• Court Upholds Complaint Seeking Common Law Dissolution of Family-Owned Business
  • June 30, 2012 | Author: Peter A. Mahler
  • Law Firm: Farrell Fritz, P.C. - New York Office
  • Almost 50 years ago, in Leibert v. Clapp, New York's highest court cemented a minority shareholder's common law right to judicial dissolution of a closely held corporation when the controlling shareholders "have so palpably breached the fiduciary duty they owe to minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by statute."

    Leibert reacted to a remedial vacuum that, 16 years later, was filled by the legislature's enactment of §§1104-a and 1118 of the Business Corporation Law authorizing courts to dissolve closely held corporations when the majority engages in "oppressive conduct" against minority shareholders, and giving the majority an election to purchase the petitioning shareholder's interest for fair value. But the statutes did not occupy the field completely due to their requirement that a minority shareholder petitioning for dissolution hold at least 20% of the corporation's voting shares. For the minority shareholder with less than 20% of the voting shares, or who holds non-voting shares in any percentage, common law dissolution remains the only avenue for realizing the fair value of his or her shares in the face of the controlling shareholders' squeeze-out tactics which often are designed to force the minority to sell out to the majority at a heavily discounted price.

    In the last 50 years there have been few reported decisions applying Leibert's common law dissolution standard, and even fewer that meaningfully explore and refine its broad principles. A trial court ruling earlier this month by Westchester County Commercial Division Justice Alan D. Scheinkman breaks the pattern and then some. Justice Scheinkman's thorough, 26-page decision in White v. Fee, 2012 NY Slip Op 51133(U) (Sup Ct Westchester County June 7, 2012), denying a defense motion to dismiss a complaint seeking common law dissolution of a large, family-owned firm, likely sets a new baseline for analysis of common law dissolution claims at the pleading stage. [Disclosure: The author of this blog represents a plaintiff in an unrelated common law dissolution case pending before Justice Scheinkman, in which a defense motion to dismiss the complaint awaits decision.]

    Reliable Automatic Sprinkler Co.: A Family-Owned Company

    White v. Fee involves a dispute among five siblings -- three brothers against two sisters -- who are the third generation owners of Reliable Automatic Sprinkler Co. Reliable bills itself as one of the world's largest producers of automatic fire sprinklers and sprinkler system control equipment. Headquartered in suburban Elmsford, New York, Reliable has approximately 700 employees and enjoys annual gross sales of about $220 million.

    The company was founded almost 100 years ago by Frank J. Fee. His son, Frank J. Fee, Jr., led the company from 1945 until his death in 1976 when his son, Frank J. Fee III ("Frank") became president. The senior management also includes Frank's two brothers, Kevin Fee and Michael Fee. Since their mother's death in 2009, the three brothers constitute the company's Board of Directors.

    The company's capital stock includes Class A voting shares and Class B non-voting shares. Since their father's death, the three Fee brothers have owned in equal thirds all 40 of Reliable's Class A voting shares. They also collectively own 275 Class B non-voting shares.

    Their two sisters, Marilyn White and Candida ("Candy") Funke, each received 50 Class B non-voting shares upon graduation from college and another 69.5 Class B shares each from a testamentary trust after their mother's death in 2009, giving them a collective total of 239 Class B shares. Neither sister is employed by the company or participates in its management.

    The siblings' father's will also established a residuary trust for their mother's benefit holding 264 Class B shares. In 1999, in a transaction disputed by the sisters, Frank as trustee sold 75 of those shares to himself and his brothers (25 each). The trust's remaining 189 Class B shares eventually will be distributed equally to the five siblings and to the children of a sixth sibling who predeceased the mother (those two children also own collectively another 50 Class B shares).

    As best as I can discern from the complaint in the case, which includes references to other Class B shares sold at earlier times to unidentified owners, including their partially disputed interest in the residuary trust shares, the sisters overall hold 35% to 40% of the company's capital stock in Class B non-voting shares.

