It’s hard not to feel sorry for the petitioner in Fernandes v Matrix Model Staffing, Inc., Decision and Order, Index No. 160294/2021 [Sup Ct, NY County Apr. 20, 2022].

In Fernandes, Manhattan Supreme Court Justice Frank P. Nervo authored a thorough, step-by-step analysis of the legal issues and defenses most commonly raised in support of and in opposition to a petition for corporate dissolution based upon “illegal, fraudulent or oppressive actions” by the entity’s controllers under Section 1104-a (a) (1) of the Business Corporation Law (the “BCL”).

The Court serially ruled that the petitioner stated sufficient grounds to dissolve Matrix Model Staffing, Inc. (“Matrix”), a modeling agency with offices in New York, Florida, and California, and that the respondent entity: (i) failed to demonstrate petitioner’s lack of standing, (ii) failed to raise a genuine issue of fact as to any of the facts in the petition, (iii) failed to demonstrate the existence of an “adequate, alternative remedy” to dissolution, and (iv) failed to forestall dissolution by exercising the buyout election under BCL § 1118. Sounds like a winning petition.

To the hapless petitioner’s undoubted dismay, though, the Court still referred the matter to a referee for an evidentiary hearing. Let’s see why the Court might have felt compelled to order a hearing on a petition for which the respondent failed to show any real defense.

The Petition

According to his petition, Alvin Clayton Fernandes (“Fernandes”), self-described as a “super model,” actor, and restaurateur, was holder of 20%, and Jacquelyn Willard (“Willard”) the holder of 80%, of the voting shares of stock of Matrix.

The petition alleged that around 2017, Willard removed any reference to Fernandes (the alleged founder) on the firm’s social media and web pages and “excluded” him “from the decision-making process and financial dealings of Matrix.” Fernandes alleged, “Jacquelyn no longer treats me as a business associate and I have effectively been precluded from participating in a small, closely held corporation to which I have devoted my time, energy and reputation over many years.”

The petition further alleged, “At some unknown time . . . Jacquelyn, without my knowledge and consent, designated me to the Internal Revenue Service as a ‘person responsible for collecting, truthfully accounting for, or paying over employment taxes for the entity,'” then failed to collect and remit the required taxes to the IRS, resulting in the IRS “advising me that I was being personally charged the Trust Fund Recovery Penalty . . . for willfully failing to collect, account for, pay over, or otherwise evade employment” taxes. As one of its only exhibits, the petition attached the IRS’s notice of tax delinquency totaling over $210,000. The petition alleged, “At no time since Matrix Staffing’s inception was I ever responsible for collecting, truthfully accounting for, or paying over employment taxes. This was the sole responsibility of Jacquelyn.”

From these allegations – a skimpy 33 paragraphs and two exhibits – Fernandes alleged a single cause of action for dissolution.

The Dismissal Motion

Matrix moved to dismiss the petition under CPLR 3211 (a) (1) and (7), submitting just a lawyer affirmation, a handful of emails (which New York case law holds are not “documentary” evidence a court may consider under CPLR 3211 (a) (1)), and a memorandum of law, arguing that Fernandes failed to demonstrate his shares were voting stock, so he lacked standing to sue; alternatively, that he failed to sufficiently plead grounds to dissolve the business under the BCL § 1104-a (a) (1) standard; and alternatively, that dissolution would be bad “policy” because “Matrix employs 170 people” (though there was no evidentiary support for this proposition in the record).

Fernandes opposed the motion with an affidavit – the only one either side submitted – and a memorandum of law.

The Decision

On the issue of standing, the Court ruled that the dismissal motion was “palpably devoid of merit” because the petition alleged Fernandes’ right to vote, and Matrix, as movant, “conflates the burden of proof; it is respondent who bears the burden on a CPLR 3211 motion to establish, via documentary evidence, that petitioner’s shares are non-voting. Respondent has failed to proffer any proof of this contention” and “cites no authority for the proposition that where a voting shareholder’s status is not contested the failure to annex proof of the voting shares is fatal to a dissolution action.”

On the issue of grounds to dissolve, the Court noted that the petition “alleges that respondent . . . acting through its director Willard, failed to pay appropriate employment taxes, resulting in over $200,000.00 in penalties being assessed against petitioner, personally, by the Internal Revenue Service,” and “that petitioner was never responsible for collecting, accounting, or paying employment taxes for respondent’s employees.”

