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.
Judicial Estoppel + Dead-Man's Statute = No Standing to Seek Judicial Dissolution of Close Corporation
The purported co-owner of an ice skating rink, who petitioned to dissolve the business claiming he was frozen out by his fellow shareholder, got a cold reception from a judge who dismissed the case for lack of standing primarily based on a prior bankruptcy reorganization plan that did not identify the petitioner as a shareholder. The decision earlier this month in Matter of Gleich (Iceland, Inc.), Short Form Order, Index No. 19767/10 (Sup. Ct. Nassau County Apr. 6, 2011), issued by Nassau County Acting Supreme Court Justice Thomas A. Adams, also invoked the evidentiary rule known as the Dead-Man's Statute in rejecting the petitioner's testimony concerning an alleged oral stock conveyance agreement by a deceased shareholder.
The corporation known as Iceland, Inc. was formed in 1991 to operate an ice skating rink in New Hyde Park on Long Island. At inception the shares were owned 47% by Jacqueline Haenel, 3% by petitioner Stephan Gleich, and the remaining 50% by two others. Gleich, an attorney, previously represented Mrs. Haenel's husband in business matters and they became social friends as well.
The rink's business floundered leading to a Chapter 11 bankruptcy filing in 1994. It was uncontested that Gleich performed considerable legal work for the company. Gleich claimed he did so as an "employee" of the company while Mr. Haenel characterized his role as Iceland's "counsel" even though his retention was never approved by the bankruptcy trustee.
Gleich contended that, as consideration for his legal services which the Haenel's could not otherwise afford, and for his contribution of half the $30,000 necessary to effectuate Iceland's reorganization plus future legal fees, it was agreed among them that Gleich and Mr. Haenel would own Iceland 50/50 if they succeeded in saving the business.
The bankruptcy judge approved a reorganization plan on December 21, 1995, in which Mr. and Mrs. Haenel were identified as sole shareholders upon reorganization holding 19% and 81% interests, respectively. Gleich alleged that Mr. Haenel orally agreed that he and/or his wife would hold Gleich's 50% interest in their names until such time as Gleich "would request issuance of the stock" to Gleich or his nominee. Gleich also alleged that Mr. Haenel was understood to be the "real" owner of Iceland and that Mrs. Haenel was given a majority interest solely for "liability" purposes.
Justice Adams' decision does not recite any facts concerning what happened over the next 13 years after the reorganization. Presumably the stock ownership did not change in that period. The story picks up in late 2008, when Gleich allegedly received a $10,000 profit distribution shortly before Mr. Haenel allegedly "locked him out of Iceland's management and control." Mr. Haenel claimed the December 2008 payment to Gleich and prior payments to him were repayment of loan.
Mrs. Haenel died in July 2009, leaving her shares to Mr. Haenel who thereupon claimed 100% ownership of Iceland. In December 2009, Gleich sent Mr. Haenel a proposed memorandum of agreement formalizing Gleich's 50% stock interest, which Mr. Haenel rejected in March 2010. Gleich subsequently filed a petition for involuntary dissolution of Iceland based on deadlock under Section 1104 of the Business Corporation Law, claiming to be the beneficial owner of a 50% stock interest. Mr. Haenel moved to dismiss the petition alleging that Gleich was not a shareholder and therefore had no standing to seek dissolution.
Justice Adams' ruling grants the motion and dismisses the petition, writing as follows (citations omitted):
Here, the December 21, 1995 Second Amended Plan of Reorganization identifying Mr. and Mrs. Haenel as Iceland's sole shareholders is sufficient to establish the respondents' prima facie entitlement to dismissal of the petition on the ground that the petitioner lacks standing. Even liberally construing the facts in his favor and according the petitioner every favorable inference, he has failed to create a triable issue of fact warranting disclosure. More specifically, in addition to the restriction imposed by CPLR 4519 (i.e., the Dead Man's statute) following Mrs. Haenel's July 11, 2009 passing, the alleged oral agreement (which is reportedly to have been consummated on December 13, 1995 when the petitioner allegedly invested, rather than loaned, $15,000 to Mr. and Mrs. Haenel), is in direct contravention of the subsequent December 21, 1995 Second Amended Plan of Reorganization approved by the Bankruptcy Court and therefore unenforceable.
