"Unclean Hands" Defense Can Backfire in Deadlock Dissolution Case
The seminal New York case defining "oppressive" conduct under the statute authorizing a minority shareholder to seek corporate dissolution, Matter of Kemp & Beatley, Inc., 64 NY2d 63, 74 (1984), cautioned that a minority shareholder "whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression should be given no quarter in the statutory protection." This language gave birth to what has become known as the "unclean hands" defense in shareholder oppression cases under Section 1104-a of the Business Corporation Law (BCL). The unclean hands defense often is based on allegations that the petitioning minority shareholder secretly is involved with or planning to launch a competing business to steal the customers and good will of the company whose dissolution is sought.
Over the years since Kemp, the unclean hands defense also has crept into dissolution cases brought by a 50% shareholder under BCL Section 1104 based on deadlock and internal dissension. Unlike oppression cases under Section 1104-a, where the minority shareholder must prove some form of at-fault or unfair conduct by the majority, cases under Section 1104 focus on the deterioration of the relationship between the two 50/50 shareholders and the resulting corporate paralysis, without necessarily assigning fault to one side or the other.
A recent decision by Nassau County Commercial Division Justice Stephen A. Bucaria, in Matter of Rieger (Airmarine Electroplating Corp.), Short Form Order, Index No. 010524/09 (Sup Ct Nassau County Aug. 27, 2009), illustrates the difficulty of maintaining the unclean hands defense in a deadlock dissolution case where, absent compelling proof, the allegations of inequitable conduct by the petitioner can themselves contribute to the court's sense of shareholder hostility and corporate dysfunction warranting dissolution.
Continue Reading...Controlling Shareholder's Unreasonable Refusal to Admit Petitioners' Stock Ownership Constitutes Ground for Corporate Dissolution, Incurs Award of Attorney's Fees
"Well over one and a half years have been wasted on a defense which is utterly without support."
Pretty strong stuff, coming from a recent decision by Nassau County Commercial Division Justice Stephen A. Bucaria in Rosenfeld v. Luccaro, 2009 NY Slip Op 30963(U) (Sup Ct Nassau County Apr. 23, 2009), where the court granted dissolution of two closely held corporations based on "hopeless" deadlock and bitter dissension between two 50% shareholder factions. The court's sharp words were provoked by the respondent's assertion that the petitioners were not -- and had never been -- shareholders, despite a seeming avalanche of corporate and tax records to the contrary.
The subject corporations were formed in the 1970s by 50-50 shareholders Anthony Luccaro's father and Walter Rosenfeld to own and operate a marina called Toms Point Marina located in Port Washington on Long Island. Anthony Luccaro subsequently acquired his father's interest, and Rosenfeld died some time in the 1980s. His estate's distributees included his second wife, Judith, and his three children from a prior marriage.
Fast forward to 2007, when the Rosenfeld children commenced judicial dissolution proceedings under Sections 1104 and 1104-a of the Business Corporation Law, claiming deadlock and oppression by Luccaro who allegedly refused to recognize the election of petitioner Todd Rosenfeld as director, refused access to the bylaws and other books and records, threatened the life of petitioner Steven Rosenfeld if he entered the marina property, operated the marina as a cash business without proper controls and employed his family members without proper accounting, refused to issue K-1 tax forms to the Rosenfelds, and took cash and other distributions for himself without making any distributions to the Rosenfelds.
Continue Reading...Court Grants Dissolution, Rejects Claim that Failed Buy-Sell Agreement Was "Ploy" by Petitioner to Take Over Corporation's Retail Store Lease for His New Business
Has anyone else noticed an uptick in the number of cases asserting claims for breach of fiduciary duty and fraud arising from stock buy-outs among owners of closely held companies? Perhaps it should be called the Littman Effect, after the First Department's 2008 decision in Littman v. Magee, where the court upheld this type of claim notwithstanding broad releases and disclaimers in the buy-out agreement. (Read my post on Littman here.)
