50 N.Y.2d 92 | NY | 1980
Lead Opinion
OPINION OF THE COURT
On these appeals we conclude that when all of the stockholders of a Delaware corporation agree that, except as specified in their agreement, no "business or activities” of the corporation shall be conducted without the consent of a minority stockholder, the agreement is, as between the original parties to it, enforceable even though all formal steps required by the statute have not been taken. We hold further that the agreement made by the parties to this action was violated when the corporation entered into two agreements without the minority stockholder’s consent but was not violated by the
Defendant Lombard-Wall Incorporated ("Lombard”) was owned by Equimark Corporation. Wishing to acquire Lombard, defendant Kurtz, a dealer in unregistered securities, caused a corporation originally known as H-K Entreprises, Inc., the name of which was later changed to Lombard-Wall Group, Inc. ("Group”), to be formed under Delaware law. Kurtz was the sole stockholder of Group, but neither Kurtz nor Group could provide the $4,000,000 needed to acquire Lombard from Equimark. It was in fact acquired with a short-term loan from a Swiss bank, shortly thereafter repaid from Lombard’s cash, loaned by Lombard to Group on Group’s noninterest bearing note.
Since Lombard’s business required book assets at the full value of $4,000,000 and Group had no assets other than Lombard’s stock, Group’s note to Lombard was secured by a nonrecourse guarantee from Half Moon Land Corporation, of which plaintiff Zion is the principal shareholder, collateralized by California lands owned by Half Moon. The loan agreement recited that Half Moon had made no representation as to the value of the land and Lombard and Group agreed that should Lombard’s accountants require additional acts or documents in order to maintain the value of the note, they would pay to Half Moon in advance all expenditures necessary to meet the accountants’ requirements.
At the time the note, loan agreement and guarantee were entered into Zion, Kurtz and Group entered into a stockholders’ agreement. Zion and Kurtz were the sole stockholders of Group at that time, Zion holding class A stock and Kurtz, class B.
"(a) Engage in any business or activities of any kind, directly or indirectly, whether through any Subsidiary or by way of a loan, guarantee or otherwise, other than the acquisition and ownership of the stock of L-W as contemplated by this Agreement, provided, however, that the Corporation or LW may obtain and pay the premiums for, and shall be the beneficiary of, term life insurance, if obtainable, on the lives of the Purchaser, Kurtz and such other executive personnel of the Corporation and/or L-W, and in such amounts, as the directors of the Corporation or L-W may from time to time approve or as otherwise expressly provided in this Agreement.”
Notwithstanding that provision, Group and Lombard some eight months thereafter, at the suggestion of Group’s accountants, entered into an agreement which made the previously noninterest bearing loan from Lombard to Group bear interest provided interest could be paid out of earnings, and an escrow agreement with Chase Manhattan Bank pursuant to which Group deposited $580,000 in bonds to secure payment of the note. The two agreements were authorized by Group’s board over Zion’s objection.
The stockholders’ agreement also provided for escrow of the class B stock, Zion’s attorneys being the escrow agent designated in the separately executed escrow agreement. On October 15, 1976, Zion signed on behalf of Half Moon and the class A stockholders letters consenting to the formation by Group of two wholly owned subsidiaries, Lombard-Wall Services, Inc., and Lombard-Wall Management Corporation. In both letters Lombard agreed to execute an appropriate amendment to the escrow agreement with Zion’s attorneys by which the shares of the two subsidiaries would be held subject to the same escrow agreement as was the class B stock. The two corporations were formed on December 9, 1976, following a resolution of Group’s directors, adopted unanimously at a meeting attended by Zion, which ratified formation of the subsidiaries "subject to the Amendment to the Shareholders’ Agreement and subject to the approval of the majority of the Class A stockholders.” Disagreement thereafter arose between the parties concerning what was an appropriate amendment to
Plaintiffs thereafter began this action for declaratory and injunctive relief, asking in their first cause of action that the interest and escrow agreements executed without Zion’s consent be declared in violation of the stockholders’ agreement and annulled, and in the second cause of action that the formation of the subsidiaries be declared in violation of the agreement and that they be dissolved. Defendants’ answer in addition to a number of affirmative defenses stated a counterclaim for reformation on the ground that if the stockholders’ agreement prohibited execution of the interest and escrow agreements the stockholders’ agreement "did not set forth the actual understanding and agreement of the parties.”
