New York Law Review

Tag: Close Corporation

  • Fender v. Prescott, 101 A.D.2d 418 (N.Y. App. Div. 1984): Corporate Opportunity Doctrine and Buy-Sell Agreements

    Fender v. Prescott, 101 A.D.2d 418 (N.Y. App. Div. 1984)

    The execution of a buy-sell agreement does not automatically release a shareholder, officer, or director of a close corporation from their fiduciary duty not to usurp a viable corporate opportunity of which they became aware in their corporate capacity.

    Summary

    This case addresses whether a buy-sell agreement automatically releases a corporate fiduciary from the duty not to usurp corporate opportunities. Prescott, a shareholder, officer, and director of National Cold Storage Co., sought summary judgment, arguing that a buy-sell agreement with Fender absolved him of liability for allegedly taking corporate opportunities. The court held that the buy-sell agreement did not automatically release Prescott from his fiduciary duty. The court found triable issues of fact existed regarding the viability of National’s potential acquisition of Merchant’s Refrigerating Co. and Prescott’s acquisition of National Gypsum Company’s Gold Bond Division.

    Facts

    Prescott was a shareholder, officer, and director of National Cold Storage Co. (National). While serving in that capacity, he became aware of potential acquisition opportunities for National, specifically Merchant’s Refrigerating Co. and National Gypsum Company’s Gold Bond Division. Fender and Prescott entered into a buy-sell agreement regarding the stock of National. Prior to the execution of the buy-sell agreement, Prescott acquired National Gypsum Company’s Gold Bond Division. After the buy-sell agreement, it was alleged that Prescott co-opted the opportunity to acquire Merchant’s Refrigerating Co.

    Procedural History

    The trial court denied Prescott’s motion for summary judgment. Prescott appealed to the Appellate Division of the Supreme Court, which affirmed the trial court’s decision.

    Issue(s)

    1. Whether the execution of a buy-sell agreement between shareholders of a close corporation automatically releases a shareholder, officer, and director from their fiduciary duty not to usurp a viable corporate opportunity of which they became aware in such capacities.

    2. Whether National Cold Storage Co.’s primary business of purchasing and operating cold storage facilities precluded it from entering into other fields, thus negating a corporate opportunity regarding the acquisition of National Gypsum Company’s Gold Bond Division.

    Holding

    1. No, because the buy-sell agreement does not automatically release a corporate fiduciary from the obligation not to co-opt a viable corporate opportunity of which they became aware in their corporate capacity. There was a triable issue of fact as to the viability of National’s negotiations for acquiring Merchant’s Refrigerating Co.

    2. No, because the affidavits established that National negotiated for the acquisition of businesses widely diverse from cold storage. Therefore, triable issues of fact existed as to that acquisition as well.

    Court’s Reasoning

    The court reasoned that a buy-sell agreement, while defining the terms of stock transfer, does not inherently waive the fiduciary duties owed by officers, directors, and shareholders in a close corporation, particularly concerning the corporate opportunity doctrine. The court emphasized that the duty not to co-opt corporate opportunities continues until explicitly waived. The court stated, “Execution of a buy-sell agreement between plaintiff and defendant with respect to the stock of National Cold Storage Co., Inc., did not automatically release defendant from his obligation as a shareholder, officer and director of that close corporation not to co-opt a viable corporate opportunity of which he became aware in such capacities.”

    Regarding the acquisition of National Gypsum Company’s Gold Bond Division, the court found that National’s business was not so narrowly defined as to preclude it from pursuing other acquisitions. The court highlighted that National had engaged in negotiations for businesses diverse from cold storage, which created a triable issue of fact regarding whether the Gold Bond Division acquisition constituted a corporate opportunity. This suggests the scope of a corporation’s business activities, for corporate opportunity purposes, is determined by what it actually does and what it credibly plans to do. The court reasoned that just because the company engaged in purchasing and operating cold storage facilities does not preclude its entry into other fields.

  • H.J.R. Realty Corp., 24 N.Y.2d 543 (1969): Corporate Dissolution and Benefit to All Shareholders

    H.J.R. Realty Corp., 24 N.Y.2d 543 (1969)

    A court may order the dissolution of a close corporation when the corporation no longer fulfills its intended function and its assets are used solely for the benefit of only some of its shareholders, thereby frustrating the purpose for which it was created.

    Summary

    Minority shareholders sought dissolution of a close corporation, H.J.R. Realty Corp., arguing it no longer served its intended function. The corporation’s primary asset was a building where the shareholders, who were also tenants, originally operated their businesses. Over time, the majority shareholders’ businesses expanded, benefiting from artificially low rents, while the minority shareholders, having moved out, received no return on their investment. The court denied dissolution, finding no evidence of looting or wrongful diversion of assets. A dissenting opinion argued that the corporation’s purpose had been subverted, warranting dissolution to prevent inequity.

    Facts

    The petitioners (minority shareholders) and the respondents (majority shareholders) formed H.J.R. Realty Corp. to purchase and operate a building where they were tenants. The initial agreement ensured all shareholders, also tenants, would benefit from minimum rental expenses. Petitioners later moved out of the building. Respondents expanded their occupancy, securing most of the building. The corporation generated negligible profits, largely because the majority shareholders benefited from significantly reduced rent. Minority shareholders received no return on their investment, despite contributing over 44% of the capital.

