Does Profitability Matter in the Context of Judicial Dissolution Under BCL § 1104?

• Posted on: Aug 29 2019

New York’s Business Corporation Law (“BCL”) provides shareholders owning 50% or more of a corporation two paths to judicial dissolution: a) BCL § 1104 – deadlock at the board or shareholder level such that the corporation “cannot continue to function effectively, and no alternative exists but dissolution”; or b) BCL § 1104-a – where directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholder(s).

Dissolution Under the BCL

Under BCL § 1104, dissolution may be ordered where deadlock between shareholders establishes that the 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); Matter of Kemp & Beatley [Gardstein], 64 N.Y.2d 63, 73 (1984).

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)).

“In determining what is beneficial to the stockholders, the court must take into consideration the type of corporation [it is] dealing with in [each] case.” Matter of Pivot v. Punch & Die Corp., 15 Misc. 2d 713, 715 (Sup. Ct., Erie County 1959). Courts recognize that “in the case of a close corporation, the relationship between the shareholders is akin to that of partners.” Greer v. Greer, 124 A.D.2d 707, 708 (2d Dept. 1986). When the relationship deteriorates and “the record demonstrates sufficient differences and animosity between the shareholders,” dissolution is often granted. Patti v. Fusco, 809 N.Y.S.2d 482 (Sup. Ct., Nassau County 2005).

Notably, dissolution should not be denied because the corporation has been conducted at a profit (see BCL § 1111(b)(3)) or because the dissension has not impacted the profitability of the corporation. The cases make clear that profitability is simply not the issue. E.g., Application of Bankhalter, 128 N.Y.S.2d 81, 83 (Sup. Ct., N.Y. County 1953).

Moreover, “[i]n determining whether dissolution is in order, the issue is not who is at fault for a deadlock, but whether a deadlock exists.” Matter of Kaufmann, 225 A.D.2d 775 (2d Dept. 1996). “[T]he underlying reason for the dissension is of no moment, nor is it at all relevant to ascribe fault to either party. Rather, the critical consideration is the fact that dissension exists and has resulted in a deadlock precluding the successful and profitable conduct of the corporation’s affairs.” Matter of Goodman v. Lovett, 200 A.D.2d 670, 670-71 (2d Dept. 1994).

In the Matter of Cellino v. Cellino & Barnes, P.C., 2019 N.Y. Slip Op. 06365 (4th Dept. Aug. 22, 2019) (here), the Court addressed the question of the corporation’s profitability and its impact, if any, on the decision whether to grant dissolution. In doing so, the Court held that “dissolution is not to be denied in a proceeding brought pursuant to Business Corporation Law § 1104 simply because the corporate business has been conducted at a profit (see § 1111 [b] [3]) or because the dissension has not yet had an appreciable impact on the profitability of the corporation (see Molod v Berkowitz, 233 AD2d 149, 150 [1st Dept 1996], lv dismissed 89 NY2d 1029 [1997]).” Slip Op. at *2.

Matter of Cellino v. Cellino & Barnes, P.C.

Background

Cellino & Barnes, P.C. (the “PC”) was for formed in 1998 by Petitioner, Ross Cellino (“Cellino”), and Respondent, Stephen Barnes (“Barnes”). The PC began as a regional law firm with offices in Buffalo and Rochester, New York. In 2008, the PC expanded into the downstate market.

In 2013, Barnes approached Cellino about opening an office in California. Cellino declined but, according to Cellino, by that time Barnes and the chief operating officer (“COO”) of the PC had already made preparations to open an office in Los Angeles. Barnes thereafter formed Cellino & Barnes, L.C. (the “LC”), a California corporation that was separate from the PC and in which Barnes had a 99.9% interest. Cellino became a minority owner with a .1% ownership in the LC.

In 2017, Cellino filed an initial petition for dissolution of the PC and also withdrew from and divested himself of his interest in the LC. Petitioner subsequently filed an amended petition for dissolution, pursuant to BCL § 1104 (a) (1) and (3), alleging, among other things, that there had been a breakdown in communication between himself and Barnes with respect to the management and direction of the PC. In particular, Cellino alleged that Barnes had favored the LC to the detriment of the PC by allowing the LC to utilize the PC’s computer network, telephone number, and employees without adequate compensation. Cellino further alleged, inter alia, that Barnes had directed to the LC mass tort cases solicited by the PC in the Northeast; paid a bonus to the PC’s COO from the PC’s account for work that the COO did on behalf of the LC; refused Petitioner’s request to terminate the COO as a PC employee and hire him as an LC employee; and rejected Petitioner’s request to restrict the COO’s access to the PC’s bank account.

