It may surprise some of you to learn that the Surrogate’s Courts in New York have jurisdiction to hear petitions for judicial dissolution of closely held corporations involving the estate of a deceased shareholder. These cases are relatively rare — most shareholder agreements contain provision for mandatory stock redemption upon death — but they do happen from time to time. Case in point: last month the Appellate Division, Second Department, affirmed a ruling by the Surrogate’s Court awarding the estate of a deceased minority shareholder the value of its stock interest, to be paid by the surviving shareholders in proportion to their stock interests. Matter of Verdeschi, 2009 NY Slip Op 05355 (2d Dept June 23, 2009).
As laid out more fully in the underlying September 2006 Decision and Order issued by Westchester County Surrogate’s Court Justice Anthony Scarpino, Jr., Verdeschi involves an accounting firm known as G.B. Tepper & Associates Ltd. ("Tepper & Associates") organized in 1992 as a business corporation (as opposed to the more common professional corporation) with four shareholders: the decedent, Carl Verdeschi (35%), Gerald Tepper (35%), Monte Tepper (15%) and Jay Samuels (15%). They had no shareholders agreement. Prior to Verdeschi’s death in late 2003, each shareholder received a salary and a share of profits proportionate to their stock percentage. After Verdeschi died, the surviving shareholders conducted no further business through Tepper & Associates. Instead, Monte Tepper and Jay Samuels formed a new firm known as Tepper Tax Associates, Inc. ("Tepper Tax") which occupies the same office used by Tepper & Associates, provides the same accounting services to the old firm’s clients, and uses all of the old firm’s office equipment, computers and furnishings. The new firm also employed Gerald Tepper.
The estate’s administrator commenced a turnover proceeding in Surrogate’s Court pursuant to Section 2103 of the Surrogate’s Court Practice Act and Section 1104-a of the Business Corporation Law, to compel the surviving shareholders of Tepper & Associates to turn over to the estate the decedent’s interest therein. The administrator’s petition alleged that the surviving shareholders had engaged in "oppressive actions" toward the estate under BCL 1104-a(a)(1) and had looted, wasted and diverted the corporation’s property for non-corporate purposes under BCL 1104-a(a)(2).
The administrator thereafter moved for summary judgment of liability, and the respondents cross moved to dismiss the petition. After discussing the applicable legal principals, Justice Scarpino granted the administrator’s motion under BCL 1104-a(a)(2) on the basis of the undisputed evidence that the surviving shareholders had misappropriated Tepper & Associates’ assets for their own private purposes in forming and operating Tepper Tax. Justice Scarpino found that the surviving shareholders’ defenses, based in part on allegations that prior to his death the decedent orally disavowed any expectation of a death benefit to any shareholder, were either unsupported by competent affidavit or barred by the Dead Man’s Statute (CPLR 4519).
The court subsequently appointed a Judicial Hearing Officer to hear and determine the appropriate remedy and to value the decedent’s 35% stock interest. The JHO held a two-day trial at which each side presented the expert testimony of an appraiser. The JHO’s September 2007 post-trial decision notes that, prior to trial, the parties stipulated that both appraisers were qualified as experts, but that had the qualifications of respondents’ expert been challenged, it is "doubtful" that he would have been found qualified. In any event, the JHO for the most part accepted the administrator’s expert’s valuation using a 1.2 multiple of Tepper & Associates’ 2003 gross revenues which, after various adjustments, resulted in a value of the estate’s 35% interest of about $260,000. In rejecting the respondents’ appraiser’s zero valuation of the stock interest, he specifically challenged the appraiser’s contention that the firm had no good will value, observing that
the fact that the remaining partners after dissolving its firm to exclude one partner but immediately reconstitute themselves as a new firm using the same name, address, facilities and client list as the dissolved firm, indicates that the dissolved firm had good will to distribute.
The JHO subsequently entered a Decree awarding the estate $260,000 payable by the three surviving shareholders in proportion to their stock interests, plus statutory interest from December 31, 2003. The Decree also awarded judgment for the entire amount against Tepper Tax jointly and severally.
On appeal by the respondents, the Second Department upheld the Surrogate’s Court’s rulings across the board. Here’s what the court said on the issue of liability under BCL 1104-a:
As corporate officers, the surviving shareholders stood in a fiduciary relationship to their corporation and were not allowed to divert and exploit for their own benefit any opportunity that should be deemed an asset of the corporation. Their establishment of a new corporation with two of the same principals, which used the same office, equipment, and furniture, and which served many of the same clients, violated that duty. In opposition, the appellant [Gerald Tepper], who was a surviving shareholder and a full-time employee in the new corporation, failed to raise a triable issue of fact sufficient to defeat summary judgment on the issue of his liability. Specifically, he failed to adduce any evidence in support of his contention that the administrator had steered the decedent’s clients away from the corporation in an attempt to force a judicial dissolution. [Citations omitted.]
The Second Department with equal force rejected the respondents’ challenge to the valuation award, writing as follows:
Contrary to the appellant’s contention, the judicial hearing officer was directed to "hear and determine" all issues concerning the "judicial dissolution" of the corporation and, thus, possessed the same powers as the Surrogate’s Court to conduct a nonjury trial on the issue of damages and to render a final decree. In reviewing that determination, "this Court’s authority is as broad as that of the trial court, and this Court may render a judgment it finds warranted by the facts, taking into account in a close case the fact that the trial judge had the advantage of seeing the witnesses". Here, the judicial hearing officer properly credited the testimony of the administrator’s expert witness regarding the value of the decedent’s share of the value of the corporation, including the value of goodwill, and properly rejected the testimony of the expert testifying for the surviving shareholders. As the Surrogate’s order properly granted summary judgment on the issue of liability upon the establishment of grounds for the dissolution of the corporation pursuant to Business Corporation Law § 1104-a(a)(2), the court was authorized, in its discretion, to provide for the distribution of the decedent’s interest in the corporation to the estate pursuant to Business Corporation Law § 1111(c). The court providently exercised its discretion in fashioning a remedy, and we see no reason to disturb it. [Citations omitted.]
Interestingly, the Decree did not actually order the dissolution of Tepper & Associates which, as of this writing, remains listed as an active corporation on the Department of State’s online database listing. From that standpoint, and given that the surviving shareholders never elected to purchase the decedent’s shares as permitted by BCL Section 1118, the award seems to be in the nature of a compelled buyout even though the Decree also omits any directive requiring the transfer of the estate’s shares upon payment.