Court Rejects Oppressed Shareholder’s Bid for Dissolution or Buy-Out, Finds Money Damages Sufficient

October 05, 2020

A minority shareholder petitioning for dissolution under BCL § 1104-a must establish, by a preponderance of the evidence, that the majority shareholders have engaged in “illegal, fraudulent or oppressive actions,” (BCL § 1104-a(a)(1)), or that the “property or assets of the corporation are being looted, wasted, or diverted for non-corporate purposes by its directors, officers or those in control of the corporation,” (BCL § 1104-a(a)(2)).

The New York Court of Appeals, in its landmark ruling construing § 1104-a, Matter of Kemp & Beatley, 64 NY2d 63, 73 [1984], put a finer point on what constitutes “shareholder oppression” under § 1104-a, establishing a “reasonable expectations” test under which “oppression should be deemed to arise only when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decision to join the venture.”  The Court cautioned, however, that “[i]t would be contrary to this remedial purpose to permit [the statute’s] use by minority shareholders as merely a coercive tool.  Therefore, the minority shareholder whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complained-of oppression should be given no quarter in the statutory protection.”

Based on this guidance, it is not at all uncommon to see allegations of misconduct and improprieties hurled in both directions in a § 1104-a dissolution proceeding.  An ousted minority shareholder alleges that he was wrongly shut out of the corporation, denied employment, dividends, and access to information.  Majority shareholders answer that the minority shareholder was ousted due to his own misconduct, so he is a bad faith petitioner with no right to seek dissolution.  See this previous post on Kimelstein v. Kimelstein; this post on Sansum v. Fiorati; Matter of Hannon (J.B.H.H. Corp.), No. 604817/99 [Sup. Ct. N.Y. Co. Oct. 13, 2000] [dismissing dissolution petition by 33% shareholder who defrauded the corporation out of approximately $1,000,000].

But apart from (and perhaps, alternative to) an unclean hands defense, what if the majority shareholders could show that the complained-of oppressive conduct was a discrete act designed only to “true-up” or restore equilibrium after the purported misconduct of the petitioner?  If the “oppression” was simply restoring to all shareholders the reasonable expectations attendant to their share ownership and, going forward, the majority shareholders will behave, is dissolution (or a compelled buy-out) an appropriate remedy?

That’s precisely the issue that the Court considered in the recent case of Hammad v Jamal Kamal Corp, 2020 N.Y. Slip Op 51092(U), in which Queens County Commercial Division Justice Leonard Livote declines to dissolve two real estate companies collectively owned by five brothers, despite finding that the reclassification of certain payments constituted oppression under § 1104-a.  (Full disclosure: one of the respondents in Hammad is a Farrell Fritz client.)

Background

With a narrative arc fit for a page-turning novel, Hammad v Jamal Kamal considers the story of two real estate holding companies—Maysa Realty Corp. and Jamal Kamal Corp. (the “Corporations”)—owned by five brothers.

In 1980, the brothers’ father purchased a supermarket.  When the father was tragically killed, the eldest brother Jamal assumed control of the supermarket.  Over the next seven years, Jamal grew the family’s real estate holdings, acquiring several different properties and establishing 10 different corporations.  And although Jamal was solely responsible for the growth, he offered his younger brothers equal opportunities to participate in the Corporations as shareholders.

In 2013, Jamal decided to sell his shares in the Corporations.  Each of the remaining four brothers, Nedal, Samir, Omar, and Kamal, agreed to buy out Jamal’s interest.

With Jamal’s steady, fair hand out of the picture, Nedal—who by then had been appointed President of the Corporations—formed a property management company, Highcrest Management, owned 50% each by Nedal and Samir.  Highcrest charged the Corporation substantial fees for property management services, and in turn paid Nedal and Samir salaries, benefits, car payments, and other perqs.

In 2016 and disappointed with the Corporations’ performance with Nedal as President, the remaining shareholders, Kamal, Omar, and Samir, asked Jamal to rejoin the Corporations and restore order.  They each subsequently transferred 5% of their shares to Jamal.  With Jamal back in the picture, the four brothers (Jemal, Kamal, Omar, and Samir) sent Nedal a list of fourteen demands with regard to the running of the Corporations, including that Nedal make no further payments to Highcrest, which the brothers felt Nedal was using to drain money from the Corporations for his own benefit.

When Nedal defied the demands of his brothers by continuing to make payments to Highcrest, the four brothers called a special meeting of the Corporations’ shareholders.  At the shareholders meeting, which Nedal did not attend, the four brothers unanimously elected Jamal as President.

