- Case Illustrates How Not to Plan for the Death of a Shareholder in a Professional Corporation
- June 21, 2011 | Author: Peter A. Mahler
- Law Firm: Farrell Fritz, P.C. - New York Office
The P.C., as in professional service corporation, has been called a "strange creature." The strangeness stems mainly from the statutory restrictions on the voluntary or involuntary transfer of ownership in a P.C. to persons who are not licensed members of one of the regulated professions permitted to utilize the P.C. business form under Title 8 of the Education Law, including lawyers, doctors, dentists, accountants and miscellaneous others.
In New York, P.C.s are governed by the same general provisions of the Business Corporation Law (BCL) applicable to all for-profit business corporations, including Articles 10 and 11 of the BCL governing voluntary and judicial dissolution. The P.C. ownership transfer restrictions, along with other provisions specific to the formation, operation, limited liability and disposition of P.C.s, are collected in Article 15 of the BCL. The somewhat obscure interplay between the general dissolution provisions in BCL Articles 10 and 11 and the P.C. ownership transfer restrictions in Article 15 can create havoc for the professional in a multi-member P.C. who fails to appreciate those provisions or, worse yet, fails to enter into a shareholders' agreement that protects the professional's financial interests under various exit scenarios including death.
It's hard to imagine a more painful illustration of such havoc than the case decided last week by a Brooklyn appellate court involving a P.C. dental practice in which the majority shareholder died without a shareholders' agreement, called Matter of Bernfeld (Michael Bernfeld, D.D.S. and Yakov Kurilenko, D.D.S., P.C.), 2011 NY Slip Op 05071 (2d Dept June 7, 2011). The deceased dentist's widow, who had found a buyer for the practice's assets for over a half million dollars, now stands to walk away empty handed as a result of the statutory default provisions that prevent her both from seeking judicial dissolution and from resisting the surviving shareholder's right to have the P.C. purchase her late husband's interest possibly at negative book value.
The Facts: Michael Bernfeld and Yakov Kurilenko had a dental practice known as Howard Beach Dental Associates in Brooklyn, New York. The practice, organized as a P.C., was owned 75% by Bernfeld and 25% by Kurilenko. Bernfeld and Kurilenko had no shareholders' agreement. Bernfeld died in September 2009 at the age of 64. The P.C. had significant bank debt. The practice's website lists four other associate dentists. Bernfeld's wife, as executor, hired a business broker and secured an offer from dentist Fred Cohen to purchase the P.C.'s assets for $530,000. On February 16, 2010, Mrs. Bernfeld held a shareholder meeting at which she voted to dissolve the P.C., approve the sale of the P.C. to Cohen, and to appoint Cohen as business manager of the P.C. Kurilenko objected to the proposed sale. A week after the meeting, Mrs. Bernfeld petitioned under BCL Section 1103 for judicial dissolution of the P.C. In April 2010, Kurilenko sent Mrs. Bernfeld a written demand to purchase her shares for $0 based on an appraisal he obtained valuing the company's book value at negative $159,000 with no value assigned for goodwill.
What is Section 1103? BCL Section 1103 authorizes a shareholder petition for judicial dissolution of a close corporation "[i]f the shareholders . . . adopt a resolution stating that they find that its assets are not sufficient to discharge its liabilities, or that they deem a dissolution to be beneficial to the shareholders . . .." Under subsection (c), such a resolution "may be adopted at a meeting of the shareholders by vote of a majority of the votes of all outstanding shares entitled to vote thereon." This type of judicial dissolution proceeding is extremely rare, the reason being that the same majority required to authorize it can and almost always will opt for a non-judicial, voluntary dissolution.
