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lwpat
lwpat, Attorney
Category: Business Law
Satisfied Customers: 25384
Experience:  Attorney with over 35 years of business experience.
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I have shares (10%) in a privately held company in New York.

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I have shares (10%) in a privately held company in New York. I resigned from my position there two years ago but cannot sell the shares back to the company because they did not have a shareholders agreement in place.

I would not mind holding onto the shares if I did not have to pay taxes on the earnings each year but when I have to shell out $$ to the IRS for earnings that I do not receive any compensation from the company for - its frustrating.

Is there anything I can do? I have spent over 20K in legal fees on this issue and nothing has been resolved.
Submitted: 5 years ago.
Category: Business Law
Expert:  Law Pro replied 5 years ago.
You are receiving the income from the company earnings - correct?
Customer: replied 5 years ago.
I am not receiving any earnings from the income.The owner bonuses himself and his wife to cover their share (84%) of the taxes. Until I left, he was providing me with a bonus to cover tax liability but no longer is that the case.
Expert:  Law Pro replied 5 years ago.

Minority shareholders in closely held New York corporations, unlike many other states, must hold at least 20% of the corporation’s voting shares to petition for judicial dissolution on grounds of oppression under Section 1104-a of the Business Corporation Law. There’s little if any legislative history to explain the arbitrary 20% threshold. I imagine it was included as a compromise to satisfy legislators opposed to judicial interference with traditional corporate majority rule.

 

Shareholders with less than 20%, and without any claim for breach of shareholders' agreement, have limited options to right perceived wrongs by the controlling shareholders. They may bring a derivative action under BCL Section 626 for corporate waste, diversion of assets or other wrongs causing injury to the corporation, but first they either must make proper demand upon the board of directors or demonstrate demand futility. BCL Section 627 also requires a derivative plaintiff-shareholder with less than a 5% interest to give security for the corporation's costs including legal expenses. Furthermore, depending on the circumstances, commencing a plenary action for breach of shareholders' agreement or asserting derivative claims for recovery on the corporation's behalf may not provide sufficient leverage to induce a buy-out of the plaintiff's shares, assuming the plaintiff is pursuing an exit strategy.

 

The below-20% shareholder has one other option: common law dissolution. It carries no minimum ownership percentage. It's harder to establish than statutory oppression under BCL 1104-a, and rarely successful, but under the right circumstances it may give such a shareholder at least a toe-hold toward dissolution, which also may be enough to induce serious buy-out negotiations.

 

A recent decision by Queens County Commercial Division Justice Orin R. Kitzes presents one of the relatively rare instances in which a claim for common law dissolution successfully advances past the pleading stage. The case, Matter of Mouzakitis (Pearl Nightlife, Inc.), Index No. 28420/08 (Sup Ct Queens County Feb. 24, 2009), was previously featured on this blog when the court initially dismissed without prejudice a common law dissolution petition because the plaintiff's husband, who co-owned the shares as tenants by the entirety, was not a party to the action. Husband and wife thereafter filed a new action as co-plaintiffs, again suing for common law dissolution.

In his decision addressing the new petition, Justice Kitzes lays out the petition's allegations as follows:

Petitioners are wife and husband, and they jointly own fifteen shares in Pearl Nightlife, Inc., the operator of a restaurant located at 45-30 Bell Boulevard, Bayside, New York. According to a shareholder's agreement executed on or about October 9, 2007, the petitioners own their shares as tenants by the entirety. The corporation has issued a total of one hundred shares, and the Mouzakitis allegedly contributed approximately $125,000.00 for their fifteen per cent interest. Nicholas Kiriakis, the holder of thirty shares and the corporation’s president, serves as the manager of the restaurant. The restaurant opened for business on or about March 1, 2008, only about six months ago. The petitioners allege that those in control of the corporation have failed to make required contributions to the business, have failed to pay salaries and dividends, have refused to permit an inspection of corporate books and records, and have diverted corporate funds and assets. The amount of liquor purchased by the restaurant allegedly does not match sales, and Kiriakis has allegedly diverted food supplies to his other restaurants, claiming that the food spoiled. On May 4, 2008, the other shareholders allegedly had the petitioner arrested at the restaurant.

