Shareholders’ agreements often include broad arbitration clauses mandating arbitration of all disputes arising out of or relating to the agreement.  Courts routinely enforce such clauses when a non-compliant shareholder files a court petition for judicial dissolution of the corporation.  (For more on general principles concerning arbitration of dissolution disputes, read here.) 

In a recently decided dissolution case called Matter of Rosenberg (ARS Financial Services, Inc.), 2010 NY Slip Op 30616(U) (Sup Ct Nassau County Mar. 17, 2010), the shareholders’ agreement contained the following arbitration clause:

Any controversy, dispute or question arising out of, or in connection with, or in relation to this agreement or the interpretation, performance or non-performance of any breach thereof shall be determined by arbitration . . ..

Reads like a standard, broad arbitration clause, doesn’t it?  Yet, the court refused the respondent shareholders’ application to compel arbitration.  What went wrong (or right, depending on your perspective)?

Rosenberg involved a petition by a 50% shareholder for judicial dissolution of a financial planning and wealth management firm.  The petitioner alleged that the respondent 50% shareholder had diverted corporate monies and that there was a complete breakdown in the shareholders’ relationship leading to a state of irreconcilable deadlock.  The respondent countered that the petition was a bad faith effort to "blow up" a profitable company so that the petitioner could take the business and its clients for himself and his alleged new business partner.

The respondent asked the court to stay the proceeding and to compel arbitration based on the above-quoted arbitration clause.  He argued that the clause was indistinguishable from clauses enforced in other dissolution cases including Ehrlich v. Stein, 143 AD2d 908 (2d Dept 1988), where the court held that the omission of an express reference to corporate dissolution in the clause did not render dissolution proceedings non-arbitrable, and that 

the general subject matter of the dispute, i.e., whether and if so, on what terms, the shareholders should sever their corporate ties, is more than reasonably related to the general subject matter of the [shareholders’] agreement establishing those ties.

In opposition, the petitioner relied on a separate provision in the shareholders’ agreement providing for the agreement’s termination upon the following events:

The filing of a voluntary or involuntary petition in bankruptcy, or the appointment of a receiver for the corporation, or the granting of the petition for the dissolution of the Corporation.  [Emphasis added.]

The petitioner argued that the agreement to terminate the shareholders’ agreement upon the granting of a dissolution petition embodied the parties’ further agreement that there is a right to commence a petition before a court.  The petitioner also argued that the sole issue of deadlock raised by the petition did not relate to any of the "limited" terms and covenants in the shareholders’ agreement.  The petitioner relied heavily on Matter of Bunzl, 224 AD2d 245 (1st Dept 1996), where the court refused to compel arbitration of a dispute concerning the ownership of a constituent corporate shareholder under the arbitration clause contained in the shareholders’ agreement of the upstream corporation.

The court’s decision, by Nassau County Commercial Division Justice Ira B. Warshawsky, sided with the petitioner and denied arbitration.  The court’s analysis first noted that the party seeking arbitration "bears the burden of demonstrating that the agreement clearly and unequivocally requires arbitration of the dispute."  Then, after setting forth the headings of each section of the shareholders’ agreement, Justice Warshawsky concluded that

[t]he matter at hand, i.e., the right to dissolution, let alone pursuant to the Business Corporation Law, is not addressed by the Shareholders Agreement.  Therefore, it does not fall under this broad arbitration clause.

Justice Warshawsky also agreed with petitioner’s interpretation of the agreement’s termination clause, writing as follows:

The Shareholders Agreement specifically provides that it will terminate upon the "granting of a petition of corporate dissolution of the Corporation" (emphasis added).  Applying a basic principle of contract construction, the Shareholder’s Agreement cannot be interpreted as requiring arbitration of this dispute because to do so would leave the clause declaring its termination upon the "granting of a petition for corporate dissolution of the corporation" without any effect.

The cases relied on by defendant where arbitration of disputes relating to dissension, deadlock, looting or mismanagement was required based on broad arbitration clauses are all easily distinguished as here, the parties’ Shareholder Agreement provides that the Shareholders’ Agreement shall terminate upon ". . . the granting of the petition for dissolution . . .."

While denying arbitration, the court also ruled that the petition for dissolution could not be resolved summarily.  Instead, Justice Warshawsky ordered the respondent to file his answer to the petition, and he left open the possibility of an evidentiary hearing following the completion of discovery.

In general I’ve never been a big fan of termination clauses in shareholders’ agreements.  As Rosenberg illustrates, their potential for mischief can outweigh their usefulness.  Anyone drafting a shareholders’ agreement that includes a termination clause along with an arbitration clause  therefore must pay careful attention to the verbiage used to ensure that the former does not render the latter equivocal in regard to the parties’ intent to submit dissolution disputes to arbitration.