You’re an oppressed minority shareholder of a close corporation. You petition the court for dissolution. The controlling shareholder opts to avoid dissolution by electing in the corporation’s name to purchase your shares for fair value. You settle in for prolonged discovery and valuation proceedings during which you’re excluded from the company with no way to monitor the business or its finances. How can you be sure the company or controlling shareholder will have the financial ability to pay the award when the day arrives? What if the controlling shareholder diverts assets or drives the company into bankruptcy? Will you ever get paid for your shares?
I can tell you from my own experience, these are not idle concerns. The degree of insecurity felt by the selling shareholder is even more acute when the company is a service or sales business with few hard assets such as real estate.
Fortunately, the statute that provides a buy-out option also authorizes the court to require the purchaser to post a bond to secure payment of the fair value award. Section 1118(c)(2) of the Business Corporation Law provides:
The court, in its discretion, may require, at any time prior to the actual purchase of petitioner’s shares, the posting of a bond or other security in an amount sufficient to secure petitioner for the fair value of his shares.
Notice that the provision contains no criteria by which the court is to exercise its discretionary power to require security. While the case law applying the statute is sparse, enough clues have emerged to guide petitioner’s counsel in considering whether to ask the court to require a bond.
The most frequently cited appellate authority is Matter of Kastle, Inc., 234 AD2d 181 (1st Dept 1996). In that case, a lower court refused to require the electing majority shareholder to post a bond. The appellate court reversed, stating:
In light of petitioner’s serious allegations [of looting and diversion of corporate assets], the rather questionable financial capability of William Shalom to carry through on his offer to purchase petitioner’s shares, the parties’ drastically different opinions as to the value of petitioner’s shares, the pendency of several lawsuits against William Shalom and his family and the likelihood, if petitioner’s allegations of waste and mismanagement are substantiated, that the corporation would be worthless, the IAS Court’s denial of petitioner’s application was improvident. As for the amount of such an undertaking, there is significant evidence that the corporation is worth far more than the Shaloms claim. In our view, a bond in the amount as indicated herein will protect petitioner’s interests.
Lower court decisions following in the wake of Kastle show mixed results. For example, in Matter of Bronstein (Prestige Bay Plaza Development Corp.), Index No. 112846/99 (Sup Ct NY County Dec. 13, 2000), the court required the posting of a $16 million bond based on drastically varying valuation estimates and questions raised regarding the electing corporation’s financial capability to pay the award. The lower court in Hayes v. Reynolds, Index No. 11956/04 (Sup Ct Monroe County Mar. 4, 2005), also required a bond in a case involving waste allegations, stating that the primary purpose of the bond requirement “is to protect minority shareholders against tactical fluctuations in their share price during the valuation process.” In contrast, in Matter of Cavallo (Brothers II Business Machines, Inc.), Index No. 11469/01 (Sup Ct Suffolk County Nov. 23. 2001), the court denied a bond application where the petitioner presented no evidence that the corporation and its controlling shareholders “lack the finances to buy out the petitioner or that corporate assets are being wasted.”
Earlier this month, in a case called Matter of Gold (Hazardous Elimination Corp.), Index No. 17735/10 (Sup Ct Nassau County Apr. 11, 2011), Nassau County Commercial Division Justice Stephen A. Bucaria granted the petitioner’s application to require the electing majority shareholder to post a bond to secure her buy-out of the petitioner’s shares. In Gold, brother Donald and sister Cathleen owned 49% and 51%, respectively, of a company specializing in the remediation of hazardous substances in residential and commercial buildings. Donald sued for dissolution after Cathleen terminated his employment and gave notice of a shareholders meeting to remove him as director and officer.
Justice Bucaria initially denied Donald’s dissolution application with leave to renew after the expiration of the statutory 90-day period for Cathleen to elect to purchase Donald’s shares (read the November 24, 2010 decision here). After Cathleen elected to purchase, Donald asked the court to require her to post a $2 million bond to secure the fair value award pending the valuation. Donald alleged that the company’s accounts receivable showed a precipitous decline versus the same period in the prior year, and he accused Cathleen of mismanagement and waste of corporate assets including a $7,500 per month consulting agreement with her brother after she was diagnosed with breast cancer. Cathleen countered that, while Donald ran the company, there were financial improprieties including gross inflation of accounts receivable.
Citing Matter of Kastle, Justice Bucaria writes that “[a]mong the factors to be considered are the financial capability of respondents to carry through on their offer to purchase petitioner’s shares and the evidence as to the value of the company.” He then grants Donald’s application — though not the $2 million amount requested — stating as follows:
[The company’s] balance sheet states that the total stockholders’ equity was $1,590,502, as of December 31, 2009. Thus, as of the date of the balance sheet, petitioner’s 49% interest was worth approximately $779,346. [Cathleen] alleges that she has in excess of $1 million in retirement accounts and access to another $1 million from her family. Nevertheless, it is not clear that either of these sources of funds would be available to purchase petitioner’s shares. Accordingly, petitioner’s application is granted to the extent that respondent shall post a bond with a responsible surety in the amount of $750,000 to secure payment for petitioner’s shares within 15 days of the date of this order.
The outcome of a bonding request can have a major impact on the overall dynamic of buy-out proceedings and potential settlement. For the purchasing shareholder or company, a sizeable bond may require a pledge of cash or other collateral that may impose a personal or corporate hardship. For the selling shareholder, absent a bond there is no guarantee of collecting a fair value award, and the seller also faces the risk of an award that allows a multi-year pay-out with little or no meaningful security. Given the high stakes, both sides must treat an application to post a bond with the utmost seriousness.
Update May 7, 2011: Yesterday the Appellate Division, Fourth Department, affirmed a decision by Monroe County Commercial Division Justice Kenneth R. Fisher ordering the respondents in an 1118 buyout proceeding to post a $1 million bond. Matter of Stevens (Allied Builders, Inc.), 2011 NY Slip Op 03787 (4th Dept May 6, 2011). The bond amount was $800,000 less than the petitioner requested. Read here Justice Fisher’s decision.
Update August 24, 2011: By Order dated August 8, 2011 (read here), Justice Bucaria denied Cathleen’s motion to reargue Donald’s bond application. She argued that the court had misapprehended the company’s “draft” balance sheet, and that the “final” balance sheet showed a $1.4 million deficit rather than a $1.5 million positive balance. Justice Bucaria based his ruling on Cathleen’s failure to offer proof of her ability to purchase Donald’s shares even assuming the company’s fair value was not accurately reflected in the draft balance sheet.