The statutory scheme governing judicial dissolution of closely held New York business corporations resides in Article 11 of the Business Corporation Law. Article 11 includes several provisions empowering the courts to preserve corporate assets while the case is being litigated. The best known and most frequently invoked provisions are BCL § 1113, authorizing a court-appointed receiver, and BCL § 1115, granting the court broad authority to issue injunctions restraining the corporation’s shareholders, directors, officers and creditors from imperiling the corporation’s assets.
Wedged between those two provisions is a lesser known and rarely used statute, BCL § 1114, that gives the courts powers akin to those exercised by bankruptcy judges, to void any post-filing sale, transfer or encumbrance of corporate property made without the court’s prior approval. Here’s the full text of the statute:
A sale, mortgage, conveyance or other transfer of, or the creation of a security interest in, any property of a corporation made, without prior approval of the court, after service upon the corporation of a summons in an action, or of an order to show cause in a special proceeding, under this article in payment of or as security for an existing or prior debt or for any other or for no consideration, or a judgment thereafter rendered against the corporation by confession or upon the acceptance of any offer, shall be void as against such persons and to such extent, if any, as the court shall determine.
The case law applying § 1114 (and its Stock Corporation Law predecessor) is sparse. The few decisions I’ve found (besides the Lowbet case discussed below) include:
- Matter of Schramm, 107 Misc. 2d 393 [Sup Ct, NY County 1980], rejecting arguments that the court lacked authority to set aside a Civil Court consent judgment of eviction in favor of the corporation’s landlord, entered into on the corporation’s behalf by one of the corporation’s two 50% shareholders after the other shareholder commenced a dissolution proceeding.
- Matter of Rappaport, 110 AD2d 639 [2d Dept 1985], voiding the respondent 50% shareholder’s post-filing issuance of stock to his brother-in-law in an effort to defeat the petitioner’s standing as a 50% shareholder to bring a deadlock dissolution proceeding.
- Matter of Musano, 28 AD3d 349 [1st Dept 2006], affirming the lower court’s order voiding the respondent’s issuance of shares after commencement of dissolution proceeding.
The court’s remedial authority under § 1114 is not all or nothing. Rather, the statute’s language gives the court broad discretion to fashion equitable relief tailored to the facts and circumstances of the case. As the court in the above-cited Schramm case explained,
[S]ection 1114 of the Business Corporation Law does not mandate that the consent judgment be declared void. Although the statute uses mandatory language (“shall be void”, rather than “may be void” or “shall be voidable”), the manifest intent of the statutory scheme, as well as additional language, indicate otherwise. First, the use of the further clause “as against such persons and to such an extent, if any, as the court shall determine” directs the court to determine the issues entirely according to its discretion; obviously, the empowering of the court to use its inherent equitable powers belies any mandatory intent. Moreover, if the intent of section 1114 was to automatically void any such transactions, much of section 1115 would be rendered unnecessary. Section 1115 (subd [a], par ) of the Business Corporation Law empowers the court to enjoin “the corporation and its directors and officers from * * * paying out or otherwise transferring or delivering any property of the corporation, except by permission of the court.” The intent of each section is similar: to enable the court to preserve corporate property for the benefit of shareholders and creditors; while section 1115 looks prospectively, to prevent improper future actions injurious to the corporate estate, section 1114 operates retrospectively permitting the court to set aside past injurious acts which, as alleged here, have come to light only after their commission. [Citation omitted.]
The Lowbet Case
If ever I wanted to invent a case that tests a court’s discretion to fashion equitable relief under § 1114, I couldn’t do better than a matter presently pending before Brooklyn Commercial Division Presiding Justice Carolyn E. Demarest called Matter of Lowbet Realty Corp.
Lowbet involves one of the most brazen shareholder heists I’ve seen. The petitioner–let’s call him Shareholder A–in 1980 became 100% shareholder of a corporation, Lowbet Realty Corp., that owned a Brooklyn residential apartment building. In 1985 he married and gave his wife–let’s call her Shareholder X–a 25% stock interest. They separated in 1995 at which point Shareholder A returned to his Chinese homeland, leaving his wife running the corporation for many years afterward. In late 2011, by which time the husband-wife relationship had further deteriorated and after Lowbet had been administratively dissolved, Shareholder A filed a petition for judicial supervision of Lowbet’s winding up and liquidation. However, in early 2012, in blatant contempt of Justice Demarest’s interim restraining order and without notice to Shareholder A, Shareholder X deeded the apartment building to an outside buyer (973 Realty) for $1.6 million. By the time Shareholder A discovered what had happened, Shareholder X fled the country with the sale proceeds, never to return.
