For the vast majority of non-publicly traded close corporations, there is little or no market for minority shareholders to sell their shares. Likewise, the default rules under the statutes governing close corporations do not require the corporation or the controlling shareholders to redeem or buy out the stock interest of a minority shareholder who seeks an exit. Most states, including New York, partially alleviated the problem of minority shareholder lock-in by enacting laws that authorize a minority shareholder to sue for judicial dissolution of a close corporation where the majority engages in undefined "oppressive conduct" and, at the same time, that give the majority an elective right to avoid a dissolution contest by purchasing for "fair value" the shares of the suing shareholder.
New York adopted such laws in 1979, codified in Sections 1104-a and 1118 of its Business Corporation Law. Over the next 30-plus years, the task has fallen to the courts to resolve on a case-by-case basis the myriad shareholder disputes leading to dissolution petitions, using what’s known as the "reasonable expectations" test for gauging majority oppression. Under this test, first formulated in Gardstein v. Kemp & Beatley, 64 NY2d 63 (1984), oppression exists when the majority conduct "substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the [petitioning minority shareholder’s] decision to join the venture."
Part of the difficulty for courts in these cases is balancing the minority shareholder’s reasonable expectations against the rights and obligations flowing from a shareholders’ agreement — when one exists. As Professor Larry Ribstein writes in a recently published paper (about which I’ll be posting in coming weeks), "[t]he indeterminacy of close corporation law is especially evident when the oppression remedy meets an actual contract." To what extent should courts rein in the statutory oppression remedy on account of express contractual provisions dealing with rights of continued employment, distributions, redemption or buyout? How should courts assess reasonable expectations when the shareholders’ agreement is silent as to the circumstances constituting the alleged oppression?
A good illustration of the how these questions play out in real life is last month’s decision by Suffolk County Commercial Division Justice Emily Pines in Matter of Hack (National Employee Assistance Providers, Inc.), 2010 NY Slip Op 33024(U) (Sup Ct Suffolk County Oct. 25, 2010), where the court dismissed a dissolution petition based in part on evidence that the parties had discussed, but failed to include in their written shareholders’ agreement, a provision for buyout of shareholders who wished to sell their shares during their lifetime.
In Hack, the petitioner Michael Hack held 24.5% of the shares in two affiliated companies (the "Companies") that provide employee assistance programs for corporate human resources departments. Hack co-founded the Companies in 2000 and served as CEO for eight years, until September 2008, when he voluntarily left to pursue another opportunity. In May 2010, Hack filed a petition for judicial dissolution of the Companies under BCL 1104-a, claiming oppressive conduct by the two remaining shareholders (the "Respondents") who together held 75.5% of the Companies’ shares. Hack alleged that the Respondents had scheduled a shareholders meeting for the purpose of authorizing and issuing additional capital shares which would dilute and devalue Hack’s stock interest. Hack also alleged that one of the Respondents made repeated promises that if Hack wanted to sell his shares, they would be purchased.
Justice Pines’ decision describes as follows Hack’s allegations concerning his efforts over the years to secure a written buyout agreement:
Hack further contends that in the eight years he worked for the company and was a shareholder, he tried to memorialize an agreement which would define the roles of the shareholders and memorialize Detor’s undertakings and promises to provide a market for Hack’s shares if he decided to sell. Hack states that an agreement of the shareholders was finally entered into by all the shareholders in 2004 however, it did not define the rights of the shareholders in the event any shareholder wished to sell his shares. Rather, it only defined the shareholders’ rights in the event of a shareholder’s death.
Hack contended that the "pattern of behavior" by the Respondents, including turning down a million dollar offer by an independent third-party to buy the Companies, will dilute his shares, reduce their value, and "make it impossible to sell his shares in the Companies which is oppressive conduct by the majority shareholders entitling him to dissolution of the Companies."
The Respondents countered that Hack is a "passive, minority shareholder" who is "frustrated because there is no present market for his shares" and who "brought the petition for dissolution to force the respondents to purchase his shares in the Companies" even though they have "no legal or contractual obligation" to do so. With respect to lifetime stock dispositions, they argued that the 2004 shareholders’ agreement merely gave the Companies a non-obligatory right of first refusal if a shareholder sought to sell his shares to a third party. They argued that the Companies are viable, profitable going concerns whose dissolution is not warranted. They also submitted affidavits in which they represented that they were withdrawing the proposed resolution to authorize additional shares, and pledged not to authorize additional shares in the future without unanimous shareholders’ consent.
Justice Pines’ legal analysis summarizes the statutory provisions and sets forth the applicable standards under the reasonable expectations test. Applying the law to the facts set forth in the petition and in the Respondents’ motion to dismiss, she finds that Hack "has failed to demonstrate that he has been oppressed by the majority shareholders." She explains:
It is undisputed that Hack voluntarily left the employment of [the Companies] to pursue another opportunity. It is also evidenced by the executed shareholder agreement attached to the motions that there was no provision/agreement to be bought out in the event one or more of the shareholders wished to sell. While Hack argues that this provision was discussed and contemplated by the parties, it was never reduced to writing and incorporated in the agreements between the shareholders.
Although Hack also argues that the shareholders expressly stated that the strategy amongst the three of them was to grow and then sell the business, Detor argues that his plan for the companies differed. However, the agreements between the shareholders do not reflect any anticipated buy-out other than that which would occur upon the death of one of the shareholders.
It would be tempting to downgrade Hack‘s significance based on the fact that Hack voluntarily left his employment with the Companies well before he sued for dissolution. After all, you may ask, how can someone voluntarily leave and later claim oppression? But that would be wrong. In the seminal Gardstein v. Kemp & Beatley case mentioned above, in which New York’s highest court upheld an order dissolving the corporation, one of the two petitioners also voluntarily left his company before seeking dissolution.
How then should Hack be read? One way to read it is that, whatever reasonable expectations Hack may have had at the Companies’ inception about being able eventually to liquidate his stock interest, such expectations are trumped by the parties’ contractual intent as reflected in the 2004 shareholders’ agreement, not to grant shareholders the right to put their shares to the Companies or the other shareholders whenever they wished to exit. If so, one also can say that Justice Pines resisted the invitation to rewrite the parties’ agreement under the guise of divining their reasonable expectations.