Summer Shorts: Stock Sale Under Duress and Other Recent Decisions of Interest
Temperatures in the 90's. Manhattan sidewalks sizzling. Judges on vacation. Lawyers under beach umbrellas squinting at their iPads. A perfect time to offer over-heated readers some short summaries of a few recent decisions of interest involving disputes between business co-owners.
First, we'll look at two trial court decisions in which the parties dispute the complainant's ownership interest in the subject business entities. In one, the court finds that the complainant sold his shares under duress but limited his remedy to damages. In the other, the court held that a prior Beth Din ruling governed ownership claims in subsequent civil litigation brought by one of the ex-spouses. The last case we'll look at is a split decision by an appellate panel concerning the authority to defend litigation brought against a deadlocked limited partnership.
Court Orders Money Damages in Lieu of Dissolution for Sale of Shares Under Duress
Ma v. J.C. Sake, Inc., 2011 NY Slip Op 50999(U) (Sup Ct Kings County June 3, 2011). The case involves a small restaurant in Coney Island that opened in 2007. The plaintiff, Ma, invested about $47,000 for what he thought was a one-third interest. Ma also was the cook and primary manager. About a year later Ma had a falling out with the other owners who threatened to kick him out if he didn't accede to their demands. The parties then agreed that Ma would leave upon a calculation of what was owed to him. After Ma rejected an offer of $47,000, the other owners locked Ma out of the restaurant, made a new offer of $35,000, and threatened to close the restaurant permanently and pay Ma nothing if he didn't accept the new offer. Shortly afterward Ma was paid $38,000 and signed a simple agreement acknowledging his sale of "all equity" in the corporation and stating that he would have no further involvement with the restaurant.
Ma, claiming that he was forced to sell his shares under economic duress, thereafter filed two lawsuits, the first seeking judicial dissolution of the corporation and the second asserting shareholder derivative claims for diversion of corporate assets. Brooklyn Commercial Division Justice Carolyn E. Demarest conducted a framed issue hearing to resolve the defendant owners' contention that Ma was not a shareholder by virtue of the sale and lacked standing to sue. Justice Demarest concluded that Ma had "capitulated" when faced with defendants' "unconscionable" threat to close the restaurant and leave Ma with nothing, and that such coercion "compelled" Ma to sell his shares for less than their value.
The court nonetheless refused to void the sale, finding that the parties had agreed to transfer Ma's shares to settle their irreconcilable differences, hence Ma lacked standing to obtain dissolution or to assert shareholder claims. Instead, Justice Demarest ruled, "the appropriate equitable remedy here is the voidance of the price and an award of money damages based upon an assessment of the value of plaintiff's shares" as of the date of the agreement to sell Ma's shares.
Beth Din Ruling Precludes Wife From Claiming LLC Membership Interest in Ex-Husband's Subsequent Lawsuit
Glatzer v. Webster, 32 Misc 3d 1202(A), 2011 NY Slip Op 51152(U) (Sup Ct Kings County June 23, 2011). In this case, also decided by Justice Demarest, Jay and Rose Glatzer were married in 1996 when they invested in several nursing homes operated by limited liability companies. The investments were held in the name of Rose's sister, Helen, as nominee. In 2005, Jay and Rose decided to get a civil and religious divorce, and entered into a contract of arbitration with the Beth Din which, in 2006, issued a ruling reflecting that Rose had "renounced and denied" having any partnership interest in the nursing homes. The civil court later confirmed the Beth Din's award. Meanwhile, in 2006, Jay sued his former sister-in-law Helen, Rose, and others, claiming that Helen had withheld distributions prior to his divorce from Rose and, after the divorce, repudiated Jay's ownership interest.
Jay moved for partial summary judgment declaring his ownership interest in one of the LLCs. Rose contested Jay's sole ownership of the interest. Jay argued that the Beth Din's ruling collaterally estopped Rose's assertion of ownership. Justice Demarest agreed, finding that "there was an identity of issue that was necessarily decided in the Beth Din's . . . decision regarding" the contested nursing home interests. Rose's position in the Beth Din, that the partnership interests were non-existent, "precludes her from taking an inconsistent position in this action." Justice Demarest also ruled that the doctrine of judicial estoppel barred Rose's ownership claim which was "manifestly at odds with her representation to the Beth Din denying and renouncing any such ownership." Under the doctrine, Justice Demarest added, "Rose cannot be permitted to simply change her position so as to frustrate plaintiff's recovery of interests where were proved before the Beth Din merely because her interests have changed."
