Past is Prologue: Refusal to Adopt Dividend Policy After Petitioner Resigns Not Ground for Dissolution
September 10, 2018
In the judicial dissolution case that John (“Jake”) Feldmeier brought after resigning as the highly paid president of the family-owned business, the central issue over which he and his opposing siblings fought was whether the siblings’ subsequent refusal to issue shareholder distributions, as Jake claimed, was the discontinuation of a longstanding practice of awarding de facto a/k/a disguised dividends to shareholders in the form of bonuses or, as the siblings contended, was the continuation of a company policy over which Jake himself presided for many years whereby the owners and managers made good-faith business judgments to award merit-based bonuses to officers and employees.
In support of his claim, and in opposition to his siblings’ summary judgment motion, Jake invoked the granddaddy of all New York minority shareholder oppression cases, Matter of Kemp & Beatley, Inc., in which the state’s highest court upheld an order of judicial dissolution in favor of terminated employee-shareholders who similarly complained about the non-issuance of dividends where the evidence showed, prior to their departures, that the company historically awarded de facto dividends based on stock ownership in the form of “extra compensation bonuses.”
In opposition to Jake’s claim, and in support of their summary judgment motion, the siblings argued, on the law, that the reasonable-expectations standard for oppression formulated in Kemp, a case brought under Section 1104-a of the Business Corporation Law, did not apply to Jake’s non-statutory claim for common-law dissolution — Jake, as a 12% shareholder, lacked standing under Section 1104-a’s 20% minimum — and, on the facts, that Kemp was distinguishable because, unlike in that case, prior to Jake’s departure and with his active participation and approval as company president, bonuses were paid disproportionately to stock ownership and not at all to non-employee shareholders.
So who prevailed?
In Feldmeier v Feldmeier Equipment, Inc., 2018 NY Slip Op 05893 [4th Dept Aug. 22, 2018], the Rochester-based Appellate Division, Fourth Department, over a one-judge dissent, affirmed a decision and order issued by Justice Donald A. Greenwood of the Onondaga County Supreme Court granting the siblings’ summary judgment motion and dismissing Jake’s claims for common-law dissolution, breach of fiduciary duty, an accounting, and imposition of a constructive trust. The dissenter would have denied summary judgment on the basis of disputed factual and credibility issues raised by the parties’ dueling expert affidavits.
As background, Feldmeier Equipment, Inc. (FEI) was founded by the siblings’ father in 1953 in Syracuse, New York, in the business of designing, manufacturing, and servicing stainless steel storage and processing equipment. Beginning in the 1990s, the father and his wife transferred direct ownership of 48% of FEI’s common shares equally to their four children, with the remaining 52% held by an LLC also owned equally by the four siblings, all of whom participated in FEI’s affairs as salaried employees, officers and directors.
Jake joined the family business out of college in 1972, and served as president from 1996 until June 2011 when he abruptly resigned from all positions with FEI and the LLC. Jake’s resignation followed rising tensions and disagreement with his siblings over the proposed hiring of his son-in-law and issues of succession and control in anticipation of their father eventually stepping down as chairman and CEO of FEI and as manager of the majority shareholder LLC.
The court’s opinion mentions that Jake started a competing business after resigning from FEI but offers no other details.
Jake received no dividends or distributions from FEI after he resigned. In 2013, Jake brought suit against his siblings and FEI, asserting claims for breach of fiduciary duty, common-law dissolution, an accounting, and imposition of a constructive trust, alleging that the siblings were “looting” FEI’s profits for their sole benefit and depriving Jake of his right to a return on his interest in FEI. In addition to their alleged wrongful refusal to declare dividends, Jake launched a litany of accusations against his siblings including but not limited to taking unwarranted salary increases, engaging in nepotism, initiating discretionary 401K contributions, increasing loans to FEI’s officers, retaining excessive earnings, and increasing FEI’s bad debt and inventory.
