Pace Photographers, Ltd., Matter of

• Decision Date: 02 June 1988
• Citation: 71 N.Y.2d 737,525 N.E.2d 713,530 N.Y.S.2d 67
• Parties: , 525 N.E.2d 713, 57 USLW 2042 In the Matter of PACE PHOTOGRAPHERS, LTD., Respondent. Herman Rosen, Appellant.
• Court: New York Court of Appeals Court of Appeals

Page 67

530 N.Y.S.2d 67

71 N.Y.2d 737, 525 N.E.2d 713, 57 USLW 2042

In the Matter of PACE PHOTOGRAPHERS, LTD., Respondent Herman Rosen, Appellant.

Court of Appeals of New York.

June 2, 1988.

Andrew M. Schnier, New York City, for appellant.

Eli Feit and Stuart A. Blander, New York City, for respondent.

OPINION OF THE COURT

KAYE, Justice.

In a close corporation, the terms of a shareholders' agreement governing a voluntary sale of stock by a shareholder to the corporation do not dictate the "fair value" of a minority interest under section 1118 of the Business Corporation Law. The Appellate Division order, 133 A.D.2d 829, 520 N.Y.S.2d 202, directing a sale on the terms fixed by the shareholders' agreement at issue here, with no hearing and no evidence on valuation, should therefore be reversed and the case remitted to Supreme Court for a determination of the fair value of petitioner's interest and other terms of the purchase by the corporation.

In the early 1960's, petitioner cofounded a photography business that ultimately became respondent Pace Photographers, Ltd. (Pace). Over the decades, Pace grew from a basement operation to a major commercial photography studio with annual sales exceeding a million dollars. In 1975, the business was incorporated and, on November 10, 1982--on the occasion of taking in a fifth shareholder--a shareholders' agreement was signed. Under that agreement, petitioner--who owned 26 2/3 of the company's 100 outstanding shares--became president.

The agreement committed the five shareholders to a period of continuity by providing that none of the parties "shall sell, hypothecate, transfer, encumber or otherwise dispose of any of his shares of the Corporation * * * without the written consent of all the parties hereto for a period of five (5) years from the date of this Agreement" (para 12). A sale ¹ might be made within those first five years, but only to the other shareholders, at a deep discount: "Notwithstanding the provisions of this paragraph in the event a stockholder desires to sell his shares of the stock to the other stockholders within the first five years of this Agreement, he shall not be restricted, provided however, the price to be paid shall be one-half of the formula as set forth in paragraph 15" (para 12 ).

In paragraph 14 of the shareholders' agreement, the parties stipulated that because the actual value of a stock interest in Pace was difficult to ascertain, they would agree upon "the value of each party's stock interest in the Corporation for the purpose of determining the purchase price to be paid for the interest of any party hereto who is retiring or withdrawing from the business". Paragraph 15 specified that, in schedule A, a value would be fixed for the entire stock interest of the company, and that value would be redetermined at the end of every four-month period. Until a new value was entered in schedule A, however, the last stated value would control. Schedule A in the November 10, 1982 agreement set the total value of Pace at $400,000; that value was never updated. The final term of the shareholders' agreement relevant to the present dispute is paragraph 18: "Upon the sale of shares as herein provided," the selling stockholder for a period of three years from the date of the sale would not engage in, or in any manner become interested in, any business, trade or occupation similar to the one conducted by Pace within a 50-mile radius of the company's then office in Brooklyn.

Barely three years after the shareholders' agreement was signed, a rift developed between petitioner and the other four shareholders, culminating on October 7, 1986 in petitioner's written offer to buy them out for $440,000. Of that amount, petitioner offered $175,000 to each of the other two shareholders whose stockholdings matched his. They refused.

