Can an Arbitrator Order Extra-Judicial Dissolution?
June 10, 2019
Often business owners enter into arbitration agreements because they hope it will result in a speedier, less expensive resolution than litigation to disputes with their co-owners. Arbitration agreements often achieve that result. But sometimes, epic disputes arise over the scope of arbitration agreements and the power of arbitrators to decide controversies under them.
In Matter of Capital Enters. Co. v Dworman, 2019 NY Slip Op 04494 [1st Dept June 6, 2019], a Manhattan appeals court, after three years of litigation and multiple appeals, decided the novel question of whether an arbitrator has the power to order dissolution of a New York partnership, and if so, the extent of the arbitrator’s discretion to fashion a remedy for winding up the partnership’s affairs.
Capital Properties Company (the “Partnership”) was a New York general partnership formed in the 1960s. The Partnership owned three residential apartment buildings in Manhattan. Alvin Dworman and Michael Palin (through another entity, Capital Enterprises Company), were the two, equal general partners of the Partnership. In 1981, Dworman and Palin entered into a written partnership agreement.
Article 5.1 listed four, exclusive grounds for dissolution: “(a) the sale or other disposition of all of the assets of the Partnership; (b) a determination of the Partners to dissolve; (c) the bankruptcy or insolvency of a Partner . . .; or (d) the expiration of the term of the Partnership.”
Article 5.2 prohibited unilateral dissolution, providing that “each Partner hereby agrees to take no action which would result in the dissolution of the Partnership, except with the consent of the other Partners.”
Article 10.1 contained the following arbitration provision:
Except as otherwise provided herein, any controversy or dispute arising out of or relating to this Agreement or the breach hereof shall be settled by arbitration. Such arbitration shall be effected by each Partner’s counsel, who, in the event of a failure to reach a settlement, shall be empowered to appoint a third party as the arbitrator of the dispute. Such third party shall be mutually agreeable to counsel for both Partners. The written decision of such third-party arbitrator shall be binding, final and conclusive upon the parties involved, and judgment may be entered on any such decision in any federal or state court having jurisdiction.
The Alleged Oral Agreement to Dissolve and Divide the Properties
Around 2014, when Palin and Dworman were in their 80s and 90s, they began negotiating a deal to divide the three properties among themselves and terminate the partnership. According to Palin, in 2015, they reached a “handshake deal” to transfer one property to one partner, another property to the other, sell the third, split the proceeds, and dissolve the Partnership. According to Palin, Dworman reneged on the oral agreement.
Palin served on Dworman a demand to arbitrate, followed quickly by a petition in Manhattan Supreme Court to compel arbitration under the partnership agreement.
The Decision Compelling Arbitration
Former Commercial Division Justice Shirley Werner Kornreich issued a decision and order granting Palin’s petition to compel arbitration and denying Dworman’s motion to dismiss the petition for arbitration. In her oral ruling, however, Justice Kornreich ruled, based on Article 5.2 of the partnership agreement, that dissolution of the partnership was not arbitrable:
The Partnership Agreement does not permit dissolution of the partnership except it has to be by consent of both partners.
So, there was no writing as to this prior agreement which would be required again under the partnership agreement. So, therefore, this is not something that’s arbitrable.
On reargument, Justice Korneich again ruled that that the arbitration provision did not empower the arbitrator to dissolve the partnership absent a written agreement by both partners to dissolve.
The First Appeal
Palin appealed Justice Kornreich’s denial of his petition to arbitrate his claim for partnership dissolution. Just three months after Justice Kornreich issued her reargument decision, the Appellate Division – First Department issued a decision and order in which it “unanimously reversed” and “granted” Palin’s petition to arbitrate dissolution of the Partnership. The Court held:
Since the alleged oral agreement (i.e., the ‘handshake deal’) to sell or transfer partnership assets attempts to modify several substantive provisions of petitioner’s partnership agreement concerning the distribution of partnership assets, the broad arbitration provision of the partnership agreement controls the parties’ dispute.
