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Direct to Beneficial: Change of Corporate Ownership Structure Yields No Right to Dissent and Seek Appraisal

January 29, 2024

There are many paths to a fair value appraisal proceeding. A road less traveled begins at Section 910 of the Business Corporation Law (the “BCL”).

BCL § 909 (a) requires board and shareholder approval for a “sale, lease, exchange or other disposition of all or substantially all the assets of a corporation, if not made in the usual or regular course of the business” of the corporation.

BCL § 910 (a), in turn, provides that a shareholder who timely dissents from a corporation’s sale, lease, exchange or other disposition of “all or substantially all” assets shall “have the right to receive payment of the fair value of his shares” in an amount for the parties to litigate and the court to decide in a fair value appraisal proceeding under BCL § 623.

Cases involving a shareholder’s right to fair value appraisal of his or her stock resulting from an “all or substantially all” sales transaction are rare.

More than a dozen years ago, Peter Mahler wrote about one such case, Barasch v Williams Real Estate Co. (33 Misc 3d 1219[A] [Sup Ct, NY County 2011]).

In Barasch, former Commercial Manhattan Division Justice Bernard Fried held that a complex, multi-step reorganization ultimately resulting in the acquisition of 65% of the corporation’s former interests by a new investor triggered a shareholder’s right to dissent and cash out in an appraisal proceeding.

The Appellate Division – First Department later affirmed Justice Fried’s Barasch decision, but on other grounds, ruling that the entity was “estopped” from denying the transaction was an “all or substantially all” transaction because it sent a notice of shareholders meeting stating that it was exactly that: a “disposition of substantially all of the assets” of the company (100 AD3d 562 [1st Dept 2012]).

In his piece on Barasch, Peter Mahler wrote that the case fell in a “grey area” between, on the one hand, a clear right to appraisal from a sale or disposition that “terminates the corporation’s existence or operation,” and, on the other hand, a clear absence of right to appraisal where a corporation “merely transfers some of its assets to subsidiaries.”

Earlier this month, in Haruvi v Hungerford (81 Misc 3d 1229[A] [Sup Ct, NY County Jan. 16, 2024]), Manhattan Commercial Division Justice Andrew Borrok decided another “grey area” BCL § 909 case. In some ways, Haruvi’s facts, especially the complexity of the deal, resemble those of Barasch. But the legal outcome could not have been more different.

Simry and its Ownership Structure

Simry Realty Corp. (“Simry”) was a family-owned real estate corporation with direct ownership and legal title to seven multi-unit residential real properties in Manhattan.

Simry’s original ownership structure was as follows:

  • Abe: 50%
  • Abe’s brother, Arthur: 14.5373%
  • Arthur’s daughter, Aileen: 17.73135%
  • Arthur’s daughter, Michelle: 17.73135%

The Deal Structure

The genesis of the dispute was Abe’s desire to exit the real estate business, disposing of his 50% interest for $80 million. To cash out Abe, an outside investor, Peter, provided the financing. The deal structure went something like this:

  • Simry transferred all seven real properties it owned (the “Properties”) to newly-formed, single-asset real estate LLCs, which acquired ownership of the Properties from Simry;
  • A newly-formed holding company, Simry Holding LLC (“Simry Holding”), acquired all of the membership interests of the single-asset real estate LLCs;
  • Simry acquired a 10% common interest and a 100% preferred interest in Simry Holding;
  • A newly-formed entity, Jade Venture Partners LLC (“Jade Venture”), acquired the remaining 90% common interest in Simry Holding;
  • A newly-formed entity, Jade Realty Partners LLC (“Jade Realty), acquired 95% of the membership interests of Jade Venture. The outside investor / financier, Peter, acquired the remaining 5% of Jade Venture; and
  • Arthur acquired “legal title” to 100% of the membership interests of Jade Realty, though he did so as alleged “nominee” for his daughters, providing them a “beneficial interest” in Jade Realty equal to their 17.73135% pro rata interests in Simry.

