Corporate Governance

Subscribe to Corporate Governance

Housing cooperatives, or “co-ops” as they’re commonly known, occupy an unusual niche among forms of joint stock enterprises. Like any corporation, the tenant-shareholders have a common interest in maximizing for everyone’s benefit the value of the co-op’s assets, i.e., the apartment building and its common elements, but being neighbors who live above, below and beside one another, the tenant-shareholders also have intrinsically competitive interests regarding rights of access, use, development, transferability, etc., that can have a direct, disparate impact on quality of life and the resale value of their individual apartment units.

In large co-ops, where no single tenant-shareholder has a significant percentage of voting power, the centralized management authority of a democratically elected board of directors, exercised pursuant to the co-op’s by-laws, can regulate and mute any divergence between common and individual stockholder interests. Such centralized management, as in any corporation with widely dispersed ownership, effectively compartmentalizes decision-making at the board and shareholder levels.

But not all co-ops are large. In Manhattan and other parts of New York City there are many small co-op properties, including converted walk-up tenements and industrial loft buildings, with as few as four, five or six units where each tenant-shareholder may have a seat on the co-op’s board of directors and material voting power, thereby melding into one the theoretically distinct realms of director and shareholder authority and likewise conflating common and individual concerns.

Which also means that relations between tenant-shareholders in small co-ops can fall victim to the same kinds of infighting and dissension that afflict any small, closely held, owner-operated business enterprise. Some years ago I wrote about a Brooklyn co-op shareholder who petitioned for judicial dissolution of a five-unit co-op on grounds of oppressive conduct by the majority shareholders, which led to a statutory buy-out and contested valuation proceeding (read here and here). A Manhattan appellate panel’s decision last month in Akasa Holdings, LLC v Sweet, 2014 NY Slip Op 01822 [1st Dept Mar. 20, 2014], illustrates another kind of co-op shareholder dispute involving a battle for board control of a four-unit co-op, pitting one tenant-shareholder owning a majority of the voting shares against the other three tenant-shareholders. Continue Reading Legal Battle Over Board Seats Splits Neighbors in Manhattan Co-op

 

Kensington Publishing Corporation, founded in 1974 by the late Walter Zacharius, is the largest independent publisher of mass-market books in the United States. When Zacharius died in 2011 at the age of 87, his obituary in the New York Times described Kensington as “a leading purveyor of bodice-rippers and other romance genres.”

Zacharius left behind his second wife, Suzanne, and two children from his first marriage, Steven and Judith. The three of them are now locked in a legal battle for control of Kensington, with Suzanne, who inherited 59% of the voting shares, pitted against her two stepchildren who own most of the remaining voting shares.

Why the battle for control when Suzanne owns a clear majority of the voting equity? The answer lies in a 2005 voting agreement made by Walter and his two children which effectively gave Steven and Judith the power, following Walter’s death, to vote his shares in any election of Kensington’s directors. The children subsequently have used their board control to frustrate Suzanne’s stated goal, to sell her majority interest in Kensington to a “major publishing house,” and allegedly to withhold distributions as part of a squeeze-out plan. Continue Reading Voting Agreement Triggers Fight for Control of Family-Owned Publishing House

It’s a common drafting technique in all sorts of agreements to use the phrase, “Notwithstanding anything to the contrary in this Agreement,” to establish precedence of the appurtenant contract term with all other terms in the agreement. Ken Adams, the blogger and author of A Manual of Style for Contract Drafting, recommends against use of the phrase, even though it saves the effort of having to review the rest of the document for possible inconsistencies. As Adams explains, “[t]o reduce the chance of a drafting error, and to make life easier for the reader, it would be best to determine whether the provision in question in fact needs to trump another provision and, if it does, to specify which provision.”

Had they heeded that advice, the parties in Schepisi v. Roberts, 2013 NY Slip Op 07577 (1st Dept Nov. 14, 2013), decided last week by the Manhattan-based Appellate Division, First Department, could have saved themselves a lot of trouble and expense litigating their dispute over a pair of LLC agreements containing dueling notwithstanding clauses concerning the level of management authority required to enter into related-party contracts with LLC members. Continue Reading LLC Agreement Falters from Dueling “Notwithstanding” Clauses

It’s safe to say the pre-eminent English jurist, Sir William Blackstone (1723-1780), knew beans about like-kind exchanges under Section 1031 of the U.S. Internal Revenue Code or minority shareholder rights under New York’s Business Corporation Law although, to be fair, neither of those laws (or country or state for that matter) existed in his time.

