owned by Weiss, the principal of those later-formed entities, and were granted legal access and possession of those premises in exchange for the promise of the payment of rent. The defendants do not dispute that 55 Day Spa failed to pay rent as directed under the lease or that Peterson had personally guaranteed the monthly lease payments. The evidence demonstrates that the parties engaged in the subject business transactions and the defendants received the benefit of possession of the property. Consequently, the defendants are estopped from using the plaintiff's lack of proper incorporation to escape liability under the lease (see Boslow Family Ltd. Partnership v Glickenhaus & Co., 7 NY3d at 668; JCL Props., LLC v Equity Land Developers, LLC, 102 AD3d at 746; Rubenstein v Mayor, 41 AD3d at 828). As such, we agree with the Supreme Court's determination to deny the defendants' cross motion, in effect, for summary judgment dismissing the amended complaint on this ground."

SHAREHOLDER DISPUTES IN FAMILY CLOSE CORPORATIONS

Matter of Twin Bay Vil., Inc. v Kasian 2017 NY Slip Op 06024 Decided on August 3, 2017 Appellate Division, Third Department:

"In 1957, the Chomiak family began operating Twin Bay Village, a seasonal summer resort on the shores of Lake George. In 1970, the family formed Twin Bay Village, Inc., a closely-held corporation, for the purpose of operating the resort. At its inception, 100 shares of corporate stock were issued, and those shares were split among Stephan Chomiak and Eleonora Chomiak and their two sons, Leo Chomiak and petitioner Vladimir Chomiak. Over the ensuing years, the division of the corporate shares changed and, by 2004, Valdimir Chomiak's son and daughter, petitioners Leon Chomiak and Leonora Chomiak, were the beneficial owners of a combined 48 shares, and Leo Chomiak and his two daughters, [*2]respondents Tatiana Chomiak Kasian and Tamara Chomiak, owned the remaining 52 shares. In addition to these changes in ownership, the level of involvement of petitioners in operating the resort and managing the corporation changed over the years. Although petitioners were initially involved in helping to run the resort in the 1980s, their involvement thereafter declined, leaving the responsibility for operating the resort and managing the corporation entirely to respondents. In 2009, after years of running the corporation without petitioners' involvement, respondents attempted to force petitioners to sell their shares back to the corporation. After petitioners refused, they commenced this proceeding pursuant to Business Corporation Law § 1104-a seeking judicial dissolution of the corporation."

The court upheld the lower court's finding that the business should be dissolved:

"Business Corporation Law § 1104-a permits a court to dissolve a closely-held corporation where, as is relevant here, those in control of the corporation have engaged in "oppressive actions toward the complaining shareholders" or have "looted, wasted, or diverted" corporate assets for noncorporate purposes (Business Corporation Law § 1104-a [a] [1], [2]; see Matter of Penepent Corp., 96 NY2d 186, 191 [2001]; Matter of Clever Innovations, Inc.[Dooley], 94 AD3d 1174, 1176 [2012]; Matter of Quail Aero Serv., 300 AD2d 800, 802 [2002]). "Although the term 'oppressive actions' is not statutorily defined, the Court of Appeals has held that 'oppression should be deemed to arise . . . when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner[s'] decision to join the venture'" (Matter of Upstate Med. Assoc., 292 AD2d 732, 733 [2002], quoting Matter of Kemp & Beatley [Gardstein], 64 NY2d 63, 73 [1984]; accord Matter of Gould Erectors & Rigging, Inc., 146 AD3d at 1129). Contrary to respondents' [*4]contention, this standard is equally applicable to passive shareholders, such as petitioners, inasmuch as the standard is not focused on the complaining shareholders' level of involvement with the corporation but, rather, their reasonable expectations and whether those expectations were defeated (see Matter of Kemp & Beatley [Gardstein], 64 NY2d at 72-73; Matter of Parveen, 259 AD2d 389, 391 [1999])."

AN ISSUE FOR SOLE SHAREHOLDER CORPORATIONS

It is not unusual, though unwise, for a sole shareholder corporation to deduct personal expenses as  etc. business expenses. Besides the tax issues, etc. that are raised, when the owner of a sole shareholder corporation is in litigation, such practices can be harmful.

Illustrative is a case that was brought to my attention on an email list. It is a matrimonial where the court imputed income to the owner and is cited as E.D. v J D. 2013 NY Slip Op 52204(U) (Decided on December 23, 2013, Supreme Court, Westchester County). Note the following:

"Moreover, Defendant was not credible with respect to the explanations he provided as to why certain expenditures of the Corporation constitute business expenses. For example, in 2010, Defendant paid each of his three sons, then ages 10, 15, and 19, $7,000.00 from the Corporation's coffers, and, in 2011, paid two sons $3,000.00 and the third $2,500.00, contending that they performed various jobs for the Corporation including modeling clothing, helping with videos, editing copy for advertising, and testing the gear manufactured by one of the Corporation's clients. Except for the checks paid to Defendant's sons and Defendant's testimony, no other [*5]evidence was submitted to support these activities.[FN5] Westenberger v. Westenberger, 23 AD3d 571, 571-72 (2d Dept. 2005)(court may impute income where reported income on tax return is suspect); F.M.C. v. F.A.C., 12 Misc 3d 1169A, 2006 NY Misc. LEXIS 1489, ***47 (Sup. Ct., Nassau Co. 2006)(where father paid personal expenses out of business and reported income on tax returns was suspect, court would impute income to father).