Unanimity Requirement in General Partners' Stockholder Agreement Bars Defense of Foreclosure Action Against Limited Partnership
Crane, A.G. v. 206 West 41st Street Hotel Associates, L.P., 2011 NY Slip Op 05434 (1st Dept June 23, 2011). The case involves a failed hotel development project. The realty was owned by a limited partnership owned and controlled equally by two corporate partners. One of the partners lent the partnership the funds to acquire the realty in exchange for a note and leasehold mortgage. The partnership defaulted following which the lending partner brought a foreclosure action against the partnership. The lending partner moved for a default judgment after the partnership, because of the general partner's 50/50 deadlock, failed to answer the complaint. The other partner engaged counsel to apply to vacate the default and answer on the partnership's behalf, which the court granted. The lending partner appealed.
In a 3-2 decision, the Appellate Division, First Department, reversed the lower court and ordered the denial of the motion to vacate the default. The majority based its ruling on Section 2(c) of the stockholders' agreement of the corporate general partner, providing that "all action by the Stockholders shall require the unanimous approval of the Stockholders." The majority also found controlling the Court of Appeals' decision in Sterling Indus. v. Ball Bearing Pen Corp., 298 NY 483 (1949), which held that the presumption of actual implied authority was rebutted, or did not apply in the first instance, where the president of a corporation initiated a lawsuit notwithstanding that the corporation's board, by a deadlocked vote, had failed to authorize the litigation.
The two dissenting judges would have permitted the other partner to engage counsel to defend the foreclosure action based on other provisions in the stockholders' agreement which, they argued, gave its owner acting as president of the general partner "the power to act in his capacity as president without a resolution from the board of directors." The dissenters also reasoned that there were issues of fact whether the lending partner's refusal to allow a defense of the foreclosure action breached fiduciary duty owed the partnership.
Court Addresses Necessary Party, Res Judicata Issues in Shareholder Oppression Case Pitting Uncle Against Nephews
It's a Vlasic classic story of a second-generation family business dispute. Over four decades ago, the three Adelstein brothers started a pickle distribution business in Brooklyn. The brothers jointly made all business decisions including salary, hiring and firing of employees. In 1995, brothers Sydney and Jack brought their sons Steven and Larry, respectively, into the business.
In 2006, the business was incorporated as Finest Food Distributing Co. Sydney and Jack transferred their one-third stakes to their sons, leaving brother Joel co-owning the business with his two nephews. In 2007, Joel was sidelined by health problems leaving his nephews in charge of all operations. According to Joel, when he later returned to work, and after he turned down the nephews' buyout offer, they initiated a squeeze-out by excluding him from company decision-making and withholding distributions.
In February 2009, the nephews terminated Joel's employment prompting Joel to file a lawsuit against them for breach of contract, breach of fiduciary duty and unjust enrichment. In January 2010, Nassau County Commercial Division Justice Timothy S. Driscoll granted the nephews' motion to dismiss the complaint, holding that Joel's employment was terminable at will, that they owed him no fiduciary duty as an employee, and that his remaining claims of malfeasance must be brought derivatively on the corporation's behalf. Adelstein v. Finest Food Distributing Co. N.Y. Inc., 2010 NY Slip Op 30149(U) (Sup Ct Nassau County Jan. 13, 2010).
Two months later, Joel commenced a dissolution proceeding in Queens County under Section 1104-a of the Business Corporation Law alleging minority shareholder oppression. The nephews made a two-part motion to dismiss the petition on the grounds, first, that the nephews were "necessary parties" whom the petition failed to name as respondents and, second, that the dismissal of Joel's prior action barred the dissolution proceeding under principles of res judicata (claim preclusion) and collateral estoppel (issue preclusion).
The decision by Queens County Commercial Division Justice Orin R. Kitzes in Matter of Adelstein (Finest Food Distributing Co. N.Y. Inc.), 2010 NY Slip Op 31719(U) (Sup Ct Queens County June 15, 2010), rejected both of the nephews' contentions and ordered a hearing to resolve the disputed factual issues as to whether the nephews "have been guilty of oppressive action or whether the assets of the corporations are being wasted, looted or diverted."
Necessary Party
The necessary-party issue was easily resolved as a matter of law. BCL Article 11 contains no express requirement that the petition name as a respondent each of the corporation's shareholders. The statutory notice provisions are contained in BCL Section 1106, subsection (a) of which states that upon presentation of the petition, "the court shall make an order requiring the corporation and all persons interested in the corporation to show cause" why the corporation should not be dissolved. Section 1106(c) merely requires initial service of the papers "upon the state tax commission and the corporation and upon each person named in the petition." Justice Kitzes' decision also cites Matter of Finando, 226 AD2d 634 (2d Dept 1996), in which the appellate court rejected the argument made by an out-of-state shareholder that, because the petition did not name her as a respondent, the court lacked jurisdiction over a necessary party.
