Winter Case Notes: Time-Barred Dissolution Petition and Other Decisions of Interest

Welcome to this year’s edition of Winter Case Notes in which I highlight a collection of recent court decisions of interest to business divorce aficionados by way of brief synopses with links to the decisions for those who wish to dig deeper.

This year’s synopses feature decisions by courts in New York, Colorado, and Delaware:

  • dismissing a minority shareholder’s dissolution petition brought outside the limitations period;
  • affirming a minority shareholder’s standing to sue derivatively where her stock sale to a third party was deemed invalid under the shareholders’ agreement;
  • rejecting derivative claims on behalf of a cancelled Delaware limited liability company;
  • dismissing a shareholder derivative suit alleging demand futility where the court found that a pre-suit letter to the board constituted a demand notwithstanding the letter’s explicit disclaimer; and
  • dismissing an appeal from a dissolution order brought by shareholders in the corporation’s name, on the ground that only the court-appointed receiver can act on the corporation’s behalf.

Court Dismisses Time-Barred Dissolution Petition

It’s no surprise that dissolution cases raising a statute of limitations defense are very few and very far between. When a non-controlling owner is frozen out and deprived of income, or disabling deadlock occurs, or the controller is suspected of looting, there’s powerful incentive to bring suit expeditiously.

Matter of Yin Shin Leung Charitable Foundation v Seng, 177 AD3d 463, 2019 NY Slip Op 08261 [2d Dept Nov. 14, 2019], is one of the very few. The case involves a family-owned corporation that owns and operates commercial realty. Three siblings together holding 45% of the corporation’s shares sued for dissolution under § 1104-a of the Business Corporation Law, accusing the other three siblings of breaching fiduciary duty in connection with a pair of rent-free arrangements and the use of corporate funds in a “special account” to pay certain litigation expenses. The respondent siblings contended that the suit was time-barred under the applicable 6-year statute of limitations based on the petitioners’ admission that they had known for more than 6 years before filing suit how the corporation’s assets were being used in the manner challenged.

Early last year, Manhattan Commercial Division Justice Andrea Masley agreed with the respondents and dismissed the case (read here). On appeal, the petitioners pressed their argument that the suit was timely under the doctrine of continuing wrong. The First Department found the argument unavailing and affirmed the dismissal of the dissolution claim, finding that “for each [rent-free] arrangement, a single decision was made to permit the property to be used gratis” and that petitioners had waived any claims with respect to use of the “special account” to pay legal fees.

Invalid Stock Sale Rescues Shareholder’s Derivative Claims

Jiang v Wu, 2019 NY Slip Op 00576 [2d Dept Jan. 29, 2020], involves a 25% shareholder’s derivative action against the controlling shareholders of a real estate holding corporation. The defendant majority shareholders moved to dismiss the derivative claims, arguing that the plaintiff lacked standing under the continuous ownership rule based on the sale of her shares to a third party after the litigation was brought.

The plaintiff did not deny the sale of her shares but insisted anyway that she retained standing to sue. The lower court agreed the plaintiff had standing, but for a very different reason, namely, that the sale was invalid because plaintiff never sought or obtained the majority shareholders’ consent to the sale as required by the shareholders’ agreement. Curiously, the defendant majority shareholders did not advocate the invalidity of the sale to the third party, who was not a party to the lawsuit.

Defendants appealed. In its ruling last month, the Appellate Division affirmed that portion of the lower court’s ruling, writing:

Contrary to the defendants’ contentions, they failed to establish, prima facie, that [plaintiff’s] attempt to transfer her shares was effective. Under the shareholder agreement, a purported transfer in violation of the agreement is “null and void” and not recognized by [the corporation] or the shareholders. The second amendment provided that “No share of stock shall be transferred or sold to any outside individual or entity without being first offered on similar terms and conditions to the shareholders of the record and upon written consent of such shareholders who hold a majority interest in [the corporation], which consent shall not be unreasonably withheld.” There is no indication in the record that [plaintiff] offered her shares to the other shareholders or obtained their consent prior to her purported sale to the third party. Further, the record does not demonstrate that the other shareholders affirmed [plaintiff’s] purported sale of the shares to the third party after discovering it. Accordingly, under the terms of the shareholder agreement as modified by the second amendment, [plaintiff’s] purported sale of shares to a third party was null and void, and she remained a shareholder of [the corporation].

Court Dismisses Derivative Claims on Behalf of Cancelled LLC

Manhattan Commercial Division Justice Andrea Masley’s decision in Meissner v Yun, 2020 NY Slip Op 30012(U) [Sup Ct NY County Jan. 2, 2020], marks the eighth year of a bitter dispute between former romantic partners who co-founded and for 6 or 7 years operated a Delaware limited liability company that offered preparatory courses for business school applicants taking the GMAT exam. The owners never entered into an operating agreement. In 2011, the defendant Yun filed a certificate of cancellation of the LLC with the Delaware Secretary of State.

