If familiarity breeds contempt, does family breed contempt of court? Apparently so, at least in the recent case of Kassab v Kasab involving a corporate dissolution battle between two brothers, one of whom was held in contempt of court for using company funds to pay legal fees in violation of the court’s prior order prohibiting transactions “except in the ordinary course of business.”
We all know that, when it comes to the litigation of disputes between co-owners of a closely held business, the ability of one side to use company funds to pay their legal fees — in effect requiring the other side, which is paying its own legal fees out of pocket, to subsidize their opponent’s litigation expenses — can provide a critical financial and psychological advantage as the case slowly and expensively wends its way through the judicial process.
The issue usually surfaces in one of two ways: (1) the majority owners named as defendants use their voting control to approve the company’s advancement and indemnification of their legal expenses or (2) when the company also is named as a respondent or defendant, even if only nominally, they use their control of the company checkbook to pay whatever portion of defense costs they decide to allocate to the company, which may be 100%. The PFT Technology and Borriello cases, which I wrote about here and here, are examples of the former. An example of the latter, featuring an appellate decision in which the court explained the general parameters of when corporate funds can and cannot be used in a dissolution proceeding, is Matter of Levitt (read here).
In dissolution proceedings commenced by order to show cause, the petitioner (who usually does not have control of the checkbook) can preempt either of these two payment methods by including in the proposed order a provision explicitly prohibiting the respondent owner from using company funds to pay legal fees in the case. Here’s an example of one such order in a case of mine (see provision at bottom of page 3).
In the Kassab case, the initiating order to show cause brought by a 25% shareholder against his 75% shareholder-brother did not include such explicit language. Instead, it contained a temporary restraining order (TRO) preventing the majority shareholder from “transferring, removing, hypothecating, secreting or in any way disposing of any and all income and property of the Companies, except in the ordinary course of business.” The TRO has remained in effect ever since, first, pursuant to the parties’ so-ordered stipulation and, second, pursuant to the court’s interim decision dismissing certain of the petitioner’s claims.
In the course of discovery proceedings, the majority shareholder produced company bank statements showing two checks totaling about $36,000 paid to the law firm representing the majority shareholder. The petitioner demanded the funds be reimbursed, and when the majority shareholder refused, made a motion to hold the majority shareholder in civil contempt of court under Judiciary Law § 753 for violating the TRO’s provision enjoining transactions outside the ordinary course of business.
The majority shareholder opposed the motion, arguing that the TRO’s language did not forbid payment of legal fees and that payment of legal fees incurred in defending the minority shareholder’s dissolution petition were expenses in the ordinary course of business. The majority shareholder also contended that fees had been “allocated” between the company and himself; that he personally paid about $80,000 in fees; that he loaned the funds used by the company to pay its allocated share; and that his attorneys advised him that the payments were proper.
In a decision dated February 5, 2015 (read here), Justice Orin R. Kitzes of the Queens County Commercial Division ruled in the petitioner’s favor, finding the majority shareholder in civil contempt of the TRO and the so-ordered stipulation. Justice Kitzes cited the following factors in support of his ruling:
- The majority shareholder did not submit a copy of the law firm’s retainer agreement or any of the law firm’s bills for legal services, and thus did not establish that the law firm represented the company.
- The petitioner’s claims for breach of fiduciary duty, breach of contract, and declaratory judgment were brought solely against the majority shareholder, who alone filed a pre-answer motion to dismiss the proceeding.
- The majority shareholder failed to submit evidence in support of his allegation that he loaned the corporation the money to pay legal fees. Moreover, the majority shareholder “cannot, through the device of a loan to [the corporation], require [petitioner] to pay any portion of a debt created by [the majority shareholder] as each party is responsible for the payment of their own legal fees.”
- Case precedent holds that “in the usual dissolution proceeding, where the corporation appears as a nominal party and the proceeding amounts to a dispute between the shareholders, corporate funds may not be used in payment of counsel fees for the individual shareholder.”
- Given the lack of authority for allowing counsel fees incurred in defending a dissolution proceeding to be paid out of corporate funds, the majority shareholder’s “assertion that the payment of legal fees constituted payments in the ordinary course of business is indefensible and wholly lacking in merit.”
What remedy for contempt did the court award? Pretty much what you expect:
- The majority shareholder and his attorneys must restore to the corporation all funds paid by the corporation to the law firm.
- The majority shareholder must pay a statutory fine of $250.
- The majority shareholder must pay the legal fees incurred by the petitioner in connection with the contempt motion.
The Takeaway: If you’re the controlling owner of a business entity involved in a dissolution proceeding, be sure to consult with your legal counsel before using company funds to pay legal expenses, especially if the court has granted any type of restraining order. In general, even in the absence of a restraining order such as the one in Kassab, you’ll be allowed to use company funds only if the petition asserts adverse claims for relief against the corporation, or after you or the corporation has made an election to purchase the minority shareholder’s stock.