Valuing Shares in a Residential Co-op Corporation: Is the Whole Worth More Than the Sum of its Parts?
The residential co-operative corporation is a strange breed of closely held business entity. In New York, the co-op is formed as a for-profit corporation under the Business Corporation Law (BCL), yet it doesn't operate for profit in the traditional sense of returning cash dividends to shareholders. Instead, ownership of co-op shares entitles the shareholder to occupancy of an apartment under an appurtenant long-term proprietary lease. The co-op's income derives mostly if not entirely from tenant-shareholder maintenance payments, the level of which is designed merely to cover the common charges for building expenses. The market value of the shares held by individual shareholders within the same co-op can vary greatly, not just due to the number of shares allocated to the particular apartment, but also due to the unique characteristics of the apartment.
One of the consequences of being a for-profit corporation is that co-ops in New York are subject to the same statutes governing voluntary and involuntary dissolution as any other closely held business corporation, including BCL Section 1104-a authorizing a petition for judicial dissolution by an "oppressed" minority shareholder holding at least 20% of the corporation's shares. At least in New York City, where co-ops tend to have many apartments, the shares usually are too widely dispersed for any single tenant-shareholder to own 20%. In addition, and with all due respect to noise and odor complaints, the idea of a co-op dweller being oppressed by her neighbors is a far cry from the usual freeze-out/squeeze-out scenarios involving loss of employment, removal from the board, financial abuse by the majority, and lack of a market exit.
The fact is, however, that New York City also has many smaller co-op buildings such as converted townhouses and brownstones featuring four or five apartments, each of which may be allocated 20% or more of the co-op's shares. And, New York City being a litigious kind of town when it comes to expensive real estate (think Trump), it's inevitable that an alienated tenant-shareholder in such a co-op would opt to bring a dissolution proceeding instead of exiting by selling her apartment on the open market. A rational shareholder presumably would do so only if she believes she'll get more value from a liquidation of the corporation's assets than from selling her apartment, i.e., that the value of the entire building is greater than the sum of its parts.
That appears to be the theory behind the dissolution petition by a 20% co-op tenant-shareholder named K.C. McDaniel in McDaniel v. 162 Columbia Heights Housing Corp., 2009 NY Slip Op 29390 (Sup Ct Kings County Sept. 29, 2009), recently decided by Kings County Commercial Division Justice Carolyn E. Demarest. The case involves a multi-faceted dispute between McDaniel and her fellow apartment owners of a five-unit co-op (pictured above) located on a beautiful street in Brooklyn Heights near the promenade facing the lower Manhattan skyline. Readers of this blog may recall my April 2009 post reporting on a prior ruling in the McDaniel case involving interpretation of the co-op's bylaws. The prior post noted that the non-petitioning shareholders had exercised their right under BCL Section 1118 to purchase McDaniel's shares for "fair value" and thereby avoid adjudication of the oppression claim. In the latest decision, Justice Demarest is presented with radically different valuation approaches in which, on the one side, McDaniel asks for her pro rata share of the building's value based on its "highest and best use" as a single family residence without regard to the legal impediments posed by the existing proprietary leases and, on the other side, the respondents ask that McDaniel be awarded the appraised value of her apartment.
[Note: If you read Justice Demarest's lengthy decision you'll see that most of it is taken up with a complex factual recitation and analysis relating to a companion lawsuit between the same parties in which McDaniel sued to recover almost $800,000 arising primarily from the defense and settlement of a prior litigation with a former tenant-shareholder. I'm not going to address this aspect of the case, other than to speculate that the existence of significant money claims may help to explain as a tactical matter McDaniel's decision to sue for dissolution rather than sell her apartment on the open market.]
