As I’ve previously written (read here), the usual, broad form of arbitration clause found in many shareholder agreements mandates the arbitration of petitions for judicial dissolution of closely held corporations brought under Article 11 of the Business Corporation Law (BCL). A decision earlier this month by Brooklyn Commercial Division Justice Carolyn E. Demarest (pictured) in Pisane v. Feig, Decision and Order, Index No. 12246/11 (Sup Ct Kings County Sept. 14, 2012), serves as a compelling reminder of the extremely limited scope of judicial review of the arbitrator’s award including the arbitrator’s interpretation of the shareholders’ agreement and stock valuation. [Disclosure: My firm and I represented the prevailing party in the case.]

Round One: The Court Orders Arbitration of Dissolution Petition

Justice Demarest’s 22-page decision gives a detailed description of the proceedings. In brief, in May 2011, Neil Pisane, as 42.5% shareholder of S&N Chemical Co. and several affiliated companies, petitioned for judicial dissolution under BCL §1104-a predicated on allegations of oppressive actions and diversion of corporate assets by respondent Steven Feig, who also held a 42.5% interest in the companies. (A third shareholder, who was not named as a party, held a 15% non-voting interest.) After Feig moved to compel arbitration under the arbitration clause in the governing shareholders’ agreement, the court entered a stipulated order staying the litigation proceedings pending arbitration.

Pisane thereafter refiled his dissolution petition as an arbitration claim with the American Arbitration Association. Feig’s answer included a number of counterclaims, one of which asserted that Pisane’s filing of a dissolution petition triggered his contractual obligation under the shareholders’ agreement to sell his shares to Feig at a specified formula price and terms. In another counterclaim, Feig alternatively elected to purchase Pisane’s shares for fair value under BCL §1118.

Round Two: The Pre-Hearing Fight Over Who Buys Out Whom

Prior to the arbitration hearing, Pisane contended that he was entitled to buy out Feig’s 42.5% interest — and not the other way around — based on an alleged breach of the shareholders’ agreement in June 2010. The arbitrator issued an interim ruling dated November 30, 2011 (read here) rejecting Pisane’s buy-out bid as “null and void” and, in any event, superseded by his subsequent and continuing demand for dissolution. Instead, the arbitrator ruled, “[a]s addressed in his counterclaims and otherwise, Feig has ‘priority’ in these proceedings and the scheduled hearings shall consider, among other things, [Feig’s] offer to purchase [Pisane’s] interests in accordance with the Shareholders’ Agreement.”

Round Three: The Arbitration Hearing and Buy-Out Award

Arbitration hearings were held over the course of three days in November and December 2011 at which testimony was given by numerous witnesses including the parties, their valuation experts, the companies’ controller, and the companies’ independent outside accountant.

Pisane variously contended that the companies had an aggregate value of $2.9 million, $3.3 million or $3.675 million. The latter figured relied on the combined $3 million certificate of agreed value that the parties executed at the time the shareholders’ agreement was entered in 2004, plus a $675,000 appraisal obtained by Pisane prior to the outbreak of litigation. Pisane thus sought a range of $1.23 million to $1.56 million for his 42.5% interest.

Feig contended that the buy-out price was governed by Article 21(B) and 21(D) of the shareholders’ agreement. Article 21(B) provided that, in the event the parties are unable to agree upon the shares’ valuation, the companies’ outside accountants are required to determine the buy-out price using a specified formula and multiples taking into account cash on hand, accounts receivable, inventory, equipment and accounts and notes payable. Article 21(D) provided that the accountants’ determination shall be conclusive and binding absent “manifest error.”

On the first day of hearing, the arbitrator directed the companies’ regular outside accounting firm to value the companies in accordance with Article 21(B). At the next hearing date, the accountant submitted a computation pursuant to the formula, showing an aggregate value of the companies of a little over $1.5 million, or $639,000 (rounded) for Pisane’s 42.5% interest.

Following submission of post-hearing briefs, the arbitrator issued a Partial Final Award dated February 14, 2012 (read here) in which he found that the accountant had used the correct valuation formula under Article 21(B), and he rejected all upward and downward adjustments to the $639,000 valuation of Pisane’s 42.5% interest which he found to be “fair and reasonable.” The arbitrator directed the parties to complete the stock transfer upon the terms set forth in the shareholders’ agreement, including a 10% payment at closing and the balance over 10 years secured by Feig’s note, and imposition on Pisane of a two-year non-compete covenant. The arbitrator also determined that Feig was entitled to recover his attorney’s fees and disbursements as the “successful party” in accordance with the arbitration clause’s fee-shifting provision.

Round Four: The Legal Fees Award and Closing

After further party submissions, by Final Award dated May 7, 2012 (read here), the arbitrator awarded Feig his attorney’s fees and expenses in the sum of $152,310.

On June 4, 2012, the parties closed on the sale of Pisane’s interest in the Companies to Feig under the terms of the arbitration award.

