Charlie, a minority shareholder of Troubled Corp., petitions for judicial dissolution based on alleged oppressive acts by the majority shareholder, Ted, who, in turn, exercises his statutory right to avoid dissolution by electing to purchase Charlie’s shares for fair value. Charlie and Ted are miles apart on price, so it falls on the court to determine the fair value of Charlie’s shares at an appraisal hearing. Chances are the appraisal determination is many months or even years away, depending on the complexity of the appraisal, the pace of pretrial discovery, delays on account of motion practice, and the court’s own schedule.
In the meantime, although still legally a shareholder until the buyout is consummated, Charlie, whose employment Ted previously terminated and whom Ted voted off the board, has little or no ability to monitor much less control Troubled’s finances and business affairs. In effect, Charlie’s been demoted to creditor status while he awaits the court’s fair-value determination and his eventual payday.
Charlie’s concerned that, by the time the court renders its decision, Ted won’t have the financial wherewithal to pay or finance the fair value award. Of even greater concern, Charlie believes that Ted is running Troubled’s business into the ground either negligently or deliberately as part of a scheme to transfer the company’s good will and other assets to another company under the sole ownership of Ted’s family members. Likely the buyout will never happen if the company’s assets aren’t sufficient to finance Ted’s purchase of Charlie’s shares.
What can Charlie do the ensure that he’ll be able to collect his fair-value award?
The O’Connor Case
A recent decision by Albany County Commercial Division Justice Richard M. Platkin in O’Connor v Coccadotts, Inc., 2015 NY Slip Op 25013 [Sup Ct, Albany County Jan. 14, 2015], highlights the interim remedial choices available to a shareholder in Charlie’s position, namely,
- requiring the electing shareholder or company to bond the eventual buyout award, or
- imposing various financial and/or operational restraints and periodic disclosure requirements on the controlling shareholder and company.
O’Connor involves three corporations that operate cupcake and pastry retail shops, each owned 49% by the petitioner and 51% by one or both of the husband-and-wife respondents. The petitioner brought a hybrid action/proceeding seeking judicial dissolution of the corporations under § 1104-a of the Business Corporation Law based on the respondents’ alleged oppressive acts, and also asserting damages claims against the respondents individually (read petition here).
The petitioner alleged that, after expelling him from the companies, the respondents put the entire business at risk by shutting down a production facility and removing equipment to an unknown location. Thus, at the commencement of the action the petitioner filed a motion by Order to Show Cause (read here) seeking a temporary restraining order — which the court granted — and a preliminary injunction preventing the respondents from:
taking any actions to change or affect the corporate business, structure, management or value of the [corporations], including but not limited to the misappropriation, disbursement, expenditure, transfer, modification, or alienation of corporate funds or property, other than the routine production and sale of baked good products in the ordinary course of business and expenditures incidental thereto, except pursuant to a written agreement with [petitioner] or further order of Court.
The petitioner predicated the court’s authority to grant injunctive relief on BCL § 1115, which grants the court broad authority to grant injunctive relief, as follows:
(a) At any stage of an action or special proceeding under this article, the court may, in its discretion, grant an injunction, effective during the pendency of the action or special proceeding or such shorter period as it may specify in the injunction, for one or more of the following purposes:
(1) Restraining the corporation and its directors and officers from transacting any unauthorized business and from exercising any corporate powers, except by permission of the court.
(2) Restraining the corporation and its directors and officers from collecting or receiving any debt or other property of the corporation, and from paying out or otherwise transferring or delivering any property of the corporation, except by permission of the court.
The respondents filed an answer in which they generally denied the petition’s allegations of wrongdoing. They also filed an affidavit electing to purchase the petitioner’s shares in all three corporations pursuant to BCL § 1118.
In reply, the petitioner argued that the court has authority to order the requested injunction under BCL § 1115 notwithstanding the BCL § 1118 election. In the alternative, the petitioner requested an order requiring the respondents to post a bond or other security in an amount sufficient to secure petitioner for the fair value of his shares, pursuant to BCL § 1118 [c] .
