Dissolve for Failure to Elect a Board? Better Demand an Election First
August 10, 2020
New York’s Business Corporation Law (BCL) provides three pathways for non-controlling shareholders to achieve involuntary (judicial) dissolution. The first two are well known to business divorce practitioners and to regular readers of this blog:
- a petition under BCL § 1104 (a) by a shareholder holding 50% of the voting shares on the grounds of director deadlock, shareholder deadlock, or “internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders”; and
- a petition under BCL § 1104-a by a shareholder holding at least 20% of the voting shares on the grounds of “illegal, fraudulent or oppressive actions” or looting, waste, or diversion of corporate assets by the directors or those in control of the corporation.
The third pathway is far less familiar and is rarely invoked: a petition under BCL § 1104 (c) by any holder of any percentage of shares entitled to vote at an election of directors on the ground that
the shareholders are so divided that they have failed, for a period which includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired or would have expired upon the election and qualification of their successors.
If you read it too quickly, you might think all the statute requires is the simple failure to hold a board election on two consecutive, annual meeting dates — not a high hurdle for the countless, small close corporations that ignore corporate formalities including annual shareholder meetings. Not to be overlooked, however, are the critical words, “the shareholders are so divided that they have failed . . . to elect.”
Those words tripped up the petitioner in a noteworthy case recently decided by Manhattan Commercial Division Justice Andrea Masley. In Matter of Gupta [E.J.’s Bucket Buddies, Inc.], 2020 NY Slip Op 32446(U) [Sup Ct NY County July 24, 2020], Justice Masley summarily dismissed for legal insufficiency a § 1104 (c) dissolution petition brought by a 25% shareholder of a realty holding corporation due to the petition’s omission of any allegation that the shareholders “have ever held an annual meeting or elected directors during the company’s existence.”
The Petition
The petitioner, Mr. Gupta, is a 25% shareholder of E.J.’s Bucket Buddies, Inc. (EJ Inc.) which owns contiguous, mixed-use tenement buildings on Manhattan’s Upper West Side.
EJ Inc. has two other shareholders each holding 37.5%, only one of whom, Michael Besen, is a named respondent apparently because of alleged misconduct in his role as property manager. In later proceedings, Mr. Besen revealed that the shares allegedly held by the non-respondent named in the petition as the third shareholder were owned by that person’s wife. As you’ve probably figured out already, there was no shareholders’ agreement.
Mr. Gupta’s petition, while teeming with allegations of a sort typically found in dissolution petitions under § 1104 (a), including “deadlock,” “internal dissension,” and “irreconcilable difference of opinion” on “management” and “long term strategy,” nonetheless solely relied on § 1104 (c) as the basis for judicial dissolution of EJ Inc.
Specifically, the petition cited the section of the by-laws (and BCL §§ 701 and 703) requiring annual meetings of the shareholders on March 15th in each year to elect directors. The petition went on to allege:
The Shareholders have not held an annual meeting (on the 15th day of the month of March in each year or otherwise) for at least the past two (2) years and therefore have not elected (or re-elected) a Board of Directors as required by the By-Laws, BCL §§ 701 and 703. [¶] Upon information and belief, no meeting was ever called and held whereby directors were elected by the shareholders pursuant to the Business Corporation Law.
You read it right: according to the petition, and not disputed by the other parties’ case filings, the shareholders of EJ Inc., formed in 1994, never voted upon or seated a board of directors for the last 26 years. That’s hard to imagine, given that it’s a realty owning corporation that mortgaged the properties on several occasions — but the petition says what it says.
The petition also omits what it omits. While Mr. Gupta alleges that in late 2017 he delivered a notice of special meeting under BCL § 603 for the express purpose, among others, of electing directors, according to the petition the meeting attendees only discussed competing plans either to market and sell the corporation’s realty or to enter into a “barter and swap” agreement in which the corporation’s realty, along with other properties co-owned by the principals through other companies, would be appraised and divvied up among the three.
Justice Masley Dismisses the Petition
Mr. Besen moved for summary dismissal of the petition, arguing that it failed to allege a legally sufficient claim for dissolution and also based on conclusive documentary evidence including the corporate certificate identifying EJ Inc.’s shareholders.