In her prior ruling on the bylaws, Justice Demarest preordained that the fair value of McDaniel's interest will "largely depend on the appraisal value of the building at the valuation date, but will also include any other assets, such as bank accounts, less any liabilities such as debts of the Corporation." In her latest decision, she elaborated that "there is no profit in the operation of the Corporation, the only purpose of which is to provide housing for the five tenant shareholders" each of whom was allocated the same number of shares; that the only "return" on their investment is use of their apartment and the possibility of profit upon sale; that the share valuation "is logically the net asset value of the Corporation as a whole on the valuation date"; and that "[m]arket value is clearly implicated in this analysis as the value of the Corporation's primary asset, the Building,will depend upon appraisal of its value on the valuation date."
At the valuation hearing, each side presented expert testimony by a licensed real estate appraiser, neither of whom stayed within the confines of the court's valuation guidelines. McDaniel's expert concluded that the building was worth $5.6 million based on comparable building sales assuming a "gut renovation" of the building to achieve its "highest and best use" as a single family residence, i.e., unencumbered by the existing proprietary leases. The expert also commented that "the sum of the parts is worth less than the whole." Here's what Justice Demarest wrote in rejecting this approach as a measure of fair value:
Petitioner owns a twenty percent interest in a building which is subdivided into five dwelling units. The Corporation is encumbered in its use of the Building by proprietary leases granting occupancy well into the future. It is not reasonable or fair to suggest that the respondent shareholders should be forced to vacate their homes in order to sell the Building vacant so as to afford petitioner the maximum possible return on her investment. Given the nature of the Corporation as a residential co-operative, measuring the "fair value" of a single occupant's interest based upon the highest and best use of the entire structure is not appropriate. A more flexible standard is needed. . . . To mandate that an asset be sold in order to maximize value, so as to put the Corporation out of business, would be contrary to law.
The respondents' expert fared no better. Rather than valuing the building, he appraised McDaniel's apartment alone as of the valuation date, using comparable apartment sales to arrive at a value of $734,000 net of broker's commission and transfer taxes, which he further discounted to $550,000 for the "detrimental effect on marketability of the pending litigation." This methodology, however, ignored Justice Demarest's explicit direction to value the shares based on the market value of the building as a whole. In her own words:
This Court rejects respondents' attempt to establish the fair value of petitioner's shares based upon the market value of her apartment alone, as such measure fails to account for other assets and liabilities of the Corporation. Petitioner is the owner of 400 shares of the Corporation, the fair value of which must be ascertained upon the value of the Corporation as a whole on the valuation date.
Justice Demarest also rejected respondents' reliance on an appellate court precedent, Matter of Balk (125 West 92nd Street Corp.), 24 AD3d 194 (1st Dept 2006) (read here), which affirmed a trial court's valuation of a 30.75% stock interest in a four-apartment Manhattan co-op corporation (read here). In Balk, both sides submitted appraisals of the market value of the petitioner's apartment. "While most instructive," Justice Demarest remarked, " the case did not implicate competing standards of valuation."
The circumstances thus required Justice Demarest to arrive at her own valuation of McDaniel's shares, which she did by valuing the building as a whole at $4,250,000 based on the $850,000 sale one year earlier of another of the subject co-op's five apartments which also was allocated one-fifth of the corporation's shares. As a reality check, Justice Demarest relied on a comparable $8 million sale (which translated to $741 per square foot) of a nearby but larger apartment building "similarly burdened with tenancies that are not easily terminable." The $741 per square foot price translated to a value of $4,342,260 for the subject co-op's building. (I interpret the court's reference to "similarly burdened with tenancies" as meaning the comparable building was not a co-op but was occupied by rent stabilized or rent controlled tenancies. I've never heard of an occupied co-op building being sold.)
The court's final tally of the amount due McDaniel for her shares came to $839,760.68, computed as one-fifth of the corporation's value of $4,257,755 ($4,250,000 for the building plus cash deposits less liabilities) less deductions for unpaid maintenance charges of about $11,000. Justice Demarest refused to apply a discount for the pending litigation, as requested by respondents, although she did say that any effect the litigation had on value was offset by the general rise in market values between the 2006 sale of the other apartment for $850,000 and the valuation date in May 2007. Justice Demarest also rejected McDaniel's argument for a surcharge against the respondents for failing to make building repairs.
