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Court Finds Minority Shareholder Lacks Standing to Seek Deadlock Dissolution Under the BCL

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  • Posted on: Aug 27 2018

This Blog has written about cases involving disputes between members of a limited liability company (“LLC”) in which resolution of the matter would be governed by an operating agreement if one were in place. These cases illustrate the importance of having an operating agreement that addresses the myriad issues an LLC may encounter throughout its existence. Yet, despite the fact that the New York Limited Liability Company Law (“LLCL”) requires members of an LLC to “adopt a written operating agreement” (LLCL § 417), many LLCs fail to do so, whether at the formation stage or during the life of the company. Even LLCs that have an operating agreement are often subject to the application of the LLCL because those agreements typically do not contain language addressing the issues that can affect an LLC during its lifetime.

In the absence of an operating agreement, the rights, duties and obligations of an LLC member are governed by the default provisions of the LLCL. See, e.g., Matter of Eight of Swords, LLC, 96 A.D.3d 839 (2d Dept. 2012); Matter of 1545 Ocean Ave., LLC, 72 A.D.3d 121 (2d Dept. 2010). As one would expect, the default provisions of the LLCL do not address every circumstance that might arise during the life of an LLC. For example, as discussed in a recent Blog post, the LLCL does not specifically address the removal of LLC members. (Here.) Since the LLCL is silent on the issue, unless expressly provided in an operating agreement, there are no statutory grounds on which a member may be removed. See Man Choi Chiu v. Chiu, 71 A.D.3d 646 (2d Dept. 2010) (dismissing claim where neither the articles of organization nor the operating agreement provided for removal of a member); Matter of Goyal v. Vintage India NYC, LLC, 2018 N.Y. Slip Op. 31926(U) (Sup. Ct., N.Y. County Aug. 7, 2018) (looking to annotations to statute for guidance as to how to rule in the absence of an operating agreement) (here).

Dissolution of the LLC is another area in which the default provisions of the LLCL do not address every circumstance that may arise. As this Blog has noted on numerous occasions, breaking up is hard to do, especially in the absence of an operating agreement.   Under Section 702 of the LLCL, a court may dissolve a company “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” When there are no articles or operating agreement, courts look to the stated purposes for which the LLC was formed to determine if they are being achieved and whether the company’s finances remain feasible. E.g., Matter of Eight of Swords, LLC, 96 A.D. 3d 839, 840 (2d Dept. 2012).

It is in the court’s discretion whether to grant the request for dissolution. See Molina v. Hong (In re Extreme Wireless, LLC), 299 A.D.2d 549 (2d Dept. 2002). As such, even if the court determines that dissolution is appropriate, it may order a buyout of the member seeking dissolution as an alternative remedy. See Matter of Superior Vending, LLC, 71 A.D.3d 1153, 1154 (2d Dept. 2010).

Just as LLCL § 702 offers dissolution to a member of an LLC, Business Corporation Law (“BCL”) §§ 1104 and 1104-a offer dissolution to a shareholder of a close corporation.

Under BCL § 1104, dissolution may be ordered where deadlock between shareholders establishes that a corporation “cannot continue to function effectively, and no alternative exists but dissolution.” Molod v. Berkowitz, 233 A.D.2d 149, 150 (1st Dept. 1996), lv dismissed, 89 N.Y.2d 1029 (1997); Neville v. Martin, 29 A.D.3d 444, 444-45 (1st Dept. 2006); Matter of Cunningham & Kaming, 75 A.D.2d 521, 522 (1st Dept. 1980).  In this regard, a shareholder owning at least “one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors” may petition the court for dissolution based on one of the grounds set forth in BCL § 1104: (1) the directors are so divided about the management of the corporation’s affairs that the votes required for action by the board cannot be obtained; (2) the shareholders are so divided that the votes required for the election of directors cannot be obtained; and (3) there is internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders. BCL § l 104(a).

Once a petitioner has established a prima facie showing of entitlement to dissolution, it is within the court’s discretion whether to issue an order granting dissolution. BCL § 1111(a).

Dissolution is generally appropriate where the complained of internal dissension and/or deadlock impedes the daily functioning of the corporation (see generally Hayes v. Festa, 202 A.D.2d 277, 277 (1st Dept. 1994)), thereby “pos[ing] an irreconcilable barrier to the continued functioning and prosperity of the corporation.” Matter of T.J. Ronan Paint Corp., 98 A.D.2d 413, 421 (1st Dept. 1984). Notwithstanding, “dissolution and forced sale of corporate assets should only be applied as a last resort.” Matter of Klein Law Group, P.C., 134 A.D.3d 450 (1st Dept. (2015) (quoting Matter of the Dissolution of 168½ Delancey Corp., 174 A.D.2d 523, 526 (1st Dept. 1991) (internal citations omitted)).

As noted, the threshold requirement for seeking dissolution under BCL § 1104 is ownership of 50% of the shares entitled to vote for directors. BCL § 1104(a) (the party seeking dissolution must hold “shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors ….”). This requirement is strictly construed by the courts. Thus, where a party owns less than 50% of the voting shares, dissolution will be denied. See In re Sakow, 297 A.D.2d 229, 230 (1st Dept. 2002) (“The IAS court properly found, however, that one share of the stock claimed by petitioner had been sold, leaving petitioner short of the 50% stock ownership required, depriving her of standing to bring this action and requiring dismissal.”).

