A judge in the Supreme Court for the State of New York recently allowed a petition for “common law dissolution” of a family-owned business filed by one shareholder to proceed despite the arguments of the other shareholders that the case should be dismissed. Yu v. Bong Yu, Docket No. 656611/2016, Supreme Court, New York County (August 15, 2018). Patrick Yu claimed that he was a shareholder of Moklam Enterprises, Inc. The remaining owners allegedly include his father, Bong Yu, his brother, Raymond Yu, and his sister, Catherine Yu. Moklam was an entity that funded the Yu family’s various real estate and business activities. While the remaining family members all had roles in Moklam’s business operations, Patrick, a lawyer, was employed only as counsel to Moklam and the other Yu family entities.
Patrick alleged that in 2013, he and his wife divorced, after which Patrick decided to sell his house in Scarsdale and move to an apartment in Manhattan. Bong allegedly wanted Patrick to remain in the Scarsdale house. Since Patrick “defied his father’s wishes” by moving from the Scarsdale house, Bong allegedly demanded that Patrick sell his ownership interests in Moklam and all other Yu family entities for $3,000,000, an amount allegedly equal to approximately 5% of the fair value. Bong allegedly also directed the companies to no longer use Patrick for legal work, depriving Patrick of his main source of income, and directed Moklam to stop paying dividends to Patrick.
Patrick then sent a letter to his brother Raymond asking to inspect the books and records of the Yu family entities for the purpose of valuing his shares in the entities. In response, Patrick allegedly received only a few documents. He also received three separate demand letters seeking immediate payment from him of several hundred thousand dollars under three separate loan agreements. Patrick claimed that no amounts were due under these agreements as of the dates of the demands. The family members also commenced three separate lawsuits against Patrick based on the claims under the loans.
Patrick further alleged that Raymond and Catherine amended the operating agreements of two real estate owning entities to remove Patrick as managing member and to include a capital call provision through which any member not contributing the required amount would risk foreclosure of his LLC interest. After Patrick settled one of the lawsuits by agreeing to pay the full amount demanded under certain loans, he again demanded inspection of the family entities’ records. Less than a week later, Raymond and Catherine allegedly invoked the new capital call provision with respect to one of the family entities and sent Patrick a letter demanding that he contribute $600,000 as his share of expenses for that entity.
Patrick filed a petition for dissolution of Moklam in the New York Supreme Court based upon his family members’ conduct toward him. Specifically, he alleged that the family “repeatedly retaliated against him” for exercising his rights as a shareholder, took steps to put “enormous financial pressure on him at a time when they knew very well he was under financial duress,” and denied him any meaningful access to the books and records of the family businesses. He further claimed that the family took these steps not to further the interests of these entities, but to “pursue a personal vendetta against [him], while at the same time enriching themselves through the acquisition of his shares at a cost far below their fair value.”
The family members responded to Patrick’s claims by alleging, among other things, that Patrick “was never interested in the family business,” but instead was employed as an outside lawyer to the entities when he had trouble finding a job after law school. They further claimed that Moklam lent Patrick $900,000 over the years to help him with “financial difficulties” and also lent him $600,000 to help with the purchase of the Scarsdale home. Patrick further allegedly pledged his shares as security for the home loan and was not permitted to exercise any voting rights related to his shares, or receive and retain any dividends, distributions, or interest payable on his shares until that loan was repaid. Finally, after his divorce, Patrick allegedly asked for help again and Bong “generously suggested that Patrick sell his shares and offered $3 to $4 million staggered over several years to avoid negative tax implications.” For these reasons, and others, the family members claimed that Patrick was not entitled to an order dissolving Moklam and asked that the court dismiss his petition.
The court noted that, under New York law, “[T]he remedy of common-law dissolution is available only to minority shareholders who accuse the majority shareholders and/or the corporate officers or directors of looting the corporation and violating their fiduciary duty.” The court then determined, on the record before it, that Patrick had alleged sufficient facts in support of his claim that his family members had “repeatedly retaliated” against him for exercising his rights as a shareholder and that they were pursuing a “personal vendetta” against him while enriching themselves. Thus, the court concluded that “Patrick’s allegations set forth a reasonable basis to believe that further discovery may reveal further evidence of egregious conduct necessary to sustain the claim for common law dissolution.” The court denied the family members’ motion to dismiss and instead ordered them to file a formal answer to his complaint so the case could move forward to discovery and further pre-trial proceedings.
The remedy of common law dissolution, as available under New York law, is not recognized in every jurisdiction. However, many of the allegations in the Yu case – including termination of a shareholder’s employment, restriction of access to company books and records, and bad faith amendments to or enforcement of agreements – commonly appear in claims between shareholders for statutory dissolution under relevant state statutes and for common law breach of fiduciary duties.
In order to attempt to avoid such claims, owners and managers of family-owned businesses should attempt to fully understand their rights and obligations and should be able to provide a good faith basis for their conduct toward other shareholders.
Even otherwise defensible corporate actions or decisions may be called into question if a party’s motives are suspect. As in Yu, a claimant may be able to at least state a viable claim for corporate dissolution, breach of fiduciary duty or shareholder oppression if he or she can demonstrate that the challenged conduct was not undertaken to promote the best interests of the company but instead was designed to retaliate against a shareholder based upon strained family relationships.