Many New York businesses are incorporated in other states, Delaware being the traditional favorite. In most instances these corporations are foreign in name only, i.e., their offices, assets, employees, shareholders and directors all are located in New York. Can a shareholder sue for dissolution of a New York-based foreign corporation in a New York court under New York’s dissolution statutes?
The lead article in this month’s online newsletter published by Drinker Biddle highlights two recent, unpublished New Jersey court decisions in which that state’s dissolution statute was applied to foreign corporations based in New Jersey. In Krzastek v. Global Resource Industrial and Power, Inc., No. A-1815-06T2 (App. Div. Sept. 11, 2008), the New Jersey appellate court upheld application of the state’s oppressed minority shareholder dissolution statute in a suit brought by a minority shareholder of a Massachusetts corporation. In Conway v. DialAmerica Marketing, Inc., No. BER-C-116-08 (Super.Ct. Sept. 30, 2008), the trial court did the same in a case brought by a minority shareholder of a Delaware corporation. In both cases, the courts applied New Jersey law based on an interests-based conflict of laws analysis. In both cases, the New Jersey dissolution statute afforded the plaintiffs rights and/or remedies (especially in regard to buyout) broader than those available under the laws of the states of incorporation. In both cases, the defendants unsuccessfully argued for dismissal based on the the "internal affairs doctrine" under which courts traditionally refused to exercise jurisdiction where the determination of the rights of the litigants involves regulation and management of the internal affairs of a foreign corporation.
Could it happen in New York? Case precedent suggests not, although the issue is not fully settled.
The leading New York precedent on the internal affairs doctrine is Langfelder v. Universal Laboratories, Inc., 293 NY 200 (1944), decided by the New York Court of Appeals (the state’s highest court). The case was brought in New York by dissenting shareholders objecting to the terms of a merger involving two Delaware corporations. Here’s the court’s description of the internal affairs doctrine under which the case was dismissed:
There are cases in which our courts will entertain jurisdiction in suits against foreign corporations where suitors, even stockholders, are entitled to some relief which the State court is competent to grant. But it is well settled that jurisdiction in any case will be declined either in the absence of jurisdiction in the strict sense or where a determination of the rights of litigants involves regulation and management of the internal affairs of the corporation dependent upon the laws of the foreign State or where the court in which jurisdiction is sought is unable to enforce a decree if made or where the relief sought may be more appropriately adjudicated in the courts of the State or country to which the corporation owes its existence.
Although the doctrine generally has fallen out of favor in the ensuing decades (see former Justice Herman Cahn’s highly informative discussion of the issue in Matter of Topps Co., Inc. Shareholder Litigation, 19 Misc 3d 1103(A), 2007 NY Slip Op 52543(U)), it has retained vitality in the realm of judicial dissolution proceedings brought under Article 11 of the New York Business Corporation Law.
This is due in large part to a pair of rulings by the Appellate Division, Second Department, in Warde-McCann v. Commex, Ltd., 135 AD2d 541 (2d Dept 1987), and Matter of Porciello, 253 AD2d 467 (2d Dept 1998), where, with virtually no discussion, the court invoked the internal affairs doctrine in dismissing proceedings to dissolve Delaware and Florida corporations. These cases have been followed in numerous lower court decisions within and outside the Second Department. (A recent example is Justice Bucaria’s Schneck decision about which I wrote last year.)
The First Department’s decision in Matter of Hospital Diagnostic Equipment Corp., 205 AD2d 459 (1st Dept 1994), arguably points in a different direction. There, the court upheld the dismissal of a deadlock dissolution proceeding involving a Delaware corporation on the discretionary ground of forum non conveniens due to the corporation’s lack of substantial contacts with New York. The New York Attorney General also had moved for dismissal on the ground the court lacked jurisdiction to dissolve a foreign corporation. In its decision the First Department expressly rejected the Attorney General’s argument that, whatever the court’s authority to grant other forms of relief, under principles of comity it lacks jurisdiction to order dissolution of a foreign corporation.
