New York Law Review

Tag: corporate law

  • Erie County Employees Retirement System v. Blitzer, 28 N.Y.3d 268 (2016): Applying the Business Judgment Rule in Going-Private Mergers with Protective Conditions

    Erie County Employees Retirement System v. Blitzer, 28 N.Y.3d 268 (2016)

    In reviewing going-private mergers, the business judgment rule applies if the merger is conditioned from the outset on approval by both a special committee of independent directors and an uncoerced majority of the minority shareholders; otherwise, the entire fairness standard applies.

    Summary

    The New York Court of Appeals addressed the standard of review for going-private mergers. The court adopted the Delaware Supreme Court’s framework from MFW, holding that the business judgment rule applies if the merger is conditioned on approval by an independent special committee and an uncoerced majority of the minority shareholders. If these conditions aren’t met, the entire fairness standard is applied, placing the burden on the directors to show fair process and fair price. The court affirmed the dismissal of the plaintiff’s complaint, finding the conditions for the business judgment rule were met.

    Facts

    Kenneth Cole Productions (KCP) had two classes of stock, with Kenneth Cole holding the majority voting power. Cole proposed a going-private merger, offering to buy the remaining Class A shares. The KCP board formed a special committee to negotiate the terms. Cole’s offer was conditioned on approval by the special committee and a majority of the minority shareholders. The special committee negotiated the price, eventually recommending $15.25 per share, which the minority shareholders approved with 99.8% in favor. Shareholders sued, alleging breach of fiduciary duty.

    Procedural History

    Shareholders filed class actions in the trial court. The trial court granted the defendants’ motions to dismiss, finding no breach of fiduciary duty. The Appellate Division affirmed, holding that the entire fairness standard did not apply. The Court of Appeals granted leave to appeal.

    Issue(s)

    1. Whether the entire fairness standard should apply to the going-private merger.

    2. Whether the business judgment rule should apply to the going-private merger.

    Holding

    1. No, because the court adopted the Delaware Supreme Court’s framework in MFW, which outlines the conditions for the business judgement rule.

    2. Yes, because the conditions for the business judgement rule, as outlined in MFW, were met.

    Court’s Reasoning

    The court reviewed the history of freeze-out mergers and the standards of review applied, noting the inherent conflict of interest when a controlling shareholder seeks to take a company private. The court discussed the business judgment rule, which generally defers to directors’ decisions absent fraud or bad faith. The court specifically adopted the standard from MFW (Kahn v. M&F Worldwide Corp.), which states that the business judgment rule applies if the merger is conditioned from the outset on approval by both an independent special committee and an uncoerced majority of the minority shareholders. The court reasoned that this structure creates a situation akin to an arm’s-length transaction, protecting minority shareholders while respecting the board’s decisions. The court examined the facts under the MFW standard and found the complaint did not adequately allege that any of the six conditions were absent. The court emphasized the plaintiff’s failure to show that the special committee was not independent, lacked the ability to negotiate a fair price, or that the minority shareholders were coerced.

    Practical Implications

    This decision provides a clear framework for evaluating going-private mergers, which can provide more predictability to parties involved in these transactions. It confirms that, if structured correctly, these mergers can be reviewed under the business judgment rule. This means that if a merger satisfies the conditions set forth in MFW (an independent special committee, the committee is empowered to freely select its own advisors and to say no definitively, and an informed, uncoerced majority of the minority vote), courts will defer to the board’s decision, reducing the risk of shareholder litigation. Companies engaging in going-private mergers should carefully structure the process to meet these conditions. Plaintiff’s attorneys must allege specific facts to show any of the conditions were not met to avoid dismissal.

  • Purnell v. LH Radiologists, P.C., 90 N.Y.2d 524 (1997): Enforceability of Oral Agreements to Form a Corporation

    Purnell v. LH Radiologists, P.C., 90 N.Y.2d 524 (1997)

    An oral agreement among individuals to form a corporation with an understanding of equal ownership can be enforced despite the lack of formal stock issuance, especially when seeking inspection of corporate records.