I have seen many petitions that name the other shareholders as respondents, and many that do not. At least in the case of a deadlock dissolution petition brought by a 50% shareholder under BCL Section 1104, it's my view that the better practice is to name the other 50% shareholder as a respondent, if nothing else, to deflect respondent's possible use of the corporation's funds for legal defense costs. The circumstances under which it may make more or less sense to name and serve other shareholders as respondents in shareholder oppression cases are too varied to generalize.
Res Judicata/Collateral Estoppel
The second prong of the nephews' dismissal application required the court to determine the extent to which, if any, Joel's dissolution petition improperly sought to relitigate claims and/or factual issues deemed determined or actually decided in the prior, dismissed lawsuit. This, in turn, required Justice Kitzes to examine the interplay between minority shareholder oppression and the at-will employment doctrine involved in the prior lawsuit.
The issue has generated a fair amount of case law over the years, starting most prominently with Ingle v. Glamore Motor Sales, Inc., 73 NY2d 183 (1989), where the court indicated that a minority shareholder, whose at-will status negated any claim for fiduciary breach arising from termination of employment, nonetheless could seek recourse for oppression under BCL Section 1104-a. (Read here my prior post discussing Ingle.) A more recent example, to the same effect, is Ambar v. Devington Technologies, Ltd., 2009 NY Slip Op 32373(U) (Sup Ct NY County Oct. 13, 2009), where the court refused to dismiss a petition for involuntary corporate dissolution brought by a minority shareholder whose employment was terminated by the controlling shareholders, notwithstanding at-will employment provisions in their shareholders' agreement. (Read here my post on Ambar.)
Justice Kitzes' ruling in Finest cites no case law but reflects the same underlying principle in rejecting the nephews' argument for dismissal of their uncle's petition based on the dismissal of his prior Nassau County action. Here's what he wrote:
The acts underlying the breach claims and the alleged oppressive acts that form the dissolution claim are substantially similar. However, the analysis of these acts is substantially different in an action regarding an employee’s claims and one regarding a shareholder. An employee’s rights and obligations toward his or her employer are substantially different than those a shareholder has toward a corporation in which ownership interests exist. This results in the law treating their relationships very differently in every issue that arises in their respective relationships. Accordingly, the Nassau Action which dealt with petitioner’s rights as an employee in no way decided the instant cause of action which involves petitioner’s rights as a one third owner of the corporation.
It's not unusual, when respondents move to dismiss an oppression petition, also to ask the court to extend the 90-day statutory window to elect to purchase the petitioner's shares for fair value under BCL Section 1118. In Finest, the nephews requested an additional 60 days from the date of the court's decision. Justice Kitzes granted the request but only for 30 days in accordance with the parties' stipulation made in advance of the decision.
Bankruptcy Court's Ruling Does Not Establish "Floor" Value in Subsequent Stock Appraisal Proceeding
When bankruptcy interrupts corporate dissolution proceedings, it usually means bad news for the petitioner. For instance, last year I wrote about a petition for corporate dissolution doomed by the petitioner's failure to disclose his stock interest in prior bankruptcy proceedings. A recent decision presents an interesting departure from the norm, involving a dissolution case commenced in 1990 that took a 10-year detour through bankruptcy court before returning to state court to resume a buyout proceeding. The case, Smith v. Russo, 2009 NY Slip Op 32785(U) (Sup Ct Queens County Nov. 13, 2009), raised the question whether the bankruptcy court's basis for rejecting as inadequate a buyout settlement proposed by the bankruptcy trustee should be given collateral estoppel effect -- for the benefit of the former bankrupt -- in the subsequent state court valuation proceeding.
Husband and wife Richard and Nelsi Smith were 27.5% shareholders of Meadow Mechanical Corporation formed in 1980. In 1990, the other shareholders removed Richard as president and barred both Smiths from the business premises, prompting the Smiths to sue for dissolution under Section 1104-a of the Business Corporation Law. The other shareholders then elected to purchase the Smiths' shares for fair value under BCL Section 1118.
The case fell into a six-year quagmire featuring an initially successful, contested revocation of the buyout election due to the bankruptcy of one of the purchasing shareholders, followed by a reversal on appeal. Then, in 1996, petitioner Richard Smith filed for bankruptcy. The dissolution proceeding and a separate action against Meadow on a $275,000 promissory note were the only assets of the debtor's estate. The trustee in bankruptcy asked the bankruptcy court to approve a $350,000 settlement for both matters, which Smith and the creditors opposed.