Let's take a closer look at the two grounds for dismissal mentioned by Justice Adams. The court's reliance on the plan of reorganization implicitly invokes the doctrine of judicial estoppel which, in general, prevents a party who asserts a factual position in one legal proceeding from taking an inconsistent position in subsequent litigation. In a previous post (read here) I wrote about the dismissal of a dissolution petition brought by a purported shareholder who failed to list his stock interest in the schedule of assets included with his prior personal bankruptcy filing. Gleich differs in that the petitioner was not the bankrupt debtor (although he was a 3% shareholder of record when Iceland's bankruptcy petition was filed and presumably received legal notice of the proceedings), but the judicial estoppel doctrine does not require strict identity of the parties (see, e.g., All Terrain Properties, Inc. v. Hoy, 265 AD2d 87 [1st Dept 2000]). According to his own testimony, Gleich knowingly sought the benefit of the proposed reorganization plan and entered into an agreement with the Haenels shortly before its approval which necessarily contemplated ownership of the company's shares following reorganization in a manner contrary to the disclosure statements made in the plan adopted by the bankruptcy court.
The other ground mentioned by Justice Adams is the Dead-Man’s Statute (CPLR 4519), which makes testimony by an interested witness “concerning a personal transaction or communication between the witness and [a] deceased person or mentally ill person” excludable “[u]pon the trial of an action or the hearing upon the merits of a special proceeding.” Under the rule, as applied by Justice Adams, the court may not consider as competent evidence Gleich's testimony concerning the December 1995 oral agreement he made with the Haenels concerning his stock ownership insofar as Gleich alleges that Mrs. Haenel, who died in 2009 before the litigation commenced, agreed to convey to Gleich shares placed in her name.
John D. Rockefeller had a wise saying, "A friendship founded on business is a good deal better than a business founded on friendship." Perhaps that's the ultimate lesson of the Gleich case.
Update July 2, 2011: By Order dated June 21, 2011, Justice Adams denied Gleich's motion to reargue the court's April 6 decision.
Judicial Estoppel Doctrine Defeats Ex-Convict's Standing to Bring Shareholder Derivative Action Based on Failure to Disclose Alleged Stock Interest to Probation Authorities at Time of Sentencing
The doctrine of judicial estoppel in general prevents a party who asserts a factual position in one legal proceeding from taking an inconsistent position in subsequent litigation. Judicial estoppel occasionally comes into play in shareholder disputes when the complaining party's status as a shareholder, and thus his or her standing to sue, is challenged based on the failure to disclose the stock interest in prior legal proceedings.
For example, last year I wrote about a case called Light v. Boussi in which the court dismissed a corporate dissolution proceeding brought by a putative 50% shareholder due to his failure to list the shares as an asset in his prior bankruptcy proceeding. A recent decision by Suffolk County Commercial Division Justice Emily Pines provides another example, this time involving a shareholder's derivative action in which the plaintiff failed to disclose his alleged stock interest at the time of his sentencing in prior criminal proceedings. Watkins v. J C Land Development, Ltd., Short Form Order, Index No. 30679-08 (Sup Ct Suffolk County June 19, 2009).
The plaintiff, William "Chip" Watkins, filed a shareholder's derivative action in 2007 alleging that he owned a 50% stock interest in a real estate company called J C Land Development, Ltd. ("JCLD") formed on March 25, 1999. Watkins alleged that he invested $600,000 in JCLD including $130,000 in start-up cash. Watkins claimed that the other 50% shareholder, John Cenci, and another co-defendant as "agent" subsequently diverted ownership of JCLD's real properties by placing title in their own names for "no adequate consideration". The suit asked to set aside the allegedly improper transactions and to have the title to the real properties transferred to the corporation.
Cenci's answer to the complaint asserted that he was the sole shareholder of JCLD. He also counterclaimed against Watkins for $600,000 allegedly owing on the sale of a property developed by JCLD and sold to Watkins.
