In 1994, in Friedman v Revenue Management, Inc., the U.S. Court of Appeals for the Second Circuit, covering New York, Connecticut and Vermont, closed federal courthouse doors in those states to petitioners seeking judicial dissolution of close corporations under state law, even where subject matter jurisdiction exists. The court in Friedman applied the so-called “Burford abstention” doctrine to dismiss a complaint seeking statutory dissolution of a New York corporation, without prejudice to its re-commencement in state court.
The doctrine is named after Burford v Sun Oil Co., a 1943 decision in which the U.S. Supreme Court carved out a vaguely defined exception to the federal courts’ duty to exercise their jurisdiction, as one commentator put it, “allow[ing] federal courts to abstain from reviewing certain decisions of state administrative agencies or from otherwise assuming the functions of state courts in the development and implementation of a state’s public policies.”
The Friedman court held that Burford abstention was appropriate in corporate dissolution cases to “avoid needless interference with [the state’s] regulatory scheme governing its corporations” and in deference to the “strong [state] interest in the creation and dissolution of its corporations and in the uniform development and interpretation of the statutory scheme regarding its corporations.”
In 2002, in Caudill v Eubanks Farms, Inc., the Sixth Circuit Court of Appeals, covering Michigan, Ohio, Kentucky, and Tennessee, agreed with the Second Circuit and invoked Burford abstention to dismiss an action seeking statutory dissolution of a Kentucky close corporation. Quoting from one of its prior, non-precedential, unpublished opinions, the court reasoned,
The state should be permitted to exercise control over the internal affairs of its domestic corporations free from interference by federal courts, particularly where the issue is whether the corporation should be permitted to continue in existence or be dissolved. Moreover, the legislature has provided a forum with specialized competence in the areas of internal corporate matters. Jurisdiction over corporate dissolution rests exclusively with the circuit court of the county in which the registered office of the corporation is located.
Of the dozen or so reported corporate dissolution cases in the lower federal courts addressing Burford abstention, including a handful by District Courts outside the Second and Sixth Circuits, all but one dismissed the action without prejudice or remanded it to state court where the case initially was filed but then removed to federal court. In the one exceptional case decided by the Idaho District Court in 2020, entitled Zafer v Spengler, the court found that dissolution “does not present a complex question of state law, nor does it have any significant impact on state public policy, such that this Court needs to relinquish jurisdiction.”
Now, that imbalance may change. Earlier this month, the Eleventh Circuit Court of Appeals, covering Alabama, Florida, and Georgia, explicitly parted ways with Friedman and Caudill in a decision reversing the District Court’s Burford-based dismissal of a claim seeking judicial dissolution of a family-owned Georgia corporation. The case is Deal v Tugalo Gas Co., No. 19-14336 [11th Cir. Mar. 19, 2021].
A “Kitchen-Sink Lawsuit”
Writing for the court in Deal, Circuit Judge Kevin C. Newsom launched his plain-spoken opinion with the deprecating remark, “This kitchen-sink appeal stems from a district court’s rejection of a kitchen-sink lawsuit.” From there it doesn’t get much better for the plaintiff-appellant, a minority shareholder whose “laundry list” of direct and derivative claims against a collection of shareholders, officers, and directors centered on allegations that his cousin and company president misused company funds to pay for personal expenses.
The Court Affirms Dismissal of the Plaintiff’s Non-Dissolution Claims
The District Court dismissed each the plaintiff’s derivative claims based on its determination that the company’s special litigation committee undertook a reasonable good-faith investigation and determined that a derivative action was not in the company’s best interest. The appellate court agreed, holding that the plaintiff failed to present evidence challenging the committee’s lack of independence or the thoroughness of its investigation. Wrote Judge Newson, “while Deal may disapprove of the [committee’s] recommendation not to pursue a derivative action, he has failed to show even a modicum of taint.”
The appellate court also affirmed the District Court’s dismissal of the plaintiff’s miscellaneous causes of action styled as direct claims on the ground that, by their very nature, they could be pursued only derivatively. The court also rejected plaintiff’s contention that he suffered a “special injury” by reason of the defendants’ alleged taking of de facto distributions of which the court also found no evidence.
Rejecting Burford Abstention, the Appellate Court Reinstates the Plaintiff’s Dissolution Claim
Now we come to the more interesting part in which the court reversed the District Court’s Burford-based dismissal of the plaintiff’s claims for judicial dissolution and related relief.
Judge Newsom began his analysis of Burford abstention with a short backgrounder on its origin:
Under the “Burford abstention” doctrine, a federal court can decline to adjudicate—and can dismiss—a case that is otherwise within its jurisdiction, but only in a very particular, and “narrow,” set of circumstances. In Burford itself, the Supreme Court held that a district court should have abstained from adjudicating an action in which a plaintiff sought to enjoin the execution of an order of the Texas Railroad Commission granting a landowner the right to drill a new oil well. It did so on the ground that the grant or denial of an oil well “so clearly involve[d] basic problems of Texas policy that equitable discretion should be exercised to give the Texas courts the first opportunity to consider them.” [Citations omitted.]