The bankruptcy court held an evidentiary hearing including testimony by accountants for the trustee and Smith, and by the accountant who prepared Meadow's financial statements. In its decision, the court approximated Smith's share of the company earnings to be $300,000 and, after applying an earnings multiplier and discount for lack of marketability, concluded that "the value of the Debtor's interest in Meadow would most likely increase to no less than $600,000." On that ground the court in 2003 entered an order denying the trustee's motion to approve the settlement, stating that the proposed settlement "does not adequately reflect the value of the Dissolution Action and the note owed to the Debtor's estate."
The trustee appealed to the federal district court which affirmed the bankruptcy court's ruling in 2005, following which the bankruptcy court authorized the trustee to abandon to the debtor the claims of the debtor against any party. In 2006 -- 16 years after the action started -- the state court restored the valuation proceeding to active status.
The Smiths then sought to leverage the bankruptcy court's order by moving for partial summary judgment in the valuation proceeding. Their motion asked the state court to rule on the basis of collateral estoppel that the minimum value of their Meadow shares was $600,000 for Richard's shares and a proportionate amount of $133,333 for Nelsi's shares. In other words, they wanted the court to set a $733,333 floor for the combined value of their shares, subject to their offering evidence at a later hearing of an even higher value.
For the uninitiated, collateral estoppel, also referred to as issue preclusion, is based upon the general notion that a party, or one in privity with a party, should not be permitted to relitigate an issue decided against it. The party seeking the benefit of collateral estoppel must prove (1) that the identical issue was necessarily decided in the prior action and is decisive in the present action, and (2) that the party to be precluded from relitigating an issue had a full and fair opportunity to contest the prior determination.
The decision by Queens County Supreme Court Justice Peter J. Kelly found that the Smiths satisfied neither of the two required elements. With respect to identity of issues, Justice Kelly stated that the issue before the bankruptcy court under federal bankruptcy law was whether the trustee's proposed settlement "fell below the lowest point in the range of reasonableness," whereas the issue in the state court valuation is "what is actually the proper full value of the plaintiff's shares in Meadow." Justice Kelly elaborated:
At most, as part of its inquiry into the reasonableness of the proposed settlement, the bankruptcy court resolved the issue of what was the minimum reasonable value of the plaintiff's shares in Meadow. This court need not resolve that issue in a dissolution proceeding, but rather must determine the actual, full value of the plaintiff's shares. . . . The figure arrived at by the bankruptcy judge as the minimum reasonable value of the plaintiff's shares was just an estimate. The bankruptcy judge expressly noted that her function was merely to "canvass" the issues in the underlying litigation, "not to decide the issues of fact and law " raised therein. The bankruptcy judge speculated about the weight this court would give to certain financial documents, and stated in a tentative manner: "For the sake of argument, this court would reduce the Debtor's interest in Meadow to $300,000." (Italics added.). The bankruptcy judge did not take evidence on the crucial matter of the "multiplier" to be applied to the $300,000 in estimated earnings, but merely picked a conservative number suggested by other cases.
On the second element, Justice Kelly found that the other Meadow shareholders did not have a full and fair opportunity to litigate the issue pertaining to the minimum value of Smith's interest in Meadow. "They were not parties to the bankruptcy proceeding," wrote Justice Kelly, "and the only parties to the motion for an order approving the proposed settlement were the trustee in bankruptcy, Smith, and creditors who opposed the proposed settlement." Nor were the other shareholders in privity with the trustee.
Justice Kelly's discomfort with the Smiths' application went further. The Smiths were trying to set a valuation floor from which the ultimate determination of value could only go higher. This approach, however, left open the possibility of a state court determination "inconsistent" with that of the bankruptcy court. As Justice Kelly further explained:
[Smith's] procedural maneuver does not advance the policies underlying the doctrine of collateral estoppel, one of which is the prevention of inconsistent decisions by different courts. This court may, for example, find a different multiplier, if any, to be appropriate, thereby drastically altering the value up or down to be placed on Smith's shares. Moreover, conservation of resources, the other policy consideration underlying the doctrine of collateral estoppel, will not be promoted in this case where the issue of valuation will have to be tried de novo. [Citations omitted.]
The decision mentions Smith's allegation that, in connection with his bankruptcy, the other shareholders initially offered $400,000 to the trustee and subsequently $350,000 for Smith's interest in Meadow. One can speculate that the other shareholders might have been able to conclude the case then and there had they formally intervened in support of the trustee's motion to approve the settlement, and had they offered a full-fledged, expert appraisal bolstering the fairness of the amount. At least from a collateral estoppel standpoint they would have been no worse off for trying based on Justice Kelly's analysis of the differing, substantive standards in the bankruptcy and state court valuation proceedings.
