Lundy’s on Sheepshead Bay in Brooklyn was a world famous seafood restaurant for over 40 years. Today, it’s the site of Masal Café, a successful Turkish coffee house and restaurant that opened in 2003. It’s also the site of a food fight (sorry, I couldn’t resist) that landed in court when each of two shareholder factions claimed to hold majority ownership and control of the restaurant corporation.
The fight took an unusual turn with a ruling earlier this month compelling arbitration of one side’s claims of financial wrongdoing but reserving for judicial determination the stock ownership issue. This rare instance of concurrent arbitration and court proceedings stems from highly unusual dispute resolution provisions in the shareholders’ agreement, as well as from the procedural course charted by the parties in court.
The power struggle in Boz Export & Import, Inc. d/b/a Masal Café v. Karakus, 2011 NY Slip Op 51685(U) (Sup Ct Kings Co Sept. 15, 2011), pits shareholders Mustafa Boz and Ammer Muslu against a third shareholder, Selahattin Karakus. Before the falling out, Karakus and his cousin, Tahsin, each held 36% of the corporation’s shares while Boz and Muslu together controlled the remaining 28%. Karakus also was president. Sometime in 2010 Tahsin left the United States and was barred from reentry.
Subsequently Muslu and Karakus each claimed to be the assignee of Tahsin’s 36% interest. Karakus produced a stock purchase agreement with Tahsin signed by the latter in Germany in December 2010, whereas Muslu claimed to have purchased Tahsin’s shares in early March 2011.
Muslu and Boz challenged the December 2010 agreement as fraudulent and, in support, procured an April 2011 affidavit from Cinar Nedjet, who signed the December 2010 stock purchase agreement as witness, stating that he forged Tahsin’s signature on the document in exchange for Karakus’s promise to pay him $50,000. Karakus countered with a prior, contradictory affidavit from Nedjet signed in late March 2011, attesting that in December 2010 at Tahsin’s request he (Nedjet) witnessed Tahsin sign the stock purchase agreement.
While these events were unfolding, in mid-March 2011, Muslu and Boz called a special shareholders’ meeting and voted their purportedly majority shares to remove Karakus from the board of directors and install Muslu’s cousin, a non-shareholder, as president in Karakus’s stead.
In mid-April 2011, Boz and Muslu filed a lawsuit asserting claims individually, and in the corporation’s own name and right, against Karakus for breach of fiduciary duty, conversion, unjust enrichment and an accounting. The court initially issued a temporary restraining order that barred Karakus from entering the business premises or exercising any management rights. After a hearing later that same month, however, the court found that Karakus never was given notice of the March 2011 shareholders’ meeting, declared the meeting and vote illegal and void, reinstated Karakus as president, and vacated most of the prior restraining order.
Meanwhile, a few days after suit was filed, Karakus commenced an arbitration with the American Arbitration Association based on the arbitration clause in the parties’ April 2010 shareholders’ agreement. Karakus then filed a motion in court to stay the judicial proceedings pending the arbitration, which prompted a cross-motion by Boz and Muslu to stay the arbitration.
The arbitrability dispute centered on two seemingly inconsistent provisions in the shareholders’ agreement. Karakus relied on Section 9.8 of the agreement’s broad arbitration clause mandating arbitration of "any controversy relating to [the shareholders’ agreement]." Boz and Muslu relied on a separate Section 7.1 of the agreement providing as follows:
The parties hereto agree that the shares of Stock are unique, that failure to perform the obligations provided by the Agreement shall result in irreparable damage, and that:
a) a declaratory judgment of the parties’ rights hereunder may be obtained by suit at law; and
b) that specific performance of the obligations hereof, may be obtained by suit in equity.
Because of the apparent conflict between Sections 9.8 and 7.1, Brooklyn Commercial Division Justice Carolyn E. Demarest found it necessary to hold a hearing to examine the lawyer who drafted the agreement. The lawyer stated his view that the two sections were not in conflict, and that Section 7.1 was intended to serve as an "aid to arbitration" as authorized by Section 7502(c) of the civil practice rules "considering the commercial significance of any delay in obtaining such relief in arbitration." He also testified, as summarized by Justice Demarest in her decision, that the declaratory judgment provision in Section 7.1 was included "to resolve disputes outside the scope of arbitration, including judicial intervention necessary to determine the share ownership of the stock, given that certain shareholders were foreign nationals."
Justice Demarest finds "no question" that Section 9.8’s broad arbitration clause is "binding and enforceable"; that "the issue of stock ownership is covered by the Agreement and would be resolvable by an arbitrator"; and that "all issues and claims raised in the plaintiffs’ complaint" are within Section 9.8’s broad arbitration clause. "Given [the drafter’s] testimony," Justice Demarest writes, "there does not appear to be a conflict between Sections 7.1 and 9.8(b) of the Agreement with respect to the substance of the claims raised in the complaint."
Does this mean the dispute over stock ownership also must be arbitrated, as contended by Karakus? Justice Demarest’s "no" answer is based on practical considerations of judicial economy and Karakus’s initial consent to a judicial resolution of the ownership issue.
First, she notes that the stock ownership issue is "collateral" to the complaint’s claims against Karakus; that the testimony of non-party Tahsin "is critical to the resolution of the issue of ownership" but that he is "unavailable to give direct testimony" because of the bar to his reentry into the United States; and that the court having already issued a commission for Tahsin’s deposition in Germany, and problems having already arisen regarding the implementation of the commission, "this court will continue to be involved in litigation even were the question of share ownership referred to arbitration."
Second, and perhaps more powerfully, she notes that "when the question of disputed ownership was first raised, no objection was made to a framed issue hearing to determine such ownership." Justice Demarest further explains:
In fact, [Karakus’s] counsel stated that he favored such hearing by the court. Thus was commenced a hearing that remains pending before the court. Two witnesses have testified, and written communications have been received, addressed to the court, directly from Tahsin Karakus which will undoubtedly become evidence at trial. In light of these circumstances, this court finds it inappropriate, and a waste of judicial resources, in addition to creating additional costs to the litigants in duplicating before an arbitrator the efforts already made in litigation pending before this court, to refer the share ownership dispute to arbitration at this time.
In other words — and this is a lesson reflected in numerous court decisions — you have to be careful how far down the path of judicial proceedings you go before you ask to remove the proceedings to arbitration.
The more important lesson to be taken from this case concerns the drafting of dispute resolution provisions in agreements among business co-owners. In arbitrations governed by New York law, even if the agreement contains a broad arbitration clause with no allowance for judicial recourse, by statute (CPLR 7502[c]) any party may apply to the court for a preliminary injunction or attachment on the ground that absent such relief the ultimate arbitration award will be rendered ineffectual. There may be other circumstances, however, where business owners, although generally committed to the arbitration process, may need the expedited processes, broader interim remedial powers and disclosure available in judicial proceedings. In those circumstances, the drafter must take heed to avoid the inconsistency of a broad judicial remedy section paired with a broad arbitration clause, as occurred in the Boz Export case. The judicial remedy section must be carefully worded and narrowly drawn to specify a limited and manageable carve-out from the mandatory arbitration provision.
Update February 17, 2012: After holding a framed-issue hearing, Justice Demarest issued an order dated February 9, 2012 (read here) finding that Karakus is the bona fide purchaser of Tahsin’s shares, and declaring that Karakus therefore holds 144 shares of Boz Exports, giving him a controlling 72% ownership interest. The arbitration of the other issues remains pending.