A Deep Dive Into the Election to Purchase in Dissolution Proceedings
November 05, 2018
When a minority shareholder petitions for judicial dissolution under § 1104-a of the Business Corporation Law based on the majority’s alleged oppressive conduct, looting, waste, or diversion of corporate assets, BCL § 1118 kicks in, granting the corporation and the other shareholders the right to halt the dissolution proceeding and to convert it to a stock appraisal proceeding, by electing to purchase the petitioner’s shares for “fair value” determined as of the day before the date on which the petition was filed.
New York’s highest court, in Matter of Pace Photographers, Ltd., described § 1118’s election to purchase as “a defensive mechanism [to § 1104-a] for the other shareholders and the corporation, giving them an absolute right to avoid the dissolution proceedings and any possibility of the company’s liquidation” while, at the same time, “the minority is protected by a court-approved determination of fair value and other terms and conditions of the purchase.”
How is the election exercised? Who can exercise it? Can it be exercised conditionally? When can it be exercised? Once exercised, can it be revoked? Read on for the answers.
How is the Election Exercised?
Section 1118 is silent as to the manner or form in which the election to purchase can be exercised. Nor have court decisions required any specific formality. It can be made by ordinary correspondence or by something more formal filed with the court.
Matter of Topper (Park Sheraton Pharmacy, Inc.) is probably at the loosey-gooseyest end of the spectrum, at least in terms of the language employed. There the court accepted as a valid election a statement in the respondent shareholder’s affidavit that “we have agreed to negotiate a reasonable price for the purchase of Topper’s stock.”
The more typical practice is a captioned document filed with the court entitled something like “Notice of Election to Purchase” identifying the electing party (i.e., the corporation or one of more non-petitioning shareholders) and containing language that invokes the statute, such as X hereby elects to purchase the shares of stock in the corporation owned by Petitioner pursuant to BCL § 1118.
Who Can Exercise the Election to Purchase?
Section 1118 expressly provides that the election to purchase can be made by “any other shareholder or shareholders or the corporation.” The statute’s use of “shareholder or shareholders” rather than “respondent” means that any non-petitioning shareholder, whether or not named as a respondent in the proceeding, may elect to purchase. The statute does not require the electing shareholder to own any minimum percentage of the corporation’s shares.
Can the Election Be Made Conditionally?
In a word, no. In Matter of Davis (Alpha Packaging Industries, Inc.), the Appellate Division, Second Department, wrote that an election to purchase “must be clear, unequivocal, and unconditional.” In that case, the court held invalid an election to purchase that was conditioned on a judicial finding of grounds for dissolution.
Similarly, in Matter of Gene Barry One Hour Photo Process, Inc., the court rejected a § 1118 election in the form of a letter offering to purchase the petitioner’s shares for “$10,000, payable in cash” described in the letter as an amount “equal to the fair value of the equity interest” and further conditioning the offer on certain terms for repayment of petitioner’s loan to the corporation.
When Can the Election Be Made?
Section 1118 provides that the election to purchase can be made “at any time within ninety days after the filing of [the dissolution] petition or at such later time as the court in its discretion may allow.” As you might expect, decisions addressing timing have focused on elections made subject to the court’s discretionary approval after the expiration of the as-of-right 90-day period.
Also as you might expect, matters left to the court’s discretion are fact-specific to each case, making it difficult to discern any hard-and-fast rules. A few examples follow, though keep in mind the cases are self-selecting in the sense that, often, a petitioner will consent to a late election which virtually guarantees the court will go along with it.
- In Sobol v Les Pieds Nickels, Inc., the Appellate Division, First Department, affirmed the lower court’s denial of the respondent shareholder’s request for permission to file an untimely election made eight years after the dissolution proceeding’s commencement.
- In Matter of Flushing Office Center, Ltd., the Appellate Division, Second Department, affirmed the lower court’s order permitting the respondent’s untimely election to purchase. Unfortunately for us, the decision does not say how long after the expiration of the 90-day period the election was made.
- In Matter of Ambrosio, the trial court court permitted an election to purchase three years post-petition, conditioned on the respondent paying the petitioner’s pre-election counsel fees and giving an undertaking to secure the fair value award.
- In Matter of Weingarten (Thirty First Street Realty Corp.), which was affirmed on appeal, the court denied the respondents’ request, made about 15 months after the petition was filed, for authorization to purchase the petitioner’s shares under § 1118, finding that the respondents offered no excuse for their failure to timely exercise the right of election, and that there was no indication that continuing the corporation was viable or that allowing the election would save further litigation and expense.
The most recent word on the subject comes from Suffolk County Commercial Division Justice Elizabeth H. Emerson in Matter of Marro (Marjod Realty Corp.), 2018 NY Slip Op 51502(U) [Sup Ct Suffolk County Oct. 24, 2018], in which she granted the corporation’s motion, made almost two years after the dissolution petition was filed, for leave to exercise its right to purchase the petitioner’s shares. After observing that dissolution is a “remedy of last resort” and that “[a]bsent exceptional circumstances, courts will ordinarily exercise their discretion to authorize a buy-out,” Justice Emerson explained her ruling as follows:
The petitioners’ only objection to Marjod Realty Corp.’s exercise of its right to purchase the petitioners’ shares pursuant to Business Corporation Law § 1118 is that it is untimely. The petitioners proffer no substantive reason why Marjod should not be allowed to purchase their shares. A buy-out of the petitioners’ shares is clearly preferable to liquidation of the corporation. It would allow the petitioners to obtain a fair return on their investment while protecting the rights and interests of the remaining shareholders. Accordingly, the motion is granted.
