The concept of the corporation as a separate "person", with a legal identity distinct from its shareholders and the ability to sue and be sued in its own name, is the cornerstone of the corporate form of business organization. The essential corporate attribute of limited liability and the attendant imposition of fiduciary duties of loyalty and care on those entrusted to manage the corporation’s affairs, could not comfortably exist without corporate separateness.
Okay, I admit that’s a highfalutin way to introduce the discussion that follows, of a trite lawsuit between shareholders of a two-bit sports memorabilia business, but that’s the beautiful thing about the law, its noblest notions inform even the most mundane of disputes.
The dispute in question is the subject of a decision last month by New York County Supreme Court Justice Joan Madden in a case called Sports Legends, Inc. v. Carberry, 2008 NY Slip Op 30718(U) (Sup Ct NY County Mar. 10, 2008). The case arose when one of two 50% shareholders of a sports memorabilia business caused a suit to be filed in the name of the corporation against the other shareholder, asserting claims to recover company merchandise allegedly taken by the defendant and not returned. The primary issue in the court’s decision, of no interest here, was whether the action was barred by the statute of limitations (the court found that it was). Secondarily, and the reason I’m discussing the case, the court addressed the issue whether the shareholder who brought the suit in the company’s name had the authority to do so.
It’s a question that comes up with some frequency in disputes between 50-50 shareholders of close corporations. There are really two questions involved. The first is, who has standing to assert the claim, the individual shareholder or the corporation? The second is, if it’s the corporation, is there authority for one of the shareholders to institute suit in the corporation’s name against the other?
The answer to the first question in the Sports Legends case is easy: the corporation suffered the claimed injury and therefore only it has standing to seek relief based on the allegation that it owns the missing merchandise.
The second question turns on the issue of corporate control. New York Business Corporation Law Section 701 states that "the business of a corporation shall be managed under the direction of its board of directors". Absent some unusual voting trust arrangement or a shareholders’ agreement that appoints a third non-shareholder director, in 50-50 corporations the two shareholder-directors necessarily must agree on all board actions. Conceivably there could be bylaws or a shareholders’ agreement that delegates to the company’s president the authority to commence suit in the company’s name against the other shareholder, but who in their right mind (excepting the president-to-be) would agree to that?
The shareholder who brought the suit in Sports Legends, one Joseph Cusenza, was not oblivious to this hurdle. He tried to overcome it with the novel argument, that because his capital contributions to the corporation exceeded those of the defendant-shareholder, Paul Carberry, he acquired control and therefore could authorize the corporation to sue Carberry. Justice Madden gave the argument fairly short shrift, writing as follows:
[e]ven if it were timely, this action would be dismissed on the grounds that Cusenza lacks the authority to bring this action on behalf of Sports Legends. It is firmly established that "where there are only two stockholders each with a 50% shares, an action cannot be maintained in the name of the corporation by one stockholder against another with an equal interest and degree of control over corporate affairs." Executive Leasing Co. v. Leder, 191 AD2d 199, 200 [1st Dept 1993]. Here, while it is alleged in the unverified complaint that Cusenza’s contribution to the funds used for the corporation were greater than 50%, there is no allegation that Cusenza was issued more than 50% of the corporation’s stock.
Thus, even assuming arguendo that Cusenza contributed more capital to Sports Legends, such contribution would not give him standing to bring this suit on behalf of the corporation. The rule at issue here applies based on equal stock ownership, not the relative amounts of capital contributions made by such shareholders. See Abelow v. Grossman, 91 AD2d 553 [1st Dept 1982], appeal dismissed, 58 NY2d 1112 ; Tidy-House Paper Corp. v. Adlman, 4 AD2d 619 [1st Dept 1957]. Accordingly, since Sports Legends does not deny that Carberry and Cusenza each owned 50% of the shares of Sports Legends, Cusenza cannot maintain this action in the name of the corporation.
Does this leave a 50% shareholder such as Cusenza without a remedy for his 50% partner’s alleged perfidy? Not at all. Business Corporation Law Section 626 authorizes a shareholders’ derivative action brought in the right of the corporation to procure a judgment in its favor. Business Corporation Law Section 720 also authorizes a director or officer to bring an action to compel another director or officer to account for his "official conduct" in cases of, among other things, loss or waste of corporate assets or to set aside an unlawful conveyance of corporate assets.
So why would a 50% shareholder incur the wasted time and expense of bringing a doomed action in the company’s name when he can safely bring a shareholders’ derivative or director’s action? In my experience there are two reasons. First, if the shareholder who wants to bring the suit also controls the corporate checkbook, bringing the lawsuit directly in the name of the company lends an appearance of propriety to use of corporate funds to pay attorney’s fees, thereby forcing the defendant shareholder indirectly to subsidize litigation against himself. Second, there’s an appearance (and sometimes a reality) of greater moral authority when the attorney for one side stands before the judge as company counsel. It suggests that the shareholder-proponent of the lawsuit is not just one of two equally self-interested partners, but is fighting to protect the distinct corporate interest for the benefit of all the shareholders. Whether or not that’s true, however, begs the control issue determinative in Sports Legends.
Update April 7, 2009: On the corporation’s appeal, the Appellate Division, First Department, affirmed the lower court’s ruling, stating simply that "in an action where defendant was a 50% shareholder of plaintiff and Cusenza the holder of the remaining 50%, Cusenza had no authority to commence this action against defendant." 61 AD3d 449, 2009 NY Slip Op 02680 (1st Dept Apr. 7, 2009).
Update January 26, 2010: In Binky, Inc. v. Korff, 2010 NY Slip Op 30112(U) (Sup Ct NY County Jan. 12, 2010), the court cites the Sports Legends case in support of its decision dismissing an action brought by one 50% shareholder in the corporation’s name against the other 50% shareholder.
Update November 7, 2010: The LLC Law Monitor reports here on an interesting Connecticut case in which the court ruled that 50% members of a Connecticut LLC lacked authority to bring suit in the LLC’s name.