In its analysis of Jake’s dissolution claim, the appellate court’s majority opinion initially noted Jake’s concession that, because he directly owned less than 20% of FEI’s voting shares, and notwithstanding that his combined beneficial ownership exceeded 20% based on his 25% ownership of the LLC which owned 52% of FEI’s voting shares, he could not seek judicial dissolution based on oppression and looting under Section 1104-a. The opinion in words and practical effect, however, went on to analyze Jake’s common-law dissolution claim as if it were one under the statute, citing Kemp and explaining as follows:
“Predicated on the majority shareholders’ fiduciary obligation to treat all shareholders fairly and equally, to preserve corporate assets, and to fulfill their responsibilities of corporate management with scrupulous good faith, the courts’ equitable power [to dissolve a corporation] can be invoked when it appears that the directors and majority shareholders have so palpably breached the fiduciary duty they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by statute” (Matter of Kemp & Beatley [Gardstein], 64 NY2d 63, 69-70  [internal quotation marks omitted]; see Fedele v Seybert, 250 AD2d 519, 521 [1st Dept 1998]). Despite the different standards for statutory and common-law dissolution, courts have permitted common-law dissolution actions to proceed where there are colorable claims of oppression and looting, which are grounds for statutory dissolution under section 1104-a (1) and (2). Oppression occurs “when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the [minority shareholder’s] decision to join the venture” (Kemp & Beatly, 64 NY2d at 73; see Matter of Charleston Sq., 295 AD2d 425, 426 [2d Dept 2002]).
Applying this standard, the majority concluded that the defendant siblings properly were granted summary dismissal of Jake’s claims for breach of fiduciary duty and common-law dissolution based on the undisputed evidence that:
dividends or distributions had never been paid to shareholders and that, instead, after bonuses were paid to certain non-owner employees of the [FEI] and, at times, to the mother and father, the employee-officers were paid large bonuses. When the mother, father and nonparty Jennifer Jackson held shares of the Corporation, they did not receive bonuses commensurate with their shares of ownership. Moreover, after [the LLC] became the majority shareholder, it did not receive any money from [FEI] that could be considered a de facto or disguised dividend. Thus, defendants demonstrated that there was no misconduct by the individual defendants when they continued the established practice of paying bonuses to officers, who were also shareholders.
The majority also agreed with the siblings that the circumstances in Kemp concerning de facto dividends were distinguishable, stating that, “[c]ontrary to plaintiff’s contention, this is not a situation where the compensation policy was changed after the minority shareholder left the employ of the Corporation (cf. Kemp & Beatly, 64 NY2d at 74). Indeed, it is plaintiff who seeks to change the established compensation policy of [FEI].”
The court also concluded that the defendants satisfied their burden on summary judgment in respect of the miscellaneous, other allegations of financial and management abuses, and that Jake’s expert CPA’s affidavit opposing defendants’ showing was fully refuted by defendants’ expert’s reply affidavit. As noted above, the appellate panel’s sole dissenter came to the opposite conclusion as to the efficacy of the experts’ affidavits.
It was not a complete loss for Jake. For one thing, the appellate court unanimously reversed the lower court’s order insofar as it denied his cross-motion to require his siblings to reimburse FEI for legal fees it paid in defense of the dissolution claim. The court reasoned that the “underlying premise for determining that a corporation and its shareholders are precluded from using corporate funds to defend against a dissolution is that a corporation lacks standing to litigate the issue of its own dissolution,” regardless of the statutory or common-law source of the dissolution claim. As a practical matter, however, requiring the siblings to reimburse FEI neither fattens Jake’s wallet nor, at this late stage of the case, creates meaningful leverage going forward.
Undoubtedly more valuable to Jake was the court’s unanimous disagreement with the lower court’s denial of his cross-motion for reimbursement and advancement of his legal expenses incurred in the ongoing defense of his siblings’ unresolved counterclaims. The court found that Jake satisfied the non-stringent standard for advancement under Section 724 (c) of the Business Corporation Law, and that statutory indemnification was available “even though the counterclaims are brought, in part, by the Corporation itself,” citing (among other precedents) the Schlossberg v Schwartz decision which I wrote about here.
While every case has its peculiar facts, the big picture in the Feldmeier case is one I’ve seen time and again in closely held firms — both family owned and non-family owned, and especially in subchapter C corporations whose earnings upon distribution are subject to double taxation — where business owners, all of whom are employees and are actively involved in running the business, forgo shareholder dividends in favor of salary plus bonus paid from excess earnings, which may or may not mirror stock percentages. When an owner retires or otherwise voluntarily leaves employment, his or her interest in receiving return on investment shifts from employment compensation to dividends, putting him or her at odds with the remaining, still-active owners.
The answer, of course, is thoughtful design and implementation of an owners’ agreement with carefully tailored buy-sell provisions addressing the usual exit scenarios including death, disability, and retirement or other voluntary resignation.