Normally you don’t associate the lucrative sale of a closely held business with bitter disputes among the co-owners leading to judicial dissolution proceedings. When the cake is big enough, the thinking goes, each owner walks away sated with their own, generous slice.

But if I’ve learned anything as a business divorce lawyer, it’s that when it comes to family-owned businesses, there’s no normal. Take Hanley v Hanley, 2019 NY Slip Op 50970(U) [Sup Ct Albany County June 13, 2019], in which Justice Richard M. Platkin of the Albany County Commercial Division ordered the parties to confer regarding the use of early mediation after denying a motion to dismiss a judicial dissolution petition brought following the sale of the family business to a strategic buyer in a highly lucrative deal.

The Business

The Hanley siblings co-founded with their father a successful truck driving school organized as a New York corporation with its principal place of business in Florida. The business, known as The Commercial Driver’s License School, Inc. (CDL School), started in 1991 with the father as majority owner. Eventually, the three siblings came to own 100% of the stock: Albert 50%; Andrea 25%; Michael 25%.

CDL School built its growth and profitability in large part on contracts with the military to train service members on military bases. 

The Sale of the Business

In March 2018, CDL School entered into an agreement for the sale of all of its assets to TransForce, Inc., a commercial driver dispatcher that bills itself as the nation’s leading transportation workforce solutions company.

When the deal closed in December 2018, TransForce paid CDL School around $24 million plus another $1.25 million to an affiliated Florida limited liability company known as CDL Research also owned by the Hanley siblings. CDL School also received restricted TransForce stock valued at $10 million. In 2019 and 2020, CDL School also will receive earn-out payments based upon the company’s performance in the preceding year. Depending which Hanley sibling you ask, the total deal value is $50 million to $80 million.

The Post-Closing Breakdown

As far as I can tell from the court’s opinion, in advance of the sale’s closing the Hanley siblings did not negotiate much less reach agreement as to the winding up of the corporation and the affiliated LLC, or as to the disposition of the sale proceeds. For reasons that are hotly disputed, following the December closing battle lines developed with Albert and Andrea on one side (together holding 75% of CDL School’s shares and majority control of CDL Research) and Michael on the other.

According to Michael, his siblings engaged in a pattern of hostile and oppressive conduct towards him designed to force him into accepting less than his 25% share of the sale proceeds which Michael valued at $80 million. Among other alleged oppressive acts, Albert and Andrea removed Michael from CDL School’s board, threatened to pay themselves “exorbitant” bonuses and take loans from the company, and also threatened to use the sale proceeds to invest in unrelated business ventures.

Michael also alleged that his siblings gave him an ultimatum, to accept one or the other of their so-called “Solution Plan” and “Severance Package.” Under the Solution Plan, Michael conditionally would receive his pro rata shares of 85% of the proceeds at closing and of 85% of the 2018 earn-out. Under the Severance Package, Michael would receive $11.25 million representing 25% of the closing proceeds, 25% of the 2018 earn-out, plus an extra $1 million. Neither proposal offered Michael his percentage of the 2019 earn-out or any consideration for the $10 million TransForce equity.

If Michael accepted neither, Albert and Andrea threatened to cause CDL School to redeem Michael’s shares under Section 1.4 of the Shareholders Agreement for “fair market value . . . as determined by the certified public accountant then servicing the books of the Company.”

Michael rejected both plans. Albert then retained the company’s accountant to perform a “calculation engagement” to value the company’s equity. The accountant’s subsequent 3-page report gave a calculated value between $40 million and $41 million for 100% of the company’s equity, before any discounts for lack of control or marketability. The report does not disclose the methodology used by the accountant, the data he relied upon, or show his calculations.

Michael’s Lawsuit

In late February 2019, Albert noticed a special meeting of the shareholders to approve the redemption of Michael’s shares under Section 1.4 based on the accountant’s report. A week later, Michael filed a hybrid action/proceeding including claims for judicial dissolution of CDL School as an oppressed minority shareholder under Section 1104-a of the New York Business Corporation Law and for judicial dissolution of CDL Research under Florida’s Revised LLC Act. At the outset Justice Platkin issued an interim order restraining Albert and Andrea from proceeding with the involuntary redemption of Michael’s shares.

The Motion to Dismiss

Albert and Andrea did not elect to purchase Michael’s CDL School shares for fair value as authorized by BCL § 1118. Rather, they moved to dismiss the dissolution claim, arguing that Michael’s oppression claim was “disingenuous” in light of their offer to purchase his shares pursuant to the Severance Package for $11.25 million representing a 7,400% return on Michael’s original investment and more than he would receive under a Section 1.4 redemption at fair market value. “Thus,” Justice Platkin wrote,

defendants argue that plaintiff cannot demonstrate that his reasonable expectations as an owner of CDL School were substantially defeated by the oppressive conduct alleged in the Complaint.

