An Oppression How-To: Revoke Employment, Profit Sharing and Control
February 20, 2017
An earlier post on this blog, examining a post-trial decision in Matter of Digeser v Flach, 2015 NY Slip Op 51609(U) [Sup Ct Albany County Nov. 5, 2015], described the minority shareholder’s dissolution claim under Section 1104-a of the Business Corporation Law as a “classic case of minority shareholder oppression.” The Albany-based Appellate Division, Third Department, recently agreed with that assessment in affirming the lower court’s order finding sufficient grounds for dissolution.
The appellate panel’s unanimous decision in Matter of Gould Erectors & Rigging, Inc., 146 AD3d 1128, 2017 NY Slip Op 00228 [3d Dept Jan. 12, 2017], affirmed in every respect Albany County Commercial Division Justice Richard M. Platkin’s post-trial decision to dissolve two affiliated construction businesses. Here’s a quick recap of the case as it unfolded at the trial level.
The story begins with two father-son pairs. The petitioner, Henry A. Digeser, is a 25% shareholder of two New York corporations, Gould Erectors & Rigging, Inc. (“Gould”) and Flach Crane & Rigging Co., Inc. (“Flach Crane”). The respondent, John C. Flach, owns the remaining 75%. Digeser’s father was a close friend and business colleague of Flach’s father, who founded the companies, and served on the businesses’ boards. Eventually, the younger Digeser got involved in the businesses and became an owner.
After the Flach and Digeser elders retired, their two sons jointly managed the businesses for many years during which the companies became very successful. All corporate profits were paid in the form of compensation and bonuses, not dividends. In some years, Digeser and Flach drew salaries and bonuses exceeding $2 million.
Digeser and Flach developed a succession plan in which their respective children would ultimately assume control the businesses. Flach’s well-liked eldest son was groomed to become president of the businesses, but he died in a tragic accident in 2012.
The son’s death apparently led to a rapid unraveling of the relationship between Digeser and Flach. In mid-December 2012, Flach announced that he wanted a “divorce” from Digeser to focus on a new line of business he hoped to eventually transfer to his one surviving son.
Digeser told Flach that he was not interested in leaving the businesses or being bought out. In retaliation, in late-December 2012, Flach paid himself a $350,000 bonus, but declined to pay Digeser anything. In January 2013, Flach terminated Digeser as a director and officer and gave Digeser notice that his employment with Gould would be terminated after he completed an important project.
In April 2013, the project ended. The next day, Digeser sued for dissolution. The day after, Flach terminated Digeser’s employment with Gould.
The Lower Court’s Decision
In his petition, Digeser alleged a claim for dissolution based upon minority shareholder oppression under BCL § 1104-a which allows a holder of 20% or more of the shares of a corporation to petition for dissolution where the “directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders.”
In Matter of Kemp & Beatley, Inc., 64 NY2d 63 , the seminal case on minority oppression, the New York Court of Appeals defined oppression as “majority conduct [that] substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decision to join the venture.”
Applying this standard, Justice Platkin determined that Flach oppressed Digeser who had reasonable expectations of (i) continued employment, (ii) receipt of a proportionate share of profits through compensation and bonuses, and (iii) a role in the management and affairs of the corporations. Revocation of those benefits, the court concluded, “served to defeat legitimate expectations of the petitioner that were objectively reasonable and central to petitioner’s long-standing participation in the venture.”
Interestingly, though Digeser did not receive employment or compensation from Flach Crane (only Gould did), the Court nonetheless decided to dissolve Flach Crane as well because “the shareholders, directors and officers of Gould and Flach Crane treated the two corporations as a single, integrated economic unit” and Digeser “had a reasonable expectation of receiving at least a proportionate share of the profits of Flach Crane.”
