New York Business Divorce : New York Business Dissolution Lawyer & Attorney : Farrell Fritz Law Firm : Buy-outs, Shareholder Disputes : New York, NY

If that was the expectation in Carson, the petitioner surely was surprised and disappointed when, instead of electing to buy out petitioner, the respondent counterclaimed to dissolve the two corporations under BCL §1104, which applies to instances of directors and shareholders deadlock. Section 1104, unlike §1104-a, does not give the respondent shareholder the right to purchase the petitioner's shares for fair value.

After discovery and multiple conferences, the respondent submitted an order for the trial court's review that dissolved both corporations. The petitioner objected to the order and requested that, instead of dissolution, the court allow petitioner to purchase respondent's majority share of the corporations. The trial court, by Justice Stephen A. Ferradino of Saratoga County Supreme Court, issued the order submitted by respondent and dissolved both corporations, from which the petitioner appealed.

The petitioner offered two arguments in support of his right to compel a purchase of the respondent majority shareholder's stock interests. First, he argued that the lower court erred by not holding a hearing to determine whether a forced buyout by petitioner of respondent's interest was a more equitable remedy than dissolution. The argument relied on BCL §1109, which states that, "[a]t the time and place specified in the order to show cause, or at any other time and place to which the hearing is adjourned, the court or the referee shall hear the allegations and proofs of the parties and determine the facts." Second, he argued that the lower court erred by not conditioning its order of dissolution on giving petitioner the opportunity to purchase the respondent's shares. 

The Albany-based Appellate Division, Third Department, rejected both arguments and affirmed the dissolution order. As to the lower court's failure to hold a hearing, the court wrote:

Business Corporation Law § 1109 states that "the court . . . shall hear the allegations and proofs of the parties and determine the facts." Here, petitioner claimed in his petition that dissolution of both corporations was a "necessity" and argued that it was "the only feasible means" available to protect his investment because respondent, as the majority shareholder, was guilty of oppressive conduct. Given the content of these allegations and the concession implicit in both petitions that dissolution was a remedy that met the needs of both parties, a hearing was not required.

The court likewise rejected petitioner's second argument in support of his right to purchase the respondent's shares, explaining:

Petitioner also argues that Supreme Court should have given him the opportunity to purchase respondent's majority share when it ordered both corporations dissolved. However, such relief is not available to a petitioner who makes an application for dissolution pursuant to Business Corporation Law § 1104-a. The statute specifically provides that "any other shareholder . . . may, at any time within ninety days after the filing of such petition . . ., elect to purchase the shares owned by [petitioner] at their fair value and upon such terms and conditions as may be approved by the court" (Business Corporation Law § 1118 [a] [emphasis added]).

This is an important point which, for better or worse, underscores New York's one-sided approach to the buyout remedy. That is, only the respondent in an oppressed shareholder proceeding under §1104-a can elect to purchase the petitioner's shares, and only the respondent is given the last-resort opportunity to purchase the petitioner's shares as a condition of the order of dissolution. Compare this scheme with, e.g., New Jersey's corporate dissolution statute which gives the court authority to order a buyout by any shareholder of any shareholder made a party to the proceeding, regardless who initiated the dissolution case. 

There's no clue in the decision as to why the respondent didn't simply consent to dissolution (without admitting the allegations of oppression) rather than counterclaim for the same relief. In any event, had the respondent in Carson counterclaimed for dissolution under §1104-a instead of §1104, the petitioner clearly could have elected to purchase the respondent's majority stake under §1118. I can only assume that the respondent chose §1104 deliberately to foil petitioner's counter-buyout demand, either to secure a stronger negotiating position down the road or perhaps because he anticipates greater benefits from a winding up and liquidation of the business assets.

You can read more about the §1104-a vs. §1104 dilemma when it comes to buyout here and here.

Second, in New York as in most if not all other states, the rules governing venue in applications for judicial dissolution of corporations (Business Corporation Law 1112) and limited liability companies (LLC Law 702) specifically require the proceeding to be brought in the "judicial district" -- for the moment, think county -- "in which the office of the corporation [or LLC] is located."  Although you might think this could lead to disputes when the business has multiple offices in different counties within the state, as used in the statutes "office of the corporation" does not necessarily mean an actual place of business.  Rather, it means the county of business stated in the certificate of incorporation or, in the case of an LLC, in the articles of organization whether or not the business has an actual place of business there.