Respondents moved, inter alia, for summary judgment dismissing the amended petition, and Petitioner cross-moved for the appointment of a temporary receiver pursuant to BCL § 1202(a)(1). The supreme court granted in part Petitioner’s cross-motion for the appointment of a temporary receiver and denied Respondents’ motion insofar as it sought summary judgment dismissing the amended petition. The Appellate Division, Fourth Department, affirmed both orders.

The Court’s Decision

Respondents argued that the supreme court erred in denying their motion insofar as it sought dismissal of the amended petition on the ground that dissolution would not benefit the shareholders because the PC had continued to function effectively and prosperously. The Court rejected the argument, holding that corporate profitability is not the proper focus; rather, it is “the benefit to the shareholders of a dissolution” that “is of paramount importance” in making the determination. BCL § 1111(b)(2).

Although respondents submitted evidence demonstrating that the PC has continued to conduct business at a profit, dissolution is not to be denied in a proceeding brought pursuant to Business Corporation Law § 1104 simply because the corporate business has been conducted at a profit or because the dissension has not yet had an appreciable impact on the profitability of the corporation.

Slip Op. at *2 (citations omitted).

The Court explained that “the record contain[ed] ample evidence of dissension and deadlock between petitioner and Barnes,” sufficient to raise “issues of fact whether dissension and deadlock have so impeded the ability of the PC to function effectively that dissolution would benefit the shareholders.” Id. To underscore the point, the Court noted that the proper focus should be on the relationship of the shareholders. Id.

In a close corporation like the PC, “the relationship between the shareholders is akin to that of partners and when the relationship begins to deteriorate, the ensuing deadlock and dissension can effectively destroy the orderly functioning of the corporation (Greer v Greer, 124 AD2d 707, 708 [2d Dept 1986], appeal dismissed 69 NY2d 947 [1987]). When a point is reached at which the shareholders who are actively conducting the business of the corporation cannot agree, dissolution may be in the best interests of those shareholders (see Matter of Gordon & Weiss, 32 AD2d 279, 281 [1st Dept 1969]).…

Id.

Accordingly, the Court affirmed the denial of summary judgment, holding “that a hearing should be held to give the parties an opportunity to present their evidence on this controverted issue.” Id. (citations omitted).

Addressing the appointment of a temporary receiver, the Court affirmed the supreme court’s decision, holding that the court “did not abuse its discretion in appointing a temporary receiver … for the limited purposes of ‘oversee[ing] the separation of the LC and the PC; . . . assess[ing] the appropriate amounts due and owing from the LC to the PC, if any; and . . . oversee[ing] the separation of clients between the two entities.’” Id., citing Greer, 124 A.D.2d at 708; Nelson v. Nelson, 99 A.D.2d 917, 918 (3d Dept. 1984).

The Court found that the supreme court properly exercised discretion “to ‘make all such orders as it may deem proper in connection with preserving the property and carrying on the business of the corporation, including the appointment . . . of a receiver under article 12 (Receivership).’” Id., quoting BCL § 1113. See also BCL § 1202(a)(1). In particular, the Court noted that Petitioner adequately supported his application by demonstrating “the entanglement of the PC and the LC” and the “danger of irreparable loss” for which a receivership was “necessary for the protection of the interests of the parties.” Id.

Specifically, the affidavits of petitioner, a licensed certified public accountant (CPA) and certified valuation analyst retained by petitioner, a former CPA for the PC, and an office manager for the PC supported petitioner’s allegations of economic improprieties in the form of inadequate reimbursement by the LC to the PC for cross-charges. Those affidavits also raised issues of fact whether the LC was taking mass tort cases that otherwise would have been handled by the PC and whether it was using web addresses owned by the PC to redirect clients to the LC’s new website. Inasmuch as it likely will be difficult to quantify what, if any, economic harm the PC has suffered as a result of clients being shepherded from the PC to the LC and inasmuch as respondents have refused to allow petitioner’s CPA to speak with the COO of the PC, we conclude that the court did not abuse its discretion in appointing a temporary receiver to determine what if any amount the LC owes the PC, rather than ordering an accounting.

Id. (citation omitted).

Takeaway

Cellino addresses the question whether past and/or current profitability means that the corporation can continue to function effectively and prosperously. Though not articulated explicitly, the Fourth Department answered the question that it does not. As noted, the key question is whether the dissention or deadlock impedes the daily functioning of the corporation. This makes sense given the determination is based on the continued functioning of the corporation. Thus, as in Cellino, the courts examine whether the deadlock or dissention will, on a going forward basis, “preclude[e] the successful and profitable conduct of the corporation’s affairs.” Matter of Goodman, 200 A.D.2d at 670-71. If it does, then dissolution is appropriate, regardless of past and/or current profitability.

Tagged with: BCL § 1104, BCL § 1111, BCL § 1202(A)(1), Business Divorce, Corporate Receivership, Judicial Dissolution, Shareholder Deadlock, Shareholder Dissention