The most recent example is a case called Matter of Lerman (Tive Clothing, Inc.), Short Form Order, Index No. 2947/09 (Sup Ct Nassau County July 8, 2009), involving a single-outlet clothing store known as Effie's owned 50-50 by two shareholders. Although Lerman offers a twist on the usual fact pattern -- the fight was over the consequences of a contemplated buy-out that did not occur -- it flows from the same idea, viz, that Shareholder A wrongfully induced Shareholder B to enter into a buy-out agreement by withholding material information that Shareholder A was duty-bound to disclose.
The facts in Lerman are not complicated. The two owners, Lerman and Knaffo, set up their corporation, called Tive Clothing Inc. ("Tive"), and operated the store in leased space for almost 20 years before their relationship began to unravel over profitability and other financial issues. In June 2007 they reached an interim solution in the form of a stockholders' agreement with a buy-sell provision that permitted either of them to offer their shares to the other at a fixed price. If the offeree declined to purchase, Tive was to be dissolved and the inventory liquidated.
Continue Reading...Majority Shareholders of Accounting Firm Held Liable for Value of Deceased Minority Shareholder's Interest After They Formed New Firm Using Old Firm's Assets and Good Will
It may surprise some of you to learn that the Surrogate's Courts in New York have jurisdiction to hear petitions for judicial dissolution of closely held corporations involving the estate of a deceased shareholder. These cases are relatively rare -- most shareholder agreements contain provision for mandatory stock redemption upon death -- but they do happen from time to time. Case in point: last month the Appellate Division, Second Department, affirmed a ruling by the Surrogate's Court awarding the estate of a deceased minority shareholder the value of its stock interest, to be paid by the surviving shareholders in proportion to their stock interests. Matter of Verdeschi, 2009 NY Slip Op 05355 (2d Dept June 23, 2009).
As laid out more fully in the underlying September 2006 Decision and Order issued by Westchester County Surrogate's Court Justice Anthony Scarpino, Jr., Verdeschi involves an accounting firm known as G.B. Tepper & Associates Ltd. ("Tepper & Associates") organized in 1992 as a business corporation (as opposed to the more common professional corporation) with four shareholders: the decedent, Carl Verdeschi (35%), Gerald Tepper (35%), Monte Tepper (15%) and Jay Samuels (15%). They had no shareholders agreement. Prior to Verdeschi's death in late 2003, each shareholder received a salary and a share of profits proportionate to their stock percentage. After Verdeschi died, the surviving shareholders conducted no further business through Tepper & Associates. Instead, Monte Tepper and Jay Samuels formed a new firm known as Tepper Tax Associates, Inc. ("Tepper Tax") which occupies the same office used by Tepper & Associates, provides the same accounting services to the old firm's clients, and uses all of the old firm's office equipment, computers and furnishings. The new firm also employed Gerald Tepper.
Continue Reading...Undocumented Stock Interests Invite Challenges to Standing in Corporate Dissolution Cases: Part Three
[This is the third in a three-part series on challenges to standing to petition for judicial dissolution where the petitioner lacks a stock certificate or other definitive evidence of shareholder status. Part One looked at a recently decided case where the court ordered an evidentiary hearing to resolve the parties' contradictory factual contentions. Part Two discussed a dissolution case involving two contested corporations, in which the court rendered a split decision after an eight-day evidentiary hearing to determine whether the petitioner owned any shares. This week's highlighted case adds a family dimension to the problem of inadequate documentation of share ownership.]
If a corporate dissolution contest could be re-imagined as a TV game show, I'd call the case of Rodriguez v. Estevez, "Who Wants to be a Shareholder: Family Feud Edition".
In many instances, the same bonds of kinship and trust that give life and success to family-owned businesses can lead to the most bitter of courtroom disputes when the family members/business partners have a falling out. In Rodriguez, the dilution of family ties as control passed to the second generation, combined with a dramatic increase in the value of the business assets, created conditions rife for dissension. The resulting legal conflagration over the question of share ownership was made even more predictable by the family members' traditional aversion to the use of "outsider" lawyers and accountants to maintain proper corporate records.
