In 2008, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery — one of the many intellectual giants and gifted writers who’ve occupied seats on that bench — published an article in the Delaware Journal of Corporate Law entitled Goodbye to the Contemporaneous Ownership Requirement.  The article argued that the contemporaneous ownership rule in shareholder derivative actions, embodied in DGCL Section 327 (“In any derivative suit instituted by a stockholder of a corporation, it shall be averred in the complaint that the plaintiff was a stockholder of the corporation at the time of the transaction of which such stockholder complains or that such stockholder’s stock thereafter devolved upon such stockholder by operation of law”) and likewise in New York’s BCL Section 626 (b), should be abolished as “unnecessary,” “incoherent,” “ill-suited to each of the purposes advanced to support it,” and “arbitrarily mandat[ing] the dismissal of potentially meritorious claims.”

At the risk of vastly over-simplifying VC Laster’s multi-pronged argument, the central point he made is that, as long as the derivative plaintiff is a shareholder upon commencing the action and for its duration, it’s meaningless whether the plaintiff owned shares at the time of the challenged corporate action because the claim belongs to the corporation and is being brought for the benefit of the corporation, not the shareholder.

In one of his subsequent opinions questioning the rule’s wisdom, Bamford v Penfold, L.P., VC Laster dropped an intriguing footnote referring to a “provocative article” published in 2010 by Professor of Law Lawrence Mitchell of The George Washington University entitled Gentleman’s Agreement: The Anti-Semitic Origins of Restrictions on Stockholder Litigation (available here).  As the title suggests, Professor Mitchell’s thesis is that the statutory contemporaneous ownership rule and other restrictions on derivative actions including the security requirement for small shareholders, first enacted in New York in 1944 and in Delaware the following year, were promoted by the non-Jewish, corporate defense bar dominated by white-shoe law firms to stymie shareholder suits being brought by predominantly Jewish lawyers.  From the footnote:

In 1944, the New York legislature adopted a suite of statutory limitations on derivative actions that included a security-for-expenses requirement and a contemporaneous ownership requirement. Professor Mitchell has argued that the legislation was influenced by the anti-Semitic prejudices of the predominantly non-Jewish defense bar and their reaction to the perceived prevalence with which predominantly Jewish lawyers represented plaintiffs in stockholder derivative actions challenging the corporate establishment. The New York initiative had widespread influence, as “[p]assage of the New York statute inspired a burst of heated attacks on the derivative suit as an abusive and corrupt device from supporters of business interests throughout the country.” Donna I. Dennis, Contrivance and Collusion: The Corporate Origins of Shareholder Derivative Litigation in the United States, 67 Rutgers U. L. Rev. 1479, 1520 (2015). Delaware notably did not adopt a security-for-expenses statute, but it seems likely that the 1945 enactment of Section 327 was spurred by the New York initiative.

Whatever its origins, VC Laster’s advocacy seeking to eliminate the contemporaneous ownership rule has not spurred its repeal by the Delaware legislature, hence Section 327 remains on the books.  Which brings me to an interesting opinion handed down last week by Chancellor Kathaleen St. J. McCormick in SDF Funding LLC v Fry in which, after remarking that Section 327’s contemporaneous ownership requirement “is not universally beloved” and referring to VC Laster’s scholarship on the issue, she considered and ultimately rejected the argument of a putative derivative plaintiff who ran afoul of the rule, that he should be afforded “equitable standing” to prosecute the action.

Continue Reading Equitable Standing in Shareholder Derivative Suit Bows to the Contemporaneous Ownership Rule

It’s hard not to feel sorry for the petitioner in Fernandes v Matrix Model Staffing, Inc., Decision and Order, Index No. 160294/2021 [Sup Ct, NY County Apr. 20, 2022].

In Fernandes, Manhattan Supreme Court Justice Frank P. Nervo authored a thorough, step-by-step analysis of the legal issues and defenses most commonly raised in support of and in opposition to a petition for corporate dissolution based upon “illegal, fraudulent or oppressive actions” by the entity’s controllers under Section 1104-a (a) (1) of the Business Corporation Law (the “BCL”).