Justice Platkin began his legal analysis with a quote from the First Department’s 2012 ruling in the AriZona Iced Tea dissolution case, where that court wrote,
The buyout election accommodates the interests of the respective parties in ensuring the continued functioning of the business, while also protecting the financial interest of the shareholders and creditors. [Ferolito v Vultaggio, 99 AD3d 19, 25-26]
When a respondent exercises the statutory buyout election, Justice Platkin next observed, “the issue principally becomes one of establishing the fair value of the [corporations].” Justice Platkin also noted the correctness of the petitioner’s contention that a BCL § 1115 injunction
may issue “[a]t any stage of an action or special proceeding under [BCL Article 11]”, even following a BCL § 1118 election” (see Altop v Azaz, 2012 NY Slip Op 32262 [U] [Sup Ct, Nassau County 2012]).
Notwithstanding the court’s authority to grant post-election injunctive relief, Justice Platkin concluded, “the Court does not believe it would be a provident exercise of its discretionary authority to grant the requested preliminary injunction,” explaining as follows:
The [respondents] have made a binding election to purchase petitioner/plaintiff’s shares for their fair value as of November 24, 2014. As a result, the financial risk of future decisions concerning cupcake production, retail outlets and the like falls squarely on the [respondents] and not on petitioner/plaintiff. To be sure, there remains a theoretical possibility that the [respondents] could seek leave to withdraw their presumptively irrevocable election based upon “just and equitable considerations” (BCL § 1118 [a]), but they would bear a heavy burden (see e.g. Matter of Smith v Russo, 230 AD2d 863 [2d Dept 1996]; Matter of Chu v Sino Chemists, 192 AD2d 315 [1st Dept 1993]), and the nature and extent of any intervening changes to the business and/or its value certainly could be considered. Accordingly, while there is no dispute that petitioner/plaintiff’s hard work over the years contributed to the success of the enterprise, the [respondents] should not be restrained from confronting the business challenges faced by the [corporations] going forward.
Justice Platkin also denied, without prejudice to a subsequent, proper application, the petitioner’s alternative request for an order requiring respondents to post a bond or provide other suitable security for the fair value award. “This request was made for the first time in reply,” Justice Platkin wrote, “and it is unsupported by proof persuasively demonstrating a need for such relief.”
So What Should Charlie Do?
The most important lesson of O’Connor for our hypothetical petitioner Charlie is clear: promptly after Ted files his notice of election to purchase Charlie’s shares, Charlie should consider filing an application under BCL § 1118 [c]  to require Ted to post a bond to secure the fair-value award.
As I’ve previously written, the prevailing appellate authority sets a fairly high but not insuperable bar for entitlement to a bond, in the form of evidence of corporate waste or other circumstances raising doubt as to the respondent’s or the company’s financial capability to carry through on their offer to purchase the petitioner’s shares. The type of assets owned by the corporation is also a factor, e.g., a bond is less likely for a real estate holding company with substantial equity in its properties. Of course, any application for a bond will need to provide sufficient evidence of the likely size of the fair value award, though it needn’t be established by a full-blown appraisal.
What happens if the respondent is unable to post a court-ordered bond? I had that experience in the Altop v Azaz case cited in Justice Platkin’s decision, in which the court ordered a $1.2 million bond securing my client’s fair-value award, after which the respondent had to revoke his election when he was unable to obtain the bond. In that manner the bond application functioned like cinematic sports agent Jerry Maguire’s catch phrase, “Show me the money!”, by testing the respondent’s financial ability to pay a fair-value award and sparing my client the time and expense of a futile appraisal proceeding.
Should Charlie also seek injunctive relief? The answer depends on the specific circumstances. In the Altop case I also was able to secure both temporary and preliminary injunctions, capping the company’s credit draws, preventing a sale or mortgage of certain real properties, and requiring monthly financial reporting, that remained in place throughout the litigation including during the short-lived pendency of the buyout election. If the fair value award is not secured, Charlie should strongly consider seeking a preliminary injunction, at a minimum, that requires notice and court approval for transactions outside the ordinary course of business, and that mandates monthly or other periodic, detailed reporting of the company’s revenues and expenses.