In case you're wondering about the mechanics of the buyout, the decision notes that McDaniel previously vacated the apartment which therefore was available to be immediately marketed for sale. Justice Demarest directed the parties to submit proposed terms of sale and ordered that, "barring a different agreement between the parties, it is expected that the Corporation will either obtain a mortgage on the Building in order to pay the full value of petitioner's shares or will attempt to sell the apartment in order to fund payment to petitioner." The court's order also mandates that the apartment's $1,000 per month maintenance charges pending the completion of the buyout be deducted from the amount due McDaniel, so, depending how long the process takes and what problems with a financing or sale are encountered, it wouldn't surprise me if these litigious former neighbors aren't done fighting.
The Importance of Identifying Your Client -- And Who's Not Your Client -- When Preparing Shareholder Agreements
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.
That's pretty much what happened in Schlissel v. Subramanian, 2009 NY Slip Op 52188(U) (Sup Ct Kings County Oct. 26, 2009), decided by Kings County Commercial Division Justice Carolyn E. Demarest. The plaintiff, Schlissel, and the defendant, Wasan, decided to buy a Dunkin' Donuts franchise in Brooklyn. Wasan, the money partner, was to own 75% and Schlissel the remaining 25% in consideration of past services and for helping Wasan legalize the franchise. In early 2002, Schlissel contacted attorney Van Epps to form a new corporation to acquire the franchise. Van Epps' initial engagement letter named Wasan as the client and made no mention of Schlissel. Some months after forming the corporation Van Epps also prepared bylaws, stock certificates and tax documents reflecting the 75%/25% ownership, which Schlissel and Wasan jointly executed. In this same time period Van Epps met with Schlissel on at least two occasions in connection with setting up the corporation.
In early 2003, Van Epps proposed to Wasan (but not to Schlissel) that Wasan capitalize the company with $725,000 of which about $90,000 would be loaned to Schlissel for her contribution while reducing her ownership to 12.5%. Wasan agreed. Van Epps prepared a shareholders' agreement, new stock certificate and promissory note, all dated "as of" February 1, 2003, reflecting Wasan and Schlissel as 87.5% and 12.5% shareholders, respectively. Van Epps sent the documents to Wasan with a note stating that he should
review this [shareholders'] agreement with Jeanne Schlissel and advise if any additional changes are required. As I mentioned in our meeting, Jeanne should hire an attorney to review this agreement and the note on her behalf.
Van Epps also prepared another engagement letter dated February 5, 2003 to be signed by Wasan as the client and by Schlissel as consenting to Van Epps' representation of Wasan. The letter stated:
I am pleased to represent you in connection with the preparation of a shareholders agreement for Tim & Tab Donuts, Inc.
[After stating the terms of the engagement, the letter continued:] If you agree with the foregoing terms, please indicate by signing below and returning a copy of this letter to me at the above address. Please ask Jeanne Schlissel to sign below indicating her approval of my representation of you.
Immediately above the signature line reserved for Schlissel, the letter stated:
With my signature below, I hereby consent to your representation of [Wasan] in connection with the preparation of a Shareholders Agreement for Tim & Tab Donuts, Inc. and other matters when and as requested by him.
Schlissel and Van Epps disputed the timing of these events. According to Schlissel's complaint, Wasan brought the corporate documents to her home on February 1, 2003, where she signed them. Schlissel contended that she signed the corporate documents "without having the opportunity to discuss them with Van Epps" because she believed that
as my attorney Mr. Van Epps was protecting my interests. At no point prior to my execution of the [corporate documents], did Mr. Van Epps communicate with me in any manner concerning these documents, in no way did he suggest that any material change in the corporation was occurring, nor did he remotely hint that a notable change effecting [sic] me was in view.
Several days later, she further alleged, she received the February 5 engagement letter and also got a "curt" phone call from Van Epps telling her that he no longer represented her and that this was "in her best interests".
Van Epps contended that Schlissel signed the corporate documents after she signed the February 5 engagement letter, and he denied having the telephone conversation.
