Commercial Division Blog

Posted: October 15, 2014 / Categories Commercial, Business Divorce, Derivative Actions

Action for Corporate Waste Cannot be Brought Against the Former Sole Owner of a Company

On October 14, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Koryeo Intl. Corp. v. Kyung Ja Hong, 2014 NY Slip Op. 51495(U), dismissing an action for corporate waste and breach of contract.

The plaintiff, Steve Hong, who brought the action on his own behalf, and directly on behalf of Koryeo as its sole shareholder and officer, is the company’s founder's son. He alleged that his father and the defendant induced him to abandon his legal career and work for Koryeo for a "minimal salary" by promising him that control and ownership would eventually be transferred to him. In 1995 his father died, and his mother became the sole shareholder, director and officer. In December 2012, the defendant finally transferred the company to him, and he became sole shareholder, officer, and director. But the plaintiff soon discovered that only $54,000 had been deposited in the company's bank account in 2012, despite income of millions of dollars being disclosed on the company's tax returns and invoices. He accordingly sued his stepmother, alleging that she had looted the company before handing it over to him.

Justice Demarest denied all claims.

First, the court held that Koryeo's standing to bring claims was defeated by the "contemporaneous ownership rule" set forth in BCL § 626 (b):

[P]laintiffs' allegations that all of the alleged wrongs at issue occurred while Kyun Ja Hong was Koryeo's sole officer, director, and shareholder, and before she transferred her interest in Koryeo to Steve Hong, compel a finding that Koryeo does not have standing to bring this action. As stated by the Court of Appeals, 'the rule is that, when stockholders are individually estopped from questioning wrongs done to their corporation, they cannot redress those same wrongs through a suit brought directly by the corporation or derivatively, by themselves, for the corporation.' Two grounds support such an estoppel here. The first is that Steve Hong received his shares from Kyung Ja Hong, a shareholder who must be deemed to have unanimously ratified her own acts of waste and misappropriation. Any wrongdoing by Kyung Ja Hong is therefore imputed to Koryeo, which is equitably estopped from obtaining redress for its own actions. Furthermore, Steve Hong, Koryeo's current sole shareholder and the sole prospective beneficiary of Koryeo's recovery, acquired all of his shares after the alleged wrongful acts, and as such, he is barred from bringing a derivative action under section 626 (b). With respect to both of these grounds for estoppel, a court will pierce the corporate veil and bar a direct action by the corporation when it would only benefit a shareholder who would otherwise be barred from raising the claims in a derivative action.

(Internal citations omitted) (emphasis added).

And second, the court dismissed Steve Hong's personal breach of contract and tort claims:

According to Steve Hong, sometime prior to his father's death in 1995, Kyung Ja Hong promised to transfer ownership and control of Koryeo to him at some future time following his graduation from law school, which must have occurred prior to his admission to the Bar in 1992. Without providing for a specific time frame, and in light of plaintiff's failure to seek enforcement of the alleged contract for over twenty years, the alleged promise to turn over ownership and control of Koryeo is too indefinite to establish a legally enforceable contract. In any event, Steve Hong received exactly what was promised when Kyung Ja Hong transferred the entirely of her shares to him in December 2012. While Steve Hong asserts that he received virtually worthless shares in an indebted corporation, he has made no allegation that Kyung Ja Hong promised to transfer a company with a certain amount of assets.

(Internal citations omitted.) Steve Hong's tort claims were dismissed as derivative of his contract claim.

It may seem obvious that relying on vague promises grounded primarily in family feeling often ends in disaster, but it still happens. And in circumstances where the bad actor is the sole owner of a company, often nothing can be done.