Stock Transfer Restrictions

The P.C., as in professional service corporation, has been called a “strange creature.”  The strangeness stems mainly from the statutory restrictions on the voluntary or involuntary transfer of ownership in a P.C. to persons who are not licensed members of one of the regulated professions permitted to utilize the P.C. business form under Title 8 of the Education Law, including lawyers, doctors, dentists, accountants and miscellaneous others.

In New York, P.C.s are governed by the same general provisions of the Business Corporation Law (BCL) applicable to all for-profit business corporations, including Articles 10 and 11 of the BCL governing voluntary and judicial dissolution.  The P.C. ownership transfer restrictions, along with other provisions specific to the formation, operation, limited liability and disposition of P.C.s, are collected in Article 15 of the BCL.  The somewhat obscure interplay between the general dissolution provisions in BCL Articles 10 and 11 and the P.C. ownership transfer restrictions in Article 15 can create havoc for the professional in a multi-member P.C. who fails to appreciate those provisions or, worse yet, fails to enter into a shareholders’ agreement that protects the professional’s financial interests under various exit scenarios including death.

It’s hard to imagine a more painful illustration of such havoc than the case decided last week by a Brooklyn appellate court involving a P.C. dental practice in which the majority shareholder died without a shareholders’ agreement, called Matter of Bernfeld (Michael Bernfeld, D.D.S. and Yakov Kurilenko, D.D.S., P.C.), 2011 NY Slip Op 05071 (2d Dept June 7, 2011).  The deceased dentist’s widow, who had found a buyer for the practice’s assets for over a half million dollars, now stands to walk away empty handed as a result of the statutory default provisions that prevent her both from seeking judicial dissolution and from resisting the surviving shareholder’s right to have the P.C. purchase her late husband’s interest possibly at negative book value.

Continue Reading Case Illustrates How Not to Plan for the Death of a Shareholder in a Professional Corporation

I’m pleased to present my third annual list of the year’s top ten business divorce cases.  This year’s crop includes some very important decisions concerning the standard for LLC dissolution, expulsion of LLC members, buyouts triggered by dissolution petitions, stock valuation, and much, much more.  All ten were featured in this blog previously; click on the case name to read the full treatment.  And the winners are: 

1.  Matter of 1545 Ocean Avenue, LLC, 72 AD3d 121, 2010 NY Slip Op 00688 (2d Dept Jan. 26, 2010), in which the Second Department differentiated dissolution of LLCs from business corporations and pronounced a contract-based standard for judicial dissolution of LLCs giving primary weight to the terms of the operating agreement.

2.  Jain v. Rasteh,  Decision and Order, Index No. 109920-09 (Sup Ct NY County Feb. 1, 2010), where the court upheld the right of the LLC’s majority member to expel a minority member for breach of the operating agreement.


3.  Chiu v. Chiu, 71 AD3d 646, 2010 NY Slip Op 01768 (2d Dept Mar. 2, 2010), holding that courts have no statutory authority to order expulsion of an LLC member for alleged misconduct, absent language in the operating agreement expressly providing for an expulsion remedy. 


4.  Matter of Superior Vending, LLC, 71 AD3d 1153, 2010 NY Slip Op 02801 (2d Dept Mar. 30, 2010), in which the court upheld as an "equitable method of liquidation" the return of the petitioner’s capital contribution in exchange for his membership interest in the LLC.


5.  Matter of Eklund Farm Machinery, Inc., 73 AD3d 1319, 2010 NY Slip Op 04097 (3d Dept May 13, 2010), in which the court construed BCL Section 1217 to limit the commission payable to receivers in corporate dissolution cases.


Continue Reading Top 10 Business Divorce Cases of 2010

Does the mere filing of a petition for corporate dissolution bring about “a succession to a third person by operation of law or court order” or the transfer of the right to “control or vote” the petitioner’s shares?  The question, upon which turns the non-petitioning shareholders’ right to enforce a book-value buyout provision in the shareholders’ agreement, lies at the heart of a multi-faceted ruling earlier this month in Matter of Piekos (Home Studios Inc.), 2010 NY Slip Op 51408(U) (Sup Ct Westchester County Aug. 3, 2010).

In his 23-page decision, Westchester Commercial Division Justice Alan D. Scheinkman undertakes a thorough review of the case law before concluding (a) the filing of the dissolution petition triggers the buyout clause, but (b) an evidentiary hearing is required to determine whether the petitioner had a “meaningful choice as to whether to sign the [shareholders’] agreement” and whether it would be “unconscionable” to enforce the buyout against an oppressed minority shareholder.

