Minority Shareholder’s Petition to Dissolve Seltzer Business Loses Its Fizz
August 01, 2022
In 1950, Sam Hoffman and his two sons, Hyman and Melvin, founded Brooklyn-based Cornell Beverages, Inc. to manufacture and distribute seltzer. Those were the days when “seltzer men” made weekly home deliveries of cases of siphon seltzer bottles.
Seventy years later, the seltzer men and siphon bottles are long gone, and the primary occupation of the third-generation inheritors of the family business seems to be delivering cases of legal papers to each other.
Cornell still makes and distributes seltzer beverages, but only a trickle compared to its heyday, and not a profitable trickle at that. But don’t get too nostalgic or shed too many tears for the third-generation owners, owing to their forebears who had the foresight to acquire not only the industrial property where Cornell manufactures the seltzer, but another eight commercial properties in close proximity, all told with a current appraised value over $40 million.
Likely the patriarch, Sam, could not have foreseen the legal travails of his four grandchildren, each a 25% shareholder of Cornell and the real estate holding companies, driven in large part by three factors: the demise of the seltzer business in tandem with the phenomenal appreciation of the real estate; only two of the four grandchildren entered the business with salaried positions; and a shareholders’ agreement providing for a buyout at book value of the shares of any shareholder who wishes to exit.
For one of the “outside” shareholders who drew no salary and sought to monetize her 25% share of the trapped-in value of the real estate, those factors most likely contributed to her decision to sue for judicial dissolution of the three companies, claiming she was the victim of a freeze-out. After seven years of litigation, she walked away with nothing to show for it except legal bills, having suffered post-trial dismissals of her dissolution petitions which, just last week, were affirmed on appeal.
A Family Business
Sam and his two sons ran and co-owned as equal one-third shareholders the seltzer business and a second company named S.T.H.M. Realty Corp. Sam died in 1973, leaving his shares to his two sons who became 50/50 owners. In 1978, the two sons formed a third company called Hymel-Porter Realty Corp. as 50/50 owners.
Hyman died in 1978, leaving his 50% interests in equal shares to his son Allan and daughter Elaine. Melvin died some 10 or so years later, leaving his 50% interests to his wife. When she died in 2009, the interests passed to her daughters Donna and Judi, at which point the ownership of all three companies was held by Allan, Elaine, Donna, and Judi as equal 25% shareholders.
Alan and Donna began working at the companies in 1973 and 1986, respectively, and assumed management following their fathers’ deaths. The two others — Elaine and Judi — never worked in the business or participated in its management. As is not unusual in family-owned businesses, over the years little or no attention was paid to corporate formalities.
The Shareholders’ Agreement
A 1967 Shareholders’ Agreement as amended governed all three companies. Under its provisions:
- 2/3 shareholder approval is required for any changes to salaries or “any matters which may in anywise affect, endanger or interfere with rights of the minority shareholders”;
- any surplus “may” be declared as dividends and distributed to shareholders; and
- if a shareholder decides to offer their shares for sale, the remaining shareholders have a right of first offer to purchase the shares at book value.
The Dissolution Petitions
In late 2015, Elaine Hoffman, sister of Allan and cousin of Donna and Judi, filed three separate, essentially cookie-cutter petitions for judicial dissolution of the three companies. You can read the Cornell petition here.
Elaine’s petitions sought dissolution under Section 1104-a(a)(1) and (a)(2) of the Business Corporation Law on the grounds that, contrary to the intention of the original shareholders that the companies be operated as a “family business” and that upon their deaths the four next-generation owners each would be involved in the management and control of the companies, brother Allan and cousin Donna as officers and directors had usurped total control, taken excessive compensation, failed to provide access to company books and records, “looted, wasted, and/or diverted” corporate assets, and engaged in acts designed to “freeze” Elaine out of the companies and deny her “fair share” of the companies’ value.
Elaine Loses at Trial
The three cases were consolidated before Brooklyn Commercial Division Justice Lawrence Knipel. In October 2016, Justice Knipel issued an order denying Allan’s and Donna’s motion to dismiss the petitions, finding that the parties’ conflicting affidavits raised questions of fact regarding the merits of the petition and the appropriate remedy.
Following discovery, Justice Knipel conducted a bench trial in early 2019. In September 2019, Justice Knipel issued a post-trial decision dismissing all three petitions. The decision observes that, over the years, Cornell’s seltzer business diminished while “the real property has skyrocketed in value.” It goes on to find that:
- Elaine “was largely disinterested in corporate affairs during the years the realty was languishing in value”;
- Elaine in recent years “sought to derive an economic benefit due to both her personal needs and a realization that the realty had undergone a dramatic increase in value”;
- Elaine’s efforts were “frustrated because the other three shareholders steadfastly refuse to sell, heavily mortgage or otherwise take actions as would produce significant distributions to the shareholders”; and
- Elaine “refuses to compel a buyout under the Shareholders Agreement as such would only allow her to receive book value for her shares.”
