New York Law Review

Tag: Shareholder Agreements

  • In re Penepent Corp., 96 N.Y.2d 186 (2001): Enforceability of Shareholder Agreements vs. Statutory Election

    In re Penepent Corp., 96 N.Y.2d 186 (2001)

    When a shareholder in a close corporation makes an irrevocable election to purchase another shareholder’s shares at fair value under Business Corporation Law § 1118 in response to a dissolution petition, that election takes precedence over a mandatory buy-out provision in a shareholder agreement that would otherwise be triggered by the petitioning shareholder’s death.

    Summary

    Francis Penepent, a shareholder in Penepent Corp., petitioned for dissolution under Business Corporation Law § 1104-a. Richard Penepent, another shareholder, elected to purchase Francis’ shares at fair value under § 1118. Before the fair value was determined, Francis died. A shareholder agreement stipulated that upon a shareholder’s death, the estate must surrender the shares to the corporation for a set price, lower than the anticipated fair value. The court addressed whether Richard’s election remained binding despite Francis’ death and the shareholder agreement. The Court of Appeals held that Richard’s § 1118 election was irrevocable and took precedence over the shareholder agreement’s buy-out provision. Once the election is made, it creates a vested right to receive fair value, which survives the shareholder’s death.

    Facts

    Anthony Penepent started Penepent Corp. with his four sons, each holding a 20% share. They entered into a shareholder agreement stating that upon a shareholder’s death, the corporation would purchase the deceased’s shares at a predetermined price. Later, the four sons bought out their father, each holding a 25% share. Disputes arose, and Francis petitioned for dissolution under Business Corporation Law § 1104-a. Richard elected to purchase Francis’ shares at fair value under § 1118. Before fair value was determined, Francis died. Richard then asserted the shareholder agreement required Francis’ estate to sell the shares to the corporation at the lower, predetermined price.

    Procedural History

    Francis filed for dissolution; Richard elected to purchase his shares. Supreme Court denied Richard’s motion to dismiss the dissolution proceeding and to revoke his § 1118 election, holding that Francis’ right to fair value vested upon Richard’s election. The Appellate Division affirmed. Richard argued for a discount in the share value due to a separate pending dissolution proceeding. The referee rejected this argument, which the Supreme Court adopted. The Appellate Division affirmed, and Richard appealed to the Court of Appeals.

    Issue(s)

    1. Whether a mandatory buy-out provision in a shareholder agreement controls when a valid Business Corporation Law § 1118 election has already been made to purchase shares at fair value before the event triggering the buy-out provision (death) occurs.

    2. Whether the value of shares should be discounted because of a separate, pending dissolution proceeding when the election to purchase shares in the present dissolution proceeding has already been made.

    Holding

    1. Yes, because once a shareholder makes an irrevocable election to purchase shares under Business Corporation Law § 1118, that election creates a vested right to receive fair value, which takes precedence over a mandatory buy-out provision triggered by death.

    2. No, because a pending dissolution proceeding involving different shareholders does not impact the fair value of the shares in a separate proceeding where an election to purchase has already been made.

    Court’s Reasoning

    The Court reasoned that Richard’s § 1118 election was irrevocable and binding. The purpose of making the election irrevocable was to prevent majority shareholders from delaying dissolution proceedings and exhausting the petitioning shareholder’s resources. The Court emphasized that once the election is made, the purchasing party is obligated to purchase the shares at fair value. The divestiture event (Francis’ death) occurred after Richard made the election, solidifying Francis’ right to fair value. The Court distinguished cases where shareholder agreements divested shareholders of their shares *before* a dissolution proceeding was commenced. Regarding the valuation discount, the Court stated that any litigation pending against the corporation could be considered. However, in this instance, the pending dissolution proceeding had no bearing on fair value because Richard had already irrevocably elected to purchase the shares. The court stated the objective in calculating “fair value” is to determine “what a willing purchaser in an arm’s length transaction would offer for petitioners’ interest in the company as an operating business”. Furthermore, imposing a discount due to a minority shareholder’s lack of control would violate equitable principles of corporate governance, depriving minority shareholders of their proportionate interest and treating shares of the same class unequally. The court quotes, “the stock so purchased shall be delivered and surrendered by the representative of the [deceased] to the Corporation, which shall thereupon retire such stock.”, illustrating the original agreement terms but ultimately prioritizing statutory rights.

  • 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.