In 1997, the controlling shareholders of three affiliated fire and burglar alarm companies sold all the company assets to an outside buyer for $4.2 million. They did so without informing, or sharing any of the sales proceeds with, another 5% shareholder. Thirteen years later, the chickens have come home to roost in the form of a court order against the controlling shareholders and their lawyer, granting common-law dissolution of the companies and awarding the 5% shareholder damages totaling almost $1.2 million — and that’s before adding prejudgment interest at 9% which more than doubles the principal amount. Collins v. Telcoa International Corp., Short Form Order, Index No. 23796/97 (Sup Ct Queens County Nov. 5, 2010).
The Collins case made a splash almost ten years ago, when an appeals court was called upon to decide whether the plaintiff, Joseph Collins, was limited to an appraisal and other equitable remedies as opposed to the money damages he sought. The Appellate Division, Second Department, in an opinion reported at 283 AD2d 128 (2001), sided with Collins in ruling that, since he was not told of the asset sale much less afforded his statutory right to dissent and bring a shareholder appraisal proceeding, “nothing prevents him from maintaining a cause of action for money damages against [the controlling shareholders] based on their alleged breaches of fiduciary duty.”
The case went to trial in late 2007 before Referee Leonard Livote, who issued his report in December 2009. The report and its recommendations were confirmed in a brief order issued last month by Queens County Supreme Court Justice Martin J. Schulman. Fortunately for us, Justice Schulman’s order attaches a copy of the Referee’s report which contains a detailed set of factual findings and conclusions of law.
The Telcoa companies consisted of two closely held corporations (TNY and CSSI) engaged in the fire and burglar alarm business, and a third, public company (TIC) which owned 85% of TNY and CSSI. The remaining 15% was owned by three shareholders, Collins, Dolin and Krell, each of whom held 5%. Dolin controlled all three Telcoa companies through his 65% stock ownership in TIC in which Collins also held a 10.3% stock interest.
After joining Telcoa in 1988, Collins achieved great success building TNY’s operations and revenues. In 1995, with Krell seriously ill and Dolin at 73 years of age, Dolin initiated discussions to sell the companies to AlarmGuard Corp. Collins met with AlarmGuard’s principal who offered Collins leadership of the post-closing entity conditioned on Collins signing a five-year non-solicitation agreement upon termination of employment. After Collins turned down the offer, Dolin accused him of ruining the prospective sale and thereafter threatened to fire him unless he signed the AlarmGuard non-solicitation agreement. Collins maintained his refusal and Dolin carried out his threat.
Over the next year or two Dolin shopped the companies to other prospective buyers. He then re-initiated discussions with AlarmGuard leading to an agreement in June 1997 for the sale of all Telcoa assets for $4.2 million including $1.6 million cash and the rest in AlarmGuard stock. At the same time Dolin caused TIC to issue over 1.4 million additional shares to himself, his wife and Krell. The deal with AlarmGuard also gave Dolin a substantial salary and benefits with the new company. In 1998, a larger company made a tender offer for AlarmGuard under which Telcoa tendered some of its shares for almost $3.4 million cash.
The vast majority of the cash and stock proceeds from the AlarmGuard sale went to the Dolins and Krell. Collins received nothing. He also was forced to bring an arbitration to recover over $200,000 in unpaid commissions due him. He was not given notice of, and did not attend, the corporate meetings of TNY and TIC where the sales votes were taken. He did attend a CSSI shareholders’ meeting but abstained from voting due to the insufficient financial data given to him.
At trial, Dolin and Krell’s estate representative justified their conduct toward Collins by claiming that, based on advice given to them at the time by Telcoa’s legal counsel, Collins had “waived” his entitlement to statutory notice of shareholder meetings and distributions by virtue of an old TNY stock pledge he had given as collateral for a $2,500 loan, and because he allegedly “quit” his employment with Telcoa. Referee Livote found that both contentions were contradicted by the evidence.
Under Section 909(a) of the Business Corporation Law, a shareholders meeting must be held upon due notice to all shareholders for approval of a disposition of all or substantially all the assets of a corporation outside the normal course of business. Referee Livote’s report sharply condemns the defendants’ failure to notify Collins of the AlarmGuard sale and their other abusive conduct, finding that
the sale and merger of the Telcoa Companies to AlarmGuard was without proper notice, unlawful, egregious and that an action for the equitable relief to make Collins whole is authorized. . . . Payment of fair value as well as common-law dissolution is a suitable remedy since the assets of the Telcoa companies have long since been sold without Collins having received fair value for the sale. Telcoa’s collective actions, including terminating Collins’ employment and selling the corporation’s assets without notice to him of meetings constitutes a minority shareholder freeze out and oppression of a minority shareholder. Based upon the foregoing, Collins is entitled to an award for an equitable distributive share representing the “fair value” for his shareholdings and other benefits and interests of the TNY and CSSI sale.
The report further concludes that “the sale transaction when looked at as a whole was as a result of breaches of fiduciary duties owed [and that] the end result of no distributive share ever being paid was patently unfair and unjust to Collins.” Referee Livote determines that Collins is entitled to compensation for his “equitable share” of 5% in TNY and CSSI; for 300,000 additional shares of TIC stock to equalize the value of the additional shares taken by the defendants; for the increased stock value from the 1998 tender offer; and for the dilution of his stock interest. The Referee also finds that the company’s legal counsel is liable to Collins for breach of fiduciary duty arising from his improper advice to Dolin concerning Collins’ “waiver” of his stockholder rights.
The report’s recommendations, all of which were confirmed by Justice Schulman’s order, include common-law dissolution of the Telcoa companies; an award of $420,000 representing the fair value of Collins’ 5% interest in TNY and CSSI; an additional $492,000 against Dolin “for breach of fiduciary duty and acts of minority oppression and freeze out” as well as for dilution of Collins’ stock interest in Telcoa; another $150,000 for breach of Collins’ stock option; and, finally, a damages award of $110,000 for breach of fiduciary duty against the company’s legal counsel.
With prejudgment interest going back over ten years, the total judgment to be entered should exceed $2.5 million. This is an expensive lesson for the defendants considering that, had they simply given Collins the required notice of shareholders’ meeting for the AlarmGuard sale, Collins’ only practical resort, other than going along with the sale and receiving his pro rata share of the distributions, would have been to exercise his right to an expensive dissenting shareholder appraisal proceeding. Either way, and assuming the $4.2 million deal with AlarmGuard represented fair market value or something reasonably close to it, by my rough estimation Collins would have received less than $400,000 in cash and/or stock for his combined interests in the Telcoa companies.
Finally, Collins’ claim for common-law dissolution, as opposed to judicial dissolution for shareholder oppression under BCL 1104-a, stems from Collins’ ownership of less than the minimum 20% stock interest required by the statute. (For more on common-law dissolution, read here.) The dissolution granted in Collins seems to be mostly of symbolic value given that all of the Telcoa companies’ assets were disposed of a decade or so earlier, which is precisely what makes Collins such an interesting and important case on the issue of minority shareholder remedies for fiduciary breach surrounding the sale of a company.