Breaking Up is Hard to Do 2.0: Court Denies Motion to Dissolve Under BCL 1104-a

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Posted on: Mar 13 2023

Section 1104 of the Business Corporation Law (“BCL”) grants a court the power to order the dissolution of a corporation “when the holders of shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors,”¹ establish that “the directors are so divided respecting the management of the corporation’s affairs that the votes required for action by the board cannot be obtained”,² or that “there is internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders”.³ The primary issues for determination under BCL § 1104 are whether a deadlock actually exists⁴ and whether such deadlock poses “an irreconcilable barrier to the continued functioning and prosperity of the corporation”.⁵ Notably, the underlying reason for the deadlock is irrelevant.⁶

The mere failure to attend shareholder meetings or disagreements with the shareholder who exercises control over the corporation’s daily management do not amount to dissension between shareholders sufficient to warrant dissolution.⁷ Conversely, where “[t]he disagreements which developed and the intensity of their discord [become] so great that efficient management [becomes] impossible,” dissolution pursuant to BCL § 1104 is warranted.⁸

Under BCL § 1104-a, the court is authorized to dissolve a corporation on two grounds: (a) when the directors representing “twenty percent or more of the votes of all outstanding shares of a corporation … present a petition of dissolution”,⁹ and (b) a court finds, inter alia, that “[t]he directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders … [or that] [t]he property or assets of the corporation are being looted, wasted, or diverted for non-corporate purposes by its directors, officers or those in control of the corporation”.¹⁰

The underlying purpose of Section 1104-a is to enable minority shareholders of closely held corporations to obtain relief, when they are either being denied participation in or excluded from corporate management, being refused employment by the corporation, or being refused payment of any dividends.¹¹ Accordingly, as long as the corporation’s “stock is not traded on a securities market”,¹² BCL § 1104-a – also known as the involuntary dissolution statute – “permits dissolution when a corporation’s controlling faction is found guilty of ‘oppressive action’ toward the complaining shareholders”.¹³ Whether conduct is oppressive sufficient to warrant dissolution is best understood against the backdrop of the purpose of the BCL § 1104-a, which by limiting relief only to those corporations not traded on the securities’ market, is meant to apply to closely held corporations.¹⁴ As the Court of Appeals observed:

[i]t is widely understood that, in addition to supplying capital to a contemplated or ongoing enterprise and expecting a fair and equal return, parties comprising the ownership of a close corporation may expect to be actively involved in its management and operation … Unlike the typical shareholder in a publicly held corporation, who may be simply an investor or a speculator and cares nothing for the responsibilities of management, the shareholder in a close corporation is a co-owner of the business and wants the privileges and powers that go with ownership. His participation in that particular corporation is often his principal or sole source of income. As a matter of fact, providing employment for himself may have been the principal reason why he participated in organizing the corporation. He may or may not anticipate an ultimate profit from the sale of his interest, but he normally draws very little from the corporation as dividends. In his capacity as an officer or employee of the corporation, he looks to his salary for the principal return on his capital investment, because earnings of a close corporation, as is well known, are distributed in major part in salaries, bonuses and retirement benefits.[¹⁵]

Accordingly, oppressive conduct falls within the scope of BCL § 1104(a)(1) if it substantially defeats the reasonable expectations held by minority shareholders upon committing their capital to the particular enterprise.¹⁶

In determining whether expectations are reasonable, the court must determine what a respondent knew or should have known regarding the petitioner’s expectations in joining the corporation.¹⁷ Oppressive conduct only arises if the respondent’s conduct objectively defeats those expectations.¹⁸

In Matter of Kemp & Beatley, Inc., the Court of Appeals held that the petitioners had demonstrated that the respondent’s conduct was oppressive, when a longstanding practice of awarding dividends to shareholders solely based on the ownership of the respondent’s stock was changed shortly after the petitioners left the company. While extra compensation to shareholders continued to be awarded, it was done so based only on the service that a shareholder provided to the respondent. The Court held that such conduct was designed to exclude the petitioners from obtaining a return on their investment and, therefore, was oppressive as a matter of law.¹⁹

In Dissolution of Pickwick Realty Ltd., 246 A.D.2d 863 (3d Dept. 1998), the Third Department held that dissolution was warranted on the grounds of oppressive conduct upon proof “of the shareholders’ attempt at voiding petitioner’s shares, their falsification of corporate documents and their failure to allow petitioner access to records and documents”.²⁰