The Arbitration Decision
For over a year, the parties arbitrated before retired former Manhattan Commercial Division Justice Bernard J. Fried. After discovery and a six-day hearing, Justice Fried issued an extraordinarily thorough arbitration decision, which he later supplemented.
In his decision, Justice Fried remarked, “The parties disagree on just about everything, however, they do agree on the need for dissolution of the Partnership, although for different reasons and different grounds.” Palin, the arbitrator noted, asserted that the Partnership should be dissolved in accordance with the parties’ oral “handshake agreement” to split two of the properties and divide the sale proceeds of the third.
Dworman, in contrast, argued that “no enforceable agreement was reached by Dworman and Palin” to dissolve “and that the dissolution should be based upon the Partnership Law, section 63, and as provided for in the Partnership Agreement.”
Justice Fried concluded that the so-called “handshake deal” was “at most, a mere agreement to agree, which is unenforceable.” Instead, Justice Fried dissolved the Partnership “based upon Section 63 of the Partnership Law,” which allows dissolution where, among other things, “circumstances render a dissolution equitable.”
To carry out dissolution and winding up, the arbitrator ordered appointment of former Kings County Justice Allen Hurkin-Torres as “Special Liquidator” to sell the Partnership properties in accordance with Article 5.3 of the Partnership Agreement.
Finally, the arbitrator imposed against Palin’s company a massive damages award derivatively in favor of the Partnership of $31 million, plus prejudgment interest, for Palin’s “dishonest and wrongful conduct” and breach of fiduciary duty over decades managing the Partnerships’ real properties, to be deducted from Palin’s pro rata share of the proceeds of the real property liquidation.
The Second Appeal
In January 2019, New York County Commercial Division Justice Jennifer G. Schecter heard oral argument on whether to confirm the arbitrator’s award, confirmed the award, and denied Palin’s motion to vacate the award.
Palin immediately appealed. The parties’ appeal briefs are currently sealed on the public e-filing docket, so we cannot share them with you. But we can surmise from Palin’s memorandum of law opposing confirmation and supporting vacatur of the arbitration award that Palin argued the arbitrator “acted irrationally” by (i) declining to enforce the parties’ alleged oral agreement to divide the three properties as a plan of dissolution and (ii) appointing a liquidator to sell the properties in a bidding process in contravention of the parties’ alleged oral agreement to split the properties.
Palin fared poorly on appeal. The Appellate Division resoundingly rejected his argument, unanimously affirming Justice Schecter’s decision confirming the arbitration award, holding:
The arbitrator did not exceed his authority in ordering the dissolution of the parties’ partnership or in the manner in which he ordered the dissolution. The issue is within the scope of the arbitration clause, and was before the arbitrator in the statement of claim and throughout the hearing, and the arbitrator had broad discretion to fashion the remedy.
The remedy was not an improper punitive award . . .. The arbitrator fashioned a remedy that appeared fair to all parties, and treated all parties the same.
What are some lessons from Capital Enterprises?
First, under a properly-worded (i.e., broad) arbitration provision in a partnership agreement, disagreements between partners over whether to dissolve the business may be arbitrable.
Second, if a claim for dissolution is arbitrable, then the arbitrator will likely have broad power to grant or deny dissolution, and, unless an agreement provides otherwise, to fashion appropriate remedies and procedures to wind up the dissolved business, including liquidation of assets via public bidding or private sale and distribution of proceeds.
Third, Capital Enterprises involved a New York general partnership, but one can easily imagine its reasoning and holding being applied equally to corporations and LLCs governed by written shareholders’ or operating agreements with comparable arbitration provisions.
Lastly, in Capital Enterprises, the arbitrator was careful to note that both partners agreed that the Partnership should be dissolved, disagreeing only about how the liquidation and winding up should be accomplished. Thus, the decision leaves for another day the interesting question of whether an arbitrator can effectively override a provision in a written agreement requiring mutual consent to dissolve, and order a compelled dissolution over the objection of one or more owners.