Once in a while there comes along a corporate dissolution case fraught with so many interesting and challenging issues of fact and law that, as the saying goes, a student of business divorce could “go to school on it.” Of course, it also helps to have an engaged judge willing to serve as “teacher”, i.e., a judge who carefully parses the issues and writes a thoughtful, well-reasoned decision that sets forth the competing factual narratives and operative legal principles.
A protracted dissolution battle in Brooklyn Supreme Court called Matter of Pappas (Corfian Enterprises, Ltd.), presided over by Justice Jack M. Battaglia (pictured), is just such a case.
Pappas began in 2004, when the widow of Eleftherios Pappas embarked on what became a 6-year trek through the legal system trying to establish and get paid for her late husband’s ownership interest in commercial realty and two closely held corporations which, she alleged, were co-owned with two other individuals, Theodoros Kalogiannis and Paul Fotinos. There was no direct evidence, by way of shareholder agreement or other reliable records, establishing ownership of the corporations, of which Mr. Fotinos claimed to be 100% shareholder.
In January 2009, after holding an evidentiary hearing on the issue of Mrs. Pappas’ standing to seek corporate dissolution, Justice Battaglia wrote a tour-de-force opinion weighing the conflicting evidence and analyzing a slew of legal issues, in which he concluded that only one of the two corporations, named Corfian Enterprises, Ltd., was co-owned as equal one-third shareholders by the late Mr. Pappas’ estate along with Messrs. Kalogiannis and Fotinos. (Read here my post about the January 2009 decision.)
A year and a half later, and after holding a second trial on the merits, Justice Battaglia has issued another lengthy, fact-filled, law-laden decision in which he grants Mrs. Pappas’ petition to dissolve Corfian based on shareholder oppression by Mr. Fotinos, and directs the appointment of a referee to close the business of the corporation, marshal its assets, and determine and discharge its liabilities. The decision, dated July 23, 2010, and reported at 2010 NY Slip Op 51300(U), can be read here.
The issues addressed in the decision are too numerous to relate in detail, so I’ll just highlight them in the following bullet points:
- Statute of Limitations. Mr. Fotinos argued that the Pappas Estate’s claims sounded in “breach of a contract to issue shares of stock” and therefore accrued some years before his death in 2000, such that Mrs. Pappas’ suit brought in 2004 was time barred. The court disagreed, noting that a claim for dissolution pursuant to section 1104-a of the Business Corporation Law is governed by the “so-called six-year residual limitation” period found in section 213(1) of the Civil Practice Law and Rules; that the limitation period is measured from the “instances of alleged wrongdoing adverted to by [petitioner] as grounds for dissolution”; and that Mrs. Pappas “may legitimately support [her] claim for dissolution with evidence of ‘oppressive action’ during the six-year period prior to commencement of the Dissolution Proceeding on March 9, 2004.”
- Laches. In 2001, about a year after her husband’s death, Mrs. Pappas learned that Mr. Fotinos claimed 100% ownership of Corfian. Mr. Fotinos argued that Mrs. Pappas was guilty of laches, i.e., that he was prejudiced by her allegedly unreasonable and inexcusable delay in commencing the action in 2004. Justice Battaglia held otherwise, stating that a “period of less than four years, well within the applicable six-year statute of limitations,” did not constitute laches; that Mr. Fotinos could “point to no evidence of prejudice”; and that there was no evidence “that Mr. Fotinos did anything more than would have been expected of him consistent with the ‘high degree of fidelity and good faith’ that he owed the other shareholders in this close corporation.”
- Failure to Plead Looting as Basis for Dissolution. Mrs. Pappas’ petition solely pleaded oppressive actions as the basis for dissolution under BCL section 1104-a(a)(1). She did not plead that the corporation’s assets were being looted, wasted or diverted as grounds for dissolution under section 1104-a(a)(2), and she did not move after trial to conform the pleadings to the proof. Justice Battaglia therefore refused to consider her argument for dissolution based on subdivision (a)(2).
- Two Categories of Oppression Cases. Justice Battaglia’s decision collects oppressed-shareholder case citations which he separates into two categories: (1) “freeze out” and “squeeze out” cases involving expulsion or other deprivations directed against a shareholder actively employed in the business, and (2) dissolution claims by a merely “passive shareholder” or based upon a failure to declare dividends when dividends were never previously paid. Corfian, the court concludes, falls in the second category based on “a reasonable expectation of sharing in the ‘profits’ of the business, as they might be realized by Corfian.”
- Denial of Shareholder Status as Oppression. The “most important” factor in finding that Mr. Fotinos engaged in oppressive conduct, Justice Battaglia wrote, was Mr. Fotinos’ “denial that Messrs. Pappas and Kalogiannis were equal stockholders with him in the business”, adding that it is “difficult to recognize a more reasonable shareholder expectation than that its interest will not be repudiated in its entirety, and that legal action would be required to compel its acknowledgment.”
- Analogy to Partnership Dissolution. Although, as Justice Battaglia noted, the case authorities require that every order of dissolution be conditioned upon permitting the other shareholders to elect to purchase the complaining shareholder’s shares for fair value, here the parties had stipulated that none of them is seeking a buy-out. Mr. Pappas’ death, and the subsequent retirement of Mr. Kalogiannis, rendered dissolution “consistent with the real-world similarity between closely-held corporations and partnerships”. Just as the death or withdrawal of a partner dissolves the partnership by operation of law, Justice Battaglia wrote, “that the same result obtains here would not offend the purpose or policies of BCL section 1104-a.”
- Damages/Surcharge. Mrs. Pappas also sought a money judgment against Mr. Fotinos for approximately $1.6 million allegedly representing the amount he wrongfully dissipated from Corfian mostly for salary to himself and the value of Corfian’s building used rent-free by other companies wholly owned by Mr. Fotinos. The court rejected the claim which it characterized as a claim belonging to the corporation and therefore one required to be asserted in a derivative action, which Mrs. Pappas failed to bring. Justice Battaglia also rejected Mrs. Pappas’ alternative claim for a “surcharge” under BCL section 1104-a(d), based on: (1) her failure to cite the provision in her petition; (2) “there is at least a question” whether surcharge is permissible when dissolution is based solely on oppressive actions and not on looting-type allegations under section 1104-a(a)(2); and (3) her failure to offer evidence to support a finding of “wilful or reckless conduct” as required by section 1104-a(d).
- Spoliation. Lastly, the court notes that Mrs. Pappas sought “conclusive inferences based upon spoliation of evidence” by Mr. Fotinos who testified that he destroyed certain financial and other business records after he became aware of the claims of Mrs. Pappas and Mr. Kalogiannis. Justice Battaglia disagreed, finding no showing that any of the destroyed documents were “essential to the proof of Petitioners’ claims.”
There are other nuggets in the Corfian decision, and I would urge anyone interested to read the entire opinion.