Court in Hellman Case Re-Affirms Close Corporation President's Authority to Sign Lease Without Board Approval
The tortuous, five-year legal battle between the Hellman brothers, Bruce and Glenn, over control of their jointly owned electric supply business came to its dénouement earlier this year when Monroe County Commercial Division Justice Kenneth R. Fisher, after conducting a trial ordered by the Appellate Division, re-affirmed his prior decision upholding Bruce's authority as president to enter into a new lease relocating the business over Glenn's objection and without getting pre-approval by the company's board consisting of the two brothers. Hellman v. Hellman, 2010 NY Slip Op 20443 (Sup Ct Monroe County Feb. 11, 2010).
The focus of the fraternal fracas is Maynards Electric Supply, Inc., a Rochester-based wholesale distributor of electrical supplies founded in the 1950s by the brothers' father, the late Maynard Hellman, who retired in the 1980s whereupon Bruce became the company's President and Glenn its Vice-President. The brothers also subsequently became the company's sole, 50-50 shareholders and directors. The litigation ignited in 2005 shortly after Maynard's death, when Bruce, over his brother Glenn's objection and without board approval, signed a lease with a third-party landlord to relocate the business out of a building co-owned by the Hellman family siblings.
Bruce won the first round of litigation in a March 2008 summary judgment decision about which I reported here. In that decision, Justice Fisher dismissed Glenn's claims that Bruce lacked authority to enter into the lease on behalf of the company without prior board approval and that the third-party lease constituted corporate waste. In upholding Bruce's "presumptive implied authority to execute the lease . . . without pre-approval from the board of directors, and even when he knew that Glenn Hellman would object at a duly convened board meeting if one were scheduled," Justice Fisher relied on:
- the absence in the by-laws of any restrictions on the president's authority to manage the business;
- the prior history of the company's two, successive presidents, Maynard and Bruce, entering into leases and making other major decisions without board pre-approval; and
- Glenn's failure to make any effort to convene a meeting of the board of directors for the purpose of restricting Bruce's authority as president to enter into the lease.
As to the corporate waste claim, Justice Fisher held that the business judgment rule immunized from judicial scrutiny Bruce's decision to enter into the lease.
Round two went to Glenn. In a May 2009 decision on his appeal, the Appellate Division, Fourth Department, reversed the summary judgment and reinstated Glenn's complaint, finding that Glenn had raised a triable issue of fact based on evidence "that the previous leases signed by [Bruce] were the subject of Board resolutions granting [Bruce] the authority to sign them, or they were signed by [Bruce] 'by authority of the Board of Directors of [the] corporation.'"
The third and final round was won by Bruce following a bench trial at which, as Justice Fisher summarized in his written decision,
[Glenn] failed to carry his burden of presenting preponderant proof that the past practices of the corporation circumscribed Bruce Hellman's presumptive power to bind the corporation to the [third-party] lease. Nor did [Glenn] adduce preponderant proof that past practices revealed that the president did not have in practice, at least with respect to leases of this kind for corporate business, what otherwise would be described as the full measure of presidential power conferred on him by the by-laws and existing case law.
The scope of officer authority to act without board approval is a difficult and recurrent issue in litigation involving close corporations whose principals generally ignore corporate formalities until after disputes arise. Justice Fisher's scholarly review of the guiding principles and case authorities is must reading for attorneys who practice in this area of the law. Following are some of the most important observations made by Justice Fisher:
- Absent express limitations in the by-laws, past practices can circumscribe the president's otherwise presumptive power to engage in transactions in the ordinary course of business only if (1) the practice "was developed by the corporate actors as a means of curtailing the president's presumptive power," or (2) the practice "was established by the corporate actors for the purpose of making clear that the president had no such actual, implied power" to engage in such transactions in the first place.
- Both under Maynard's and later Bruce's stewardship as president, the several instances in which board minutes were prepared approving real estate development and leasing transactions did not evidence an intent to limit the president's powers but, rather, were done "to satisfy Maynard's fastidious desire to paper transactions after the fact with corporate board minutes" or for the benefit of outside lenders "which demanded [they] be covered by board resolutions complying with the [Business Corporation Law]."
