Minority shareholders in closely held New York corporations, unlike many other states, must hold at least 20% of the corporation’s voting shares to petition for judicial dissolution on grounds of oppression under Section 1104-a of the Business Corporation Law. There’s little if any legislative history to explain the arbitrary 20% threshold. I imagine it was included as a compromise to satisfy legislators opposed to judicial interference with traditional corporate majority rule.
Shareholders with less than 20%, and without any claim for breach of shareholders’ agreement, have limited options to right perceived wrongs by the controlling shareholders. They may bring a derivative action under BCL Section 626 for corporate waste, diversion of assets or other wrongs causing injury to the corporation, but first they either must make proper demand upon the board of directors or demonstrate demand futility. BCL Section 627 also requires a derivative plaintiff-shareholder with less than a 5% interest to give security for the corporation’s costs including legal expenses. Furthermore, depending on the circumstances, commencing a plenary action for breach of shareholders’ agreement or asserting derivative claims for recovery on the corporation’s behalf may not provide sufficient leverage to induce a buy-out of the plaintiff’s shares, assuming the plaintiff is pursuing an exit strategy.
The below-20% shareholder has one other option: common law dissolution. It carries no minimum ownership percentage. It’s harder to establish than statutory oppression under BCL 1104-a, and rarely successful, but under the right circumstances it may give such a shareholder at least a toe-hold toward dissolution, which also may be enough to induce serious buy-out negotiations.
A recent decision by Queens County Commercial Division Justice Orin R. Kitzes presents one of the relatively rare instances in which a claim for common law dissolution successfully advances past the pleading stage. The case, Matter of Mouzakitis (Pearl Nightlife, Inc.), Index No. 28420/08 (Sup Ct Queens County Feb. 24, 2009), was previously featured on this blog when the court initially dismissed without prejudice a common law dissolution petition because the plaintiff’s husband, who co-owned the shares as tenants by the entirety, was not a party to the action. Husband and wife thereafter filed a new action as co-plaintiffs, again suing for common law dissolution.
In his decision addressing the new petition, Justice Kitzes lays out the petition’s allegations as follows:
Petitioners are wife and husband, and they jointly own fifteen shares in Pearl Nightlife, Inc., the operator of a restaurant located at 45-30 Bell Boulevard, Bayside, New York. According to a shareholder’s agreement executed on or about October 9, 2007, the petitioners own their shares as tenants by the entirety. The corporation has issued a total of one hundred shares, and the Mouzakitis allegedly contributed approximately $125,000.00 for their fifteen per cent interest. Nicholas Kiriakis, the holder of thirty shares and the corporation’s president, serves as the manager of the restaurant. The restaurant opened for business on or about March 1, 2008, only about six months ago. The petitioners allege that those in control of the corporation have failed to make required contributions to the business, have failed to pay salaries and dividends, have refused to permit an inspection of corporate books and records, and have diverted corporate funds and assets. The amount of liquor purchased by the restaurant allegedly does not match sales, and Kiriakis has allegedly diverted food supplies to his other restaurants, claiming that the food spoiled. On May 4, 2008, the other shareholders allegedly had the petitioner arrested at the restaurant.
After noting that the petitioners do not meet the 20% threshold for statutory dissolution, Justice Kitzes sets forth the standard for common law dissolution as established in Leibert v. Clapp, 13 NY2d 313 (1963):
In Leibert, the Court of Appeals recognized a common-law right to dissolution of a corporation where the officers or directors of the corporation are engaged in conduct which is violative of their fiduciary duty to shareholders. Dissolution is appropriate if the directors or those in control of the corporation are looting the corporate assets to enrich themselves at the expense of the minority shareholders; continuing the corporation solely to benefit those in control; or that the actions of the directors or those in control has been calculated to depress the capital of the corporation in order to coerce the minority shareholders to sell their stock at a depressed price.
Justice Kitzes further notes that “the proof required to establish a common law dissolution is greater than is required to sustain a shareholder derivative action for waste” because, while the latter seeks to strengthen the corporation, the former seeks to “‘end the corporate life'” (quoting from Fontheim v. Walker, 282 AD 373 (1st Dept 1953), aff’d, 306 NY 926 (1954)).
Justice Kitzes concludes that the petitioners “have set forth sufficient allegations and support to raise an issue that the majority shareholders are enriching themselves at the expense of the minority” and that the “sworn statements of the petitioners are sufficient to warrant a hearing to determine the validity of these allegations.” His order also preliminarily enjoins the defendants from transferring or encumbering any corporate assets outside the normal course of business, and directs that petitioners be given access to all corporate books, including those for construction costs and operating the business.
In Leibert v. Clapp, the minority shareholder alleged that the majority had accumulated a large surplus which it then diverted to a parent company as part of a squeeze-out scheme. The Court of Appeals found that the alleged misconduct by the majority, if proven, “so palpably breached their fiduciary duties they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by the statute.” The allegations in Mouzakitis sound somewhat more garden variety than those in Leibert, but then again, the Leibert court’s pronouncement is broad enough to encompass a wide range of alleged majority shareholder misconduct.