One month later, on November 13, 1986, petitioner commenced a proceeding to compel judicial dissolution of Pace pursuant to Business Corporation Law § 1104-a. He alleged that the other four shareholders had improperly taken control of Pace, and that they were guilty of illegal, fraudulent and oppressive action toward him, and guilty of waste, mismanagement and diversion of corporate assets. At a shareholders' meeting November 17, 1986, petitioner was replaced as president and removed as a director. By letter dated November 21, 1986, respondent elected to purchase petitioner's shares as follows:

"We have received a copy of your Petition for Dissolution under Section 1104-a of the Business Corporation Law of the State of New York. Pace construes your action as an offer to sell your 26 2/3 shares of common stock of Pace ('the Shares'). As you know, such an offer is governed by an Agreement between the undersigned and yourself, dated November 10, 1982 ('the Agreement') * * *

"Pace hereby elects to purchase the Shares under the terms and provisions of the Agreement, or in the alternative under Section 1118 of the Business Corporation Law, at its 'fair value', which the Agreement establishes as being fifty (50%) percent of the amount set forth in Paragraph 15 of the Agreement. Accordingly, under the terms of the Agreement or under Section 1118 of the Business Corporation Law, Pace elects to purchase all of your shares for the sum of $53,340.00.

"This election to purchase is without prejudice to the rights of the undersigned pursuant to the Agreement."

On December 15, 1986--some three weeks after the election to buy petitioner's shares--respondent both answered the petition and made a cross motion. In its answer, respondent denied all impropriety, counterclaimed for damages caused by petitioner's own wrongdoing, and sought a declaration that petitioner was bound by the valuation established in the agreement--a price of $53,340 for his shares; alternatively, respondent requested a stay pending the determination of fair value under section 1118; and it sought enforcement of the restrictive covenant contained in the agreement. In its cross motion, respondent requested dismissal of the petition on the ground that the buy-out provision of the shareholders' agreement was the exclusive method by which petitioner could dispose of his shares--at a price of $53,340; alternatively, pursuant to Business Corporation Law § 1118, respondent sought a stay of the dissolution proceeding and a determination of the fair value of petitioner's shares in accordance with the shareholders' agreement. The cross motion was supported by an extensive affidavit detailing petitioner's wrongdoing, including promotion of his private photography business, inattention to the business of Pace, and sexual harassment of employees, and charging that the dissolution proceeding was merely an effort to circumvent the buy-out provisions of the agreement as well as the restrictive covenant.

Supreme Court denied the petition for dissolution and granted the cross motion, finding from the motion papers alone that there was no proof of the alleged misconduct toward petitioner; that the petitioner himself was the wrongdoer, having abandoned his obligations to respondent and embarked on a course of activity against its economic interests; and that respondent's actions were the result of petitioner's bad faith, injurious conduct. ² Recognizing that respondent had elected to purchase petitioner's stock pursuant to Business Corporation Law § 1118, and to have the court fix the fair value of petitioner's shares as of the day prior to filing the petition, the court further concluded that the fair value of petitioner's stock was that agreed to in the shareholders' agreement--$53,340--to be paid over a five-year period in accordance with a prior provision of the agreement (para 12 ). Finally, in the judgment (though not in the decision), the court held petitioner bound by the restrictive covenant.

The Appellate Division affirmed as to fair value, without reaching the issue of who wronged whom. In light of respondent's election under Business Corporation Law § 1118, the court perceived that the value of petitioner's shares was the sole remaining question in the case; respondent's election made it unnecessary to conduct any hearing on petitioner's allegations of misconduct. Noting that petitioner protested the fairness of the valuation under the agreement, the court nonetheless agreed with the trial court that petitioner should be bound by the unambiguous value fixed in the shareholders' agreement, which had been voluntarily entered into by all shareholders. The court, moreover, found that it was proper to enforce the restrictive covenant, in that it was reasonable in scope and duration. We now reverse.

Threshold Issues Concerning Respondent's Election

Prior to 1979, minority shareholders in close corporations who suffered abuse at the hands of the majority lacked the options available to business partners and shareholders in public corporations to extricate the value of their investments. To preserve and protect the interests of minority shareholders in such situations, the Legislature in 1979 provided a mechanism--a petition for dissolution--by which holders of at least 20% of the outstanding shares of a corporation whose stock is not traded on a securities market could salvage the value of their investments. Section 1104-a of the Business Corporation Law sets forth two possible grounds for such a petition: that those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders, and that the property or assets of the corporation are being looted, wasted or diverted for noncorporate purposes by those in control.

Concomitantly, the Legislature provided a defensive mechanism for the other shareholders and the corporation, giving them an absolute right to avoid the dissolution proceedings and any possibility of the company's liquidation by electing to purchase petitioner's shares at their fair value and upon terms...