There’s been little, subsequent case activity putting Hospital Diagnostic‘s jurisdictional view to the test. In Sokol v. Ventures Education Systems Corp., 10 Misc 3d 1055(A) (Sup. Ct. NY County 2005), the court held that it could not entertain a request to dissolve a New York-based Delaware corporation but that it had jurisdiction to grant remedies short of dissolution. Here’s how New York County Commercial Division Justice Richard B. Lowe III navigated the cross currents created by the First and Second Department precedents:
"It is well settled that ‘a foreign corporation is controlled, as to its dissolution, by the laws of its domicile, and is not affected by laws which are intended to govern the dissolution of corporations created under local laws’ " (Matter of Warde-McCann v Commex, Ltd., 135 AD2d 541, 542 [2d Dept 1987], quoting 17A Fletcher’s Cyclopedia of the Law of Private Corporations § 8579, at 516 [Perm ed] [now, at 454-55 (1998 rev ed)]; Matter of Porciello v Sound Moves, Inc., 253 AD2d 467 [2d Dept 1998]; Mook v Berger, 26 AD2d 925 [1st Dept 1966], appeal granted 19 NY2d 581 ; see BCL § 1104-a). A corporation is domiciled only in the state where it is incorporated (Sease v Central Greyhound Lines, Inc., of New York, 306 NY 284 ). VESC is incorporated under the laws of Delaware and, therefore, may be dissolved only by order of a Delaware court.
For these reasons, the branches of Sokol’s cross motion for dissolution of VESC and appointment of a liquidating receiver are denied.
However, this court may exercise subject matter jurisdiction over the other issues raised by the parties. Subject matter jurisdiction over the internal affairs, short of dissolution, of a foreign corporation may be found, in the court’s discretion, to exist in equity where the corporation’s sole connection to a foreign state or country is its place of incorporation and the corporation has significant and substantial ties with New York (Matter of Dissolution of Hospital Diagnostic Equip. Corp. [Klamm], 205 AD2d 459 [1st Dept 1994]; Broida v Bancroft, 103 AD2d 88 [2d Dept 1984]; Tosi v Pastene & Co., 34 AD2d 520 [1st Dept 1970]). Where jurisdiction exists, "the fact that the relief nominally sought (i.e., dissolution and forfeiture of the corporate charter) is not technically within the power of the Court does not bar the award of lesser or alternative relief in this action . . . which will attain substantial justice between the parties" (Matter of Dohring for the Dissolution of CVC Prods., Inc., 142 Misc 2d 429, 433 [Sup Ct, Monroe County 1989]).
Significantly, in Sokol Justice Lowe rejected the plaintiff’s request to apply New York’s substantive law to the plaintiff’s claim of minority shareholder oppression. Rather, Justice Lowe held that the claim had to be decided under the more demanding standards of Delaware statutory and common law because the corporation’s charter and bylaws demonstrated that the founders (including the plaintiff) "agreed to govern VESC’s internal affairs in accordance with the laws of Delaware." In this regard, Sokol seems incompatible with the New Jersey courts’ analysis in Krzastek and Conway.
I did not find in the two New Jersey opinions any acknowledgment of the "technical" barrier to dissolution of a foreign corporation noted in the New York cases, namely, the inability of a court in one state to order the secretary of state in another state to dissolve a corporation. The practical answer may lie in New Jersey’s strong policy in favor of buyouts, as reflected in the New Jersey dissolution statute’s express provisions authorizing the court to compel the respondent shareholders to purchase the petitioner’s shares or vice versa. New York courts have rarely compelled buyouts and, to my knowledge, never in the form of a compelled buyout of a respondent by a petitioner.
Perhaps some day one of the other Appellate Division Departments will unequivocally split with the Second Department, requiring the New York Court of Appeals to decide once and for all the scope of judicial authority to entertain a petition for judicial dissolution of a foreign corporation. Until then, New York shareholders of closely held foreign corporations who seek the remedy of judicial dissolution must do so in the state of incorporation. In the case of a minority shareholder of a Delaware corporation, this can be a daunting challenge given Delaware’s lack of a minority shareholder oppression statute (except for statutory close corporations) and given Delaware case law that is generally more hostile to oppression claims than New York’s.
Shareholders unwilling to sue for dissolution in the state of incorporation alternatively may consider bringing a derivative action, e.g., for breach of fiduciary duty, in New York state court as specifically authorized by Section 1319 of the New York Business Corporation Law. As explained by Justice Kenneth Fisher in Potter v. Arrington, 11 Misc 3d 962, 2006 NY Slip Op 26062 (Sup. Ct. Monroe County 2006), in such an action the court is still required to apply New York’s conflict of laws rules, which likely will result in application of the foreign state’s substantive law.
My thanks to Brian Waters at Drinker Biddle for providing copies of the Krzastek and Conway decisions.