    The Complaint

    The sisters' complaint for common law dissolution, filed in late 2011 (read here), broadly alleges that their brothers have "oppressively and systematically acted to strip Plaintiffs of their rights as shareholders and to devalue their holdings." The alleged oppressive conduct by the brothers includes:

    • declaring no shareholder dividends since 1990, at which time they starting paying their mother a salary in lieu of dividends
    • raising their own salaries every year
    • also paying themselves a percentage of Reliable's gross sales amounting to millions of dollars each year
    • refusing to discuss the no-dividend policy at shareholder meetings, and failing to record the sisters' objections in the meeting minutes
    • engaging in nepotistic hiring practices and paying selected family members excessive compensation and perquisites
    • using company funds to pay for multiple country club memberships
    • refusing offers by the outside family shareholders to redeem their shares
    • adopting a Class B stock redemption plan valuing the company at 50% of its actual fair market value
    • in 1999, selling to themselves at a discount to book value 75 Class B shares held in their father's testamentary residuary trust in violation of stock transfer restrictions in Reliable's certificate of incorporation
    • manipulating the company's finances by carrying excessive inventory, accumulating excessive retained earnings, and incurring excessive general and administrative expenses

    The Brothers' Motion to Dismiss

    The Fee brothers moved to dismiss the sisters' complaint, arguing that its allegations are not sufficiently particularized and that, even if accepted as true, they fail to state a valid claim for common law dissolution.

    The brothers contended that the sisters, as minority shareholders with non-voting shares, have no right to a liquidation of their interest. They also charged that the sisters brought the action "for the sole purpose of leveraging a favorable buyout of their shares by harassing their brothers and Reliable with unfounded allegations" that do not "establish any acts of misconduct which would provide a foundation for the breach of fiduciary duty claim in support of their application to dissolve Reliable."

    The brothers' motion also argued that the sisters' allegations surrounding the 1999 stock transfer and the 2004 stock redemption plan were barred by the applicable six-year statute of limitations and therefore could not be used in support of dissolution.

    The Decision

    Justice Scheinkman's decision recites in great detail the parties' opposing factual and legal contentions before turning to his own analysis of the applicable legal standards and his conclusion that the sisters' complaint adequately pleads a claim for common law dissolution.

    Justice Scheinkman's discussion of the common law dissolution case precedent, featuring Leibert v. Clapp, Lewis v. Jones, Lemle v. Lemle, Kruger v. Gerth, Shapiro v. Rockville County Club, Inc., and dicta in Matter of Kemp & Beatley (a BCL §1104-a case), is the most thorough treatment to date that I've seen on the subject, and is well worth a careful reading by business divorce practitioners. The salient principles drawn from these cases and highlighted in the decision include:

    • The plaintiff in a common law dissolution case must demonstrate that the majority shareholders seek to carry it on for the purpose of enriching themselves at the expense of the minority.
    • The fact that the corporation is operating profitably or that the complaining shareholders may have a right to relief by way of derivative suits or otherwise is not in itself a bar to compelling dissolution.
    • Dissolution may be warranted when the controlling shareholders act to force the minority to sell their shares to them at a sacrifice and to freeze them out of the corporation.
    • Dissolution also may be warranted based on allegations of accounting abuses, use of corporate funds for non-business related expenses, and payment of excessive compensation and benefits.
    • A common law right to dissolution exists when management breaches its fiduciary duty to the shareholders, however the breaches must be "egregious".
    • Common law dissolution may be warranted when the controlling shareholders are looting the corporate assets to enrich themselves at the minority's expense, continuing the corporation solely to benefit those in control, or whose actions are calculated to depress the capital of the corporation in order to coerce the minority to sell their stock at a depressed price.

    Justice Scheinkman concludes that the sisters' allegations of wrongdoing by their brothers adequately plead a claim for common law dissolution, summarizing as follows:

    . . . Plaintiffs have alleged far more than corporate waste, they have alleged, that Defendants as the only directors and the controlling voting shareholders of Reliable since their mother's death, have perpetuated Reliable's existence for their sole benefit and at the expense of the minority shareholders in an effort to freeze them out and require that they sell their shares at less than a fair market value price. Whether Plaintiffs will be able to substantiate these allegations is not the issue to be addressed in the context of a motion to dismiss where this Court must deem these allegations to be true. Accordingly, the motions to dismiss of Reliable and the Fee Defendants shall be denied. [Footnote omitted.]

    On the other hand, Justice Scheinkman agrees with the brothers that the sisters' allegations concerning the 1999 stock transfer and 2004 stock redemption plan are time-barred. Justice Scheinkman stresses the sisters' "admissions" that they "were well aware of these acts having occurred more than six years prior to the filing of this action and, indeed, in their pleadings Plaintiffs contend that they objected to the 2004 Redemption Offer at or about the time of its occurrence." For this same reason Justice Scheinkman rejects any "equitable tolling" of the statute of limitations as argued by the sisters.

    Finally, practitioners should take note of Justice Scheinkman's observation early in his decision, that at a February 2012 conference he was "unable to persuade" the defendants' counsel "to withdraw this motion" and that, "[d]espite the pendency of this motion" he ordered discovery to proceed. The decision also notes that discovery is due to be completed July 25, 2012, and that a trial readiness conference will be held the day after that. Stay tuned.