Surrogate’s Court Declines to Order Demise of Fashion Business
November 27, 2017
When you want to sue to dissolve a business in New York on behalf of the estate of a deceased shareholder, to which court should you go: Supreme or Surrogate’s Court?
For many practitioners, the Commercial Division of the Supreme Court, a specialized court in New York focusing on complex business-related disputes, is the venue of choice. Most types of disputes have a minimum monetary threshold for eligibility in the Commercial Division. Manhattan’s threshold is the highest – $500,000. The rules of eligibility for cases to be heard in the Commercial Division, which you can read here, have three exceptions to the monetary threshold – one of which lists “[d]issolution of corporations, partnerships, limited liability companies, limited liability partnerships and joint ventures — without consideration of the monetary threshold.” In part because there is no monetary threshold for dissolution proceedings, practitioners in the several New York counties that have a Commercial Division usually litigate business dissolution disputes in the Commercial Division.
But once in a blue moon a dissolution case will wind up in the Surrogate’s Court.
The Role of the Surrogate’s Court in Business Dissolution Proceedings
Generally, the Surrogate’s Court decides cases involving the affairs of deceased individuals, including the probating of wills and administration of estates. How does a business dissolution proceeding end up in Surrogate’s Court? If the decedent dies with a will (testate) and there is no stock transfer or buy-sell restriction upon the death of a shareholder in the certificate of incorporation or shareholders’ agreement, then the shareholder may generally give (bequeath) his stock to whomever he or she chooses. Similarly, if the shareholder of a New York close corporation dies a resident of the State of New York without a will (intestate), then absent a stock transfer or buy-sell restriction, the deceased shareholder’s stock will pass by New York’s intestacy statute to his or her distributees. In a close corporation, where the shareholders typically are also key employees, officers, and/or directors, the death of a shareholder and the transfer of his or her stock to an heir or distributee can lead to an infinite variety of disputes. Such a dispute may lead the executor or administrator of the decedent’s estate, or the ultimate recipient of the decedent’s stock, to petition the Surrogate’s Court to dissolve the business, often with the goal of some form of buyout. Occasionally, this blog has written about dissolution cases in the Surrogate’s Court.
Background
Earlier this month, a rare Surrogate’s Court dissolution decision came out of Manhattan in In re Mui, Opinion and Order [Sur Ct NY County Nov. 8, 2017]. In re Mui arose out of the administration of the Estate of Peter Mui, a Chinese-American fashion designer, actor, and country musician. From 1988 to 2009, Mui was the 49% shareholder and Chief Executive Officer of Yellow River, Inc., a New York corporation in the business of clothing importing and wholesaling in Manhattan. According to Wikipedia, Mui’s main fashion niche was “shirts, adorned with tattoo designs.” As Surrogate Nora S. Anderson recounted in her opinion, Mui was the “creative force” behind Yellow River’s brand and was “irreplaceable in terms of his value to the Company.”
Mui had a wife and five children. In 2009, Mui died without a will. The Surrogate’s Court appointed Mui’s wife administrator of his estate. After Mui’s death, differences arose between Mui’s estate and Yellow River’s majority shareholder, Tungtex, Inc., which owned the remaining 51% of the company’s stock.
The Dissolution Claim
Mui’s estate sued for dissolution based on “oppression” under Section 1104-a of the Business Corporation Law. According to Mui’s administrator, Tungtex caused Yellow River to pay Mui dividends for at least four years before Mui’s death, but stopped them after Mui died. Mui’s administrator also alleged that, both before and after Mui’s death, Tungtex caused Yellow River improperly to pay Tungtex “management fees.” In the Court’s decision, which addressed dueling motions and cross-motions for summary judgment to grant and dismiss the estate’s dissolution claim (and the respondents’ counterclaims), Surrogate Anderson summarized the estate’s allegations of “oppression” as follows:
According to petitioner, after decedent’s death, Tungtex caused Yellow River to stop paying dividends to the estate and instead diverted its “accrued savings and earnings to Tungtex in the form of ‘management fees’ and other charges.” Petitioner further claims that while she was still grieving the loss of her husband and in need of funds to support decedent’s family, Tungtex pressured her, albeit unsuccessfully, to sell the estate’s 49% interest in Yellow River to Tungtex for $1,000,000, an amount far below what she believed to be the Company’s fair market value.
The Court explained that “these facts, if undisputed, could be a basis for the court to exercise its discretion and direct the dissolution of Yellow River under BCL 1104-a.” But the Court held that “Yellow River and Tungtex have offered sufficient evidence to create multiple fact issues” requiring a trial. Those fact issues included the following:
For example, according to [Tungtex’s president, Lam], Tungtex did not cause Yellow River to stop paying dividends to the estate after decedent’s death. Rather, he claims that Yellow River stopped paying dividends to all of its shareholders, i.e., decedent and Tungtex, almost a year prior to decedent’s death for economic reasons after the company’s revenues and profits had substantially decreased. Lam further avers that, contrary to petitioner’s contention, Yellow River did not divert funds to Tungtex after decedent’s death through the payment of management and other fees. Yellow River had paid management fees to Tungtex with decedent’s approval for many years prior to his death. The payments continued after decedent’s death in amounts that, according to Lam, were necessary and appropriate under the circumstances.
With regard to Tungtex’s attempt to buy out the estate – the other alleged act of “oppression” – the respondents “offer[ed] a sharply different version of the substance and tone of the conversations at issue,” raising the need for a trial whether there was any undue “pressure put on petitioner to sell the estate’s interest in Yellow River.”
As a result, both sides walked away without a conclusive ruling on the estate’s claim for dissolution, requiring either a future negotiated buyout or a trial.
The Need for Planning
It is often difficult for business owners, especially founders, to accept that they will not be with their company forever. In re Mui is a reminder to owners of closely-held businesses that if they do not, for whatever reason, make arrangements for their own death, they may very well leave their heirs and former business partners in the unfortunate position of having to sort things out through litigation. In the case of corporations, the remedy of dissolution based on oppression under BCL 1104-a may actually be undermined by the shareholder’s death. The death of a shareholder who is integral to the business may cause a sudden and dramatic reversal of the corporation’s fortunes, resulting in the corporation being forced to cease longstanding economic benefits to the shareholder’s estate, like dividend payments, upon which the deceased shareholder’s family came to rely. What the deceased shareholder’s family may regard as “oppression” the majority may regard as economic necessity.
Oddly enough, the decision in In re Mui referred to a “1988 Shareholder’s Agreement between decedent and Yellow River and Tungtex.” Presumably the shareholders’ agreement was silent about what happened to a shareholder’s stock upon the death of the shareholder, a subject typically addressed in shareholders’ agreements. In its decision, the Court referred to failed buyout negotiations between the parties. Had the parties included a simple buy-sell provision in the shareholder agreement, litigation might have been avoided altogether.
Finally, there’s no hard-and-fast rule about when to choose Surrogate’s Court over Supreme Court when seeking judicial dissolution on behalf of an estate. Those of us in the Business Divorce group here at Farrell Fritz generally focus on business dissolution litigation in Supreme Court, first, because the Commercial Division judges have the most experience with such matters and, second, because the vast majority of our dissolution cases do not involve estates. The latter naturally is not true of our colleagues in the Estate Litigation group whose practice generally lands them in Surrogate’s Court. According to Eric W. Penzer, a partner in the Estate Litigation group at Farrell Fritz:
Under the right circumstances, a practitioner might find it beneficial to pursue a dissolution claim in the Surrogate’s Court, a court of equity, before a jurist sensitive to and often protective of the interests of an estate, its beneficiaries, claimants and creditors.