The Lawsuit

Apparently eager for her own cash out after her uncle’s departure, Michelle sued Peter, her father, and all seven newly-formed LLCs to rescind the transaction, or alternatively, for money damages, arguing that Simry’s reorganization was a disposition of all or substantially all of its assets for which she was entitled, but deprived, the statutory right to dissent and seek appraisal for her shares.

The Summary Judgment Decision

In a pre-answer dismissal motion converted at Michelle’s request to summary judgment, the Court focused heavily upon the concept of “beneficial ownership.”

As the Court explained, before the transaction, Michelle, Aileen, and their father, Arthur, “beneficially owned 50% of the Properties.” After the transaction, Peter “owned at most a five percent indirect beneficial interest in the Properties and Michelle, Aileen, and Arthur owned the rest of the beneficial interests in the Properties.”

Moreover, wrote the Court, before the transaction, “Simry was engaged in the real estate business through its ownership of the Properties.” After the transaction, “Simry remained in the real estate business indirectly owning exactly the same Properties (albeit without Abe as a partner).”

The Court found it particularly significant that Simry’s Certificate of Incorporation authorized the entity to engage in real estate ownership either “directly or through ownership of stock in any other corporation.” The Court wrote that “New York courts typically find the purposes stated in a corporation’s certificate of incorporation relevant to a determination of what constitutes that corporation’s normal or usual course of business.”

The Court forcefully rejected Michelle’s arguments that she lacked knowledge of the transaction before it closed, writing that contemporaneous emails, texts, and other documents demonstrated that she was “firmly aware of” and “communicated directly with Abe about” his desire to cash out, and that Michelle had “actual notice that a deal was being made with Peter” to accomplish Abe’s objectives.

The Court concluded, “To the extent that a sale of Simry’s assets occurred, it was at most an indirect sale of a mere five percent of the beneficial interest in Simry’s assets” to Peter. “A five percent sale is not an ‘all or substantially all’ sales transaction under BCL § 909.” Michelle’s argument that BCL § 909 applied to the transaction, the Court held, “put form over substance.” As a result, the Court dismissed Michelle’s complaint in its entirety.

Some Thoughts on Haruvi

Michelle’s argument that Simry’s transfer of 100% of its assets to separate LLCs certainly has intuitive appeal. As a result of the transaction, Simry went from being a direct title owner of prime Manhattan real estate to an owner of membership interests in separate LLCs. Ownership of LLC interests is quite different than direct ownership of real estate, both from a liquidity perspective and from the varying legal rights emanating from real versus personal property assets.

But, on the other hand, the two leading appellate cases applying BCL §§ 909 and 910 both focused upon whether there was a “liquidation” of the business, which in Haruvi there certainly was not:

  • Matter of Resnick v Karmax Camp Corp., 149 AD2d 709 [2d Dept 1989] [“the formation of two subsidiaries, both wholly owned by the respondent Karmax Camp Corp., and the transfer of the camping operations and its buses to the subsidiaries do not fall within the purview of Business Corporation Law §§ 909 and 910. The reason, quite simply, is that these transactions did not result in a liquidation, in whole or in part, of the camp business”]; and
  • Dukas v Davis Aircraft Prods. Co., Inc., 131 AD2d 720 [2d Dept 1987] [“The transaction in question was merely a transfer of Davis Aircraft’s operations from one building to another” and “there is no factual dispute that Davis Aircraft has engaged in the same business as it had prior to the exchange. Thus, the transaction did not result in a liquidation” and “we find that shareholder approval was not required”].

The Appellate Division – First Department has never cited Renick or Dukas. With the amount of money at stake, I can imagine a swiftly perfected appeal in Haruvi. If so, it will be interesting to see if the First Department adopts the Second Department’s entity-favorable “liquidation” standard, applies a more shareholder-favorable strict construction of BCL §§ 909 and 910, or adopts a different standard of its own.