The Court serially ruled that the petitioner stated sufficient grounds to dissolve Matrix Model Staffing, Inc. (“Matrix”), a modeling agency with offices in New York, Florida, and California, and that the respondent entity: (i) failed to demonstrate petitioner’s lack of standing, (ii) failed to raise a genuine issue of fact as to any of the facts in the petition, (iii) failed to demonstrate the existence of an “adequate, alternative remedy” to dissolution, and (iv) failed to forestall dissolution by exercising the buyout election under BCL § 1118. Sounds like a winning petition.

To the hapless petitioner’s undoubted dismay, though, the Court still referred the matter to a referee for an evidentiary hearing. Let’s see why the Court might have felt compelled to order a hearing on a petition for which the respondent failed to show any real defense. Continue Reading The Evidenceless Petition to Dissolve

In a post two weeks ago, I wrote about a pair of ground-breaking law review articles by Professors Meredith Miller and Ann Lipton addressing an issue of growing attention in society at large and in legal circles concerning sex discrimination not only against employees of firms covered by Title VII and related state and local anti-discrimination laws, but also discrimination against owners of closely held firms by their co-owners.  Generally speaking, such business owners are not within the protected class of employees covered under anti-discrimination laws.

As I promised in that post, this week I’m pleased to present a new episode of the Business Divorce Roundtable podcast featuring an interview of Professor Miller discussing her article entitled Challenging Gender Discrimination in Closely Held Firms: The Hope and Hazard of Corporate Oppression Doctrine. The article was published last year in Volume 54 of the Indiana Law Review and can be read here.

Professor Miller has law degrees from Brooklyn Law School and Temple University School of Law, clerked for a New York Court of Appeals judge, and in 2006 joined the faculty at Touro Law Center where she teaches contracts, business organizations, and employment law. Twice she’s been honored by her students as Professor of the Year. She also maintains a private practice at Miller Law, PLLC concentrating in business and employment law, appeals, and consulting.

Inspired in part by the Straka case that I wrote about in 2019, in which a New York judge in a judicial dissolution case compelled a buyout of a 25% female shareholder of an accounting firm based in part on her male co-owner’s discriminatory behavior, Professor Miller’s article explores the potential use and limitations of minority shareholder oppression doctrine to address discrimination against female co-owners of closely held businesses.

I encourage you to read the entirety of Professor Miller’s article which includes some of the basics of oppression doctrine and employment discrimination law. Below you’ll find the article’s abstract and a link to the podcast. While you’re at it, check out some of the other 20+ interviews available on the Business Divorce Roundtable available here.

The #MeToo Movement has ushered sexual harassment out of the shadows and thrown a spotlight on the gender pay gap in the workplace. Harassment and unfair treatment have, however, been difficult to extinguish. This has been true for all workers, including partners – those women who are owners in their firms and claim that they have suffered harassment or unfair treatment based on gender. That is because a partner’s lawsuit for discrimination often will suffer an insurmountable hurdle: plaintiff’s status as a partner in the firm means that they may not be considered an “employee” under the relevant employment discrimination statutes. This article discusses an underexplored and underutilized potential alternative in seeking a remedy for discrimination: oppression (or “freeze out”) doctrine in the closely held business. The article begins with a discussion of the current jurisprudence addressing when an owner is an employee for purposes of employment discrimination statutes. It also explores the doctrine of minority shareholder oppression, both as an instrument of enforcing fiduciary obligations and as a statutory mechanism to petition for dissolution or seek other equitable relief. The article then brings these subjects together by discussing how a female owner’s claim of discrimination or harassment fits into existing minority oppression doctrine, and by comparing the substantive requirements of discrimination claims and corporate oppression claims.  Ultimately, this article concludes that one of the advantages of oppression doctrine is that it need not be framed in gender-based terms to succeed. Indeed, in discrimination cases it is often very difficult to prove that the employment decisions were “based upon sex,” and oppression doctrine bypasses this requirement. However, this advantage in any individual case may also prove to be a greater overall disadvantage because, without framing the claim in gender-based terms, the broader goals of workplace equality are not advanced.

 

Closely-held business owners often hope to avoid the costs and delays of litigation by including arbitration provisions in their partnership, shareholder, and operating agreements. Things can get tricky, though, when nonsignatories get embroiled in the dispute, as the plaintiff learned in a recent decision from Suffolk County Commercial Division Justice Elizabeth H. Emerson.

