New York Law Review

Tag: Business Corporation Law § 1118

  • In re Penepent Corp., 96 N.Y.2d 186 (2001): Enforceability of Shareholder Agreements vs. Statutory Election

    In re Penepent Corp., 96 N.Y.2d 186 (2001)

    When a shareholder in a close corporation makes an irrevocable election to purchase another shareholder’s shares at fair value under Business Corporation Law § 1118 in response to a dissolution petition, that election takes precedence over a mandatory buy-out provision in a shareholder agreement that would otherwise be triggered by the petitioning shareholder’s death.

    Summary

    Francis Penepent, a shareholder in Penepent Corp., petitioned for dissolution under Business Corporation Law § 1104-a. Richard Penepent, another shareholder, elected to purchase Francis’ shares at fair value under § 1118. Before the fair value was determined, Francis died. A shareholder agreement stipulated that upon a shareholder’s death, the estate must surrender the shares to the corporation for a set price, lower than the anticipated fair value. The court addressed whether Richard’s election remained binding despite Francis’ death and the shareholder agreement. The Court of Appeals held that Richard’s § 1118 election was irrevocable and took precedence over the shareholder agreement’s buy-out provision. Once the election is made, it creates a vested right to receive fair value, which survives the shareholder’s death.

    Facts

    Anthony Penepent started Penepent Corp. with his four sons, each holding a 20% share. They entered into a shareholder agreement stating that upon a shareholder’s death, the corporation would purchase the deceased’s shares at a predetermined price. Later, the four sons bought out their father, each holding a 25% share. Disputes arose, and Francis petitioned for dissolution under Business Corporation Law § 1104-a. Richard elected to purchase Francis’ shares at fair value under § 1118. Before fair value was determined, Francis died. Richard then asserted the shareholder agreement required Francis’ estate to sell the shares to the corporation at the lower, predetermined price.

    Procedural History

    Francis filed for dissolution; Richard elected to purchase his shares. Supreme Court denied Richard’s motion to dismiss the dissolution proceeding and to revoke his § 1118 election, holding that Francis’ right to fair value vested upon Richard’s election. The Appellate Division affirmed. Richard argued for a discount in the share value due to a separate pending dissolution proceeding. The referee rejected this argument, which the Supreme Court adopted. The Appellate Division affirmed, and Richard appealed to the Court of Appeals.

    Issue(s)

    1. Whether a mandatory buy-out provision in a shareholder agreement controls when a valid Business Corporation Law § 1118 election has already been made to purchase shares at fair value before the event triggering the buy-out provision (death) occurs.

    2. Whether the value of shares should be discounted because of a separate, pending dissolution proceeding when the election to purchase shares in the present dissolution proceeding has already been made.

    Holding

    1. Yes, because once a shareholder makes an irrevocable election to purchase shares under Business Corporation Law § 1118, that election creates a vested right to receive fair value, which takes precedence over a mandatory buy-out provision triggered by death.

    2. No, because a pending dissolution proceeding involving different shareholders does not impact the fair value of the shares in a separate proceeding where an election to purchase has already been made.

    Court’s Reasoning

    The Court reasoned that Richard’s § 1118 election was irrevocable and binding. The purpose of making the election irrevocable was to prevent majority shareholders from delaying dissolution proceedings and exhausting the petitioning shareholder’s resources. The Court emphasized that once the election is made, the purchasing party is obligated to purchase the shares at fair value. The divestiture event (Francis’ death) occurred after Richard made the election, solidifying Francis’ right to fair value. The Court distinguished cases where shareholder agreements divested shareholders of their shares *before* a dissolution proceeding was commenced. Regarding the valuation discount, the Court stated that any litigation pending against the corporation could be considered. However, in this instance, the pending dissolution proceeding had no bearing on fair value because Richard had already irrevocably elected to purchase the shares. The court stated the objective in calculating “fair value” is to determine “what a willing purchaser in an arm’s length transaction would offer for petitioners’ interest in the company as an operating business”. Furthermore, imposing a discount due to a minority shareholder’s lack of control would violate equitable principles of corporate governance, depriving minority shareholders of their proportionate interest and treating shares of the same class unequally. The court quotes, “the stock so purchased shall be delivered and surrendered by the representative of the [deceased] to the Corporation, which shall thereupon retire such stock.”, illustrating the original agreement terms but ultimately prioritizing statutory rights.

