One need not peruse the pages of this blog for long to learn that its authors strongly advise against entering into an owners’ agreement that calls on the members to “annually” (or worse, “regularly”) update a critical aspect of the agreement. Most times, these planned updates relate to a buy-sell provision, where the buyout value is fixed by a “Schedule A”—sometimes called a “Certificate of Value”—to be updated annually. Almost invariably, the parties never get around to updating Schedule A. And years later, after the value of the business has changed dramatically, an owner invokes the buy-sell provision and argues that the stale Schedule A is binding.
“The next time someone tells me they’re preparing a shareholder buy-sell agreement using a fixed price memorialized in a so-called Certificate of Value, I’m going to tell them to rename it a Certificate of Legal Fees,” said Peter Mahler a decade ago.
This week’s post features a new variant of the dispute over a stale Schedule A, in litigation over the valuable caseload of a two-member personal injury law firm, Saftler & Bacher PLLC, Law Off. of J Bacher, PLLC v Saftler, 2023 NY Slip Op 06334 [1st Dept Dec. 12, 2023]. By finding that an evidentiary hearing is necessary to determine the parties’ intentions with respect to a stale Schedule A, the case gives a lifeline to those opposing summary enforcement of such an agreement.
Saftler and Bacher PLLC, Schedule A
In 2014, Lawrence Saftler and James Bacher formed Saftler & Bacher, PLLC, a law firm focused on plaintiffs’-side personal injury litigation. At the time of formation, Saftler and Bacher executed an Operating Agreement governing their respective rights as members.
Saftler was the “senior” attorney between the two, and the Operating Agreement provided him with considerable discretion regarding management of the Firm, including the amount and timing of distributions. Over the years, Bacher took on more responsibilities, and his ownership share ultimately increased from 20% to 50%. Saftler continued to originate most of the Firm’s cases, and Bacher worked on many of the cases that Saftler originated.
The Operating Agreement stated that either member could choose to dissolve the Firm, and it set forth a framework for how the Firm’s caseload would be treated in the event of dissolution. Section 3.04 is one mouthful of a paragraph that sets forth the following rules:
- “All cases revert to the partner who brought said case into the partnership upon dissolution.”
- On cases where “origination is unknown or in dispute,” the members shall arbitrate the question of origination.
- “Whatever work was performed on a file prior to dissolution will inure to the file and the partner who is entitled to retain it.”
- “Schedule A attached hereto identifies those files in the firm at the inception of the partnership, to be revised yearly, and who would retain said file if the firm dissolves.”
Schedule A to the Operating Agreement contained a list of the Firm’s then-existing case inventory, with handwritten notations indicating that the originating partner was either Saftler or Bacher.
Of course, despite the requirement in the Operating Agreement that Saftler and Bacher revise Schedule A annually, the members never did so.
The Falling Out and the Stale Schedule A.
The Firm operated until November 2018, when Saftler gave Bacher notice of his election to dissolve the Firm. By that time, however, the Firm’s inventory of cases had substantially changed: only nine of the cases originally listed on Schedule A were still active, and the firm’s inventory included 45 new cases that were not on Schedule A, most of which Saftler had originated.
Despite the parties’ failure to update Schedule A, Saftler insisted that upon dissolution, he was entitled to 100% of the fees on all of the cases that he originated. Section 3.04, Saftler contended, says exactly that: “all cases revert to the partner who brought said case into the partnership. . . ”
Bacher, on the other hand, argued that Schedule A was controlling: Saftler was entitled to 100% of the fees on the nine cases that expressly appeared on Schedule A, but not on the many other cases that Saftler originated, because they were never included in an updated Schedule A. If a case does not appear on Schedule A, it belongs to the Firm, and the fees earned thereon are subject to a 50/50 split.
In support of his reasoning, Bacher creatively argued that Section 3.04 was essentially a forfeiture provision. In the event of dissolution, Bacher would forfeit his right to share in the fees earned by the many cases that he worked on but that Saftler originated. And because forfeiture provisions must be construed in the narrowest way possible, any doubt about the meaning of Section 3.04 must be resolved against the substantial forfeiture that would occur under Saftler’s interpretation of the agreement (i.e., Bacher would forfeit the value of the work that he performed on Saftler’s files).