Plaintiffs moved for severance of and summary judgment on their first cause of action and for summary judgment dismissing the counterclaim. Defendants cross-moved for summary judgment dismissing the second cause of action. Special Term, finding issues of fact as to both causes of action, denied both motions. The Appellate Division reversed, concluding that defendants were entitled to summary judgment dismissing the second cause of action, but that plaintiffs were entitled to summary judgment dismissing the counterclaim and on their first cause of action declaring that execution of the interest and escrow agreements violated the shareholders’ agreement and should be enjoined.
Just prior to the Appellate Division decision Group made the final payment on the note and caused the escrow agreement with Chase Manhattan to be released. On defendants’ motion to the Appellate Division reciting those facts, that court filed a supplemental memorandum amending its previous decision to limit relief on the first cause of action to the declaration of a past violation. The order entered by the Appellate Division, and the judgment entered pursuant to it by the county clerk so declare, but state that the above-quoted provision of the agreement has expired by its terms and that any declaration as to future violation of it "is moot, there no longer being an agreement capable of future violation.”
For the reasons hereafter stated we conclude (1) that under Delaware law, which governs, the provision proscribing corporate action without the consent of a minority stockholder is not against the public policy of that State and under the circumstances of this case is enforceable even though not
I
The stockholders’ agreement expressly provided that it should be "governed by and construed and enforced in accordance with the laws of the State of Delaware as to matters governed by the General Corporation Law of that State”, and that is the generally accepted choice-of-law rule with respect to such "internal affairs” as the relationship between shareholders and directors (cf. Greenspun v Lindley, 36 NY2d 473, 478; see Restatement, Conflict of Laws 2d, § 302, Comment g). Subdivision (a) of section 141 of the General Corporation Law of Delaware provides that the business and affairs of a corporation organized under that law "shall be managed by a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” Included in the chapter referred to are provisions relating to close corporations, which explicitly state that a written agreement between the holders of a majority of such a corporation’s stock "is not invalid, as between the parties to the agreement, on the ground that it so relates to the conduct of the business and affairs of the corporation as to restrict or interfere with the discretion or powers of the board of directors” (§ 350) or "on the ground that it is an attempt by the parties to the agreement or by the stockholders of the corporation to treat the corporation as if it were a partnership” (§ 354), and further provides that "The certificate of incorporation of a close corporation may provide that the business of the corporation
Clear from those provisions is the fact that the public policy of Delaware does not proscribe a provision such as that contained in the shareholders’ agreement here in issue even though it takes all management functions away from the directors. Folk, in his work on the Delaware Corporation Law, states concerning section 350 that "Although some decisions outside Delaware have sustained 'reasonable’ restrictions upon director discretion contained in stockholder agreements, the theory of § 350 is to declare unequivocally, as a matter of public policy, that stockholder agreements of this character are not invalid” (at p 518), that section 351 "recognizes a special subclass of close corporations which operate by direct stockholder management” (at p 520), and with respect to section 354 that it "should be liberally construed to authorize all sorts of internal agreements and arrangements which are not affirmatively improper or, more particularly, injurious to third parties” (at p 526).
