The vast majority of corporate dissolution cases fall into one or another familiar fact pattern involving 50/50 deadlock or minority shareholder oppression. So it’s always refreshing when a new case comes along presenting a novel scenario, as in Matter of Toledano (Home Tower Group, Inc.), 2011 NY Slip Op 32127(U) (Sup Ct Nassau County July 25, 2011), where the court converted a failed voluntary dissolution into a compulsory judicial dissolution.

Shmouel Toledano and Yoram Eliyahu are real estate developers who, prior to 2006, acquired 41 commercial properties in New York and Connecticut.  Toledano and Eliyahu each own 50% of the shares in 10 separate corporations formed to hold title to the properties. In November 2006, they entered into a written “dissolution agreement” to sell as many of the properties as possible over the following 18 months, at the end of which any unsold properties would be distributed to the shareholders.

The agreement required Eliyahu to divide the unsold developed properties into two pools, giving Toledano first choice. The agreement also required that certain undeveloped “keeper” properties be offered for sale subject to the shareholders’ right of first refusal. Finally, the agreement required Eliyahu to purchase for $600,000 Toledano’s half interest in the property housing the corporate offices.

The dissolution agreement could not have been more poorly timed. Starting in 2007, the theretofore frothy real estate market began its stone-like descent. The details are not provided in the court’s decision, but between 2006 and 2010 when Toledano brought suit, it seems that at least the bulk of the properties remained unsold.

Toledano’s lawsuit alleged that Eliyahu breached the 2006 agreement by refusing to divide the unsold properties into two lists for distribution to the shareholders, and by refusing to buy out his interest in the corporate offices. Toledano sought judicial dissolution of the 10 corporations on two alternative grounds, first, asking for specific enforcement of the 2006 dissolution agreement and, second, asking for judicial dissolution based on shareholder deadlock under Section 1104 of the Business Corporation Law.

Eliyahu opposed the petition. Primarily he contended that the 2006 agreement should be rescinded on the ground of mutual mistake based on the parties’ unrealized expectations that the real estate market would remain active and the properties could be sold at reasonable prices within 18 months.

Not so, rules the court in a decision by Nassau County Commercial Division Justice Stephen A. Bucaria.  Mutual mistake, he writes, means “an absence of the requisite meeting of the minds to the contract” based on a mistake that “must exist at the time the contract is entered into.” The mistake “cannot relate to the occurrence of future events.” For that reason, the court explains,

[Eliyahu] cannot obtain rescission of the dissolution agreement based upon [his] assumptions as to future conditions in the real estate market. Moreover, it is unlikely that an experienced real estate investor would assume that the market would not fluctuate in any event.

But that doesn’t mean Toledano can enforce the 2006 agreement, the court adds in denying Toledano’s application for summary judgment on his claim to compel Eliyahu’s compliance with the agreement’s property division scheme. Rather, Justice Bucaria writes,

[t]he court determines as a matter of law that [Eliyahu’s] rejection of the dissolution agreement has resulted in deadlock precluding the successful and profitable liquidation of the real estate properties.

In reaching its conclusion, the court notes that “the existence of an agreement with respect to the winding up of the affairs of the corporation does not, of itself, preclude a finding of deadlock,” citing Matter of Johnsen (ACP Distribution, Inc.), 31 AD3d 172 (1st Dept 2006), where the appellate court enforced a buyback provision in a shareholders’ agreement triggered by a 50% shareholder’s filing of a dissolution petition.

The court’s decision does not mention whether the 2006 agreement resulted from a contentious falling out of the two owners or a felicitous compact designed to maximize profits and future development opportunities. Either way, once the two owners agreed to wind up the business and dissolve, and once that agreement became inoperable, the availability of BCL Section 1104 to break the deadlock seems almost inevitable.

The consequences of judicial dissolution versus voluntary dissolution under the 2006 agreement can be quite significant. Unless the parties reach a new agreement allowing for division and distribution of the properties to the shareholders, under the court’s ruling the properties will have to be sold either privately or at auction – perhaps under supervision of a court-appointed receiver if the parties cannot cooperate – which can result in far less than optimal sales. The manner of asset disposition also may have important tax consequences.

One last observation. The winding up of a multi-property, multi-corporation real estate business such as the one in Toledano, i.e., a business not conducive to sale as a going concern, is no simple affair. When drafting the winding up and dissolution agreement, the parties and their counsel must anticipate and make specific provision for any number of contingencies, including future uncertainty over marketability of the corporate assets and future disagreement over implementation of the stipulated processes for sale or distribution in kind of the assets. In Toledano, for instance, the parties might have avoided subsequent discord by creating a backup mechanism for property division and/or escape clauses tied to threshold asset values. 

Update January 6, 2012:  Following the court’s decision, Toledano sought to disqualify Eliyahu’s attorney on the ground of conflict of interest based on the attorney’s alleged prior representation of Eliyahu as well as the corporation. Justice Bucaria, in an order dated December 7, 2011 (read here), denied disqualification on the ground that the attorney’s prior representation was unrelated to the dissolution proceeding.

Update March 30, 2012:  By order dated March 20, 2012 (read here), Justice Bucaria denied Toledano’s motion to reconsider the prior denial of his request to disqualify Eliyahu’s attorney. The order also denied Toledano’s motion for summary judgment of liability on his cause of action for breach of the 2006 agreement. Finally, the order directed the submission of final orders of dissolution for each corporation within 30 days and that, upon failure to do so, Toledano’s claim for dissolution will be deemed abandoned by the court.

Update January 23, 2013:  Eliyahu appealed from that part of Justice Bucaria’s July 2011 order dismissing his claim seeking rescission of the dissolution agreement. In a short memorandum decision this date, the Appellate Division, Second Department, affirmed Justice Bucaria’s order, stating that Eliyahu “failed to raise a triable issue of fact as to whether the agreement was executed under a mutual mistake or a unilateral mistake induced by a fraudulent misrepresentation by the petitioner/plaintiff” (read here).