The Court wrote, “Notably, no affidavit from Willard or respondent is submitted on this motion.” The Court ruled:

Failing to pay tax liabilities is corporate mismanagement which defeats a petitioner’s reasonable expectations sufficient to constitute oppression. It is beyond argument that a shareholder, who is not responsible for payroll and accounting, has an objectively reasonable expectation that the corporation will not designate the shareholder as the responsible party for payroll withholdings in IRS filings. The designation of the shareholder, without their consent, in IRS filings as the responsible party for payroll taxes and the corporation’s subsequent failure to properly withhold payroll taxes — resulting in several hundred-thousand dollars of tax penalties being levied against the shareholder — is oppressive, if not fraudulent or criminal behavior (citation omitted).

“Consequently,” the Court ruled, “the petition alleges a demonstrated risk to petitioner’s rights — chiefly continued future tax and other financial liabilities arising from respondent’s oppressive conduct” — sufficient to grant dissolution.

Then, noting that a court may not grant dissolution if there is an “adequate, alternative remedy,” the Court held:

Respondent has failed to offer alternative remedies. Respondent’s concern that dissolution will result in its 170 employees being terminated is largely contradicted by respondent Matrix’s failure to offer any alternatives to dissolution. A court has broad latitude in fashioning alternative relief, but when there has been a complete deterioration of relations between the parties, a court should not hesitate to order dissolution (quotations omitted).

But – even after all of these holdings in Fernandes’ favor – the Court held:

However, the Court is mindful of BCL § 1109, generally which requires a hearing establishing the underlying facts prior to a finding of dissolution. As discussed, supra, respondent has not denied the allegations of the petition, nor has respondent offered any alternative remedy to dissolution. While neither respondent corporation nor its director, Willard, has submitted an affidavit raising a question of fact, respondent has, nevertheless, questioned the need for dissolution. Accordingly, the matter is referred to a referee to hear and report on the issue of dissolution” (citation omitted).

The Court ordered the referee to hold an evidentiary hearing and issue a report on the following broad subjects: “Establishing the underlying facts of the petition for dissolution, the merits of the petition, and the appropriate remedy.”

Outcome of Fernandes

In my view, the Court ordered a fact-finding hearing in Fernandes because the case was a bit like an evidentiary standoff, neither side coming to the draw with any actual documentary evidence to support his or her contentions. Even basic items of evidence like the entity’s organizational documents were nowhere to be found.

As we have said on this blog many times (read here and here), a special proceeding for judicial dissolution under Article 4 of the CPLR should never be confused with an ordinary plenary action. In a plenary action, the complaint need only state on its face the basic essential legal elements and facts necessary to support a cause of action. In a plenary action, no evidence is required at the pleadings stage.

A special proceeding is far different. In a special proceeding, at the pleadings stage, the petitioner must not just allege the facts and legal elements in the petition – but show the Court with evidentiary proof in admissible form accompanying the petition itself – that the petitioner is entitled to judicial dissolution as a matter of law. Courts are empowered on a proper showing to grant dissolution based on the petition alone, and it is the goal of every dissolution petitioner to supply the court with as much evidence as possible to try to do just that, demonstrating the absence of disputed factual issues requiring a hearing.

As Peter Mahler once wrote, “[I]f you’re a petitioner in a dissolution proceeding you need to load up your petition (or supplemental affidavits) with as many facts as are available in support of your claims; bare ‘notice’ pleading will not suffice. My advice to respondents wishing to oppose dissolution essentially is the same: whether you file an answer or a motion to dismiss, don’t hold back, put in everything you’ve got by way of factual affidavits with as much documentary support as possible.”

These concepts appeared totally lost on the parties in Fernandes. Both treated their petition and dismissal cross-motion like no evidentiary showing was needed. That, in my view, is why the Court ordered a hearing: to see if there is any actual evidence to back up the parties’ bare-bones allegations.

Bottom line: if you’re petitioning in a special proceeding to dissolve, or moving in a special proceeding to dismiss, do not hold back. Make your evidentiary showing up front. The consequence can be a time consuming and costly evidentiary hearing even if there may be few, if any, disputed factual issues in the papers.