Defendants argue, however, that Group was not incorporated as a close corporation and the stockholders’ agreement provision was never incorporated in its certificate. The answer is that any Delaware corporation can elect to become a close corporation by filing an appropriate certificate of amendment (Del General Corporation Law, § 344) and by such amendment approved by the holders of all of its outstanding stock may include in its certificate provisions restricting directors’ authority (ibid., § 351). Here, not only did defendant Kurtz agree in paragraph 8.05(b) of the stockholders’ agreement to "without further consideration, do, execute and deliver, or cause to be done, executed and delivered, all such further acts, things and instruments as may be reasonably required more effectively to evidence and give effect to the provisions and the intent and purposes of this Agreement”, but also as part of the transaction by which the Half Moon guarantee was made and Zion became a Group stockholder, defendant Kurtz, while he was still the sole stockholder and sole director of Group, executed a consent to the various parts of the transaction under which he was "authorized and empowered to execute and deliver, or cause to be executed and delivered, all such
The result thus reached accords with the weight of authority which textwriter F. Hodge O’Neal tells us sustains agreements made by all shareholders dealing with matters normally within the province of the directors (1 Close Corporations, § 5.24, p 83), even though the shareholders could have, but had not, provided similarly by charter or by-law provision sanctioned by statute (ibid., § 5.19, pp 73-74). Moreover, though we have not yet had occasion to construe subdivision (b) of section 620 of the Business Corporation Law,
II
Defendants’ arguments against summary judgment for plaintiffs on the first cause of action center on the use in section 3.01 of the word "engage”, which they suggest involves continuity of action rather than a single act, the presence of other proscriptions that would be unnecessary if section 3.01(a) by itself gave Zion an absolute veto over corporate action, and the purpose of the guarantee which was to maintain the $4,000,000 value of Group’s note to Lombard.
The difficulty with limiting the provision to multiple action is that though in many contexts "engage” does denote more than a single transaction (People v Bright, 203 NY 73; Black’s Law Dictionary [4th ed], p 622),
Nor can it successfully be argued that because the additional proscriptions against sale or pledge of Lombard stock, merger with any corporation other than Lombard, amendment of Group’s certificate of incorporation and issuance of additional stock are set forth in subdivisions of section 3.01 lettered (b) through (e) rather than as additional subparagraphs of subdivision (a) the broad sweep of the latter must be held limited because the former would otherwise be meaningless. So to hold puts an extraordinary premium on the form of outlining rather than the substance of content, but more importantly overlooks the necessity of such protections for a minority stockholder-guarantor in Zion’s position. Any careful legal draftsman, intent upon protecting his client’s interests and familiar with the history, for example, of contract indemnification clauses from Thompson-Starrett Co. v Otis Elevator Co. (271 NY 36) through Levine v Shell Oil Co. (28 NY2d 205) and Margolin v New York Life Ins. Co. (32 NY2d 149), would make indelibly clear that the (b) through (e) proscriptions were "expressed in unequivocal terms” (Thompson-Starrett, supra, at p 41), even though they were encompassed by the language of subdivision (a), lest a court conclude that by subdivision (a) alone "the parties must have meant something else” (Levine, supra, at p 211).
The purpose of the guarantee provides no stronger a basis for reading into subdivision (a) or the contract as a whole the right to enter into the interest and escrow agreements without Zion’s consent. The stockholders’ agreement makes reference to the loan agreement between Group, Lombard and Half Moon. While the loan agreement spells out the importance of the Group note continuing to be valued at the-guaranteed amount as adjusted from time to time, the purpose of that provision, as its wording makes clear, is to protect Half Moon against a claim that it made a representation as to the value
The intention of the parties being determinable from the words of their written agreements, interpretation of those agreements was for the court and summary judgment based on that interpretation was proper (Mallad Constr. Corp. v County Fed. Sav. & Loan Assn., 32 NY2d 285, 291).
III
What has been so far written disposes also of the contention that there was any mutual mistake warranting reformation of the contract. The extensive and intricate provisions of the various interrelated documents executed by the parties make crystal clear that this was an arm’s length transaction in which plaintiffs sought the protection of a veto over any "business or activities” of Group other than those expressly spelled out in the stockholders’ agreement. Defendants, of course, were not required to accede to the provision, but then neither was Zion obligated to provide Half Moon’s guarantee. That Kurtz may not have foreseen the necessity for the interest and escrow agreements the accountants later thought required at best establishes a unilateral mistake on his part in not negotiating for a further exception to Zion’s veto power. Nothing in defendants’ papers other than the conclusory allegations that should the court interpret the provisions of section 3.01(a) as Zion does "then there was a mutual mistake of fact” because Zion’s interpretation "is utterly contrary to the basic understanding of all parties” suggests any legal basis for reformation and those allegations are, of course, insufficient to defeat summary judgment on the counterclaim.
