When Dissolution under BCL § 1104-a is Unavailable, Common Law Dissolution May Do the Trick

• Posted on: Sep 12 2018

The History of Common Law Dissolution

Judicial dissolution of a corporation at the request of a minority shareholder “is a remedy of relatively recent vintage in New York.” Matter of Kemp & Beatley (Gardstein), 64 N.Y.2d 63, 69 (1984).  Historically, New York courts were prevented from exercising their equity powers to order dissolution, as statutory prescriptions were deemed exclusive. Id. (citation omitted). Statutory dissolution was either limited by the types of corporations seeking such relief or restricted to certain parties, such as the Attorney-General, or the directors, trustees, or majority shareholders of the corporation. Id. (citations omitted).

Minority shareholders were granted standing in the absence of statutory authority to seek dissolution of corporations when controlling shareholders engaged in certain egregious conduct. Id. (citations omitted). In that regard, courts invoked their equitable powers when “the directors and majority shareholders … so palpably breached the fiduciary duty they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by statute.” Id. at 69-70 (internal quotation marks and citations omitted). See also Leibert v. Clapp, 13 N.Y.2d 313 (1963) (holding, “[a]lthough there is no explicit statutory authority for the relief of dissolution sought in this action, the entire court is agreed that it is available as a matter of judicial sponsorship.”).

This common-law right of dissolution of minority shareholders was supplemented by the New York Legislature in 1979, when it enacted Business Corporation Law § 1104-a, which provided the holders of 20% or more of the outstanding shares of a close corporation with the right to petition for judicial dissolution under certain “special circumstances.” BCL § 1104-a(a). Fedele v. Seybert, 250 A.D.2d 519, 521 (1st Dept. 1998). The circumstances that give rise to dissolution fall into two general categories: mistreatment of complaining shareholders (e.g., through fraud and oppression) (subd. (a), par. (1)), or misappropriation of corporate assets (subd. (a), par (2)) by controlling shareholders, directors or officers.

Minority Oppression Explained

In Kemp & Beatley, the Court of Appeals held that oppression occurs “when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the [minority shareholder’s] decision to join the venture.” 64 N.Y.2d at 73. In doing so, the Court explained:

It 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.

Shareholders enjoy flexibility in memorializing these expectations through agreements setting forth each party’s rights and obligations in corporate governance. In the absence of such an agreement, however, ultimate decision-making power respecting corporate policy will be reposed in the holders of a majority interest in the corporation. A wielding of this power by any group controlling a corporation may serve to destroy a stockholder’s vital interests and expectations.

A shareholder who reasonably expected that ownership in the corporation would entitle him or her to a job, a share of corporate earnings, a place in corporate management, or some other form of security, would be oppressed in a very real sense when others in the corporation seek to defeat those expectations and there exists no effective means of salvaging the investment.

Id. at 71-73 (citations omitted).

Thus, oppressive conduct may be found where “a minority shareholder has been excluded from participation in corporate affairs or management for no legitimate business reason or personal animus,” or “corporate policies are changed by the majority to prevent the minority shareholder from receiving a reasonable return on [his or her] investment.” Petition for Dissolution of Affiliated Agency, Inc. v. Duggan, 2011 N.Y. Slip Op. 33667[U], *4 (Sup. Ct., Nassau County 2011). See also In the Matter of Charleston Square, Inc., 295 A.D.2d 425, 426 (2d Dept. 2002).

The Court of Appeals has cautioned the lower courts that the standard to be used in determining oppression is an objection one:

A court considering a petition alleging oppressive conduct must investigate what the majority shareholders knew, or should have known, to be the petitioner’s expectations in entering the particular enterprise. Majority conduct should not be deemed oppressive simply because the petitioner’s subjective hopes and desires in joining the venture are not fulfilled. Disappointment alone should not necessarily be equated with oppression.

Id. at 73.

The Court made “[o]ne further observation” when it comes to defining oppression: courts should be vigilant in ensuring that minority shareholders do not use involuntary dissolution “as merely a coercive tool.” Id. at 74.  Therefore, whether the minority shareholder’s “own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression,” the courts “should be given no quarter” to the allegedly aggrieved shareholder. Id. (citation omitted).