    Summary

    Twelve radiologists agreed to form two corporations, LH Radiologists, P.C. (LH) and Lenox Hill Radiology Associates, P.C. Each contributed capital with the understanding they would be equal shareholders. Dr. Rothman, tasked with incorporation, issued all LH shares solely in his name, backdating the documents. When Drs. Purnell and Donovan sought to inspect LH’s records due to financial concerns, their request was denied based on their lack of formal shareholder status. The New York Court of Appeals held that the initial agreement to form the corporation and the radiologists’ contributions established shareholder status for the purpose of inspecting corporate records, irrespective of the missing stock certificates.

    Facts

    In 1984, twelve radiologists, including Drs. Purnell, Donovan, and Rothman, agreed to form LH Radiologists, P.C. (LH) and Lenox Hill Radiology Associates, P.C. They intended to be equal shareholders in both corporations. Each radiologist, except Patel and Rothman, made initial capital contributions totaling $61,000, deposited into a special account. Dr. Rothman signed the certificate of incorporation for LH, listing all twelve radiologists as original shareholders, with 100 authorized shares. However, stock certificates were never issued to Drs. Purnell and Donovan. Sometime later, Rothman unilaterally issued all shares in his name alone, backdating the documents to the incorporation date.

    Procedural History

    Drs. Purnell and Donovan commenced a special proceeding under Business Corporation Law § 624 to inspect LH’s books. The matter was referred to a Special Referee who found them to be shareholders. Supreme Court confirmed the Referee’s report, holding they were entitled to inspect the books. The Appellate Division affirmed. The Court of Appeals granted leave to appeal and affirmed the Appellate Division’s order.

    Issue(s)

    Whether an oral agreement to form a corporation, coupled with capital contributions and participation, is sufficient to establish shareholder status for the purpose of inspecting corporate records under Business Corporation Law § 624, despite the lack of formal stock issuance and the potential applicability of the Statute of Frauds under UCC § 8-319 and Business Corporation Law § 503(b).

    Holding

    Yes, because the agreement among the radiologists was not merely a contract for the sale of securities or a subscription agreement, but a pre-incorporation agreement to form a corporation with equal ownership. The Statute of Frauds and the writing requirement for stock subscriptions do not bar the petitioners’ claim to shareholder status for the limited purpose of inspecting corporate records.

    Court’s Reasoning

    The Court of Appeals distinguished between a pre-incorporation agreement among individuals to form a corporation and a contract for the sale of securities or a stock subscription agreement. The radiologists entered into a pre-incorporation agreement to create two equally owned corporations. Rothman breached this agreement by unilaterally issuing all shares to himself. The court stated, “[P]arties [may] make an agreement to form a corporation, and to provide therein what their respective interests in such corporation shall be * * *. A corporation cannot be formed without a preliminary agreement among parties proposing to form it…” (King v Barnes, 109 NY 267, 288). UCC 8-319, which requires a writing for the sale of securities, does not apply because the agreement was not for the sale of securities, but the formation of a corporation. Similarly, Business Corporation Law § 503(b), requiring written stock subscriptions, is inapplicable because the petitioners are not seeking to enforce an oral subscription against the corporation; instead, they are seeking to enforce their rights as existing shareholders to inspect the corporate books. The court emphasized that the evidence, including the certificate of incorporation listing the petitioners as original shareholders, their financial contributions, and shareholder meetings, supported their status as shareholders for the purpose of a Business Corporation Law § 624 inspection proceeding. The Court found that “the omission of issuance of stock certificates to petitioners does not displace that array of evidence which supports shareholder status for these purposes.” The court also affirmed the lower court’s decision to prevent appellants from using corporate funds to defend the action, suggesting bad faith in their actions.