In Fritch v Bron (74 Misc 3d 1217 [A] [Sup Ct, Suffolk County Mar. 1, 2022]), Justice Emerson considered, but ultimately rejected as inapplicable under the particular facts of the case, three of the five theories under New York law for binding nonsignatories to arbitration agreements. Fritch was a thoughtful discussion of the law of enforcement of arbitration agreements against nonsignatories, and offers an opportunity for us to author our first article devoted exclusively to the subject. Continue Reading Binding Nonsignatories to Arbitration Agreements

Longtime readers of this blog may recall a post I wrote three years ago titled Minority Shareholder Oppression in the #MeToo Era. The post highlighted an apparent first-of-its-kind decision in a judicial dissolution case brought by certified public accountant Diane Straka, a minority shareholder of an accounting firm. The court upheld her claim of oppression by the male, majority shareholders based on their toleration of demeaning behavior directed at Ms. Straka by a senior employee at the firm and other discriminatory conduct concerning her profit-sharing and management role. Central to the court’s decision in Straka was its finding that the majority shareholders “and indeed, any shareholder of any corporation, should know that a female shareholder reasonably expects to be treated with equal dignity and respect as male shareholders forming the majority.”

No one should be under the illusion that the fact pattern presented in Straka presents a singular anomaly in the world of closely held  companies. Nor should anyone underestimate the complexity of the reasons why female business owners who suffer discrimination in its various forms at the hands of their partners don’t come forward, much less sue their partners. Nor should anyone think there are easy legal solutions under existing common and positive law that would resolve the tension between society’s interests in protecting individuals from discriminatory behavior violating our fundamental cultural and legal norms, and promoting the freedom of business owners to order their business affairs and partner relations as they know best to maximize productivity and economic growth.

Which is why it’s important to bring to interested readers’ attention two recent, thought-provoking articles authored by two law professors with legions more knowledge and insight concerning these issues than I possess. Last year, the Indiana Law Review published an article by Professor Meredith Miller of the Touro Law Center entitled Challenging Gender Discrimination in Closely Held Firms: The Hope and Hazard of Corporate Oppression Doctrine, available on SSRN here. More recently, the Houston Law Review published an article by Professor Ann Lipton of the Tulane University Law School entitled Capital Discrimination, available on SSRN here. Continue Reading It’s Time to Address Sex Discrimination Against Women Owners of Closely Held Companies, Say These Two Law Professors

A watershed moment or a forgettable outlier?  It is often difficult to predict how much a novel decision will impact the body of laws governing closely-held corporations and their shareholders.  Decisions that seem the most innovative can be forgotten or distinguished, while seemingly run-of-the-mill decisions can become the footings for a fundamental change in the law.  Cases are won and lost in the grey areas created by those novel decisions, and they’re what keep the avid followers of New York caselaw coming back for more.

Consider the First Department’s decision last week in Stile v C-Air Customhouse Brokers-Forwards Inc., which arguably seems poised to make at least two big waves in the area of minority shareholder’s rights (2022 NY Slip Op 02244 [1st Dept April 5, 2022]).  First, the Court enforces an anti-dissolution provision of the type previously deemed void as a matter of public policy.  Second, the Court upholds the minority shareholder’s common law cause of action for money damages arising from alleged shareholder oppression.  This post explores those rulings and their potentially significant impact.

Continue Reading A New Stile: First Department Shakes Up the Shareholder Oppression Claim

The fair value and fair market value appraisal standards applicable in contested buyout and dissenting shareholder valuations cut across state lines, which is one of the main reasons I occasionally highlight significant court decisions in valuation cases from outside New York.

As in other areas of the law concerning the internal affairs of business entities, the courts of Delaware play an outsized role in setting standards for assessing competing valuations in contested appraisal proceedings involving both privately and publicly owned companies.  In this post, I’m putting Delaware aside in favor of four recent cases that reached the Supreme Courts of four different states — Nebraska, Iowa, Indiana, and North Carolina — involving a number of frequently litigated issues in valuation cases, including  discounts.

