Judicial Dissolution as the Nuclear Option When Other Means Falter

February 25, 2019

nu•cle•ar op•tion (noun): the most drastic or extreme response possible to a particular situation

The litigation arsenal of business divorce lawyers contains weapons of varying firepower. The choice of weapon for any particular assignment will depend on many factors including the type and size of the business; whether the client is a controlling or non-controlling owner; the nature of the dispute; the form of the business entity (LLC, close corporation, partnership); the character and magnitude of the adverse owner’s complained-of actions and whether the claimed injury is to the owner directly or derivatively; the likelihood or not of reconciling the co-owners’ differences; the impact of litigation on the company’s business and employees; the client’s time horizon and ability to finance the litigation; and the client’s ultimate divorce preference, be it selling the company or its assets on the open market, buying out the other owner, being bought out, or dividing the company’s assets when possible.

The Books and Records Proceeding

The basic weapons in the arsenal are threefold, the lowest caliber one being a lawsuit by a non-controlling owner to compel access to company books and records that the controlling owner refuses to make available. This weapon is designed to gather information of managerial and financial abuse by the controlling owner that, in a best case scenario for its wielder, provides ammunition for a negotiated outcome without necessarily having to air, much less prove in a public forum, specific allegations of malfeasance by the controller. When handled properly, it can be a relatively simple, expeditious, and cost-effective exercise.

The Plenary Action for Breach of Fiduciary Duty, Etc.

Taking it up a notch, next is the all-purpose plenary action commenced by ordinary summons and complaint asserting direct and/or derivative claims for money damages and/or equitable remedies based on breach of fiduciary duties, breach of contract, fraud, and various and sundry other business torts. Cases of the sort can involve intense motion practice at the outset for interim injunctive relief, followed by countersuit and more motion practice, followed by prolonged discovery proceedings, followed by summary judgment motions, followed by trial, followed by appeals — all of which can take years.

Cases of the sort also signal an irreconcilable rupture of relations between co-owners and, taking into consideration the potentially fearsome costs of litigation on both sides, can properly be used and viewed as tactical lawsuits designed to enhance negotiating leverage for a buy out or other type of settlement agreement allowing the co-owners to part ways.

Judicial Dissolution

Finally, there’s what I call the nuclear option: a summary proceeding seeking involuntary a/k/a judicial dissolution of the company and liquidation under the supervision of a court-appointed receiver. Under New York law, when a minority shareholder seeks dissolution on grounds of oppression, the majority can avoid a possible corporate death sentence by electing to purchase the minority owner’s shares for fair value. There is no similar buy-out election in dissolution cases based on shareholder or director deadlock, however.

Absent a buy-out, the dissolution action is a bet-the-company gamble, the mere pendency and public knowledge of which can have a negative impact on operations, customer and vendor relations, availability of financing, and employee morale and turnover. If the company has goodwill value and remains viable through the turmoil, and if a liquidation sale of the company’s assets would wipe out considerable equity value, chances are one ownership faction sooner or later will buy out the other. If the company is not viable . . . well, as I like to say, who wants to spend money litigating over a corpse?

The Nuclear Option Illustrated

All of which brings to mind a recent decision by Commercial Division Justice Richard M. Platkin of the Albany County Supreme Court in Matter of Papakonstadinou (Gozzer Corp.), 2019 NY Slip Op 50164(U) [Sup Ct Albany County Jan. 31, 2019]. The case involves a deadlock dissolution petition under BCL § 1104 (a). Justice Platkin’s decision denied the respondent’s pre-answer motion to dismiss the petition; found that the petitioner had shown a “significant likelihood of success of the merits”; and granted the petitioner’s request to appoint a temporary receiver to take control of the company’s assets consisting primarily of a commercial property being used rent-free by the respondent’s separate company and which attracted an outside purchase offer for $850,000.

The particulars of the case and the grounds for dissolution don’t interest me as much as the fact that the dissolution petition was filed after three years of fairly intense, motion-heavy, inconclusive litigation in Queens County Supreme Court between the same parties. In that lawsuit, the parties sued and counter-sued each other mainly for money damages over ownership of the company’s shares, alleged misappropriation of company funds and diversion of business to their separately owned companies, and use of the company’s realty. In October 2018, the court referred the case to a Judicial Hearing Officer for trial scheduled to begin April 1, 2019.

Not long after the reference for trial, the defendant in the Queens County action finally used the nuclear option by petitioning for dissolution in Albany County where the now-defunct business was located. What’s interesting about the Albany filing is that the corporation’s certificate of incorporation names Queens County as the location of its office. Under BCL Article 11’s venue provision, the dissolution proceeding had to be brought in Queens County. Justice Platkin’s decision notes that the respondents in the dissolution case, who are the plaintiffs in the Queens County case, did not object to venue in Albany County.

I’m speculating here, but it’s as if both sides saw the writing on the wall, i.e., that the dissolution case had now become the main event that would drive the final resolution; that dissolution and appointment of a receiver likely would be granted; that the dissolution case likely would proceed far more quickly than the Queens County case; and that, as a practical matter, the winding-up process under a receiver in the dissolution case likely would preempt the claims and counterclaims in the Queens County action.

Along those lines, in his ruling Justice Platkin offered some astute comments on the interplay of the two cases as regards his appointment of a temporary receiver:

The appointment of the temporary receiver and the receiver’s due diligence regarding a sale of the Premises can be conducted in parallel with other significant events in this litigation and in the Queens County Action. Specifically, apart from issues of temporary relief, the next step in this proceeding is joinder of issue and prompt determination of petitioner’s dissolution claims. [Emphasis added.] Meanwhile, as [respondents] emphasize, “the reality is that the [Queens County] case is still currently scheduled for trial on April 1, 2019” (Reply Mem, p. 8).

Thus, by the time a receiver is appointed and qualified and has had the opportunity to examine the advisability of a sale of the Premises, it may be possible to have a ruling on dissolution in this proceeding, together with a verdict and accounting in the Queens County Action that can guide the work of the receiver should the application for dissolution be granted. And even if some or all of these issues are not decided by the time of the receiver’s report, the Court’s decision on a favorable sale recommendation from the receiver (if one is received) can be informed by, among other things, the present status of the cases and the potential prejudice to [respondents] that may result from allowing a sale of the Premises pendente lite.

Justice Platkin issued his ruling on January 31, 2019. Two weeks later, the lawyers in the Queens County case filed a stipulation jointly requesting the court to adjourn the trial date at least three months, from April to July, “to allow for the completion of discovery and mediation” (emphasis added). Is it a coincidence that the parties agreed to meet with a mediator to attempt settlement on the heels of Justice Platkin’s order appointing a receiver and predicting the likelihood that he will grant dissolution? I doubt it.

There are pluses and minuses to each of the litigation strategies available when business co-owners have a falling out and cannot resolve their disputes amicably. Counsel must carefully evaluate not only the legal merits but also the practical consequences of a judicial dissolution petition before recommending it to a client. In the Papakonstadinou case, the use of the nuclear option after three years of inconclusive litigation seems to have brought the parties much closer to a final resolution which, after all, is the goal of any business divorce.