Which makes it all the more fascinating that his greatest work, Commentaries on the Laws of England, was cited as authority in a recent decision by a New York judge weighing a dispute between majority and minority factions of a close corporation over whether the latter’s consent was required for the corporation’s sale of its sole realty asset and purchase of a replacement property as part of a so-called 1031 exchange. I’ll begin with some background information:

What is a 1031 Exchange? The 1031 exchange is a popular tax planning device for owners of realty and other qualified business assets with built-in gains. The tax code permits a property owner to defer taxes on the gain from a sale of property used in a trade or business or for investment if, within 180 days, the sale proceeds are reinvested in similar property. As explained on an exchange intermediary trade association website: Continue Reading With Sir Blackstone’s Help, Court Thwarts Minority Shareholder’s Effort to Block 1031 Exchange

The internal affairs doctrine is a choice of law rule under which a court will apply the law of the state of the subject entity’s formation (lex incorporationis) rather than the law of the jurisdiction where suit is brought (lex fori) to governance disputes and other internal conflicts concerning rights and duties among the entity, its owners and managers. So, for instance, when a shareholder or member of a New York based Delaware corporation or LLC brings suit in a New York court against an officer or manager for breach of fiduciary duty, the New York judge ordinarily will adjudicate the claim under Delaware law, which may differ materially from the analogous New York common or statutory law.

The internal affairs doctrine in theory acknowledges the superior interest of the state of formation in the application of its laws to the entity’s internal governance, even when the entity is based outside the state and has no connection with the state other than its formation. The doctrine also serves to avoid the uncertainty and high transactional costs that would occur if a business entity operating in multiple states was subject to different rules of governance in each state. Finally, it reflects a strong presumption that those who chose to form their entity in a particular state desire to have their legal relations governed by the laws of that state.

I don’t think I’m going out on a limb stating that the overwhelming majority of partnership agreements, shareholder agreements and LLC agreements that contain an express choice of law provision select the law of the state of formation, i.e., there is no inconsistency between the parties’ contractually stated preference and the internal affairs doctrine. But once in a while I come across an exceptional case. Those of you who followed the Pappas v. Tzolis saga may recall that the New York-based Delaware LLC involved in that case had an operating agreement with a New York choice of law clause. As I noted in one of my several posts about the case (read here), the trial judge side-stepped the conflicts of law issue by finding the result the same under either state’s law, and the issue unfortunately was not addressed in the subsequent appellate rulings deciding the case under New York law.

Another exceptional case recently came to my attention. Gelman v. Gelman, Index No. 12664/10 (read here), is an unreported decision dated April 3, 2013, by Nassau County Supreme Court Justice Daniel Palmieri involving a dispute between two siblings who co-own a Delaware LLC. The court enforced a New York choice of law provision in the operating agreement in deciding the right to appointment of a receiver. As in Pappas, however, the court opined that the result would be the same under either state’s law. Continue Reading What Law Applies When Internal Affairs Doctrine Clashes With Choice-of-Law Clause?

The title of this post is a riff on English playwright Brian Clark’s play Whose Life Is It Anyway? set in the hospital room of a car accident victim rendered quadriplegic, who must overcome opposition to his determination to end his life by euthanasia.

The play came to mind when I read the recent decision by Westchester Commercial Division Justice Alan D. Scheinkman in Briarcliff Solutions Holdings, LLC v. Fifth Third Bank (Chicago), Decision and Order, Index No. 70431/2012 (Sup Ct Westchester County Apr. 25, 2013), in which opposing stakeholders in a paralyzed, defunct limited liability company are fighting over who has the right to control and potentially terminate a lawsuit brought in the name and right of the LLC against one of the factions. The court’s ruling, in the procedural setting of a preliminary injunction motion, is notable primarily for its novel application of the irreparable injury requirement to a threatened board takeover designed to thwart prosecution of claims against the very same putative board members.

The lawsuit concerns a company known as Briarcliff Solutions Group, LLC (“BSG”) that, prior to its cessation of business in March 2011, owned operating subsidiaries that provided enterprise software solutions to leading retailers and wholesale distributors. At the risk of oversimplification, Faction #1 led by Paul Lightfoot held a majority equity stake in BSG while Faction #2 (a small group of private institutional and individual lenders) financed the company with rights to obtain majority control of the company’s managing Board of Directors in the event of loan default.       Continue Reading Whose Lawsuit Is It Anyway?