  • In re Seagroatt Floral Co., 78 N.Y.2d 439 (1991): Valuing Minority Shares and Joint & Several Liability in Corporate Buyouts

    In re Seagroatt Floral Co., 78 N.Y.2d 439 (1991)

    When valuing minority shares in a close corporation buyout under Business Corporation Law § 1118, courts must consider the lack of marketability of the shares, but cannot impose joint and several liability on separate corporations unless justified under traditional corporate law principles.

    Summary

    This case concerns the valuation of minority shareholders’ stock in two closely held corporations, Seagroatt Floral and Henry J. Seagroatt, after the corporations elected to purchase their shares to avoid dissolution proceedings. The New York Court of Appeals addressed whether the lack of a public market for the shares was properly considered in the valuation and whether it was appropriate to impose joint and several liability on the two corporations. The Court held that while lack of marketability was considered, imposing joint and several liability was an error because the corporations were separate legal entities and such liability was not justified under the circumstances. The court modified the appellate division’s order.

    Facts

    The Seagroatt family operated a rose-growing business (Henry J. Seagroatt) and a wholesale floral business (Seagroatt Floral). These were incorporated as separate entities. Two minority shareholders (Riccardi and Seagroatt) owning approximately 17% of each corporation, sought dissolution, alleging oppressive actions by the directors. The corporations elected to buy out their shares under Business Corporation Law § 1118. The parties disagreed on the fair value of the stock, leading to a court-ordered valuation process.

    Procedural History

    The case was referred to a Referee who determined the fair value of the stock, valuing the corporations as a single business. The Referee applied a 25% lack-of-marketability discount, finding the expert had not considered it. The Supreme Court entered judgment against the corporations jointly and severally. Both sides appealed. The Appellate Division upheld joint and several liability but removed the 25% discount, concluding the expert had considered lack of marketability. The corporations then appealed to the New York Court of Appeals.

    Issue(s)

    1. Whether the lack of a public market for the corporations’ shares was adequately taken into account when valuing the companies for the purposes of buying out the petitioners’ minority stockholdings under Business Corporation Law § 1118?
    2. Whether the imposition of joint and several liability on the two corporations was legally permissible?

    Holding

    1. No, because the Appellate Division correctly determined the expert had considered lack of marketability.
    2. No, because joint and several liability is inconsistent with the language and goals of Business Corporation Law § 1118 and the separate legal existence of the corporations.

    Court’s Reasoning

    Regarding the lack-of-marketability discount, the Court of Appeals deferred to the Appellate Division’s finding that the expert had considered this factor when choosing his capitalization rate. The court stated that while lack of a public market should be considered, there is no single mandated method for calculating its effect on value. The court emphasized that its role was to determine which findings more closely comport with the weight of evidence.

    Regarding joint and several liability, the Court found that it was an error because it disregarded the separate legal existence of the two corporations. The Court reasoned that Business Corporation Law § 1118 grants the corporation or its shareholders the right to purchase the petitioner’s shares, but does not allow forcing a separate entity to purchase those shares through joint and several liability. The court stated that “The statute is quite specific as to which parties may exercise the buy-out option. Unless a second corporation is a shareholder in the company against whom the 1104-a petition has been filed, it does not have standing to make an election to purchase under Business Corporation Law § 1118. It follows from the language of the statute that an entity lacking standing to make the election to purchase cannot be forced to repurchase those very shares through the imposition of joint and several liability.”

    The Court also expressed concern that imposing joint and several liability could negatively impact the preferred shareholders of Seagroatt Floral and jeopardize Henry J. Seagroatt’s status as an S corporation. The court cited Port Chester Elec. Constr. Corp. v Atlas, 40 NY2d 652, 656, stating that “Under ordinary circumstances, a corporation’s independent existence cannot be ignored… Allowing a court— through joint and several liability — to in effect pierce the corporate veils, without the proper inquiry and proof according to established guidelines, undermines bedrock principles of corporate law.”