The Rodriguez saga starts with two first generation immigrants to the United States, Rafael Rodriguez and Joaquin Estevez, who became successful retail business owners in New York City. Rafael owned and operated a liquor store. Joaquin went into the retail grocery and food trades. Rafael married Joaquin's sister. Joaquin had two daughters and five sons, several of whom became involved in their father's businesses.
Continue Reading...Undocumented Stock Interests Invite Challenges to Standing in Corporate Dissolution Cases: Part One
In the world of closely held corporations, what makes a shareholder a shareholder?
Section 508 of New York's Business Corporation Law states that "the shares of a corporation shall be represented by certificates or shall be uncertificated shares." Scattered throughout the BCL are references to "shareholders of record". BCL Section 624 requires every corporation to keep "a record containing the names and addresses of all shareholders" and makes such record "prima facie evidence of the facts stated therein" in any action or special proceeding against the company, its directors, officers or shareholders.
However, ask lawyers about their experiences with small, closely held corporations and you will hear countless stories about companies that never issued stock certificates, never kept a stock ledger, never adopted bylaws, never had a written shareholders' agreement, and never held formal shareholder meetings much less kept meeting minutes.
Such widespread record keeping lapses create fertile ground for disputes over shareholder status in many different legal settings, including corporate dissolution contests. Sometimes the dispute is over the stock percentage held by an otherwise acknowledged shareholder. This kind of dispute is geared toward either supporting or defeating the specific stock-holding percentage requirements for bringing a deadlock dissolution proceeding under BCL 1104 (50%) or an oppressed minority shareholder dissolution proceeding under BCL 1104-a (20%).
Then there are the cases in which the respondent contends that the petitioner never held a stock interest. More often than not, these cases are brought under the oppression statute by putative minority shareholders who lack control of, or access to, the corporation's books and records.
This is the first of three consecutive posts on the standing challenges to be overcome by a petitioner who holds no stock certificate or other direct evidence of a stock interest. Each of the three cases highlighted in these posts presents a distinct factual scenario. All three cases remind us of the substantial additional litigation costs and time involved when an initial evidentiary hearing must be held to determine the petitioner's standing before proceeding to a hearing on the merits of the dissolution petition.
Continue Reading...Top 10 Business Divorce Cases of 2008
The nominations are in, the votes are counted, envelope please! Following are my picks for last year's top 10 business divorce cases, all of which were featured in prior posts:
- Tzolis v. Wolff, 10 NY3d 100 (2008), in which the Court of Appeals resolved conflicting First and Second Department decisions on the question whether LLC members can bring derivative actions on the LLC's behalf. They can.
- Matter of Beverwyck Abstract, LLC, 53 AD3d 503 (3d Dept 2008), in which an appellate court upheld a lower court's ruling that the de facto dissolution of an LLC did not terminate the members' fiduciary duty to account for ongoing profits up until formal dissolution.
- Tal v. Superior Vending, LLC, 20 Misc 3d 1103(A) (Sup Ct Westchester County 2008), in which the court crafted an equitable remedy in an LLC dissolution by ordering a return of the petitioner's investment.
- Dingle v. Xtenit, Inc., 20 Misc 3d 1123(A) (Sup Ct NY County 2008), in which the court required a bona fide purpose for a controlling shareholder's dilution of the minority shareholder's interest.
- Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC, 19 Misc 3d 1138(A) (Sup Ct Monroe County May 12, 2008), subsequent decision, 20 Misc 3d 1104(A), in which the court upheld the petitioner's standing to seek LLC dissolution after finding that the other member lacked authority to engage the LLC's attorney who had accepted the petitioner's resignation.
- Hellman v. Hellman, 19 Misc 3d 695 (Sup Ct Monroe County 2008), modified, 2009 NY Slip Op 02418 (4th Dept Mar. 27, 2009). involving a corporation owned 50-50 by brothers, in which the court upheld a new company lease executed by the brother who served as president over the other's objection that the lease required board approval.
