When Estate Plans and Stock Transfer Restrictions Collide
November 16, 2020
A recent decision from Bronx County Supreme Court Justice Llinet M. Rosado, Sebrow v Sebrow, 2020 NY Slip Op 20269 [Sup Ct, Bronx County Oct. 9, 2020], is a stark reminder to corporate shareholders, attorneys who plan their estates, and their prospective beneficiaries, to exercise due diligence before attempting to make, draft, or receive testamentary dispositions of corporate stock.
The Stockholders’ Agreement
In 1997, two father-and-son pairs, Abraham, Joseph, Zvi, and David Sebrow, all four of whom owned 25% of the shares of stock of Worbes Corporation (“Worbes”), entered into a written Stockholders’ Agreement, Section 6 of which imposed the following stock transfer restriction:
No stockholder of . . . Worbes . . . shall sell, transfer, assign, mortgage, [or] hypothecate his shares . . . without the unanimous consent of all the other stockholders with the sole exception that any stockholder may make a testamentary disposition of his shares to his issue in which event his issue shall own the shares of his deceased father but subject nevertheless to any terms and conditions contained in this agreement. Any other attempted transfer of such shares shall be a nullity and unenforceable (emphasis added).
The Last Will and Testament
Upon their deaths, Abraham and Joseph, through testamentary dispositions, conveyed their 25% stock interests to their respective children, Zvi and David, making each a 50% shareholder of Worbes.
In 2010, David executed his Last Will and Testament. Article 2 provided a residuary bequest of all real and personal property of his estate, apparently intended to include his stock in Worbes, to his wife, Betty Sebrow, but if Betty were to predecease him, then pursuant to Article 2.a, his shares of stock would pass to his son, Jeffrey, and his daughter, Laura. The will read:
2 – All the rest, remainder, and residue of my property, real or personal, . . . I give devise and bequest to my wife, BETTY SEBROW, provided she shall survive me. If she shall not survive me, this bequest to her shall lapse and go instead as follows:
a – Any interest or ownership that I may have upon my demise in WORBES CORP. . . I hereby give, devise and bequest as follows: two/thirds (66.6666%) to my son, JEFFREY ISAAC SEBROW and one/third (33.3333%) to my daughter, LAURA SEBROW.
In 2017, David died. After his death, Betty insisted that she became a 50% shareholder of Worbes under the residuary clause of David’s will. Betty’s brother-in-law, Zvi, refused to acknowledge her status as shareholder, setting the stage for inevitable litigation.
In 2019, Betty, individually and as purported shareholder of Worbes, filed a lawsuit against Zvi alleging causes of action for: (i) accounting based upon the alleged existence of a fiduciary duty Zvi owed Betty as shareholder of Worbes, (ii) a shareholder derivative claim under Section 626 of the Business Corporation Law (the “BCL”), (iii) constructive trust, (iv) dissolution of Worbes based upon 50/50 deadlock under BCL 1104, and (v) partition of the real property owned by Worbes located in Bronx, New York. Betty alleged that Zvi “cut [her] out of all decisions” involving the business, and breached his duties to her as shareholder of Worbes by causing foreclosure of the real property owned by Worbes.
The Dismissal Motion
Zvi moved to dismiss Betty’s complaint on two grounds.
First, Zvi argued that Betty lacked standing to sue, arguing that Section 6 of the Stockholders’ Agreement prohibited shareholders from transferring stock to anyone but their “issue” (a term of art meaning lineal descendants). In his moving affidavit and memorandum of law, Zvi asserted that he never consented to David’s transfer of stock to his wife, who did not qualify as his “issue,” so the attempted bequest was ineffective. Second, Zvi argued, in the alternative, that a rabbinical arbitration provision in Section 9 of the Stockholders’ Agreement barred Betty’s lawsuit.
Betty opposed Zvi’s dismissal motion on three grounds.
