As we have often noted on this blog, the importance of businesspeople setting all the terms of their agreements into a writing cannot be overstated.  If a term is not in a written agreement – such as a requirement that all partners must actually work for a company rather than be a passive investor – with limited exceptions, the term might as well not exist.  A recent decision in a “business divorce” case pending in the Commercial Division of the New York County Supreme Court is the latest reminder of the wisdom of a signed writing.

In Stavroulakis v. Pelakanos, et al., 2018 N.Y. Slip Op. 50180(U) (Sup. Ct. N.Y. Co. Feb. 13, 2018), plaintiff – a minority member of the company that owned and franchised the Bareburger restaurant brand – sued the other shareholders alleging they transferred all the assets of the company (including the rights to franchise royalties and the Bareburger Trademark) without consideration to a new entity formed by the other shareholders that did not include plaintiff.  Plaintiff alleged, among other claims, that his partners breached their fiduciary duties to plaintiff and the company by self-dealing, usurping corporate opportunities and engaging in corporate waste.  The defendant-shareholders claimed they were justified in effectively kicking plaintiff out of the business because plaintiff had not performed any work and owed his equity stake in the company solely to an initial cash investment.  Notably, however, the company’s written agreement did not require any shareholder to work for the company.  Nonetheless, defendants argued the “business judgment rule” – a doctrine prohibiting courts from inquiring into the internal business decisions of a company – protected their actions against plaintiff.

The Court disagreed with defendants and skewered their defense.  The Court noted that the business judgment rule only protects acts taken in good faith and in legitimate furtherance of corporate purposes.  The Court held that transferring the assets of the company to a new entity for no consideration solely to exclude plaintiff because he did not work for the company was not done in good faith or in the interest of the company.  Further, defendant-shareholders all had a personal interest in the transaction – each shareholder’s interest in the business increased by eliminating plaintiff – barring application of the business judgment rule.  Accordingly, defendants had the burden of proving the “entire fairness” of the transition to the company and plaintiff.

Defendants did not attempt to prove the fairness of the process of the transaction (done behind plaintiff’s back) or the price for the transaction (none).  Defendants, rather, argued it was “fair” to cut out plaintiff because he had not worked for the company.  The Court summarily dispensed with that defense because none of the company’s written agreements, nor the Business Corporation Law, obligated any shareholder to perform work for the company.  To the contrary, the Court found that when the company was formed, the parties understood that only some of the shareholders would work for the company and would receive a salary unrelated to their economic interests as shareholders.  The Court granted plaintiff partial summary judgment holding the transfer of assets for no consideration was not fair and breached defendants’ fiduciary duties.  The Court noted the company’s agreements could have obligated shareholders to work or, alternatively, defendant-shareholders could have bought out plaintiff or engaged in a “freeze-out” merger (a strategic merger conducted to eliminate unwanted minority shareholders, the mechanics of which are beyond the scope of this post).  The Court, relying on the precedent setting decision obtained by Frydman LLC in Yudell v. Gilbert, 99 A.D.3d 108 (1st Dep’t 2012), held plaintiff could recover damages against defendants derivatively on behalf of the company because the company suffered the harm of loss of its assets.  The Court also determined plaintiff could recover money damages based on defendants’ oppression of plaintiff as a minority shareholder.  The Court held off determining which type of recovery was appropriate until after trial.

If you have any questions about disputes among business partners, the best ways to avoid them or a partner’s rights in trying to resolve them, please do not hesitate to contact us.