Your client, a 50% shareholder of a New York close corporation, tells you that the business is in complete disarray due to irreconcilable disputes with the other 50% shareholder and that he believes the other shareholder has misappropriated the corporation’s assets and diverted business opportunities.
The client accepts your recommendation to bring a judicial dissolution proceeding. You review Article 11 of the Business Corporation Law before drafting the dissolution petition. You come across two dissolution statutes denominated § 1104 and § 1104-a. Section 1104, called “Petition in case of deadlock among directors or shareholders,” confers standing on a 50% shareholder and, as the name straightforwardly suggests, authorizes a court to dissolve based on deadlock precluding board action or election of directors, or other “internal dissension” warranting dissolution.
Section 1104-a, with the more cryptic name, “Petition for judicial dissolution under special circumstances,” confers standing on a shareholder with 20% or more of the corporation’s voting shares, and authorizes dissolution when the controlling shareholders or directors engage in “illegal, fraudulent or oppressive actions” against the petitioning shareholder, or have “looted, wasted, or diverted” the corporation’s property.
You quickly realize that your 50% shareholder-client has standing to seek dissolution under both statutes. Which one should you choose? If you believe you have facts sufficient to obtain dissolution under one of them, is there any reason to consider the other? Can you choose both? Does it really matter?
It most certainly does matter, for a couple of reasons mainly having to do with the different remedies offered by the two statutes.
The better known difference concerns the buy-out. A petition under § 1104-a automatically triggers the non-petitioning shareholder’s and the corporation’s right to elect to purchase the petitioner’s shares for “fair value” under § 1118. A petition under § 1104 does not. As I’ve written before, there are circumstances where a 50% shareholder seeking dissolution will want to offer the other 50% shareholder the right to force a buy-out, and there are other circumstances that weigh against doing so. Counsel and client therefore must think long and hard about whether utilizing § 1104-a helps or hurts bargaining leverage from the standpoint of the eventual buy-out. If it helps, there is no downside to including deadlock allegations and citing § 1104 as additional grounds for dissolution.
A less well known difference concerns the “surcharge” remedy that is available under § 1104-a but not under § 1104. Subsection (d) of § 1104-a provides:
The court may order stock valuations be adjusted and may provide for a surcharge upon the directors or those in control of the corporation upon a finding of willful or reckless dissipation or transfer of assets or corporate property without just or adequate compensation therefor.
In effect, the statute allows the petitioner to assert within the dissolution proceeding claims on the corporation’s behalf for monetary recovery against the controller without having to bring a separate, shareholder’s derivative action. If dissolution is granted, and if the petitioner is able to establish an improper transfer of assets, the surcharged controller will be compelled to reimburse the corporation for the benefit of its creditors and the equity holders in the winding up and liquidation phase.
As already noted, the deadlock dissolution statute, § 1104, contains no similar provision, as the petitioner found out the hard way in Matter of Singh (Mohthi Transportation, Inc.), Decision and Order, Index No. 600768/14 [Sup Ct, Nassau County June 25, 2014]. The petitioning 50% shareholder in that case sought dissolution of an interstate trucking business. His petition (read here) expressly cited § 1104 as grounds for dissolution. It also cited § 1104-a, not as grounds for dissolution, but in support of the petition’s request for “damages, penalties or surcharge” against the respondent 50% shareholder who, allegedly, used corporate funds for personal expenses and diverted business to his wife’s competing business.
The court, in a decision by Nassau County Commercial Division Justice Vito M. DeStefano, granted the unopposed request for dissolution but denied the petition’s demand for a surcharge because the petition did not seek dissolution under § 1104-a. As Justice DeStefano explained,
It is the petitioner who chooses the statutory authority under which dissolution is sought (Business Corporation Law § 1105). Here, the petition for dissolution specifically sets forth the statutory section under which it seeks dissolution, namely, Business Corporation Law § 1104(a). Having sought dissolution pursuant to that section of the Business Corporation Law, Petitioner cannot seek additional remedies available under dissolution pursuant to Business Corporation Law § 1104-a, notwithstanding allegations in the petition that [respondent’s] wife incorporated a competing business which is being used to convert assets, income and opportunities from [the subject corporation].
The court’s reference to BCL § 1105 shouldn’t be overlooked. The section commands that the petition for dissolution “specify the section or sections of this article under which it is authorized and state the reasons why the corporation should be dissolved.” The petition in Singh, although it mentioned both sections 1104 and 1104-a, specified the former alone as grounds for dissolution, and the latter merely as authority for a surcharge.
Singh‘s lesson for the 50% shareholder is simple: if you want to pursue a surcharge claim, you must explicitly seek dissolution under § 1104-a, either alone or in combination with § 1104. The decision as to which statute to employ, however, should also take into consideration the respondent shareholder’s possible election to purchase if § 1104-a is invoked.