The plaintiff, Meissner, never sought to nullify or revoke the certificate of cancellation, which, applying Delaware case law, required the court in a 2015 ruling to dismiss all of Meissner’s derivative claims for lack of standing. That ruling was affirmed on appeal.

In her recent decision, Justice Masley addressed Yun’s motion to dismiss Meissner’s remaining claim for breach of fiduciary duty pleaded as a direct claim, arguing that it is effectively an improper derivative claim. Justice Masley agreed, finding that “[i]n the absence of a valid operating agreement, plaintiff’s claim is wholly derivative, no matter how it is denominated in the [complaint],” and that its allegations of self-dealing, diversion of business opportunities, and misappropriation arising from the dissolution constitute injuries to the LLC, not Meissner.

If It Looks, Walks, and Quacks Like a Demand, It’s a Demand

Under Delaware law, once a shareholder makes a demand upon the board of directors to take legal action, and the board declines to do so, a subsequent derivative action must plead with particularity that the board declined the demand in bad faith or with gross negligence. Because it’s such a high hurdle, potential litigants will skip the demand and plead demand futility whenever possible.

In Dahle v Pope, C.A. No. 2019-0136-SG [Del Ch Jan. 31, 2020], the plaintiffs seemed to want it both ways. First, they sent a letter to the board complaining about allegedly excessive compensation paid to non-employee directors. The letter suggested remedial measures coupled with a threat to make use of “all available shareholder remedies.” But in a footnote, the letter also stated that “nothing herein shall be construed as a pre-suit litigation demand” and that “[w]e do not expect the Board to initiate any legal action against its members.”

Then, after the board hired outside counsel to investigate and concluded that no civil action or change to board compensation was warranted, the plaintiffs filed a derivative action alleging demand futility. The complaint made no mention of their letter to the board.

Vice Chancellor Glasscock didn’t buy it, among other reasons, because of a prior Chancery Court ruling in another case in which the same plaintiffs’ counsel brought the same arguments regarding a nearly identical letter to the board of directors of a different company, also challenging director compensation. The court in that case dismissed the action, finding that a pre-suit communication, to be considered a demand, need not expressly demand litigation so long as it communicates the legal action the shareholder wants the board to take on the corporation’s behalf. The letter in that case and its clone in Dahle did so. “Here,” VC Glasscock wrote,

the Plaintiffs crafted a communication intended to spur the Board to the same action it would take in response to an explicit demand, although simultaneously attempting to skirt through clever draftsmanship the tacit concession that results from making such demand. This was a conscious attempt to make a pre-suit demand without consequence . . ..

Corporation’s Right to Appeal Dissolution Belongs to Court-Appointed Receiver

In Francis v Camel Point Ranch, Inc., 2019 COA 108 [Colo. Ct. App. 2019], a Colorado appellate court addressed the novel question whether shareholders can appeal an order of judicial dissolution in the name and right of the corporation without getting the approval of the receiver appointed by the court to wind up the corporation’s affairs.

The order of appointment gave the receiver:

all the powers of the corporation, through or in place of its board of directors, to the extent necessary to manage the affairs of the corporation in the best interests of the shareholders and creditors. The receiver shall have all authority and power to run Camel and protect its assets . . .. [citation omitted]

After the respondent shareholders filed an appeal from the dissolution order, the petitioners filed a motion to dismiss the appeal based on the receiver’s lack of involvement and approval. The appellate court granted the motion and dismissed the appeal, ruling that the order of appointment:

empowered the receiver to decide, subject to his fiduciary duties and under the court’s oversight, whether to spend corporate assets on litigation–including whether to challenge the trial court’s order dissolving the corporation. In short, once appointed, the receiver was vested with title to all of the corporate property and power to represent the interests of all of Camel’s shareholders.

The court’s ruling does not leave shareholders powerless. “Once the trial court ordered Camel’s dissolution and appointed a receiver,” the Court wrote,

the shareholders purporting to appeal on Camel’s behalf could have sought redress in two ways: directly appeal the trial court’s order appointing the receiver or demand that the receiver appeal the dissolution order, and if refused, petition the trial court to order the receiver to appeal.

Why didn’t the respondent shareholders appeal in their own names and right? Was it possibly an attempt to shift to the corporation the fees and costs of the appeal? The opinion doesn’t say.

Winter Case Notes: Time-Barred Dissolution Petition and Other Decisions of Interest