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Posted: November 7, 2014

Court Applies Rules of Common Law Dissolution to Shareholder Dispute

On October 28, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Cortes v. 3A N. Park Ave Restaurant Corp., 2014 NY Slip Op. 24329, discussing the process of common law dissolution.

In Cortes, the plaintiff brought an action relating to his investment in a restaurant. The court wrote a comprehensive decision after trial addressing many interesting issues; it is worth reading in its entirety. This post focuses on the court’s discussion of common law dissolution. The court explained that:

the remedy of common-law dissolution is available only to minority shareholders who accuse the majority shareholders and/or the corporate officers or directors of looting the corporation and violating their fiduciary duty. These grounds parallel, to some degree, the statutory grounds for judicial dissolution set forth in BCL §1104-a, which is unavailable to plaintiff because he does not reach the threshold criteria of owning at least 20% of the corporation. However, the equitable remedy of judicial dissolution at common law remains available where the shareholders in control have been looting the company’s assets at the expense of the minority shareholders, continuing the corporation’s existence for the sole purpose of benefitting those in control, and have sought to force and coerce the minority shareholders to sell and sacrifice their holdings to those in control. As explained by the Court of Appeals in Matter of Kemp & Beatley[Gardstein](64 NY2d 63 [1984]), historically, minority shareholders were granted standing in the absence of statutory authority to seek dissolution of corporations when controlling shareholders engaged in certain egregious conduct. Predicated on the majority shareholders’ fiduciary obligation to treat all shareholders fairly and equally, to preserve corporate assets, and to fulfill their responsibilities of corporate management with scrupulous good faith, the courts equitable power can be invoked when it appears that 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.

(Internal quotations and citations omitted) (emphasis added). The court went on to hold that the plaintiff had met the high standard to justify common law dissolution. However, it went on to explain that

[w]hether it is necessary to actually dissolve the corporation in order to redress plaintiff’s grievances is, however, a matter to be considered independently once grounds for dissolution have been established. Business Corporation Law §1104-a(b)(1) directs the court, in analogous circumstances of a 20% shareholder action for dissolution based upon grounds comparable to those established here, to consider whether liquidation of the corporation is the only feasible means whereby the petitioners may reasonably expect to obtain a fair return on their investment. Whereas judicial dissolution is an equitable remedy, the court has substantial discretion in determining the appropriate relief. In many situations, a buy-out of plaintiff’s interest for fair value is the more appropriate remedy. In this case, in his sixth cause of action, plaintiff seeks just such relief and, in their dismissed third counterclaim, defendants sought to enforce a contract to purchase plaintiff’s shares, albeit not at fair value. Clearly, the parties do not wish to continue their association in this highly profitable business, but liquidation, in order to recompense plaintiff for the injustices visited upon him by defendants, is not warranted unless defendants fail to buy him out at fair value.

Pursuant to BCL §1118, in a proceeding pursuant to BCL §1104-a, any shareholder, or the corporation itself, may elect to purchase the petitioner’s share in order to avoid dissolution and liquidation. Under the statute, upon such election, the dissolution proceeding is stayed so that the court may determine the fair value of the petitioner’s shares as of the day prior to the date on which such petition was filed giving effect to any adjustment or surcharge found to be appropriate under section 1104-a. This rule appears to be equally applicable to common law dissolution.

(Internal quotations and citations omitted) (emphasis added). In analyzing the plaintiff’s remedy, the court observed that the plaintiff’s expert had used “the net income method using his own projection of net income for the last full fiscal year of the corporation ending July 31, 2012, and multiplying by a factor of 3 and 5 to produce a range he testified is appropriate based upon professionally-accepted standards,” while the defendants’ expert “based his determination of the value on the gross sales method and relied upon the information as reported by the restaurant’s accountant.” The court found the plaintiff’s expert’s approach to be “more accurate in the circumstances.” However, it noted, with respect to discounts to be applied to the valuations, that the plaintiff’s expert did

not address whether the marketability of the plaintiff’s shares affect their value. [The defendants’ expert] testified that minority shares in a restaurant that do not give decision-making authority to the holder, are significantly less marketable and require a discount of 35 to 50% in order to attract a buyer. The application of such a minority discount based on lack of control has been expressly rejected in this State, but the lack of general marketability of shares in a closely-held corporation is recognized to be a factor to be considered in valuing such shares. As no evidence was offered as to a discount specifically applicable to plaintiff’s shares in this, apparently highly profitable, closely-held corporation, the Court will apply only a 10% discount for lack of marketability.

(Internal quotations and citations omitted) (emphasis added). The court also examined the relationship between the valuation of the plaintiff’s shares and the damages to the corporation that the plaintiff had proved at trial, explaining:

In Matter of Dissolution of Exterior Delite, Inc. (14 Misc 3d 910 [Sup Ct, Bronx Co, 2006]), in an action closely analogous to the case at bar in which claims of misappropriation of corporate funds were interposed in a proceeding seeking dissolution of the corporations pursuant to BCL §1104-a, the Court rejected the finding of a referee that the evidence of diversion of assets should be disregarded in the valuation of the corporation for purposes of a buy-out pursuant to BCL §1118, noting that the alleged wrongdoing of misappropriation of corporate assets may play a role in the valuation determination and is relevant if such misconduct has had an adverse impact upon the corporation’s value. The Court relied upon the language of BCL §1104-a(d), authorizing an adjustment to stock value upon a finding of wilful or reckless dissipation of assets, and the language of BCL §1118, directing that any such finding be given effect in determining the value of shares, concluding that a derivative action for misappropriation of assets is intertwined with the determination of fair value of petitioner’s shares. This Court concurs in the Exterior Delite Court’s analysis and reasoning.

This Court has determined that the individual defendants looted 3A North Park of cash over many years, depriving the corporation of its profits, and a judgment is to be entered for the sums diverted. That judgment is an asset of the corporation that should be added to the value calculated based upon the net income for a single year for the purpose of assessing the air value of plaintiff’s shares. Accordingly, upon the addition of $4,957,511 (the judgment for 3A North Park), to $3,216,177, the Court finds the fair value of 3A North Park on June 12, 2011, to be $8,173,688. Plaintiff’s 16.67% interest is, accordingly, valued at $1,362,554, less 10% as a discount for limited marketability ($136,255), for a total fair value of $1,226,299. As required by law, this sum, less a credit of $25,000 acknowledged to have been received by plaintiff in cash, shall accrue interest from June 12, 2011, to the date of payment, at the statutory rate of 9% per annum (see Matter of Blake, 107 AD2d at 150). As defendants have indicated an interest in buying plaintiff’s shares to avoid dissolution, and such forced buy-out appears to be the preferable alternative to dissolution, the purchase of plaintiff’s shares at the above price shall be closed within 90 days hereof, or as agreed between the parties. However, upon notice to this Court that no purchase is anticipated, dissolution will be granted and a liquidating trustee will be appointed by the Court.

(Internal quotations and citations omitted) (emphasis added).

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