Nebraska Supreme Court Overturns Application of Discounts In Fair-Value Buyout

Bohac v Benes Service Co., 310 Neb. 722 [Neb. Sup. Ct. 2022]. The Nebraska Supreme Court’s Bohac opinion involves a family-owned farming business in which a sibling schism followed the parents’ death, leading to a dissolution petition, leading to the other siblings’ election to purchase the petitioners’ 14.84% interest under the statutory fair value standard. The trial court valued the shares at approximately $2.9 million after applying discounts for lack of control (DLOC) and marketability (DLOM). On appeal, the petitioners primarily challenged the discounts, the trial court’s non-award of their litigation costs and fees, and payment terms of the award. The respondents’ cross-appeal challenged the trial court’s application of the asset-based approach over the income-based approach. Continue Reading Recent Stock Valuation Decisions Reign “Supreme”

Serving dual roles as urban homestead and non-profit business operation, residential condominiums and co-ops occupy a special niche in the arena of dispute resolution among co-owners of joint enterprises.

As discussed in greater detail here, New York co-ops are governed by the same organizational requirements and management rules of traditional business corporations under the Business Corporation Law including an elected board of directors and appointed officers, with the additional overlay of proprietary leases. New York condominiums, organized as unincorporated associations governed by the Condominium Act codified in the Real Property Law, have no shareholders but nonetheless are required to adopt by-laws providing for the election of a board of managers and officers.

Co-op and condo boards are sometimes perceived as entrenched bodies exercising dictatorial powers over building issues affecting finances, unit re-sales, and quality of life, sometimes pitting neighbor against neighbor and ego against ego which, as you might imagine, can generate emotionally charged controversies and litigation over issues that can’t always be measured in dollars, including contested board elections.

We’ve previously written herehere, and here about some of the relatively few reported court decisions in co-op and condo disputes involving access to books and records as well as board representation. Last week, in two separate appeals, Appellate Division panels in the First and Second Departments handed down significant decisions upholding a co-op owner’s common-law right to an unredacted copy of the shareholder list for the purpose of campaigning for a board seat, and affirming a lower court’s post-trial order banning the condominium sponsor and members of her family from holding more than two of six seats on the board of managers for the next six board elections. Let’s take a closer look.

Continue Reading Appellate Rulings Endorse Courts’ Broad Remedial Powers Over Condo and Co-op Board Elections

I can’t say what the number is, but my own experience tells me that a significant percentage of lawsuits by a minority owner of a closely-held company against those in control of the company include a demand for an accounting.  And at the risk of over-generalizing, I’d say that in many if not most of those cases, the accounting demand is not the central focus of the minority owner’s claim; it is a tacked-on, ancillary cause of action, pleaded in general terms and almost as a matter of course.  Sometimes, as this blog has covered, plaintiffs demand an accounting without even realizing what they’re asking for.

An equitable accounting is not a books and records demand.  Rather, it requires the fiduciary—in business divorce litigation, those in control of the company—to prepare detailed and supported schedules of income and expenses over a defined period, followed by the plaintiff’s filing of objections to the accounting, followed by proceedings, often before a court-appointed referee, to hear and recommend or determine the accounting.  Once complete, “the plaintiff gets an order directing payment of the sum of money found due” (Ederer v Gursky, 881 NE 2d 204 [2007]).

The potentially significant undertaking of an accounting might explain why it is so often demanded in business divorce litigation.  By invoking a demand for an equitable accounting, a closely-held business owner raises the specter of a time consuming, expensive, and needling process in which costs will almost certainly be disproportionally borne by the company and those in control.

Continue Reading But What of the Equitable Accounting?

In Congel v Malfitano, New York’s highest court wrote that business partners are free to include in partnership contracts practically “any agreement they wish,” including about “the means by which a partnership will dissolve, or other aspects of partnership dissolution.” This broad freedom of contract, the Court explained, is circumscribed only by “prohibitory provisions of the statutes,” countervailing “rules of the common law,” or “considerations of public policy.”

Two weeks ago, Peter Sluka wrote about one example of public policy prohibiting contracts among closely-held business owners: a recent decision ruling unenforceable a buy-sell provision in an LLC agreement because the contract deemed breach of any provision, no matter how minor, to be “forfeiture for a dollar,” which the Court found “grossly disproportionate,” “unreasonable,” and an “unenforceable penalty.”

This week, we’ll look at another example of public policy curtailing enforcement of agreements among closely-held business owners. A strand of a half dozen New York appellate decisions have held that contractual prohibitions on judicial dissolution proceedings – so-called “anti-dissolution” provisions – are potentially unenforceable depending on how broadly and in what manner they prohibit access to courts. We’ll summarize the state of the law at the end of this article. Continue Reading Anti-Dissolution Provisions and Public Policy