Which brings us to the Third Department's decision this month in Matter of Supplier Distribution Concepts, Inc., in which Stephen Richards, as one-third owner of a close corporation ("SDC") and an affiliated limited liability company ("MDR"), sought to dissolve both by petition filed in the Supreme Court in Binghamton, New York, located within the Broome County judicial district where he resides and his lawyer practices.  Richards' petition identically described each company as having "a place of business located in Broome County, New York."  Note how the description varies slightly but importantly from the statutory language, "the judicial district in which the office of the [entity] is located." 

It turns out, the difference in locution was no oversight.  SDC's certificate of incorporation, as amended in 2003, designated Monroe County as the location of the corporation's office, as did MDR's articles of organization filed the following year.  Monroe County, the seat of which is Rochester, is about 100 miles from Binghamton.  It's also the residence of the managing owner, Charles Dekar, and the bricks-and-mortar location of the companies' main operations.

Richards' filing in Broome County did not sit well with Dekar and his Rochester-based lawyers who quickly filed a motion to change the venue to Monroe County Supreme Court under BCL 1112 and LLC Law 702 based on the office location designated in the organizational documents on file with the Secretary of State.  Richards responded with a cross motion to retain venue in Broome County under Section 510(3) of the Civil Practice Law and Rules which gives judges broad discretion to change venue where "the convenience of material witnesses and the ends of justice will be promoted by the change."

The motions were heard by Broome County Supreme Court Justice Ferris D. Lebous who ruled in favor of Richards.  As reflected in the transcript of the oral argument on the motions (read here), Justice Lebous was swayed to retain venue for several reasons.  First, while agreeing that as a "general rule" venue in dissolution cases is determined by the office location stated in the filed organizational documents, there is an "exception" where the petitioner seeks relief beyond dissolution, such as enforcement of other shareholder or director rights.  Second, with respect to the presence in Broome County of material witnesses -- Richards submitted a list of 42 supposed witnesses residing in Broome and nearby counties -- he focused on the fact that Dekar had contacted police authorities and the district attorney's office in Broome County to pursue allegations that Richards had misappropriated company property.  Third, expressing his hope that he could preside over a more prompt settlement of the case, Justice Lebous states that

the ends of justice will be promoted and judicial economy will be promoted by getting a handle on these things now, putting the brakes on, and getting this thing resolved in as mutually agreeable a fashion as possible. [Transcript p. 30]

Justice Lebous signed a formal order retaining venue on June 21, 2010 (read here), from which Dekar appealed to the Albany-based Appellate Division, Third Department.  The appellate court's decision reversing Justice Lebous's order does not address the latter's stated goal of judicial economy, but it does make short work of his two other rationales.  After citing the BCL's and LLC Law's venue provisions, the appellate court addresses and rejects the other-relief issue as follows:

[E]ven assuming that a proceeding seeking judicial dissolution which also requests other types of relief may be brought in a venue other than where the offices of the corporation or limited liability company are located (see e.g. Matter of Tashenberg v Breslin, 89 AD2d 812, 812 [1982]), our review of the record reveals that petitioner did not request any other relief here, only minimal disclosure. While petitioner alleges in his petition that respondents, among other things, failed to authorize dividends or cash distributions and attempted to deprive him of compensation, he does not seek any relief based upon these alleged wrongdoings other than dissolution.

The court also faults the lower court's reliance on the presence of material witnesses in Broome County, finding that Richards did not adequately substantiate grounds to depart from the special venue statutes governing dissolution.  Here's what the court said:

Regarding petitioner's cross motion, we are cognizant that a court may, in its discretion, change or retain venue upon consideration of "the convenience of material witnesses and the ends of justice" (CPLR 510 [3]; see Vasta v Village of Liberty, 235 AD2d 1006 [1997]). However, in order to retain venue in Broome County, it was petitioner's burden to provide "the names and addresses of the witnesses, the substance and materiality of their testimony relative to the issues in the case, [and assurances] that the witnesses have been contacted and are willing to testify on behalf of the movant, and the manner in which they will be inconvenienced" (Gissen v Boy Scouts of Am., 26 AD3d 289, 290-291 [2006]). "A discretionary change of venue under CPLR 510 (3) is addressed to the convenience of nonparty witnesses" (State of New York v Quintal, Inc., ___ AD3d ___, ___, 2010 NY Slip Op 09061 [2010] [emphasis added and citations omitted]; see State of New York v Slezak Petr. Prods., ___ AD3d ___, 910 NYS2d 268 [2010]). Inasmuch as petitioner failed to delineate the substance or materiality of the nonparty witnesses' testimony as it relates to respondents' dissolution and proffered only conclusory statements as to the manner or extent to which those witnesses would be inconvenienced by trial in the Seventh Judicial District [Monroe County] (see Frontier Ins. Co. in Rehabilitation v Big Apple Roofing Co., Inc., 50 AD3d 1239, 1239-1240 [2008]; Root v Brotmann, 41 AD3d 247, 247 [2007]; Gissen v Boy Scouts of Am., 26 AD3d at 290-291), his cross motion to retain venue in Broome County should have been denied.

