You Sued for Dissolution, They Elected to Buy You Out, What Else Do You Want?

June 18, 2018

Article 11 of the Business Corporation Law features multiple provisions giving judges broad authority and discretion to impose interim remedies designed to preserve corporate assets and otherwise to protect the petitioning minority shareholder’s interests pending judicial dissolution and buy-out proceedings involving closely held New York corporations. They include appointment of a temporary receiver, injunction, setting aside certain conveyances, and bonding the eventual buy-out award.

As in any type of civil litigation, an application for one or more of Article 11’s interim remedies can be motivated by tactical as well as strategic goals, namely, to paint the adverse party as the “bad guy” and to gain leverage for settlement purposes.

Matter of Hammad v Al-Lid Food Corp., Decision and Order, Index No. 518406/17 [Sup Ct Kings County May 29, 2018], decided last month by Brooklyn Commercial Division Justice Sylvia G. Ash, looks like one of those cases in which tactical ambitions overshadowed strategic merit, resulting in the court’s denial of the minority shareholder-petitioner’s motion to impose multi-faceted interim, coercive remedies against the controlling shareholders, well after the corporation elected to purchase the petitioner’s shares for fair value.

Broken Band of Brothers

The Al-Lid case involves a family enterprise of five brothers who co-own seven separate companies, four of which own commercial real estate and three of which are retail operations. For many years, petitioner Nedal Hammad, who holds 25% of the shares in each company, controlled the day-to-day operations of all seven companies as a salaried officer and through his separate management company.

In August 2017, the four other brothers exercised their combined majority vote to remove Nedal as an officer and director of all seven companies and to replace him with two of the other brothers as the directors and operating officers. They did so based on their belief that Nedal was paying his management company excessive and/or unauthorized fees, acting unilaterally in derogation of the rights and duties of the companies’ other officers and directors, and refusing to provide his brothers with access to the company’s financial records.

The following month, Nedal filed seven separate petitions — one for each company — claiming that his ouster constituted oppressive conduct by his brothers warranting judicial dissolution and liquidation under Section 1104-a of the Business Corporation Law.

The three operating companies, but not the realty companies, subsequently elected to purchase Nedal’s shares for fair value, thereby avoiding further dissolution proceedings. One of the three was Al-Lid Food Corp. which operates a KeyFoods supermarket in Brooklyn.

In January 2018, Al-Lid offered Nedal $250,000 for his shares less the $75,000 Nedal allegedly took from the company as a “loan” shortly before his ouster. Nedal rejected the offer.

Nedal’s Motion for Interim Remedies

Two months later, Nedal filed a motion accusing his brothers of assorted misconduct including misappropriation of company assets and taking excessive compensation following their takeover, and seeking a range of interim remedies, including:

enjoining his brothers from engaging in any transactions outside the ordinary course of business;
collecting any debt owed the company absent court approval;
using company funds for legal fees in the litigation;
voiding any transfers of “property” from the company to any of its shareholders;
appointing a temporary receiver to take full control of the company’s affairs;
requiring the company to post a bond to secure the eventual fair value award; and
referring the case to a judicial hearing officer to determine the fair value of Nedal’s shares.

Nedal’s brothers vigorously denied wrongdoing on their part and argued that, following the company’s election to purchase Nedal’s shares, his only legitimate interest going forward is in receiving payment for the fair value of his shares determined as of the day before he filed his dissolution petition in September 2017, and that Nedal failed to show that the company lacked the financial wherewithal to pay any award. They also argued that Nedal’s request to have a judicial hearing officer, rather than the presiding judge, hold a hearing to determine the fair value of his shares is contrary to BCL section 1118.

The Court’s Decision

After summarizing the parties’ contentions, Justice Ash’s analysis went straight to the heart of the issue, declaring:

The issues alleged by [Nedal] are remedied by the Corporation’s [election] to purchase [Nedal’s] shares at the fair value retroactive to the day prior to the date on which the petition was filed irrespective of the Corporation’s actions. Moreover, there is no indication that the Corporation is in jeopardy of losing its financial ability to pay [Nedal] the fair value of his shares absent an injunction or a security bond. Accordingly, the court finds that the appointment of a receiver is not warranted and would be a waste of the Corporation’s assets.

Justice Ash cited in support the O’Connor v Coccadotts case, about which I wrote here, where for similar reasons Justice Richard Platkin likewise declined to grant injunctive relief pending a buy-out, emphasizing that following a buy-out election, the financial risk of future decisions concerning the business “falls squarely” on the remaining shareholders and not on the petitioner.

Justice Ash nonetheless handed Nedal a partial if pyrrhic victory on the issue of his brothers using company funds to pay legal fees in the dissolution action, holding that, consistent with the Appellate Division, First Department’s 1985 decision in Matter of Public Relations Aids, Inc., company funds may be used for legal fees following — but not before — the election to purchase the petitioner’s shares. The decision does not disclose whether, in fact, company funds were used for legal fees pre-election, but assuming they were, (a) the election was made very soon after the petition was filed, so the amount of fees would likely be modest, and (b) any such funds are to be refunded to the company, which does nothing for Nedal and does not impact the valuation to be determined as of the day before he filed his petition.

Referee’s Appointment

One other aspect of Justice Ash’s decision deserves mention, and that is, her grant of Nedal’s request to refer the case to a judicial hearing officer (a/k/a Special Referee) “to determine the fair value of [Nedal’s] shares.” This raises two questions: Does BCL Article 11 authorize appointment of a Special Referee to conduct the fair value hearing and, if so, is it to “determine” fair value or to “hear and report” to the court for its confirmation, rejection, or modification of the Special Referee’s recommendation?

On the one hand, the buy-out statute, BCL section 1118, states that when an election to purchase is made and the parties cannot agree on fair value, “the court . . . may stay the [dissolution] proceedings . . . and determine the fair value of the petitioner’s shares.”

On the other hand, BCL sections 1108 (“If a referee was not designated in the order to show cause, the court, in its discretion, may appoint a referee when or after the order is returnable”) and 1109 (“The decision of the court or the report of the referee shall be made and filed with the clerk of the court with all convenient speed”) both contemplate the appointment of a Special Referee, albeit without explicit reference to valuation hearings.

In my experience and observations over the years, I’ve seen plenty of instances in which Special Referees have been appointed to hear and report on the fair value of the petitioner’s shares, but not to “determine” the fair value unless both sides consent to a “hear and determine” appointment.

The Takeaway. Once the company or the respondent shareholders elect to purchase the petitioning minority stockholder’s shares for fair value, the petitioner effectively is relegated to creditor status, awaiting determination and payment of the fair value award based on an appraisal as of the day prior to the date on which the petition was filed. This is a bit of an over-generalization, given the theoretically available — but rarely sought and even more rarely granted — possibility of the electing party later applying to the court to revoke the election.

The petitioner clearly has an interest in seeking a judicial remedy to secure the future award when the circumstances cast doubt on the electing party’s ability to pay it. I once applied successfully to the court on behalf of a minority shareholder, following an election to purchase, to require the company to post a bond to secure the estimated fair value of the shares; when the company failed to post the bond, the court revoked the election and the company subsequently was dissolved.

But in the ordinary case such as Al-Lid, where there’s no genuine issue of the electing company’s or shareholder’s ability to finance the buy-out, it will almost always be a tough sell to convince the court to grant interim remedies designed to constrain or eliminate managerial control of the company’s affairs by the respondent shareholders who alone will bear the risk and reward of the company’s post-petition fortunes.