Franklin C. McRoberts, counsel in the Uniondale office of Farrell Fritz and a member of the firm’s Business Divorce Group, prepared this article.
Article 11 of the Business Corporation Law governs dissolution of closely held New York business corporations. Article 11 has existed, more or less in its current form, for decades. Some of its provisions have been heavily litigated, including Sections 1104 and 1104-a governing judicial dissolution for deadlock and oppression, and Section 1118 governing buyout of a minority’s interest in an oppression proceeding. Other provisions have received surprisingly little attention.
In Morizio v Roeder, 2017 NY Slip Op 50248(U) [Sup Ct Albany County Feb. 17, 2017], Albany County Commercial Division Justice Richard M. Platkin addressed one of these latter, relatively-overlooked sections.
Section 1116 of the Business Corporation Law governs the circumstances in which a party who sues for dissolution may later change his or her mind and withdraw the claim for dissolution. The key language of the statute provides that a petitioner who wishes to withdraw his or her claim must “establish” to the court “that the cause for dissolution did not exist or no longer exists.”
What does that mean? Only a few courts have considered the issue, including a decision last year by Justice Timothy Driscoll in the Cardino case. As it turns out, a leading case to consider the legal standard to withdraw a dissolution claim was an earlier decision in the Morizio litigation.
In the first Morizio decision in 2014 (“Morizio I”), a minority shareholder and former employee of Adirondack Research & Management Inc., a financial investment advisory firm, sued the majority shareholders for a battery of common-law claims, including breach of contract, fraud, tortious interference with contract, breach of fiduciary duty and unjust enrichment. He also asserted a claim for dissolution based upon oppression under BCL § 1104-a.
At the time, the plaintiff claimed to own 25% of the voting shares of stock of the corporation, in excess of the 20% threshold to sue under BCL § 1104-a. The defendants moved to allow the corporation a late election to purchase the plaintiff’s shares under BCL § 1118, i.e., an election made more than 90 days after the filing of the dissolution petition.
In response, the plaintiff made an unusual, conditional cross-motion under BCL § 1116 to withdraw his claim for dissolution, but only “if the Court intend[ed] to authorize an untimely election.”
The court granted defendants’ motion to allow a late election to buy the plaintiff’s shares, adopting defendants’ argument that “allowing a late election would serve the best interest of the [corporation] while causing no identifiable prejudice to plaintiff.” Then, the court denied plaintiff’s motion to withdraw his claim for dissolution. The court held that the plaintiff “has not demonstrated that ‘the [alleged] cause for dissolution no longer exists’” (quoting BCL § 1116). The court explained:
Even if the BCL § 1104-a cause of action were withdrawn, the parties would remain embroiled in litigation in which plaintiff accuses the corporation and its majority shareholders of a persistent course of wrongful conduct. This concern is underscored by the equivocal nature of plaintiff’s cross-motion, which apparently seeks to leave plaintiff free to pursue the dissolution of ARMI if defendants are denied leave to invoke BCL § 1118.
Moreover, the Court finds the equities of the case support allowing the requested late election. Through the execution of the Buy-Sell Agreement, plaintiff expressly contemplated and agreed that a shareholder no longer actively involved in ARMI would divest his equity in the corporation. And even if the value of ARMI has increased substantially since the filing of the Complaint, there has been no showing that any post-filing appreciation is due to plaintiff’s ongoing contributions.
The court’s reference to post-filing appreciation in the value of the business provides a possible clue to plaintiff’s motive in resisting buy-out. Section 1118 fixes a valuation date as of the day before the filing of the dissolution petition, which in this case occurred a year or more before the defendants’ motion for leave to elect. Possibly the plaintiff believed that his proportionate share of the break-up value of the business at the time of the court’s decision in 2014 was greater than what he would receive by way of a fair value award based on the going-concern value of the business as of the statutory valuation date.
Events Between Morizio I and Morizio II
Morizio I did not end plaintiff’s quest to avoid a Section 1118 buy-out. To that end, the plaintiff subsequently presented the novel argument to reduce his percentage of voting shares in the company below the 20% statutory threshold for seeking dissolution under Section 1104-a, which in turn would defeat the statutory buy-out under Section 1118, or so the theory went.
As recounted in the second Morizio decision (“Morizio II”), after the court decided Morizio I, the parties engaged in almost three years of discovery. In discovery, the plaintiff claimed to have unearthed “newly discovered evidence establish[ing] that he lacks the 20% voting interest required to maintain a claim under BCL § 1104-a.”