Next, Judge Newsom emphasized the limited circumstances to which Burford abstention applies:
Importantly here, both we and the Supreme Court have since explained that Burford abstention is warranted only when, by exercising its jurisdiction, a federal court would interfere with an ongoing state administrative proceeding or action. The Supreme Court [in New Orleans Pub. Serv., Inc. v. Council of City of New Orleans, 491 U.S. 350, 360-61 (1989)] has described the metes and bounds of the Burford abstention doctrine specifically by reference to “the proceedings or orders of state administrative agencies”:
Where timely and adequate state-court review is available, a federal court sitting in equity must decline to interfere with the proceedings or orders of state administrative agencies: (1) when there are difficult questions of state law bearing on policy problems of substantial public import whose importance transcends the result in the case then at bar; or (2) where the exercise of federal review of the question in a case and in similar cases would be disruptive of state efforts to establish a coherent policy with respect to a matter of substantial public concern.
Turning to the case at hand, Judge Newson concluded that the plaintiff’s claim for judicial dissolution and associated claims for equitable relief did not fall within the Burford abstention doctrine’s “metes and bounds”:
Here, there was (and is) no ongoing state administrative proceeding—or, for that matter, even any preexisting action by a Georgia state court or executive official to dissolve Tugalo. All we have is a potentially thorny legal question— namely, whether a federal court has the authority to dissolve a state-chartered corporation. Standing alone, that’s no basis for refusing to decide a properly filed case.
Any way you slice it, Burford is “an extraordinary and narrow exception” to a federal court’s “virtually unflagging obligation” to exercise jurisdiction. We see no compelling justification for extending it to judicial-dissolution claims. Doing so would require us to elide the key ingredient that we and the Supreme Court seem to have demanded—the existence of an ongoing state administrative proceeding (or, at the very least, enforcement action). Accordingly, because it “based its ruling on an erroneous view of law,” we hold that the district court abused its discretion when it abstained from adjudicating Deal’s equitable counts. Rather than abstaining, the district court here should simply have decided, on the merits, whether the governing state law permits a federal court to dissolve a state-chartered corporation. [Citations omitted.]
In a footnote, Judge Newson noted that, ‘[t]o the extent that other courts have extended Burford to state-law judicial dissolution claims, we disagree,” followed by citations to Friedman and Caudill.
What’s the Future Hold for Burford Abstention in Dissolution Cases?
The choice of federal over state court will always be an attractive one for close corporation shareholders seeking judicial dissolution, assuming they can establish subject matter jurisdiction based on diversity of citizenship or the inclusion of other claims arising under federal law. [N.B.: Generally speaking, absent federal claims, federal court is not an option in dissolution cases involving LLCs and other unincorporated associations whose citizenship takes on the citizenship of its members, thereby precluding complete diversity except where courts find the entity to be a “nominal” party.]
As things stand currently, a federal forum for dissolution petitioners is not available in the seven states within the Second and Sixth Circuits, is available in the three states within the Eleventh Circuit, and may or may not be available in the remaining forty states (and District of Columbia) in the nine other Circuits that have not yet addressed the issue of Burford abstention in dissolution cases.
I discount heavily the likelihood that the U.S. Supreme Court, as the ultimate arbiter of conflicting rulings among the Circuit Courts, will decide the issue any time soon, if ever. It would have to be one hell of a case, with stakes the magnitude of which is not typical of dissolution cases involving closely held corporations and a timeline that avoids mootness, to justify a petition for certiorari to the Supreme Court.
More likely, the Eleventh Circuit’s ruling will encourage dissolution petitioners who can satisfy subject matter jurisdictional requirements to file their petitions in District Courts in the nine “undecided” Circuits. Should that happen, and should more District Courts in those Circuits, like the Idaho District Court in Zafer v Spengler mentioned above, hold Burford abstention inapplicable, and should some of those cases get affirmed on appeal, eventually that might encourage litigants in the Second and Sixth Circuits to pursue appeals asking those courts to take a fresh look at the issue. Of course, decisions in the other Circuits could go the other way, leaving the Eleventh Circuit as the lone dissenter. Only time — a lot of it — will tell.
Update 10/30/21: I’m aware of two decisions by District Judges in the Southern District of New York handed down some months after Deal v Tugalo, neither of which mentions the Eleventh Circuit’s ruling, both of which cite Friedman and apply Burford abstention to dismiss judicial dissolution claims: Kastrati v M.E.G. Restaurant Enterprises Ltd. (BCL 1104-a dissolution claim) and Goureau v Lemonis (same).