Last week’s post on the Deblinger case examined a first-impression decision in a corporate dissolution proceeding concerning the court’s authority under Section 1008 of the New York Business Corporation Law to compel a shareholder to present a derivative claim against another shareholder-director.  The same statute occupies center stage in yet another novel decision handed down last month in Matter of Darvish (Haslacha, Inc.), 2010 NY Slip Op 32339(U) (Sup Ct NY County Aug. 23, 2010).  This time, the issue is whether Section 1008 authorizes the court to assess against one shareholder’s distributive share of the liquidation proceeds the court-appointed receiver’s legal fees incurred as a result of the shareholder’s misconduct.

You can tell Darvish is one of those protracted, rancorous shareholder disputes just from the “01” suffix in the case’s index number — indicating the case is nine years old — and from the most recent motion sequence number indicating that the parties have filed over 50 separate motions since the case began.

The petitioner, Darvish, as 50% shareholder filed for judicial dissolution of three single-asset real estate companies based on deadlock and dissension with the other 50% shareholder, Lavian, under BCL Section 1104.  In 2004, Manhattan Commercial Division Justice Herman Cahn (since retired) granted the petition as to two of the three corporations, named Urban Homes, Inc. (“Urban”) and Primary Residence, Inc. (“Primary”).  Justice Cahn directed further proceedings with respect to the third corporation, Haslacha, Inc. (“Haslacha”), based on Lavian’s assertion that he was sole shareholder of that entity.  (Read Justice Cahn’s decision here.)

Justice Cahn subsequently referred the issue of Haslacha’s ownership to a Special Referee who, in October 2008, issued a report that Justice Cahn subsequently confirmed, finding that Darvish and Lavian each own 50% of Haslacha’s shares.  (Read report here.)

In November 2008, Justice Cahn granted dissolution of Haslacha and appointed a Receiver to manage its commercial property located in Manhattan and to collect rents and profits.  (The buildings owned by Urban and Primary were put under the same Receiver’s control in 2004.)

In 2009, the Receiver made a series of motions, contested by Lavian, relating to tenancies at Haslacha’s building, and for approval of payments to his appointed counsel from the corporation’s receipts.  Darvish supported the Receiver’s motions and filed a cross motion asking that the Receiver’s counsel fees be paid not from the corporation’s funds, but from Lavian’s share of any final distribution from Haslacha, Urban and Primary.  Darvish contended that the court had authority to charge Lavian’s interest under BCL Section 1008(5) on the grounds that the Receiver’s counsel fees were incurred solely as a result of Lavian’s acts, misconduct and interference with the receivership.

The motions were referred  to the Special Referee who issued a report in June 2010 (read here) granting the Receiver’s motions but denying Darvish’s cross motion to charge Lavian’s distributive share, explaining as follows:

BCL 1008(5) authorizes the court to determine and enforce the liability of any “director, officer, shareholder or subscriber for shares, to the corporation or for the liabilities of the corporation,” but does not authorize the court to charge an award of attorney’s fees to any distributive share of a “director, officer, shareholder or subscriber” of a corporation, upon the grounds of misconduct.

In a subsequent report the Special Referee approved the Receiver’s counsel fees in the sum of approximately $200,000.

Darvish then moved before Manhattan Commercial Division Justice Melvin L. Schweitzer, who had taken over the case from the retired Justice Cahn, to reject the Special Referee’s report insofar as it denied Darvish’s cross motion to charge the Receiver’s counsel fees against Lavian’s distributive share.   Here’s how Justice Schweitzer frames the issue in his August 23, 2010 decision:

The court now turns to the issue of how the costs and fees are to be allocated: should they be borne by the Haslacha Estate and/or the Primary Residence and Urban Homes Estates irrespective of share ownership or should they be borne exclusively from Mr. Lavian’s distributive shares in those Estates as advocated by Petitioner?

The answer is foretold in Justice Schweitzer’s immediately following observation, that the Special Referee’s reports “leave no doubt” that Lavian’s conduct, such as “filing numerous motions, refusing to obey the orders of the court and the Receiver, and by engaging in sham leasing transactions,” required “the appointment of the Receiver in the first place and caused him to incur the costs and attorneys’ fees awarded to” the Receiver’s counsel.

Justice Schweitzer next explicitly rejects the Special Referee’s reading of BCL 1008, which “invests broad discretion in the court ‘without limitation’ to issue orders with respect to ‘all matters’ in connection with the winding up of the affairs of the corporation.”  Citing BCL 1008(5), Justice Schweitzer states that “it is clear that the corporation’s liability for the Receiver’s legal fees” to be paid from the sale proceeds of the corporation’s assets have

arisen due to the acts of a shareholder, i.e., Mr. Lavian [whose] refusal to comply with the court’s orders, and his vexatious litigation, is responsible for the corporation’s liability to pay legal fees.  The court is invested by the statute with the power to “determine” Mr. Lavian’s liability and to “enforce” that liability, by ordering Mr. Lavian to pay the liability he caused out of his distributive share.

Justice Schweitzer also grounds his decision on subdivision (6) of Section 1008, which authorizes the court to enter orders for the “payment, satisfaction or compromise of claims against the corporation . . ..”  Lavian’s actions, the court continues,

have wasted the corporation’s assets and he should not benefit by the petitioner’s being required to pay one-half the costs. . . . It would be unfair to allocate the costs and fees attributable solely to Mr. Lavian’s fault or vexatious litigation tactics equally between Mr. Darvish and Mr. Lavian by virtue of the fact that they are each 50% owners in the Estates of Haslacha, Primary Residence and Urban Homes.

Notwithstanding the court’s harsh assessment of Lavian’s conduct, in the end he is not assessed 100% of the $200,000 in attorney’s fees incurred by the Receiver.  Instead, Justice Schweitzer orders that the fees be paid 65% from Lavian’s distributive share and 35% from Darvish’s distributive share.  Justice Schweitzer does not explain the allocation, though presumably it reflects some quantum of services by the Receiver’s counsel not directly related to Lavian’s actions.

Taken together, the Deblinger and Darvish cases, decided within days of each other by two different judges, underscore the potent and extremely broad judicial powers granted in BCL Section 1008.  Counsel involved in the winding up of a judicially dissolved corporation must familiarize themselves with this important statute. 

Update January 2, 2010:  By Supplemental Order dated December 20, 2010, Justice Schweitzer clarified his prior order by also allocating to Lavian 65% of the $25,200 settlement costs of the related mortgage foreclosure proceeding.