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Current Developments in the Commercial Divisions of the
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Posted: February 22, 2018

Shareholder’s Failure to Help Run Company No Basis for Reducing His Shareholding

On February 13, 2018, Justice Kornreich of the New York County Commercial Division issued a decision in Stavroulakis v. Pelakanos, 2018 NY Slip Op. 50180(U), holding that a shareholder’s failure to help run a company was not a valid basis for reducing his shareholding, explaining:

To the extent defendants invoke the concept of “fairness” by contending that it was fair to cut plaintiff out of the Company because he was not working for it, . . . that contention is legally baseless. When the restaurants were opened and the Company was formed, the evidence shows the parties understood that only some of the shareholders would have to work for the Company. Those that did were paid a salary. Neither the BCL nor any executed shareholders’ agreement contains any requirement for plaintiff to work for the Company. Defendants do not dispute this fact. Rather, they relied on a subjective belief that plaintiff’s lack of contributions warranted taking plaintiff’s interest in the Company.

This belief is misguided at best and disingenuous at worst. Many businesses have passive investors. After the initial investment, the passive investor’s stake in the company may be worth far more than the amount invested. This 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 such a 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. The Shareholder Defendants did not avail themselves of these permissible options, but took all of the Company’s assets, leaving plaintiff with equity in an empty shell corporation. This is corporate malfeasance amounting to a breach of the Shareholder Defendants’ breach of their fiduciary duty of loyalty to the Corporation. They engaged in corporate waste and stole the Company’s corporate opportunities and gave them to their newly formed LLCs. Plaintiff has standing to prosecute these claims on the Company’s behalf given the Shareholder Defendants’ substantial likelihood (now, really, a guaranteed possibility) of personal liability.

(Internal citations omitted) (emphasis added).

This decision relates to a significant part of our practice: business divorce (a break-up between the owners of a closely-held business). Indeed, Schlam Stone & Dolan partner Jeffrey M. Eilender and associate Lee J. Rubin were contributors to the recently-released 2017 Supplement to Litigating the Business Divorce by Kurt Heyman and Melissa Donimirski. Contact Jeffrey Eilender at jeilender@schlamstone.com or Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding a business divorce.

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