Lastly, Justice Platkin rejected an argument by Flach that “multiple acts of wrongful behavior” by Digeser, like using the businesses for personal family expenses and transactions, justified Flach’s exclusion of Digeser from the businesses. In essence, the court held that both shareholders were guilty of the same thing, so it was a wash:
Simply put, the record shows that a tacit agreement existed over the years between the two shareholders to use corporate funds to personally benefit the Flach and Digeser families in various ways.
Arguments on Appeal
Flach raised three issues on appeal:
- Did the lower court incorrectly conclude there was sufficient evidence to dissolve Gould and Flach Crane under BCL § 1104-a?
- Did the lower court incorrectly treat Gould and Flach Crane as a single integrated entity?
- Did the lower court incorrectly discredit Flach’s argument that Digeser’s own wrongful conduct justified his exclusion from the businesses?
The Appellate Ruling
The appeals court rejected all three of Flach’s arguments. First, after reciting the reasonable-expectations standard in Matter of Kemp & Beatley, the appeals court held that the trial evidence “amply supports” the lower’s court’s conclusion that Flach oppressed Digeser. The appeals court explained:
On our review of the record, we confirm that the weight of the evidence supports the finding that petitioner’s reasonable expectations at the time of his acquisition of stock in both corporations was long-term employment, a role in corporate management and compensation in the form of profit-sharing, and that Flach’s actions defeated those expectations.
Second, the appeals court held that the lower court correctly dissolved Flach Crane, even though Digeser drew his employment and compensation only from Gould, “given the close overlap of the two corporations and that the shareholders, officers and directors treated both corporations as one integrated economic unit.” The appeals court concluded, “There can be no question that the freezing out of petitioner from [Gould] had the same effect on his interest in [Flach Crane].”
Third, the appeals court agreed with the lower court that Digeser’s alleged use of Gould’s finances for personal family expenses and transactions did not justify Flach oppressing him because “Flach also engaged in similar transactions where personal interests were advanced at the expense of [Gould].” So, as they say, two wrongs don’t make a right.
Lessons from Gould
Gould Erectors was a clean sweep for the minority and serves as a fine example of what not to do as a majority shareholder lest one be faced with a claim of minority oppression. Suddenly take away a minority shareholder’s employment, compensation, and control, all founded upon many years of prior history and conduct, and the minority has a mighty strong case for oppression. As seen in Gould Erectors, when a majority shareholder acts in such a way it can also, perhaps unexpectedly, lead to dissolution of an affiliate, from which the minority shareholder did not even receive employment or compensation.
Another important dimension of the case, which the appeals court did not address, was what to do with the corpporations’ assets upon dissolution. One has to wonder why the majority shareholder apparently chose not to exercise his statutory buyout rights within 90 days of Digeser’s filing the petition under BCL § 1118. Presumably Flach gambled he could defeat the dissolution petition on the merits. At the conclusion of the lower court’s post-trial decision, Justice Platkin alluded to that issue, ordering the parties to appear for a conference “to schedule further proceedings regarding a remedy.”
The fact that Flach lost at trial did not necessarily mean the buy-out ship sailed. In Matter of Kemp & Beatley, the Court of Appeals explained that courts have broad discretion to fashion an “adequate, alternative remedy” to liquidation, including “permitting any shareholder of the corporation to elect to purchase the complaining shareholder’s stock at fair value.” That may be what happened here or perhaps Digeser and Flach reached a buy-out settlement agreement. The latter may be more likely given that the court’s website lists the case as “disposed” without any indication of further proceedings and, judging from the companies’ websites, both entities seem to be very much in business.
Update February 21, 2017: Mystery solved. Turns out that after Justice Platkin’s November 2015 decision finding grounds for dissolution, Digeser and Flach agreed to a fair-value buy-out of Digeser’s shares as the appropriate remedy. Just today, New York Official Reports posted online Justice Platkin’s decision dated January 31, 2017, valuing Digeser’s shares in the two companies following a valuation hearing last year. We’ll tell you more about the valuation decision in next week’s post.