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NY Business Divorce Information on Dissolution and Other Disputes Among Owners of New York Corporations, LLCs and Partnerships

Dueling Dissolution Petitions Lead to Forced Buy-Out of 50% Shareholder

Posted in Compulsory Buyout, Grounds for Dissolution

Last December I wrote about a business divorce case from Saratoga County involving dueling dissolution petitions that went up on appeal to the Appellate Division, Third Department, called Matter of Carson (Carrabasset Mgmt. Corp.). The appellate court affirmed the lower court’s order of dissolution and held that the minority shareholder, who filed for dissolution under the oppressed shareholder statute, §1104-a of the Business Corporation Law (BCL), had no right to compel a buy-out of the majority shareholder who had cross-petitioned under the deadlock statute, BCL §1104.

Less than four months later, along comes another case from Saratoga County also on appeal to the Third Department, once again involving dueling dissolution petitions. This time around, in Matter of Clever Innovations, Inc., 94 AD3d 1174, 2012 NY Slip Op 02536 (3d Dept Apr. 5, 2012), the appellate court upheld the lower court’s order compelling a 50% shareholder, who had petitioned to dissolve under the deadlock statute, to purchase for fair value the stock of the other 50% shareholder who had cross-petitioned to dissolve under the oppressed shareholder statute.

Confused? Don’t be. The unifying principle in both cases is that a petitioner seeking dissolution under the oppressed-shareholder statute, BCL §1104-a, can seek a forced buy-out of his or her own interest, but cannot compel a buy-out of the other shareholder, even when the other shareholder files a competing deadlock petition under BCL §1104.

Background

In 2001, Paul Neilson as sole shareholder and director formed what became an e-tail business called Clever Innovations, Inc., naming his wife Gwen as vice-president and treasurer. A year later, Christopher Dooley became a 50% shareholder. Dooley and Paul Neilson shared responsibility for day-to-day operations, although Dooley was never formally elected as an officer or director. The decision does not mention the existence of a written shareholders’ agreement.

In 2009, by which time the company was highly profitable, Paul Neilson died unexpectedly and without a will. His widow was appointed administrator of her late husband’s estate including his shares in Clever Innovations. Relations between Dooley and Gwen Neilson quickly deteriorated, due in part to the latter’s refusal to accept Dooley’s assertion that he was an officer of the company, which in turn led to the company’s bank freezing its account. In May 2009, the parties agreed to work toward negotiating a buy-out of the estate’s shares by Dooley who, in the interim, would operate the business and keep Ms. Neilson apprised of all financial transactions.

The court’s decision does not indicate if any buy-out negotiations took place, but a month afterward, in June 2009, Dooley filed a deadlock dissolution petition under BCL §1104. Simultaneously he opened a new bank account for the company funded with $280,000 from customers, and he redirected the company’s mail to his home address. In August 2009, Ms. Neilson commenced her own dissolution proceeding on the estate’s behalf under BCL §1104-a, alleging oppressive conduct by Dooley and seeking a mandatory buy-out of the estate’s shares for fair value upon the authority of BCL §1118 and Matter of Wiedy’s Furniture Clearance Center Co., 108 AD2d 81 (3d Dept 1985).

In an unreported September 2010 decision, the Saratoga County trial court denied Dooley’s motion for summary judgment in his favor, and instead granted Ms. Neilson’s petition and ordered Dooley to purchase the estate’s shares for fair value. Dooley appealed to the Albany-based Appellate Division, Third Department.

The Appellate Court’s Decision

The Third Department’s analysis emphasizes that the dueling dissolution petitions, while both seek to terminate the parties’ business relationship, ”invoke different grounds and seek very different relief.” Dooley’s petition under BCL §1104 requires a showing that the “shareholders are so divided that the votes required for the election of directors cannot be obtained” or that ”there is internal dissension” such that “dissolution would be beneficial to the shareholders,” in which case the company would be dissolved and its assets distributed among the shareholders. In contrast, Ms. Neilson’s petition under  BCL §1104-a requires a showing of oppressive conduct by the controlling shareholder in which case the court has discretion to determine whether the appropriate remedy is dissolution or an alternative such as a forced buy-out.

Addressing Dooley’s deadlock petition, the appellate court agrees with the lower court that Dooley

failed to set forth a prima facie case that the shareholders were deadlocked. Although the parties were experiencing disagreement and, while [Ms. Neilson] is acting on behalf of the estate, each controls 50% of the company’s shares, [Dooley] does not assert that an election was held or demonstrate that a deadlock was harming the shareholders. Rather, the record demonstrates instead that the parties had met and agreed upon an interim arrangement for operating the company, but that the arrangement was never fully implemented due to [Dooley's] unilateral decision to act in contravention of it by filing a petition for dissolution. 

The appellate court next agrees with the lower court’s determination that Dooley engaged in oppressive conduct warranting the grant of Ms. Neilson’s §1104-a petition, based on Dooley’s “unwillingness to either negotiate a sale of the estate’s shares or to include [Ms. Neilson] in the operation of the company.” The court also rejects Dooley’s argument that the lower court should have conducted a hearing on this issue, stating as follows:

[A] hearing is required only when allegations contained in the pleadings present issues of fact (see Business Corporation Law § 1109; Matter Carrabasset Sq. Mgt. Corp., 90 AD3d 1279, 1279-1280 [2011]). Here, the only factual issue in dispute is whether, despite the absence of an official appointment, [Dooley] had become an officer of the company. As this fact is not material to the issue of whether [Dooley] – a 50% shareholder – engaged in oppressive conduct, and given that he apparently never requested a hearing, we find that Supreme Court was not required to hold one (see Matter Carrabasset Sq. Mgt. Corp., 90 AD3d at 1279-1280; Matter of Quail Aero Serv., 300 AD2d 800, 803 [2002]; Matter of Wiedy’s Furniture Clearance Ctr. Co., 108 AD2d at 84).

The court last addresses the mandatory buy-out remedy, again stressing the lower court’s “broad latitude in fashioning alternative relief.” Here’s how the court explains its affirmance of the buy-out remedy:

It is undisputed that the parties no longer desired to continue in business together, but it is also clear from the record that, had they reached agreement on a price, [Dooley] would have purchased the estate’s shares. With [Paul Neilson's] passing, [Dooley] maintained the primary relationship with the company’s customers and, considering his actions designed to move the operation of the company beyond [Ms. Neilson's] reach, Supreme Court was justified in finding that, through dissolution, [Dooley] seeks to avoid paying the estate the fair value of its shares while personally continuing to profit by operating the company’s business either individually or through a new corporation. Under these circumstances, we cannot say that Supreme Court abused its discretion in ordering the extraordinary remedy of a forced buyout.

I’ve commented before that dissolution involving 50/50 shareholders raises some of the trickiest tactical decisions for litigation counsel. Clever Innovations highlights two very important lessons that counsel must keep in mind when planning to file or respond to a dissolution petition involving 50/50 shareholders:

  • Don’t labor under the false notion that only minority shareholders can seek dissolution under the oppression statute, BCL §1104-a. The statute gives standing to a shareholder holding at least 20% of the voting shares, which includes a 50% shareholder or, in theory, even a 99% shareholder.
  • Don’t labor under the false notion that buy-out in a §1104-a case can only occur when the respondent affirmatively elects to purchase the petitioner’s shares under BCL §1118. The Third Department’s 1985 Wiedy’s decision, authorizing a court to compel a buy-out of the petitioner’s shares notwithstanding the absence of any explicit statutory authorization, has garnered a wide enough following to become an accepted part of the court’s remedial toolbelt.