A year ago I wrote a piece called The Elusive Surcharge in Dissolution Proceedings highlighting the rare appearance in the case law of the surcharge provision found in Section 1104-a (d) of the Business Corporation Law. The provision allows a court in dissolution proceedings brought by an “oppressed” minority shareholder to “order stock valuations be adjusted and may provide for a surcharge upon the directors or those in control of the corporation upon a finding of willful or reckless dissipation or transfer of assets or corporate property without just or adequate compensation therefor.”

If something strikes you amiss, at least as to the provision’s first clause concerning stock valuation, you’re not alone. If the court orders dissolution, there’s no stock valuation to be adjusted, right? The best (if not wholly satisfactory) answer I can give points to subsection “b” of BCL Section 1118, enacted at the same time as Section 1104-a, which allows the court, in determining the fair value of the petitioner’s shares once there has been a buy-out election, to “giv[e] effect to any adjustment or surcharge found to be appropriate in the proceeding under section 1104-a of this chapter.”

To my eye, that’s just sloppy legislative drafting. The stock valuation adjustment and surcharge both feed off the same thing: a transfer of corporate assets without fair consideration. The drafters should have excised the needlessly confusing reference to stock valuation adjustment in Section 1104-a (d), and more simply should have provided in Section 1118 (b) that the court, in determining the fair value of the petitioner’s shares, can “give effect to any surcharge found to be appropriate under section 1104-a (d) of this chapter.” How the surcharge is to be given effect — whether by way of a pro rata distribution to the petitioner of a discrete surcharge amount on top of the fair value award, or by factoring (“adjusting”) it into the business appraisal upon which the fair value award is based — is up to the appraisal experts and ultimately the court. Justice Dianne Renwick’s 2006 decision in the Exterior Delite case gives guidance to that effect.

The legislative sloppiness continues to have real-world consequences, which is why I’m revisiting the subject a year later prompted by a trial court decision earlier this month in Matter of Carter (Ricwarner, Inc.), 2017 NY Slip Op 51479(U) [Sup Ct Bronx County Nov. 2, 2017]. Continue Reading The (Even More) Elusive Surcharge in Dissolution Proceedings

SurchargeHidden in plain view in Section 1104-a (d) of the New York Business Corporation Law, which authorizes an oppressed minority shareholder to petition for judicial dissolution, is a provision empowering the court to adjust stock valuations and to “surcharge” those in control of the corporation for “willful or reckless dissipation or transfer” of corporate assets “without just or adequate compensation therefor.”

A second, fleeting reference to surcharge appears in Section 1118 (b) of the buy-out statute, empowering the court in its determination of the stock’s fair value to give effect to any surcharge “found to be appropriate” under Section 1104-a.

The ordinary definition of surcharge, at least in the context of settling accounts, is to show an omission for which credit ought to have been given. But what does it mean in its statutory setting, and how has it been applied by the courts? Continue Reading The Elusive Surcharge in Dissolution Proceedings

Your client, a 50% shareholder of a New York close corporation, tells you that the business is in complete disarray due to irreconcilable disputes with the other 50% shareholder and that he believes the other shareholder has misappropriated the corporation’s assets and diverted business opportunities.

The client accepts your recommendation to bring a judicial dissolution proceeding. You review Article 11 of the Business Corporation Law before drafting the dissolution petition. You come across two dissolution statutes denominated § 1104 and § 1104-a. Section 1104, called “Petition in case of deadlock among directors or shareholders,” confers standing on a 50% shareholder and, as the name straightforwardly suggests, authorizes a court to dissolve based on deadlock precluding board action or election of directors, or other “internal dissension” warranting dissolution.

Section 1104-a, with the more cryptic name, “Petition for judicial dissolution under special circumstances,” confers standing on a shareholder with 20% or more of the corporation’s voting shares, and authorizes dissolution when the controlling shareholders or directors engage in “illegal, fraudulent or oppressive actions” against the petitioning shareholder, or have “looted, wasted, or diverted” the corporation’s property.

You quickly realize that your 50% shareholder-client has standing to seek dissolution under both statutes. Which one should you choose? If you believe you have facts sufficient to obtain dissolution under one of them, is there any reason to consider the other? Can you choose both? Does it really matter?

It most certainly does matter, for a couple of reasons mainly having to do with the different remedies offered by the two statutes. Continue Reading Choose the Right Dissolution Statute for the Right Remedy

A company’s financial statements constitute the core data used by business appraisers to value shareholder equity in statutory appraisal proceedings triggered by dissolution petitions brought by oppressed minority shareholders.