Specifically, the plaintiff claimed to have learned that in 2011, the corporation purported to issue a new class of non-voting stock to certain other shareholders. According to the plaintiff, the language of the certificate of incorporation did not explicitly allow voting and non-voting classes of stock, so it was “legally insufficient under BCL § 501 (a) and (c) to authorize the issuance of non-voting shares.” As a result, the plaintiff claimed that the stock the corporation issued in 2011 “must be deemed by operation of law to carry voting rights,” in which case the newly issued shares “had the effect of diluting his voting interest in the corporation to 18.75%.”
Armed with this “newly discovered evidence,” the plaintiff moved to renew his earlier motion to withdraw his claim for dissolution. He contended that he was unaware of the alleged dilution of his voting interest when the parties litigated Morizio I.
The court discredited plaintiff’s argument that he learned of the alleged dilution of his stock for the first time in discovery. The court cited evidence showing that in February 2011, prior to the corporation’s issuance of new non-voting stock, the plaintiff received formal written notice of both a shareholders meeting to amend the certificate of incorporation to authorize additional issuance of stock, as well as a “proposed resolution of the board of directors authorizing the issuance of forty shares of Class B stock without voting rights.”
Moreover, in his original complaint, the plaintiff alleged an “improper dilution” of his stock. Justice Platkin thus concluded that “the facts upon which the renewal motion is based were in plaintiff’s possession when he commenced this lawsuit in 2012 and when he cross-moved for leave to withdraw his BCL § 1104-a cause of action in 2014.”
The court also found plaintiff’s new position not credible based on the parties’ prior course of conduct. The court explained, “Until the issue was raised by plaintiff’s motion for renewal, all parties—including plaintiff—acted in accordance with the belief that the Class B shares were non-voting and plaintiff, therefore, continued to possess a 25% voting interest in ARMI.” As support, the court cited the corporation’s stock register, as well as formal corporate disclosures to the IRS, SEC, and investors, all stating that plaintiff had a 25% voting interest in the corporation.
The court also gave short shrift to the plaintiff’s argument under BCL § 501 that the language of the certificate of incorporation was insufficient to allow multiple classes of stock, calling it “a novel and highly technical application of the Business Corporation Law.”
On the ultimate issue of withdrawal of the claim for dissolution, the court ruled that plaintiff’s motion fell far short of showing that “the cause for dissolution did not exist or no longer exists.” The court explained, “In the intervening three years” between Morizio I and Morizio II, “the parties’ acrimony and ill will towards one another appears to have only increased.” According to the court:
Even if the Court were to consider and adopt plaintiff’s dilution argument and authorize discontinuance of the BCL § 1104-a claim under BCL § 1116, the parties’ longstanding conflict and contention are likely to engender future litigation of the issues raised by the dissolution claim. If plaintiff’s voting interest . . . were found to be less than 20% and that were the final word on the matter, plaintiff presumably would recast his complaints of ongoing oppression . . . in the form of the common-law remedies available to minority shareholders, including claims for breaches of fiduciary duty and the like.
“Thus,” the court concluded, “this is not a case where allowing voluntary discontinuance of a claim for judicial dissolution pursuant to BCL § 1116 would avoid the need for further litigation between the parties.” As a result, the court once again denied the plaintiff’s motion under BCL § 1116 to withdraw his claim for dissolution.
The legal standard the court applied in Morizio I and Morizio II makes it difficult to withdraw a claim for dissolution where, even were the claim withdrawn, litigation will continue between the parties concerning the same underlying disputes. Morizio I and Morizio II thus serve as a cautionary tale for a minority shareholder considering suing under BCL § 1104-a who may not be prepared for the consequences of a buy-out election inside or outside the statutory 90-day period.
Why would the plaintiff in Morizio go to such lengths to force a liquidation rather than be bought out and, failing that, to withdraw his dissolution claim and retain his status as a non-controlling shareholder mired in bitter litigation with his business partners?
As noted above, one factor may have been the plaintiff’s concern, based on the statutory valuation date, over not capturing the perceived appreciation in the value of the business in the 4 or 5 years since the plaintiff filed his lawsuit in 2012. It also possibly could be explained by a desire to attain greater negotiating leverage with the majority by depriving them of the right to compel a buy-out. We’ll never know.