The case will now be transferred to Rochester and a new judge, almost nine months after its commencement.  The Broome County Supreme Court docket information available online only shows a recent motion to compel disclosure, so it's hard to tell how far the case has progressed in the interim or whether the majority owners elected to purchase Richards' interest.  We'll just to wait and see whether the change in venue will expedite an out-of-court settlement or harden the parties' positions.

The Eklund case involved a protracted corporate dissolution of a family-owned business for which the trial court appointed a receiver.  In 2007, the trial court's order granting dissolution was affirmed on appeal.  The dissolution proceeding then settled, making a sale of the corporation's assets unnecessary.  The receiver had made two prior, interim applications for commissions which were awarded without opposition, in which his commissions were calculated by applying § 1217's percentage scale twice, to both the sums received and again to those disbursed by the receiver.

Following settlement the receiver submitted a final application for commissions based upon transactions that occurred after his prior applications, using the same calculation method.  This time the parties objected, arguing that the receiver used an incorrect calculation method and seeking to recalculate and modify the prior, interim commission awards.  The trial court refused to modify the prior awards based on the parties' failure to object timely, but it agreed that the final commissions must be computed by applying the statutory percentages only once to the sums that passed through the receiver's hands since the interim awards.

On the receiver's appeal to the Appellate Division, Third Department, the court confronted the issue whether § 1217's reference to commissions on "sums received and disbursed" (emphasis added) permits an aggregate award of commissions on sums received plus commissions on sums disbursed, or requires the court to apply the percentage only once to the sums that pass through the receiver's hands.  The court agreed with the trial court's single-calculation interpretation, commenting as follows:

Although we have not previously considered this specific question of whether Business Corporation Law § 1217(a) authorizes awards of commissions calculated upon both the "sums received and disbursed," we note the interpretations given by other courts to the similar language in CPLR 8004 (see Eastrich Multiple Inv. Fund v Citiwide Dev. Assoc., 218 AD2d 43, 44 [1996]; Coronet Capital Co. v Spodek, 202 AD2d 20, 26-27 [1994]; People v Abbott Manor Nursing Home, 112 AD2d 40, 41 [1985]), and we read the statute here as contemplating that the commission paid to a receiver will be the statutory percentage of the amount that has been both collected and disbursed. That is, "a commission is due upon the total amount which passes through the receiver's hands" (Matter of Jakubowicz v A.C. Green Elec. Contrs., Inc., 25 AD3d 146, 150 [2005] [internal quotation marks and citation omitted]).  Accordingly, we conclude that Supreme Court did not err in  . . . granting commissions based upon the total amount that passed through the receiver's hands.

The decision does not describe the receiver's services, the hours he devoted, or the amounts collected and disbursed, so it's hard to know whether or to what extent the receiver's award -- before or after it's halving by the court -- constitutes reasonable compensation.  What is known is that, had the case not settled, and had the receiver gone forward with liquidation, the sums upon which his commissions would have been computed would have included substantial proceeds from the sale of assets.  Considering that the receiver's temporary stewardship of the corporation likely contributed to its preservation and to the ultimate settlement that permitted the parties to avoid liquidation, it certainly can be argued that the receiver effectively was penalized financially for doing a good job.

This point was driven home even more forcefully in the Jakubowicz case cited in the above-quoted passage.  Jakubowicz also involved a protracted dissolution proceeding which was settled shortly before the judicial sale of the corporation's properties including realty valued between $12 million and $20 million.  The court-appointed receiver, who was an attorney, devoted 300 hours over an 11-month period including conducting the mediation that resulted in the settlement.  The amount received and disbursed by him totaled about $380,000 which, applying § 1217's percentages, resulted in commissions less than $5,800, or about $19 per hour.