After quoting the language of BCL § 1104 (c), Justice Masley’s decision cut to the chase, stating, “Gupta’s allegations do not meet the statutory requirements for dissolution because he fails to allege a division preventing the actual shareholders from electing directors.“
Justice Masley’s analysis focused mainly on Mr. Gupta’s failure to follow through on his single demand to hold a board election, the undisputed evidence that EJ Inc. never in its decades-long history had a duly elected board, and the petition’s failure to allege a nexus between the supposed shareholder deadlock or internal dissension and the failure to hold board elections. As the court explained,
The E.J. Inc. corporate by-laws require that an annual meeting be held on March 15 where an a election of directors will take place. However, despite this requirement, there is no allegation or evidence that E.J. Inc.’s shareholders have ever held an annual meeting or elected directors during the company’s existence.
“The mere failure to hold shareholders’ meetings in and of itself, does not constitute sufficient grounds to bring about dissolution under [BCL § 1104 (c)]” (Nelkin v H.J.R. Realty Corp., 25 NY2d 543, 549 [1969] [holding that the petition for dissolution must be dismissed because it is not alleged that the shareholders are so divided that they cannot elect directors but merely that no meeting was held for the election of directors]. The Shareholders must be “so divided” that they fail to elect directors “for a period which includes at least two consecutive annual meeting dates” (NY CLS Bus Corp § 1104 [c]).
Gupta’s conclusory allegation that “there is internal dissension between and among the three factions of shareholders holding 100% of the voting stock who are so divided that they are unable or unwilling to elect directors as called for in Business Corporation Law §§ 701 and 703” is insufficient to support dissolution. Gupta does not dispute that E.J. Inc. has never held an annual meeting and has never elected directors. Thus, to simply allege “internal dissension” as the reason why an annual meeting was not held on March 15, 2017, without more, knowing that the Shareholders have never held an annual meeting to elect directors, is insufficient. The Shareholders’ failure to hold an annual meeting in March 2017 can be attributed to the Shareholders’ customary practice of foregoing the annual meeting every year. [Record citations omitted.]
Justice Masley gave no weight to Mr. Gupta’s alleged December 2017 demand for a special meeting to elect directors, while stressing the absence of any follow-through:
Further, Gupta does not dispute Besen’s assertion that the issue of electing directors was never raised following the December 20th meeting nor was an annual meeting held in March 2018 in accordance with E.J. lnc.’s By-Laws. There are no allegations that Gupta called for an annual meeting to elect directors or that there was internal divide between the Shareholders preventing the March 2018 meeting (see Fazio Realty Corp. v Neiss, 10 AD3d 363, 364 [2d Dept 2004] [holding that “absence of evidence that the petitioners ever called for an election or proposed a third director, it cannot be said that the election of another director was necessary or could not be obtained]).
Mr. Gupta’s Dilemma
Mr. Gupta found himself in the unenviable position of owning a minority stake in a realty-holding close corporation with no shareholders’ agreement, whose business affairs and finances were under the de facto control of another minority shareholder, and whose three owners (at least as alleged) were locked in an intractable stalemate over how to separate their multi-entity business interests from each other.
Were Mr. Gupta a 50% shareholder in EJ Inc., he might have had a potent recipe for a deadlock dissolution petition under BCL § 1104 (a). As a 25% shareholder, however, he lacked standing to do so.
Mr. Gupta did not want for standing to seek dissolution for minority shareholder oppression under BCL § 1104-a, but the allegations in his complaint did not suggest he had grounds under that statute, nor is it apparent that he would have wanted to give Mr. Besen or the third shareholder the right to elect to buy his shares for fair value under BCL § 1118.
That left the little used BCL § 1104 (c). Mr. Gupta’s counsel seemingly ventured down the right path to utilize the statute when he demanded a special meeting in December 2017. For reasons that are not clear — my best guess is that the discussion at that meeting led Mr. Gupta to believe some sort of separation agreement was within reach, so he chose not to rock the boat by forcing what would have been a contentious and disruptive election — he never followed through, either by nominating directors and calling for votes at that or a subsequent annual meeting, or getting on record the other shareholders’ refusal to hold an election. By not doing either, Mr. Gupta’s dissolution petition met its early demise.