Question: What do you get when you take a luxury automobile dealership consisting of multiple corporations and limited liability companies, stir in three business partners, add contradictory documents concerning one partner’s ownership interest, season with a federal indictment of that same partner for stock fraud following which the other two partners freeze him out of the business, top off with a pair of litigators and bring to a boil?
Answer: A great recipe for a corporate dissolution slugfest recently played out in Nassau County Supreme Court.
Business divorce devotees can go to school on this case, thanks to a series of fact-filled and law-laden written decisions authored by Justice Ira B. Warshawsky of the Nassau County Supreme Court, Commercial Division. About the only disappointing thing about this battle royal, entitled Matter of Marciano (Champion Motor Group, Inc.), is that the plaintiff’s first name isn’t Rocky.
This first of five consecutive postings on the Marciano case summarizes the underlying facts. It then examines the court’s handling of the primary defense raised by the defendants in their initial attack on the dissolution petition, in which they challenge Marciano’s standing as a shareholder to seek dissolution. In subsequent postings New York Business Divorce will discuss a number of other issues discussed in each of the court’s four, separate decisions, including:
- whether Marciano’s criminal indictment justified the defendants’ decision to exclude him from the business;
- Marciano’s application under Section 702 of the LLC Law to dissolve the several LLCs formed by the parties;
- Marciano’s request for appointment of a limited receiver or financial monitor to oversee the business;
- Marciano’s request for access to all corporate records;
- Marciano’s request to compel distributions to him pending the proceedings;
- Marciano’s application to amend his pleading to add post-commencement derivative claims for waste and mismanagement;
- Defendants’ application made after discovery for summary judgment dismissing the action based on lack of standing and Marciano’s eventual guilty plea to unrelated federal charges;
- Marciano’s application to dismiss defendants’ “unclean hands” and estoppel defenses; and
- Marciano’s application for injunctive relief concerning the defendants’ alleged self-dealing when they assigned the dealership’s lease to a related company in which they alone are principals, following which the related entity exercised an option to purchase.
The Basic Facts
In his initial, 19-page decision dated September 5, 2006, Justice Warshawsky sets forth the relevant background as follows:
Prior to 2001, defendants Brustein and Todd operated a high-end automobile dealership engaged in the sale and service of luxury automobiles through a corporation called Champion Motor Group, Inc. (“Champion”) which was organized as a subsidiary of Champion Leasing Group, Inc. (“Leasing”). Marciano claimed that in 2001, following negotiations with defendants they agreed that he would become a 40% beneficial owner in Champion (later reduced to 38%). Champion’s governing corporate documents never were modified so as to formally identify Marciano as a shareholder, director or officer, however, he did become a record shareholder or member in several related companies and LLCs.
Marciano contended that, with his assistance including a $1 million letter of credit secured by his personal assets, Champion acquired a highly lucrative Bentley Motors franchise and relocated to new dealership premises.
Marciano also alleged that, notwithstanding his omission in Champion’s corporate records as a shareholder, director or officer, he was listed as a 30% owner and as secretary/treasurer in a “Statement of Ownership and Management” executed by the parties and submitted to Bentley; corporate distributions were made in conformity with his alleged 38% interest; and that the respective shares and membership interests in the related entities were held in similar percentages.
The defendants alleged that no new shareholders agreement was executed because Marciano himself insisted that he did not want anything in writing to reflect his ownership in Champion or Leasing. The companies’ accountant testified likewise as to his conversations with Marciano, who supposedly agreed to record ownership of only one share of stock in Leasing representing 0.99% ownership.
Champion’s subsequent distributions to defendants were reflected on their K-1’s, while distributions to Marciano were reported in a 1099 tax form. Marciano admitted receiving K-1’s reflecting his 0.99% ownership interest in Champion and Leasing, although he also claimed that he never inspected them.
In July 2004, a federal grand jury indicted Marciano and others for conspiracy, money laundering and securities fraud arising out of certain unrelated stock transactions. The indictment received coverage in major newspapers including an article in the Washington Post.
The defendants alleged, and Marciano denied, that Marciano knew of the criminal investigation as early as 2001 and deliberately hid or minimized his alleged shareholder-ownership interest in Champion from prosecutors, the IRS and creditors.
The Bentley Dealer Agreement contained provisions authorizing termination based on dealer misconduct including the conviction of dealer executives of any fraud-based felony if, in Bentley’s opinion, it would adversely affect the dealer’s business or Bentley’s goodwill or reputation.
The three parties discussed the impact of the indictment and Marciano’s role in the business pending charges. Marciano sent defendants a letter in July 2005 describing the indictment as “scandalous” and suggesting that any negative impact was overstated, but also stating that if defendants felt he was not “deserving of any consideration that would let us jointly grow our business . . . I will accept such decision.”
In the Fall of 2005, Marciano and the defendants conducted unsuccessful, acrimonious negotiations concerning a final appraisal of Marciano’s interest in the business. In December 2005, citing negative fall-out from the indictment and bad publicity, the defendants barred Marciano from the business premises and excluded him from participating in its day-to-day operations.
In January 2006, Marciano filed a combined action and proceeding for dissolution of the several related corporations and LLCs pursuant to Section 1104-a of the Business Corporation Law (BCL) and Section 702 of the Limited Liability Company Law (LLCL). The complaint-petition also included claims for monetary damages, breach of fiduciary duty, an accounting and declaratory relief to the effect that Marciano is the beneficial owner of a 38% interest in Champion.
Marciano’s Standing to Seek Judicial Dissolution of Champion
Marciano sought judicial dissolution of Champion and Leasing under BCL § 1104-a on the ground that the defendants had engaged in “oppressive conduct” by freezing him out of the business. The statute requires that the shareholder seeking dissolution hold at least 20% of the corporation’s voting shares.
The defendants argued that Marciano did not hold the requisite 20% interest in Champion and therefore could not maintain a dissolution action under BCL § 1104-a. They contended that Marciano had “unclean hands” since he allegedly hid his interest in Champion and also received without objection K-1’s confirming his minimal shareholder interest in that entity.
Justice Warshawsky began his legal analysis by addressing the general doctrine of unclean hands, which rests on the premise that one cannot prevail in an action to enforce an agreement where the basis of the action is immoral or inequitable. The court also noted that the doctrine applies only where the conduct relied on is directly related to the litigation’s subject matter and the party invoking the doctrine was injured by such conduct. Turning specifically to BCL § 1104-a dissolution proceedings, the court stated that the unclean hands doctrine is not an automatic bar to relief under the statute. Rather, only when the minority shareholder’s own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complaint of oppression should relief be barred.
Applying this standard, the court denied the defendants’ dismissal motion because of unresolved factual issues surrounding Marciano’s stock ownership. The court found no evidence that Marciano’s actions were undertaken with a view toward forcing an involuntary dissolution. It also found that the K-1’s issued to Marciano were not conclusive of his shareholder status.
At the same time, the court clearly indicated that Marciano was not out of the woods on the issue of standing: he never executed a shareholders agreement reflecting his alleged 38% interest; he did not later insist that the defendants revise the corporate records so as to formalize his shareholder status in Champion; he did not otherwise explain his acquiescence in the omission of all reference to his formal ownership status in Champion’s corporate records; and he allowed his distributions to be reported as 1099 income instead of on his K-1’s.
“In short”, the court summed up, “despite the additional indicia of ownership on which the plaintiff relies, factual questions exist as to whether, by his own election and affirmative conduct, the plaintiff effectively agreed to forego the rights and benefits which would otherwise inure to him as a formally denominated 38% shareholder in Champion.”
To be continued . . .