New York Law Review

Tag: Board of Directors

  • Levandusky v. One Fifth Avenue Apartment Corp., 75 N.Y.2d 530 (1990): Business Judgment Rule for Co-op Board Decisions

    75 N.Y.2d 530 (1990)

    The business judgment rule, requiring good faith and legitimate corporate purpose, applies to decisions made by cooperative boards of directors, protecting them from judicial second-guessing absent evidence of bad faith, self-dealing, or discriminatory treatment.

    Summary

    Ronald Levandusky, a shareholder in a cooperative apartment building, sought to renovate his kitchen, including altering a steam riser. The co-op board initially approved the plans but later rescinded approval and issued a stop-work order after learning of the riser alteration, citing a policy against moving risers. Levandusky sued, arguing the board’s decision was arbitrary. The New York Court of Appeals held that the business judgment rule applies to decisions of cooperative boards, meaning courts should defer to board decisions made in good faith for a legitimate purpose. Because Levandusky failed to show the board acted outside its authority or in bad faith, the Court upheld the board’s decision.

    Facts

    Levandusky, a shareholder and former board president of One Fifth Avenue Apartment Corp., planned to renovate his kitchen. His plans, approved by the building architect and initially by the board, included modifications to plumbing risers but did not explicitly mention altering a steam riser. After the board learned of Levandusky’s intent to move the steam riser, they reaffirmed a policy against relocating risers and denied him a variance. Levandusky proceeded with the alteration, prompting the board to issue a stop-work order.

    Procedural History

    Levandusky filed an Article 78 proceeding to set aside the stop-work order. The Supreme Court initially granted his petition, then reversed itself, applying the business judgment rule. The Appellate Division modified the judgment, siding with Levandusky and finding the board’s decision unreasonable. The Court of Appeals reversed the Appellate Division, holding that the business judgment rule applied, and reinstated the Supreme Court’s revised ruling.

    Issue(s)

    Whether the business judgment rule is the appropriate standard for judicial review of decisions made by the board of directors of a residential cooperative corporation regarding building policy.

    Holding

    Yes, because the business judgment rule best balances the interests of individual shareholders and the cooperative as a whole, protecting board decisions made in good faith and for a legitimate purpose from undue judicial interference.

    Court’s Reasoning

    The Court reasoned that cooperative boards, like corporate directors, are responsible for managing the affairs of the entity. Applying the business judgment rule, which protects corporate directors’ decisions made in good faith and for a legitimate corporate purpose, is appropriate for cooperative boards as well. This standard prevents courts from second-guessing board decisions unless there is evidence of self-dealing, bad faith, or discriminatory treatment. The Court emphasized that cooperative living involves ceding some individual rights to the collective good, and the board’s authority is necessary to maintain the stability and desirability of the community. The Court rejected a “reasonableness” standard, finding it would lead to excessive judicial involvement in board decisions. The Court stated, “So long as the board acts for the purposes of the cooperative, within the scope of its authority and in good faith, courts will not substitute their judgment for the board’s.” The Court found that Levandusky did not meet the burden of proving that the board breached its fiduciary duty. The court noted the board acted on the advice of its engineer and was enforcing a consistent policy. Ultimately, the Court concluded, “Under the rule we articulate today, we decline to review the merits of the board’s determination that it was preferable to adhere to a uniform policy regarding the building’s piping system.” The concurring opinion agreed with the result, but argued for applying an “arbitrary and capricious” standard, typical of Article 78 proceedings, instead of the business judgment rule.

  • Matter of Rye Psychiatric Hosp. Ctr., Inc., 68 N.Y.2d 336 (1986): Determining Corporate Board Size When Bylaws are Silent

    Matter of Rye Psychiatric Hosp. Ctr., Inc., 68 N.Y.2d 336 (1986)

    When a corporation’s bylaws are silent on the number of directors, the default rule under New York Business Corporation Law § 702(a) is that the board shall consist of three directors.

    Summary

    This case addresses how to determine the size of a corporate board of directors when the corporate bylaws are silent on the matter. Rye Psychiatric Hospital Center’s bylaws did not specify the number of directors. A dispute arose among the shareholders, and a special meeting was held where some shareholders elected themselves as three directors. Other shareholders challenged this election, arguing that the board size had been established as six by prior practice. The New York Court of Appeals held that, because the bylaws were silent, Business Corporation Law § 702(a) applied, fixing the board size at three. The court rejected the argument that the board size could be determined by custom or acquiescence.