The Allegedly Oppressive Conduct

With Jamal back as President, the Corporations ousted Nedal and took several steps to remedy what the brothers believed was Nedal’s misconduct.  The majority shareholders:

1. removed Nedal from his position as manager;
2. terminated the Corporations’ relationship with Highcrest;
3. repaid certain dividends to the Corporations, reclassifying Nedal’s share of those dividends as loans from the Corporations to Nedal; and
4. reclassified payments to Highcrest as loans to Nedal.

Nedal responded with a petition to dissolve the Corporation under BCL § 1104-a, claiming that each of the above actions constituted oppression warranting dissolution.  In the alternative, Nedal asked that the Court order his brothers to buy him out of the Corporations.

Jamal and the remaining shareholders opposed Nedal’s dissolution request.  They argued that Nedal was a bad faith petitioner; his ouster was necessitated by his own misconduct, including his defying their instructions to stop making payments to Highcrest.

No Dissolution or Buy-Out; Money Damages Sufficient

After an 11-day hearing, Justice Livote considered each of Nedal’s purported grounds for oppression.  Justice Livote made short work of most of Nedal’s grounds.

First, the Court held that “removal of Nedal as President and manager of the Subject Corporations does not constitute oppressive conduct.”

Second, termination of Highcrest was not oppressive conduct because, “the retention of Nedal’s separate company as manager, is not a reasonable expectation of his stock ownership.”

Third, reclassification of dividends to Nedal as loans was not oppressive conduct, since “[a]ll of the other shareholders were treated equally because they returned or did not accept the distributions.”

The Court held, however, that Nedal did establish oppression on his fourth ground, the reclassification of payments to Highcrest as loans to him.  The Court found that “although the brothers alleged that Nedal was self-dealing through Highcrest, they did not prove the allegations.”  Moreover, the brothers’ direction that Nedal not make any transfers to Highcrest was not sufficient to allow them to reclassify the transfers because that direction was not made pursuant to a board meeting.  Accordingly, the Court held, “the re-classification of payments into loans payable solely by Nedal constitutes oppressive conduct.”

The Court then turned to the appropriate remedy.  Mindful of his obligation to consider whether “liquidation of the corporation is the only feasible means” to protect the complaining shareholder’s expectation of a fair return on his or her investment (§ 1104-a[b][1]), Justice Livote reasoned that based on the nature of the oppressive conduct here—a discrete, one-time reclassification of payments that the brothers made to remedy what they viewed as Nedal’s self-dealing—neither dissolution nor a forced buyout was an appropriate remedy.

Rather, the appropriate remedy was to (i) repay Nedal for the financial losses he suffered as a result of the improper reclassification and (ii) ensure that going forward, Nedal receive his reasonable expectations of share ownership—i.e., a dividend in proportion to his ownership.  And because nothing in the record suggested that the brothers intended to cut Nedal out of future dividends, the Court simply ordered that the brothers repay Nedal the amount equal to the improperly reclassified payment, approximately $60,000.

So, notwithstanding Nedal’s establishing that he was an oppressed shareholder under § 1104-a, the Court rejected Nedal’s bid for dissolution or a compelled buy-out, finding money damages sufficient to remedy the oppression.

Closing Thoughts

Years ago, on this Blog, Peter A. Mahler mused that there must be circumstances where a majority shareholder breaches his fiduciary duty to the minority shareholder, but the breach is of a form or character insufficient to constitute oppression warranting dissolution under § 1104-a and Matter of Kemp.  For instance, negligent oversight of an employee who causes the company some harm, or financial misconduct that is of insufficient magnitude to constitute frustration of reasonable expectations.  In those cases, one would expect the Court to reject the petitioner’s § 1104-a dissolution claim and allow a plenary claim for breach of fiduciary duty to proceed.

Nedal did not assert an alternative, plenary claim for breach of fiduciary duty.  But by finding that an arguably minimis transaction—reclassification of approximately $60,000 in payments—constituted oppression under § 1104-a, then holding that a money judgment would remedy the oppression, the Court effectively rejected Nedal’s dissolution claim and converted it into a legal claim for breach of fiduciary duty.  That makes this case unique—I am not aware of any other case where a court held that money damages are a sufficient remedy for shareholder oppression under § 1104-a.

In my view, this bit of judicial creativity not only recognizes that not all misconduct by majority shareholders is worthy of dissolution or a compelled buy-out, but it also has the benefit of judicial economy—the parties hardly would have been satisfied if Justice Livote, after an 11-day hearing, denied dissolution and directed the parties to litigate any breach of fiduciary duty claims anew.

In all events, Hammad is a sharp reminder to minority shareholders that, even if they could arguably show some misconduct approaching shareholder oppression, the devil is in the remedy.  Absent serious misconduct or evidence that the shareholder’s reasonable expectations of share ownership are compromised going forward, dissolution or a court-ordered buy-out is an unlikely result.