Common Law Dissolution

egregiousKurt Vonnegut observed in his novel Deadeye Dick that the word “egregious,” which “most people think means terrible or unheard of or unforgivable has a much more interesting story than that to tell. It means ‘outside the herd.'”

He’s right. The original Latin ēgregius did indeed translate as “standing outside the herd” in the non-judgmental sense of exceptional, and it wasn’t until the late 16th century that the word took on its modern, disapproving sense.

I’ll grant you it’s a bit of a leap from etymology to business divorce, but in the court decision I’m about to describe, the meaning of the word “egregious” took center stage in a minority shareholder’s lawsuit seeking common-law dissolution of a closely held corporation.

The court’s decision last month in Braun v Green, 2016 WL 4539488 [Sup Ct NY County Aug. 31, 2016], sprang from a dispute between fellow shareholders in a Florida corporation whose sole asset is a commercial realty development near Houston, Texas. The plaintiff 8% shareholder, Braun, sourced the investment opportunity and presented it to the defendant 92% shareholder, Green, who provided all of the needed capital. Continue Reading Non-Egregiously Aggrieved Minority Shareholder Can’t Sue for Common-Law Dissolution

cash registerAppellate case law in New York generally prohibits use of company funds to pay for legal defense costs in judicial dissolution proceedings.

The theory supporting the prohibition, as articulated over 50 years ago in Matter of Clemente Brothers, 19 AD2d 568 [3d Dept], aff’d, 13 NY2d 963 [1963], is that the statute authorizing dissolution proceedings “grants to the corporation as a separate entity no authority to determine whether a proceeding shall be initiated to dissolve itself,” thus making the corporation a proper jural party “for the limited and passive purpose of rendering it amenable to the orders of the court” and barring it from assuming a “militant alignment on the side of one of two equal, discordant stockholders.”

The principles animating Clemente and its progeny such as Matter of Rappaport, 110 AD2d 639 [2d Dept 1985], and Matter of Boucher, 105 AD3d 951 [2d Dept 2013], involving deadlock dissolution proceedings between 50-50 shareholders, have been extended to cases brought under the separate statute enacted in 1979 providing a dissolution remedy for oppressed minority shareholders. Continue Reading The Prohibition Against Using Company Funds for Legal Fees in Dissolution Proceedings

No  SaleA bitter feud among third-generation owners of a family business has yielded a notable court decision upholding the plaintiff’s standing to seek common-law dissolution and to assert shareholder derivative claims in the face of the defendants’ argument that the plaintiff’s shares automatically were redeemed by operation of the shareholders’ agreement upon the termination by the defendants of the plaintiff’s husband’s employment.

Sounds complicated? Not really.

Queens County Commercial Division Justice Duane A. Hart’s decision in Berger v Friedman, Short Form Order, Index No. 702322/15 [Sup Ct Queens County Oct. 27, 2015], centers on a wholesale distributor of electrical parts and equipment founded in 1945 by the grandparents of the three sibling litigants who each acquired a one-third interest from their parents in 1993. The siblings entered into a shareholders agreement (read here) naming each of them as an officer and director, requiring their unanimous consent for specified “major actions,” and defining a series of trigger events compelling stock redemption at a defined purchase price and on specified terms. Continue Reading Court Rejects Majority’s Gambit to Compel Buyback of Shares in Family-Owned Business

winding roadThe Delaware Supreme Court last week refused to rehear its affirmance of Chancery Court’s post-trial decision in a case called Zutrau v Jansing. The Appellate Division of the New York Supreme Court last May affirmed a post-trial decision in a closely related case involving the same parties. The two appellate decisions effectively close out a tenaciously fought, seven-year litigation saga involving a minority shareholder’s largely unsubstantiated, multi-faceted attack on the majority shareholder’s management and financial stewardship of a small, New York-based Delaware corporation specializing in proxy servicing.

The litigation history includes an initial books-and-records proceeding in New York followed by serial suits in New York and Delaware asserting a variety of claims for unlawful termination of the minority shareholder’s employment; direct and derivative claims for breach of fiduciary duty; breach of contract; and a challenge to the validity and fairness of a reverse stock split that cashed out at fair value the minority stockholder’s shares while litigation was pending concurrently in New York and Delaware courts. [Disclosure: The defendants are clients of my firm which served as co-counsel in the New York litigation and acted as lead counsel in connection with the reverse stock split.]

