We call it deadlock dissolution when a 50% shareholder of a close corporation, who claims to be at an impasse with the other 50% shareholder, asks the court to dissolve and liquidate the corporation. New York’s deadlock dissolution statute, unlike its statutory cousin for minority shareholder oppression petitions, does not give the non-petitioning 50% shareholder the right to avoid dissolution by acquiring the petitioner’s shares for “fair value” as determined by the court, nor do the courts have statutory or common-law authority to compel a buyout. Absent a settlement, the litigation outcomes are binary: either dissolution is granted, in which case the court usually will appoint a receiver to sell the corporation’s assets, or it’s denied, in which case the co-owners continue indefinitely their fractious co-existence.
There’s one particular subspecies of deadlock dissolution that may not be motivated primarily by the usual disputes over finance, personnel, owner compensation, budget, distributions, or other such operational issues. Rather, sometimes a deadlock dissolution petition is brought when the two owners disagree whether to dissolve or continue to operate a functioning business. The petitioner may need the liquidity for unrelated financial reasons, or in contemplation of retirement, or because he or she believes the optimal time to sell the business or its assets is at hand. Perhaps the two owners also discussed a buyout but couldn’t agree on terms. Over time, as resentments fester and pressures grow, one or both owners typically undertake unilateral actions affecting the business, or block management actions advanced by the other, that push the standoff to crisis mode and into the hands of lawyers and judges.
A recent decision by Manhattan Commercial Division Justice Saliann Scarpulla shows how a deadlock dissolution petition of this existential sort can play out.
Matter of Ades
Matter of Ades (A&E Stores Inc.), 2018 NY Slip Op 30128(U) [Sup Ct NY County Jan. 22, 2018], involves a company named A&E Stores, Inc. formed in 1973 to develop and operate three off-price retail clothing chains named Strawberry, Bolton’s, and Half Pay. A&E’s shares are owned 50% by the petitioner Alan Ades and 50% by respondent Albert Erani and his brother. A&E’s four-member board includes the two Eranis, Ade, and Ade’s son. Ades and Erani no longer work at A&E fulltime; its day-to-day operations are performed by three senior executives.
Ades and the Eranis have no shareholders’ agreement, and the corporate by-laws include no mechanism for avoiding deadlock or for dissolution.
The Dissolution Petition
According to Ades’ dissolution petition, the A&E retail chains declined significantly in recent years due to a variety of factors, with the number of its stores halving between 2013 and 2015 and revenues declining 40% in the same period and projected to decline further along with additional store closings. Based on his belief “that the Company faces insurmountable problems that, over time, will erode all remaining value in the Company,” and on his concern about the potential for personal liability on store lease guarantees, Ades decided that the A&E stores “should be sold or liquidated to best obtain any remaining value.”
Ades allegedly urged the Eranis “to act now, before the value that remains in A&E is lost forever,” also pointing out that with all three shareholders in their 70’s, “the time has come to move on.” The Eranis, according to Ades, “have a different view” and are “adamant that A&E Stores should continue to operate the Bolton’s line” and insist that, “despite the declining nature of their operations, A&E Stores must continue as a going concern, with Mr. Ades held hostage to their personal wishes.” The fundamental disagreement over A&E’s future, according to Ades, has caused “every decision” concerning business operations to “become a source of conflict,” culminating in a shareholders’ meeting in late 2016, called by Ades to vote on a resolution to sell or liquidate the stores, which was aborted after only a few minutes after the Eranis, over Ades’ objection, insisted on tape recording the meeting.
Albert Erani’s opposing affidavit alleged that “the only dissension is that which [Ades] has deliberately caused” and that “no deadlock exists.” The company’s sagging fortunes, Erani claimed, is due in large part to deliberate, unilateral actions taken by Ades designed to harm A&E financially. Ades manufactured dissension to force A&E’s dissolution, Erani alleged, and the business continues to function notwithstanding any disagreement between himself and Ades.
