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Will COVID-19 Affect Dissolutions Under the Business Corporation Law (BCL) CL or Limited Liability Corporation (LLC) Law?

Apr 14, 2020Litigation & Dispute Resolution

At some point in time, after the world comes back to life, we will be dealing with the aftereffects of the massive business shutdown as a result of the COVID-19 virus. Many businesses will have to consider whether they have a future in a post-COVID 19 world. Individual owners of those businesses may determine that it is in their personal interest to liquidate their holdings and consolidate cash for the difficult times ahead.

However, can a shareholder or LLC member seek a dissolution because that shareholder or member is in dire financial straits individually and is of the view that carrying on the business might serve to be a losing proposition for all?

For shareholders, there are three ways to seek dissolution: pursuant to BCL §1104, §1104-a and/or “common law” dissolution. An LLC member has fewer choices as judicial dissolution of an LLC in New York is governed by Section 702 of the LLC law. Of course, all of this assumes that the shareholders and/or members of their respective business organizations did not have the foresight to prepare a shareholder agreement and/or operating agreement which precisely define the rights of a shareholder and/or member to withdraw.

BCL §1104 is available to those shareholders owning one-half of all votes of all outstanding shares of a corporation entitled to vote in an election of directors. The grounds are limited to: (1) that the directors are so divided respecting the management of the corporation’s affairs that the votes required for action by the board cannot be obtained; (2) that the shareholders are so divided that the votes required for the election of directors cannot be obtained; and/or (3) that there is internal dissension and two or more factions of the shareholders are so divided that dissolution will be beneficial to the shareholders.

BCL §1104-a is available to those holders of shares representing 20% or more of all outstanding shares of the corporation. If that condition precedent exists, the grounds for dissolution are: (1) the directors or those in control have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders; and/or (2) the property or assets of the corporation are being looted, wasted or diverted for non-corporate purposes by its directors, officers or those in control of the corporation. Under Section 1104-a the court must take into account (1) whether the liquidation of the corporation is the only feasible means whereby the petitioners may reasonably expect to obtain a fair return on their investment; and (2) whether liquidation of the corporation is reasonably necessary for the protection of the rights and interests of any substantial number of shareholders.

Under common law, such a claim is properly stated wherein it is alleged with sufficient factual detail that the shareholders in control have been looting their company’s assets at the expense of minority shareholders. Leibert v. Clapp, 13 N.Y.2d 313, 315-316, 247 N.Y.S.2d 102 (1963). It has been held that the remedy of common-law dissolution is reserved for egregious conduct. Kassab v. Kasab, 56 Misc. 3d 1213(A), 65 N.Y.S.3d 492 (Sup. Ct. Queens Co. 2017), citing Kemp v. Beatley, Inc., 64 N.Y.2d 63, 69-70, 484 N.Y.S.2d 799 (1984).

For an LLC, the complaining member’s job is even more difficult. There, dissolution is only available where the discord in disputes by and among the members are shown to be inimical to achieve the purpose of the LLC as stated in the articles of organization or operating agreement. In sum, the evidence must demonstrate that it is “not reasonably practical to carry on the business” under the circumstances presented. It is clear that judicial dissolution under Section 702 is a drastic remedy. See, Matter of 1545 Ocean Avenue, LLC, 72 A.D.3d 121, 131, 893 N.Y.S.2d 590 (2d Dep’t 2010).

So, knowing the lay of the land, the question remains: does the fact that an individual shareholder and or member finds himself in a financially distressed state, particularly as a result of the ongoing business shutdown, mean that the shareholder and/or member can use such a basis to claim dissolution of the respective business is an appropriate act?

Initially, the answer would be “no.” The issue of financial hardship of a particular shareholder as a grounds for seeking dissolution has been addressed by several courts. In Matter of Murphy, 120 A.D.2d 733, 735-736, 502 N.Y.S.2d 518 (2d Dep’t 1986) the court determined after a trial that the petitioners were seeking dissolution of several companies because they had accumulated a large amount of liquid assets and petitioners determined that they could make better use of those assets on their own. The courts clearly stated “the mere fact that a closely-held corporation may have substantial liquid assets which a shareholder wishes to reach is an insufficient basis for judicial dissolution.” On the issue of hardship, in Matter of Dubonnet Scarfs, Inc., 105 A.D.2d 339, 343, 484 N.Y.S.2d 541 (1st Dep’t 1985), the court ruled the petitioners had failed to present any legal authority holding that a shareholder, who is in personal financial difficulty, unrelated to the corporation, can demand to be bought out because he or she needs cash to satisfy personal creditors, adding “neither sympathy nor a shareholder’s need for cash qualify as either a statutory or common law ground for judicial dissolution.”

Normally that would be the end of it. However, one can see a factual scenario developing whereby a business that has lost its market share to competitors during the shutdown as well as its key employees might not survive going forward despite the well-intentioned views of one or more of its shareholders. Thus, while it may be true that the dissenting shareholder is experiencing severe financial difficulties as a result of forces related to COVID-19 or otherwise, one would think that there might be legitimate grounds, certainly under BCL §1104, to maintain the directors are “so divided respecting the management of the corporation’s affairs that the votes required for action by the board cannot be obtained.” A similar argument might be made under §1104-a that, while a corporation’s assets are not being looted or diverted for non-corporate purposes they may be, in fact, “wasted” considering the business realities facing that corporation going forward. The dissenting shareholder may argue that the majority are “throwing good money after bad” by continuing operations in light of economic realities that many businesses will face post-COVID-19 and that any remaining value to the company will be lost if the majority shareholders have their way and continue operations until, as the dissenting shareholder will argue, the eventual destruction of the company.

In a post-COVID-19 world, businesses are going to have to reevaluate how they do business and/or whether to continue to do business. It might be the case that a dissenting shareholder can make a valid argument that continuing operations based on precise criteria and data-driven arguments support dissolution, notwithstanding, and/or in addition to, to the fact that the dissenting shareholder is suffering economically and in need of an inflow of cash.