  • Gallagher v. Lambert, 746 N.E.2d 562 (N.Y. 1989): Enforceability of Stock Buy-Back Agreements Upon Termination

    Gallagher v. Lambert, 746 N.E.2d 562 (N.Y. 1989)

    A stock buy-back agreement in a close corporation, which mandates repurchase of shares at book value upon termination of employment before a specified date, is enforceable even if the employee is terminated to trigger the lower buy-back price, provided the agreement is clear and unambiguous.

    Summary

    Gallagher, a minority shareholder and employee of Eastdil Realty, was fired before a specific date, triggering a stock buy-back agreement at book value. He sued, claiming a breach of fiduciary duty, arguing the firing was in bad faith to avoid a higher buy-back price tied to company earnings after that date. The New York Court of Appeals held that the buy-back agreement was enforceable. The court reasoned that parties in close corporations can contractually agree to stock repurchase terms, and these agreements define the scope of fiduciary duty. Absent fraud or illegality, courts should not interfere with such agreements based on claims of unfairness, as doing so would undermine the certainty and predictability these agreements are designed to provide.

    Facts

    Gallagher was employed by Eastdil Realty and later became an officer, director, and executive of a subsidiary.
    In 1981, Eastdil offered executive employees the opportunity to purchase stock subject to a mandatory buy-back provision.
    The buy-back provision stipulated that upon termination before January 31, 1985, the stock would be repurchased at book value; after that date, the price would be based on company earnings.
    Gallagher accepted the offer, purchased 8.5% of Eastdil’s stock, and helped draft the buy-back agreement.
    On January 10, 1985, Eastdil fired Gallagher.
    Gallagher claimed entitlement to the higher buy-back price, arguing his termination was timed to avoid it.

    Procedural History

    Gallagher sued Eastdil, asserting multiple causes of action, including breach of fiduciary duty.
    The trial court denied Eastdil’s motion for summary judgment, finding factual issues regarding Eastdil’s motive in firing Gallagher.
    The Appellate Division reversed, dismissed the claims based on breach of fiduciary duty, and ordered payment at book value.
    The Appellate Division granted leave to appeal to the New York Court of Appeals and certified the question of whether its order was properly made.

    Issue(s)

    Whether a close corporation breaches a fiduciary duty to a minority shareholder/employee when it terminates their employment to trigger a stock buy-back agreement at a lower price, where the agreement is clear and unambiguous.

    Holding

    No, because the parties negotiated a clear buy-back provision, and absent evidence of fraud or illegality, courts should enforce the agreement as written to maintain certainty and predictability in such transactions.

    Court’s Reasoning

    The court emphasized the importance of upholding contractual agreements, especially in close corporations where buy-back provisions are designed to maintain control of the company within the remaining owners-employees.
    It distinguished the duty owed to a shareholder from the duty owed to an employee, noting that the plaintiff’s claim was based on his status as a shareholder but was inextricably linked to his employment status due to the buy-back agreement’s terms.
    The court reasoned that allowing the claim to proceed would undermine the purpose of the buy-back agreement, which is to provide a certain formula for valuing stock and avoiding costly litigation.
    The court stated that “[t]hese agreements define the scope of the relevant fiduciary duty and supply certainty of obligation to each side. They should not be undone simply upon an allegation of unfairness. This would destroy their very purpose, which is to provide a certain formula by which to value stock in the future”.
    The court distinguished this case from situations involving fraud or illegality, where intervention might be warranted. Here, the buy-back provision was clear, negotiated, and agreed upon by both parties.
    The court emphasized that the employer had the right to terminate the employee at will, and the buy-back agreement was a mutually agreed-upon mechanism for handling stock ownership upon termination.
    The court rejected the dissenting opinion’s characterizations, asserting that its decision rested on fundamental contractual principles applied to the stock repurchase agreement.

