Professional service corporations are "interesting" and "strange creatures". So says Nassau County Commercial Division Justice Ira B. Warshawsky in an interesting (but not strange) post-trial decision issued last month, rejecting a claim for statutory buyout in a suit brought by a terminated partner in a law firm organized as a professional corporation.
The case is Lubov v. Welikson, 2008 NY Slip Op 28392 (Sup Ct Nassau County Sept. 29, 2008). You can read the decision here. Additional background is found in the court’s January 2008 decision denying summary judgment motions (read here).
The law firm in Lubov initially was organized in 1989 as a general partnership. In 1993 it converted to a professional service corporation ("P.C.") under Article 15 of the Business Corporation Law. P.C.s are a popular form of limited liability entity eligible for partnership tax treatment, available to lawyers, doctors, accountants and other regulated professions.
The plaintiff alleged that prior to the firm’s conversion to a P.C. the partners made an agreement to redeem the interest of a withdrawing partner for the sum of the partner’s capital contribution and percentage of accounts receivable. Plaintiff also alleged that the shareholders nee partners of the P.C. adopted the same agreement.
Plaintiff’s percentage interest in the P.C. started at 30%. In 1994 he voluntarily surrendered half his interest at the same time he began working fewer days and pursued other personal business affairs. At the time, he allegedly asked about redemption of the surrendered shares, but supposedly was put off by the majority shareholder. Plaintiff’s percentage interest rose to 16% in 1997 when another 10% shareholder left the firm.
In his summary judgment ruling, Justice Warshawsky wrote that "plaintiff was, speaking plainly, thrown out" of the firm in February 1999. Plaintiff thereafter brought suit to recover the redemption value of his claimed shares of stock in the P.C. as of 1994, with respect to the 15% stock interest he surrendered at that time, and as of February 1999 with respect to the 16% interest.
The court rejected the plaintiff’s claim for breach of express redemption agreement, stating that "the proof at trial was less than convincing that there was either a written or oral agreement in existence at the time the plaintiff was removed from the firm that controlled the rights of a departing shareholder."
The plaintiff alternatively pursued redemption rights under BCL 1510 which provides that P.C.s "shall purchase or redeem the shares of a shareholder" who dies or is disqualified under BCL 1509 within six months after death or disqualification, at the book value of the shares. Section 1509 requires a shareholder who "becomes legally disqualified to practice his profession within the state" to "sever all employment with, and financial interests (other than as a creditor) in, such corporation forthwith or as otherwise provided in section 1510."
A lawyer generally becomes "legally disqualified" to practice his or her profession one of two ways: voluntary resignation from the bar, or involuntary disbarment. The plaintiff nonetheless contended that he qualified for redemption under Section 1510 because he "retired" from the practice of law in 2004 and because, as a matter of public policy, the statute should be construed to apply to instances where a shareholder is discharged from employment, as well as death or disbarment.
Justice Warshawsky declined the plaintiff’s invitation, finding no "constitutional rule, legislative enactment or court decision which supports a doctrine or public policy that would support an expansion of BCL 1510." The P.C., he wrote,
has existed under our laws for over thirty-five years and there has been no amendment of the sections of the BCL which control the Professional Corporation that would either expand section 1510 or independently expand the law to cover the distribution rights of a terminated shareholder. * * * * * Section 1510 in no way indicates that an obligation exists to purchase the shares of a discharged owner. While it does state that a P.C. is obligated to purchase or redeem the shares of a deceased or disqualified shareholder, the absence of any instruction for a discharged owner in a statute rife with specificity seems to indicate that no remedy in such a case was contemplated by the legislature, in spite of what may seem illogical to plaintiff and, in fact, to the court. * * * * * Perhaps the legislature preferred that such provisions to be taken care of in the certificate, by-laws, or agreement, where P.C.s could set terms based on numerous factors, such as the value an owner brought to a practice. Perhaps the legislature felt that the partnership aspect of a P.C. is dominant, and as such shares do not have the same inherent worth as a typical corporation. Such speculation, however, is irrelevant for the court’s decision making. As it stands, the legislature has written a clear statute that spells out certain conditions for redemption or purchase, and these conditions are not met by plaintiff. However unfair this may seem, the court is not about to write new laws nor replace the role of the legislature.
The court also rejected the plaintiff’s contention that his voluntary "retirement" from the practice of law in 2004 should be deemed legal disqualification within the meaning of BCL 1509:
Plaintiff wishes the court to equate "retirement" with "legal disqualification." This court will not. Plaintiff’s retirement was, to our knowledge, voluntary. It does not fit the scenario as set forth in section 1510. Not only was the plaintiff no longer employed by [the law firm], but his disqualification to be a shareholder in a Professional Corporation came through his own voluntary acts, i.e., he was not forced out of the Professional Corporation (due to a lack of license) which would trigger the offer to sell his shares. The court rejects this theory that "retirement from the practice of law" equals "disqualification from the practice of law" for the purposes of BCL § 1510.
At first blush it may seem strange, to use the judge’s word, that the statute treats more favorably a professional who is disqualified by reason of his or her serious violation of official disciplinary rules, than one who is ousted from the P.C. by action of the majority shareholders. On the other hand, it’s not illogical that the legislature would craft a statute that compels a swift and certain severance of a defrocked professional from the P.C., while leaving to the realm of private negotiation the terms and conditions of disassociation from the P.C. under circumstances not implicating the state’s interest in professional regulation.