- Murphy v. U.S. Dredging Corp., 2008 NY Slip Op 31535 (Sup Ct Nassau County May 19, 2008), a valuation proceeding involving shares in a subchapter C real estate holding corporation in which the court applied a discount for built-in capital gains.
- Matter of Youngwall, 2008 NY Slip Op 30811(U) (Sup Ct Nassau County Mar. 14, 2008), adhered to upon reargument in unreported decision dated July 28, 2008, in which the court granted dissolution of an unprofitable LLC and also ruled that a provision in the operating agreement waiving the right to seek judicial dissolution is void as against public policy.
- Ross v. Nelson, 54 AD3d 258 (1st Dept 2008), in which the court enforced the LLC's default statute in upholding a majority vote of the members to remove one of the managers.
- Manitaras v. Beusman, 56 AD3d 735 (2d Dept 2008), in which the court found that an LLC operating agreement's silence on the sale of the LLC's sole asset permitted majority approval under the default statute even though the sale automatically triggered dissolution.
What will 2009 bring? It's not illogical to think that the stress of the economic meltdown will lead to an increase in business divorce. But in my years watching the scene I've never detected any correlation between business cycles and the rate of litigious business break-ups involving closely held companies. If anything, I would lean in favor of the theory that financial success and opportunity in a business create even more incentive for dissension among co-owners. A recent NY Times article pointed out how falling real estate values are impeding marital divorces by eliminating the primary resource for financial settlement. I think a similar phenomenon could be at play with businesses in the current climate, by reducing the upside for a disgruntled owner contemplating a tactical lawsuit designed to induce a buyout.
Poorly Drafted Disability Clause in Operating Agreement Provides Novel Defense to LLC Dissolution Proceeding
"You can't dissolve the company, you're crazy!"
That more or less sums up one of the most novel defenses I've ever come across in a dissolution proceeding, in which the respondent 50% member of an LLC argued that the petitioning 50% member could not dissolve the company because he was under a mental disability as defined in the parties' operating agreement. Although the defense ultimately failed in this case, there's a lesson to be learned about the proper drafting of disability clauses in shareholder and operating agreements.
The case is Matter of Swett (Factors Walk, LLC) decided several years ago by Monroe County Commercial Division Justice Kenneth R. Fisher. In 2002, Bradford Swett and W. Curtis Barnes as 50/50 members formed a limited liability company known as Factors Walk, LLC to develop and sell real estate consisting of a 75-acre subdivided tract. The operating agreement vested management in the two members equally. It also appears to have included a provision, not fully described in the court's decision, authorizing a member to precipitate voluntary dissolution simply by giving notice to the other member.
In 2005, Swett gave Barnes the prescribed notice following which he commenced a proceeding for judicial supervision of the winding up of the LLC pursuant to LLC Law Section 703(a). The statute authorizes a member to seek such relief for an LLC that has been dissolved either voluntarily or by judicial decree under LLC Section 702.
Continue Reading...Court Enforces Stock Buyout Triggered by Shareholder's Death Notwithstanding Pending Dissolution Proceeding
According to one online review, Greek restaurant Telly's Taverna located in Astoria, Queens, "exudes Mediterranean calm with its beach mural, bucolic back garden and airy main dining room."
Nine miles away, in the courtroom of Queens County Commercial Division Justice Orin R. Kitzes, the atmosphere has been anything but bucolic as the restaurant's 50-50 owners have waged a bitter shareholder dispute for over two years, including a deadlock dissolution proceeding under Section 1104 of the Business Corporation Law.
In the midst of those proceedings, the 50% shareholder who petitioned for dissolution died. The ensuing, convoluted legal proceedings ultimately boiled down to one question: Did the petitioner's death entitle the surviving shareholder to enforce the valuation and buyout provision in the shareholders' agreement, thereby mooting the dissolution proceeding?