- "In other words," Justice Fisher explained, "the mere existence of board resolutions supporting the prior leases may as the Appellate Division held create a question of fact whether past practice circumscribed the inherent authority of the president, but they would only carry plaintiff's burden at trial on the ultimate issue if they were shown to have intended to circumscribe the president's otherwise inherent authority."
- Glenn's inability under the by-laws to call a board meeting is not material because "he made no effort to convene the board and did not learn of his powerlessness to do so until litigation was well underway." Glenn also made no effort to dissolve the corporation on grounds of deadlock or breach of fiduciary duty. Justice Fisher also cites case precedent holding that the president's anticipation of board deadlock on a particular matter, and his consequent deliberate failure to call a board meeting, does not limit the president's otherwise presumptive power to act.
- Justice Fisher draws a sharp distinction between rulings by New York's highest court in Sterling Industries, Inc. v. Ball, 298 NY 483 (1949), where the court invalidated officer action following a board meeting at which the board did not authorize the specific action as a result of a deadlocked vote, versus Rothman & Schneider v. Beckerman, 2 NY2d 493 (1957), where the court upheld the disputed officer action in the absence of any formal board consideration. Justice Fisher likens the circumstances in Hellman to Rothman and rejects Glenn's reliance on Sterling.
Justice Fisher lastly revisits and readily disposes of Glenn's claim of corporate waste, finding that Bruce's decision to relocate "was reasonable given the economic realities" of the two competing sites, "was made in good faith despite his short-lived plan to compete with Maynards," and is "protected by the business judgment rule for the reasons stated in the court's earlier Decision and Order."
Hellman is a classic example of the turmoil that can and often does result when the founder of a family business fails to design and implement a plan of succession that addresses the predictable personality tensions and conflicts of interest among the second generation manager-owners. A carefully considered, well drafted shareholders agreement may not guarantee perpetual family harmony, but it certainly can reduce substantially the potential for a damaging and expensive courtroom battle.
Update January 3, 2010: In a decision handed down on December 30, 2010 (2010 NY Slip Op 09813), the Appellate Division, Fourth Department, rejected Glenn's appeal and summarily affirmed Justice Fisher's ruling discussed in this post.
Pay Attention to the Latent Power of Corporate Bylaws
The lead-up to business divorce litigation is a tense pas de deux in which, once the dispute reaches critical mass, the two sides "lawyer up" and begin tactical maneuvers to best position themselves for the coming court battle. Sometimes the maneuvering consists of a series of back-and-forth letters between the lawyers staking out their positions and attacking the other's. Especially when one faction owns a controlling interest in the company, the maneuvering also may include formal meetings of the shareholders or the corporation's board of directors (or members/managers in the case of an LLC) to authorize actions adverse to the non-controlling faction.
Never mind that the owners never once held a formal meeting or kept minutes or adopted written resolutions since the day the corporation was formed. Never mind that the corporate kit, containing the organizational documents, stock ledger and certificates, has been sitting untouched, gathering dust since day one.
Among the likely neglected documents in the corporate kit are the corporation's bylaws. Bylaws are to be distinguished from the shareholders' agreement. The latter typically sets forth the stock interests of the individual shareholders, designates directors and officers, and contains restrictions on the transfer of shares, among other provisions. In contrast, think of bylaws as the corporation's operating system, consisting of internal rules not specific to any named individuals, governing such matters as quorum and notice requirements for meetings of the shareholders and board of directors; procedures for the election and replacement of directors; the number and term of directors; and the titles and duties of the corporation's officers. Section 601 of the Business Corporation Law mandates the adoption of bylaws by the incorporators at the initial organization meeting required under BCL Section 404.
I can't say whether all the parties and counsel in Matter of McDaniel (162 Columbia Heights Housing Corp.), 23 Misc 3d 784, 2009 NY Slip Op 29047 (Sup Ct Kings County 2009), were cognizant of the bylaws as they maneuvered prior to commencement of dissolution proceedings. I can say that the bylaws played a dispositive role in the court's determination of their preliminary dispute over a certain stock transfer involving shares of a residential co-operative corporation.
