49% Shareholder Can’t Seek Deadlock Dissolution Despite Shareholders’ Agreement Granting Co-Equal Control
July 30, 2018
Shareholders A and B are the sole shareholders of a real estate holding corporation. Their shareholders’ agreement includes provisions that:
- guarantee each of them a seat on the two-member board of directors and appoint each as co-president;
- prohibit their removal from the board with or without cause;
- in the event of death, disability, or resignation, authorize the vacant board seat to be filled by the departing shareholder’s child;
- require majority (i.e., effectively unanimous) board consent for all board actions;
- require 55% (i.e., effectively unanimous) shareholder consent for all actions needing shareholder approval.
Under these provisions, neither A nor B can take any action at the board or shareholder level without the other’s consent. Sounds like a perfect set-up for a deadlock dissolution petition in the event A and B reach impasse on some critical issue jeopardizing the corporation’s viability, doesn’t it?
What if I now add that Shareholders A and B own 49% and 51%, respectively, of the corporation’s common shares? Can Shareholder A still bring a deadlock dissolution petition?
Not according to a recent decision by Manhattan Commercial Division Justice Saliann Scarpulla in Balkind v Nickel, 2018 NY Slip Op 31703(U) [Sup Ct NY County July 16, 2018], in which she dismissed a deadlock dissolution petition filed under Section 1104 of the Business Corporation Law brought by a 49% shareholder, despite his co-equal board and shareholder control.
Section 1104 is one of the two provisions found in BCL Article 11 authorizing petitions for judicial dissolution of close corporations, the other being Section 1104-a dealing primarily with minority shareholder oppression, whereas Section 1104 deals with deadlock in its several manifestations including:
- that the directors are so divided respecting the management of the corporation’s affairs that the votes required for action by the board cannot be obtained (§ 1104 [a] );
- that the shareholders are so divided that the votes required for the election of directors cannot be obtained (§ 1104 [a] );
- that there is internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders (§ 1104 [a] ).
The decisive issue in Balkind was not whether grounds existed to petition for judicial dissolution — the central issues over which the co-owners allegedly were deadlocked were the listing and acceptable sale prices for the marketing and sale of the corporation’s sole realty asset consisting of a mixed use Manhattan property — but, rather, whether the petitioning 49% shareholder had standing to seek dissolution under the statute, which authorizes a petition by:
the holders of shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors . . ..
The petitioner in Balkind alleged in his petition, not without some logical support, that the statute’s standing requirement was satisfied despite his 49% stock ownership because, under the terms of the shareholders’ agreement summarized above, the petitioner and respondent “each have an equal (or one-half right) to elect directors of the Corporation.” As further elaborated in the petitioner’s brief opposing dismissal, the parties’ voting agreement in their shareholders’ agreement rendered the respective ownership percentages “irrelevant”
because the focus of BCL § 1104 is whether “the management of the corporation’s affairs” has ceased due to “internal dissension” among equal factions of shareholders that require assent from each other to operate the company. Here, it is undisputed that Petitioners and Respondent require assent from each other to perform even the most basic functions of the Corporation [italics in original; footnote omitted].
The respondent’s brief countered very simply, that regardless of the shareholders’ agreement, 49% stock ownership does not satisfy the statute’s express “threshold requirement” for seeking dissolution under § 1104, namely, the petitioner’s ownership of “one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors” (italics in original).
Neither side’s brief cited case precedent directly on point, that is, where a shareholders or voting agreement gave equal rights to elect directors despite unequal stock ownership percentages, making this a case of apparent first impression.
Justice Scarpulla’s decision sided with the respondent’s “plain meaning” statutory interpretation and dismissed the petition for lack of standing, reasoning as follows:
Contrary to Balkind’ s position, BCL § 1104 is clear – to petition for judicial dissolution, petitioners must be “the holders of shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors ….” Under the plain meaning of the statute, Balkind, as the holder of 49% of the voting stock, does not have standing, and New York courts strictly interpret and apply the statute [citations omitted].
Neither does reference to the Shareholder Agreement confer standing under BCL 1104. That agreement merely designates Aubrey Balkind and Nickel as the Corporation’s two directors irrespective of voting stock ownership, which is not the same as equal voting power to elect directors in the context of BCL § 1104’s standing requirement. Under these circumstances, Balkind is unable to invoke BCL § 1104 as a deadlock breaking device.
Justice Scarpulla also sounded a note of frustration, writing, “I have been urging the parties to settle this dispute for quite some time, and am aware that my decision essentially puts the parties back at the starting gate.” Nonetheless, she continued, “the law is clear and [respondent] has established that [petitioner] lacks standing as a matter of law.”
Don’t Overlook BCL § 1104 (c)
I can’t say why the parties in Balkind structured their ownership and control rights the way they did, where the one shareholder’s superior ownership percentage conveyed absolutely no superior voting or control rights.
But I can say, § 1104 does provide a remedy under certain conditions when owners of close corporations choose to alter the statutory default rules in regard to the proportion of votes required for action by the board, or the proportion of votes of shareholders required for election of directors. When that happens, § 1104 (c) attaches two conditions to being able to bring a deadlock dissolution petition: (1) the disproportionate voting protocol must be included in the certificate of incorporation (missing in Balkind), and (2) the petitioner must hold at least one-third of the shares entitled to vote in an election of the directors.
Two final observations are in order.
First, the shareholders in Balkind were not oblivious to the possibility of deadlock when they made their deal. Their shareholders’ agreement featured a separate article entitled “Deadlock” requiring that “any deadlocks on actions of the Board of Directors shall be resolved by arbitration in New York City in accordance with the rules of the American Arbitration Association.” For whatever reasons, it seems that both sides preferred to duke it out in court rather than arbitrate, as evidenced on respondent’s side by his brief in which he argued lack-of-standing secondary to his argument on the merits that no deadlock existed, and gave the duty to arbitrate an even lower ranking.
Second, uncoupling equity ownership from management rights is much more common in LLCs than close corporations. Balkind illustrates the relatively rare instance in which an LLC minority member who holds co-equal management rights would have an easier time bringing an action for judicial dissolution under the LLC Law, which confers standing on any member without more, than the identically situated minority shareholder of a corporation under the BCL.