Did Mrs. Bernfeld Have Standing to Seek Dissolution? This is the crux of the case. Kurilenko moved to dismiss the petition based on Mrs. Bernfeld's lack of standing to seek dissolution under Section 1103. Both the trial judge and the appellate panel agreed with Kurilenko based on the stock-voting proscriptions applicable to non-eligible P.C. shareholders under BCL Section 1511, which states in pertinent part:
No shareholder of a professional service corporation may sell or transfer his shares in such corporation except to another individual who is eligible to have shares issued to him by such corporation or except in trust to another individual who would be eligible to receive shares if he were employed by the corporation. Nothing herein contained shall be construed to prohibit the transfer of shares by operation of law or by court decree. No transferee of shares by operation of law or court decree may vote the shares for any purpose whatsoever except with respect to corporate action under [BCL § 909] and [BCL § 1001]. . . (italics added).
Under the statute, Mrs. Bernfeld, as transferee of her late husband's shares by operation of law, is permitted to vote her shares for two purposes only. First, under BCL Section 909 which addresses the "sale, lease, exchange or other disposition of all or substantially all the assets of a corporation" and, second, under BCL Section 1001 relating to voluntary dissolution of a corporation by a vote of either a majority or two-thirds of the outstanding shares depending when the corporation was formed. The appellate court's opinion, written by Associate Justice John M. Leventhal, essentially holds that the statute means what it says, and what it says excludes authorization for a nonprofessional transferee to vote for judicial dissolution:
. . . Business Corporation Law § 1511 enumerates the specific matters upon which a nonprofessional shareholder in a professional corporation who owns shares by operation of law may vote. Although voluntary dissolution under Business Corporation Law § 1001 is one of those matters, a vote in favor of a shareholder's petition for judicial dissolution pursuant to Business Corporation Law § 1103 is not. Thus, Business Corporation Law § 1511, standing alone, statutorily bars the petitioner from obtaining a judicial dissolution of the P.C. pursuant to Business Corporation Law § 1103.
What About Fromcheck? It's not as if Mrs. Bernfeld had no support whatsoever for her position. She argued, with enough justification to merit extended discussion in the appellate court's opinion, that under the Second Department's 1998 ruling in Matter of Fromcheck (Brentwood Pain & Medical Services, P.C.), 254 AD2d 485, Section 1103 should be construed in favor of her standing to seek judicial dissolution. In Fromcheck the court dismissed a judicial dissolution petition under BCL Section 1104-a alleging shareholder oppression because the petitioner did not own shares in the subject P.C. Section 1104-a authorizes a dissolution petition brought by a minimum 20% shareholder "entitled to vote in an election of directors." Fromcheck implied that if BCL Sections 909 and 1001 related to the election of directors, then a petition under Section 1104-a may have been permitted. Mrs. Bernfeld therefore argued that a nonprofessional transferee may seek judicial dissolution under Section 1103 because that section, unlike Section 1104-a, does not have the limiting language, "entitled to vote in an election of directors." The court disagreed, stating that Section 1511 "clearly proscribes the types of corporate action upon which a nonprofessional shareholder, such as the petitioner, may vote." The court further notes that the distinctive limiting language in Section 1103 (judicial dissolution resolution may be adopted by a vote of "a majority of the votes of all outstanding shares entitled to vote thereon") is consistent with the strict limitations on voting rights under Section 1511.
What of the February 16, 2010 Resolution? Recall that Mrs. Bernfeld used her 75% voting power to adopt a resolution authorizing dissolution of the P.C. and a sale of the practice to a third party. Shouldn't it have had legal force under Section 1511 as a permitted voting exercise under BCL 1001 relating to voluntary dissolution? In theory, perhaps, but the problem is, Mrs. Bernfeld never carried through with voluntary dissolution. As the court observes, a voluntary dissolution is effectuated not by judicial petition, but by filing a certificate of dissolution with the Department of State. "Thus," the court continues,
a nonjudicial dissolution pursuant to Business Corporation Law § 1001 does not require a court's permission, the Supreme Court correctly determined that dissolution pursuant to Business Corporation Law § 1001 does not require court action and, therefore, there was no need to address the impact, if any, of the resolution dated February 16, 2010.
