If you’re going to accuse your business partner of bad acts and ask for judicial dissolution of the business, be prepared to settle or take the case all the way to trial. That seems to be the message given to the petitioner in one recent dissolution proceeding when the court turned down her request to discontinue the case “without prejudice” to her bringing a future dissolution proceeding based on the same allegations.  Matter of Holland (Romper Nursery, Inc.), Short Form Order, Index No. 8871/07 (Sup Ct Nassau County Dec. 30, 2008).

The underlying dispute is a fascinating one involving one of the toughest nuts to crack in the realm of business divorce:  What should a court do when a 50% shareholder seeks judicial dissolution of a profitable operating company under the deadlock statute (BCL 1104) on the ground of “internal dissension” due to personal animus between the two shareholders?  I wrote an October 2004 article for the New York State Bar Association Journal on the subject, in which I concluded that

Cases decided under the internal dissension statute exhibit something of a split personality, depending on whether the court views the corporation, successful or not, as more akin to a partnership terminable at will, or as an entity distinct from its owners, to be maintained if financially viable notwithstanding internecine warfare.  Arguably, this duality is inherent in the statute’s requirement that the petitioner establish both the existence of internal dissension and that the factions are so divided that dissolution would be beneficial to the shareholders. In other words, the statute can be read such that the cessation of shareholder hostilities itself is an adequate benefit of dissolution, or it can be read to require some other benefit (i.e., financial) that may be hard to show when the business is otherwise viable and making money.

The Romper Nursery Case Background

The Romper Room Nursery School seems an unlikely setting for a bitter shareholder dispute.  Jeanie Holland and Margaret Zack as 50-50 shareholders opened the nursery school in 1975.  During the summer a day camp operates at  the school’s two locations in Great Neck and East Williston on Long Island.  The school also offers bus transportation.

The nursery school prospered over the following three decades despite extreme alienation between the co-owners.  As related in a January 2008 decision by Nassau County Commercial Division Justice Ira B. Warshawsky , for 13 years, between 1989 and 2001, Holland and Zack did not even speak to each other.  They have no shareholders’ agreement and never held meetings of the Board of Directors.  They nonetheless devised a workable division of labor which keeps the business profitable.  Each performs separate duties and works on two separate days of the week.  They take equal salaries and distributions.

In 2005, Holland filed the first of two successive petitions for judicial dissolution of Romper Nursery under BCL 1104.  The first proceeding was withdrawn without prejudice in March 2007 so that the parties could negotiate a buyout.  As things developed, the parties could not even agree which one would be the buyer, much less could they agree on price.

Two months later, Holland filed her second deadlock dissolution petition accusing Zack of the same “divisive acts” including waste of corporate assets and property; permitting child transportation on unsafe buses; dereliction of payroll duties; keeping school open during inclement weather; and involving employees in management disputes.  Zack denied all allegations of misconduct and asserted that Holland was trying to push her out of the business.

In his January 2008 decision mentioned above, Justice Warshawsky ruled that the issues raised in Holland’s dissolution petition required an evidentiary hearing.  The court noted with apparent understatement that the communications arrangement between the parties was “unusual,” but went on to say:

Yet, the system has inured to the benefit of the corporation according to the record now before me.  Seemingly, each generation of new parents send their children to the nursery school they attended. . . . There is no evidence, nor factual proof, before the court that the personal animus between the shareholder-directors prevents efficient management and corporate success. . . . Each case turns on its facts.  The court cannot make a determination on the facts in the record whether this is a case of a business which is profitable, but the dissension is so pervasive that dissolution is warranted for the benefit of the shareholders.

The Bid to Withdraw the Second Proceeding

It’s not clear from the decisions whether the evidentiary hearing was held.  What is clear is that Holland subsequently changed lawyers and that her new lawyer applied for an order pursuant to CPLR 3217(b) permitting Holland to voluntarily discontinue the dissolution proceeding without prejudice.  Holland gave as her reasons for withdrawing the case the financial and emotional costs of the litigation, and the uncertainty of its outcome despite the “rosy predictions” of her first lawyer.

Zack contended that any dissolution must be with prejudice, meaning that Holland would be unable later to start a new dissolution proceeding based on the same factual circumstances.  Holland countered that a discontinuance with prejudice would “serve as an absolution of [Zack’s] potentially or actually bad behavior” and that “should [Zack’s] behavior in the future cause a threat to the safety and well being of the children attending Romper Nursery it would be a ‘travesty’ to allow [Zack’s] past behavior to be considered irrelevant.”

Justice Warshawsky agreed with Zack in his December 30, 2008 decision.  He denied Holland’s application to discontinue without prejudice and instead offered her the choice of accepting a dismissal with prejudice or proceeding to trial on a date certain.  Here’s the crux of his ruling, omitting the case citations:

[T]he court directs that those acts by [Zack] which are central to this special proceeding are precluded from serving as a basis for initiating another lawsuit.  To allow [Holland] to sue [Zack] for the same acts as have been vigorously defended in this lawsuit would prejudice a substantial right of [Zack] to have a timely resolution of the matter after committing substantial resources to her defense, or to be free of litigation.  But, subject to the application of evidentiary rules by the justice presiding over any future matter any prior acts may be introduced into evidence for other purposes.

Justice Warshawsky then elaborated on his ruling as follows:

Seemingly [Holland] has figuratively weighed the perceived danger to the nursery school children against the tangible and intangible costs she has paid to protect them, and found the costs to be greater than the danger.  The future will not change the present, only perceptions of it, and [Holland’s] decision based on facts known to her now is final.  The law does not permit a litigant to change his or her mind based on hindsight once given a full and fair opportunity to seek redress for a wrong.

For obvious reasons, courts like it when litigants voluntarily withdraw a case.  A “with prejudice” discontinuance just as obviously is a deterrent to voluntary withdrawal, so courts tend to use sparingly their power under CPLR 3217(b) to impose “with prejudice” as a condition of discontinuance.  Here, a number of factors justified the condition: it was the second successive dissolution petition asserting the same claims; the respondent, Zack, incurred substantial legal fees defending herself in the two proceedings spread over three years; and the two successive requests to discontinue raise an inference that the litigation’s tactical purpose to force a buyout was at least as large a factor in bringing the case as the petition’s professed alarm over mismanagement and school safety issues.