The receiver unsuccessfully asked the trial court to award him an additional $150,000 based on 1% of the value of the corporation's real properties which he valued at $15 million.  On the receiver's subsequent appeal, the Manhattan appeals court reluctantly agreed with the lower court,  stating that § 1217 is subject to "strict construction," that the statute does not authorize commissions on the value of property owned but not sold by the corporation, and that the payment of commissions in excess of the statutory rate is "contrary to its plain meaning."  The court's opinion commends the receiver's successful mediation efforts and notes that § 1217 discourages a receiver from assisting with settlement by tying commissions solely to sums received and disbursed.  In the court's own words: 

Although we are required to give literal application to the provisions of Business Corporation Law § 1217, we cannot detract from the value of the services rendered by the receiver, which were applauded by Supreme Court and acknowledged, albeit reluctantly, by the parties. The statutory reimbursement scheme contemplates the actual dissolution of the corporation and the distribution of corporate assets by the receiver; it does not address the situation where dissolution is avoided. In this case, the receiver was able to extract a negotiated settlement and so preserve, more effectively than by means of a judicial sale, the value of the corporate assets for the share owners. This outcome is favorable both to the parties and to the court. As a matter of policy, settlement is favored as a means of facilitating the resolution of disputes and preserving judicial resources (see Mitchell v New York Hosp., 61 NY2d 208, 214 [1984]; Matter of Hofmann, 287 AD2d 119 [2001]). These salutary purposes will not be promoted by a compensation provision that dissuades a receiver from attempting to settle a dispute between share owners in order to preserve his entitlement to an adequate commission for the services he has rendered.

In sum, the remedy lies not with the courts but with the Legislature. We strongly urge that consideration be given to amending Business Corporation Law § 1217 to afford a court discretion to fix a receiver's commission based upon the value of the services rendered in those cases where, as here, dissolution and the consequent disposition of corporate property are not effectuated (particularly as the result of a negotiated settlement), subject to limitation by reference to a percentage of the total assets administered.

I know first hand the importance of finding an experienced, qualified receiver to take charge of a dysfunctional business in the throes of dissolution litigation.  I also know that most of these cases -- at least the ones involving businesses with going concern value -- eventually result in a buyout settlement which, as in Eklund and Jakubowicz, can substantially reduce the prospects for receiver compensation.  This undoubtedly deters many qualified attorneys and other professionals from taking on receivership assignments.  It is unfortunate that the Jakubowicz court's plea for legislative amendment seems to have fallen on deaf ears in our state capitol.  

The baseball camp opened under the name Cooperstown All Star Village, but relations among the owners soon deteriorated over various financial disputes which erupted in a pair of lawsuits centering on Cooperstown Capital's obligations for capital contributions and payments on the Patton note.  In December 2007, in a suit commenced by the Pattons against Cooperstown Capital demanding payment of the note, the Appellate Division, Third Department, upheld the denial of the Pattons' summary judgment motion, stating that "[b]ecause the note requires defendants to pay, but the operating agreements include payments under the note as operating expenses of Abner and CASV, questions of fact exist concerning the breach of the agreements and the amount, if any, due under the note."  (Read decision here.)

Now comes the "squeeze-out play."  Apparently not content to await trial, in February 2008, the Pattons with the support of the other 30% member, Lionetti, called a meeting of Abner's members to vote upon and approve a capital call upon Cooperstown Capital alone, demanding that it contribute over $450,000 for operating expenses consisting of amounts allegedly due under the Patton note.  Under Abner's operating agreement, the other members may make a capital contribution if a requested party fails to do so, and such action is treated as a loan for a period of 90 days.  Thereafter, if the loan is not repaid, the defaulting member's interest may be decreased and the contributing member's interest increased accordingly.

Cooperstown Capital quickly sought to enjoin implementation of the February 2008 capital call, contending that when it refused to make the demanded contribution, the Pattons purported to loan Abner the funds (to pay themselves) and were threatening to dilute Cooperstown Capital's membership interest so as to give the Pattons absolute control of the business.

LLC member disputes usually turn on the express provisions of the operating agreement, and Cooperstown is no exception.  Section 5.2 of Abner's operating agreement governing additional capital contributions provides:

The Members shall contribute such additional capital on a pro rata basis in proportion to their respective "Membership Interests", as hereinafter set forth in Section 6 hereof, as such amount is determined in good faith by the consent of Members holding a majority in interest.