In November 2012, in a decision I wrote about here, Justice Demarest granted Shareholder A’s request to file an amended petition naming 973 Realty and the building’s managing agent as additional respondents, and asserting claims against them under § 1114 to rescind the sale and for damages.
Over a year later, it appears that the fallout from Shareholder X’s thievery remains far from resolved. Earlier this month, Justice Demarest issued a new decision on a motion by the property manager to dismiss cross claims for indemnification and contribution filed against it by the buyer, 973 Realty. Matter of Lowbet Realty Corp., 2014 NY Slip Op 24041 [Sup Ct, Kings County Feb. 18, 2014].
973 Realty’s cross claim asserted that, in the event the court rescinds the sale under § 1114, it would be entitled to indemnification and/or contribution from the property manager for its financial losses, including the $1.6 million purchase price, stemming from Shareholder A’s allegations that the property manager facilitated his wife’s fraud. The property manager sought to dismiss the cross claim for legal insufficiency.
The issue is more complicated than meets the eye, and Justice Demarest’s decision carefully and at length analyzes the statutory and common law framework governing claims for contribution and indemnity. Ultimately she denies the motion to dismiss the cross claim. Here are some of the highlights:
- The right to contribution requires underlying tort liability; liability in contract, and contract-based economic damages, do not qualify. Because 973 Realty’s claims against the property manager, assuming the sale is rescinded under § 1114, are based upon its actual out of pocket loss of property as a result of tortious acts, the damage to 973 Realty states a valid claim for contribution.
- Shareholder A’s claims for rescission and an accounting based on § 1114 are analogous to a tort-based claim for fraudulent conveyance in which 973 Realty’s liability would be based on its knowledge of, or negligent failure to ascertain, Shareholder X’s lack of authority to convey the corporation’s real property.
- Although Shareholder A’s claims against 973 Realty and the property manager are premised on different theories, they nonetheless can be considered joint tortfeasors.
- The equitable remedy of rescission normally results in contract-based economic loss ineligible for contribution. However, case law including American Home Assurance Co. v Nausch, 71 AD3d 550 [1st Dept], recognizes that in some circumstances rescission may have the same effect as subjecting a party to damages for which contribution is allowed, or when the court awards damages where rescission is impossible or impracticable.
- Common-law indemnification, in its classic form, exists in favor of a party who is held vicariously liable for the tort of another, and a party may not obtain indemnification for its own wrong. 973 Realty therefore would not be able to obtain indemnification from the property manager if it is found liable for rescission based on its own fraudulent conduct.
- On the other hand, Shareholder A’s § 1114 claims for rescission and an accounting may, in effect, impose vicarious liability on 973 Realty for the actions of its co-defendants because § 1114 does not require the court to find the recipient of the corporate property at fault before setting aside a sale.
- At this stage of the case, and given the parties’ conflicting accounts of the property’s sale, it cannot be determined as a matter of law based on the pleadings that 973 Realty’s indemnification claim is invalid.
When I wrote about the Lowbet case in 2012, I queried how the unauthorized sale got past the normal due diligence expected of the title company and the buyer’s counsel. The fact is, anyone with online access can, within a matter of minutes, discover the pendency of a dissolution proceeding concerning a property seller that would lead any reasonable prospective purchaser to inquire further.
How will Lowbet turn out? Did the purchaser know or have reason to know Shareholder X lacked authority to sell the building, and that the property was subject to a court’s restraining order in a dissolution proceeding? Did the property manager knowingly facilitate the unauthorized sale? Only time, pretrial discovery and ultimately a trial will tell.
Meanwhile, Shareholder X, wherever you are, if you’re reading this, please drop me a line and let me know how you pulled it off. It’ll be our secret (or not).