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MATTER JULIAN NELKIN ET AL. v. H. J. R. REALTY CORPORATION (12/11/69)

COURT OF APPEALS OF NEW YORK


decided: December 11, 1969.

IN THE MATTER OF JULIAN NELKIN ET AL., APPELLANTS,
v.
H. J. R. REALTY CORPORATION, RESPONDENT

Matter of Nelkin v. H. J. R. Realty Corp., 31 A.D.2d 923, affirmed.

Judges Burke, Bergan, Breitel and Gibson concur with Judge Scileppi; Chief Judge Fuld dissents and votes to reverse in a separate opinion in which Judge Jasen concurs.

Author: Scileppi

 H.J.R. Realty Corporation was organized in 1941 under the laws of the State of New York, by tenants of 128-138 Mott Street in New York City for the sole purpose of owning and managing the property and the building at that address.

The tenants involved in the corporation were Chatham Metal Products, Inc. (hereinafter referred to as Chatham), National Machinery Exchanges, Inc. (hereinafter referred to as National) and Henry Nelkin, Inc. (hereinafter referred to as Nelkin).*fn1

At the time of the incorporation, all of the shareholders entered into an agreement, which, in relevant part, provided: "That all of the parties to this agreement, are not only shareholders in H.J.R. Realty Corporation, but are also tenants or are financially interested in firms which are tenants in the building owned by the said realty corporation. That in furtherance of the aim to make the building show a profit and so that the building may be kept in good repair, the following have been agreed upon:

"That the rental per square foot shall be decided upon and shall be charged equally to each tenant interested in the corporation owning the building. The charge for other tenants shall be decided by the officers of the corporation."

Since 1941 Chatham, National and Nelkin (until 1961) have occupied most of the space in the building at rentals far lower than the property's fair rental value. As a result the corporation has earned little, if any, net profits since its inception.

In 1946 Charles Richter sold his interest in Chatham and in 1961 Nelkin terminated its tenancy in the building. Richter and Nelkin no longer derived any benefit from owning stock in the corporation since neither of them shared in the discounted rentals. In 1968 the Nelkin and Richter interests (who control 4/9 of the issued stock) began a campaign to convince the shareholders of Chatham and National (who control the other 5/9 of the stock) to disregard the shareholders' agreement and pay a fair and reasonable rent, to dissolve the corporation and sell the building, or to buy the minority shares at a reasonable price. In February of 1968 the shareholders of National refused to attend a special meeting called by Nelkin and Richter and, instead, an informal meeting was held. It became clear at the meeting that the differences between the majority shareholders (National and Chatham) and the minority shareholders (petitioners Nelkin and Richter) were irreconcilable. For one thing, the majority shareholders declared that the shareholders' agreement of 1941 authorized the corporation to charge "interested tenants" discounted rentals and that as the controlling majority they intended to manage the buildings in compliance with the agreement. Moreover, in response to Richter and Nelkin's offer to sell their stock, the majority offered only what they had paid in 1941. It was also announced by Chatham that it was intending to move into even more space in the building which was to be vacated by another tenant.

In October of 1968 Nelkin and Richter, as minority shareholders, instituted the instant special proceeding in accordance with section 1104 (subd. [c]) of the Business Corporation Law seeking judicial dissolution of the corporation. The Supreme Court granted the petition and placed the proceeding on the calendar. On appeal, the Appellate Division reversed and dismissed the petition on the ground that it failed to state a cause of action for dissolution.

The sole issue presented on this appeal is whether petitioners, Nelkin and Richter, have made out a cause of action for dissolution of respondent corporation.*fn2 It is our opinion that they have not.

In our opinion petitioners' contention that the majority shareholders are continuing the existence of the corporation solely for their own benefit and that, therefore, the corporation should be dissolved "as a matter of judicial sponsorship" in accordance with Leibert v. Clapp (13 N.Y.2d 313-315) is without merit (Kruger v. Gerth, 16 N.Y.2d 802).

