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Shareholder Disputes: How to Obtain Company Documents, by Stuart F. Gartner

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What can you do if you suspect that shareholders in your company are engaging in fraud or mismanaging the company, yet your requests for corporation records go unheeded? In Novikov v. Oceana Holdings Corp., a case handled by this Firm, the Kings County Supreme Court answered that question: so long as you have a legitimate purpose (such as investigating suspected mismanagement), you can force the company to turn over relevant corporation records.

Our client was a minority owner in a closely held corporation (the "Company") that owned a mixed commercial and residential building ("Building") in the Brighton Beach area of Brooklyn.  Our client had been kept out of the decision making loop by the other shareholders, and received virtually no information from them as to the Company.  Over time, he began to suspect that the other shareholders were engaging in self-dealing and mismanaging the Company.  Among other things, our client believed that one  of the shareholders had taken a substantial loan from the Company that had gone unpaid, and that the other shareholders were paying themselves unreasonable salaries, and had rented a commercial unit in the Building at a below market rent to another, separate company owned by them.  To investigate the suspected misconduct, our client demanded to see Company tax returns, financial statements, and property leases.

The Company refused to give over the documents voluntarily, so this Firm brought a Supreme Court petition on our client's behalf to compel the Company to do so.  The Company opposed the petition, saying that it had already given a redacted Company tax return, and that our client had bad motives for seeking the documents.

The Court granted the petition, ordering the Company to give over to our client unredacted State and Federal tax returns, profit and loss statements, leases, employment and commission agreements, shareholder meeting minutes and lists, and mortgage and loan documents.  (A copy of the decision is found at www.gbglaw.com under Decisions.)  The key to the Court's decision is a well-known point of law:  In addition to a statutory right for certain documents, "[a] shareholder has a common law right to inspect corporate books and records when the request is made in good faith and for a proper purpose....Investigating alleged misconduct by management and obtaining information that may aid legitimate litigation are in fact proper purposes ..." 

(Critically, our client with other counsel had tried previously to compel the Company to produce documents, but was turned away by the Court for failing to show a proper purpose for his request.  Our petition on his behalf included documentary evidence supporting his belief of Company mismanagement.)
 
The lesson offered by the Novikov decision is clear: the Business Corporations Law provides protections for minority shareholders; but whether you succeed in your request to obtain company documents depends on how well you can, prior to commencing a lawsuit, garner relevant facts and articulate a strong basis for your belief that the company is being mismanaged.   -SFG 11/3/2014

    




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The Legal Fees Sword, by Arthur Xanthos

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Many proprietary leases between a Co-op and a shareholder-tenant contain a boilerplate legal fees provision, obligating the shareholder-tenant to pay reasonable attorneys fees if the Co-op has to sue to enforce a provision of the lease. Because most lawsuits between Co-ops and shareholders are relatively quick summary proceedings in landlord-tenant court, the attorneys fees in question tend to be modest.

Sounds great, right? Except that sometimes it’s the shareholder-tenant who sues the Co-op (e.g., on a claim that the Co-op has breached the warranty of habitability), and by operation of the Real Property Law it is the shareholder-tenant who will be owed the reasonable attorneys fees if he or she prevails. These shareholder initiated lawsuits usually are plenary actions in Supreme Court, take years to litigate, and the attorneys fees in question can be substantial.   Our Firm's experience is that most Co-ops are willing to take that risk; thus, the boilerplate legal fees provision remains, well, boilerplate in most proprietary leases.

We believe however that serious consideration should be given to removal or modification of the legal fees provision in proprietary leases. Here is why. Assume a shareholder-tenant’s apartment is flooded due to a burst pipe from inside a wall. For whatever reason (inattentive Board, inexperienced managing agent), the apartment is not repaired for several months, and the shareholder-tenant relocates to a hotel. Disillusioned with the slow pace of repair, the shareholder-tenant repairs the apartment herself and sues the Co-op in Supreme Court for out-of-pocket expenses (the hotel bills, dry cleaning cost), the cost of repair (putting up new walls and ceiling), the damage to her personal property (furniture, artwork), a refund of maintenance payments for the period in question, and attorneys fees under the proprietary lease. The shareholder-tenant's lawsuit is based, in part, on the allegation that the Co-op breached the proprietary lease. If the shareholder-tenant prevails on her claim, she is likely entitled to attorneys fees, and the amount will be far more than the typical amount generated in the usual summary proceeding. That is because a fully litigated plenary action almost always generates significantly more legal fees than a summary proceeding generates. Worse for the Co-op, the award of attorneys fees to the shareholder-tenant (and for that matter, any award refunding maintenance payments) is almost never covered by the Co-op’s general liability insurance policy. Thus, a Co-op that has the boilerplate legal fees provisions in its proprietary lease and loses such a case will, (a) have to pay with out-of-pocket, non-insurance dollars, and (b) have to explain to its shareholders the reason for the hit to the Co-op's finances.

With no attorneys fees provision in the proprietary lease, the Co-op never faces this scenario; but must a Co-op forgo entirely the right to collect attorneys fees in all cases involving shareholder-tenants? Maybe not. Consider this: a proprietary lease that allows recovery of legal fees but only up to a specified dollar amount, say $15,000.00. In the majority of non-payment proceedings against shareholder-tenants, the Co-op will in most instances be made whole, as the legal fees generated will not exceed the specified dollar amount (i.e., $15,000.00). On the other hand, the maximum exposure the Co-op would face in Supreme Court if a shareholder-tenant prevailed would similarly be limited to $15,000.00, and most likely result in a “savings” of tens of thousands of dollars. In this light, a modified attorneys fees provision can be considered an additional insurance policy for the Co-op. We are unaware of any reported case addressing the validity of such a modified attorneys fees provision, but there is no good reason why a well-drafted limited attorneys fees provision wouldn’t be enforced in accordance with ordinary contract principles.

                                                                                             -APX 1/17/14
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