As to the core dispute over A&E’s future, Erani alleged that Ades “cannot assert that his desire to liquidate and my desire to continue to operate the Company constitutes deadlock” and that Ades “has at all times been free to sell his shares either to me or to any third party.” Erani accused Ades of bringing his petition in “bad faith” based in part on his “inconsistent position” that, on the one hand, “the Company is a failing business that he no longer wishes to be a part of” while, on the other hand, demanding from Erani a price for his shares that “assumes the Company will have greater value if it continue to operate and generate profits . . . without him.”
The Court’s Ruling
Justice Scarpulla’s analysis begins by setting forth the three statutory grounds for deadlock dissolution in Sections 1104 (a) (1), (2), and (3) of the Business Corporation Law:
- director deadlock “respecting the management of the corporation’s affairs;
- shareholder deadlock preventing an election of directors; and
- “internal dissension and two or more shareholder factions are so divided that dissolution would be beneficial to the shareholders.”
She then highlights several important principles drawn from case law interpreting the statute (internal quotes and citations omitted):
- “Dissolution is generally appropriate where the complained of internal dissension and/or deadlock impedes the daily functioning of the corporation” thereby “posing an irreconcilable barrier to the continued functioning and prosperity of the corporation.”
- ”Where the undisputed facts show that genuine dissension and/or deadlock exists, it is irrelevant whom is at fault for the underlying conflict, and a hearing is not required. Rather, the critical consideration is the fact that dissension exists and has resulted in a deadlock precluding the successful and profitable conduct of the corporation’s affairs.”
- ”However, even if dissension and/or deadlock do exist, allegations that a petitioner acted in bad faith by creating the underlying disputes to justify dissolution constitute a defense to a dissolution proceeding, and a hearing is required.”
Applying the above principles, Justice Scarpulla initially deals two setbacks to Ades’ hopes for a summary grant of his petition. First, she finds that even though the disagreement between Ades and Erani — whether A&E should be dissolved or continue to operate — is undisputed, such disagreement “is not dispositive” of the dissolution question because “A&E is not a service corporation, and because neither Ades nor Erani is responsible for A&E’s day-to-day operations.” In other words, the disagreement over A&E’s future does not necessarily impede the daily functioning of the corporation or preclude its future prosperity.
Second, Justice Scarpulla finds that Ades’ contention, “that he wants to sell or liquidate A&E while it is still profitable so that he may recoup his investments and avoid any personal financial loss,” by itself “is not a basis for dissolution under BCL § 1104.”
The foregoing setbacks to a summary disposition in Ades’ favor do not, however, add up to a present victory for the Eranis. Justice Scarpulla ultimately concludes that a hearing is required since she:
cannot determine whether dissolution is appropriate on the papers alone because of the parties’ conflicting submissions and allegations. Material issues of fact exist as to whether the dissension and deadlock alleged by Ades exists and whether Ades acted in bad faith by manufacturing the complained-of disputes and dissension to financially harm A&E and justify dissolution.
As of this writing, a hearing has been scheduled before a Special Referee at the end of this month. It would not surprise me if the parties adjourn the hearing to discuss a buyout settlement.
The Takeaway. Imagine A&E Stores’s business was operating like a well-oiled machine with profits rolling in by the boxcar. We’d probably all agree under those circumstances that a deadlock petition brought by a 50% owner, alleging a disagreement however genuine over whether to sell or continue the business, likely would fall flat. Thus it makes sense that the same disagreement at a time when the business is undergoing financial distress, as Justice Scarpulla held, by itself does not entitle the petitioner to dissolution. The disagreement or dissension must be the proximate cause — not merely a symptom — of the business’s dire state of affairs. Such a showing may inherently be more difficult when the two 50/50 owners are not actively involved in the corporation’s management, as appears to be the case in Ades. Keep in mind, however, that every case rests on its unique facts and the petitioner in Ades may yet be able to establish adequate grounds for dissolution. Also keep in mind the deeper lesson of cases like Ades, which is the potentially high cost of not having a shareholders’ agreement with buy-sell provisions.