Watkins, however, had a bigger problem. The same year he and Cenci allegedly formed JCLD, Watkins pleaded guilty to federal narcotics charges. At the time of his guilty plea on March 5, 1999 -- only 20 days before the formation of JCLD -- SDNY District Judge Rakoff stated that "no fine will be imposed because the Court made a finding that, in his present circumstances and in the foreseeable future, [Watkins] will not be able to pay any material fine."
Based on the discrepancy between that statement and Watkins' allegations in his derivative action, Cenci applied to Judge Rakoff for disclosure of Watkins' sealed Presentence Report ("PSR"). Over Watkins' opposition, Judge Rakoff ordered partial disclosure of the PSR which reflected Watkins' omission of any disclosure to the Probation Department of his alleged, contemporaneous interest in JCLD. Here's what Judge Rakoff said in his June 2009 order, as quoted in Justice Pines' decision:
Throughout all proceedings before this Court, [Watkins] was represented by court-appointed counsel, based on his representations to the Court that he was financially unable to employ counsel himself. . . . In the New York action and dissolution [sic] proceeding, however, [Watkins] alleges that on or about March 25, 1999, i.e., twenty days after [Watkins] pleaded guilty before this Court, he and [Cenci] formed a real estate development company, and that, beginning a month after being incarcerated, [Watkins] invested approximately $600,000 in that corporation. . . . After pleading guilty, [Watkins] provided certain information to the probation department concerning his finances for use in his PSR. At [Watkins'] sentencing hearing, the Court adopted the factual findings of the PSR, . . . and, as noted, declined to impose any fine based on its determination concerning [Watkins'] inability to pay.
Justice Pines' decision also notes that, under the applicable Sentencing Guidelines, the federal court was required to impose a fine unless the defendant establishes both his inability to pay and the likelihood that such inability will continue.
Cenci argued that the statements made by Watkins and relied upon by Judge Rakoff at his sentencing judicially estopped Watkins from asserting his stock ownership in JCLD in the state court derivative action. Watkins argued that there was no evidence of any on-the-record statement by Watkins regarding his financial situation and that there were many reasons for the sentencing including Watkins' personal family situation at the time of sentencing.
Justice Pines agreed with Cenci and granted summary judgment dismissing the action. Her decision summarizes the doctrine of judicial estoppel as follows:
The well recognized doctrine of judicial estoppel is designed to protect the integrity of the court system as a whole by prohibiting deliberate alteration of a stated position before the same or different courts in order to obtain favorable treatment. The doctrine prohibits a party who, having obtained a favorable ruling based upon an asserted position, seeks to alter the position simply because the litigant's interests have changed. [Citations omitted.]
Justice Pines concluded that Watkins failed to raise any genuine issue of material fact in response to Cenci's prima facie showing of entitlement to summary judgment based on judicial estoppel. Here's what she wrote:
Applying the doctrine set forth above, and Judge Rakoff's statements in his Order and the released portions of the PSR, the Court cannot imagine a more apt scenario for application of the doctrine of judicial estoppel. The Federal Court specifically relied on Watkins' assertions of penury in declining to impose an otherwise mandatory fine in connection with Watkins' pleas of guilty to the crime of conspiracy to violate the federal narcotics laws. Thus, Watkins obtained a judgment in his favor based upon his statements, including those declaring the lack of assets. The same litigant will not be permitted to utilize the State Court system to litigate his claims to real property or accountings based on funds he now states he began transferring at the precise time of his contradictory statements to probation, relied upon by a federal judge. Plaintiff has not raised any issue [of] fact, and indeed cannot do so, when faced with the statements of the sentencing judge, and the admissions contained in the PSR.
As Watkins illustrates, the doctrine of judicial estoppel obviates the court's determination of the plaintiff's asserted stock ownership rights. In theory -- and I'm not referring here to the Watkins case -- the "other" shareholders could reap a windfall if, in fact, the plaintiff acquired an ownership interest but then, for whatever reason, he or she concealed it in bankruptcy or criminal proceedings. But such forfeiture is the price exacted by the doctrine, in the greater interest of ensuring the integrity of judicial proceedings.
Note: Farrell Fritz, P.C. represented one of the co-defendants in the Watkins case.
