Someday, if and when the facts come out in discovery, we’ll learn what really happened in the curious case of Matter of Hu (Lowbet Realty Corp.), 2012 NY Slip Op 22314 (Sup Ct Kings County Nov. 2, 2012), in which a slippery minority shareholder somehow managed to sell the corporation’s sole realty asset and abscond with $1.6 million sale proceeds in violation of court order in a pending liquidation proceeding brought by the majority shareholder. In the meantime, the buyer and the property manager now find themselves ensnared in the majority shareholder’s effort to rescind the sale and to recover damages.

The court’s decision in Lowbet, issued earlier this month by Brooklyn Commercial Division Justice Carolyn E. Demarest, tells a remarkable story of brazen disobedience of court order by one Margaret Liu, a 25% shareholder of Lowbet Realty Corp. The decision also sheds light on an interesting, rarely seen procedural question in corporate dissolution proceedings, namely, whether the court may adjudicate within such summary proceedings a shareholder’s claim for relief against a third party who is neither a shareholder nor officer/director of the corporation, rather than being forced to commence a separate, plenary action by ordinary summons and complaint.

Background

The petitioner, Shau Chung Hu, was the 100% owner of Lowbet when, in 1980, it purchased a 19-unit apartment building in Brooklyn. In 1985, Hu married Margaret Liu and gave her a 25% stock interest in Lowbet. Mr. Hu and Ms. Liu separated in 1995, at which time Mr. Hu went to China where he has resided ever since, leaving Ms. Liu in full control over Lowbet.

Apparently their relationship further deteriorated by 2006, when Mr. Hu called a special shareholders meeting which Ms. Liu failed to attend at which Mr. Hu and an associate were named sole officers and directors of Lowbet. Ms. Liu thereafter filed for divorce from Mr. Hu, however, the matrimonial proceeding was dismissed in mid-2011 after she failed to appear for trial. Prior to the dismissal, the matrimonial judge sanctioned Ms. Liu for using Lowbet funds to pay for own expenses and legal fees in violation of a prior restraining order.

It was not to be the last time Ms. Liu ignored judicial mandate.

The Winding-Up Petition

In October 2011, Mr. Hu filed a petition for judicial supervision of the winding up and liquidation of Lowbet which, some years earlier, had been administratively dissolved for failure to file and pay franchise reports and taxes. Justice Demarest signed an Order to Show Cause (read here) which directed the then-property manager, Bay Shine Management Company (“Bay Shine”), to continue its management role and prohibiting both Mr. Hu and Ms. Liu from “participat[ing] in the management of the realty or remov[ing] assets of the corporation without further direction by a Justice of this Court.”

In January 2012, Ms. Liu’s counsel filed an answer asserting that she owns 100% of the shares of Lowbet. On April 10, 2012, Justice Demarest struck Ms. Liu’s answer on default after she failed to appear at a hearing on Mr. Liu’s petition that date.

Ms. Liu’s Unauthorized Sale of the Property

Sometime the following week, Mr. Hu discovered that by deed dated February 22, 2012, Ms. Liu, purporting to act on Lowbet’s behalf, in violation of the court’s October 2011 restraining order, sold the corporation’s realty for $1.6 million to an entity named 973 44th Street Realty LLC (“973 Realty”). A title company, acting through an agent, appeared at the closing and issued title insurance to 973 Realty.

On April 23, 2012, Justice Demarest signed another Order to Show Cause (read here) to hold Ms. Liu in contempt of the court’s October 2011 restraining order barring any transfer of corporate assets. Justice Demarest subsequently held Ms. Liu in contempt and issued a warrant for her arrest. Ms. Liu, however, left the country and never returned. She also never returned any of the sale proceeds. Her attorney, who admitted never having met Ms. Liu in person, thereafter withdrew as counsel.

The Motion to Amend the Petition

On May 30, 2012, Mr. Hu moved by Order to Show Cause (read here) for permission to join 973 Realty, Bay Shine, the title company and its agent as additional respondents in the proceeding, and asserting new claims to rescind the unauthorized sale by Ms. Liu to 973 Realty and for damages against the proposed additional respondents.  The proposed amended petition:

• as against 973 Realty, added claims predicated on fraud and under §1114 of the Business Corporation Law (BCL) for rescission and an accounting;
• as against Bay Shine, alleged claims for breach of fiduciary duty and negligence in “facilitating” the fraudulent transfer of the property in violation of the October 2011 restraining order by providing Ms. Liu the keys to the property and Lowbet’s books and records shortly before the sale; and
• as against the title company and its agent, alleged claims sounding in negligence for “failing to discover Ms. Liu’s fraud.”