The case spawned a plethora of pretrial motions, lengthy trials in New York Supreme Court and Delaware Chancery Court, and appeals in both jurisdictions. Ultimately, the courts rejected the plaintiff’s claims for unlawful termination of her employment and contract breach, rejected the bulk of her claims against the majority shareholder for breach of fiduciary duty, upheld the validity of the reverse stock split, and upheld the company’s fair value appraisal with modest adjustments. Continue Reading Business Divorce Case Reaches End of Long and Winding Road

Unclean HandsJudicial dissolution of a business entity, whether pursuant to statute or common law, is an equitable remedy subject to equitable defenses, including the doctrine of “unclean hands.”

As described a few years ago by Justice Emily Pines in the Kimelstein dissolution case, the unclean hands doctrine “bars the grant of equitable relief to a party who is guilty of immoral, unconscionable conduct when the conduct relied on is directly related to the subject matter in litigation and the party seeking to invoke the doctrine was injured by such conduct.”

The doctrine has been employed in dissolution cases in two ways. First, it can defeat a petitioner’s standing to seek dissolution, as in Kimelstein where Justice Pines held that the petitioner’s admitted concealment from his ex-wives, creditors and federal government of his alleged, undocumented 50% equity interest in two corporations owned by his brother barred him from asserting the requisite stock holdings to seek statutory dissolution. Second, even when the petitioner’s stock ownership is conceded, the doctrine can bar the petitioner’s dissolution claim on the merits.

The doctrine’s latter use rarely has been successful. A recent exception is Sansum v Fioratti, 128 AD3d 420 [1st Dept 2015], in which the Appellate Division, First Department, ordered the dismissal of a common-law dissolution claim brought by a 6% shareholder in an art gallery based on the plaintiff’s “embezzlement” of company funds for which he pled guilty to larceny and related charges. The decision packs an even more powerful punch by virtue of the court’s summary disposition of the claim, disagreeing with the lower court that a hearing was required and invoking the doctrine of in pari delicto (Latin for “in equal fault”) to reject the plaintiff’s counter-argument, that the defendant stockholders themselves conducted illegal business operations. Continue Reading Wash Hands Before Suing

Del Ct Chancery 2Viewing the arc of Delaware Chancery Court jurisprudence over the last two decades implementing that state’s Limited Liability Company Act, and witnessing the Delaware legislature’s frequent amendments to the statute in reaction to judicial developments, you can’t help but detect a pattern of maintaining the unique attributes of the Delaware LLC, as compared to other forms of business entity, by:

  • rigorously promoting freedom of contract (in the form of the LLC agreement) and its corollary, “you made your bed now lie in it”;
  • deciding internal governance disputes within the bounds of the interplay of the Delaware LLC Act’s default rules and the LLC agreement; and
  • strongly disfavoring judicial intervention based on open-ended notions of fairness (the main exception being when managers take on fiduciary duties by agreement or by default under the statute).

Stated simply, in Delaware certainty trumps indeterminacy.

Well, not always, as seen in a first-impression ruling last week by Vice Chancellor J. Travis Laster in In re Carlisle Etcetera LLC, C.A. No. 10280-VCL (read here), in which the court held that the assignee of an LLC membership interest, who as a non-member and non-manager lacked standing to seek involuntary dissolution under Section 18-802 of the Delaware LLC Act, nonetheless had standing to seek equitable dissolution under the Chancery Court’s common-law authority as a court of equity.  Continue Reading Delaware Chancery Court Endorses Equitable Dissolution of LLC

Ready to take a pop quiz? Here we go:

  1. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under the deadlock statute, Business Corporation Law § 1104?  __ Yes  __ No
  2. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under the oppressed shareholder statute, Business Corporation Law § 1104-a?  __ Yes  __ No
  3. Can a 50% shareholder of a closely held corporation petition for judicial dissolution under common law?  __ Yes  __ No
  4. Can a 50% shareholder of Company A, who also is a director of Company B in which Company A holds a majority interest, petition for judicial dissolution of Company B under common law?  __ Yes  __ No

Let’s see how you did. If you answered “Yes” to #1, you’re right. But that was easy. Without even looking at the statute, BCL § 1104, logic tells you that a shareholder who possesses half the available voting power — that is, not enough to secure majority approval for shareholder or board action but enough to block the other 50% shareholder from doing the same — should be able to seek dissolution where deadlock results from disagreement with the other 50% shareholder. Continue Reading Take the 50% Shareholder/Dissolution Pop Quiz!