First, Betty argued that Zvi’s affidavit was not properly notarized and, and therefore, inadmissible. Second, Betty submitted an affidavit alleging that her husband’s signature on the Stockholders’ Agreement was a forgery, raising a disputed factual issue about its authenticity. Third, Betty argued that even if the Stockholders’ Agreement arguably prohibited David’s stock transfer to her, she and David married years before the agreement’s execution. Betty argued, “By that time, as David Sebrow’s wife, [Betty] may already have had certain rights to her husband’s shares in Worbes based upon the length of the marriage, as [David’]s share[s] were a marital asset. Thus, whether or not a shareholders agreement is ultimately considered by the Court, the provision which, in essence, seeks to disinherit [Betty], as a spouse, is unenforceable as a matter of public policy.” Betty cited no case law for her policy-based argument.
In his reply memorandum of law, Zvi pointed out the inconsistency of Betty asserting that the Stockholders’ Agreement was forged, because she admitted in paragraph 10 of her own complaint that David was one of “four signatories” to the document.
The Court rejected Betty’s three arguments.
Addressing the procedural issue of proper notarization of Zvi’s affidavit, the Court ruled that is was “duly sworn” and executed before a New Jersey attorney, who is “authorized to administer such oath,” and therefore, admissible under New York law.
Addressing the issue of forgery, the Court ruled that Betty “did not raise an issue that the Stockholders’ Agreement is unenforceable in her complaint,” and if “the Stockholders’ Agreement was actually forged, then [Betty] should not rely on such Stockholders’ Agreement to allege her causes of action.” Due to the “inconsistent arguments” Betty made in her complaint and opposition papers simultaneously affirming and rejecting authenticity of the Stockholders’ Agreement, the Court held that the “Stockholders’ Agreement submitted as a documentary evidence resolved all factual issues as a matter of law, and the defendant made a prima facie showing that the plaintiff does not have standing to sue as a matter of law.”
Addressing the conflict between the attempted residual bequest in Article 2 of the Last Will and Testament, and Section 6 of the Stockholders’ Agreement, the Court ruled:
According to the Stockholders’ Agreement, unless David made a testamentary disposition of his shares to his issue, or [Zvi] consented to David’s transfer of his shares in Worbes to his wife, such transfer or disposition of the shares in Worbes shall be a nullity and unenforceable.
Even if this Court accepts David’s Will and Testament as true, there is no evidence that David made a testamentary disposition of his shares to his issue or obtained a consent from [Zvi]. Furthermore, [Betty] failed to offer any statute or case law that defeats the language of the Stockholders’ Agreement.
Therefore, after David’s death, as of the date of this motion, [Zvi] remains as the sole shareholder of Worbes, and [Betty] is not a shareholder of Worbes.
As a result, the Court dismissed Betty’s complaint in full for lack of standing, and declined to reach the issue of the arbitration provision in the Stockholders’ Agreement.
Enforceability of Stock Transfer Restrictions and Buy-Sell Agreements
In 1983, New York’s highest court decided Matter of Riefberg, 58 NY2d 134 , holding that shareholder buy-sell on death agreements are valid “testamentary substitutes,” meaning that the value of the deceased shareholder’s stock interest is potentially “includable in computing the estate against which the decedent’s surviving spouse may exercise her statutory right of election.”
Just two months later, in Isaacson v Beau Label Corp., 93 AD2d 880 [2d Dept 1983], an appeals court rejected a deceased shareholder’s widow’s attack, based in part upon Riefberg, upon the enforceability of certain stock buy-sell on death agreements, arguing that they were “illegal and unenforceable” due to what she argued was “inadequate consideration in exchange for her mandatory offer of sale of decedent’s stock to the corporations.” The Court held, “In the absence of fraud, duress, or undue influence,” shareholder buy-sell on death agreements “are valid and enforceable.” The Court ruled that Riefberg “does not create a right to challenge the adequacy of consideration under such a buy-sell provision when said consideration passes through the estate” of the deceased shareholder.
After Isaacson, “[i]t is well settled that absent fraud, duress, or undue influence, agreements between shareholders which call for the purchase and sale of stock by a shareholder who dies are valid and binding,” and will trump competing estate plans (Matter of Gusman, 178 AD2d 597 [2d Dept 1991] [citation omitted]).
The bottom line: if you hope to bequeath corporate shares of stock, make sure your will complies with any stock transfer restriction / buy-sell provisions in your shareholders’ agreement (if you have one). If your will conflicts with the contract, you may leave behind a very disappointed beneficiary.