In support of its injunction application, Cooperstown Capital argued that Section 5.2 does not authorize a selective capital call upon one member, and that by diluting its membership interest the Pattons effectively would wrest over two-thirds control of the LLC giving them the unchecked power to sell major LLC assets and dissolve the LLC.  In a Memorandum Decision and Order dated April 21, 2008, Oneonta County Supreme Court Justice Kevin M. Dowd agreed with Cooperstown Capital and granted the injunction, stating:   

Plaintiff has shown a probability of success on the merits.  The operating agreement for Abner states in Section 5.2, "The Members shall contribute such additional capital on a pro rata basis in proportion to their respective 'Membership Interest,'…"  Section 5.8 further states that in determining the amount of any additional capital contribution the members shall consider all the operating expenses.  Operating expenses are defined by Section 13.13 of the Operating Agreement to include payments of principal and interest due under the Patton notes.  Based upon these sections, there appears to be no basis to make a capital call on Plaintiff alone.

The Pattons appealed, arguing that the injunction was inconsistent with the Third Department's December 2007 decision in which it found questions of fact concerning whether Abner and CASV or Cooperstown Capital was obligated to pay the Patton note.  In its March 26, 2009 opinion, the appellate court rejected this argument and upheld the injunction, writing:

While both Supreme Court and this Court previously determined that questions of fact preclude summary judgment in the parties' related case (Patton v Ferrara, 46 AD3d at 1205), plaintiff has still established a likelihood of success here.  Abner's operating agreement permits capital calls, but specifies that the "[m]embers shall contribute such additional capital on a pro rata basis in proportion to their respective '[m]embership [i]nterests.'"  Under the operating agreement and the promissory notes, the Patton notes are payable as operating expenses of Abner and CASV rather than the individual members, and capital calls "shall" be shared pro rata by the "members" plural.  Hence, despite questions of fact, it is at least likely that plaintiff will succeed in proving the impropriety of Abner's notice requiring a capital contribution only from plaintiff to pay the Patton note.

An opportunity for defendants to shift the balance of power and wrest complete control over the company can constitute irreparable injury (see Vanderminden v Vanderminden, 226 AD2d 1037, 1041 [1996]; Casita, LP v Maplewood Equity Partners [Offshore] Ltd., 17 Misc 3d 1137A, *8 [2007]; see also Matter of Brenner v Hart Sys., 114 AD2d 363, 366 [1985]).  If plaintiff does not pay the capital contribution, the operating agreement permits the remaining members to meet the capital contribution on plaintiff's behalf as a loan, then repay the loan with plaintiff's equity interests in Abner.  In that scenario, plaintiff would lose not only its shares of Abner, but also its ability to block certain actions which require a two-thirds vote. Those actions include selling major LLC assets and dissolving the LLC.  The possibility of plaintiff losing any real say in Abner, as opposed to maintaining the status quo where defendants suffer no actual harm, suggests that the equities balance in plaintiff's favor.  Thus, Supreme Court did not abuse its discretion in granting the preliminary injunction (see Matter of Kalichman, 31 AD3d 1066, 1067 [2006]). 

The occasional need for additional capital contributions is a fact of life for many closely held businesses.  A business organized as a New York limited liability company must pay attention to Section 502 of the LLC Law which sets forth certain default rules surrounding member liability for contributions.  Section 502 does not, however, mandate any consequences to the membership interest of the defaulting member, leaving this entirely to the operating agreement.  Here's what it says in Section 502(c): 

The operating agreement may provide that the membership interest of any member who fails to make any required contribution shall be subject to specified consequences of such failure. Such consequences may include, but are not limited to, reduction or elimination of the defaulting member's interest, subordination of the defaulting member's interest to that of nondefaulting members, a forced sale of the defaulting member's interest, forfeiture of the defaulting member's interest, the lending by the other members of the amount necessary to meet the defaulting member's commitment, a fixing of the value of the defaulting member's interest by appraisal or by formula and redemption or sale of such member's interest at such value, or other consequences

In other words, if the operating agreement does not expressly authorize dilution, forfeiture, or other adverse consequences to the non-contributing member's interest, the LLC has no immediate recourse beyond seeking to enforce the payment obligation.  This was not the problem for the Pattons in Cooperstown.  Rather, their problem was adopting a selective capital call designed to bring down the operating agreement's "hammer" provisions upon only one member, contrary to the operating agreement's pro rata formula for additional member contributions.  

Update October 25, 2010:  Read here my post on Georgi v. Polanski, where the Kings County Commercial Division held invalid a capital call in contravention of the operating agreement.