New York and most other states have judicial dissolution statutes protecting minority shareholders in close corporations against “oppressive actions” by controlling shareholders and directors. In many of those states, including New York, courts define oppression as conduct that defeats the minority shareholder’s “reasonable expectations.” The reasonable-expectations standard necessarily is a flexible one that allows courts to address the myriad circumstances under which minority shareholders, who generally lack exit rights and whose shares have no public market, face squeeze-out or freeze-out by the majority.
If I had to describe the classic case of minority shareholder oppression, it would be (1) an owner-operated business (2) that pays no stock dividends (3) in which the majority shareholder terminates the minority shareholder’s employment (4) thereby cutting off the minority shareholder’s sole source of economic benefits in the form of salary and bonus (5) while also removing the minority shareholder from the board of directors (6) thereby depriving the minority shareholder of any voice in company management.
I’ve pretty much just described the circumstances present in Matter of Digeser v Flach, 2015 NY Slip Op 51609(U) [Sup Ct Albany County Nov. 5, 2015], a post-trial decision handed down earlier this month by Albany County Commercial Division Justice Richard M. Platkin in which the court concluded that the petitioning minority shareholder established grounds for dissolution of two affiliated construction companies.
The companies involved in Digeser have aspects of a family-owned business without exactly being one. The companies’ founder, John P. Flach, is the father of the respondent-majority shareholder John C. Flach. Henry J. Digeser, a licensed engineer and the father of the petitioner-minority shareholder Henry A. Digeser, worked closely with Flach senior for many years. The two sons came into the business and co-managed it from 1990 until 2012, with the junior Flach owning 75% and the junior Digeser 25% while their fathers continued to serve as company directors.
The two juniors also had a close working relationship and their families were friendly — so friendly that, by 2007, they formulated a succession plan involving the junior Flach’s two sons and the junior Digeser’s three sons. Meanwhile, the companies became very successful and profitable, allowing the juniors to draw compensation totaling over $2 million in some years. Typical for companies of this sort, stock dividends were never declared or paid.
Relations between the Flach and Digeser families turned sour, however, following the accidental death in 2012 of the junior Flach’s oldest son who was highly regarded by all and was pegged to take the company helm. By the end of that year, Flach told Digeser (I’ll stop calling them “junior” at this point) he wanted a “divorce” to focus on developing a business more suitable for his other son. Digeser, however, had no interest in leaving to start a new company.
In January 2013, Flach removed Digeser as director and gave him notice that his employment would be terminated after he completed an important project. On April 30, 2013 — one day before his employment was formally terminated — Digeser commenced a proceeding for judicial dissolution of the two companies under the oppressed minority shareholder statute, § 1104-a of the Business Corporation Law. Flach did not invoke his statutory right of election to purchase Digeser’s shares for fair value under BCL § 1118.
Digeser’s petition principally contended that his removal as director and the termination of his employment constituted oppressive action under the statute. Flach contested Digeser’s ownership of certain shares in the companies, apparently in an effort to defeat Digeser’s standing under BCL § 1104-a which requires the petitioner to hold at least 20% of the corporation’s voting shares. Flach also contended that Digeser’s termination was justified by Digeser’s bad-faith conduct including “theft and misuse” of corporate assets.
After an evidentiary hearing, and despite some discrepancies in the corporate records, in his decision Justice Platkin upheld Digeser’s 25% stock ownership in the two companies. The decision then turned to the question of oppression under the reasonable-expectations standard adopted by the New York Court of Appeals in 1984 in Matter of Kemp & Beatley, commenting that “oppression may be found where the minority shareholder is excluded from the operation of the corporation” and is denied “employment or a share in the profits” of the business. Justice Platkin seemingly had little trouble in concluding that Flach was guilty of oppressive actions consisting of:
- removing Digeser as a director
- dismissing Digeser as corporate secretary
- terminating Digeser’s employment
- following termination, denying Digeser access to his work computer and email
- restricting Digeser’s interaction with customers and employees
- holding secret off-site staff meetings in which Flach accused Digeser of improprieties
- after Digeser refused Flach’s buy-out offer, firing Digeser’s sons and dismissing other employees perceived to be loyal to Digeser
- paying himself a $350,000 bonus and nothing to Digeser
As Justice Platkin summed it up:
The Court is satisfied that respondent’s conduct in denying petitioner continued employment, freezing him out of the management and affairs of [the company] and denying him at least a proportionate share of the corporation’s profits all served to defeat legitimate expectations of the petitioner that were objectively reasonable and central to petitioner’s long-standing participation in the venture.
In reaching his conclusion, Justice Platkin explicitly rejected Flach’s contentions that Digeser was not oppressed because his employment terminated the day after Digeser filed the dissolution proceeding, or because the companies had no history of paying dividends, or because some of Digeser’s shares were gifted to him. Justice Platkin also found insufficient or unsubstantiated Flach’s various allegations of misconduct by Digeser including his alleged running of certain personal expenses through the business which, the court found, was part of a “tacit agreement [that] existed over the years between the two shareholders to use corporate funds to personally benefit the Flach and Digeser families in various ways.” Moreover, Justice Platkin explained, even assuming Digeser’s own conduct fell short,
respondent went too far in freezing petitioner out of [the company] and stripping him of virtually all of the incidents of ownership reasonably associated with his substantial minority stake. If respondent truly had lost trust and confidence in petitioner, it was incumbent upon him to craft a reasonably proportionate response — one that, at a minimum, recognized petitioner’s reasonable expectation of deriving at least some economic benefit from his stock ownership. [Citations omitted.]
The court’s order granted Digeser’s petition to the extent of determining that Digeser established grounds for dissolution based on oppression under § 1104-a. The order also directed a conference next month to schedule further proceedings concerning a remedy, without mentioning what the remedy may be, although it’s not hard to guess that a forced buy-out of Digeser’s shares for fair value likely will be on the conference agenda — a classic ending to a classic case of minority shareholder oppression.
Update December 29, 2015: The ever creative mind of Tom Rutledge has managed to work a quote from Bram Stoker’s Dracula (“Your ways are not our ways”) into a post on his Kentucky Business Entity Law blog comparing and contrasting New York’s oppressed shareholder remedy as illustrated above with the absence of same in the Bluegrass State (read here).