In Leibert v. Clapp (supra) a minority shareholder sued to compel the dissolution of the corporation in which he owned stock. The plaintiff alleged that the majority shareholders of the corporation were maintaining the corporate existence only to enable them to wrongfully divert assets and income to the parent corporation and, furthermore, that the majority shareholders were attempting to coerce the minority into selling their stock at greatly depreciated prices. This court recognized that there was no statutory authority for judicial dissolution in such a case but stated (p. 315) that such relief is available "as a matter of judicial sponsorship" where the majority shareholders or directors: "'have so palpably breached the fiduciary duty they owe to the minority shareholders that they are disqualified from exercising the exclusive discretion and dissolution power given to them by the statute'". (13 N.Y.2d, at p. 317.)

In the instant case, however, the alleged behavior of the majority shareholders could in no event be characterized as a wrongful diversion. The recent case of Kruger v. Gerth (16 N.Y.2d 802, supra, affg. 22 A.D.2d 916) is in point. In Kruger a minority shareholder alleged that for several years a majority shareholder had been taking substantial salaries and bonuses, leaving the corporation with only minimal net income. The plaintiff prayed for non-statutory judicial dissolution in accordance with our decision in Leibert on the ground that the majority shareholder was continuing the corporate existence solely to "provide himself with employment, at substantial salaries and bonuses * * * thereby * * * exploiting the corporation to the detriment of the other stockholders". (22 A.D.2d 916).

The Appellate Division, in Kruger, found that the majority shareholder was not looting the corporate assets nor was he maintaining the corporation for his own special benefit and that, therefore, the minority shareholder had not established sufficient facts to warrant non-statutory dissolution. This court affirmed on the opinion at the Appellate Division.

The case for dissolution in Kruger was even stronger than in the instant case since here the majority shareholders have been acting in compliance with a shareholders' agreement entered into by the minority. Petitioners have alleged only that the shareholders' agreement entered into in 1941 is invalid and that the rents paid by the majority shareholders pursuant thereto are unreasonably low. Even if these allegations are assumed to be true, the majority shareholders have not been guilty of looting or exploiting the corporation to the detriment of the minority shareholders, and their actions clearly do not constitute a breach of fiduciary duty owed to the minority. The discounted

    --> rentals that they have been paying since 1941 were not set arbitrarily but in accordance with the shareholders' agreement. Furthermore, although it is true that because of the change in circumstances the majority alone is now benefiting, the existence of the corporation has been continued for the original purpose of operating the building in accordance with the shareholders' agreement.

It must be noted that the actual validity of the shareholders' agreement is not relevant in this proceeding for non-statutory dissolution. The fact that the controlling majority has paid the lower rents in good faith in accordance with the agreement which was believed to be valid by all shareholders until the minority brought about a change in circumstances, belies the allegation of wrongful diversion even if the agreement was in fact invalid. Moreover, both petitioners enjoyed the benefits of the low rent provision in the agreement while their firms were tenants. The fact that by their own voluntary action they no longer benefit by the agreement does not of itself entitle them to judicial dissolution.

As an alternative ground for dissolution, the petitioners state that the corporation failed to hold business meetings between 1952 and 1968 and that, therefore, the minority shareholders are entitled to judicial dissolution according to the terms of section 1104 (subd. [c]) of the Business Corporation Law which authorizes a petition for dissolution on the ground that: "the shareholders are so divided that they have failed, for a period which includes at least two consecutive annual meeting dates, to elect successors to directors".

It is our opinion that even if the facts alleged in the petition are taken to be true, dissolution pursuant to section 1104 (subd. [c]) is not warranted since it is not alleged that the shareholders are so divided that they have failed to elect directors but merely that the corporation failed to call a meeting for such purpose until 1968.

In our opinion, the mere failure to hold shareholders' meetings in and of itself, does not constitute sufficient grounds to bring about a dissolution under section 1104 (subd. [c]). As was well stated in Matter of Gliedman (N.Y.L.J., March 5, 1964, p. 15, col. 3): "Mere failure to hold annual meetings cannot in itself give cause for dissolution of the corporation. In the absence of a showing of equal division and disagreement among the directors, a petition is insufficient which alleges only that the stockholders are equally divided and cannot elect directors, without showing that an unsuccessful attempt to elect directors has been made".

Moreover, it should be noted that the majority called a special meeting for the purpose of electing directors, and on November 11, 1968 the meeting was held and directors were elected.