  • Matter of Grand Jury Subpoena Duces Tecum Served Upon Morano, 69 N.Y.2d 700 (1986): Jurisdiction Over Out-of-State Documents of Corporations Doing Business In-State

    Matter of Grand Jury Subpoena Duces Tecum Served Upon Morano, 69 N.Y.2d 700 (1986)

    A corporation doing business within a state is subject to that state’s subpoena power, compelling the production of documents under its control, regardless of where those documents are physically located.

    Summary

    This case addresses whether New York courts can compel corporations doing business in New York to produce documents located outside the state in response to a subpoena. The Court of Appeals held that it can, clarifying that the Uniform Act to Secure the Attendance of Witnesses from Without the State in Criminal Proceedings (CPL 640.10) is not the exclusive means to obtain such documents. Because the corporations were doing business in New York, they were subject to New York’s jurisdiction and subpoena power, enabling the court to order the production of all documents under their control, irrespective of their location. This ruling ensures that businesses operating within New York cannot shield documents from legal scrutiny by storing them out of state.

    Facts

    Two New Jersey corporations and their president, all doing business in New York, were served with subpoenas. These subpoenas required them to produce records held in New Jersey before a New York County Grand Jury investigating Medicaid fraud. The corporations sought to quash the subpoenas, arguing that the only way to compel production of out-of-state documents was through the Uniform Act to Secure the Attendance of Witnesses from Without the State in Criminal Proceedings (CPL 640.10).

    Procedural History

    The lower courts denied the motion to quash the subpoenas, ordering the corporations to produce the requested documents. The corporations appealed. The Court of Appeals affirmed the lower courts’ decision, holding that CPL 640.10 is not the exclusive means to compel the production of out-of-state documents from corporations doing business within New York.

    Issue(s)

    Whether the issuance of compulsory process pursuant to CPL 640.10, the Uniform Act to Secure the Attendance of Witnesses from Without the State in Criminal Proceedings, is the exclusive means by which an out-of-State corporation doing business in New York may be compelled to produce out-of-State documents at a criminal proceeding within New York.

    Holding

    No, because corporations doing business in New York are considered “within the state” for jurisdictional purposes and are therefore subject to New York’s subpoena power, allowing the court to compel the production of documents under their control, regardless of location.

    Court’s Reasoning

    The Court reasoned that CPL 610.10 allows a person “within the state” to be compelled to attend a criminal proceeding and produce evidence via subpoena. Because the corporations were doing business in New York, they were “within the state” for jurisdictional purposes, citing Laufer v. Ostrow, 55 N.Y.2d 305, 309-310 and Tauza v. Susquehanna Coal Co., 220 N.Y. 259, 267-268. The court also referenced Matter of Standard Fruit & S. S. Co. v. Waterfront Commn., 43 N.Y.2d 11, 15-16, to support the holding that the lower courts correctly required the corporations to produce all documents within their control, regardless of location.

    The Court explicitly stated that “Pursuant to CPL 610.10, a person ‘within the state’ may be required to attend a criminal proceeding and to produce specified physical evidence by the issuance and service upon him of a subpoena.”

    The Court emphasized the practical implications of its decision, clarifying that corporations cannot avoid compliance with New York subpoenas simply by housing documents outside of the state’s borders. This ensures the effectiveness of legal proceedings within New York and prevents corporations from using out-of-state document storage as a shield against legal scrutiny. The court also explicitly rejected the contrary holding in Matter of Brennick v Hynes (68 AD2d 980, lv denied 47 NY2d 706), stating that “To the extent that Matter of Brennick v Hynes reaches a contrary result, it is not to be followed.” This creates a clear precedent for lower courts to follow, solidifying the reach of New York’s subpoena power over corporations operating within its borders.

  • New York Metro Corp. v. Chase Manhattan Bank, N.A., 52 N.Y.2d 732 (1980): Authority of Corporate Officer to Withdraw Funds Absent Resolution

    52 N.Y.2d 732 (1980)

    A bank can defend against liability for an unauthorized withdrawal from a corporate account by arguing that the corporate officer had authority to direct withdrawals, even without a specific corporate resolution on file.

