The doctrine of unclean hands is a highly adaptable defense employed by litigants in opposition to all manner of claims for equitable relief. Based on the maxim, “those seeking equity must do equity,” it basically means that a plaintiff who comes to the court with “dirty hands”, that is, has acted unethically or in bad faith in regard to the subject of the complaint, may not obtain an equitable remedy.

In the business divorce arena, we see the unclean hands defense raised when the petitioner has some ulterior, “bad” motive for seeking dissolution. We also see it in the silent partner context, where someone seeking judicial dissolution of a closely held business entity claims to have owner status but, because the person (or the business) had some need to conceal the ownership interest, it never was recorded in the entity’s records, reported to tax authorities, or otherwise reflected in the business’s transactional documents. Often the circumstances also involve some representation or omission in prior judicial proceedings, such as bankruptcy court, where the later-alleged ownership interest effectively was negated.

This is not my first post addressing the unclean hands defense and its close cousin, the doctrine of judicial estoppel against inconsistent litigation positions. For instance, in 2008, I wrote about Light v. Boussi where the court denied standing to a petitioner who omitted his alleged stock ownership interest from his prior bankruptcy filing. Also in 2008, I wrote about Matter of Marciano (Champion Motor Group, Inc.) where the court determined there were factual issues surrounding petitioner’s motives for hiding his stock interest. In 2009, I wrote about Watkins v. J C Land Development, Ltd. in which the court denied standing to a petitioner who did not disclose his alleged stock ownership to probation authorities at the time of his sentencing for a criminal conviction. And last year, I wrote about Matter of Gleich (Iceland, Inc.) in which the court denied standing to a petitioner whose alleged stock ownership interest had not been disclosed in the corporation’s bankruptcy reorganization plan.

Those cases are now joined by Kimelstein v. Kimelstein, 2010 NY Slip Op 31689(U) (Sup Ct Suffolk County June 22, 2012), decided last month by Suffolk County Commercial Division Justice Emily Pines. In Kimelstein, Justice Pines granted summary judgment dismissing a dissolution lawsuit between brothers based primarily on the complaining brother’s admission that he avoided formalizing his alleged stock ownership interest to conceal it from his ex-wives and so as not to jeopardize his veteran’s disability payments.

Kimelstein involves two corporations formed around 2000 called The Van Depot, Inc. (“Depot”) and L&J Realty, Ltd. (“L&J”). Depot bought and sold used vehicles on a lot owned by L&J. The plaintiff, Larry Kimelstein, claimed that he and his brother, defendant Jeffrey Kimelstein, formed the companies as “50/50 partners,” as evidenced in part by the “L” for Larry and “J” for Jeffrey in L&J Realty. Larry contended that they jointly borrowed $100,000 from their parents to use for the down payment on the realty and another $30,000 to start up Depot. Larry alleged that over the years he put into the businesses about $150,000 of his own money, most of which he expected to be paid back. The brothers each drew a weekly salary of $2,000 in cash. Larry had check signing authority on Depot’s corporate account and exercised various management responsibilities.

Larry alleged that in summer 2007, Jeffrey orally agreed to buy out Larry’s interest in the two companies for $350,000, which would be paid at the weekly rate of $850 until Jeffrey could refinance the realty, at which point he would pay the balance. Larry stopped working in September 2007 but only received weekly payments for about three months. One of the checks bore a memo notation written by Jeffrey, “Payment Towards Buy Out of V.D.” in which V.D. stood for Van Depot. Larry claimed that Jeffrey was unable to refinance the realty and told Larry he would have to sue him to get his money.

Jeffrey alleged that at all times he was the sole owner of the two companies; that he alone hired a lawyer and an accountant to form the corporations; that only his name was on the corporate formation papers; that only he signed the closing papers for the purchase of the realty; that Larry was nothing more than a paid employee; that Larry never was issued any shares in the corporations; that he never offered to purchase Larry’s interest in the companies for any amount; that he asked Larry to leave the business because he refused to work; and that he decided to give Larry $850 per week severance to help him get back on his feet.

