New York Law Review

Tag: closely held corporation

  • Glenn v. Hoteltron Systems, Inc., 74 N.Y.2d 32 (1989): Recovery in Derivative Suits and Allocation of Damages

    Glenn v. Hoteltron Systems, Inc., 74 N.Y.2d 32 (1989)

    In a shareholder derivative suit, damages for corporate injury are typically awarded to the corporation, even if the wrongdoer is a shareholder, unless equitable considerations and the rights of creditors necessitate a different approach.

    Summary

    This case addresses the proper allocation of damages, legal expenses, and attorney’s fees in shareholder derivative suits, especially when the injured corporation is closely held and the wrongdoer is also a significant shareholder. The court held that damages should be awarded to the corporation, even if the wrongdoer indirectly benefits. The court also affirmed that legal expenses and attorney’s fees for the plaintiff shareholder should be paid out of the award to the corporation. This decision emphasizes the importance of protecting corporate assets for creditors and adhering to the established rules for derivative actions.

    Facts

    Jacob Schachter and Herbert Kulik were 50% shareholders and officers of Ketek Electric Corporation. Schachter diverted Ketek’s assets and opportunities to Hoteltron Systems, Inc., a corporation wholly owned by him. Kulik initiated a shareholder derivative suit against Schachter for breach of fiduciary duty. The lower court initially found neither party liable, but the Appellate Division found Schachter liable for diverting Ketek’s assets to Hoteltron.

    Procedural History

    The Supreme Court initially ruled neither party liable. The Appellate Division reversed, finding Schachter liable. Following a trial on damages, the Supreme Court awarded damages to Kulik personally, including profits from Hoteltron and Kulik’s legal expenses. The Appellate Division modified this, awarding profits to Ketek and directing Ketek to pay Kulik’s legal expenses. The New York Court of Appeals granted leave to appeal.

    Issue(s)

    1. Whether damages in a shareholder derivative suit involving a closely held corporation should be awarded directly to the innocent shareholder or to the corporation itself when the wrongdoer is also a shareholder.

    2. Whether legal expenses and attorneys’ fees should be paid by the wrongdoer or by the corporation out of the damage award.

    Holding

    1. No, because the diversion of corporate assets resulted in a corporate injury, and awarding damages to the corporation protects the rights of creditors and adheres to the general rule for derivative actions.

    2. The legal expenses should be paid by the corporation from the award, because this aligns with the principle of reimbursing the plaintiff for expenses incurred on the corporation’s behalf.

    Court’s Reasoning

    The Court of Appeals affirmed the Appellate Division’s decision, emphasizing the general rule that recovery in a shareholder derivative suit benefits the corporation. The court acknowledged the anomaly that Schachter, as a 50% shareholder, would indirectly benefit from the award to Ketek but reasoned that making an exception for closely held corporations would undermine the general rule. The court stated: “An exception based on that fact alone would effectively nullify the general rule that damages for a corporate injury should be awarded to the corporation.”

    The Court emphasized that awarding damages directly to the innocent shareholder could impair the rights of creditors. “The fruits of a diverted corporate opportunity are properly a corporate asset. Awarding that asset directly to a shareholder could impair the rights of creditors whose claims may be superior to that of the innocent shareholder.”

    Regarding attorneys’ fees, the court cited Matter of A. G. Ship Maintenance Corp. v Lezak, 69 NY2d 1, 5, affirming that attorneys’ fees are incidents of litigation not collectable from the loser unless authorized by agreement, statute or court rule. The court reasoned that the basis for awarding attorneys’ fees in derivative suits is to reimburse the plaintiff for expenses incurred on the corporation’s behalf, and these costs should be borne by the corporation itself.

  • Amodio v. Amodio, 70 N.Y.2d 5 (1987): Valuing Stock in Closely Held Corporations for Equitable Distribution

    Amodio v. Amodio, 70 N.Y.2d 5 (1987)

    When determining the equitable distribution of property in a divorce, the valuation of stock in a closely held corporation should consider various factors, including restrictions on transfer and any existing buy-sell agreements, but the price fixed in such agreements is not conclusive evidence of value.

    Summary

    In a divorce action, the primary issue was the valuation of the husband’s 15% stock interest in a closely held corporation for equitable distribution. The stock was acquired under a shareholder’s agreement with a right of first refusal for other shareholders at the original purchase price of $87,500. The lower courts valued the stock at $87,500, based on the agreement. The Court of Appeals affirmed, holding that while buy-sell agreements are a factor, they are not the sole determinant of value. Since the plaintiff’s expert failed to account for transfer restrictions, the agreement price was the only evidence of actual value presented.

    Facts

    The husband owned a 15% stock interest in Capitol Electrical Supply Co., Inc., acquired in 1980 for $87,500. A shareholder’s agreement stipulated that if the husband wished to sell the stock within 20 years, other shareholders had a right of first refusal at the original price. The agreement also provided that if the husband died within the 20-year term, the surviving shareholders could purchase his interest for $87,500. During the divorce proceedings, the valuation of this stock became a point of contention.

    Procedural History

    The trial court determined the stock was worth $87,500, aligning with the shareholder’s agreement price. The Appellate Division affirmed this valuation. The case then reached the New York Court of Appeals.