They also argued for dismissal of the dissolution claim, as well as Michael’s other miscellaneous claims for breach of fiduciary duty and injunctive relief, based on the forum selection clauses in the CDL School shareholders agreement and the CDL Research operating agreement. Both agreements designate Miami, Florida, as the exclusive venue to commence litigation concerning “any dispute under the Agreement.”

Albert and Andrea also sought dismissal of the CDL Research dissolution claim on the ground that a New York court lacks subject matter jurisdiction to dissolve a foreign LLC.

The Court’s Rulings

Dissolution of CDL School.  Justice Platkin denied the motion to dismiss Michael’s statutory and common-law claims to dissolve CDL School, citing a number of reasons:

  • The reasonableness of the Severance Package, which omits any portion of the 2019 earn-out and the grant of TransForce equity, “remains open to question.” Thus, “there has been no conclusive demonstration that defendants’ $11.25 million offer is reasonably reflective of the fair value of plaintiff’s 25% ownership interest.”
  • Contrary to defendants’ argument, the plaintiff’s reasonable expectations concerning his ownership interest in CDL School are not tied to “an expected percentage return on his original investment.”
  • “Defendants cite no authority allowing majority shareholders to use oppressive means to force a voluntary buy-out, even a reasonable one.”
  • In any event, defendants have not established that the $11.25 million offer exceeds what plaintiff would receive in redemption under Section 1.4 based on deficiencies surrounding the accountant’s reported calculation of value. “In the Court’s view, the absence of any description of the accountant’s methodology in a client-driven ‘calculation engagement’ is troubling where, as here, the client representative/majority owner has a strong pecuniary interest in the outcome of the valuation . . ..”
  • The accountant’s report also fails to quantify the proceeds from the sale to TransForce, whether $80 million as Michael alleges, $50 million as Albert alleges, or any other value. “The fair market value of plaintiff’s shares will, of course, be heavily influenced by the amount of the Sale Proceeds.”
  • While a forced redemption under Section 1.4 “may constitute an adequate alternative to involuntary dissolution of CDL School, the present record fails to conclusively establish that application of Section 1.4 in the manner contemplated by defendants will accord plaintiff a fair return.”

Dissolution of CDL Research.  Justice Platkin had little difficulty dismissing Michael’s claim for dissolution of the Florida LLC based on what has become settled law holding that New York courts lack subject matter jurisdiction in dissolution cases involving foreign business entities.

Forum Selection Clause.  Justice Platkin rejected defendants’ argument to dismiss based on the Florida forum selection clauses. The claims for dissolution of CDL School and Michael’s remaining claims arose under statutory and common law, i.e., did not arise under the shareholders or operating agreements of the two entities as specified in the forum selection clause. The court also noted that the defendants invoked the forced redemption under Section 1.4 as a defense to dissolution.

Interim Relief.  The court granted in part and denied in part Michael’s request for interim injunctive relief. Justice Platkin agreed with Michael that an injunction was warranted to safeguard the sale proceeds from depletion by the defendants and to prevent them from proceeding with a forced redemption of Michael’s shares pending the litigation. The court disagreed with Michael on the need to appoint a temporary receiver for CDL School.

Mediation.  As mentioned above, Justice Platkin’s order included a provision requiring counsel to confer regarding the use of early mediation/ADR and to report to the court within two weeks as to their clients’ willingness to participate. The Hanley case practically screams “buyout.” If there’s any one category of business divorce litigation that lends itself to ADR, it’s that.

Drafting Anomalies

Attorneys who draft shareholder and operating agreements should take note of a few anomalies highlighted by the Hanley case:

  • The CDL School shareholders agreement provides that the agreement is governed by Florida law even though it’s a New York corporation. This can lead to vexatious issues in shareholder litigation, especially as regards statutory claims arising exclusively under New York law such as dissolution and dissenting shareholder rights. Most would agree the better practice is to align choice-of-law with the state of formation.
  • There may be valid reasons to limit the scope of an arbitration clause, but if you’re going to require arbitration of all claims arising under the owners’ agreement, the better practice is to go all the way, i.e., unlike the narrower clause in Hanley, use a standard, broad clause requiring arbitration of “any controversy or claim arising out of or relating to this agreement, or the breach thereof.”
  • I can’t possibly say whether the atypical, forced redemption provision in the CDL School shareholders agreement, allowing the majority at its whim to compel the minority shareholder to sell his shares, was a negotiated provision. I have my doubts. What I can say with assurance is that, if you’re going to include anything like it in your agreement, I highly recommend a more robust provision for valuing the shares to be redeemed than the bare-bones one used in the CDL School shareholders agreement — one that requires use of an accredited, independent business appraiser and that sets forth not only the standard of value but also the premise and level of value.