Petitioners' allegations that the 1941 shareholders' agreement is invalid and that Chatham's proposed occupation of additional space within the building is in violation of the agreement, may be adequately adjudicated in a shareholders' derivative action to rescind or reform the agreement. They are not, however, sufficient to justify the exercise of the Supreme Court's inherent power to order non-statutory judicial dissolution.

Accordingly, the order of the Appellate Division dismissing the complaint should be affirmed.

Disposition

Order affirmed, with costs.

Chief Judge Fuld (dissenting). In my view, the petition states a cause of action for dissolution of respondent H.J.R. Realty Corporation and should not have been dismissed without a hearing.

The petitioners-appellants hold 4/9ths of the outstanding shares of the corporation and the Epstein Estate and the Horowitzes, the remaining 5/9ths. The corporation has as its sole asset a seven-story building in Manhattan. It has no other business. In 1941, the petitioners and the present majority shareholders were tenants, operating their own respective businesses, in the building. They agreed, at that time, to join together and organize a corporation which would purchase the building and operate it for their mutual benefit at a minimum rental for each. More specifically, each was to pay the same artificially low rent per square foot and only the nonshareholder tenants would be charged a normal market price rental.

When, several years later, the petitioners moved out of the building, the nature of the corporation -- originally formed, as already indicated, for the benefit of all of its stockholders -- changed radically. The portion of the premises occupied by the majority shareholders expanded to the point that there was (and is) only one other tenant, occupying less than half of a single floor in the seven-story building. Although the corporation's assets were worth in excess of $350,000, it showed only negligible profits in 1966 and 1967 and a loss amounting, we are told, to more than $4,800 in the first eight months of 1968. The reason for this, quite obviously, was that the entire profit which the corporation could potentially earn was being siphoned off by the majority group in the form of reduced rent. The minority stockholders, although they had contributed more than 44% of the corporation's capital, were realizing no return whatsoever on their investment and there was no prospect of any change.*fn1

Implicit in the agreement which the parties signed was the idea that H.J.R. was not to be an ordinary real estate corporation formed to collect rent and distribute or reinvest the proceeds. Rather, it was conceived as a co-operative venture by which several tenants in a building would insure themselves a minimum rental expense by acting as their own landlord. The shareholders' agreement expressly recited that " all the parties to this agreement, are not only shareholders in H.J.R. Realty Corporation, but are also tenants or are financially interested in firms which are tenants in the building ". (Italics supplied.) The agreement is instinct with the understanding that, should any of those shareholders cease to be (or represent) a tenant in the building, the agreement would no longer be applicable to him and he would not be required to maintain his interest in the corporation. Thus, it may well be said, the existence of the corporation in its initial form was conditioned upon each of the stockholders continuing as a tenant in the building.

The circumstance that majority shareholders may not be "looting" the corporation or "wrongfully diverting" its assets is insufficient basis for denying corporate dissolution. What is significant and operative is the indisputable fact that this corporation is being continued solely and exclusively for the benefit of those holding 5/9ths of the company's shares. Stated somewhat differently, in the light of what has occurred, the reason for corporate existence is gone.

    --> Although our decision in Leibert v. Clapp (13 N.Y.2d 313) may not mandate such a result, it certainly points the direction in which we should go. And our later holding in Kruger v. Gerth (16 N.Y.2d 802), which was decided only after there had been a full hearing and findings of fact, hardly requires that the petition in the present case be dismissed without affording the petitioners a hearing. If it can be shown, as asserted in the petition, that the corporation no longer fulfills the function for which it was organized, no longer serves the interests of the shareholders for whose benefit it was created, then, there is neither reason nor justification to keep it alive, and the courts should not hesitate to direct its dissolution.

In refusing to allow an action for dissolution where it is alleged that a close corporation no longer serves the function for which it was created and employs its assets for the exclusive benefit of only some of its shareholders, the court, I suggest, ignores business reality and perpetuates inequity. A close corporation, like a partnership or joint venture, is nothing more than a convenient business arrangement entered into for the mutual advantage of its participants. Although control of its assets may be exclusively vested in the majority, it is implicit, in the nature of the corporate form, that its purpose is to provide some benefit for all of those who have contributed their capital to the venture. When changing circumstances render that purpose impossible of achievement, a court of equity should be no more reluctant to permit a corporate dissolution than it would be to dissolve a purely contractual relationship.

The order appealed from should be reversed and Special Term's reinstated.


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