It’s a truism that one must be a shareholder to seek judicial enforcement of shareholder rights.  The petitioner’s shareholder status is one of the most frequently waged, threshold battles in proceedings for involuntary dissolution, access to corporation books and records, and other types of internal, shareholder disputes involving close corporations.

Last year I wrote a 3-part series on cases highlighting shareholder standing contests (see here, here and here) including one called Matter of Pappas in which the judge hit it on the nose:

"In the real world, particularly that in which close corporations operate, clear evidence of share ownership is often not found in the corporate books and records, for any number of reasons."

These cases are by their very nature extremely fact intensive.  Sometimes the issuance or non-issuance of stock certificates is critical; sometimes not.  Sometimes the case turns on the issuance or non-issuance of K-1 tax forms (if it’s an S corporation) to the petitioner; sometimes not.  Sometimes the petitioner’s contribution or non-contribution of start-up funds is an important factor; sometimes not.  You get the idea.

Last month, in a case called Kun v. Fulop, 2010 NY Slip Op 02101 (2d Dept Mar. 16, 2010), a panel of the Brooklyn-based Appellate Division, Second Department, affirmed a lower court’s findings and order dismissing an action in which the plaintiff sought a declaration of her status as a 50% shareholder of a close corporation.  The case merits attention (a) because of the relative paucity of appellate decisions in this area, and (b) because it defines the inquiry in contract terms.

The facts of the case are described in detail in the lower court’s October 7, 2008, post-trial decision written by Justice Leonard B. Austin who, subsequently, was promoted to the Appellate Division, Second Department.  The case involves two dentists, Kun (the plaintiff) and Fulop (the defendant), who had a close personal friendship for about five years before their business paths crossed.

In 2002, Fulop found space on Long Island to open a new dental office.  Fulop negotiated the lease which was signed in January 2003, and oversaw the build-out without Kun’s involvement.   The tenant under the lease was a newly formed S corporation with a name proving that dentists do indeed have a sense of humor flavored with optimism: Bucked Tooth Realty Corp.

Kun visited the space, offered to become an equal partner in the leasehold, and relocated her practice there in 2003.  In her lawsuit, which Kun brought in 2007 after Fulop’s attorney sent her an eviction notice, Kun claimed that from its inception she was a 50% shareholder of Bucked Tooth.  The evidence Kun offered in support included:

  • She contributed $1,000 seed money into the corporate bank account;
  • She was designated Vice President of Bucked Tooth on its banking resolution;
  • She paid half of the costs of incorporating Bucked Tooth including filing and legal fees;
  • The office opening announcements sent to patients of the two referred to Kun as Fulop’s "partner" and to the office as "our new location";
  • Kun and Fulop signed equipment lease documents as "owners";
  • Kun paid half the monthly rent due the overlandlord by depositing funds in the Bucked Tooth account.

Fulop contended that, at all times, she alone owned the capital stock of Bucked Tooth.  She offered the following evidence in support:

  • Fulop never agreed to Kun’s request to be an equal owner;
  • The stock ledger reflected the issuance of shares to Fulop only;
  • Only Fulop received K-1’s for the years 2003-06, during which time Kun never inquired as to her entitlement to a K-1;
  • The corporate account was used solely as a conduit for rent payments to the landlord;
  • Kun never intended to have anything more than a landlord-tenant relationship with Kun. 

Justice Austin ruled, and on appeal the Second Department agreed, that Kun failed to establish her ownership of shares in Bucked Tooth.  The appellate ruling observed that the absence of a stock certificate in Kun’s name was not dispositive and, quoting from the above-mentioned Pappas case:

"[t]he relationship between a corporation and its stockholders is contractual . . . To constitute one a stockholder a subscription or contract whereby the right to hold stock or upon some condition to demand stock and to exercise the rights of a stockholder is required" (id. [internal quotation marks omitted]). Pursuant to Business Corporation Law § 504, consideration for the issuance of shares can include money or other property, or "labor or services actually received by or performed for the corporation or for its benefit or in its formation or reorganization."

Kun’s critical shortcoming, the court concluded, was her failure to adduce evidence at trial "demonstrating any understanding or meeting of the minds between Kun and Fulop sufficient to invoke the protection of Business Corporation Law § 504."  Fulop and her attorney both credibly testified, the court noted, that Kun did not ask to become a shareholder until several years after Bucked Tooth’s formation, during which time Kun never asked for or received K-1’s.  The court also noted Kun’s delay of several months in commencing an action after Fulop rebuffed Kun’s demand for shareholder rights.

The Kun case teaches that unilateral expectations and consideration, plus some equivocal trappings of ownership, do not add up to shareholder status absent sufficient evidence of an agreement with the party who formed the corporation.  It is a lesson many, many would-be business owners have ignored, and will continue to ignore, at their own peril.