I don’t know if it’s the largest potential involuntary dissolution ever of a highly successful, privately-held U.S. company, but it surely must rank up there. The two 50% owners of the companies that make AriZona Iced Tea and a host of other beverages have been at odds for years, including multiple lawsuits brought and defended by top-flight law firms. Now, one of them has filed a petition in Nassau County Supreme Court asking a judge to order the dissolution of the two main operating companies — both incorporated in New York — on the ground of shareholder oppression.
According to the petition filed by John Ferolito (read it here), he and the other 50% shareholder, Domenick Vultaggio, launched the AriZona Iced Tea brand of beverages in 1992. Initially, Vultaggio managed the warehouse operations and Ferolito managed the corporate office. In 1994, Vultaggio joined Ferolito in the newly relocated corporate office in Lake Success which, according to Ferolito, is when their relationship began to unravel due to “differences in their approaches to management and decision-making.”
Around 1997, by which time the situation had become “unbearable” for Ferolito, they agreed there could “only be one captain of the ship.” Ferolito therefore relinquished day-to-day management to Vultaggio in order to prevent “the inevitable deadlock” that would have ensued. As part of this arrangement, according to the petition, it also was agreed that the company CFO would “keep Ferolito informed as to the operations of the business” and that Ferolito as co-owner would participate in all “big picture” business decisions.
In 1998, Ferolito and Vultaggio entered into a written Owners’ Agreement requiring that “all material matters” regarding the business “be resolved by mutual agreement” of the co-owners, and that all profits be distributed equally.
Over the next 10 years it appears that Ferolito had relatively little involvement with the running of the business. According to the petition, in the years 2002 through 2007 the co-owners received equal distributions in the eye-popping, aggregate amount of over $470 million.
In early 2008, Ferolito sued Vultaggio in Manhattan Supreme Court over the latter’s refusal to allow Ferolito to consummate the sale of his 50% interest in the AriZona conglomerate to a major, international beverage distributor. The lawsuit challenged the transfer restrictions in the 1998 Owners’ Agreement. In May 1999, the court ruled in Vultaggio’s favor upholding the transfer restrictions. (Read Ferolito’s complaint and the court’s decision here and here.) The decision is on appeal.
Ferolito’s dissolution petition filed last week alleges a number of oppressive acts by Vultaggio. First, Ferolito alleges that beginning in 2008 Vultaggio retaliated against Ferolito’s efforts to sell his interest to an outsider by terminating payment of “management fees” to Ferolito and refusing to make shareholder distributions under pretext that the company was experiencing a “cash crunch.” Ferolito allegedly was forced to make “massive annual tax payments” out of his own funds on the undistributed S corporation net income. Ferolito alleges that the distributions cut-off was designed as a financial squeeze to force him to sell his 50% interest to Vultaggio at a “reduced, concessionary price and to give up his voting rights.”
Second, Ferolito alleges that Vultaggio has “deliberately thwarted several of Ferolito’s good faith attempts to sell the Ferolito Group’s ownership interest” while simultaneously cutting off distributions. Ferolito’s petition recounts a series of negotiations with major companies starting in 2005 allegedly involving multi-billion dollar offers either for the entire enterprise or Ferolito’s half interest.
Third, Ferolito alleges that in September 2009 Vultaggio unilaterally undertook and announced a corporate restructuring of the AriZona entities, in violation of Ferolito’s right under the 1998 Owners’ Agreement to participate in “macro” decisions.
Fourth, Ferolito alleges that Vultaggio cut off his access to company financial information and blocked his efforts to communicate directly with the company controller.
Ferolito’s petition concludes that, “[t]hrough a persistent course of mistreatment, Vultaggio has attempted to affect a freeze-out to prevent Ferolito from participating in any meaningful respect in the Corporations that he co-founded nearly 20 years ago”; that Ferolito “has been totally frozen out of the management and decision-making for the Corporations”; that Ferolito has been left “without a voice to protect his interest in the Corporations”; and that “[d]issolution of the Corporations is the only feasible means whereby [Ferolito] may reasonably expect to obtain a fair return on his investment.”
From a tactical standpoint, what I find most interesting about the petition is the decision by Ferolito and his counsel to ask for dissolution based only on shareholder oppression pursuant to Section 1104-a of the Business Corporation Law, i.e., not to seek dissolution based on 50/50 shareholder deadlock and dissension under BCL Section 1104. Here’s what I wrote in a prior post on the tactical considerations for the 50% shareholder in choosing to proceed under one or the other or both statutes:
In the judicial dissolution arena, one of the trickiest decisions faced by counsel representing a 50% shareholder of a closely held New York corporation is whether to ask for dissolution based on deadlock under Section 1104 of the Business Corporation Law (BCL), or based on allegations that the other 50% shareholder is guilty of illegal, fraudulent or oppressive conduct or has looted, wasted or diverted corporate assets under BCL Section 1104-a, or under both statutes.
The choice can have a dramatic effect on the outcome of the proceedings, not just because of the different proofs required, but because only one of the statutes – BCL Section 1104-a – triggers the other shareholder’s right to avoid dissolution by electing to purchase for “fair value” the shares of the petitioning shareholder.
In many business divorce cases involving two 50% shareholders there nonetheless is one natural buyer and one natural seller. Sometimes it’s because one of the two controls more of the client relationships. Sometimes it’s because one of the two personally or through a separate company owns the realty leased by the co-owned company. Sometimes it’s because one of the two has far deeper pockets. In these situations, the 50% shareholder who wants out and his or her counsel must think long and hard about whether they gain or lose bargaining leverage by handing the opposing shareholder the right to force a buyout. In my experience, a deadlock petition under BCL Section 1104 usually packs a bigger wallop than an 1104-a petition by denying the automatic buyout and thereby putting added pressure on the shareholder who may be more motivated to keep the company as a going concern.
It would appear that Ferolito, by proceeding only under Section 1104-a, and consistent with his past efforts over several years to liquidate his ownership interest, is inviting Vultaggio to exercise his statutory right under BCL Section 1118 to elect to purchase Ferolito’s shares for “fair value” to be determined by the court unless the parties can agree on price and terms. The election must be made within 90 days of the filing of the petition, unless extended by the court.
The case has been assigned to Nassau County Commercial Division Justice Timothy S. Driscoll. Stay tuned.
Update November 18, 2010: The Appellate Division, First Department, has affirmed the lower court ruling mentioned above, which upheld the stock transfer restrictions in the 1998 Owners’ Agreement. Read it here.