There are at least two reasons you’ll want to read the Piekos decision.  First, it collects and dissects the relevant case law to date on this important and recurring issue on which I have written numerous times, including an article in the New York Law Journal which Justice Scheinkman cites (read here) and several posts on this blog (read here, here and here).  Second, wholly apart from the legal issues, the decision’s detailed recital of the factual background tells a gripping story of broken relationships, bruised egos and sharp tactics amidst a fight for economic primacy and survival among business partners.

Continue Reading Decision Breaks New Ground in Dispute Over Enforcement of Stock Buyback Triggered by Filing of Dissolution Petition

A decision earlier this month by an upstate appellate court in a corporate dissolution proceeding called Matter of Stevens (Allied Builders, Inc.), 2010 NY Slip Op 05066 (4th Dept June 11, 2010), adds uncertainty to the already fuzzy array of precedents surrounding the question whether the filing of a dissolution petition triggers a mandatory buyback of the petitioner’s shares under the provisions of a right of first refusal (“RFR”) in the shareholders’ agreement.

I’ll first set the stage with some basics, then I’ll dig into Stevens.

What’s an RFR?

RFRs are most familiar in the real estate setting, e.g., a tenant’s right to match a third-party purchase offer during the lease term.  Less well known is the use of RFRs in the close corporation setting as a stock transfer restriction found in shareholders’ agreements.  This type of RFR requires each shareholder to sell his or her shares to the corporation and other shareholders before they can be sold to an outside buyer.  The shareholder RFR primarily serves as a further deterrent to any sale of non-controlling interests which, for the vast majority of closely held corporations, are non-marketable unless very steeply discounted.

There are infinite variations on how to draft RFR trigger events and pricing mechanisms.  A narrow version, analogous to the tenant’s right to match a third-party purchase offer, is triggered only by a bona fide third-party offer for the shares, which then must be offered back to the corporation or the other shareholders at the same price and on the same terms.  The third-party sale can proceed only if the corporation or the other shareholders turn down the purchase opportunity.

Very frequently, however, a much broader RFR is used, with attributes more akin to a right of first offer, which mandates a stock buyback triggered by any event constituting a voluntary or involuntary transfer of shares.  The broad-form RFR more often than not will fix share price at book value or use some other formula or pre-determined price unfavorable to the selling shareholder.

What’s the Issue?

When relations among fellow shareholders in close corporations deteriorate beyond repair, a petition for judicial dissolution may be the only effective remedy.  The issue is whether the mere filing of a petition for judicial dissolution triggers the RFR.

Courts unquestionably will enforce an RFR triggered by the filing of a dissolution petition where the RFR expressly provides that the filing is deemed an offer to sell.  The interpretive problem arises, as it did in the Stevens case, when the RFR contains no express reference to a dissolution petition, but only uses general references to “involuntary transfer” or to a shareholder who seeks to “otherwise dispose” of his or her shares.

Continue Reading Appellate Court Rejects Mandatory Stock Buyback Triggered by Dissolution Petition

The right of first refusal (RFR) is a type of stock transfer restriction found in shareholder agreements of closely held corporations.  Under the most common form of RFR, the shareholder seeking to transfer his or her shares to another person is required to submit sequentially to the corporation and, if the corporation declines, to the other shareholders the opportunity to purchase the shares on the same terms as are being offered by the proposed purchaser.  The courts routinely enforce RFRs in recognition of the special partnership-like character of close corporations.

A recent decision by the Appellate Division, First Department, in Giaimo v. EGA Associates Inc., 74 AD3d 815, 2009 NY Slip Op 09277 (1st Dept Dec. 15, 2009), illustrates the mischief that can occur when the RFR is not properly spelled out in a shareholders’ agreement but, instead, is set forth in abbreviated and incomplete form on the back of the share certificates.  Giaimo also illustrates the paramount importance New York courts place on the fiduciary duties owed by majority shareholders and directors of close corporations to minority shareholders, arguably to the point of preempting the statutory scheme governing director’s self-interested transactions.

EGA Associates Inc. (EGA) is a closely held New York corporation formed in 1961 to own and operate real estate.  According to the complaint filed by Robert Giaimo (read here), the stock of EGA was held one-third each by Robert and his siblings, Edward and Janet.  Edward died after a long illness in March 2007.  Edward’s will bequeathed his EGA shares in equal parts to Robert and Janet, which would have left them as equal 50% shareholders.  Two weeks before his death, however, Edward sold one of his shares to Janet for $80,000, thereby giving her majority ownership upon Edward’s death.  Some months later, Janet gave notice of meetings of the shareholders and directors at which she obtained voting control of the board by electing herself and her lawyer as two of the three directors.