Someday, if and when the facts come out in discovery, we’ll learn what really happened in the curious case of Matter of Hu (Lowbet Realty Corp.), 2012 NY Slip Op 22314 (Sup Ct Kings County Nov. 2, 2012), in which a slippery minority shareholder somehow managed to sell the corporation’s sole realty asset and abscond with $1.6 million sale proceeds in violation of court order in a pending liquidation proceeding brought by the majority shareholder. In the meantime, the buyer and the property manager now find themselves ensnared in the majority shareholder’s effort to rescind the sale and to recover damages.

The court’s decision in Lowbet, issued earlier this month by Brooklyn Commercial Division Justice Carolyn E. Demarest, tells a remarkable story of brazen disobedience of court order by one Margaret Liu, a 25% shareholder of Lowbet Realty Corp. The decision also sheds light on an interesting, rarely seen procedural question in corporate dissolution proceedings, namely, whether the court may adjudicate within such summary proceedings a shareholder’s claim for relief against a third party who is neither a shareholder nor officer/director of the corporation, rather than being forced to commence a separate, plenary action by ordinary summons and complaint.

Background

The petitioner, Shau Chung Hu, was the 100% owner of Lowbet when, in 1980, it purchased a 19-unit apartment building in Brooklyn. In 1985, Hu married Margaret Liu and gave her a 25% stock interest in Lowbet. Mr. Hu and Ms. Liu separated in 1995, at which time Mr. Hu went to China where he has resided ever since, leaving Ms. Liu in full control over Lowbet. Continue Reading Dissolution Case Ensnares Buyer of Corporation’s Realty in Unauthorized Sale

Reading the post-trial decision by Suffolk County Commercial Division Justice Emily Pines in Nastasi v. Carlino, 2011 NY Slip Op 30626(U) (Sup. Ct. Suffolk County Mar. 8, 2011), one can’t help but be struck by the utter futility of an intense three-year litigation between business partners over a now-defunct company in which the court finds them all at fault and sends them all home empty handed.

Aletto & Nastasi Ltd. ("A&N") was formed in 2004 by shareholders Nastasi (40%), Carlino (40%) and Aletto (20%) to operate a marble and granite sales business including warehouse and showroom in Bohemia, New York.  Nastasi managed the business until early 2008 when Carlino and Aletto held a shareholders meeting without proper notice at which they voted to remove Nastasi from management and, as described in the court’s decision, "had him thrown off the property" after they determined that Nastasi was running sales through a separate company wholly owned by Nastasi.

In May 2008, Nastasi filed a petition for judicial dissolution of A&N as an oppressed minority shareholder under Section 1104-a of the Business Corporation Law.  Carlino and Aletto responded in kind with their own suit against Nastasi and his separately owned companies seeking an accounting based on Nastasi’s alleged conversion of corporate funds for his own personal use and breach of fiduciary duty.      

Continue Reading Court Sends Everyone Home Empty Handed in Bitter Business Breakup

In 1997, the controlling shareholders of three affiliated fire and burglar alarm companies sold all the company assets to an outside buyer for $4.2 million.  They did so without informing, or sharing any of the sales proceeds with, another 5% shareholder.  Thirteen years later, the chickens have come home to roost in the form of a court order against the controlling shareholders and their lawyer, granting common-law dissolution of the companies and awarding the 5% shareholder damages totaling almost $1.2 million — and that’s before adding prejudgment interest at 9% which more than doubles the principal amount.  Collins v. Telcoa International Corp., Short Form Order, Index No. 23796/97 (Sup Ct Queens County Nov. 5, 2010).

The Collins case made a splash almost ten years ago, when an appeals court was called upon to decide whether the plaintiff, Joseph Collins, was limited to an appraisal and other equitable remedies as opposed to the money damages he sought.  The Appellate Division, Second Department, in an opinion reported at 283 AD2d 128 (2001), sided with Collins in ruling that, since he was not told of the asset sale much less afforded his statutory right to dissent and bring a  shareholder appraisal proceeding, “nothing prevents him from maintaining a cause of action for money damages against [the controlling shareholders] based on their alleged breaches of fiduciary duty.”

The case went to trial in late 2007 before Referee Leonard Livote, who issued his report in December 2009.  The report and its recommendations were confirmed in a brief order issued last month by Queens County Supreme Court Justice Martin J. Schulman.  Fortunately for us, Justice Schulman’s order attaches a copy of the Referee’s report which contains a detailed set of factual findings and conclusions of law.

Continue Reading Court Grants Common-Law Dissolution and Awards Damages for 5% Shareholder Excluded From Sale of Company Assets