Over the years I’ve litigated and observed countless cases of alleged oppression of minority shareholders by the majority. Oppression can take endlessly different forms, some more crude than others in their execution, some more draconian than others in their effect.

If there was an award for the crudest and most draconian case of shareholder oppression, Matter of Twin Bay Village, Inc., 2017 NY Slip Op 06024 [3d Dept Aug. 3, 2017], decided earlier this month by an upstate appellate panel, would be a serious contender.

The case involves a bitter dispute between two branches of the Chomiak family over a lakefront resort called Twin Bay Village located on beautiful Lake George in upstate New York. In 1957, the husband-and-wife founders, Stephan and Eleonora Chomiak, opened the summer resort on land they owned. They and their two sons, Leo and Vladimir, together ran the business until 1970 when they transferred ownership of the land and business to newly-formed Twin Bay Village, Inc. owned 26% by each parent and 24% by each son. Continue Reading And the Award For Most Oppressive Conduct By a Majority Shareholder Goes to . . .

The litigation in Manhattan Supreme Court between a privately-held company known as FaceCake Marketing Technologies, Inc. and minority stockholders Beryl Zyskind and Joel Gold has been plodding along for over three years, still with no resolution in sight thanks to two appellate decisions — including one handed down last week — reversing lower court orders.

Painful as it might be for the parties, there are some useful lessons for the rest of us concerning the drafting of investor agreements contemplating serial funding over a period of time in exchange for a combination of stock and company notes.

In September 2004, Zyskind and Gold each entered into an agreement with FaceCake to acquire an aggregate of $625,000 principal amount of 8% senior notes plus common stock. Each agreement called for an initial investment of $125,000 in exchange for notes and 337,500 shares, with ten subsequent, monthly investments of $50,000 each in exchange for additional notes and shares at a fixed ratio that, assuming full funding, would have given Zyskind and Gold an aggregate holding of 20% of the company’s common shares plus notes totaling $1.25 million. Continue Reading Appellate Court Cancels Corporation’s Cancellation of Minority Shares

Disclosure: The author represents the plaintiff and argued the appeal in the case discussed in this post.

Minority shareholder oppression takes many forms, the most common ones being termination of the minority shareholder’s employment, expulsion from the board of directors and payment of excessive compensation to the controlling shareholders.

Oppression also can take the form of stock dilution, as occurs in the absence of preemptive rights when the controlling shareholders authorize and issue new shares to themselves without providing minority shareholders the opportunity to maintain their percentage interest. The Xtenit case, in which the controlling shareholder authorized and granted himself new shares sufficient to dilute the minority shareholder from 15% to 1%, is one of the more notable examples of a court placing the burden on the controlling shareholder as fiduciary to demonstrate a bona fide business purpose for such unequal shareholder treatment.

This principle was reaffirmed in a recent decision by the Appellate Division, Second Department, in Armentano v. Paraco Gas Corp., 90 AD3d 683, 2011 NY Slip Op 09075 (2d Dept. Dec. 13, 2011), involving a dispute between the second generation shareholders of a family-owned propane distribution business. The decision in Paraco primarily turned on whether the bonusing of treasury shares to the controlling shareholders had a dilutive effect on the minority shareholder’s stock interest. The lower court held that it did not and dismissed the complaint. The appellate court unanimously reversed the lower court’s order, holding that the plaintiff’s complaint sufficiently alleged that the controlling shareholders breached fiduciary duty by granting themselves treasury shares without  legitimate business purpose and for the sole purpose of diluting the minority shareholders.

Continue Reading Minority Shareholder Wins Appeal Challenging Grant of “Bonus” Treasury Shares to Controlling Shareholders

You’re an attorney.  You’re approached by Mortimer who tells you that he recently formed a new business corporation with Archibald, and that they want to hire you to prepare a shareholders’ agreement.  You also learn that Mortimer is the 51% "money" partner while Archibald is the 49% operating partner.

You’ve prepared many a shareholders’ agreement, and you know that the interests of Mortimer as majority owner and Archibald as minority owner inherently are in conflict on diverse management and financial issues, not to mention restrictions on stock transfer and redemption.  Should you represent both Mortimer and Archibald, or only one of them?  The disparate financial wherewithal and contributions of the two partners only accentuates the conflict.  If you represent Mortimer alone, and Archibald has no attorney of his own, is that a problem?

The rules of professional ethics set forth standards and proscriptions governing the simultaneous representation of multiple clients with conflicting interests.  Under the right circumstances, with appropriate client counseling and disclosure, it may be ethically acceptable to represent both Mortimer and Archibald in the preparation of the shareholders’ agreement.  In all events, it is vitally important that the attorney identify and document exactly whom they’re representing — and whom they’re not representing — in these situations.  The lawyer who fails to do so is taking on risk of a subsequent lawsuit by a disappointed shareholder for malpractice or fiduciary breach.

Continue Reading The Importance of Identifying Your Client — And Who’s Not Your Client — When Preparing Shareholder Agreements

Baseball has the squeeze play.  Majority owners of closely held companies have the squeeze out.  It’s only fitting, then, that I refer to what happened in the recently decided case, Cooperstown Capital, LLC v. Patton, 60 AD3d 1251 (3d Dept 2009), involving a dispute between majority and minority owners of a baseball camp, as the “squeeze-out play.”

Martin and Brenda Patton owned land in upstate New York about 20 miles from the Baseball Hall of Fame in Cooperstown.  In 2004, they entered into agreements with Cooperstown Capital, LLC to build and operate a baseball camp and hotel on the Patton land.  The Pattons contributed the land to Abner Doubleday, LLC (“Abner”) in exchange for 35% membership interests in Abner and a second company formed to operate the baseball camp, called Cooperstown All Star Village, LLC (“CASV”).  Cooperstown Capital paid $400,000 and gave a $1 million promissory note for 35% interests in the two companies.  A third investor, Marco Lionetti, acquired the remaining 30% interests.

The $1 million promissory note was made payable to the Pattons, but the operating agreements designated the payments as operating expenses of the companies and treated Cooperstown Capital’s additional capital contributions as credits against the Patton note. 

Continue Reading Court Enjoins “Squeeze-Out” Capital Call by Controlling Members of LLC

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:

  1. 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. 
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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. 
  7. 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. 
  8. 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. 
  9. 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. 
  10. 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.

Squeeze-out of minority shareholders in close corporations can take many different forms.  One common technique is stock dilution.  The careful minority shareholder will insist, before investing capital or sweat equity, on a shareholders’ agreement that preserves his or her percentage by a combination of preemptive rights, super-majority approval requirements for changes in authorized and issued shares, and other protective devices.  Absent such bargained-for protection, however, is a minority shareholder’s stake at the mercy of the controlling faction?

The answer is a qualified "no", according to a recent decision by New York County Commercial Division Justice Herman Cahn in Dingle v. Xtenit, Inc., 20 Misc 3d 1123(A) (Sup Ct NY Co 2008), where the court elevated the controlling shareholder’s fiduciary duty over his reliance on statute and the business judgment rule in refusing to dismiss the minority shareholder’s wrongful dilution claim.

Continue Reading Controlling Shareholder’s Dilution of Minority Interest Requires Bona Fide Business Purpose