IV
With respect to the second cause of action, however, the
Summary judgment was, therefore, properly granted to defendants on the second cause of action, but since as indicated below the consent agreement has not terminated, dismissal of the second cause of action should be stated to be without prejudice to such further action as plaintiffs may be advised to take to obtain escrow deposit of the shares of the subsidiaries. Unless that is done it will not be clear that in dismissing the second cause of action the court has not passed upon whether performance of the escrow deposit agreement may be had.
V
The Appellate Division’s conclusion that there was no longer any agreement capable of future violation was based upon Group’s payment to Lombard of the balance due on the note which defendants contend terminated the "loan period” during which section 3.01 was by its terms to remain in effect. Plaintiffs argue that the "loan period” as defined in the stockholders’ agreement did not end until Group no longer had any obligation, contingent or otherwise, to Half Moon and that Half Moon’s assertion of a claim for attorneys’ fees is still unpaid. It is unnecessary to pass upon that question for article
Notwithstanding that fact plaintiffs are not entitled to injunctive relief in this action, predicated as its only remaining cause of action is on execution of the interest and escrow agreements. Those agreements having been terminated, there simply is no need for an injunction to terminate them. The court has not overlooked the statements in plaintiffs’ brief that defendants breached section 3.01 by Group’s borrowing to pay off the note and that a separate action for a declaration to that effect has been begun. Whether plaintiffs are correct in that contention and if so whether injunctive relief is warranted must await determination of that action, however, and furnishes no basis for injunctive relief in this action.
That is true, however, not because section 3.01 has terminated but because the interest and escrow agreements have been terminated. It was, therefore, error for the Appellate Division on the basis of the papers before it to direct judgment declaring section 3.01 terminated. Accordingly, its order must be modified by deleting that direction.
For the foregoing reasons the order of the Appellate Division should be modified, as above indicated.
. The agreement prohibited transfer of stock by Zion and Kurtz except by a so-called "exempt transfer”. Exempt transfers were made by each, but the agreement required any transferee to accept its terms and defendant’s affidavit recites that transfers made by himself as well as by Zion were made subject to the terms, restrictions and conditions of the agreement. Moreover, the, agreement provided that during the lifetime of Zion any consent of class A stock should be given by Zion and during the lifetime of Kurtz any consent of class B stock should be given by Kurtz. The opinion, therefore, speaks of Zion and Kurtz as though they were in fact the sole stockholders during all of the events referred to.
. In the agreement "Corporation” refers to Group and "L-W” to Lombard.
. The fallacy of the dissent is that it converts a shield into a sword. The notice devices on which the concept of the dissent turns are wholly unnecessary to protect the original parties, who may be presumed to have known what they agreed to. To protect an original party who has not been hurt (indeed, has expressly agreed to the limitation he is being protected against and affirmatively covenanted to see to it that all necessary steps to validate the agreement were taken) because a third party without notice could have been hurt had he been involved can only be characterized as a perversion of the liberal legislative purpose demonstrated by the Delaware statutes quoted in the text above.
. That provision reads: "(b) A provision in the certificate of incorporation otherwise prohibited by law because it improperly restricts the board in its management of the business of the corporation, or improperly transfers to one or more shareholders or to one or more persons or corporations to be selected by him or them, all or any part of such management otherwise within the authority of the board under this chapter, shall nevertheless be valid: (1) If all the incorporators or holders of record of all outstanding shares,. whether or not having voting power, have authorized .such provision in the certificate of incorporation or an amendment thereof; and (2) If, subsequent to the adoption of such provision, shares are transferred or issued only to persons who had knowledge or notice thereof or consented in writing to such provision.”
. (1961 Legis Doc No. 12, at p 40.)
