New York Law Review

Tag: Close Corporations

  • Kemp & Beatley, Inc., 64 N.Y.2d 63 (1984): Defining “Oppressive Actions” in Close Corporations

    Kemp & Beatley, Inc., 64 N.Y.2d 63 (1984)

    In a close corporation, the majority shareholders’ actions that substantially defeat the reasonable expectations of minority shareholders regarding their participation and return on investment can constitute “oppressive actions” under Business Corporation Law § 1104-a, warranting dissolution.

    Summary

    Two minority shareholders of Kemp & Beatley, Inc., Dissin and Gardstein, sought dissolution of the corporation under Business Corporation Law § 1104-a, alleging “oppressive actions.” The shareholders had been terminated or resigned from the company and no longer received distributions of corporate earnings. The court found that the majority shareholders had altered a long-standing policy of distributing earnings based on stock ownership, effectively freezing out the minority shareholders. The New York Court of Appeals held that such actions could constitute “oppressive actions” and affirmed the lower courts’ decision, but modified the order to extend the time for the corporation to purchase the petitioners’ shares.

    Facts

    Kemp & Beatley, Inc. manufactures table linens. Dissin and Gardstein were long-time employees and minority shareholders. Dissin resigned in 1979, and Gardstein was terminated in 1980. Before their departures, they received a share of the company’s earnings through dividends or extra compensation, based on their stock holdings. After they left, the company changed its policy, and they no longer received these distributions. They alleged they were “frozen out” of the corporation.

    Procedural History

    Gardstein and Dissin petitioned for dissolution under Business Corporation Law § 1104-a. The Supreme Court referred the matter to a referee, who recommended dissolution, subject to the corporation’s option to buy out the petitioners’ stock. The Supreme Court confirmed the referee’s report, finding the new dividend policy prevented petitioners from receiving a return on investment and deemed liquidation the only means to achieve a fair return, conditioned on the corporation being permitted to purchase petitioners’ stock. The Appellate Division affirmed. The Court of Appeals granted review.

    Issue(s)

    Whether the majority shareholders’ conduct in altering the distribution of corporate earnings to exclude minority shareholders constitutes “oppressive actions” under Business Corporation Law § 1104-a, justifying judicial dissolution of the corporation.

    Holding

    Yes, because the majority’s actions substantially defeated the reasonable expectations of the minority shareholders, representing oppressive conduct under the statute, and the lower courts did not abuse their discretion by concluding that dissolution was the only means by which petitioners could gain a fair return on their investment.

    Court’s Reasoning

    The Court of Appeals defined “oppressive actions” by examining the characteristics of close corporations. Shareholders in close corporations often expect to be actively involved in management and to receive a return on their investment through employment, dividends, or other means. Because the stock of closely held corporations is not readily salable, minority shareholders can be trapped if they are at odds with management. The court adopted a “reasonable expectations” standard, defining oppressive conduct as that which substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and central to the petitioner’s decision to join the venture.

    The court found sufficient evidence that Kemp & Beatley had a long-standing policy of awarding de facto dividends based on stock ownership. This policy was changed shortly before or after the petitioners’ employment ended, and extra compensation was still awarded but was no longer based on stock ownership. The court found it reasonable to determine that this change in policy was an attempt to exclude petitioners from any return on their investment. The court held that the lower court did not abuse its discretion in ordering dissolution. The court emphasized that dissolution is appropriate when alternative remedies are doubtful, especially when there has been a complete deterioration of relations between the parties.

    The court cautioned against the use of the involuntary dissolution statute as a coercive tool by minority shareholders acting in bad faith. However, in this case, the actions of the majority shareholders warranted the remedy. The court modified the Appellate Division’s order to extend the time for the corporation to exercise its option to purchase the petitioners’ shares.

  • 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.