The foregoing principles were at play in Feldmeier v. Feldmeier Equipment, Inc., 2018 N.Y. Slip Op. 05893 (4th Dept. Aug. 22, 2018) (here), where the court affirmed the dismissal of an application for common law dissolution because the plaintiff failed to demonstrate oppression and waste of corporate assets.

Feldmeier v. Feldmeier Equipment, Inc.

Background

Plaintiff, John B. Feldmeier (“Plaintiff”), a former employee, officer, and director and a minority shareholder of Defendant, Feldmeier Equipment, Inc. (“Corporation”), a closely-held corporation, commenced the action against Robert E. Feldmeier, Jeanne C. Jackson and Lisa F. Clark (collectively, the “Individual Defendants” and with the Corporation, the “Defendants”), also officers and directors of the Corporation. Plaintiff alleged that the Individual Defendants breached their fiduciary duties to him. As a result of the alleged “egregious breach of the[ir] fiduciary duties,” Plaintiff sought damages as well as common-law dissolution of the Corporation. Defendants answered the complaint with general denials and asserted counterclaims for, inter alia, unfair competition, misappropriation of trade secrets and breach of fiduciary duty.

Approximately three years after the action was commenced, Defendants jointly moved for, inter alia, summary judgment dismissing the complaint. Plaintiff cross-moved for summary judgment seeking, inter alia, an order “directing that [the Corporation] be dissolved under the common law,” an order advancing him certain amounts and reimbursing him for his expenses in defending against the counterclaims, and an order restraining the Individual Defendants from using the Corporation’s funds “to pay for attorneys’ fees and other professional service fees related to this action.” The motion court granted Defendants’ motion and denied Plaintiff’s cross motion. The appeal ensued.

The Fourth Department’s Decision

The Fourth Department found that the motion court properly granted Defendants’ motion but erred in denying those parts of Plaintiff’s cross motion seeking reimbursement and an advance of funds related to defending against the counterclaims and seeking to restrain the Individual Defendants from using the Corporation’s funds to defend against dissolution of the Corporation.

With regard to the application to dissolve the Corporation, the Court affirmed the motion court’s ruling. The Court rejected Plaintiff’s argument that Defendants had looted the Corporation “by awarding themselves excessive compensation, which had the effect of oppressing him and depriving him of a fair return on his stock in the Corporation.” The Court found that “the individual defendants were paid less after plaintiff resigned and the money was, instead, reinvested in the Corporation, which grew substantially.” Thus, it could not be said that “the challenged compensation bore no relationship to the value received by the company,” thereby “rendering it unjustifiably excessive.”

Takeaway

Common law dissolution cases are relatively rare in New York. They will be sustained only where “the directors and majority shareholders ‘have so palpably breached the fiduciary duty they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by statute.” Lieb, 13 N.Y.2d at 317. Since the enactment of BCL § 1104-a, such claims have been sustained only under the most egregious circumstances, such as looting the corporate assets or minority oppression. E.g., Fedele, 250 A.D.2d at 521 (noting that minority shareholder could seek dissolution prior to the enactment of BCL § 110-4-a “only where the controlling shareholder engaged in certain egregious conduct”); Lemle v. Lemle, 92 A.D.3d 494, 500 (1st Dept. 2012) (“egregious conduct necessary to sustain” common law dissolution); Matter of Sternberg, 181 A.D.2d 897, 897-898 (2d Dept. 1992) (common law dissolution available “only to minority shareholders who accuse the majority shareholders and/or corporate officers or directors of looting the corporation”); Ferolito v. Vultaggio, 99 A.D.3d 19, 28 (1st Dept. 2012) (allegations of breaches of fiduciary by corporate officer sufficient to sustain a claim for common law dissolution). The burden to demonstrate egregious conduct is high.

The cases show that egregious conduct involves circumstances that “go far beyond charges of waste, misappropriation and illegal accumulations of surplus, which might be cured by a derivative action for injunctive relief and an accounting.” Liebert v. Clapp, 13 N.Y.2d 313, 316 (1963). The conduct involves the diversion of corporate assets for personal gain or oppression such that the minority shareholder’s expectations that were central to his/her decision to invest in the corporation are objectively thwarted by the majority. In Feldmeier, the Court found that the conduct at issue was not sufficiently egregious to warrant common law dissolution.

Tagged with: BCL § 1104-A, Business Divorce, Business Litigation, Commercial Litigation, Common Law Dissolution, Corporation