One of my pet issues, on which I’ve written a number of times (see here, here and here), is whether the filing of a dissolution petition triggers a mandatory stock buyback under a shareholders’ agreement that provides a right of first refusal (RFR). The cases raising the issue have all been deadlock dissolution petitions brought by 50% shareholders under Business Corporation Law Section 1104(a). That statute, unlike Section 1104-a governing minority shareholder oppression, does not give the respondent shareholders the right to purchase the petitioner’s shares under Section 1118.
If the shareholders’ agreement expressly provides that the filing of a dissolution petition triggers the RFR, unquestionably it should be enforced. The problem arises with the more typical RFR that does not contain such express language, but instead contains what most would consider boilerplate reference to stock transfers. Is enforcement by reason of such general language consistent with a shareholder’s reasonable expectations, and with the statutory right to seek dissolution? The issue has very serious ramifications for the petitioner (and for petitioner’s lawyer who may be unwary of the trap) because the RFR typically provides a below-market price for the buyback with a long-term payout.
A 2006 appellate decision by the First Department in a case called Matter of Johnsen (ACP Distribution, Inc.) ruled that a dissolution petition triggered an RFR containing the operative terms, "donate, hypothecate, pledge, transfer or otherwise dispose of his Stock in any manner whatsoever." A September 2007 trial court decision in Matter of Schneck (R&J Components Corp.) (previously blogged here) went the other way where the operative terms were "sell, assign, mortgage, hypothecate, transfer, pledge, create a security interest or lien, encumber, give or otherwise dispose of any of the shares."
Now comes another case, Matter of El-roh Realty Corp., where the operative trigger language in the RFR referred to any transfer of shares "including, without limitation, transfers that are voluntary, involuntary, by operation of law or with or without valuable consideration." The February 1, 2008, decision by the Appellate Division, Fourth Department, affirmed the lower court’s order (see decision here) holding that the filing of a dissolution petition by a 50% shareholder triggered the RFR. Here’s what the appellate court said:
In examining the terms of the agreement as a whole and giving a practical interpretation to the language employed, the court properly concluded that respondents’ construction of the agreement is the only construction which can fairly be placed thereon and thus properly refused to consider the extrinsic evidence offered by the petitioner. Contrary to petitioner’s further contention, such a construction does not violate public policy. [Citations omitted.]
I remain troubled by cases such as Johnsen and El-roh, for several reasons. First, as a matter of contract interpretation I am not convinced that a petition to dissolve a corporation entails a stock "transfer" or "disposition". To file a dissolution petition is not to transfer or dispose of one’s shares. Even when dissolution occurs, there is no transfer or disposition of shares, rather, all shares are extinguished. I have yet to see any court decision addressing this point.
Second, I fear the courts may be favoring the expediency of a compelled buyout at the expense of shareholder rights to seek dissolution. It is no secret that dissolution cases can be especially acrimonious and typically involve heavy motion practice placing disproportionate demands on scarce judicial resources. Such considerations should have no role in determining shareholder rights.
Third, the effect of Johnsen and El-roh will be to deter dissolution proceedings in favor of plenary actions seeking injunctive relief and damages based primarily on claims for breach of fiduciary duty and the like. Ultimately the courts will not be spared the Sturm und Drang of intense shareholder disputes. In my view, the aggregate uncertainty and risk on both sides in dissolution contests is greater than in such a plenary action, and therefore is more conducive to settlement.