When one of a handful of shareholders in a close corporation decides to sell his shares to another shareholder, is the buying shareholder obligated to offer the other remaining shareholders the opportunity to participate in the purchase on an equal basis? In the absence of a shareholders’ agreement regulating such transfers, is there a common law fiduciary duty to share the shares with the remaining shareholders?

If you answered these questions “no,” you’ll take comfort in a decision issued last week by Kings County Commercial Division Justice David Schmidt in a case called Varveris v. Zacharakos, 2012 NY Slip Op 50947(U) (Sup Ct Kings County May 24, 2012), turning down a bid by a disappointed shareholder to require equal participation in the purchase of a departing shareholder’s shares.

Varveris involves a real estate business known as Jarc Realty Co. formed in 1986 to own and operate a residential apartment building in Brooklyn. Upon incorporation, Jarc’s 200 shares were issued and distributed equally among four shareholders: Zacharakos, Sichenze, Kristiansen and Varveris. After Zacharakos transferred his shares to his wife in 1999, he continued to serve as president. A company initially owned by Zacharakos, and later transferred to his daughter, manages the property.

In March 2010, Kristiansen agreed to sell his 25% interest in Jarc to Zacharakos for $350,000. Zacharakos told the other two shareholders, Varveris and Sichenze, about his intended purchase. That’s where the stories diverge. Zacharakos alleged that, while Sichenze offered to purchase one-third of Kristiansen’s shares, to which Zacharakos agreed, Varveris never requested to participate in the purchase. Varveris alleged that he and Zacharakos discussed the specific terms of Varveris’s purchase of one-third of Kristiansen’s shares, but that Zacharakos never followed up before Varveris learned that Zacharakos and Sichenze had already completed their acquisition of Kristiansen’s shares.

In July 2010, Varveris brought suit against Zacharakos and Sichenze, claiming that he should be entitled to purchase one-third of Kristiansen’s shares. The defendants eventually moved for summary judgment, arguing that the suit was barred by the statute of frauds and that the complaint fails to state a viable claim.

It was undisputed that there was no shareholders’ agreement for Jarc or any corporate document restricting the sale of shares. It also was undisputed that Varveris had no enforceable agreement with either Kristiansen or Zacharakos regarding the purchase of Kristiansen’s shares.

Based on the absence of any agreement, Justice Schmidt found the statute of frauds defense irrelevant. “The essential issue presented,” he wrote, “is whether Zacharakos breached a fiduciary duty to plaintiff, as a shareholder of Jarc, as the managing agent of Jarc, or as president of Jarc, when plaintiff was denied the opportunity to purchase one-third of the Kristiansen shares” [footnote omitted].

Justice Schmidt’s decision notes Varveris’s concession that “there does not appear to be any controlling authority directly on point with regard to whether the duty owed by a shareholder to other shareholders extends to a requirement to offer equal participation in the purchase of shares of a departing shareholder.” Rather, Varveris’s primary argument for imposition of a fiduciary duty is by analogy to cases holding that close corporation directors may not issue stock options or treasury shares to themselves without granting the opportunity to other shareholders to purchase those shares on the same terms. Justice Schmidt rejects the analogy and grants summary judgment dismissing the claim, reasoning as follows:

There is no allegation that the transaction reduced the number or value of [Varveris’s] shares, that the transaction injured the corporation in any respect or that the transaction was tainted with fraud or illegality. . . .  Zacharakos and Sichenze did not purchase treasury shares owned by the corporation, but rather purchased shares owned privately by an individual shareholder. As the Kristiansen shares were not owned by the corporation, [Varveris] did not have a beneficial interest in those shares by virtue of his status as shareholder of the corporation. Rather, the shares were owned entirely by a private individual who was free to sell and agreed to sell them to certain individuals of his choosing. There is no evidence or allegation that Kristiansen was seeking to sell the shares back to the corporation for the benefit of all shareholders, had any intent to transfer a portion of the shares to plaintiff or believed that Zacharakos would subsequently deliver any shares to [Varveris] following the sale. Under these circumstances, the court finds as a matter of law that there was no breach of fiduciary duty to [Varveris], or that [Varveris] is otherwise entitled to any portion of the shares purchased by defendants in their private transaction with Kristiansen.

Varveris, like so many other cases I’ve written about, highlights the vital function of the shareholders’ agreement as the primary means by which close corporation shareholders can preserve the balance of voting and economic rights. So long as they do not constitute unreasonable restraints on alienation (read more about that here), courts routinely will enforce stock transfer restrictions in agreements among shareholders. Such provisions governing lifetime transfers typically are styled as compulsory rights of first offer and refusal in which the remaining shareholders participate on a pari passu basis, either by direct purchase or indirectly by means of a share redemption, when a departing shareholder seeks to sell his or her shares. The absence of any such agreement in Varveris left each of the shareholders free to transfer his shares however, whenever, and to whomever he chose.

Update October 30, 2013Today the Appellate Division, Second Department, rejected Varveris’s appeal from Justice Schmidt’s ruling, holding that Zacharakos’s status as an officer, director, or shareholder did not, by itself, create a fiduciary relationship as to his purchase of shares from Kristiansen. Read here the appellate decision.