Mrs. Bernfeld, the court adds, suffered under "a misapprehension of the distinctions between voluntary dissolution under Business Corporation Law article 10 and judicial dissolution under Business Corporation Law article 11 . . .."
Whence Kurilenko's Buyout Right? In April 2010, Kurilenko offered a $0 buyout of Mrs. Bernfeld's 75% interest based on an appraisal showing negative book value of the practice. Can he enforce it? The answer lies in BCL Section 1510 which works in tandem with Section 1511 to regulate the passage of P.C. ownership interests to (1) avoid ownership by nonprofessionals and (2) preclude the departed shareholder (or his or her estate representative) from transferring the interest to another professional without the remaining shareholders' consent. Absent a permitted transfer to another professional, under Section 1510(a) the P.C. must redeem at book value the shares of a deceased or de-licensed shareholder. Here's the pertinent portion of the statute:
A professional service corporation shall purchase or redeem the shares of a shareholder in case of his death or disqualification pursuant to the provisions of section 1509, within six months after the appointment of the executor or administrator or other legal representative of the estate of such deceased shareholder . . . at the book value of such shares as of the end of the month immediately preceding the death or disqualification of the shareholder as determined from the books and records of the corporation in accordance with its regular method of accounting.
Importantly, the statute also expressly authorizes the shareholders to modify the redemption period or pricing method by provision in the P.C.'s certificate of incorporation, by-laws or, as is more often the case in practice, in the shareholders' agreement.
Would a Voluntary Dissolution Cut Off Kurilenko's Buyout Right? Let's assume Mrs. Bernfeld had carried through and filed with the Department of State a voluntary certificate of dissolution. Would it have precluded Kurilenko's subsequent demand to purchase Mrs. Bernfeld's shares for book value? The court's opinion notes that the issue is not squarely presented for decision, but it hints that, as the surviving professional shareholder, Kurilenko's right under BCL Section 1510 to acquire Mrs. Bernfeld's shares for book value likely would not have been defeated by a voluntary dissolution. Here's what the court says:
Moreover, it remains unresolved whether the P.C.'s right to purchase the petitioner's shares pursuant to Business Corporation Law § 1510 can be nullified by dissolution. Once dissolved, a corporation continues to "function for the purpose of winding up the affairs of the corporation in the same manner as if the dissolution had not taken place" (Business Corporation Law § 1006[a]). Arguably, in this post-dissolution state, the P.C. could still act under Business Corporation Law § 1510.
Does Mrs. Bernfeld Have Any Recourse? Yes, but likely limited to contesting the buyout price. Citing a number of cases, the court in Bernfeld states that "[t]he parties' contentions regarding Kurilenko's timely offer to purchase the petitioner's shares pursuant to [BCL] § 1510 for 'book value' of $0 are more properly raised in an action to compel purchase or redemption." Such an action, the court further notes, "would be the appropriate vehicle in which the petitioner could argue that compelling her to sell her shares at 'book value' would result in an unjust hardship to the decedent's estate or result in a windfall to Kurilenko."
Get Thee a Shareholders' Agreement. Any multi-owner P.C. without a shareholders' agreement including buy-sell provisions is asking for trouble. Perhaps Dr. Bernfeld was lulled by the fact of his 75% ownership into believing that his future executor could do as she wished to sell the practice. All of the problems facing Mrs. Bernfeld could have been foreseen and avoided with adequate planning by way of shareholders' agreement providing for a funded or unfunded buyout of the estate of a deceased shareholder, or alternatively mandating a sale of the practice. To like effect is Justice Leventhal's closing admonition to the parties in Bernfeld:
Lastly, we note that the entire controversy relating to the valuation of the petitioner's shares could have been obviated had the decedent and Kurilenko crafted a certificate of incorporation, shareholder agreement, or other provision providing for a method of valuation of the P.C., other than by the book value, in accord with the P.C.'s regular method of accounting (see Business Corporation Law § 1510).
Amen to that.