    Facts

    Rye Psychiatric Hospital Center (Rye Center) was incorporated in 1973 with five equal shareholders. Bylaws were adopted, but they did not specify the size of the board of directors. In 1977, a sixth shareholder joined. The corporation operated as if all six shareholders were directors, though no formal elections were held. In 1982, a dispute arose among the shareholders. Three shareholders commenced a legal proceeding challenging the sixth shareholder’s status as a board member. The remaining three shareholders then called a special meeting to elect directors. The complaining shareholders boycotted the meeting. At the meeting, the other three shareholders elected themselves as the three directors and then as officers.

    Procedural History

    The shareholders who boycotted the meeting filed a proceeding under Business Corporation Law § 619 to nullify the election. Special Term granted the petition, declaring the election invalid. The Appellate Division modified, declaring the election of three directors valid but overturning their election as officers, holding that the board size was six based on prior dealings and the complaining shareholders remained as holdover directors. The Court of Appeals reversed the Appellate Division’s determination regarding the size of the board of directors.

    Issue(s)

    Whether, when a corporation’s bylaws do not specify the number of directors, the number of directors can be determined by custom, usage, and acquiescence, or whether Business Corporation Law § 702(a) controls.

    Holding

    No, because when corporate bylaws are silent on the number of directors, Business Corporation Law § 702(a) dictates that the board shall consist of three directors.

    Court’s Reasoning

    The Court of Appeals focused on the plain language of Business Corporation Law § 702(a), which states that “[i]f not otherwise fixed under this paragraph, the number shall be three.” The court emphasized that this provision applies when the bylaws do not specify the number of directors. The court distinguished Thistlethwaite v. Thistlethwaite, which suggested that board size could be established by “custom, usage and acquiescence,” labeling this statement as non-binding dictum and incompatible with the statute’s clear mandate. The Court reasoned that allowing custom to determine board size would create uncertainty and debate, undermining the statutory policy of clarity in corporate governance. The Court stated, “Such a rule would be wholly incompatible with the clear mandate of section 702 that a board of directors shall consist of three members in the absence of a bylaw provision to the contrary.” Because Rye Center’s bylaws were silent, § 702(a) applied, fixing the board size at three. Therefore, the three shareholders who attended the special meeting validly elected themselves as directors and subsequently elected themselves as officers.

  • Zion v. Kurtz, 50 N.Y.2d 92 (1980): Enforceability of Shareholder Agreements Restricting Director Authority

    Zion v. Kurtz, 50 N.Y.2d 92 (1980)

    A shareholder agreement that requires unanimous consent for corporate actions, even if it restricts the board of directors’ authority, is enforceable between the original parties under Delaware law, especially when no third-party rights are implicated.

    Summary

    Zion and Kurtz, the sole shareholders of Lombard-Wall Group, Inc. (Group), entered into a shareholder agreement requiring Zion’s consent for any corporate activities. Despite this, Group entered into interest and escrow agreements without Zion’s consent. The court held that the agreement was enforceable between the parties, even though it was not formally incorporated into Group’s charter, because all shareholders had agreed to it. The court reasoned that Delaware law permits such restrictions, particularly in close corporations, and that Kurtz was estopped from challenging the agreement’s validity. The court modified the Appellate Division’s order, clarifying the ongoing validity of the consent provision.

    Facts

    Kurtz formed Group to acquire Lombard-Wall Incorporated (Lombard). Zion, through Half Moon Land Corporation, guaranteed Group’s debt. A shareholder agreement between Zion and Kurtz required Zion’s consent for Group to engage in any business activities. Subsequently, Group, without Zion’s consent, entered into agreements that made a previously non-interest bearing loan from Lombard to Group bear interest and established an escrow account to secure the loan. Zion objected to these agreements.

    Procedural History

    Zion sued for declaratory and injunctive relief, arguing the interest and escrow agreements violated the shareholder agreement. The lower court denied summary judgment to both parties. The Appellate Division reversed, granting summary judgment to Zion on the first cause of action (violation of shareholder agreement) and dismissing defendants’ counterclaim for reformation, while granting summary judgment to defendants dismissing Zion’s second cause of action (regarding the formation of two subsidiaries). The New York Court of Appeals modified the Appellate Division’s order, affirming the declaration of a past violation, dismissing the reformation counterclaim, and dismissing the second cause of action without prejudice, clarifying the ongoing validity of the consent provision.

    Issue(s)

    Whether a shareholder agreement requiring unanimous consent for corporate actions is enforceable under Delaware law, even if it restricts the board of directors’ authority and is not incorporated in the corporation’s charter.