    Summary

    New York Metro Corp. sued Chase Manhattan Bank for allowing the corporation’s president to make an unauthorized withdrawal. The bank argued it had a corporate resolution authorizing the withdrawal, which was later lost. The jury found that no such resolution was on file. The bank also argued that the president had the authority to withdraw funds regardless of any resolution. The trial court refused to submit this question to the jury. The Court of Appeals reversed, holding that the bank was entitled to have the jury consider whether the president had the authority to withdraw funds independently of a corporate resolution. Because there was evidence to support that contention, it was error for the trial court to not submit it to the jury.

    Facts

    New York Metro Corp. maintained a corporate account with Chase Manhattan Bank.

    The corporation’s president, Mr. Schuddekopf, directed a withdrawal from the account.

    The bank permitted the withdrawal.

    New York Metro Corp. claimed the withdrawal was unauthorized and sued the bank to recover the funds.

    The bank defended by claiming it had a corporate resolution on file authorizing the withdrawal, but the resolution was inadvertently destroyed.

    Procedural History

    The trial court instructed the jury to determine whether a corporate resolution authorizing the withdrawal was on file with the bank. The jury found that no such resolution existed.

    The trial court refused the bank’s request to instruct the jury on whether the president had the authority to make withdrawals independent of a corporate resolution.

    The jury found in favor of New York Metro Corp.

    The Appellate Division affirmed.

    The Court of Appeals reversed and remanded for a new trial.

    Issue(s)

    Whether the trial court erred in refusing to submit to the jury the question of whether the corporation’s president had the authority to direct withdrawals from the corporate account independent of any corporate resolution.

    Holding

    Yes, because the bank presented evidence that the president had such authority, and the jury should have been allowed to consider this evidence.

    Court’s Reasoning

    The Court of Appeals held that the trial court erred in refusing to submit the question of the president’s independent authority to the jury. The court noted that the bank, while primarily arguing the existence of a corporate resolution, also contended that the president had the authority to direct the withdrawal regardless. The court stated, “Inasmuch as there was evidence in the case to support this contention it was error not to have submitted it to the jury.” The court emphasized that the bank was entitled to have the jury consider all possible defenses, including the president’s inherent authority. The Court further explained that a jury verdict for the plaintiff could not be sustained on a theory that the bank did not exercise reasonable care, as that theory was never submitted to the jury.

  • Zetlin v. Hanson Holdings, Inc., 48 N.Y.2d 684 (1979): Sale of Corporate Control and Minority Shareholder Rights

    48 N.Y.2d 684 (1979)

    Absent looting, conversion of a corporate opportunity, fraud, or bad faith, a controlling stockholder can sell their controlling interest at a premium, without necessarily sharing that premium with minority shareholders.

    Summary

    Zetlin, a minority shareholder in Gable Industries, sued Hanson Holdings, which owned a controlling share (44.4%), for selling their shares to Flintkote at a premium. Zetlin argued minority shareholders were entitled to share in the premium. The court ruled that controlling shareholders are generally free to sell their shares at a premium, absent evidence of corporate looting, conversion, fraud, or bad faith. The court reasoned that imposing a requirement to share premiums would fundamentally alter corporate control transfers, essentially mandating tender offers, a change best left to the legislature.

    Facts

    Plaintiff Zetlin owned about 2% of Gable Industries’ shares. Defendants Hanson Holdings and Sylvestri owned 44.4% of Gable’s shares, representing effective control. The defendants sold their shares to Flintkote Co. for $15 per share. At the time of the sale, Gable stock traded on the open market for $7.38 per share. The 44.4% stake acquired by Flintkote represented effective control of Gable.