“Schedule A” Business Divorce Litigation
Saftler is not the first New York case to consider what happens when an owners’ agreement contemplates regular updates to a “Schedule A” that never happen. And decisions concerning the enforceability of a stale schedule A are divergent. In some cases, Courts enforce the stale Schedule A as written:
- In Estate of Connie Collins v. Tabs Motors of Valley Stream Corp., No. 160529/2019 (NY County 2021) (discussed here), New York County Justice Reed enforced the buy-sell provision of a shareholders’ agreement in 2021 at a value set forth on “Schedule B” that was last updated in 2012.
- In Namerow v PediatriCare Associates, LLC, No. C-273-17 (New Jersey Superior Court, Bergen County 2018) (discussed here), the court enforced a fixed price buy-sell agreement among members of a medical practice where the original certificate of value hadn’t been updated for 16 years at the time of the plaintiff doctor’s retirement from the practice.
In other cases, Courts find—often with the help of creative arguments from counsel—that a stale schedule A creates enforceability issues requiring a trial or evidentiary hearing:
- DeMatteo v. DeMatteo Salvage Co., No. 18199-03 (Suffolk County 2005) (discussed here) considered a corporation’s attempt to buy-out the estate of a deceased owner in 2002. Although the Corporation had been appraised (at $66,000 per share) in 2000, “Schedule A” was never updated, and it specified that the buyout value would be $7,500 per share. An evidentiary hearing was required to determine whether the 2000 appraisal superseded the stale Schedule A.
- In Nimkoff v. Central Park Plaza Associates, 2010 NY Slip Op 31374(U) (Sup Ct Nassau County May 25, 2010) (discussed here), Nassau County Justice Bucaria found a triable issue of fact regarding whether the majority member’s failure to update the value on Schedule A was not in good faith, and allowed the plaintiff to state a claim for breach of fiduciary duty arising from the controlling member’s failure to update the certificate of value.
Saftler & Bacher’s Failure to Update Schedule A Creates an Ambiguity
Following an arbitration decision establishing that Saftler originated most of the Firm’s then-active cases, Saftler moved for a declaratory judgment enforcing his reading of Section 3.04—that 100% of the fees on all cases originated by him revert to him, including those not on Schedule A. He also sought to vacate charging liens filed by Bacher on each of those cases. Bacher in turn cross-moved for a declaratory judgment enforcing his interpretation of the provision, and for an order directing that Saftler as the member in control of the PLLC render an accounting.
By Decision and Order dated April 18, 2023, New York County Justice Arlene P. Bluth denied both motions. The Court held that the Operating Agreement was ambiguous, because “the agreement does not say [ ] what happens when Schedule A is not revised.”
Reading the trial court’s decision, I’m somewhat skeptical of the finding of an ambiguity requiring parol evidence, for a few reasons. For one, the fact that the Operating Agreement does not address all circumstances—in this case, the failure to update Schedule A—does not, in my view, beget an ambiguity in the language. Second, if only the cases on Schedule A go to the originating partner, then what could possibly be the purpose of the requirement that the parties arbitrate the issue of case origination? Finally, the parties apparently both acknowledged that there was no extrinsic evidence that would shed light on the “ambiguity,” created by the stale Schedule A.
Perhaps for those reasons, both Saftler and Bacher appealed Justice Bluth’s order, both arguing that Section 3.04 was unambiguous and in their favor.
The First Department’s Decision
By Order Dated December 12, 2023, however, the First Department affirmed Justice Bluth’s finding of ambiguity. The First Department held,
The operating agreement of the parties’ former partnership explicitly states that only the originating law partner is entitled to fees after dissolution (with one exception not relevant to this appeal) and that all prior work “will inure to the file and the partner who is entitled to retain it” (Operating Agreement § 3.04). The operating agreement states that the originating partner in disputed cases is to be determined by arbitration. The operating agreement also states, however, that a schedule to be revised yearly identifies who would retain files in the event of dissolution. This schedule was never revised. Therefore, neither party established its entitlement to the relief it sought, as the contested language is ambiguous as to the circumstances under which cases would revert to the originating partner upon the firm’s dissolution.
The First Department held that Justice Bluth correctly determined that a trial is necessary to determine the parties’ intent in drafting and negotiating Section 3.04.
It seems premature to offer my concluding thoughts before the Court hears the evidence concerning Section 3.04. While I give Saftler the slight edge based on the language of the provision, the Court’s finding of an ambiguity all but ensures that the trial will feature a major credibility dispute centered on conflicting testimony from Saftler and Bacher about their intentions in drafting Section 3.04.
It also means that more legal fees will be spent on litigation over Section 3.04. And for that reason, the decision is a sharp reminder that an owners’ agreement with a stale “Schedule A” is begging for trouble.