tie-breakerThe New York Business Corporation Law offers the 50% shareholder of a close corporation two avenues to judicial dissolution: deadlock at the board or shareholder level or internal dissension under BCL § 1104, and oppressive actions by the directors or those in control of the corporation under BCL § 1104-a.

The 50% petitioner faces an important strategic decision whether to invoke one or the other (or both) of the statutes. That’s because § 1104-a — but not § 1104 — triggers the respondent’s elective right under BCL § 1118 to acquire the petitioner’s shares for fair value. As I’ve written previously, often a 50% petitioner may gain greater negotiating leverage by proceeding solely under § 1104 based on deadlock, thereby depriving the other 50% faction of a statutory buy-out opportunity.

I can only speculate whether a strategic decision of that sort was at work in Matter of Hudson (Pure Lime USA, Inc.), Short Form Order, Index No. 600127/16 [Sup Ct Nassau County June 16, 2016], in which Nassau County Commercial Division Justice Stephen A. Bucaria dismissed the 50% shareholders’ § 1104 dissolution petition that superficially asserted director deadlock, but where the governing shareholders agreement authorized one of the respondent’s designees on the four-member board to cast the deciding vote in case of a tie vote. How can there be deadlock, the winning argument went, when the parties had a tie-break provision specifically designed to avoid deadlock?

The company at the center of the dispute, known as Pure Lime USA, Inc., is owned 50% by the petitioners Diane and Stuart Hudson and 50% by a Danish company known as Pure Lime APS which designs and manufactures active and fitness clothing for women and girls, which is then marketed and sold by Pure Lime USA in the United States.

Under their 2009 shareholders agreement, the Hudsons as salaried officers ran the operations of Pure Lime USA under the supervision of a four-member board consisting of the two Hudsons plus two designees of Pure Lime APS, one of whom was designated Chairman. The agreement provided “[i]n case of a tie vote, the Chairman shall cast the deciding vote.”

In September 2015, the Hudsons filed a shareholders derivative action against Pure Lime APS and its designees on the Pure Lime USA board, accusing them of diverting profit from Pure Lime USA to Pure Lime APS through various means in breach of contract and fiduciary duty, and failing to pay Pure Lime USA’s salaries and creditors. In January 2016, Justice Bucaria dismissed some of the claims as non-viable and granted the Hudsons leave to file an amended complaint as to others (read decision here).

That same month, the Hudsons filed a separate petition to dissolve Pure Lime USA based on deadlock under § 1104 (read petition here). The petition alleged most if not all of the same grievances alleged in the derivative action, and although it included rote allegations of deadlock, it failed to identify a single instance of an actual deadlock involving a board vote.

The respondents moved to dismiss the petition, arguing primarily that the shareholders agreement’s tie-break provision prevented the possibility of deadlock under § 1104.

Initially, by decision dated April 11, 2016 (read here), Justice Bucaria denied the dismissal motion, stating that the tie-break provision “does not expressly limit a shareholder’s right to bring a dissolution proceeding.” The decision in passing also noted that, while the petition’s allegations “also state a claim for dissolution on the ground of oppressive conduct pursuant to BCL § 1104-a,” the respondents have no right to elect to buy the petitioners’ shares under § 1118 since § 1104 was the petition’s only stated basis for dissolution.

The decision had a short shelf life, however, as a result of the respondents’ subsequent motion for leave to reargue which Justice Bucaria granted in his decision last month dismissing the petition without prejudice to re-filing a new petition under § 1104-a. His ruling noted that because, under the shareholders agreement, the Chairman of Pure Lime USA “has the power to break ties . . . there cannot be a deadlock,” and that “while the petition alleges various acts of oppression of shareholders Diane and Stuart Hudson, it does not allege a deadlock on the board of directors with respect to any particular action.”

The Hudsons suffered a further setback last month when Justice Bucaria issued another order in their shareholders derivative action, dismissing a number of claims in their second amended complaint (read decision here).

Little surprise, then, that late last month the Hudsons took up Justice Bucaria’s invitation to file an amended dissolution petition alleging oppressive conduct under § 1104-a.

The petition is scheduled to be heard early next month. To date the respondents have not filed opposing papers or an election to purchase the petitioners’ shares for fair value under § 1118, so we’ll just have to wait and see how the matter resolves.

The Takeaway:  Not all tie-breakers are created equal. If the intent is to maintain parity of control between co-equal shareholders, the normal drafting solution in the shareholders agreement is to designate a neutral third-party to break board deadlock on the specific occasion of a tie vote. The tie-break provision in the Pure Lime USA shareholders agreement is of a different sort, one that effectively gives board control to one of the two 50% shareholders. Presumably the Hudsons’ Danish partners had the superior bargaining power to extract an agreement for this type of control-begetting tie-breaker.

  • Erica Garay

    Requiring unanimity is the simplest way to avoid the deadlock situation, but that could just lead to paralysis where the shareholders cannot agree on a course of action. A terrific way to avoid deadlock is to trigger an ADR clause that requires mediation of the dispute or arbitration. The use of an arbitrator is especially intriguing. The two shareholders (who are likely directors), each present their “case” to the arbitrator who sits as the tie-breaking vote and actually “decides.” I’ve seen this in use and it is a terrific way to avoid deadlock, and, hopefully, keep the company viable.