New York Law Review

Tag: shareholder rights

  • 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.

  • 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.

  • 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.

  • Matter of General Host Corporation, 30 N.Y.2d 262 (1972): Validity of Corporate Elections and Shareholder Rights

    Matter of General Host Corporation, 30 N.Y.2d 262 (1972)

    A corporate election will not be overturned due to an individual wrong to a shareholder unless it is shown that the outcome of the election would have been different had the wrong not occurred; mere misrepresentations are insufficient.

    Summary

    This case addresses whether a corporate election should be invalidated when a significant shareholder (Goldfield) was denied the opportunity to vote due to a breach of duty by the corporation (General Host) acting as a pledgee, and when other shareholders received incorrect information about the voting rights of those shares. The court held that while General Host may have wronged Goldfield, the election was valid because there was no evidence that the outcome would have been different had the wrong not occurred, or that other shareholders were materially misled.

    Facts

    Goldfield beneficially owned 16.7% of General Host’s outstanding common stock, which was pledged to Union Bank of Los Angeles. General Host acquired the notes secured by the pledge. General Host transferred the shares into its name as pledgee after Goldfield allegedly defaulted, but did not notify Goldfield of this transfer. As a result, Goldfield did not receive notice of the annual meeting. Proxy materials indicated that Goldfield’s shares were pledged and might not be voted if a default was called or an option to purchase was exercised. General Host later sent a notice of default to Goldfield and informed shareholders that Goldfield’s shares could not be voted, without disclosing the earlier transfer of record title. Goldfield attended the meeting but was not allowed to participate as a representative.

    Procedural History

    Goldfield petitioned to annul the corporate meeting and set aside the election of directors. The Supreme Court initially heard the case. The Appellate Division’s order, presumably affirming the lower court’s decision upholding the election, was appealed to the New York Court of Appeals.

    Issue(s)

    1. Whether the corporate election should be annulled because Goldfield, a beneficial owner of a substantial number of shares, was not given notice of the meeting.

    2. Whether the corporate election should be annulled because proxy materials contained misrepresentations about Goldfield’s right to vote its shares.

    3. Whether General Host’s breach of duty to Goldfield as a pledgee warrants overturning the election, even if the misrepresentations did not affect shareholders at large.

    Holding

    1. No, because Goldfield was not the owner of record on the record date and therefore was not entitled to notice.

    2. No, because other shareholders were not misled by the alleged misrepresentation; Goldfield made no attempt to solicit proxies or propose an alternative slate of directors.

    3. No, because despite the wrong done to Goldfield, there was no possibility of a different result in the election.

    Court’s Reasoning

    The court reasoned that while failure to provide proper notice generally renders an election void, Goldfield was not the record owner on the record date and therefore wasn’t entitled to notice. The court acknowledged that it *could* look beyond record ownership in some cases, but not here. The court emphasized that an election will not be overturned for just *any* misrepresentation. Instead, courts should consider the materiality of the misrepresentation, the completeness of other available information, and the likelihood that shareholders might have voted differently. The court quoted Matter of Hoe & Co. stating, “Even assuming there were misstatements or concealments, the election may not be set aside unless the court concludes further that the result would have been different had no such improprieties been injected into the proxy campaign, or that an inequitable result has been thereby produced”.

    Even though General Host wronged Goldfield by failing to notify them of the record transfer (preventing Goldfield from obtaining a proxy), this individual wrong did not justify a new election. Goldfield never attempted to solicit proxies or propose an alternative slate of directors. Management controlled 60% of the vote by the meeting date. The court noted, “There being no possibility of a different result, whatever wrong was done to Goldfield as an individual shareholder does not justify holding a new election, with all the practical problems entailed.” The court referenced the pledgee’s duty to issue a proxy to the pledgor upon demand (Business Corporation Law, § 609, subd. [d]). However, this duty did not change the outcome because of Goldfield’s inaction and management’s control of the vote.

  • Haberman v. W состоящий в Federal Sav. & Loan Ass’n, 17 N.Y.2d 85 (1966): Establishes Member’s Right to Inspect Membership List in Federal Savings & Loan

    Haberman v. W состоящий в Federal Sav. & Loan Ass’n, 17 N.Y.2d 85 (1966)

    A member of a federally chartered savings and loan association has a common-law right, similar to that of a corporate shareholder, to inspect the association’s membership list, subject to a showing of good faith and a proper purpose.

    Summary

    The New York Court of Appeals held that members of a federal savings and loan association have a common-law right to inspect the association’s membership list, analogous to shareholders’ rights in a corporation. This right is not absolute and is contingent upon the member demonstrating “good faith” and a “proper purpose” for seeking the inspection. The court emphasized that this right is limited to names and addresses only to protect the privacy of other members. The court reversed the lower court’s decision, remanding the case for a hearing to determine if the petitioners had the requisite “good faith”.

    Facts

    Haberman and Schulze, through their construction company, acquired an apartment building subject to a mortgage held by West Side Federal Savings and Loan Association. After West Side Federal denied their requests to increase the mortgage and refused to waive a prepayment charge and refund an origination fee, Haberman sued the association unsuccessfully. Subsequently, Haberman, Schulze, and Haberman’s sister-in-law opened savings accounts with the association and then initiated a special proceeding seeking to inspect the association’s minute book and membership list, alleging mismanagement by the board of directors.

    Procedural History

    The trial court granted the petition for inspection of the membership list but not the minute book, finding an issue of fact regarding the petitioners’ good faith. The Appellate Division affirmed. The Court of Appeals reversed the Appellate Division’s order and remitted the case to the Special Term for a hearing to determine the issue of fact regarding the petitioners’ good faith.

    Issue(s)

    1. Whether a member of a federally chartered savings and loan association possesses a common-law right to inspect the association’s membership list, similar to the right of a shareholder in a corporation.

    2. Whether the enforcement of this inspection right is contingent upon the member demonstrating “good faith” and a “proper purpose”.

    Holding

    1. Yes, because the court found a close analogy between the rights and duties of a shareholder in a corporation and a member in a savings and loan association, justifying the extension of the common-law inspection right to association members.

    2. Yes, because the common-law inspection right is enforceable subject to the sound discretion of the Trial Judge and upon a showing of good cause, good faith, and a proper purpose; an issue of fact concerning the petitioners’ good faith was raised in this case.

    Court’s Reasoning

    The court reasoned that while no New York statute directly applies to the internal management of federal savings and loan associations, the enactment of state corporate controls did not diminish common-law safeguards for shareholder inspection rights. The court drew a strong analogy between the rights of shareholders and association members, noting their similar financial interests, voting rights, and ability to participate in management. The court quoted Matter of Steinway, stating, “We do not think that the statute now in force is exclusive, or that it has abridged the common-law right of stockholders with reference to the examination of corporate books…By simply providing an additional remedy the existing remedy was not taken away.”

    The court emphasized that the inspection right is not absolute and must be exercised in good faith and for a proper purpose. The court stated, “As this court stated in Matter of Steinway (supra, p. 263) : ‘We think that, according to the decided weight of authority, a stockholder has the right at common law to inspect the books of his corporation at a proper time and place, and for a proper purpose.’” It found a triable issue of fact regarding the petitioners’ good faith, given their prior dispute with the association and the timing of their request for inspection. The court determined that a hearing was necessary to resolve this factual issue before the inspection right could be enforced, since using the inspection right for harassment or personal gain, rather than for the benefit of the association, would be an improper purpose.