“[T]he Court concludes that it lacks subject-matter jurisdiction to dissolve a Delaware corporation, and thus dismisses the First Cause of Action.”

Sounds familiar? It should. The above ruling, found in Nassau County Commercial Division Justice Timothy S. Driscoll’s decision last month in Bonavita v Savenergy Holdings, Inc., Short Form Order, Index No. 603891-13 [Sup Ct Nassau County Dec. 8, 2014], adds to the growing list of cases in New York’s Second and Third Departments in which courts have declined subject-matter jurisdiction over claims for judicial dissolution of a foreign business entity. It also accentuates the schism, about which I’ve previously written, between decisions in those Departments and a smaller number of First Department rulings upholding jurisdiction in similar cases.

The plaintiffs in Bonavita, likely aware of the Second Department precedent stacked against them, took a somewhat different tack by asserting in their complaint’s First Cause of Action (read here) a claim for common-law dissolution of the subject Delaware corporation rather than a statutory claim for judicial dissolution under Article 11 of the Business Corporation Law. (Delaware has no statute authorizing judicial dissolution at the behest of a minority shareholder.) Continue Reading Court Declines Jurisdiction Over Claim for Common-Law Dissolution of Delaware Corporation

The under-reporting of cash receipts a/k/a skimming by restaurant owners and other cash-intensive businesses costs many billions of dollars in lost tax revenues each year and, when detected by audit, can lead to stiff penalties and even criminal prosecution. When the business has multiple owners, not all of whom are in on the skimming, it also can constitute grounds for judicial dissolution, as illustrated in a fascinating post-trial decision last week by Brooklyn Commercial Division Presiding Justice Carolyn E. Demarest in Cortes v 3A N. Park Ave. Rest Corp., 2014 NY Slip Op 24329 [Sup Ct, Kings County Oct. 28, 2014].

Any publicly aired business divorce involving allegations of looting can be a nasty affair. Throw into the litigation mix the specter of under-reported taxes and it becomes positively toxic, which is the flavor I got from reading Justice Demarest’s detailed findings of fact and conclusions of law in her 24-page ruling which, ultimately, found that the controlling shareholders skimmed about $3.7 million and conditionally ordered dissolution of the corporation, contingent upon the controllers’ buy-out of the plaintiff’s shares for over $1.2 million.

Background

The Cortes case involves a 150-table Mexican restaurant, bar, and nightclub called Cabo, located in Rockville Center on Long Island. In 2003, the plaintiff, Porfirio Cortes, acquired for $50,000 a 16.67% stock interest in the restaurant’s operating company, in which the remaining shares were owned equally by defendants Angelo Ramunni and Domenick DeSimone. The purchase agreement gave the corporation the right to repurchase Cortes’s shares in the event he resigned his designated position as managing partner though, oddly, it did not specify a price or a pricing mechanism. Continue Reading Restaurant’s Cash-Skimming Majority Owners Forced to Buy Out Minority Shareholder or Face Dissolution

Nassau County Commercial Division Justice Vito M. DeStefano (pictured) last month handed down an important ruling in Schlossberg v Schwartz, 43 Misc 3d 1224(A), 2014 NY Slip Op 50760(U) [Sup Ct, Nassau County May 14, 2014], addressing rights of indemnity and advancement when a company brings claims against its own officer or director for alleged misconduct undertaken in a corporate capacity. The scholarly decision, which traces the convoluted history of the governing Business Corporation Law (BCL), rejects the company’s position that its bylaws and the BCL preclude advancement and indemnification for intra-company claims, i.e., claims brought directly by the company against an officer/director, as opposed to extra-company claims, i.e., claims brought by outside, third parties.

Schlossberg also is noteworthy:

  • for upholding the right to seek advancement and indemnity for expenses incurred in the defense of the company’s counterclaims, on an apportioned basis, in a suit initiated by a minority shareholder, director and former officer asserting direct and derivative claims against the controlling shareholder, inter alia, for breach of fiduciary duty, breach of contract and common law dissolution; and
  • for its numerous citations to decisions of the Delaware Chancery Court, which rightfully boasts an advanced jurisprudence in the area of indemnification and advancement.  Continue Reading Court Upholds Former Officer’s Right to Seek Indemnity and Advancement in Intra-Company Dispute