Round Five: The Cross-Motions to Vacate and Confirm the Award

The case next returned to court on Pisane’s motion to vacate the award and Feig’s cross-motion to confirm the award. Pisane argued that the arbitrator was required to use $3 million — the value of the companies set forth in the eight-year old certificate of value — pursuant to Article 21(A) of the shareholders’ agreement in establishing the purchase price for Pisane’s shares. Pisane contended that the arbitrator irrationally failed to follow this contractual mandate, thereby exceeding his authority and requiring the vacatur of the buy-out award and the legal fees award. Specifically, Pisane relied on a single sentence in Article 21(A) stating: “If, at the time it is necessary to determine the value of the [companies], and no certificates of valuation have been executed within two years, the total value shall be the higher of the values fixed in the last certificate executed by the Stockholders [or the companies’ book value].”

Feig countered that the award was correctly calculated under the formula in Article 21(B) of the shareholders’ agreement based on the parties’ inability to agree upon the value of the stock of the companies, and that such valuation by the companies’ outside accountant was final and binding under Article 21(D). Feig also pointed to a sentence in Article 21(A) ignored by Pisane, stating that the certificate of value was conclusive only if it were “dated less than two years before the date as of which the value is to be determined” (emphasis added).

Justice Demarest’s analysis begins with an overview of the applicable legal principles. First, she emphasizes the “broad authority” given to arbitrators to resolve disputes through “informal and expeditious means” and the concomitant limits on judicial authority to modify or vacate awards. Second, Justice Demarest notes that the scope of judicial review of arbitration awards is confined to the limited grounds available under Section 7511(b) of the Civil Practice Law and Rules, and that otherwise the court lacks authority to set aside an award even where an arbitrator has made an error of law or fact. Third, a court may find that an arbitrator exceeded his or her power under Section 7511(b) only in the “rare circumstances” where the award violates a strong public policy, is “irrational” or “clearly exceeds a specifically enumerated limitation on the arbitrator’s power.” Fourth, an arbitrator’s interpretation of the parties’ contract is “impervious to judicial challenge” even where the plain meaning of the words of the contract has been disregarded, i.e., a court may not pass upon the merits of the dispute or substitute its contract interpretation for the arbitrator’s.

Applying these principles, Justice Demarest finds that the arbitrator did not exceed his powers and that Pisane’s arguments fall short of the strict standard for vacatur of an arbitration award, writing as follows:

Here, the Certificate of Value was dated well over two years before the date that value was determined. While Article 21(A) of the Shareholders’ Agreement sets forth that the stockholders may execute a new Certificate of Value to update and supersede all prior Certificates of Value, the Shareholders’ Agreement specifically contemplated that the parties might not agree to reach a valuation of the shares of stock in the Companies and provided for a specific formula for such valuation in Article 21(B).

Justice Demarest also rejects Pisane’s reliance on the sentence in Article 21(A) referring to the higher of the last certificate of value or book value, as follows:

Although the language in Article 21(A) appears inconsistent with Article 21(B) of the Shareholders’ Agreement, [the arbitrator], faced with these provisions, reasonably determined to use the methodology mandated by Article 21(B) and (D), which required a formula-based valuation by the Companies’ outside accountant, rather than ignoring this specific formula and the language of Article 21(B) and (D) and using an eight-year-old Certificate of Value.

. . . [The arbitrator] stayed within the confines of the four corners of the Shareholders’ Agreement, appropriately resolving a conflict among its provisions. Such resolution by [the arbitrator] constituted an interpretation of this contract which is impervious to challenge.

Justice Demarest also rejected Pisane’s bid to vacate the arbitrator’s award of Feig’s attorney’s fees, finding that his determination that Feig was the “successful party” as that term was used in the arbitration clause’s fee-shifting provision “was borne out by the fact that Feig’s interpretation of the Shareholders’ agreement was the one adopted by [the arbitrator].”

In addition to confirming the arbitration award, Justice Demarest also granted Feig’s application for reimbursement of his legal fees incurred in connection with opposing Pisane’s motion to vacate the award and in cross-moving to confirm the award, under the provision in the arbitration clause stating, “If a successful party to the arbitration shall be required to resort to court action to enforce any award in arbitration, the losing party agrees to pay for the other parties’ counsel fees and the costs and disbursements of such action or proceeding.”

With the offset of the legal fees awarded by the arbitrator plus the additional legal fees to be determined by the court, it can be anticipated that the net amount to be paid to Pisane for his 42.5% stock interest will be significantly less than $500,000.

Imperfections and ambiguities in shareholders’ agreements, like any other form of contract, can lead to legal disputes requiring adjudication. What the Pisane case reinforces above all is that the courts’ limited authority to review arbitral decisions, to determine if the arbitrator exceeded his or her power, may not be used as a vehicle for second guessing the judgments made by arbitrators in resolving such contract construction disputes. Were the rule otherwise, arbitration, instead of being a final destination, would become a way station en route to new rounds of adjudication by the courts, which would run counter to fundamental public policy encouraging arbitration as an expeditious and informal means of resolving civil disputes.