Civil litigation in federal court can be a luxury experience. The quality of the judiciary is superb. Federal judges often give their cases substantial individualized attention. Lawsuits progress relatively quickly. The procedural rules in federal court have been litigated nationwide, so lawyers can easily find case law on almost every procedural nuance. Yet, business divorce cases are almost never litigated in federal court. Why?
The Friedman Decision
In 1994, the United States Court of Appeals for the Second Circuit all but sealed the courthouse door to business dissolution cases in federal court, at least in the territorial jurisdiction of the Second Circuit, which includes New York.
In Friedman v. Revenue Management, Inc., 38 F3d 668 [2d Cir. 1994], a shareholder of a New York corporation sued for dissolution in Manhattan Federal District Court. The District Court dismissed the petition as improperly brought in federal court and the Court of Appeals affirmed. The Court of Appeals held, based upon a doctrine known as Burford abstention, that a federal court “may abstain from hearing a case or claim [for dissolution] over which it has jurisdiction to avoid needless disruption of state efforts to establish coherent” regulation of New York corporations. The court held that “New York has a strong interest in the creation and dissolution of its corporations and in the uniform development and interpretation of the statutory scheme regarding its corporations,” so state courts, not the federal courts, are more appropriate to rule on applications for dissolution.
An earlier post discussed the Friedman decision and its all-but total elimination of business divorce litigation in New York’s federal courts. Another earlier post discussed a state-court analogue of Friedman’s abstention principle: New York state courts decline subject matter jurisdiction over petitions to dissolve entities formed in foreign states. In both situations, the idea is that dissolution is a matter best left to courts of the state in which the entity was formed.
Friedman’s abstention principle usually arises when a defendant affirmatively argues that the federal court should decline to consider a claim for dissolution and send the plaintiff packing to state court. But what happens when a defendant, without objection by the plaintiff, removes the dissolution lawsuit from state court to federal court? In other words, what happens when both sides want the claim decided in federal court? A recent decision by the Hon. Leonard D. Wexler, United States District Judge, Eastern District of New York, considered that very issue.
Facts and Procedural History
In Mecca v Lennon, Memorandum and Order, 16-cv-1414 [SDNY Apr. 18, 2017], Dawn Mecca, an alleged shareholder of two New York close corporations, sued in state court in Nassau County. Mecca’s complaint, which you can read here, alleged three claims: i) breach of contract, ii) “larceny by trick and conversion of corporate funds,” and iii) dissolution of the two corporations. The complaint did not specify under which statute the plaintiff sought dissolution.
Under federal law, there is a statutory procedure by which a defendant can remove to federal court a case originally brought in state court if the plaintiffs and defendants are citizens of different states. Mecca was a citizen of Florida. Defendants were citizens of New York. Sure enough, because there was diversity jurisdiction, defendants removed the case to federal court.
But there was a hitch with the removal. Under the “forum defendant” rule, a defendant is not permitted to remove a case to federal court if he or she is a citizen of the state in which the federal court sits. Because the defendants were citizens of New York, Mecca had grounds to remand the case back to state court based on the forum defendant rule but, for whatever reason, chose not do so.
The Motion to Dismiss
After removing the case to federal court, the defendants moved to dismiss the complaint, including Mecca’s dissolution claim. In the ensuing legal briefs, which you can read here, here and here, both sides argued whether the dissolution claim met the pleading standards for a claim of minority shareholder oppression under Section 1104-a of the New York Business Corporation Law.
But neither side even addressed Friedman or the concept of Burford abstention. Instead, defendants argued that the court should rule on Mecca’s dissolution claim and dismiss it on the ground that Mecca “failed to establish any grounds for dissolution.” In his decision, Judge Wexler considered, and dismissed, each of Mecca’s claims.
On the first cause of action for breach of contract, Judge Wexler held that the bare-bones complaint, which the court described as “completely lacking in factual content,” failed to allege “any facts constituting a breach of contract claim.”
On the second cause of action for “larceny by trick and conversion of corporate funds,” the court construed the claim as possibly alleging two distinct causes of action – “larceny by trick” and “conversion of corporate funds.” With respect to the former, the court held that “New York law does not provide a civil cause of action” for larceny by trick, which is strictly a criminal offense.
With respect to the latter, conversion of corporate funds, Judge Wexler observed that it was “not at all clear . . . whether this claim is asserted individually or derivatively.” The court noted, “Although the caption indicates Plaintiff is proceeding both individually and as a shareholder, the allegations within the pleading claim only injury to the corporation, but contrarily seek only individual relief to Plaintiff.” Thus, the court held, “given the confusion in the complaint between derivative and individual claim language, it is appropriate to dismiss this claim.”
On each of the first and second causes of action, Mecca asked for, and Judge Wexler granted, leave to replead, thereby keeping the federal court lawsuit alive for the time being.
Not so on the third cause of action for dissolution. Instead, without commenting on the adequacy of its pleading, Judge Wexler held sua sponte – meaning on the court’s own initiative – that the claim belonged in state court, and dismissed the claim under Burford abstention without prejudice – meaning the court permitted Mecca to re-file it in state court. Specifically, the court ruled:
It has been suggested . . . that federal courts may not have subject matter jurisdiction over corporate dissolution claims. This issue has not been directly addressed as courts have found that a claim for judicial dissolution of a state-created corporation implicates the Burford abstention doctrine, in which a federal court may abstain from hearing a case or claim over which it has jurisdiction to avoid needless disruption of state efforts to establish coherent policy in an area of comprehensive state regulation. Given New York’s strong interest in the creation and dissolution of its corporations and in the uniform development and interpretation of the statutory scheme regarding its corporations, courts in the Second Circuit have almost uniformly ruled that even if federal courts have subject matter jurisdiction over claims for corporate dissolution, they should abstain from exercising it. This Court agrees that abstention is appropriate, without ruling on the issue of subject matter jurisdiction. [Internal citations, quotations and brackets omitted.]
As of this writing, based on a search of the state court’s electronic case filing system, so far Mecca has not re-filed her dissolution claim in state court. Perhaps the prospect of litigating concurrently her overlapping claims in two separate courts is too daunting.
The ultimate takeaway from Mecca is that regardless of the procedural route by which a dissolution claim winds up in federal court – either by the plaintiff’s choice of forum or the defendant’s removal of the case – a federal court is highly unlikely to consider the dissolution claim. Lawyers can save their clients considerable time and expense by heeding the Second Circuit’s admonition in Friedman – dissolution claims belong in state court.