The Court also found that numerous other claimed business expenses of the Corporation actually were Defendant's personal expenditures. As noted above, his legal fees in this action have been paid by the Corporation. In addition, Defendant testified that he regularly charged restaurant meals with his children as a business expense to the Corporation, as well as monthly charges for the three children's cell phones, and the expense for use of Zip Cars, despite the fact that he used the cars to pick up and drop off his children. Defendant's claim that the transport of the parties' children was incidental to his business use of the Zip Cars was not credible; indeed, it appears that Defendant's business expenses were directly tailored to benefit his personal needs.

For example, in 2007, Defendant deducted travel expenses for a trip he took to Israel purportedly to meet with representatives of an Israeli clothing company, at the same time that his son's Bar Mitzvah was scheduled to take place there, and, in 2010, Defendant deducted expenses for a three week trip to Mount Everest, including costs for training to climb that mountain, purportedly because he was working on marketing for a company that sold mountaineering gear. Defendant's claim that "it was determined that he should go," was not plausible; instead, given his control of the Corporation, the Court finds that Defendant decided to go to Mount Everest and used corporate funds to pay for it. Notably, no receipts were produced to verify these "business" expenses nor evidence verifying the "business" nature of the trips taken.[FN6]

Moreover, even if such receipts had been provided by Defendant, the evidence shows that Defendant alone controlled the Corporation's travel decisions as well as all other expenditures and any such expenses reduced the amount of funds available to increase Defendant's salary had he wanted to increase his salary.

Moreover, Defendant testified that he lives and works out of his studio [*6]apartment, and that, since 2007, he has apportioned 75% of the rent for the apartment to the Corporation as an expense.

As the Court noted in its July Decision, the very items Defendant declared as corporate business expenses - travel, rent, phones, dinners - are expenditures that a court typically is mandated to consider in calculating child support to the extent that such business expenses reduce the personal expenditures of such party. DRL § 240 (1-b)(b)(5)(vi).

In light of Defendant's lack of credibility, his clear co-mingling of business expenditures with his own personal needs and the fact that he is the sole decision maker as to how much salary he earns from the Corporation, together with the precipitous drop in Defendant's reported income after 2007,[FN7] the year he formed the Corporation, this Court will impute income to the Defendant for the years 2008 through 2012. DRL § 240 1-b(b)(5(iv); Matter of Rubley v. Longworth, 35 AD3d 1129, 1130 (2006), app. denied 8 NY3d 811 (2007)(trial court may impute income based upon past employment experience, future earning capacity, and/or payment of personal expenses from business accounts); Kelly v. Bovee, 9 AD3d at 642; Brefka v. Dobies, 271 AD2d 876, 877, app. denied 95 NY2d 759 (2000). "

SMALL BUSINESS CHECKLIST

Here is a link to a checklist entitled Small Business Fundamentals from Thomas Gallo, CPA:

From Cohen Greve & Company CPA - SMALL BUSINESS FUNDAMAENTALS 

THE USE OF CORPORATE OFFICER TITLES

I recently came across this article in the New York Times:

NYT - Real Estate Professionals Lose Some Curb Appeal

BCL Article 7, and Section 715 in particular, defines some of the duties and responsibilities of corporate officers. It would thus certainly appear, at least under the BCL, the use of corporate honorifics without any actual corporate duties is improper.

FOREIGN CORPORATIONS DOING BUSINESS IN NEW YORK - LIEN LAW

From a discussion on a listserv.........

A question arose regarding one's client, a foreign corporation. A foreign corporation doesn't necessarily mean a corporation from another country: it means one organized in another state. So despite the GW Bridge, a New Jersey corporation in Fort Lee that travels 10 minutes to do some work on 181st Street in Manhattan is a foreign corporation.

The NYS Attorney General Office has a memo on their website as to the requirement of why foregin corporations that do business in New York need to file an autrhorization, etc. A link to it is here:

http://www.dos.ny.gov/cnsl/do_bus.html

An excellent memo and the bottom line, as it states: “The consequence of doing business without authority is that the organization may not affirmatively use New York courts until it obtains authority and pays all arrears in fees, penalties, and taxes.”

I do many consultations with Superstorm Sandy victims. One of the many issues we are now facing is foreign (out of state) contractors who came in and did repair work, charged high prices, etc. Besides all the issues of home improvement licenses, breach of contract, shoddy work, etc., there is one other issue: granted these foreign contractors may not be able to sue for large balances allegedly due because they were not authorized to do business in NY but there is nothing in the Lien Law that prevents them from filing a mechanics lien.

And that’s what we have – homeowners with liens filed from foreign contractors – some of these homeowners are elderly too and get anxious when their mortgage free home has a lien put on it. And removing the lien can take time and run into legal fees, even assuming they are defective on their face.

So although foreign corporations not authorized to do business should not do business in NY – they do.

 

SMALL BUSINESSES - LIABILITY INSURANCE

While I am on the subject of small businesses, I have recently been having discussions with small business owners and others as to whether or not they should carry liability insurance. I know it is an expense and it can be considerable. Even with attorneys in practice, there are some attorney who, for reasons of cost or whatever, do not carry malpractice insurance (although we do have the New York State Lawyers' Fund for Client Protection, still that doesn't protect all clients' from the misconduct of attorneys). But all small businesses, professional services or otherwise, should carry liability insurances and some types of businesses are required under law or contract to carry such insurance. As a lawyer, I would not advise anyone to contract with anyone for services who was uninsured and would ask that my client, in any contract for services, be named as an additional insured and received a binder. Dealing with the uninsured is not recommended by me. Moreover, although you may be incorporated, etc. and feel your personal assets are protected, usually an attorney will name the business owner or owners individually as a defendant in the action and thus you are open to potential liability, especially if the plaintiff is able to "pierce the corporate veil", viz., that, inter alia, the corporation was used not just as a business but for personal expenses, etc.