    Procedural History

    The lower courts ruled in favor of the defendants, upholding the right of the controlling shareholder to sell their shares at a premium. The case reached the New York Court of Appeals, which affirmed the lower court’s decision.

    Issue(s)

    Whether minority shareholders are entitled to an opportunity to share equally in any premium paid for a controlling interest in the corporation.

    Holding

    No, because controlling shareholders have a right to sell their shares at a premium, absent looting, conversion of a corporate opportunity, fraud, or other acts of bad faith. This right stems from the inherent value of controlling the corporation’s direction.

    Court’s Reasoning

    The court based its decision on the principle that those who invest to acquire a dominant ownership position have the right to control the corporation. The court stated, “Recognizing that those who invest the capital necessary to acquire a dominant position in the ownership of a corporation have the right of controlling that corporation, it has long been settled law that, absent looting of corporate assets, conversion of a corporate opportunity, fraud or other acts of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that controlling interest at a premium price.” The court acknowledged the need to protect minority shareholders from abuse by controlling shareholders but emphasized that minority shareholders are not entitled to inhibit the legitimate interests of other stockholders. The court also recognized that a premium reflects the added value of influencing the corporation’s affairs. To mandate that controlling interests be transferred only through offers to all stockholders would represent a radical change to existing law, which should be effected by the legislature, not the courts.

  • 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.

  • 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.

  • Grace v. Grace Institute, 19 N.Y.2d 303 (1967): Inherent Power to Remove Corporate Members for Cause

    Grace v. Grace Institute, 19 N.Y.2d 303 (1967)

    A corporation possesses the inherent power to remove a member, officer, or director for cause, even without an explicit provision in its charter or bylaws.

    Summary

    This case addresses whether a life member and trustee of the Grace Institute, a charitable corporation, could be removed from his position for cause, despite the absence of a specific removal provision in the corporation’s charter or bylaws. The Court of Appeals held that corporations possess the inherent power to remove members for cause. The court found the trustee’s actions, which included initiating multiple unsuccessful lawsuits against the Institute, were detrimental and justified his removal. The court also determined that the trustee was afforded a reasonable opportunity to be heard before his removal.

    Facts

    Michael P. Grace II was a life member and trustee of the Grace Institute, a corporation dedicated to providing educational opportunities to women. During his tenure, Michael initiated several unsuccessful lawsuits against the Institute. As a result, the Institute brought charges against him, held a hearing, and subsequently removed him as a trustee and life member. The incorporating statute and bylaws lacked any provision for the removal of a life member.

    Procedural History

    Michael initiated an Article 78 proceeding seeking judicial review of his removal. The Special Term Justice determined that a trial was necessary to resolve factual issues related to the good faith of the removal decision and the fairness of the hearing. The Institute appealed, arguing for summary dismissal. The Appellate Division modified the Special Term’s order, treating the Institute more like a charitable trust than a membership corporation, and revised the questions for trial. The Institute then appealed to the Court of Appeals by permission, challenging the correctness of the Appellate Division’s order.

    Issue(s)

    Whether the Grace Institute had the authority to remove Michael P. Grace II from his position as a life member and trustee for cause, despite the absence of a specific provision authorizing such removal in the Institute’s incorporating statute or bylaws.

    Holding

    Yes, because a corporation possesses the inherent power to remove a member, officer, or director for cause, regardless of the presence of a specific provision in the charter or bylaws.

    Court’s Reasoning

    The Court of Appeals reasoned that settled law establishes a corporation’s inherent power to remove a member for cause, citing previous cases such as People ex rel. Manice v. Powell, 201 N.Y. 194. The court emphasized a policy of non-interference with internal corporate management. It noted that the trustees, vested with the power to manage the Institute, had determined that Michael’s conduct was detrimental to the Institute’s interests. The court found ample evidence to support this determination, pointing to Michael’s repeated, unsuccessful lawsuits against the Institute. The Court stated, “Under these circumstances, courts should not substitute their judgment for the judgment of those charged by the Legislature with the responsibility of running the corporation and seeing to it that it fulfills the purposes for which it was created.” The court also found that Michael was given a reasonable opportunity to be heard and answer the charges against him, highlighting that he was represented by counsel and given the chance to cross-examine witnesses, which he declined to do. The court rejected Michael’s argument that the Legislature exclusively held the power to alter rights granted by the act of incorporation, stating that the Legislature could not have intended a life member to retain their position regardless of their actions or abuse of trust. The Court interpreted the statute’s provision for successor designation in cases of “death, resignation or otherwise” to include involuntary removal.

