The Majority Owners Of Bareburger Are Told By The New York Supreme Court That They Can’t Have It Their Way

• Posted on: Mar 2 2018

The parties in Stravroulakis v. Pelakanos, 58 Misc.3d 1221(A) (Sup. Ct. N.Y. Co. Feb. 13, 2018), are the owners of Bareburger.  The majority owners attempted to oust a shareholder by improper means and the court thought otherwise.

The oversimplified facts of Stravroulakis are as follows.  Plaintiff and some of his buddies (the “Owners”) owned a dive bar in Brooklyn called Sputnik, in which they started to sell organic hamburgers.  The hamburgers became so popular that the Owners, with the help of some investors (collectively, the “Founders”), decided to form a corporation to own the first “Bareburger” restaurant.  A few of the “buddies” worked at the restaurant and drew salaries while the remainder of the shareholders, who had full time jobs, did not.

The first restaurant was so successful that the Founders decided to franchise Bareburger and formed Bareburger, Inc. (the “Company”) for that purpose.  Each of the six Founders invested $6,000 and received 16.666% of the Company.  The Company received its Bareburger trademark from the PTO in 2010.

The Founders and some additional investors formed another corporation and entered into a franchise agreement with the Company to own a second Bareburger restaurant.  Prior thereto, however, all of the Founders (with the exception of plaintiff) (the “Shareholder Defendants”) began discussing terminating plaintiff’s interest in the Company (but not the two restaurants in which he had an ownership interest) because he was not working for the Company (as he was a passive investor that had no obligation to work – as the court pointed out many times throughout the Stravroulakis decision).  In this regard, in a letter from one Founder to the remaining Shareholder Defendants, it was written, among other things:

…After repeated attempts to work and motivate [plaintiff] we have not seen the results expected by this company.  As per our conversation with him, he was granted a probationary period that has now lapsed.  At this time, I propose we terminate our good friend but inattentive partner [plaintiff]…. (Emphasis added by court.)

Similarly, meeting minutes reflect that the Shareholder Defendants discussed the hours they worked while plaintiff was absent and the fact that the “money invested is minimal compared to the amount of labor and time involved….”  According to the minutes:

[o]ptions discussed include (1) removing [plaintiff] (2) giving [plaintiff] back the $6,000 invested plus interest (3) start over with those willing to do the work required.  Members/shareholders agree that they will either remove [plaintiff] or take other measures to the same effect.  [Plaintiff] should receive fair value for the amount he contributed.  Any interests [plaintiff] has in the actual physical restaurant will not be affected.  (Emphasis supplied by court; footnote omitted.)

Thereafter, and after some internal disputes as to how to deal with plaintiff, the five Shareholder Defendants formed Bareburger Group (“Group”) and each received a 20% interest in same.  Eventually, all the Company’s assets (the right to royalties under the franchise agreements, cash and the Bareburger trademarks) were transferred, without plaintiff’s knowledge, to Group without consideration.  Almost a year later, and after repeated requests for his K-1 from the Company, plaintiff was advised that the Company had no income, the Company’s assets were transferred to Group and he had no interest in Group.

An assignment of the Bareburger trademark from the Company to Group was filed with the PTO indicating “that it was for good and valuable consideration [even though] no actual cash or other assets of value were paid by Bareburger Group to the Company.”) (Emphasis supplied by the court; some internal quotation marks and brackets omitted.)  On the same day, Group filed a trademark application for the word “Bareburger” based on its ownership of the “Bareburger Organic” trademark, which application contained numerous misrepresentations.

In its franchise agreements, Group permitted franchisees to use the Bareburger trademarks although it was not the true owner of the trademarks and “did not have the power or authority to license their use.”

Plaintiff asserted twenty causes of action in his complaint and moved for summary judgment on the following seven: breach of fiduciary duty (corporate waste and self-dealing); breach of fiduciary duty (shareholder oppression);  breach of fiduciary duty (corporate waste, self-dealing and usurpation of a corporate opportunity); trademark infringement under the Lanham Act; fraud on the trademark office; fraudulent conveyance (constructive and intentional); and, aiding and abetting breach of fiduciary duty.

The court granted summary judgment to plaintiff on the breach of fiduciary duty claims. In so deciding, the court reasoned that the “business judgment rule” does not apply where the challenged “acts [did] not further the interest of the corporation, especially when the directors have a personal stake in the corporation” and where “the board acted in bad faith, e.g., deliberately singled out an individual for harmful treatment.”  (Emphasis added by court; some internal quotation marks and citations omitted.)  Because of the inapplicability of the “business judgment rule” to “create a presumption of legality”, the burden shifted to the interested directors or shareholders to prove their good faith and the “entire fairness” of the transaction.  Because the subject transactions were not fair to a minority shareholder in terms of “price” and “process” and because the transactions could not be ratified by the Shareholder Defendants because they were not “disinterested,” the Shareholder Defendants do not pass the “entire fairness” test.