The Court’s Decision

Justice Demarest’s analysis begins by rejecting 973 Realty’s procedural defense, that the asserted claims against it can be prosecuted only by way of a separate plenary action or, as quoted in the decision, that “petitioner is attempting to bootstrap onto a corporate dissolution special proceeding what is quintessentially a quiet title action under RPAPL 1501” (referring to the Real Property Actions and Proceedings Law).

Justice Demarest instead concludes that the remedy provided by the RPAPL “is not exclusive and thus does not preclude relief pursuant to [BCL] §1114” which requires court approval of the sale of corporate assets in dissolution proceedings.  Justice Demarest also cites Matter of Schramm, 107 Misc 2d 393 (Sup Ct NY County 1980), where the court held that the judicial authority to supervise dissolution proceedings under BCL Article 11 includes “power pendente lite to preserve the corporate estate” and that “logic and the public interest in judicial economy dictate that interrelated issues” regarding the dissolution “be adjudicated by the same court so as to expeditiously produce a just and coherent result.”

973 Realty also argued that Mr. Hu should not be permitted to seek rescission of the sale because Ms. Liu had “apparent authority” to sell the property and because 973 Realty was a bona fide purchaser for value with no knowledge of the pending litigation. This argument likewise garners the court’s disapproval based on BCL §909 which, in the case of Lowbet formed before that statute’s amendment, requires two-thirds shareholder consent to the sale of substantially all of the corporation’s assets. “Because Liu owned only 25% of Lowbet’s shares,” Justice Demarest writes,

she did not have plenary authority, or apparent authority, to sell the Property on Lowbet’s behalf. As petitioner correctly asserts, a deed that is void due to lack of authority for the transfer cannot convey title to property, even to a good faith purchaser for value. Moreover, Liu’s conveyance of the Property was in clear derogation of the Court’s order. Therefore, petitioner’s claims for rescission of the sale of the Property, pursuant to [BCL] §1114 and predicated on Liu’s fraud, are not devoid of merit . . . [and] petitioner is granted leave to amend his petition to seek such relief. [Footnote and citations omitted.]

Bay Shine was no more successful than 973 Realty in its opposition to Mr. Hu’s motion. Justice Demarest observes that “Bay Shine, as managing agent, owed a fiduciary duty to Lowbet” and that, because Bay Shine “was aware of the instant proceeding, it knew or should have known that its actions [in providing keys and corporate records to Liu prior to the sale] would provide material assistance to Liu in breaching her fiduciary duty to the corporation and to petitioner.”

The title company and its agent, in contrast, successfully persuaded Justice Demarest that they did not belong in the suit. They argued that they could not be found liable for negligence “because they had no privity with petitioner or the corporation and thus owed them no duty, and because they did not cause any damages that petitioner suffered.” Justice Demarest agreed that they owed no duty of care to petitioner and, in the absence of any allegations of fraud against them, denied Mr. Hu leave to add them as additional respondents.

The decision also grants Mr. Hu leave to serve upon 973 Realty and Bay Shine broad demands for discovery which, under §408 of the Civil Practice Law and Rules, is not permitted in special proceedings absent leave of court. Leave for discovery is warranted, Justice Demarest rules, because petitioner had no knowledge of Ms. Liu’s unauthorized sale and cannot be expected to get necessary documents from Ms. Liu who left the country.

The deed signed by Ms. Liu on Lowbet’s behalf, conveying the property to 973 Realty (view here), contains no representation that the sale was duly authorized by the requisite super-majority of the selling corporation’s shareholders. The court’s decision also makes no mention whether Ms. Liu provided at the closing any separate certification of shareholder approval. As I said at the outset, it will be interesting to learn how the unauthorized sale got past the normal due diligence expected of the title company and the buyer’s counsel, including a routine search for pending litigation which would have revealed the existence of the dissolution proceeding.