In my experience, most small and medium sized closely held businesses do not have audited financial statements but instead rely on their outside accountant to prepare either a compilation or review report which merely compiles management’s financial reports without any probing whatsoever (compilation) or employs a limited analysis of the company’s accounting practices and other factors but without any data testing as would be done in an audit (review).

When using the income and market approaches to value a business, appraisers engaged as expert trial witnesses routinely make “normalizing” adjustments to the income statement (a/k/a Profit & Loss statement or “P&L”) before applying a capitalization rate or market value ratios. For instance, the appraiser will eliminate extraordinary gains or losses, or may adjust officer/owner compensation to reflect reasonable compensation rates based on generally accepted industry surveys.

But beyond standard normalization, an expert appraiser using non-audited statements must determine whether the underlying income, expense, asset and liability data provided by management are reliable to a reasonable degree. Otherwise it’s GIGO — garbage in, garbage out.

That’s where forensic accounting comes in, as nicely illustrated in a recent case decided by Queens County Commercial Division Justice Orin R. Kitzes in Matter of Adelstein (Finest Food Distributing Co. N.Y., Inc., 2011 NY Slip Op 33256(U) (Sup Ct Queens County Nov. 3, 2011).

Continue Reading Forensic Accounting Helps Wins the Day in Oppressed Shareholder Stock Valuation Proceeding

Once in a while there comes along a corporate dissolution case fraught with so many interesting and challenging issues of fact and law that, as the saying goes, a student of business divorce could “go to school on it.”  Of course, it also helps to have an engaged judge willing to serve as “teacher”, i.e., a judge who carefully parses the issues and writes a thoughtful, well-reasoned decision that sets forth the competing factual narratives and operative legal principles.

A protracted dissolution battle in Brooklyn Supreme Court called Matter of Pappas (Corfian Enterprises, Ltd.), presided over by Justice Jack M. Battaglia (pictured), is just such a case.

Pappas began in 2004, when the widow of Eleftherios Pappas embarked on what became a 6-year trek through the legal system trying to establish and get paid for her late husband’s ownership interest in commercial realty and two closely held corporations which, she alleged, were co-owned with two other individuals, Theodoros Kalogiannis and Paul Fotinos.  There was no direct evidence, by way of shareholder agreement or other reliable records, establishing ownership of the corporations, of which Mr. Fotinos claimed to be 100% shareholder.

Continue Reading Final Round of Corfian Case Features Diverse Dissolution Issues

The residential co-operative corporation is a strange breed of closely held business entity.  In New York, the co-op is formed as a for-profit corporation under the Business Corporation Law (BCL), yet it doesn’t operate for profit in the traditional sense of returning cash dividends to shareholders.  Instead, ownership of co-op shares entitles the shareholder to occupancy of an apartment under an appurtenant long-term proprietary lease.  The co-op’s income derives mostly if not entirely from tenant-shareholder maintenance payments, the level of which is designed merely to cover the common charges for building expenses.  The market value of the shares held by individual shareholders within the same co-op can vary greatly, not just due to the number of shares allocated to the particular apartment, but also due to the unique characteristics of the apartment.

One of the consequences of being a for-profit corporation is that co-ops in New York are subject to the same statutes governing voluntary and involuntary dissolution as any other closely held business corporation, including BCL Section 1104-a authorizing a petition for judicial dissolution by an “oppressed” minority shareholder holding at least 20% of the corporation’s shares.  At least in New York City, where co-ops tend to have many apartments, the shares usually are too widely dispersed for any single tenant-shareholder to own 20%.  In addition, and with all due respect to noise and odor complaints, the idea of a co-op dweller being oppressed by her neighbors is a far cry from the usual freeze-out/squeeze-out scenarios involving loss of employment, removal from the board, financial abuse by the majority, and lack of a market exit.

The fact is, however, that New York City also has many smaller co-op buildings such as converted townhouses and brownstones featuring four or five apartments, each of which may be allocated 20% or more of the co-op’s shares.  And, New York City being a litigious kind of town when it comes to expensive real estate (think Trump), it’s inevitable that an alienated tenant-shareholder in such a co-op would opt to bring a dissolution proceeding instead of exiting by selling her apartment on the open market.  A rational shareholder presumably would do so only if she believes she’ll get more value from a liquidation of the corporation’s assets than from selling her apartment, i.e., that the value of the entire building is greater than the sum of its parts.

Continue Reading Valuing Shares in a Residential Co-op Corporation: Is the Whole Worth More Than the Sum of its Parts?