    Holding

    Yes, because under Delaware law, a provision proscribing corporate action without the consent of a minority stockholder is not against public policy and, under the circumstances of this case, is enforceable even though not incorporated in the corporation’s charter.

    Court’s Reasoning

    The court applied Delaware law, as stipulated in the shareholder agreement, noting that Delaware law permits restrictions on director authority, especially in close corporations. Delaware General Corporation Law sections 350, 351, and 354 do not invalidate agreements restricting director discretion. The court emphasized that Kurtz, as the initial sole shareholder, consented to the agreement and was thus estopped from challenging its validity. The court reasoned that the agreement’s language, prohibiting “any business or activities of any kind,” was comprehensive and unambiguous. The court rejected the argument that the term “engage” necessitates multiple actions, finding that the context indicated a broader prohibition. The court emphasized the importance of protecting the minority shareholder’s interests, especially considering the guarantee provided by Half Moon. The court stated, “the agreement requires nothing that is not permitted by statute, and all of the stockholders of the corporation assented to it.” The court found no basis for reformation of the contract, as the parties engaged in an arm’s-length transaction with clear intentions. The court emphasized that the consents to form the subsidiaries were not conditioned upon the actual deposit of stock in escrow. The court concluded that the consent provision in the shareholder agreement remained in effect, rejecting the argument that it terminated upon full payment of the note.

  • Matter of Elias v. Serota, 24 N.Y.2d 68 (1969): Interpreting Corporate By-Laws for Filling Board Vacancies

    Matter of Elias v. Serota, 24 N.Y.2d 68 (1969)

    When a specific corporate by-law addresses filling board vacancies, it takes precedence over general by-laws requiring a supermajority for transacting business, especially when applying the general rule would paralyze corporate functions.

    Summary

    This case concerns a dispute over the validity of an election to fill a vacancy on a corporate board of directors. The petitioner challenged the election, arguing that a supermajority vote was required under the corporation’s general by-laws. The Court of Appeals held that a specific by-law addressing the filling of vacancies controlled over the general quorum and voting requirements. The Court reasoned that applying the general rules would lead to corporate paralysis, and the specific by-law was designed to ensure the corporation’s continued functioning. The court emphasized that the specific by-law complemented statutory provisions regarding filling vacancies, and should prevail over the general by-laws.

    Facts

    The corporation had five authorized directors. Two directors resigned, leaving three directors in office: the petitioner and the respondents, Moskowitz and Barrakette. A meeting was held where respondents Moskowitz and Barrakette voted to elect respondent Brody to fill one of the vacant positions. The petitioner objected, arguing that the election required a unanimous vote of the existing three directors.

    Procedural History

    The petitioner sued under Section 619 of the Business Corporation Law to invalidate the election. Special Term found the election valid and denied the application. The Appellate Division affirmed. The Court of Appeals granted leave to appeal.

    Issue(s)

    Whether a specific corporate by-law allowing “the directors in office” to fill vacancies on the board takes precedence over general by-laws requiring a 75% quorum and 75% vote for transacting business when those general rules would prevent the filling of vacancies.

    Holding

    Yes, because the specific by-law addressing the filling of vacancies is designed to ensure the continued functioning of the corporation and complements statutory provisions regarding filling vacancies, and thus prevails over general by-laws that, if applied, would paralyze the corporation.

    Court’s Reasoning

    The Court emphasized the specific language of by-law 14, which granted “the directors in office” the power to choose successors to fill vacancies. This by-law was authorized by Business Corporation Law § 705(a), which allows directors to fill vacancies even if less than a quorum exists, unless the certificate of incorporation or by-laws provide otherwise. The Court distinguished this specific provision from the general quorum and voting requirements in the certificate of incorporation and by-laws, which required 75% of the directors for any business transaction. The Court reasoned that applying the general rules would make it impossible to fill vacancies when the board was reduced to three members, as 75% of the original five directors would be four, an unattainable number. The Court stated: “Rather, it seems to us, the vitality of the corporation was to be preserved and the paralysis of its functions and its mandatory dissolution were to be avoided by the specific, exclusive and practical procedure enacted as by-law 14, complementing, as it does, section 705 (subd. [a]) of the Business Corporation Law. By-laws 20 and 21 apply to the company’s ‘business’, in general; by-law 14 to its special and vital function of succession.” Therefore, the specific by-law regarding filling vacancies controlled over the general quorum and voting requirements, ensuring the corporation’s continued operation.