Approximately five years later -- apparently, Schlissel's annual K-1 tax forms until 2008 continued to show her with a 25% interest -- Schlissel sued Wasan and Van Epps, among other claims, for breach of fiduciary duty in connection with the dilution of her stock interest from 25% to 12.5%. As summarized by Justice Demarest, Schlissel asserted that Van Epps "unilaterally advanced Wasan's interests over those of plaintiff, that he prepared certain corporate documents for the purpose of diluting and diminishing plaintiff's interest in [the company], and that he concealed material information from plaintiff concerning the adverse contents of these documents."
Van Epps moved to dismiss the claim, arguing that he was not Schlissel's attorney and therefore owed her no fiduciary duty. He pointed to the initial 2002 engagement letter which stated that Wasan was his client and, by implication, that he was not representing Schlissel. Justice Demarest observed that "[t]here is no set of rigid rules that must be followed to form an attorney-client relationship" which "may exist without an explicit retainer agreement or payment of fee." Rather, the "court must look to the actions of the parties to ascertain the existence of such a relationship . . . bearing in mind that plaintiff's unilateral belief does not confer upon her the status of defendant's client."
Applying this standard, and assuming the truth of Schlissel's allegations for purposes of a motion to dismiss, Justice Demarest found that Schlissel "had reason to believe" Van Epps was her attorney based on the fact that she was the one who first sought him out, her multiple meetings with Van Epps in 2002, and Van Epps' preparation of the initial corporate and tax documents signed by Wasan and Schlissel in April and May 2002.
Van Epps alternatively argued that any attorney-client relationship he had with Schlissel terminated when she counter-signed her consent on the February 5, 2003 engagement letter with Wasan. Justice Demarest disagreed, for two reasons. First, Van Epps' allegation, that Schlissel signed the shareholders' agreement and related documents after expressly consenting to his retention by Wasan, was contradicted by Schlissel's affidavit, and thus raised an issue of fact not resolvable on a motion to dismiss.
Second, under Rule 1.9 of the Rules of Professional Conduct, Van Epps was required to get Schlissel's "informed consent, confirmed in writing," before he could terminate any pre-existing attorney-client relationship with Schlissel while continuing to represent Wasan's interests adverse to Schlissel. According to Justice Demarest,
[t]he cursory "consent" signed by [Schlissel] does not evidence the requisite informed consent to overcome the edict of the Rule. There is no claim that Van Epps met with [Schlissel] or specifically advised her of the conflict of interest implicated in the proposed representation of Wasan alone.
Justice Demarest accordingly denied Van Epps' dismissal motion, finding that Schlissel's complaint "sufficiently alleges that Van Epps represented conflicting interests at the time [Schlissel] signed the corporate documents" and damages resulting from "alleged misconduct by [Van Epps] by his alleged simultaneous representation of adverse interests." Justice Demarest also was careful to note that the "court makes no determination concerning the merits of [Schlissel's] claims, as the motion to dismiss was addressed solely to the sufficiency of her pleadings and affidavits."
New York's highest court, in Matter of Kelly v. Greason, 23 NY2d 368, 375 (1968), opined that an attorney-fiduciary "is charged with a high degree of undivided loyalty to his client." In an earlier decision by Justice Demarest, which she cites in Schlissel, she expanded on that principle in the conflicts setting as follows:
An attorney has a fiduciary obligation to bring to his or her client's attention all relevant considerations when recommending a course of conduct. An attorney who fails to disclose a conflicting representation or circumstance that causes him or her to represent a client with diminished rigor, breaches his or her fiduciary duty to his or her client. (Macnish-Lenox, LLC v. Simpson, 17 Misc 3d 1118 [A], 2007 WL 3086028, *7, 2007 NY Slip Op 52055 [U] [Sup Ct Kings County 2007])
It is not at all unusual for business partners to prefer using a single attorney to set up a new business entity and prepare owner agreements. The level of trust between the partners typically is high at the outset, and the cost of multiple attorneys may be prohibitive. The partners also may be unaware of the conflicting interests involved in putting together a shareholders' agreement. Schlissel is a strong reminder to attorneys who take on such assignment, as the only attorney on the scene, that they should explicitly and unambiguously document who it is they do and don't represent, that if they do undertake joint representation they should carefully explain the potential conflicts and make a record of the same, and that they should obtain the written acknowledgment of any non-represented owner before they undertake legal services that, absent such acknowledgment, could reasonably be perceived as acting on behalf of all.