Continue Reading Court Invalidates Control-Shifting Stock Transfer Made in Violation of Corporation’s Right of First Refusal

See full size imageOur English common-law heritage includes what’s known as the rule against unreasonable restraints on alienation.  Law students first encounter the rule in their property class, where they learn about the abolishment of the feudal “fee tail” which restricted the transfer of real property to a specific line of male heirs.  Basically, our laws and public policy strongly favor the right of persons to freely dispose of their property both real and personal.  Agreements that place ownership of property in the hands of one person and the right to alienate, i.e., sell or otherwise convey the property, in the hands of another, are unenforceable.

The rule is not absolute.  It only prohibits unreasonable restraints on alienation.  For instance, where a niece agreed to pay $15,000 to her uncle and aunt for a $100,000 farm that was in the family for generations on condition that, during the uncle’s and aunt’s lifetimes, the niece wouldn’t mortgage the farm or convey it to her husband, a court enforced a reversion clause in the recorded deed giving the property back to her relatives when the niece placed mortgages on the farm that subsequently were foreclosed.  The court found it reasonable to enforce the restraint to preserve family ownership of the farm for a limited duration.  Moreover, the niece’s interest in free alienation was outweighed by her agreement to the restraint in consideration for a drastically reduced price.  (Example taken from Alby v. Banc One Financial, 128 P3d 81 [Sup. Ct. Wa. 2006].)

What’s this got to do with shareholder and operating agreements?

Continue Reading Beware Unreasonable Restraints on Alienation When Drafting Shareholder and Operating Agreements

See full size image


Some months ago, in a post about the intersection of the at-will employment doctrine and fiduciary duty among shareholders in close corporations, I wrote:

The most common allegation of oppression by minority shareholders involves termination of employment by the controlling shareholders.  The Court of Appeals in Matter of Kemp & Beatley noted that obtaining employment is often the main reason for becoming a shareholder in a closely held company that typically pays no shareholder dividends.  As I’ve pointed out before, case law holds that the majority’s termination of the minority’s at-will employment does not give rise to a wrongful termination remedy under either a contract or tort theory, but it may be oppressive for purposes of seeking judicial dissolution where the shareholder joined the venture with the reasonable expectation of getting and keeping a job. 

This principle is vividly on display in a recently decided case called Ambar v. Devington Technologies, Ltd., 2009 NY Slip Op 32373(U) (Sup Ct NY County Oct. 13, 2009), where the court refused to dismiss a petition for involuntary corporate dissolution brought by a minority shareholder whose employment was terminated by the controlling shareholders, notwithstanding at-will employment provisions in their shareholders’ agreement.

Continue Reading Fired Minority Shareholder’s Oppression Claim Not Barred by At-Will Employment Provisions in Shareholders’ Agreement

One of my pet issues, on which I’ve written a number of times (see here, here and here), is whether the filing of a dissolution petition triggers a mandatory stock buyback under a shareholders’ agreement that provides a right of first refusal (RFR).  The cases raising the issue have all been deadlock dissolution petitions brought by 50% shareholders under Business Corporation Law Section 1104(a).  That statute, unlike Section 1104-a governing minority shareholder oppression, does not give the respondent shareholders the right to purchase the petitioner’s shares under Section 1118.

If the shareholders’ agreement expressly provides that the filing of a dissolution petition triggers the RFR, unquestionably it should be enforced.  The problem arises with the more typical RFR that does not contain such express language, but instead contains what most would consider boilerplate reference to stock transfers.  Is enforcement by reason of such general language consistent with a shareholder’s reasonable expectations, and with the statutory right to seek dissolution?  The issue has very serious ramifications for the petitioner (and for petitioner’s lawyer who may be unwary of the trap) because the RFR typically provides a below-market price for the buyback with a long-term payout.

A 2006 appellate decision by the First Department in a case called Matter of Johnsen (ACP Distribution, Inc.) ruled that a dissolution petition triggered an RFR containing the operative terms, "donate, hypothecate, pledge, transfer or otherwise dispose of his Stock in any manner whatsoever."  A September 2007 trial court decision in Matter of Schneck (R&J Components Corp.) (previously blogged here) went the other way where the operative terms were "sell, assign, mortgage, hypothecate, transfer, pledge, create a security interest or lien, encumber, give or otherwise dispose of any of the shares."

Continue Reading Appellate Court Enforces Stock Buyback Triggered by Dissolution Petition