McDaniel involves a 5-unit co-op occupying a landmarked brownstone building in Brooklyn. In May 2004, one of the units was vacated as part of a settlement with a former shareholder. A dispute arose among the remaining shareholders regarding the disposition of the vacant unit and its appurtenant shares which petitioner McDaniel contended were owned by her and the others believed were owned by the corporation. In June 2005, McDaniel resigned her positions as president and as one of the board's two directors.
McDaniel apparently hoped that by resigning as director she effectively would disable the corporation, now with a one-member board, from taking any action contrary to her claimed ownership of the disputed unit. In August 2005, the other shareholders gave written notice of a shareholders meeting the following month to elect a new board of directors. McDaniel's attorney appeared at the meeting with his client's proxy. A vote was taken to place the disputed unit on the market for sale, to which all parties, except McDaniel through her attorney, agreed. A process server then interrupted the meeting to serve a complaint by McDaniel to recover certain monies owed her by the corporation. The shareholders meeting was adjourned to October 2005 on which date the other shareholders -- McDaniel did not attend personally or by proxy -- elected two of their number as directors. At subsequent directors meetings the board approved the sale of the disputed unit to an outside buyer for $850,000. The sale was completed in May 2006.
A year later, in May 2007, McDaniel petitioned for judicial dissolution of the corporation under the oppressed minority shareholder statute, BCL Section 1104-a. The corporation elected to purchase McDaniel's shares for fair value under BCL Section 1118. This set the stage for the initial skirmish over the interest to be valued, i.e., 25% as claimed by McDaniel versus 20% as claimed by the remaining shareholders, with the outcome dependent on the validity of the two-member board elected in October 2005.
The decision by Kings County Commercial Division Justice Carolyn Demarest hinges primarily on the corporation's bylaws, starting with Article III, Section 4 stating as follows:
Newly created directorships resulting from an increase in the number of directors and vacancies occurring in the board for any reason except the removal of directors without cause may be filled by vote of the board. If the number of the directors then in office is less than a quorum, such newly created directorships and vacancies may be filled by vote of a majority of the directors then in office . . . .
McDaniel argued that the remaining director could not alone constitute a "majority" with the power to appoint an interim replacement director. Justice Demarest disagreed, calling such analysis "illogical" since "any decision taken by the only authorized director would necessarily be unanimous and thus exceed the required 'majority.''' McDaniel's argument also would contradict the clear intent of the bylaws "to provide a mechanism to overcome the paralysis arising from the lack of sufficient directors to act on behalf of the Corporation." Justice Demarest further noted that "petitioner deliberately resigned knowing that her absence would impede the functioning of the board."
McDaniel next contended that under Article II of the bylaws and BCL Section 605, all actions taken by the corporation following her resignation were void based on the failure to give written notice of the October 2005 meeting at which the new board was elected. Justice Demarest again disagreed, holding that both the bylaw and statute permitted the adjournment of the properly-noticed September 2005 meeting without further written notice. Not only did McDaniel receive written notice of the September 2005 meeting, her attorney attended the meeting and was present when it was adjourned to October after his process server showed up. Justice Demarest also found that McDaniel waived any objection to defective notice based on Article II, Section 3 of the bylaws stating as follows:
The notice [of shareholder meetings] provided for in the two foregoing sections is not indispensable but any shareholders' meeting whatever shall be valid for all purposes if all the outstanding shares of the Corporation are represented thereat in person or by proxy . . ..
The bylaws also contradicted McDaniel's argument that authorization for the contract of sale of the disputed unit required a shareholders' meeting and vote. "A perusal of the By-Laws for the Corporation indicates that such authority is vested in the Corporation's Board of Directors," wrote Justice Demarest.
McDaniel also argued unsuccessfully that, even assuming a properly constituted board, she nonetheless held a 25% interest because the shares appurtenant to the disputed unit were cancelled upon reacquisition by the corporation at the time of the 2004 settlement with the former shareholder. Citing BCL Section 515 governing reacquired shares, Justice Demarest found that the disputed shares were not cancelled but were retained as treasury shares and were subsequently sold for fair consideration.
The court accordingly determined that McDaniel is entitled to receive only 20% "of the fair value of the assets of the Corporation, including the market value of the building . . . and any other Corporate assets, less the Corporation's liabilities." The case appears to have gone to trial last month; I'll be sure to report on any written decision on valuation.