Larry initially sued to enforce the alleged $350,000 buy-out agreement. In a February 2010 decision, Justice Pines dismissed Larry’s claims for breach of oral agreement and specific performance based on the statute of frauds; denied Jeffrey’s motion to dismiss a claim to impose a constructive trust; and granted Larry leave to amend his complaint to add a claim, among others, for corporate dissolution as an oppressed shareholder under §1104-a of the Business Corporation Law.

In an October 2011 decision, Justice Pines dismissed Larry’s amended claims for breach of fiduciary duty and for a formal accounting which were asserted individually instead of derivatively as required. At the time, Justice Pines refused to dismiss Larry’s claim for dissolution based on lack of standing because “there exists documentary evidence presented on both sides of this issue,” and she allowed Larry to proceed with his equitable claims in the alternative.

Justice Pines’ decision last month granting summary judgment tosses all of Larry’s remaining claims. Why the different outcome than the prior decision? For one, the prior decision denied a motion to dismiss the pleadings, in which the court is required to assume the truth of Larry’s allegations. The later decision grants a summary judgment motion in which the parties must lay bare their proofs in order to demonstrate either there are or are not factual disputes requiring a trial.

The other, essential difference is the court’s reliance on a series of testimonial admissions by Larry evidencing his “unclean hands.” These include:

  • He was not an officer, director, or shareholder of either corporation because he had declared personal bankruptcy in 1999 and did not want his negative credit to harm the corporations’ credit.
  • He knowingly failed to disclose in his bankruptcy proceeding that he had $87,000 in cash in a safe deposit box because he needed the cash to open his next business.
  • He knew Depot required financing to obtain inventory and, because of his bankruptcy, that  they would not get it if his name was on the papers.
  • He never asked for formal recognition as a shareholder because he had two ex-wives to whom he paid child support and he did not want them to see that he was doing well.
  • He also never sought formal shareholder status because he was concerned it would disqualify him from receiving his veteran’s disability payments.
  • He described the concealment of his business ownership as trying to “fly under the radar.”
  • He did not review or sign the corporate tax returns.
  • He had no personal liability for any of the corporations’ debt.

Justice Pines’s analysis defines the doctrine of unclean hands as

bar[ring] the grant of equitable relief to a party who is guilty of immoral, unconscionable conduct when the conduct relied on is directly related to the subject matter in litigation and the party seeking to invoke the doctrine was injured by such conduct.

After recapitulating Larry’s admitted reasons for keeping his alleged ownership interest “under the radar,” Justice Pines minces no words in finding it

clear that Plaintiff’s purpose in engaging in this scheme was to prevent his creditors, both present and future, as well as his ex-wives and the federal government, from collecting on their accrued or potential claims against the Plaintiff. Contrary to Plaintiff’s contention, the Defendants have established that they were injured by Plaintiff’s conduct as it cannot be said that the hindering and defrauding of Plaintiff’s creditors did not in any way affect the rights between the parties herein. In fact, Plaintiff admitted that as a result of the scheme he was not obligated to pay any debts of the corporations.

Larry’s “scheme” to deceive present and future creditors, and his “admi[ssion] at his deposition that he was never a shareholder of either L&J or Van Depot,” Justice Pines concludes, require the dismissal without a hearing of his claim for dissolution under BCL §1104-a as well as his claims for imposition of a constructive trust and for unjust enrichment.

The famous 1889 case of Riggs v. Palmer, in which a grandson murdered his grandfather to accelerate his inheritance lest the grandfather change his will, is still taught to law students to illustrate the unclean hands defense. Kimelstein will never achieve Riggs‘s stature, but the case nonetheless serves as a valuable lesson highlighting the perils for those who choose the silent partner role for the wrong reasons.