. But note that Black’s Fifth Edition (at p 474) drops that part of the definition which states that more than a single transaction is denoted by "engage”.
Dissenting Opinion
(dissenting in part). I agree with the majority’s conclusion that plaintiff’s cause of action concerning the formation of two subsidiary corporations must be dismissed.
It is beyond dispute that shareholder agreements such as the one relied upon by plaintiff in this case are, as a general rule, void as against public policy. Section 3.01 of the agreement, as interpreted both by plaintiff and by a majority of this court, would have precluded the board of directors of Group from taking any action on behalf of the corporation without first obtaining plaintiff’s consent. This contractual provision, if enforced, would effectively shift the authority to manage every aspect of corporate affairs from the board to plaintiff, a minority shareholder who has no fiduciary obligations with respect to either the corporation or its other shareholders. As such, the provision represents a blatant effort to "sterilize” the board of directors in contravention of the statutory and decisional law of both Delaware and New York.
Under the statutes of Delaware, the State in which Group was incorporated, the authority to manage the affairs of a corporation is vested solely in its board of directors (Del General Corporation Law, § 141, subd [a]). The same is true under the applicable New York statutes (Business Corporation Law, § 701). Signficantly, in both States, the courts have declined to give effect to agreements which purport to vary the statutory rule by transferring effective control of the corporation to a third party other than the board of directors (see Abercrombie v Davies, 35 Del Ch 599, 604-611, revd on other grounds 36 Del Ch 371; Adams v Clearance Corp., 35 Del Ch 459, 464-466; Long Park, Inc. v Trenton-New Brunswick Theatres Co., 297 NY 174, 178-179; McQuade v Stoneham, 263 NY 323; Manson v Curtis, 223 NY 313, 323; Matter of Abbey [Meyerson], 274 App Div 389, affd 299 NY 557; cf. Matter of Farm Inds., 41 Del Ch 379, 390; Triggs v Triggs, 46 NY2d 305; Matter of Glekel [Gluck], 30 NY2d 93; see, also, University Computing Co. v Lykes-Youngstown Corp., 504 F2d 518, 532 [applying Delaware law]; see, generally, Delaney, The Corporate Director: Can His Hands Be Tied in Advance, 50 Col L Rev 52, 54-57). The common-law rule in Delaware was aptly stated in Abercrombie v Davies (35 Del Ch, at p 611, supra): "So long as the corporate form is used as presently provided by our statutes this Court cannot give legal sanction to agreements which have the effect of removing from directors
True, the common-law rule has been modified somewhat in recent years to account for the business needs of the so-called "close corporation”. The courts of our State, for example, have been willing to enforce shareholder agreements where the incursion on the board’s authority was insubstantial (Clark v Dodge, 269 NY 410) or where the illegal provisions were severable from the otherwise legal provisions which the shareholder sought to enforce (Triggs v Triggs, 46 NY2d 305, supra). Neither the courts of our State nor the courts of Delaware, however, have gone so far as to hold that an agreement among shareholders such as the agreement in this case, which purported to "sterilize” the board of directors by completely depriving it of its discretionary authority, can be regarded as legal and enforceable. To the contrary, the common-law rule applicable to both closely and publicly held corporations continues to treat agreements to deprive the board of directors of substantial authority as contrary to public policy.
Indeed, there heretofore has been little need for the courts to modify the general common-law rule against "sterilizing” boards of directors to accommodate the needs of closely held corporations. This is because the Legislatures of many States, including New York and Delaware, have enacted laws which enable the shareholders of closely held corporations to restrict the powers of the board of directors if they comply with certain statutory prerequisites (Del General Corporation Law, §§ 350, 351; Business Corporation Law, § 620, subd [b]). The majority apparently construes these statutes as indications that the public policies of the enacting States no longer proscribe the type of agreement at issue here in cases involving closely held corporations. Hence, the majority concludes that there is no bar to the enforcement of the shareholder agreement in this case, even though the statutory requirements for close corporations were not fulfilled. I cannot agree.
