There are a couple of lessons to be learned from a recent decision by Nassau County Supreme Court Justice Daniel Palmieri in a quirky case called The Woods Knife Corp. v. Eastman Machine Co., 2009 NY Slip Op 32069(U) (Sup Ct Nassau County Sept. 2, 2009).
The first is, a minority shareholder who also does business with the corporation, and who fails to secure safeguards in the shareholders’ agreement concerning the commencement of lawsuits by the corporation regarding their business dealings, cannot count on shareholder dissension issues to forestall enforcement of the corporation’s commercial rights.
The second lesson is, if you’re going to seek involuntary corporate dissolution, you must follow the procedural dictates of Section 1106 of the Business Corporation Law, which requires commencement of a special proceeding by petition and order to show cause with publication and service upon necessary parties including the state tax commission. A counterclaim for judicial dissolution in an existing litigation won’t cut it.
The case involves two companies, Woods Knife Corporation and Eastman Machine Company, both formed many decades ago. Eastman, owned by the Stevenson family, manufactures cloth cutting machines. Woods Knife, owned 49% by the Stevenson family and 51% by the Woods family, manufactures blades used in Eastman’s machines. The original agreement contained Eastman’s pledge to "make every effort" to purchase its blade requirements from Woods Knife, but also permitted Woods Knife to sell to others. Nonetheless, over time Woods Knife became wholly dependent on Eastman for sales of its blades.
The commercial relationship between the two came under stress in recent years due to intense price competition from Chinese blade manufacturers. Eastman claimed that it could no longer sell or resell Woods Knife blades for use in Eastman’s machines because of their high cost. Eastman alleged that in its role as minority shareholder and adviser, it attempted to help Woods Knife reduce costs and expand its customer base, but did not succeed due to lack of cooperation by James Woods, the principal and manager of Woods Knife. Eastman offered to purchase James Woods’ 51% interest in Woods Knife, but the offer was rejected.
The first litigation salvo was fired by Woods Knife by way of a complaint alleging that Eastman owed it over $184,000 for blades sold and delivered to Eastman from October 2008 through January 2009. Eastman’s answer to the complaint did not deny that it ordered and accepted the blades. Instead, its answer included a counterclaim for judicial dissolution under BCL Section 1104-a contending that James Woods had engaged in oppressive conduct and breach of fiduciary duty to Eastman as minority shareholder, and that James Woods’ lack of cooperation threatened the viability of Woods Knife and consequently Eastman’s 49% interest.
Woods Knife then moved for summary judgment on its claim for goods sold and delivered. In opposition, Eastman contended that Woods Knife was "moribund," "insolvent" and "in de facto dissolution" due to the cessation of Eastman’s orders. Eastman also suggested that any monies recovered by Woods Knife in the action "will not go to support the business, but will instead go to the individual [James Woods], to the detriment of Eastman’s interest." Eastman offered to pay $100,000 into court to retire "legitimate debts" of Woods Knife, "pending an accounting to determine all of the plaintiff’s legal liabilities and who should receive payment."
Justice Palmieri granted summary judgment for Woods Knife based on the admissions in Eastman’s answer and opposing affidavit that it had accepted shipment of the blades, that the amounts sought were accurate, and that Woods Knife had not been paid. Eastman’s opposition, based on the alleged need to dissolve Woods Knife, was no defense, Justice Palmieri wrote, because
even if dissolution of the plaintiff is available to the defendant as 49% shareholder, this cannot serve as a reason to deny plaintiff judgment on its first and second causes of action. The Court agrees with the plaintiff that the defendant’s concern about how payment will be used by the plaintiff is irrelevant in the context of the present action.
Woods Knife also sought summary judgment on the merits dismissing Eastman’s dissolution counterclaims, which Justice Palmieri denied. He did, however, dismiss them without prejudice as procedurally defective, for failure to comply with BCL Section 1106’s above-noted requirements for the commencement of a judicial dissolution proceeding.
Eastman appears to have heeded Justice Palmieri’s advice. On October 8, 2009, Eastman filed a separate new proceeding in Nassau County Supreme Court which, from the limited information available online, appears to be one for judicial dissolution of Woods Knife. If there’s any decision in the new case, I’ll be sure to report on it.
Update March 28, 2010: As promised, by order dated March 10, 2010 (read here), Nassau County Supreme Court Justice Antonio I. Brandveen dismissed Eastman’s dissolution petition upon finding that Eastman had failed to meet its burden to prove oppressive conduct.