The short answer is "yes". Here's the full story:
In January 2001, Joanna ("Nana") Loiselle and Aristotelis ("Telly") Vagianderis as 50-50 shareholders formed Kalamaki Taverna, Inc. to operate the restaurant known as Telly's Taverna. A month later they entered into a written shareholders' agreement including an optional provision for stock buyout upon death, as follows:
Continue Reading...In the event of the death of a stockholder, the Corporation business may be continued by the surviving parties on giving notice of such election to continue to the legal representative of said deceased party within thirty (30) days following the death of such deceased party. The deceased party's interest in the Corporation shall terminate on the date of his or her death and the value of the interest of such deceased party in the Corporation shall be determined as of the date of such deceased party's death. The interest so determined shall be paid to his or her legal representative . . ..
Failure to Disclose Stock Interest in Bankruptcy Petition Defeats Standing in Later Dissolution Proceeding
It's not often that bankruptcy law intersects with corporate dissolution proceedings based on deadlock or minority shareholder oppression, but when it does, likely it's bad news for the petitioner seeking to liquidate the company or to be bought out by another shareholder.
Such was the fate of the plaintiff in a recently decided dissolution case called Light v. Boussi, 2008 NY Slip Op 51212(U) (Sup Ct Kings County June 19, 2008). In 2006, plaintiff Beril Light sued Samuel Boussi for an accounting, imposition of constructive trust, damages and an order compelling dissolution of a real estate holding company formed in 1995 called 10-18, Inc. Light claimed that he and Boussi were 50-50 shareholders. Light alleged that Boussi failed to maintain corporate formalities, provide him with notice of corporate meetings or financial information, or distribute to Boussi 50% of the company profits. Boussi denied that Light ever was a shareholder and also asserted as affirmative defenses that Light lacked legal capacity to sue, and that Light's claims were barred by the doctrine of judicial estoppel.
Both defenses arose from the fact that in 1998, Light and his wife filed a voluntary petition under Chapter 11 of the Bankruptcy Code. Their petition listed various assets owned by them including real properties and interests in stock corporations, but made no mention of 10-18, Inc. The bankruptcy court entered a final decree in 2002, Light's bankruptcy case was closed, and the trustee was discharged.
Continue Reading...Appellate Court Enforces Stock Buyback Triggered by Dissolution Petition
One of my pet issues, on which I've written a number of times (see here, here and here), is whether the filing of a dissolution petition triggers a mandatory stock buyback under a shareholders' agreement that provides a right of first refusal (RFR). The cases raising the issue have all been deadlock dissolution petitions brought by 50% shareholders under Business Corporation Law Section 1104(a). That statute, unlike Section 1104-a governing minority shareholder oppression, does not give the respondent shareholders the right to purchase the petitioner's shares under Section 1118.
If the shareholders' agreement expressly provides that the filing of a dissolution petition triggers the RFR, unquestionably it should be enforced. The problem arises with the more typical RFR that does not contain such express language, but instead contains what most would consider boilerplate reference to stock transfers. Is enforcement by reason of such general language consistent with a shareholder's reasonable expectations, and with the statutory right to seek dissolution? The issue has very serious ramifications for the petitioner (and for petitioner's lawyer who may be unwary of the trap) because the RFR typically provides a below-market price for the buyback with a long-term payout.
A 2006 appellate decision by the First Department in a case called Matter of Johnsen (ACP Distribution, Inc.) ruled that a dissolution petition triggered an RFR containing the operative terms, "donate, hypothecate, pledge, transfer or otherwise dispose of his Stock in any manner whatsoever." A September 2007 trial court decision in Matter of Schneck (R&J Components Corp.) (previously blogged here) went the other way where the operative terms were "sell, assign, mortgage, hypothecate, transfer, pledge, create a security interest or lien, encumber, give or otherwise dispose of any of the shares."
Continue Reading...Anatomy of a Dissolution Slugfest: Part IV
This is the fourth in a series of postings on a multi-faceted corporate dissolution battle waged in Nassau County Supreme Court called Matter of Marciano (Champion Motor Group, Inc.) involving three partners and a luxury automobile dealership.