As note, when a shareholder is denied participation in the management of a corporation, solely based on a subjective expectation, dissolution is unwarranted.²¹ In Hoffman, the petitioner sought dissolution because she was not allowed to participate in the corporation’s management. In denying the petition, the Second Department held that since the petitioner never participated nor sought to be involved in the day-to-day management of the corporation for years, she had no reasonable expectation, when she became a shareholder that she would be allowed to be involved in such activities.²²

Significantly, before dissolution is ordered, it must be determined, pursuant to BCL § 1104-a, that “feasible means whereby the petitioners may reasonably expect to obtain a fair return on their investment”²³ and “liquidation of the corporation is reasonably necessary for the protection of the rights and interests of any substantial number of shareholders or of the petitioners.²⁴ To that end, once oppressive conduct is found, it is the burden of the parties opposing dissolution to submit evidence demonstrating an adequate alternative to dissolution and in the absence of such evidence dissolution is warranted.²⁵

Whether dissolution is warranted, is a determination solely within the court’s sound discretion.²⁶

Against the foregoing analysis of the law, the court in Matter of Ilich, 2023 N.Y. Slip Op. 50171(U) (Sup. Ct., Bronx County Mar. 8, 2023), denied respondent’s motion to dissolve two corporations under BCL § 1104 and BCL § 1104-a.

Matter of Ilich

Ilich concerned petitions to dissolve a number of corporations. In particular, respondent sought an order, pursuant to BCL § 411, granting a judgment of dissolution with regard to two corporations: Drive Enterprises Inc. (“Drive”) and Zuelette Realty Corp. (“Zulette”).²⁷

Drive is real estate management company, which owns and manages premises located at 905 Brush Avenue, Bronx, NY (“905”). Drive rents space at 905 to Unitron Products, Inc. (“Unitron”) and six other tenants. Unitron pays Drive $12,500 per month in rent and the remaining tenants collectively pay Drive $25,000 per month in rent. Drive is authorized to issue 200 shares of common stock.

On December 22, 1997, after petitioner guaranteed a loan secured by a mortgage pledging 905 as security, petitioner was issued 100 shares of Drive’s stock by respondent, petitioner’s father. As such, petitioner owns 50 percent of Drive’s stock and respondent owns the remaining 50 percent. Petitioner alleged that for at least 10 years, respondent had instructed all tenants at 905, to pay rent directly to him instead of Drive. Rather than depositing the foregoing funds into Drive’s bank account, which, inter alia, were used to pay Drive’s mortgage, respondent used the money for his personal use. Petitioner asked respondent to deposit the foregoing sums into Drive’s account, but respondent refused to do so. In addition, respondent failed to provide petitioner with dividends to which petitioner was entitled and failed to provide petitioner portions of the rental income due to Drive as an equal owner of Drive. Even though petitioner had been managing Drive for 20 years, respondent removed petitioner’s signatory authority from Drive’s accounts, refused to grant petitioner access to Drive’s books and records, refused to discuss the disposition of Drive’s rental income, and refused to speak to petitioner.

In addition, on September 2014, respondent threatened petitioner with criminal prosecution for embezzlement of Drive’s funds and requested that petitioner relinquish all shares of Drive’s stock. Attempts to resolve the issue by scheduling a shareholder’s meeting were fruitless; respondent failed to attend such meeting, which petitioner scheduled on April 1, 2015.

Based on the foregoing, respondent sought Drive’s dissolution pursuant to BCL § 1104(a)(1) and (3), arguing that the division between the directors was such that the votes required for action could not be obtained and that the internal dissension between the directors was such that dissolution would be beneficial to the shareholders. Respondent also sought Drive’s dissolution pursuant to BCL § 1104-a(1), on grounds that respondent was guilty of oppressive action toward petitioner.

The petition concerning Zulette stated that Zulette is a real estate management company, which owns and manages premises located at 2811 Zulette Avenue, Bronx, NY (“2811”). Zulette initially rented 2811 to a company that manufactured rehabilitation equipment, but currently rents 2811 to the Center for Family Support, which pays $8,000 in monthly rent. Zulette is authorized to issue 200 shares of common stock.

On December 28, 1999, after petitioner guaranteed a loan secured by a mortgage pledging 2811 as security, petitioner was issued 100 shares of Zulette’s stock by respondent. As such, petitioner owns 50 percent of Zulette’s stock and respondent owns the remaining 50 percent. Even though petitioner has managed Zulette for 20 years, respondent removed petitioner’s signatory authority from Zulette’s accounts, has refused to grant petitioner access to Zulette’s books and records, refuses to discuss the disposition of Zulette’s rental income, and refuses to speak to petitioner at all.

