One of three, equal shareholders in a family-owned business licensed by the state liquor authority was convicted of a felony. Under state law the felony conviction of an owner jeopardizes the company’s license and with it, the entire business. The other two shareholders therefore adopted a resolution terminating his employment and simultaneously exercised the company’s option, set forth in their shareholders’ agreement, to redeem his stock at a value to be determined by appraisal.
Problem solved? Not quite. For one thing, the termination of employment was made retroactive about three months, arguably contrary to a provision in the shareholders’ agreement requiring that the purchase option be exercised within 30 days of termination. For another, the company did not obtain the required appraisal or propose a closing until about a year after the termination, whereas the agreement required that the company close on its option to redeem the shares within 90 days of the termination.
The ousted shareholder refused to tender his shares, contending that the company forfeited its purchase option by failing to exercise it in a timely fashion. The company, under pressure of a threatened de-licensing, sued to enforce the buy-out.
Probably you won’t be surprised to learn that, last week, an appellate panel in A. Cappione, Inc. v Cappione, 2014 NY Slip Op 05230 [3d Dept July 10, 2014], affirmed the trial court’s decision in favor of the company, ordering the ousted shareholder to convey his shares but also allowing him to contest the appraised value offered for his shares. The court’s ruling is particularly important in that it ordered the conveyance even assuming the option to purchase was not timely exercised, based on the manifest intent of the shareholders’ agreement to retain managerial control within the family, and the risk to the company of losing its critical license.
Cappione involves a wholesale beer distribution business owned by the three sons of the company’s two founding brothers. In February 2011, Marc Cappione pleaded guilty to a felony involving the attempted dissemination of indecent materials to a minor. In April 2011 he began serving a multi-year prison term. Under New York’s Alcoholic Beverage Control Law, as a convicted felon Marc is barred from maintaining an ownership interest in a wholesale beer distributorship, otherwise the company risks the loss of its license.
In response, in July 2011, the other two owners and Marc’s cousins, John and David Cappione, held a shareholders’ meeting at which they adopted resolutions terminating Marc’s employment retroactive to March 30, 2011, and authorizing the company to purchase Marc’s shares under Section 2(d) of the shareholders’ agreement which treated the voluntary or involuntary termination of a shareholder’s employment as an offer to sell pursuant to the right of first refusal provided in Section 2(a).
Section 2(a) called for the company’s exercise of the purchase option within 30 days after the employee’s delivery of notice of intent to sell to a third party. The agreement did not specifically provide for a time period to exercise the option when triggered by termination of a shareholder’s employment under Section 2(d).
Under Section 4(a), the purchase price is fair market value as a going concern, to be determined by an independent evaluator. Section 4(b) requires that any sale of shares under the agreement “shall be closed” within 90 days “after the event giving rise to the option or obligation to sell.”
In May 2012 — long after the expiration of the 90-day closing period — the company’s evaluator issued its report valuing Marc’s shares around $911,000. A closing subsequently was proposed in the Fall of 2012. By November 2012, however, Marc refused to execute a redemption agreement or to tender his shares, prompting the company to sue for a declaratory judgment validating its right to redeem Marc’s shares.
In a Decision and Order dated May 24, 2013 (read here), St. Lawrence County Supreme Court Justice David Demarest granted judgment in the company’s favor on its claim to enforce its purchase of Marc’s shares, finding that, “[a]lthough the Agreement does contain specific time limitations, it does not make ‘time of the essence’ with those or similar words.” The company’s failure to “strictly” comply with the time limitations, Justice Demarest added, caused no prejudice to Marc who, because of his felony conviction, is “incapable by law of owning an interest in a beer distributorship” and “placed the company in jeopardy of losing its license to do business.”
The court nonetheless preserved Marc’s rights to dispute the valuation of his shares on the ground the company’s evaluator did not use generally accepted accounting principles on a consistent basis, as expressly required by the shareholders’ agreement.
The Appellate Ruling
Marc appealed the decision. His appeal brief (read here) argued that the absence of time-of-the-essence language in the agreement did not relieve the company of its obligation to exercise its option and to close the purchase in strict compliance with the agreement’s time limitations. The company’s opposing brief (read here) countered that Marc sought to rewrite the shareholders’ agreement whose time limitations were not applicable to an employee/shareholder’s termination due to criminal misconduct, and that even if the company failed to strictly comply with the agreement, equitable considerations supported the lower court’s order.
Last week’s opinion by the Appellate Division, Third Department, unanimously affirmed Justice Demarest’s order, emphasizing that Marc’s position was inconsistent with provisions in the shareholders’ agreement reflecting the intent to maintain a family-owned, shareholder-managed business and, due to Marc’s inability under law to maintain an ownership interest in a beer distributorship and the consequent harm to the company. As the court explained:
There is no question that the shareholders’ agreement does not expressly address the precise situation posed here — namely, where the corporation (in the form of David Cappione and John Cappione) purportedly fails to exercise its purchase option within the initial 30-day window, there are no “other shareholders” remaining to exercise the purchase option outlined in section two, paragraph A of the agreement and the shareholder whose shares are sought to be purchased not only is no longer employed by the corporation but, more to the point, by virtue of his underlying felony conviction, is statutorily precluded from trafficking in alcoholic beverages. That said, reading the agreement as a whole and affording it a practical construction that is consistent with and gives proper effect to the parties’ stated intentions (see Currier, McCabe & Assoc., Inc. v Maher, 75 AD3d at 891-892), we are satisfied that Supreme Court properly granted plaintiffs’ motion to compel Cappione to sell his shares to the corporation — even if that option to purchase was not timely exercised. To hold otherwise and permit Cappione to retain his shares due to the asserted noncompliance with the time period set forth in the shareholders’ agreement not only would effectively rewrite the parties’ agreement and undermine its stated purpose, i.e., to retain managerial control within the closely-held family corporation, but would place the corporation at risk of losing its distributor’s license, thereby rendering its stock worthless. Furthermore, as aptly noted by Supreme Court, there is no discernible prejudice flowing from the corporation’s asserted failure to strictly comply with the time period set forth in the agreement.
The company, in its appeal brief, accused Marc of engaging in an “extortion scheme” ultimately designed to compel a buy-out on more favorable terms. Whether the final valuation of Marc’s shares, via negotiation or further litigation, will exceed the company’s $911,000 figure remains to be seen.
No written agreement can possibly anticipate every contingency. Cappione is one of those cases where strict enforcement against the company of the agreement’s time limitations would have exalted form over substance under unique circumstances not fully anticipated in the agreement. Strict enforcement also could have produced an absurd outcome in which the company lost its business, and its shares rendered worthless, because of a shareholder’s unrelated criminal conviction.
My thanks to attorney Ryan Cummings, who represented the company, for providing copies of the appeal briefs and the lower court’s decision.