How Can the Election Period Be Extended?
Oftentimes the respondent in a dissolution proceeding brought under § 1104-a believes it has valid grounds to dismiss the petition, e.g., for lack of standing, or because the petition fails to state a viable claim for dissolution, or on the ground that the petitioner has brought the proceeding in bad faith, etc. At the same time, the respondent may want to preserve its as-of-right election to purchase under § 1118 in the event its dismissal motion is denied, which may not be decided by the court until after 90 days from the date the petition is filed. What’s a respondent to do?
The easiest solution is to enter into a so-ordered stipulation with the petitioner at the time the respondent makes its dismissal motion, agreeing to extend the time for the respondent to elect to purchase for a specified amount of time after the court decides the dismissal motion. Most petitioners who prefer to be bought out will readily agree.
If the petitioner won’t agree, then the respondent may want to seek a court order by order to show cause, extending the election period until after the dismissal motion is decided.
Can the Election Be Revoked?
As originally enacted in 1979, an electing shareholder or corporation could revoke its election at any time. That changed in 1986 with the statute’s amendment, as the Court of Appeals explained in Matter of Penepent Corp.:
As originally enacted, section 1118 permitted electing shareholders to revoke their elections at any time. The amendment was prompted by concerns that majority shareholders could make section 1118 elections, prolong negotiations as to the fair value, and then revoke their elections, thus delaying the dissolution proceeding and exhausting the petitioning shareholder’s resources (Davidian, Corporate Dissolution in New York: Liberalizing the Rights of Minority Shareholders, 56 St John’s L Rev 24, 71 ). To prevent this mischief, the Legislature made section 1118 elections irrevocable and binding (L 1986, ch 861).
The statute qualifies the election’s irrevocability by providing that the election “shall be irrevocable unless the court, in its discretion, for just and equitable considerations, determines that such election be revocable.” This wiggle room has generated a fair amount of litigation in which courts for the most part have denied applications to revoke elections:
- Matter of Pace Photographers, Ltd. in which, following a prior Court of Appeals ruling invalidating a fixed-price buy-out under the parties’ shareholders’ agreement, the Appellate Division, Second Department, affirmed an order denying leave to revoke respondent’s election to purchase, finding revocation not warranted based on the respondent’s desire to avoid a fair value determination.
- Matter of F.P.D. Realty Corp. in which the Appellate Division, First Department, reversed the lower court’s order permitting the respondent to withdraw its election after a Judicial Hearing Officer conducted a valuation hearing and adopted the petitioner’s appraisal.
- Matter of Rey (Pan American Cash & Carry Corp.) in which the Appellate Division, Second Department, affirmed an order permitting revocation of the respondent’s election to purchase after a fire destroyed the corporation’s retail store business.
- Matter of Androtsakis (Ithaca Development Corp.) where the Appellate Division, First Department, affirmed an order denying revocation of the respondent’s election to purchase due to respondent’s failure to support its contention that redeeming stock would render the corporation insolvent.
- Matter of Chu (Sino Chemists, Inc.) in which the Appellate Division, First Department, reversed the grant of the respondent’s motion to revoke her election to purchase after the referee’s valuation of petitioner’s shares, finding that the death of one of the two respondents and the surviving respondent’s dissatisfaction with the referee’s valuation did not warrant rescission.
- Matter of Smith (Russo) in which the Appellate Division, Second Department, reversed an order permitting revocation by two of three electing respondents after the third respondent filed for bankruptcy where, in response to the petitioner’s prior application to require them to bond the fair value award, the two respondents assured the court of their ability to pay for the shares in the event the third respondent could not.
The Kemp Trump Card
If the respondent never elects to purchase the petitioner’s shares, opposes on the merits the petitioner’s claims of oppression, looting, etc., and loses, is dissolution of the corporation and liquidation of its assets inevitable?
Not according to the Court of Appeals’ 1984 opinion in Matter of Kemp & Beatley, Inc., a landmark business divorce case best known for its formulation of the reasonable expectations test for oppressive majority conduct. Less well known is its affirmance of the lower courts’ remedial provision in that case, ordering dissolution based on the majority’s oppressive conduct unless within a stated period the respondents agreed to purchase petitioner’s shares at fair value. The Court seemingly removed trial judges’ discretion in the matter, stating categorically that “[e]very order of dissolution . . . must be conditioned upon permitting any shareholder of the corporation to elect to purchase the complaining shareholder’s stock at fair value.”
The Court in Kemp found support for its remedial edict in § 1104-a (b) (1) and (2), which require a court, in deciding whether to order dissolution, to take into account whether liquidation “is the only feasible means whereby the petitioners may reasonably expect to obtain a fair return on their investment” and is “reasonably necessary for the protection of the rights and interests of any substantial number of shareholders or of the petitioners.”
Does Kemp‘s imperative run counter to § 1118’s remedial scheme insofar as the statute extinguishes after 90 days the respondent’s otherwise absolute right to avoid dissolution and a judicial determination of the petition’s misconduct allegations by electing to purchase the petitioner’s shares? In other words, does Kemp allow the respondent to have its cake (fight dissolution) and eat it too (buy out the petitioner’s shares)?
Only superficially. There remain substantial advantages and savings for a respondent who elects to proceed immediately to an appraisal hearing rather than opposing the petition on the merits, losing on grounds of oppression or looting, etc., and only afterward accepting the court’s invitation to purchase at fair value under the certainty of dissolution if the invitation is declined.