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.
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.
The court's decision, written by Justice Carolyn E. Demarest of Kings County Supreme Court's Commercial Division, sustains both of Boussi's defenses based on the omission from the bankruptcy petition, and consequently dismisses the case.
Under Section 541 of the Bankruptcy Code, all property that a debtor owns or subsequently acquires, including a cause of action, vests in the bankruptcy estate upon the filing of a voluntary petition. As Justice Demarest explains,
"title to the debtor's property will remain in the bankruptcy estate unless the property is listed in the schedule of assets filed with the [bankruptcy] court or otherwise deemed abandoned" [and] "a debtor's failure to list a legal claim as an asset in his or her bankruptcy proceeding causes the claim to remain the property of the bankruptcy estate and precludes the debtor from pursuing the claim on his or her own behalf".
Thus, under principles of federal bankruptcy law, even if it were true that plaintiff had a shareholder interest in 10-18, Inc., upon the filing of the bankruptcy petition, that alleged interest, if it existed, became the property of the bankruptcy estate. As a result of plaintiff's failure to list his alleged shareholder interest, that alleged asset did not revert back to plaintiff upon the conclusion of his bankruptcy case. Consequently, plaintiff now lacks legal capacity to assert claims based upon his alleged interest in 10-18, Inc. [Citations omitted]
Light argued that his failure to list the corporation in his bankruptcy petition was "inadvertent" and had no affect on his ownership interest. Justice Demarest calls this contention "devoid of merit" and finds it immaterial to Light's loss of legal capacity to sue mandated by the substantive bankruptcy law.
The court's decision also sustains Boussi's defense based on the state law doctrine of judicial estoppel, which prevents a party who asserts a factual position in one legal proceeding from taking an inconsistent position in subsequent litigation. On that point Justice Demarest writes:
Under the doctrine of judicial estoppel, a discharged debtor who fails to list an asset in his or her prior bankruptcy proceeding is precluded from asserting claims based on ownership of that asset (see e.g. Madden v Corey, 251 AD2d 257, 258 [1998]; Manhattan Ave. Dev. Corp. v Meit, 224 AD2d 191, 192 [1996]; Cafferty v Thompson, 223 AD2d 99, 102 [1996]). Thus, inasmuch as plaintiff failed to disclose any alleged shareholder interest in 10-18, Inc. in his bankruptcy petition or at any time during his bankruptcy proceeding, he is precluded, under the doctrine of judicial estoppel, from asserting the claims herein based upon an alleged ownership of an interest in 10-18, Inc.
I've seen this issue arise once before in the dissolution context, in another Kings County Supreme Court decision from 2002 in Matter of Kessler (Steven Kessler Motor Cars, Inc.). The record before the court did not show whether the petitioner's bankruptcy petition reflected his previously commenced dissolution proceeding, so the court ordered the petitioner to submit a copy of his debtor schedule of assets filed with the bankruptcy court along with a copy of the bankruptcy trustee's final report. What also made Kessler interesting was that prior to the bankruptcy, the respondent shareholder in the dissolution proceeding had elected to purchase the petitioner's stock interest in 1997, but the petitioner waited until 2002 to prosecute the valuation proceeding, during which time he filed for bankruptcy and obtained a discharge in 2000.
It's difficult to fathom how someone can file a bankruptcy petition, not disclose in their schedule of assets a stock interest or a pending dissolution proceeding, obtain discharge, and still expect to pursue a dissolution or valuation. Then again, that may explain why there are so few cases like Light and Kessler.
