The seminal New York case defining “oppressive” conduct under the statute authorizing a minority shareholder to seek corporate dissolution, Matter of Kemp & Beatley, Inc., 64 NY2d 63, 74 (1984), cautioned that a minority shareholder “whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression should be given no quarter in the statutory protection.”  This language gave birth to what has become known as the “unclean hands” defense in shareholder oppression cases under Section 1104-a of the Business Corporation Law (BCL).  The unclean hands defense often is based on allegations that the petitioning minority shareholder secretly is involved with or planning to launch a competing business to steal the customers and good will of the company whose dissolution is sought.

Over the years since Kemp, the unclean hands defense also has crept into dissolution cases brought by a 50% shareholder under BCL Section 1104 based on deadlock and internal dissension.  Unlike oppression cases under Section 1104-a, where the minority shareholder must prove some form of at-fault or unfair conduct by the majority, cases under Section 1104 focus on the deterioration of the relationship between the two 50/50 shareholders and the resulting corporate paralysis, without necessarily assigning fault to one side or the other.

A recent decision by Nassau County Commercial Division Justice Stephen A. Bucaria, in Matter of Rieger (Airmarine Electroplating Corp.), Short Form Order, Index No. 010524/09 (Sup Ct Nassau County Aug. 27, 2009), illustrates the difficulty of maintaining the unclean hands defense in a deadlock dissolution case where, absent compelling proof, the allegations of inequitable conduct by the petitioner can themselves contribute to the court’s sense of shareholder hostility and corporate dysfunction warranting dissolution.

Rieger involved a fight between brother and sister Ernest and Laurie Rieger.  The Riegers are 50/50 shareholders of Airmarine Electroplating Corp. which is in the business of refurbishing airplane parts.  The Riegers also co-own a second company called Airlift Hydraulics which holds the FAA certificate enabling Airmarine to receive FAA aircraft component refurbishing manuals.

Ernest filed a petition for judicial dissolution of Airmarine under Section 1104 based on animosity and dissension between himself and his sister.  He alleged that they could not reach agreement on how to manage the corporation; that the ensuing deadlock prevents the corporation from benefiting the shareholders; and that no purpose would be served by holding a shareholders or directors meeting.

Laurie sought dismissal of the petition based on Ernest’s “unclean hands”.  As described in Justice Bucaria’s decision, Laurie claimed that Ernest was seeking to dissolve Airmarine

to create his own personal corporation using the same clients and the same FAA certificate that are used by [Airmarine].  Laurie alleges that her theory is bolstered by the fact that Ernest does not seek to dissolve Airlift Hydraulics, because then he would no longer be in possession of the FAA certificate and would not be able to open his own personal Aircraft refurbishing corporation.

Laurie also alleged that her brother was misappropriating corporate funds, taking excessive salary, and “hiding” documents from her.

The court’s reference to Laurie’s “theory” may or may not indicate a lack of hard proof of her brother’s plans to start his own refurbishing business.  In any event, Justice Bucaria held that her unclean hands defense was not adequate to stave off dissolution since “‘the critical consideration is the fact that dissension exists and has resulted in a deadlock precluding the successful and profitable conduct of the corporation’s affairs'” (quoting Matter of Goodman v. Lovett (200 AD2d 670)).  Laurie’s allegations of misconduct by her brother, Justice Bucaria wrote,

essentially demonstrate that the standard for involuntary dissolution has been met.  Laurie and Ernest clearly do not agree on how the Corporation should be run, and act in a hostile manner towards one another.  Laurie further admits that the company has not been operating at a profit as of late, and she has provided no plan that the company will do so in the future.  Laurie states that Ernest has breached his good faith duty to her as a co-shareholder, and this only re-iterates that the standard for involuntary dissolution has been met.

The fact that Laurie claims Ernest acted in bad faith regarding the management of the Corporations is of no moment, inasmuch as the dissension and distrust is palpable and real.  The petitioner showed, and the respondent reinforced, that the disagreements between the two parties “pose an irreconcilable barrier to the continued functioning and prosperity of the corporation.”  [Citations omitted.]

It would be an overstatement to say that the unclean hands defense has no application in the deadlock dissolution context.  I can readily imagine a scenario in which a 50% shareholder deliberately manufactures dissension and brings a dissolution proceeding in furtherance of a plan to walk off with the company’s customers.  It really boils down to a matter of proof and, as Rieger illustrates, in the absence of compelling proof the allegations of unclean hands only serve to reinforce the atmosphere of irreconcilable hostility supporting involuntary dissolution.