This month’s Business Valuation Update includes a lengthy analysis of a recent stock valuation decision in a high-stakes corporate dissolution case, Kaplan v. First Hartford Corp., 2009 WL 737681 (D. Me. Mar. 20, 2009), brought by an oppressed minority shareholder of a Maine corporation that developed, owned and operated strip malls. The court, which had to contend with three different expert appraisals that came in $9 million at bottom and $48 million at top, valued the entire enterprise at $15 million based on “Pink Sheets” market trades adjusted — as required by Maine’s buyout statute — to exclude any minority and marketability discounts. The decision is well worth the read for students of the art of stock valuation, but that’s not what I want to address here. Rather, what I find most interesting about the case is who decided it: a federal judge.
Why is that interesting? The federal courts have two basic sources of subject matter jurisidiction: (1) the case involves a federal question, meaning the complaint asserts claims arising under federal statute or the U.S. Constitution, and (2) diversity of citizenship, meaning in most cases that the plaintiffs and defendants are citizens of different states. The typical case seeking judicial dissolution of a state-chartered corporation seeks state law remedies solely, which leaves diversity of citizenship as the only possible avenue to bring a corporate dissolution case in federal court.
In the U.S. Second Circuit, which encompasses New York, Connecticut and Vermont, the federal courts uniformly have abstained, i.e., refused to hear a case over which they otherwise have jurisdiction, from hearing corporate dissolution cases where jurisdiction is based on diversity of citizenship. Abstention doctrine is a highly complex area of federal (and sometimes state) law with several different strains. One of those strains, called Burford abstention after a U.S. Supreme Court case of that name, holds that a federal court sitting in diversity jurisdiction should abstain to avoid needless disruption of state efforts to establish coherent policy in an area of comprehensive state regulation. In Friedman v. Revenue Management, Inc., 38 F3d 668 (2d Cir. 1994) , the Second Circuit Court of Appeals applied Burford abstention to dismiss a complaint seeking judicial dissolution of a New York corporation under Section 1104 of the Business Corporation Law based on shareholder deadlock. The plaintiff-50% shareholder resided in Indiana. The other shareholder was an Illinois corporation. The appellate court determined that abstention was appropriate because it
would avoid needless interference with New York’s regulatory scheme governing its corporations. New York has a strong interest in the creation and dissolution of its corporations and in the uniform development and interpretation of the statutory scheme regarding its corporations. Moreover, to exercise jurisdiction over a dissolution of a state corporation would allow “the possibility of federal dissolution actions, based on [state statutes], being commenced in a number of different districts in which a particular … corporation was subject to service, thereby placing an onerous burden on the corporation.” In addition, every federal court that has addressed the issue of dissolving state corporations has either abstained or noted that abstention would be appropriate, assuming jurisdiction existed. [Citations omitted.]
The federal District Court judges in the Second Circuit have rigorously followed Friedman, to the point of dismissing diversity-based corporate dissolution cases sua sponte, meaning, of their own accord, even when not asked by the defendant to do so, as in Boucher v. Sears, 1999 WL 736532 (NDNY Nov. 21, 1997).
I haven’t done a comprehensive search of federal decisions outside the Second Circuit. A 2002 decision by the Sixth Circuit Court of Appeals, which covers Michigan, Ohio, Kentucky and Tennessee, agreed with Friedman. See Caudill v. Eubanks Farms, Inc., 301 F3d 658 (6th Cir. 2002). I haven’t come across any decision on the subject by the First Circuit Court of Appeals which includes Maine where Kaplan was decided. There is, however, a 2008 decision by the U.S. District Court for the District of New Hampshire, which also is within the First Circuit, abstaining from deciding a corporate dissolution case brought under the court’s diversity jurisdiction. See Neary v. Miltronics Manufacturing Services, Inc., 534 F Supp2d 227 (DNH 2008).
It does not appear that the defendants in Kaplan ever raised abstention as grounds to dismiss the case. In 2006, the federal judge held a trial of the plaintiff’s state law claims for oppression, fraud and breach of fiduciary duty. The Court’s April 2007 decision merely recites that the court has jurisdiction based on diversity of citizenship, and then goes on to uphold the oppression claim.
I can’t close without noting that the Second Circuit’s Friedman decision was in 1994, the year before the Commercial Division was established in the New York Supreme Court, initially in Manhattan and Rochester and later in many other counties throughout the state. The judges of the Commercial Division hear most of the corporate dissolution cases and, over the years, have developed great expertise and understanding of the special needs and dynamics of these cases. Therefore, and apart from the fact that diversity of citizenship among the co-shareholders and the corporation is infrequent, I don’t think that the closing of the federal courthouse door to would-be dissolvers of New York corporations is a significant detriment anymore.
Variation on a Theme (Updated April 28, 2015): In Seismic Reservoir 2020, Inc. v Paulsson, decided yesterday by the United States Court of Appeals for the Ninth Circuit (read here), the court held that, contrary to the lower court’s ruling, the district court did have subject matter jurisdiction in a diversity suit over counterclaims alleging minority shareholder oppression under Canadian law but that the Canadian law’s exclusive jurisdiction provision nonetheless precluded the U.S. court from granting relief.
. . . and a Non-Variation on a Theme (Updated April 17, 2018): Tom Rutledge’s post yesterday on his Kentucky Business Entity Law blog featured a decision last month by a federal District Court judge in the Eastern District of Kentucky in which the court applied Burford abstention to dismiss, without prejudice to re-filing in state court, a diversity action brought by a close corporation against a minority shareholder who had dissented from a merger, seeking a fair value appraisal of the dissenter’s shares under the Kentucky merger statute. The case is Henley Mining, Inc. v Parton, 2018 WL 1526081 [ED Ky. Mar. 28, 2018].