Like most states, New York’s Business Corporation Law (BCL) permits a shareholder to opt out of mergers and certain other corporate restructurings by electing to be cashed out for the “fair value” of his or her shares. The so-called dissenting shareholder statute, BCL Section 623, sets forth procedures and deadlines for submission of the shareholder’s written objection to the proposed transaction, for the corporation’s making of a price offer, and for the filing of a judicial appraisal proceeding in the event the shareholder rejects the corporation’s offer. A statutory appraisal proceeding also may result from a “freeze-out merger” in which the controlling shareholders compel minority shareholders to redeem their shares for cash. The dissenting shareholder statute typically comes into play with merger transactions involving corporations with relatively large capitalization and whose minority shareholders include passive investors. Section 1005 of the New York Limited Liability Company Law likewise permits members to dissent and cash out from mergers or consolidations involving LLC’s.
A recent court decision, in a case called McCully v. Jersey Partners, Inc., 18 Misc 3d 1138(A) (Sup Ct NY Co 2008), raises a caution flag for dissenting shareholders and their counsel when it comes to asserting claims for dividends that accrue prior to merger consummation but are not payable until afterward.
Robert McCully was a shareholder of Jersey Partners, Inc. (“Jersey”). In August 2001, Jersey solicited shareholder approval for a corporate reorganization involving the merger of two of its subsidiaries. McCully dissented. The reorganization was consummated on November 30, 2001. Jersey offered McCully $3.2 million for his shares, which McCully rejected. A judicial appraisal proceeding followed in which McCully obtained, in June 2006, a judgment for an additional $12.8 million with 9% interest from the consummation date, plus his costs and attorney’s fees of almost $2 million. The judgment was affirmed on appeal in December 2007.
Meanwhile, in December 2006, McCully started a separate action against Jersey to recover tax dividend distributions for the years 2000 and 2001 under a shareholders’ agreement providing that:
If, and as long as [Jersey] is an S Corporation, then not later than two and one half months after the end of each fiscal year of [Jersey], [Jersey] shall declare and pay a dividend in an amount not less than the amount of income tax that would have been payable by [Jersey] for the most recently ended fiscal year if no election by the Stockholders of S Corporation treatment had been in effect, calculated using the highest incremental rate in effect in the jurisdictions in which [Jersey] maintains its principal place of business.
McCully’s complaint asserted that under this provision, he was entitled to receive in excess of $500,000 as distributions to pay income tax on the company’s income allocated to him on his K-1’s for the 2000 and 2001 fiscal years. McCully alleged that, although he received a tax dividend payment for 2000, he was entitled to receive an additional dividend due to amended 2000 tax returns filed by Jersey. He also alleged that he had received no tax dividend with respect to the 2001 fiscal year.
Jersey moved to dismiss McCully’s complaint on the grounds of a defense founded upon documentary evidence and failure to state a cause of action. Justice Bernard J. Fried of the New York County Supreme Court, Commercial Division, agreed with Jersey and dismissed the complaint.
As to the year 2000 tax dividend, Jersey submitted unrefuted documentary evidence showing that the amended tax returns and K-1’s did not increase McCully’s personal tax liability and that none of the other Jersey shareholders received any additional tax payment dividend as a result of the amendments.
Of greater interest is the court’s discussion of McCully’s claim for 2001 tax payment dividend. Justice Fried’s decision lays out a three-part analysis as follows:
- Under the terms of the shareholders’ agreement (quoted above), Jersey was not obligated to pay a tax dividend for 2001 until two and a half months after the end of the 2001 fiscal year, i.e., March 15, 2002.
- By exercising his dissenting shareholder rights under BCL Section 623, McCully “lost the right to receive dividends declared and paid by [Jersey] after the consummation of the reorganization on November 30, 2001”.
- McCully offered no proof that Jersey actually declared and paid a tax dividend for year 2001 prior to November 30, 2001.
Subdivision (e) of BCL Section 623 expressly provides that upon consummation of the corporate reorganization, “the [dissenting] shareholder shall cease to have any of the rights of a shareholder except the right to be paid the fair value of his shares and any other rights under this section”. The right to receive dividends, Justice Fried observes, “is clearly among the rights lost upon consummation of the corporate action”.
Further support for this conclusion is drawn from Section 623(e)’s provision, that a shareholder who loses his dissenter’s rights by revoking his objection or otherwise, shall be “reinstated to all his rights as a shareholder as of the consummation of the corporate action, including . . . the right to payment of any intervening dividend or other distribution”. “The right to receive any dividend paid following the consummation of the corporate action”, Justice Fried writes, “could only be ‘reinstated’ upon a dissenting shareholder’s loss of his dissenter’s rights if, as a prior matter, the shareholder’s exercise of his dissenter’s rights had triggered his loss of the right to receive any such dividend”.
The decision does not disclose whether or exactly when a 2001 tax payment dividend was distributed to the non-dissenting shareholders following the consummation. Perhaps it was not in the record of the court proceedings because the case was decided on a pre-discovery dismissal motion. In any event, it’s probably safe to assume that by dissenting, McCully missed out on a substantial tax payment dividend for his allocable share of the company’s 2001 net income.
Or did he? The real question is whether McCully’s valuation experts accounted for future tax dividends in their appraisal reports and testimony at the valuation hearing. Justice Fried alludes to this when he points out:
Moreover, if McCully were permitted to recover herein the amount of a dividend paid on his shares after November 30, 2001, such a recovery would be duplicative of his recovery of the fair value of those shares in the Appraisal Proceeding, since that fair value presumably encompassed the value of the right to receive future dividends that would be paid on the shares. (Emphasis added.)
That’s all the court’s opinion says on the subject, so we don’t know whether, in fact, McCully’s follow-up lawsuit effectively sought a double recovery, or whether his experts in the appraisal proceeding omitted the 2001 tax dividend in their valuation. Here’s what the statute, BCL Section 623(h)(4), says about valuing shares in an appraisal proceeding:
In fixing the fair value of the shares, the court shall consider the nature of the transaction giving rise to the shareholder’s right to receive payment for shares and its effects on the corporation and its shareholders, the concepts and methods then customary in the relevant securities and financial markets for determining fair value of shares of a corporation engaging in a similar transaction under comparable circumstances and all other relevant factors.
The language of the statute certainly is broad enough to encompass distributions in the nature of foreseeable post-consummation dividends payable on account of pre-consummation tax liabilities. The important lesson of McCully, therefore, is to understand that Section 623(e)’s cut-off of shareholder rights as of the consummation date does not foreclose the dissenting shareholder from receiving, as part of the fair value award, elements of value arising from future payments of contractual origin under the shareholders’ agreement. Equally important, McCully teaches that if such value is omitted at the appraisal stage, the dissenting shareholder will not get a second chance to recover it.
Update March 26, 2009: The plaintiff McCully appealed Justice Fried’s decision to the Appellate Division, First Department. The appellate court today issued an order affirming Justice Fried’s dismissal of the claim for 2001 tax dividend but reinstated McCully’s claim for additional tax dividend for 2000 on the procedural ground that the defendants’ documentary evidence failed to establish that McCully’s 2000 tax liability did not increase as a result of the company’s amended 2000 tax return.