Kenneth C. Murphy, Partner & J’Naia L. Boyd, Associate, Rivkin Radler
All too often, friends or family members start a business with the best intentions. Rarely do the optimistic entrepreneurs anticipate a potential major disagreement about how to run the business. After all, in the beginning, they go into business together because they want to be in business together.
Sometimes, despite these good intentions, over time the partners disagree about how to run things. We are not discussing trivial disagreements such as how to organize the file cabinet or how to lay out the website, but major conflicts such as whether to invest profits in pursuing other markets or buying expensive new equipment.
Ideally, an operating agreement would address how the partners should deal with major decisions when they are at an impasse, what is commonly referred to as a deadlock. Under Business Corporation Law § 1104-a, deadlock occurs when a business’s board of directors are so divided on managing the corporation’s affairs that the votes required for action simply cannot be obtained. At the shareholder level, deadlock occurs either when the shareholders are so divided that the votes required for the election of directors cannot be obtained or there is internal dissension and two or more shareholder factions are so divided that dissolution would be beneficial to the shareholders.
In cases of deadlock, New York law offers a solution for a non-public corporation owned by a limited number of shareholders, also referred to as a close corporation – a judicial dissolution.
While this path can be difficult and unpleasant (and a settlement is always the better course), in some cases, it is the only path to resolve what can be a very difficult and stressful situation.
What most business owners do not realize, however, is that in considering the dissolution of a corporation, it never matters who is at fault (cue a collective gasp from litigators). In fact, a court considers only the existence of dissension and that deadlock has brought the corporate train to a halt. If the existence of a deadlock is undisputed, then the court will grant the dissolution without even a hearing.
Two recent cases from the same judge in Kings County illustrate this principal.
In the first, Matter of Hussein, (2019 WL 2407257 [Kings Cnty Sup Ct June 3, 2019]), Brooklyn Supreme Court Justice Leon Ruchelsman granted the motion of petitioner Shorouk Hussein for dissolution of Nile Marketplace Inc.
The Nile Marketplace, Inc. was established in April 2018 by Shorouk Hussein and respondent Abdelmez Alileala, each holding a 50% ownership of the corporation. The corporation executed a lease to operate a supermarket at 6922 Fourth Avenue in Brooklyn. Hussein’s husband, Dr. Mohamed Hassan, was a guarantor of the lease. (Dr. Hassan and Alileala were former business partners.) However, the supermarket never opened its doors.
Hussein sought dissolution of the corporation on the ground that internal dissension existed amongst the shareholders, which prevented the opening and operation of the supermarket. She alleged that Alileala “engaged in character assassination, and made derogatory and threatening comments” about Dr. Hassan such as calling him a “thief” to friends and members of the community. According to Hussein, these comments began in June 2018, shortly after the corporation was established. In November 2018, a dispute arose between the parties regarding damage to the supermarket’s signage. After Hussein replaced the sign, Alileala allegedly sent threatening messages to her and her husband and continued to make threatening remarks thereafter. In January 2019, a temporary order of protection was issued prohibiting Alileala from coming into contact with Dr. Hassan. Hussein also alleged that she had paid for all of the corporation’s expenses without Alileala’s assistance and that she could not solely operate the supermarket.
Alileala opposed dissolution, disputing many of Hussein’s allegations, including that he had engaged in oppressive acts against her and that he had failed to contribute to the corporation’s expenses. Alileala asserted that Hussein had locked him out of the premises, failed to provide an accounting and did not open the books for inspection. He also requested that Hussein be ordered to open the books for inspection and provide a full accounting for the period the corporation existed before any dissolution could occur.
In his decision, Justice Ruchelsman held that, because there is no dispute that deadlock existed and the parties could work together, the dissolution petition had to be granted. The court cited the January 2019 order of protection prohibiting Alileala from coming into contact with Dr. Hassan, which demonstrated an inability for the parties to work together. The court ignored the fact that Alileala disputed Hussein’s allegations, stating that the allegations were “tangential to the issue of whether the parties can function together.” In other words, regardless of who was at fault in the parties’ bitter battle, dissension clearly existed and precluded the supermarket from even opening its doors. Therefore, the court granted the petition.
In the second example, Matter of DeAngelis (2019 WL 3400946 [Kings Cnty Sup Ct July 19, 2019]), Justice Ruchelsman made the same ruling, over the objections of the Respondent and without a hearing, discovery or the costly expenses of protracted litigation.
In the Matter of DeAngelis, Petitioner Guy DeAngelis and his nephew, Michael DeAngelis, equally owned Dean’s Pork Products Inc., a company originally established in 1972. Dean’s Pork is the maker of pork products, particularly sausages. The corporation had been operating at a loss for many years. To try and turn the company around, Michael suggested an equipment upgrade, which would cost approximately $500,000. Guy considered the upgrade to be a risky investment due to the corporation’s declining market share of the industry. Consequently, he would not agree to the investment. As a result, Guy sought dissolution of the company on the grounds that the shareholders could not agree on how best to run the company and, therefore, a deadlock existed. Michael opposed the motion and lodged allegations against Guy concerning improper corporate conduct.
As in Matter of Hussein, the court found that there was no dispute that a deadlock existed and that the parties cannot work together. The court reasoned that, because Michael believed that the entire future of the business was dependent upon upgrading the packaging system, Guy’s unwillingness to agree to this change “renders a deadlock that cannot be reconciled.” Although the court found that Michael’s allegations of improper corporate conduct and accounting of the corporation’s books and records could be independently pursued, those contentions were not taken into consideration given the clear deadlock between the parties and would not be used to forestall a dissolution. Thus, the court granted the motion seeking to dissolve the corporation.
The key here is that undisputed deadlock between the parties will result in judicial dissolution of the corporation. When deadlock exists, lodging allegations against a co-owner such as corporate misconduct and accounting failures in opposition to a dissolution petition will not defeat the petition. But, fear not! You can fight those battles another day.