Many shareholders’ agreements include clauses requiring the parties to arbitrate their disputes. Do such clauses apply when a shareholder seeks judicial dissolution of the corporation based on deadlock or shareholder oppression under Sections 1104 and 1104-a of the Business Corporation Law?
Courts answer the question with an emphatic “Yes”. As a matter of public policy, courts strongly favor arbitration and will readily stay litigation proceedings and compel arbitration when the dispute falls within the scope of the applicable agreement’s arbitration clause. Generally speaking, where the arbitration clause is broad, there arises a presumption of arbitrability, and arbitration of even a collateral matter will be ordered if the issues in the case implicate issues of construction of the shareholders’ agreement or the parties’ rights and obligations under it. Judicial dissolution proceedings alleging deadlock or oppression invariably raise allegations of breach or, even absent breach allegations, turn on the parties’ rights and obligations under the shareholders’ agreement. But even absent specific allegations of breach, courts will find that the dissolution petition is arbitrable.
Here’s an example. In Matter of Tlapanco (Las Pobanitas Inc.), the petitioner filed a court petition for judicial dissolution of a corporation with two 50% shareholders under BCL Section 1104. The corporation operated a restaurant. Petitioner alleged that the restaurant had never shown a profit and that he was no longer employed there. His petition also alleged various breaches of the shareholders’ agreement. The other shareholder asked the court to stay the litigation and to compel arbitration under the following, typical clause in the shareholders’ agreement:
Any dispute arising under the terms of this Agreement shall be resolved by arbitration in accordance with the rules of the American Arbitration Association then obtaining in New York, New York and judgment on the award of the arbitrators may be entered in any court having jurisdiction thereof. Such arbitration shall be a condition precedent to any suit upon or by reason of such claim or controversy.
The court granted the application to compel arbitration. After noting that state policy favors arbitration as a means of resolving disputes and conserving judicial resources, the court continued:
When parties adopt a “‘broad’ arbitration clause agreeing . . . to submit to arbitration all disputes arising out of the contract,” the court’s inquiry is limited to determining whether there is a reasonable relationship between the dispute and the contract. [Citation omitted.] Even a judicial dissolution proceeding has been submitted to arbitration on the ground that the issues of whether and how “shareholders should sever their corporate ties is more than reasonably related to the general subject matter of the agreement establishing those ties.” (Ehrlich v. Stein, 143 AD2d 908, 910 [2d Dept 1988]).
In a similar case, Matter of Kushner (Smiles Candy Corp.), decided by Nassau County Commercial Division Justice Leonard B. Austin, the court compelled arbitration of a shareholder oppression dissolution proceeding even though the respondent majority shareholder never formally moved to compel arbitration.
The lesson of these cases is clear: A broad arbitration clause in the shareholders’ agreement will require arbitration of an involuntary dissolution petition whether or not the petitioner alleges specific breaches of the agreement. In my experience, this is more of an issue, and a bigger disappointment for a petitioner, when the dissolution proceeding does not convert to a buyout and valuation proceeding, thereby likely requiring extensive discovery and adjudication of complex deadlock or oppression issues, and where the hostile parties are likely to encounter ongoing disputes as co-managers of the business while they pursue their legal remedies.
Update July 13, 2011: In Matter of Parness v. Saul, 2011 NY Slip Op 31879(U) (Sup Ct NY County July 6, 2011), Manhattan Supreme Court Justice Debra James granted an application to compel arbitration of a proceeding for judicial dissolution of a New York LLC. The LLC’s operating agreement contained a broad arbitration clause requiring arbitration of “any controversy or claim arising out of or relating to this Agreement, or the breach thereof.”