Justice Knipel next rejected Elaine’s allegations of oppression and financial misconduct by Allan and Donna, finding:
- All the shareholders “initially agreed to (or acquiesced in) the employment” of Allan and Donna and that at least 75% agreed to later changes in their compensation;
- There was “no significant evidence that the entities have been run in anything other than an honest and straightforward manner or that compensation was anything other than reasonable and modest”; and
- While Allan and Donna managed the companies in a “very conservative fashion,” the court “is without discretion to substitute its own business judgment for that reasonably (although perhaps not optimally) adopted by a solid three of the four shareholders.”
In his conclusion, alluding to the “reasonable expectations” test for oppression, Justice Knipel commented on Elaine’s allegedly unfulfilled expectations as a shareholder of the corporations which, he found,
have been frustrated only in the sense that she desires the corporate entities, which now possess a great deal of equity in real property, to liquidate some or all of that wealth and distribute it to the shareholders. This is decidedly not the frustration needed for liquidation under BCL 1104-a. No credible evidence of illegal, fraudulent, or oppressive conduct, or looting, wasting, or diverting of assets for non-corporate purposes, has been adduced at trial. A buyout herein cannot be compelled on any basis other than that provided in the Shareholders Agreement. Under the circumstances, New York law permits the three shareholders controlling 75% of the shares to block the remaining shareholder, with whom, they profoundly disagree, from corporate management.
Elaine’s Unsuccessful Appeal
Elaine appealed to the Appellate Division, Second Department, from the dismissal of her lawsuits. In its unanimous decision handed down last week in Matter of Hoffman v S.T.H.M. Realty Corp., 2022 NY Slip Op 04725 [2d Dept July 27, 2022], the appellate court solidly affirmed Justice Knipel’s rulings and underlying rationale, writing:
The trial evidence here demonstrated that, after inheriting her stock interests in the corporations, the petitioner did not seek employment or responsibilities in the day-to-day management of the corporations, or express an interest in shareholders’ meetings, but, rather, remained, for many years, a passive shareholder, acquiescing in the exercise of control by Allan Hoffman and Donna Hoffman over the day-to-day management of the corporations. This and other evidence supports the Supreme Court’s determination that the petitioner did not evince a reasonable expectation of actively participating in the management of the corporations, and that, while the petitioner might now disagree with the manner in which the corporations’ assets are being managed, the conduct of the majority shareholders was not oppressive.
Course of Conduct Matters
The archetypical minority shareholder oppression case, particularly in close corporations that pay no dividends, features either or both the loss of employment (and the compensation that goes with it) and the loss of voice in management as a result of being removed as an officer and director.
In Hoffman, one of the pillars on which Elaine’s oppression case rested was a provision in the Shareholders’ Agreement stating that “[t]he holders of the stock of the corporations shall become employed by the corporations and perform such duties and draw such salaries as shall be unanimously agreed between them.”
The evidence at trial of the parties’ course of conduct, however, failed to establish that Elaine, who became a shareholder upon her father’s death in 1978, sought employment in the family business or appointment as an officer or director, or complained about exclusive management by Allan and Donna, until she began to press for a buyout or other liquidity event involving what had become extraordinarily valuable realty.
That’s not to suggest that course of conduct alone did in Elaine’s dissolution cases. Equally prominent in the courts’ decisions is the Shareholders’ Agreement’s provision authorizing, by the consent of two-thirds of the holders of the shares — i.e., 2 of the 3 original shareholders and 3 of the 4 eventual shareholders — to make changes in salaries or drawings of those employed by the corporations or “any matters which may in anywise affect, endanger, or interfere with the rights of minority shareholders.”
Presumably for her own reasons, Donna’s sister Judi, who, like Elaine, never worked for the companies or participated in their management, sided with Allan and Donna in opposing Elaine’s desire to sell or mortgage the realty, thereby yielding the requisite supermajority to overcome that component of Elaine’s oppression claim alleging the denial of her “fair share” of the companies’ value.
Finally, I find it somewhat hard to accept that Sam Hoffman and his two sons, in 1967 when they entered into their Shareholders’ Agreement, thought that the value of their large realty holdings hadn’t already increased substantially and wouldn’t continue to gain in value. If so, the provision for a right of first offer at book value may have been intended as a disincentive for a shareholder to voluntarily sell his or her shares.
In Elaine’s case, the disincentive worked like a charm but it also had the likely unintended consequence of incentivizing her to construct and prosecute claims for minority shareholder oppression in an effort to achieve her understandable but ultimately unsuccessful goal of monetizing her interests for their fair value.