    Procedural History

    The petitioners sought dissolution of H.J.R. Realty Corp. The lower court dismissed the petition without a hearing. The appellate division affirmed the dismissal. The case was appealed to the New York Court of Appeals.

    Issue(s)

    Whether a court should order the dissolution of a close corporation when it is alleged that the corporation no longer serves the function for which it was created and employs its assets for the exclusive benefit of only some of its shareholders.

    Holding

    No, because the petitioners did not demonstrate looting or wrongful diversion of corporate assets by the majority shareholders. A dissenting opinion argued that the corporation’s purpose had been subverted, warranting dissolution to prevent inequity.

    Court’s Reasoning

    The majority held that in the absence of looting, misconduct or misappropriation of corporate property by the majority stockholders, the petition for dissolution should be dismissed. The court found no evidence that the majority shareholders were wrongfully diverting corporate assets. The court stated that allegations of waste and inefficiency are insufficient grounds for judicial intervention in the internal management of a corporation where the complaining shareholders have an adequate remedy at law.

    The dissenting opinion (Fuld, C.J., dissenting) argued that the corporation was initially formed for the mutual benefit of all its stockholders, particularly regarding rental expenses. When the petitioners moved out, the corporation’s nature changed, benefiting only the majority shareholders through reduced rent. The dissent contended that the corporation’s purpose was gone, and it was being continued solely for the benefit of the majority. Citing the understanding that the corporation’s existence was conditioned upon each stockholder being a tenant, the dissent argued that the court should have held a hearing. Chief Judge Fuld stated, “When changing circumstances render that purpose impossible of achievement, a court of equity should be no more reluctant to permit a corporate dissolution than it would be to dissolve a purely contractual relationship.” He suggested the court was ignoring business reality and perpetuating inequity by refusing dissolution, advocating for a more flexible approach in close corporations similar to partnerships or joint ventures.

  • Katzowitz v. Sidler, 24 N.Y.2d 512 (1969): Minority Stockholder Protection in Close Corporations

    Katzowitz v. Sidler, 24 N.Y.2d 512 (1969)

    In close corporations, directors breach their fiduciary duty when they issue new stock at prices far below fair value without a valid business justification, especially when it dilutes a minority shareholder’s interest.

    Summary

    Katzowitz, Sidler, and Lasker were equal shareholders and directors of Sulburn Holding Corp., a close corporation. After a falling out, Sidler and Lasker orchestrated a stock issuance at 1/18th the book value, which Katzowitz declined to purchase, resulting in the dilution of his equity. The court held that this action breached the directors’ fiduciary duty because there was no valid business justification for the underpriced issuance and it unfairly prejudiced Katzowitz. The court emphasized the heightened duty of fairness in close corporations where market remedies are ineffective.

    Facts

    Sulburn Holding Corp. was formed by Katzowitz, Sidler, and Lasker, each holding an equal number of shares.
    Disagreements arose, and Sidler and Lasker sought to exclude Katzowitz from management.
    Despite a prior stipulation to maintain equal stock interests, Sidler and Lasker called a board meeting to issue additional shares at $100 each, while the book value was $1,800 per share.
    Katzowitz declined to purchase the additional shares, and Sidler and Lasker bought them, diluting Katzowitz’s ownership.
    Upon dissolution, Katzowitz received significantly less than Sidler and Lasker due to the dilution.

    Procedural History

    Katzowitz sued for a declaratory judgment to restore his proportional interest.
    Special Term ruled against Katzowitz, finding he waived his rights by not exercising his preemptive rights.
    The Appellate Division affirmed, holding that disparity in price alone was insufficient to prove fraud.
    The New York Court of Appeals reversed the Appellate Division’s order, ruling in favor of Katzowitz.

    Issue(s)

    1. Whether directors of a close corporation breach their fiduciary duty to a minority shareholder by issuing stock at a price far below its fair value without a valid business justification, thereby diluting the minority shareholder’s equity.

    Holding

    1. Yes, because directors in a close corporation have a fiduciary duty to treat all stockholders fairly when issuing new stock, and issuing stock at a significantly undervalued price without a valid business justification constitutes a breach of that duty, particularly when it serves to dilute the equity of a dissenting shareholder.

    Court’s Reasoning

    The court reasoned that directors owe a fiduciary duty to all stockholders, especially in close corporations where the usual protections of a public market do not exist. The court stated that “directors, being fiduciaries of the corporation, must, in issuing new stock, treat existing shareholders fairly.” The court found that the stock issuance at a price significantly below book value ($100 vs. $1,800) lacked a valid business justification and was designed to pressure Katzowitz into investing additional funds or suffer dilution. The court emphasized that preemptive rights offer illusory protection in close corporations due to the limited market for shares. It was not enough to offer Katzowitz the right to purchase; the price itself was unfair and coercive. The court noted, “The corollary of a stockholder’s right to maintain his proportionate equity in a corporation by purchasing additional shares is the right not to purchase additional shares without being confronted with dilution of his existing equity if no valid business justification exists for the dilution.” The court concluded that Sidler and Lasker should not benefit from their conduct and ordered that Katzowitz receive his aliquot share of the assets upon dissolution, less the amount invested by Sidler and Lasker in the unfairly issued stock. Chief Judge Fuld dissented without opinion.