  • Boericke v. Stevenson, 43 N.Y.2d 704 (1977): Enforceability of Corporate Bylaws Requiring Supermajority Vote

    Boericke v. Stevenson, 43 N.Y.2d 704 (1977)

    A corporate bylaw requiring a supermajority vote for amendment is invalid if it conflicts with a state business corporation law stipulating a simple majority, unless such a provision is included in the certificate of incorporation; furthermore, a resolution to change the number of directors is ineffective absent a bylaw authorizing such a change by resolution.

    Summary

    This case concerns a dispute over the validity of a corporate bylaw requiring a two-thirds majority to amend certain bylaws, and the effectiveness of a simple majority resolution to increase the number of directors. The New York Court of Appeals held that the supermajority bylaw was invalid because it conflicted with the Business Corporation Law, which requires only a simple majority unless the certificate of incorporation states otherwise. The court also found that a simple majority resolution to increase the number of directors was ineffective because it was not authorized by an existing bylaw.

    Facts

    The shareholders attempted to amend the bylaws to increase the number of directors from four to five by a simple majority vote.

    Article VIII of the corporate bylaws required a two-thirds majority vote to amend certain bylaws, including the one setting the number of directors.

    There was no bylaw in effect that provided for changing the number of directors through a simple resolution.

    Procedural History

    The case was submitted to the Appellate Division under CPLR 3222, asking whether a simple majority resolution of the stockholders, increasing the number of directors, was valid and effective.

    The Appellate Division ruled in the negative.

    The New York Court of Appeals affirmed the Appellate Division’s order.

    Issue(s)

    1. Whether a corporate bylaw requiring a two-thirds majority shareholder vote to amend certain bylaws is valid when the Business Corporation Law allows for amendment by a simple majority unless the certificate of incorporation provides otherwise.

    2. Whether a simple majority resolution of the stockholders, increasing the number of directors, is valid and effective without an existing bylaw authorizing such a change by resolution.

    Holding

    1. No, because the Business Corporation Law clearly provides that a simple majority vote of the shareholders is sufficient to amend the bylaws, unless the certificate of incorporation provides otherwise.

    2. No, because subdivision (b) of section 702 of the Business Corporation Law requires either an amendment to the bylaws or a bylaw in effect that provides for the change by a simple resolution.

    Court’s Reasoning

    The court reasoned that the supermajority voting requirement in the bylaw was invalid because it directly conflicted with the Business Corporation Law, which mandates a simple majority for bylaw amendments unless the certificate of incorporation specifies otherwise. The court cited Matter of Faehndrich, 2 Y 2d 468, 473, 474, noting that the two-thirds majority vote provision would have been valid had it been placed in the certificate of incorporation.

    Regarding the resolution to increase the number of directors, the court pointed to Business Corporation Law § 702(b), which allows shareholders to change the number of directors either through a bylaw amendment or by a simple resolution *if* there is a bylaw in effect allowing for such a change by resolution. Because the shareholders acted by resolution alone, and no such bylaw existed, the resolution was deemed unenforceable. The court emphasized that “even though a simple shareholder vote could have effected a change in the number of directors if such a by-law had been adopted authorizing such a vote, their naked resolution to do so cannot be enforced.” This highlights the importance of following proper corporate governance procedures and adhering to the specific requirements of the Business Corporation Law.