Under Delaware law, as the majority notes, the shareholders of a close corporation are free to enter into private, binding agreements among themselves to restrict the powers of their board of directors (Del General Corporation Law, § 350). The same appears to be true under the present New York statutes (Business Corporation Law, § 620, subd [b]). Both the Delaware and the New York statutory schemes, however,
In my view, these statutory provisions are not merely directory, but rather are evidence of a clear legislative intention to permit deviations from the statutory norms for corporations only under controlled conditions. In enacting these statutes, which are tailored for "close corporations”, the Legislatures of Delaware and New York were apparently attempting to accommodate the needs of those who wished to take advantage of the limited liability inherent in the corporate format, but who also wished to retain the internal management structure of a partnership (see, generally, 1 O’Neal, Close Corporations, § 5.02). At the same time, however, the Legislatures were obviously mindful of the danger to the public that exists whenever shareholders privately agree among themselves to shift control of corporate management from independent directors to the shareholders, who are not necessarily bound by the fiduciary obligations imposed upon the board. In order to protect potential purchasers of shares and perhaps even potential creditors of the corporation, the Legislatures of Delaware and New York imposed specific strictures upon incorporated businesses managed by shareholders, the most significant of which is the requirement that restrictions on the statutory powers of the board of directors be evidenced in the certificate of incorporation. This requirement is an essential component of the statutory scheme because it ensures that potential purchasers of an interest in the corporation will have at least record notice that the corporation is being managed in an unorthodox fashion. Absent an appropriate notice provision in the certificate, there can be no assurance that an unsuspecting purchaser, not privy
Since I regard the statutory requirements discussed above as essentially prophylactic in nature, I cannot subscribe to the notion that the agreement in this case should be enforced merely because there has been no showing that the interests of innocent third parties have actually been impaired. As is apparent from the design of the relevant statutes, the public policies of our own State as well as those of the State of Delaware remain opposed to shareholder agreements to "sterilize” the board of directors unless notice of the agreement is provided in the certificate of incorporation. Where such notice is provided, the public policy objections to the agreement are effectively eliminated and there is no further reason to preclude enforcement (see Lehrman v Cohen, 43 Del Ch 222, 235). On the other hand, where, as here, the shareholders have entered into a private agreement to "sterilize” the board of directors and have failed to comply with the simple statutory prerequisites for "close corporations”, the agreement must be deemed void and unenforceable in light of the inherent potential for fraud against the public. Indeed, since it is this very potential for public harm which renders these agreements unlawful, the mere fortuity that no one was actually harmed, if that be the case, cannot be the controlling factor in determining whether the agreement is legally enforceable. For the same reason, the illegality in the instant agreement cannot be cured retroactively, as the majority suggests, by requiring defendants to file the appropriate amendments to the certificate of incorporation. And, of course, it is elementary that a party to an agreement cannot be estopped from asserting its invalidity when the agreement is prohibited by law or is contrary to public policy (e.g., Brick v Campbell, 122 NY 337).
By its holding today, the majority has, in effect, rendered inoperative both the language and the underlying purpose of the relevant Delaware and New York statutes governing "close corporations”. According to the majority’s reasoning, the only requirements for upholding an otherwise unlawful shareholder agreement which concededly deprives the directors of all discretionary authority are that all of the shareholders concur in the agreement and that no "intervening rights of third persons” exist at the time enforcement of the agreement is sought. The statutes in question also recognize these factors as conditions precedent to the enforcement of
For all of the foregoing reasons, I must respectfully dissent and cast my vote to modify the order of the Appellate Division by directing dismissal of plaintiff’s first cause of action.
Judges Jasen, Jones and Fuchsberg concur with Judge Meyer; Judge Gabrielli dissents in part and votes to modify in a separate opinion in which Chief Judge Cooke and Judge Wachtler concur.
Order modified, with costs to plaintiffs, in accordance with the opinion herein and, as so modified, affirmed.
Since their interests and rights are identical in the present appeal, plaintiffs Zion and Gross will be referred to in the singular as "plaintiff” for the sake of convenience.