The court also found that there was corporate waste because assets were transferred without consideration.  The court also found that corporate opportunities were diverted.  This occurs when directors divert opportunities “to other companies in which neither the corporation nor its minority shareholder has an interest.”  (Citation omitted.)   The court noted that “[t]his doctrine is violated where, as here, a director secretly forms a new entity and transfers the corporation’s entire business to that entity.” (Citation omitted.)   The court explained:

[s]imply put, where the defendants are either conflicted or have engaged in corporate waste, they have the burden of establishing entire fairness.  Here, the Shareholder Defendants (or their wholly owned LLCs) are members of Bareburger Group, which owns Be My Burger.  Hence, the subject transfers of the Company’s assets are interested transactions.  That, in addition to the discussed evidence of waste and theft of corporate opportunities, makes entire fairness the applicable the [sic] standard of review.  (Footnote omitted.)

The court found that the Shareholder Defendants did not meet their burden and, to the extent that they invoked the fairness concept by urging that plaintiff refused to work for the Company, the argument was rebuffed by the court.  In rebuking the Shareholder Defendants for justifying their subjective belief that their actions were warranted because of plaintiff’s “lack of contributions” coupled with the fact that they were not lawyers, the court stated in footnote 26:

Defendants note that they are not corporate lawyers.  However, the subject transactions were done with the aid of a lawyer and accountant.  Leaving aside the court’s dismay that a lawyer could agree to help structure an illegal transaction, defendants cannot hide behind ignorance of corporate law to claim a lack of bad faith.  Their contemporaneous emails demonstrate a clear intent to steal plaintiff’s interest in the business, which [one of them] recognized was problematic.

The court, in recognizing that many businesses have passive investors, whose interest may be worth far more than the amount invested, stated:

[t]his is a good thing, and is an aspirational outcome in the minds of many who decide to chance their money on a fledgling business.  If investors intend to condition an equity grant on the requirement of further contribution (either labor or capital), they must expressly agree to that condition.  The majority investors may not, as here, later decide that pari passu treatment of active and passive investors is not fair.  Likewise, to the extent a majority believes a business would be better off without a problem shareholder, there is legal recourse available to them, such as a buyout or a freeze-out merger.  (Emphasis in original; citations omitted.)

Summary judgment was also granted on plaintiff’s claim that one of the defendants aided and abetted the Shareholder Defendants in their respective breaches of fiduciary duty.  The elements of such a claim are: “(1) a breach by a fiduciary of obligations to another, (2) that the defendant knowingly induced or participated in the breach, and (3) that plaintiff suffered damage as a result of the breach.”  (Citation omitted.)  As to the first prong, the court found that the Shareholder Defendants breached their fiduciary duty to plaintiff.  The second prong requires “substantial assistance”, which exists where “(1) a defendant affirmatively assists, helps conceal, or by virtue of failing to act when required to do so enables the fraud to proceed, and (2) the actions of the aider/abettor proximately caused the harm on which the primary liability is predicated.”  (Citations and internal quotation marks omitted.)  The court found that the aider/abettor “knowingly and intentionally” participated in the fiduciary breaches by, inter alia, helping to transfer assets, crafting audited financial statements that hid the illicit formation of Group from plaintiff, and preparing Group tax returns and operating agreements that excluded plaintiff.  Plaintiff clearly suffered damage from defendant’s actions.

The court also granted summary judgment on plaintiff’s trademark infringement claim and stated:

There is no question of fact that…Bareburger Group used the Trademark without authorization and without providing any consideration to the Company.  This is trademark infringement…. Indeed, the very reason why they executed the Trademark Assignment Agreement was because they recognized that Bareburger Group…needed to obtain the rights to the Trademark to validly use and license it to the franchisees.  (Citations omitted.)

The court did not dismiss the infringement claim as duplicative because plaintiff may be entitled to treble damages under the Lanham Act – a quantum of damages unavailable under the other causes of action subject to the plaintiff’s summary judgment motion.

The court did, however, did dismiss plaintiff’s fraudulent conveyance and fraud on the PTO causes of action to the extent that the damages in those causes of action are duplicative of the damages to which plaintiff would be entitled for the fiduciary duty breach and/or the trademark infringement claims.

TAKEAWAY

There are appropriate ways to excise unwanted shareholders/members from a business.  The court in Stravroulakis was not pleased with the way that defendants proceeded to remove plaintiff.

Tagged with: Breach of Fiduciary Duty, Business Divorce, Business Judgment Rule, Commercial Litigation