Mandatory Arbitration of Dissolution Proceedings
Many shareholders' agreements include clauses requiring the parties to arbitrate their disputes. Do such clauses apply when a shareholder seeks judicial dissolution of the corporation based on deadlock or shareholder oppression under Sections 1104 and 1104-a of the Business Corporation Law?
Courts answer the question with an emphatic "Yes". As a matter of public policy, courts strongly favor arbitration and will readily stay litigation proceedings and compel arbitration when the dispute falls within the scope of the applicable agreement's arbitration clause. Generally speaking, where the arbitration clause is broad, there arises a presumption of arbitrability, and arbitration of even a collateral matter will be ordered if the issues in the case implicate issues of construction of the shareholders' agreement or the parties’ rights and obligations under it. Judicial dissolution proceedings alleging deadlock or oppression invariably raise allegations of breach or, even absent breach allegations, turn on the parties' rights and obligations under the shareholders' agreement. But even absent specific allegations of breach, courts will find that the dissolution petition is arbitrable.
Continue Reading...Controlling Shareholder's Dilution of Minority Interest Requires Bona Fide Business Purpose
Squeeze-out of minority shareholders in close corporations can take many different forms. One common technique is stock dilution. The careful minority shareholder will insist, before investing capital or sweat equity, on a shareholders' agreement that preserves his or her percentage by a combination of preemptive rights, super-majority approval requirements for changes in authorized and issued shares, and other protective devices. Absent such bargained-for protection, however, is a minority shareholder's stake at the mercy of the controlling faction?
The answer is a qualified "no", according to a recent decision by New York County Commercial Division Justice Herman Cahn in Dingle v. Xtenit, Inc., 2008 NY Slip Op 32034(U) (Sup Ct NY Co July 16, 2008), where the court elevated the controlling shareholder's fiduciary duty over his reliance on statute and the business judgment rule in refusing to dismiss the minority shareholder's wrongful dilution claim.
Continue Reading...Divided Appeals Court Upholds Removal of LLC Member-Manager Contrary to Voting Agreement
In a 3-2 decision, a panel of Appellate Division, First Department judges last week upheld the removal of an LLC member-manager by majority vote of the members, notwithstanding provision in the operating agreement requiring all members to vote for the ousted member-manager in any election for managers. The case is Ross v. Nelson, 2008 NY Slip Op 06504 (1st Dept Aug. 5, 2008).
The underlying facts in Ross are described in the trial court's decision dated October 12, 2006, written by New York County Commercial Division Justice Helen E. Freedman. Since 1996, Dean Ross owned minority membership interests in two New York limited liability companies, each of which owned rental properties in Manhattan. The LLCs had substantially identical operating agreements naming Ross, Eric Nelson and Gary Podell as the member-managers. Each LLC also had a number of non-manager members. Things went smoothly until 2001, when severe strains developed in the relationship between Podell and Nelson on the one hand and Ross on the other. Podell and Nelson called meetings of the LLCs' members to vote on the removal of Ross as a member-manager, and to replace him with Ross's brother who also was a member of both LLCs. The resolutions passed. Ross brought suit seeking to invalidate the vote and to declare that he continued to be a member-manager of the LLCs. He also sought to recover one-third of property management fees that were paid to a separate company owned by Podell and Nelson.
Continue Reading...Courts Differ on Application of Marketability Discount in Stock Valuation Proceedings
Ever since the Appellate Division, Second Department's 1985 landmark decision in the Blake case (107 AD2d 139), it has been fairly well settled that courts apply a discount for lack of marketability -- but not for lack of control -- in stock valuation proceedings under Section 1118 of the Business Corporation Law. That's the statute that permits the majority stockholder to elect to purchase for "fair value" the shares of an "oppressed" minority shareholder who seeks judicial dissolution of a close corporation under BCL Section 1104-a.
The discount for lack of marketability (DLOM) typically is the single largest downward adjustment to stock value, and therefore tends to be the most heavily contested in valuation proceedings. DLOM essentially reflects the greater time and expense of selling shares of a close corporation versus shares for which there exists an efficient public market. The cases generally reflect DLOM percentages ranging from 10% on the low end to 35% on the high end, with 25% being most frequent. Of course, every case is different and it is up to the expert appraiser to do a proper analysis taking into account all relevant factors.
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