    Issue(s)

    Whether the price fixed in a shareholder’s agreement restricting the transfer of stock in a closely held corporation is the sole determinant of the stock’s value for equitable distribution purposes in a divorce proceeding.

    Holding

    No, because while a bona fide buy-sell agreement predating marital discord is a factor in determining the stock’s value, it is not conclusive, and the court must consider all circumstances reflecting on the present worth of the property to the titleholder.

    Court’s Reasoning

    The Court of Appeals acknowledged that there is no rigid formula for valuing stock in closely held corporations, stating, “One tailored to the particular case must be found, and that can be done only after a discriminating consideration of all information bearing upon an enlightened prediction of the future.” The court referenced the IRS guidelines (Revenue Ruling 59-60) as a recognized method, outlining factors such as the nature and history of the business, economic outlook, book value, earning capacity, and comparable stock prices.

    The court emphasized that restrictions on transfer due to limited markets or contractual provisions must be considered. While the existence of a buy-sell agreement is relevant, it’s not the only factor. The court cautioned against reading the lower court decisions as holding the agreement price as absolutely controlling simply because the stock wasn’t immediately transferable. The court noted that marital property can have value even without present marketability, citing *O’Brien v O’Brien* and *Majauskas v Majauskas*.

    In this case, the plaintiff’s expert used two appraisal methods, valuing the stock between $172,000 and $253,000, but failed to account for the transfer restrictions. Because of this omission, the court found the $87,500 price in the shareholder’s agreement to be the only reliable evidence of the stock’s actual value in the record. The court implicitly held that the expert’s valuation was flawed because it failed to take into account a key restriction on the stock. The court’s decision highlights the importance of considering all relevant factors when valuing assets for equitable distribution and the weight given to agreements entered into prior to marital discord, absent other reliable evidence.

  • Schwartz v. Marien, 37 N.Y.2d 487 (1975): Fiduciary Duty and Unequal Treatment of Shareholders

    Schwartz v. Marien, 37 N.Y.2d 487 (1975)

    Corporate directors owe a fiduciary duty to treat all shareholders fairly and evenly, and any departure from uniform treatment requires a bona fide business purpose that outweighs the shareholder’s interest, especially in closely held corporations.

    Summary

    Plaintiff, a shareholder in a closely held corporation, sued the defendant directors for breach of fiduciary duty after they sold treasury stock to themselves and other employees without offering her the opportunity to purchase shares proportionally. The court held that while preemptive rights do not automatically apply to treasury stock, directors still owe a fiduciary duty to treat all shareholders fairly. The court found sufficient evidence to raise issues of fact regarding whether the stock sale served a legitimate corporate purpose or unfairly disadvantaged the plaintiff, precluding summary judgment.

    Facts

    Superior Engraving Co., Inc. was initially owned equally by three individuals: Smith, Marien, and Dietrich. Smith died, and the corporation bought back his shares, holding them in treasury. After Marien’s death, his shares were divided among his widow and sons. Following Dietrich’s death, his daughter, Schwartz (the plaintiff), inherited his shares. The Marien brothers, acting as directors, then sold five shares of treasury stock to themselves and two long-time employees, effectively securing control of the corporation by a single share. Schwartz was not offered the chance to buy shares. She offered to buy five shares at the same price, but her offer was rejected.

    Procedural History

    Schwartz sued to enjoin a shareholders meeting and alleged conspiracy and fraud. The Supreme Court denied cross-motions for summary judgment. The Appellate Division affirmed, with one dissenting Justice. The New York Court of Appeals affirmed the Appellate Division’s decision, holding that issues of fact existed that required a trial.

    Issue(s)

    Whether the defendant directors breached their fiduciary duty to the plaintiff shareholder by selling treasury stock to themselves and other employees without offering the plaintiff a proportional opportunity to purchase, thereby shifting corporate control.

    Holding

    No, because the existing record raises questions of fact as to whether the directors acted in good faith and for a legitimate corporate purpose, necessitating a trial to resolve these issues. The Court of Appeals answered the certified question in the affirmative, affirming the lower court’s decision.

    Court’s Reasoning

    The court emphasized that directors owe a fiduciary duty to shareholders, requiring fair and even treatment. While preemptive rights to treasury stock may not exist by statute, the fiduciary duty remains. The court cited Hammer v Werner, 239 App Div 38 and Kavanaugh v Kavanaugh Knitting Co., 226 NY 185. The court stated, “Apart from any preemptive or preferential rights which stockholders may have, they have additional rights with respect to the issuance of authorized but unissued stock and to shares which the corporation has acquired and carries in its treasury, which arise out of the fiduciary or trust relation which directors and officers sustain to stockholders”. A departure from uniform treatment is permissible only if justified by a bona fide business purpose that serves the corporation’s best interests. The burden of proving such justification lies with the directors, especially when they benefit themselves. The court noted that the disturbance of equality of stock ownership in a closely held corporation requires special justification. “Good faith or bad faith as the guide or the test of fiduciary conduct is a state or condition of mind — a fact — which can be proved or judged only through evidence”. The court determined that the case should proceed to trial to determine the directors’ motives and whether a legitimate corporate purpose existed.