Under BCL § 1104-a, the court has the power to order the dissolution of a corporation where “[t]he directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders” (BCL § 1104-a, subd. (a), par (1)) or where “the property or assets of the corporation are being looted, wasted or diverted for non-corporate purposes by its directors, officers or those in control.” BCL § 1104-a, subd. (a), par (2). Dissolution under this section is discretionary. Gimpel v. Bolstein, 125 Misc. 2d 45, 49 (Sup. Ct., Queens County May 30, 1984) (citing Matter of Topper v. Park Sheraton Pharmacy, 107 Misc. 2d 25, 28 (Sup. Ct., N.Y. County Oct. 24, 1980)). It is a “drastic” remedy, and before ordering dissolution the court must consider whether it is the only means by which the complaining shareholders can reasonably expect to receive a fair return on their investment or whether it is reasonably necessary to protect their rights and interests. Id. (citing BCL § 1104-a, subd. (b); Muller v. Silverstein, 92 A.D.2d 455 (1st Dept. 1983)). The corporation or any of its shareholders may avoid the proceeding by electing to purchase the petitioner’s shares at their fair value. Id. (citing BCL § 1118).

Recently, Justice Saliann Scarpulla of the Supreme Court, New York County, Commercial Division, dismissed a deadlock dissolution petition filed under BCL § 1104 because the petitioner owned only 49% of the voting shares despite having 50% control over the corporation. Balkind v. Nickel, 2018 N.Y. Slip Op. 31703(U) (Sup. Ct. N.Y. County July 16, 2018) (here).

Balkind v. Nickel

Background

The petitioner, Aubrey Balkind (“Balkind”), sought to dissolve Lanson Properties, Inc. (“Corporation”) on the grounds of deadlock. The respondent, Edith Nickel (“Nickel”), opposed the petition.

Balkind and Nickel entered into a shareholder agreement in November 2005 (“Shareholder Agreement”). Balkind owns 49 percent of the Corporation’s common stock, and Nickel owns the remaining 51 percent of the Corporation’s shares. The Corporation’s sole asset is property located at on East 58th Street in New York City (the “Property”).

As the only two directors of the Corporation, Balkind and Nickel agreed to sell the Property in early 2016. In mid-2017, an investor offered to purchase the Property for $15 million (which was $5 million below the asking price); the Corporation rejected the offer. Since that time, both parties have been unable to agree upon a purchase price for the Property.

Balkind petitioned the Court for dissolution pursuant to BCL § 1104 because the Corporation was unable to sell the Property at an agreed upon price. Balkind claimed that the parties were deadlocked, as the Shareholder Agreement effectively required unanimous agreement between the shareholders. Balkind further noted that: (1) no one manages the Property because the agreement with the previous property manager expired; and (2) the Property remains largely vacant and unable to generate income.

Balkind also alleged that Nickel was preventing the Corporation from selling the Property at fair market value to pressure him into waiving reimbursements to which he is entitled. Balkind said that he loaned the Corporation $2.8 million and continued to loan the Corporation money to meet the Corporation’s monthly obligations, including its mortgage payments.

Nickel opposed dissolution and separately moved to dismiss the petition, arguing that Balkind did not have standing pursuant to BCL § 1104 because Balkind owned less than 50 percent of the Corporation’s total voting stock. Nickel denied any improper conduct and instead alleged that Balkind was attempting to coerce Nickel into selling the Property below fair market value to achieve his personal goals at her expense.

The Court’s Decision

The Court dismissed the petition to dissolve the Corporation and granted the motion to dismiss.

The Court found that Balkind did not meet the threshold requirement of 50% ownership of the shares entitled to vote for directors of the Corporation. The Court rejected Balkind’s argument that the focus of BCL § 1104 is on equal power not equal ownership and concluded that the Shareholder Agreement, which merely designated Balkind and Nickel as the Corporation’s two directors “irrespective of voting stock ownership,” was not “the same as equal voting power to elect directors in the context of BCL § 1104’s standing requirement.”

Contrary to Balkind’s position, BCL § 1104 is clear — to petition for judicial dissolution, petitioners must be “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. . . .” Under the plain meaning of the statute, Balkind, as the holder of 49% of the voting stock, does not have standing, and New York courts strictly interpret and apply the statute. [Citations omitted.]

Neither does reference to the Shareholder Agreement confer standing under BCL § 1104. That agreement merely designates Aubrey Balkind and Nickel as the Corporation’s two directors irrespective of voting stock ownership, which is not the same as equal voting power to elect directors in the context of BCL § 1104’s standing requirement. Under these circumstances, Balkind is unable to invoke BCL § 1104 as a deadlock breaking device.

Takeaway

Balkind highlights the importance of meeting the standing requirements for deadlock dissolution under BCL § 1104. And, in that context, Balkind illustrates the difference between a shareholder seeking dissolution of a corporation and a member of an LLC seeking dissolution of his/her company. In the latter situation, an LLC member who holds co-equal management rights, but possesses a minority ownership interest, would have standing to seek judicial dissolution under the LLCL – i.e., under the LLCL, any member of the LLC has standing to seek dissolution. As Balkind learned, the same is not true under the BCL.

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