In addition, on September 2014, respondent threatened petitioner with criminal prosecution for embezzlement of Zuelette’s funds and requested that petitioner relinquish all shares of Zulette’s stock. Attempts to resolve the issue by scheduling a shareholder’s meeting were fruitless; respondent failed to attend such meeting, which petitioner scheduled on April 13, 2015.

Based on the foregoing, respondent sought Zulette’s dissolution pursuant to BCL § 1104(a)(1) and (3), on grounds that the division between the directors was such that the votes required for action could not be obtained and that the internal dissension between the directors was such that dissolution would be beneficial to the shareholders. Respondent also sought Zulette’s dissolution pursuant to BCL § 1104-a(a)(1), on the grounds that respondent was guilty of oppressive action toward petitioner.

The court denied respondent’s motion. The court found that “respondent utterly fail[ed] to proffer any arguments in support of dissolution, fail[ed] to proffer any evidence relevant thereto and indeed, fail[ed] to establish how the evidence submitted support[ed] such relief.”²⁸

The court found that “respondent’s papers [were] woefully deficient’ and did not warrant the relief sought.²⁹ Critically, noted the court, “[n]ot only does respondent fail to proffer any arguments whatsoever in support of dissolution, he fails to even assert which section of the BCL warrants dissolution in this action and submits proof that viewed in the best light is utterly irrelevant for purposes of demonstrating entitlement to the relief sought”.³⁰ “Significantly,” said the court, “insofar as relevant to BCL § 1104, respondent’s evidence fail[ed] to establish the existence of the requisite deadlock required by law, let alone that such deadlock present[ed] ‘an irreconcilable barrier to the continued functioning and prosperity of the corporation’”.³¹

The court also held that the deficiencies in proof with regard to dissolution under BCL § 1104 existed with regard to dissolution pursuant to BCL 1104-a:

Here, the only evidence presented, which could be arguably viewed as relevant to respondent’s burden is his scant affidavit, wherein he states that petitioner diverted funds from Unitron and Zulette to another corporation, US Products, for his own benefit and that petitioner has denied respondent access to Zulette’s records. Unfortunately, this vague and conclusory assertion fails as a matter of law. The wholesale failure to specify and discuss the breath of the foregoing conduct precludes this Court from concluding that the conduct was oppressive as a matter of law. More importantly, the dearth of facts leaves this Court unable to conclude that the conduct was pervasive enough to – as it must – defeat respondent’s reasonable expectations upon embarking on the instant enterprise (Matter of Kemp & Beatley, Inc. at 71-72; (id. at 72; Hoffman at 723; Matter of Twin Bay at 1002).[³²]

Accordingly, the court denied the motion.

[Ed. Note: This Blog examined BCL § 1104 (here, here, and here) and BCL § 1104-a (here and here).]

Takeaway

Deadlock is among the most common forms of conflict in a closely held corporation. An impasse in the decision-making process of a corporation can occur on both the director and shareholder level. If the impasse cannot be consensually resolved, the corporation’s business may incur commercial and economic loss.

Close corporations are particularly vulnerable to deadlock. Close corporations are typically composed of family or friends who are actively engaged in the management of the corporation. They usually have a large portion of their personal wealth invested in the business and contribute most, if not all, of their time and energy in trying to make the corporation a successful business. If dissension develops among the owners of a close corporation, participants who wish to leave or dissolve the entity may be unable to do so. Because of the potential for deadlock in close corporations, state legislatures and the courts have developed mechanisms for shareholders to obtain relief under circumstances in which continuing the corporation provides no benefit to them. In New York, the mechanisms are BCL §§ 1104 and 1104-a.

Under the BCL § 1104, dissolution is generally appropriate where deadlock impedes the daily functioning of the corporation such that the corporation’s prosperity is no longer viable. In Ilich, the court found that the proof needed to support the allegation of deadlock was absent. As a result, the court found that the alleged dissention between the parties was insufficient to dissolve the companies.

Business Corporation Law § 1104-a permits involuntary dissolution of a corporation when the controlling shareholders are found guilty of “oppressive action” toward the minority. Oppression arises when “those in control” of the corporation “have acted in such a manner as to defeat those expectations of the minority stockholders which formed the basis of [their] participation in the venture.”³³ Situations where the petitioner is “frozen out” or “squeezed out” are precisely the type of oppressive situations” that BCL § 1104-a is designed to address.³⁴

In Ilich, respondent alleged the diversion of corporate funds for petitioner’s own benefit. As noted, however, the proof submitted in support of dissolution was insufficient to show oppression. Consequently, the court denied the motion.