Part I of the series (read it here) reviewed the basic facts of the case and discussed the defendants’ initial, unsuccessful challenge to Marciano’s standing to seek dissolution based on allegations that he deliberately sought to conceal from tax authorities and federal prosecutors his stock ownership interest in Champion. Part II (read it here) covered some additional issues raised in the court’s initial decision in the case, including the defendants’ argument that they acted reasonably by excluding Marciano from the business after his criminal indictment. Part III (read it here) highlighted portions of the court’s second decision in the case in which it denied Marciano’s motion to compel payment to him of distributions pending the litigation and granted his motion for leave to amend his complaint.
In this Part IV, we look at Justice Warshawsky's third decision in the case dated September 19, 2007, occasioned by the defendants' renewed assertions that Marciano lacked standing to seek dissolution and that their exclusion of him from the business was reasonably required to protect the business in response to the unrelated stock fraud charges brought against him by federal prosecutors.
Continue Reading...Anatomy of a Dissolution Slugfest: Part I
Question: What do you get when you take a luxury automobile dealership consisting of multiple corporations and limited liability companies, stir in three business partners, add contradictory documents concerning one partner’s ownership interest, season with a federal indictment of that same partner for stock fraud following which the other two partners freeze him out of the business, top off with a pair of litigators and bring to a boil?
Answer: A great recipe for a corporate dissolution slugfest recently played out in Nassau County Supreme Court.
Business divorce devotees can go to school on this case, thanks to a series of fact-filled and law-laden written decisions authored by Justice Ira B. Warshawsky of the Nassau County Supreme Court, Commercial Division. About the only disappointing thing about this battle royal, entitled Matter of Marciano (Champion Motor Group, Inc.), is that the plaintiff’s first name isn't Rocky.
This first of five consecutive postings on the Marciano case summarizes the underlying facts. It then examines the court’s handling of the primary defense raised by the defendants in their initial attack on the dissolution petition, in which they challenge Marciano’s standing as a shareholder to seek dissolution. In subsequent postings New York Business Divorce will discuss a number of other issues discussed in each of the court’s four, separate decisions, including:
- whether Marciano’s criminal indictment justified the defendants’ decision to exclude him from the business;
- Marciano’s application under Section 702 of the LLC Law to dissolve the several LLCs formed by the parties;
- Marciano’s request for appointment of a limited receiver or financial monitor to oversee the business;
- Marciano’s request for access to all corporate records;
- Marciano’s request to compel distributions to him pending the proceedings;
- Marciano’s application to amend his pleading to add post-commencement derivative claims for waste and mismanagement;
- Defendants’ application made after discovery for summary judgment dismissing the action based on lack of standing and Marciano’s eventual guilty plea to unrelated federal charges;
- Marciano’s application to dismiss defendants’ “unclean hands” and estoppel defenses; and
- Marciano’s application for injunctive relief concerning the defendants’ alleged self-dealing when they assigned the dealership’s lease to a related company in which they alone are principals, following which the related entity exercised an option to purchase.
One Case, Three Great Issues
When it comes to reading court decisions in business divorce cases, I have a number of pet issues. If I come across a decision with one such issue, I’m happy. Two in the same opinion, I’m thrilled. Three in the same opinion, it’s like hitting the trifecta.
A recent decision by Nassau County Commercial Division Justice Stephen A. Bucaria offers a winning threesome: (1) arbitrability of corporate dissolution petitions; (2) petitions seeking dissolution of out-of-state corporations; and (3) dissolution petitions that trigger mandatory buybacks under a shareholders’ agreement.
The case, Matter of Schneck (R&J Components Corp.), 2007 NY Slip Op 32966(U) (Sup Ct Nassau County Sept. 17, 2007), involves two brothers who went into, and eventually each inherited 50% interests in, an electronic parts business founded by their father who died in 1990. The business came to be organized as six separate companies, two of which were formed as out-of-state corporations but all of which operated in New York. The complaining Brother A claimed that Brother B had frozen him out of the business, denied him access to business records, and took hundreds of thousands of dollars more each year than Brother A was getting. Brother A sought judicial dissolution of all the companies based on internal dissension and deadlock under Business Corporation Law § 1104.
Continue Reading...