After noting that the petitioners do not meet the 20% threshold for statutory dissolution, Justice Kitzes sets forth the standard for common law dissolution as established in Leibert v. Clapp, 13 NY2d 313 (1963):

In Leibert, the Court of Appeals recognized a common-law right to dissolution of a corporation where the officers or directors of the corporation are engaged in conduct which is violative of their fiduciary duty to shareholders. Dissolution is appropriate if the directors or those in control of the corporation are looting the corporate assets to enrich themselves at the expense of the minority shareholders; continuing the corporation solely to benefit those in control; or that the actions of the directors or those in control has been calculated to depress the capital of the corporation in order to coerce the minority shareholders to sell their stock at a depressed price.

Justice Kitzes further notes that "the proof required to establish a common law dissolution is greater than is required to sustain a shareholder derivative action for waste" because, while the latter seeks to strengthen the corporation, the former seeks to "'end the corporate life'" (quoting from Fontheim v. Walker, 282 AD 373 (1st Dept 1953), aff'd, 306 NY 926 (1954)).

 

Justice Kitzes concludes that the petitioners "have set forth sufficient allegations and support to raise an issue that the majority shareholders are enriching themselves at the expense of the minority" and that the "sworn statements of the petitioners are sufficient to warrant a hearing to determine the validity of these allegations." His order also preliminarily enjoins the defendants from transferring or encumbering any corporate assets outside the normal course of business, and directs that petitioners be given access to all corporate books, including those for construction costs and operating the business.

 

In Leibert v. Clapp, the minority shareholder alleged that the majority had accumulated a large surplus which it then diverted to a parent company as part of a squeeze-out scheme. The Court of Appeals found that the alleged misconduct by the majority, if proven, "so palpably breached their fiduciary duties they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and the dissolution power given to them by the statute." The allegations in Mouzakitis sound somewhat more garden variety than those in Leibert, but then again, the Leibert court's pronouncement is broad enough to encompass a wide range of alleged majority shareholder misconduct.

 

 

What have you attempted so far - to rack up such legal bills?

Customer: replied 5 years ago.
Letters from our attorneys requesting the shares be bought back by the corporation as well as litigation with a judge in the county where the business was started to prompt resolution. An offer was made by the corporation to purchase back the shares for $50,000, only if I agreed to a list of stipulations which would have forced me to no longer "compete" against my former employers business. I have in my possession a signed and dated letter from the owner of the corporation allowing me to enter into the business I currently run that competes with him, so I refused the offer.

How is it that I am held responsible to pay taxes on earnings I have not received?
Expert:  Law Pro replied 5 years ago.
You can't be. Your only liable for taxes on monies received - not monies retained otherwise by the company.

What are you receiving from them stating earnings that your having to report?
Customer: replied 5 years ago.
We receive a K-2 from the corporate on a yearly basis for tax purposes which we take with us to our accountant.
Expert:  Law Pro replied 5 years ago.
So they are stating that they made distributions to you on the form they send you - correct?
Customer: replied 5 years ago.
You know what - let me get the K-1 from last year and look at it to see and I will get right back to you.
Expert:  Law Pro replied 5 years ago.
That would be great!!
Customer: replied 5 years ago.
our accountant told us that taxes were owed on profits and earnings of any S-corp regardless of whether distribution was made to shareholders or not - this is a federal tax law based on the earnings reports on the K-1
Expert:  Law Pro replied 5 years ago.
I'm going to turn this over to another expert - maybe they can help you.
Customer: replied 5 years ago.
Do you agree or disagree with the information we are receiving from our accountant?

Accountant Says:
that federal taxes are owed on profits and earnings of any S-corp regardless of whether distribution was made to shareholders or not, I am responsible for 10% of the federal taxes, based on the earnings reported on the K-1

I do not receive any money (distributions) from the company
Expert:  lwpat replied 5 years ago.

Unfortunately you are responsible for the taxes although you are not receiving any distributions. You have to pay based on the K-1. I have seen this on numerous occassions but we have always been able to resolve through the threat of a dissolution. Here the problem is the NY law on the 20%. With that much in legal fees you should be somewhere on the road to a solution. That is more than any of the cases I have handled except for a couple that were on contingency based on recovery.

 

The above expert has correctly stated the status of the current law. You need to see if your attorney has properly included these claims in his pleadings. If not you need a new attorney.

lwpat, Attorney
Category: Business Law
Satisfied Customers: 25384
Experience: Attorney with over 35 years of business experience.
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