Footnotes

BCL § 1104(a).
BCL § 1104(a)(1).
BCL § 1104(a)(3).
In re Dream Weaver Realty, Inc., 70 A.D.3d 941, 942 (2d Dept. 2010); Matter of Kaufmann, 225 A.D.2d 775, 775 (2d Dept. 1996); Matter of Goodman v. Lovett, 200 A.D.2d 670, 671 (2d Dept. 1994).
Matter of Kaufmann, 225 A.D.2d at 775; Matter of Goodman, 200 A.D.2d at 671.
Dream Weaver Realty, 70 A.D.2d at 942; Matter of Kaufmann, 225 A.D.2d at 775; Matter of Goodman, 200 A.D.2d at 671.
In re Parveen, 259 A.D.2d 389, 391 (1st Dept. 1999); Nelkin v. H. J. R. Realty Corp., 25 N.Y.2d 543, 549 (1969).
Application of Sheridan Const. Corp., 22 A.D.2d 390, 391 (4th Dept. 1965), aff’d, 16 N.Y.2d 680 (1965).
BCL § 1104-a(a).
BCL § 1104-a(a)(1), (2).
Matter of Blake v. Blake Agency, Inc., 107 A.D.2d 139, 144 (2d Dept. 1985).
BCL § 1104-a(a).
Matter of Kemp & Beatley, Inc., 64 N.Y.2d 63, 68 (1984).
Id. at 71-72 (“As the stock of closely held corporations generally is not readily salable, a minority shareholder at odds with management policies may be without either a voice in protecting his or her interests or any reasonable means of withdrawing his or her investment. This predicament may fairly be considered the legislative concern underlying the provision at issue in this case; inclusion of the criteria that the corporation’s stock not be traded on securities markets and that the complaining shareholder be subject to oppressive actions supports this conclusion.”).
Id. at 71 (internal quotation marks omitted).
Id. at 72; see also Hoffman v. S.T.H.M. Realty Corp., 207 A.D.3d 722, 723 (2d Dept. 2022); Matter of Twin Bay v. Kasian, 153 A.D.3d 998, 1002 (3d Dept. 2017).
Id. at 73.
Id.
Id. at 74-75 (“It was not unreasonable for the fact finder to have determined that this change in policy amounted to nothing less than an attempt to exclude petitioners from gaining any return on their investment through the mere recharacterization of distributions of corporate income.”).
246 A.D.2d at 866.
Matter of Brach, 135 A.D.2d 711, 712 (2d Dept. 1987).
Hoffman, 207 A.D.3d at 723.
BCL § 1104-a(b)(1).
BCL § 1104-a(b)(2); Matter of Kemp & Beatley, at 64 N.Y.2d at 73.
Matter of Kemp & Beatley, 64 N.Y.2d. at 73-75 (“After the referee had found that the controlling faction of the company was, in effect, attempting to ‘squeeze-out’ petitioners by offering them no return on their investment and increasing other executive compensation, respondents, in opposing the report’s confirmation, attempted only to controvert the factual basis of the report. They suggested no feasible, alternative remedy to the forced dissolution. In light of an apparent deterioration in relations between petitioners and the governing shareholders of Kemp & Beatley, it was not unreasonable for the court to have determined that a forced buy-out of petitioners’ shares or liquidation of the corporation’s assets was the only means by which petitioners could be guaranteed a fair return on their investments.”).
Id. at 73; Matter of Blake, 107 A.D.2d at 151.
CPLR § 411 provides that “[t]he court shall direct that a judgment be entered determining the rights of the parties to the special proceeding”. Since respondent was seeking a judgment of dissolution, the court treated respondent’s application as one pursuant to BCL § 1111(a)(3), which allows a court to “make a judgment or final order dissolving the corporation … [i]n a special proceeding brought under section 1104 (Petition in case of deadlock among directors or shareholders) or section 1104-a (Petition for judicial dissolution under special circumstances).”
Slip Op. at *3.
Id. at *7.
Id.
Id. at *7-*8 (quoting, Matter of Kaufmann, 225 A.D.2d at 775, and citing, Matter of Goodman, 200 A.D.2d at 671).
Id. at *8.
Matter of Kemp & Beatley, 64 N.Y.2d at 74.
In re Wiedy’s Furniture Clearance Center Co., 108 A.D.2d 81, 84 (3d Dept. 1985); In re Rambusch, 143 A.D.2d 605, 606 (1st Dept. 1988); In re Dissolution of Pickwick Realty, 246 A.D.2d 863, 866 (3d Dept. 1998) (finding that the lower court’s ordering of dissolution following its consideration of, inter alia, the “shareholders’ attempt at voiding petitioner’s shares” was “proper in the totality of these circumstances and fully necessary to protect petitioner’s interest”).

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.