Who paysThere are two breeds of buy-outs in corporate dissolution proceedings: voluntary and involuntary.

When a minority shareholder petitions for judicial dissolution on grounds of oppression, New York’s statutory scheme gives respondents the option to avoid a dissolution contest voluntarily by electing within 90 days to purchase the petitioner’s shares for “fair value” in an amount either to be agreed upon by the parties or determined by the court in an appraisal proceeding.

The buy-out statute (Business Corporation Law § 1118) grants the right of election to “any other shareholder or shareholders or the corporation” which, as a practical matter, leaves it up to the controlling shareholders whether to purchase the shares individually or through the corporation. Not surprisingly, in my experience the election overwhelmingly is made by the corporation. After all, who wants to undertake personal liability voluntarily, especially before the court determines the value of the petitioner’s shares and the terms of payment?

Compelled Buy-Out

The other path to buy-out is the compelled variety. Where does it come from, and who can be compelled to purchase the petitioner’s shares?

A compelled buy-out has no explicit statutory basis in New York law; the closest to it is BCL § 1104-a (b) (1) & (2), instructing courts in determining whether to grant dissolution to consider both whether “liquidation of the corporation is the only feasible means” to protect the complaining shareholder’s expectation of a fair return on his or her investment and whether dissolution “is reasonably necessary” to protect “the rights or interests of any substantial number of shareholders.”

In Matter of Kemp & Beatley, Inc., the landmark 1984 decision defining minority shareholder oppression, New York’s highest court in dicta observed that “[a] court has broad latitude in fashioning alternative relief,” citing with approval a 1973 Oregon Supreme Court ruling that featured a laundry list of alternative remedies in dissolution cases including

an order requiring the corporation or a majority of its stockholders to purchase the stock of the minority stockholders at a price to be determined according to a specified formula or at a price determined by the court to be a fair and reasonable price.

The first New York appellate ruling to put a compelled buy-out into action was Matter of Wiedy’s Furniture Clearance Center Co., decided by the Appellate Division, Third Department, only a year after Kemp & Beatley, in which the court affirmed a remedial order, in lieu of dissolution, directing the majority shareholders — who were found to have engaged in oppressive conduct — to purchase the petitioner’s shares in a family-owned business at a price to be determined by an independent appraiser, adding that “respondents will be free to voluntarily dissolve the corporation after compensating petitioner, should they so choose.”

The order upheld in Wiedy’s placed liability for the buy-out directly on the majority shareholders — not the corporation — consistent with the alternative remedy spelled out in the Oregon case cited in Kemp & Beatley. 

Subsequent appellate rulings by other Departments of the Appellate Division have imposed liability for a compelled buy-out on both the corporation and the majority shareholders, e.g., the Second Department’s 1999 decision in Matter of Davis and the First Department’s 2013 decision in Gjuraj v Uplift Elevator Corp. Notably, in the Gjuraj case the appellate court modified the lower court’s buy-out order by vacating the judgment as against a non-shareholder employee of the corporation to whom the majority shareholder had distributed profits.

Qadan v Tehseldar: No More Personal Liability?

A short decision last week by the Appellate Division, Second Department, raises an intriguing question whether the court meant to create a new, bright-line rule against imposing personal liability for a compelled buy-out on the respondent shareholders except in cases where it otherwise would be appropriate to pierce the so-called corporate veil.

The decision in Qadan v Tehseldar, 2016 NY Slip Op 04036 [2d Dept May 25, 2016], provides no details concerning the underlying dissolution proceeding other than that the trial court determined that the two defendants committed oppressive actions against the plaintiff by excluding him from the business, and that it directed a buy-out of the plaintiff’s interest in the corporate defendants for the sum of about $45,000, with an alternate option for dissolution should the judgment not be paid by a specified date.

The decision does not specify against which parties the buy-out judgment was entered, but we can reasonably infer it was entered against both the individuals and the corporate defendants from the facts that the appellate panel (a) affirmed the buy-out remedy as an appropriate exercise of the lower court’s discretionary remedial authority, citing among other cases Kemp & Beatley and Wiedy’s, and (b) vacated that portion of the judgment requiring payment of the buy-out sum by the two individual shareholder-defendants.

The decision devotes but a single sentence to its rationale for relieving the two shareholders of liability:

The Supreme Court also should not have found liability on the part of Tehseldar and Tartir, who were corporate principals of the corporate defendants, because one of the primary legitimate purposes of incorporating is to limit or eliminate the personal liability of corporate principals (see Bartle v Home Owners Coop., 309 NY 103, 106), and the court did not find that they “abused the privilege of doing business in the corporate form” (Matter of Morris v New York State Dept. of Taxation & Fin., 82 NY2d 135, 142; see Business Corporation Law § 1104-a[a][2]).

The two, cited cases did not involve corporate dissolutions. Rather, they are two of the leading decisions by New York’s highest court on the subject of piercing the corporate veil, a common-law doctrine that allows corporate creditors to penetrate the limited liability shield generally enjoyed by shareholders, and to satisfy unpaid judgments against the corporation from the personal assets of the corporation’s owners, when the owners so abuse the corporate form, e.g., by intermingling corporate and personal funds, as to constitute a fraud upon creditors.

Three Questions

Question #1:  Does the Qadan ruling set a precedent against imposing personal liability on the majority shareholders for compelled buy-outs in dissolution proceedings, absent evidence sufficient to pierce the corporate veil? Veil-piercing does not lend itself to ease of proof, so if the answer is “yes,” as a practical matter the sole party responsible for a court-ordered buy-out will be the corporation.

That’s a difficult conclusion to swallow, first, because it goes against the tide of precedent and, second, because it’s the majority shareholders — not the corporation — whose oppressive actions give rise to the remedy of compelled buy-out.

Question #2:   Does it matter whether the corporation alone is liable for the buy-out? Sometimes yes, sometimes no, depending on the nature and financial health of the business, its asset profile, and the presence or not of secured creditors with priority liens against those assets.

Question #3:  Do minority shareholders have any recourse when the court restricts liability for the compelled buy-out to the corporation? Under BCL § 1118 (c) (2), at any time prior to the actual purchase the court is empowered to order the posting of a bond or other acceptable security in an amount sufficient to secure the petitioner for the fair value of his or her shares. This tool is particularly useful when the order compelling a buy-out precedes the appraisal proceeding which can take months or over a year to complete. While the statute concerns voluntary buy-outs, I can imagine a court extending it to a compelled buy-out under its broad remedial authority.

Update September 7, 2016:  Oddly enough, the New York Official Reports today published the trial court’s 2014 decision from which the appeal was taken, which you can read here. Unfortunately it sheds no additional light on the issue addressed in this post about who pays when there’s a compelled buy-out.