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.