[This is the second in a three-part series on challenges to standing to petition for judicial dissolution where the petitioner lacks a stock certificate or other definitive evidence of shareholder status.  Last week’s post set the stage and looked at a recently decided case where the court ordered an evidentiary hearing to resolve the parties’ contradictory factual contentions. This week’s post discusses another recent dissolution case involving two contested corporations, in which the court conducted an 8-day evidentiary hearing to determine whether the petitioner owns any shares.]

"In the real world, particularly that in which close corporations operate, clear evidence of share ownership is often not found in the corporate books and records, for any number of reasons."

So writes Kings County Supreme Court Justice Jack M. Battaglia (pictured) as he paints a vivid picture of contradictory, ambiguous and incomplete evidence in a five-year court contest over the stock ownership of two Brooklyn-based businesses in Matter of Pappas (Corfian Enterprises, Ltd.), 2009 NY Slip Op 50109(U) (Sup Ct Kings County Jan. 23, 2009).

The case began in 2004 when Theano Pappas, as executrix of the estate of her late husband, Eleftherios Pappas, petitioned under Business Corporation Law 1104-a for judicial dissolution of two corporations, Corfian Enterprises, Ltd. and Epiros Realty, Ltd.  The petition named as respondents Paul Fotinos and Theodoros Kalogiannis, alleged to be the corporations’ controlling shareholders.  BCL 1104-a conditions the right to seek dissolution on holding a minimum 20% stock interest.  Mrs. Pappas alleged that the estate, Fotinos and Kalogiannis each hold one-third of the two corporations’ shares.  Kalogiannis filed an answer agreeing with Mrs. Pappas as to share ownership and also seeking dissolution.  Fotinos, however, claimed to be 100% shareholder of both corporations and denied that the late Mr. Pappas or Kalogiannis ever held shares in either corporation.

Three years into the legal proceedings, Fotinos moved for summary judgment on the issue of his alleged 100% stock ownership.  The trial court’s September 2007 decision denying the motion was affirmed on appeal in June 2008.  This set the stage for what became an eight-day framed-issue hearing on the question of standing at which the court heard 14 witnesses and admitted 48 documents into evidence.

Simplifying the issues somewhat, the parties stipulated at trial that if the court found in favor of either Mrs. Pappas or Kalogiannis’ stock interest, the other’s shareholder interest would also be established, in which case both would be deemed one-third shareholders from inception.  The parties also stipulated, however, that the ownership of each of the two corporations had to be decided separately. 

The Evidence

Justice Battaglia’s lengthy decision contains a detailed recitation of the evidence at trial, the full scope and nuances of which I cannot possibly replicate here.  What follows is an oversimplified summary.

In 1982 Mr. Pappas, Kalogiannis and Fotinos bought a commercial building ("577 Baltic") as tenants in common, one-third each, where they operated a succession of businesses including Corfian providing marine and building maintenance and repair, and structural steel work.  There was no documentary evidence such as a shareholders’ agreement establishing the business relationship of the three.  Fotinos testified that Mr. Pappas and Kalogiannis were salaried employees.  Mrs. Pappas and Kalogiannis testified without documentary support that Mr. Pappas and Kalogiannis made capital contributions in the form of cash payments for machinery purchases and deductions from profit shares.  A 1994 long-term lease between the three building owners and Corfian had no fixed rent, but instead required Corfian to pay as rent the landlord’s expenses "to retain ownership . . . and to maintain and repair the building, including mortgage payments and taxes."  The personal and corporate tax returns for many years were unavailable and incomplete, although Corfian’s available returns (beginning in 1997) reflected Fotinos as sole shareholder.  Fotinos acknowledged that he possessed Corfian’s "corporate books and records" but failed to offer them in evidence because, he asserted, they "would not show ownership."

The other corporation at issue, Epiros Realty, owned a rental property ("583 Baltic") purchased in 1985.  Fotinos claimed he contributed 100% of the cash required for the acquisition, whereas Mrs. Pappas and Kalogiannis testified that Mr. Pappas and Kalogiannis each put up a third.  Neither side offered documentary support.  The closing statement for the purchase of 583 Baltic was not introduced in evidence by any of the parties although, as Justice Battaglia noted, "it would have been expected more from Mr. Fotinos."  Mr. Pappas and Kalogiannis worked on renovations to 583 Baltic.  Kalogiannis testified that they received no compensation for doing do "because it was ours" whereas Fotinos testified (without supporting documents) that they were paid a salary.   There were several refinancings of 583 Baltic, for each of which Fotinos was the sole personal guarantor.

Fotinos relied most heavily on documents relating to the estate of Mr. Pappas, including an asset questionnaire prepared by his attorney four months before Mr. Pappas’ death, and a petition for probate and tax certification signed by Mrs. Pappas as executrix.  The questionnaire’s sections for stocks and interests in corporations were left blank.  The attorney testified that Mr. Pappas mentioned no businesses in which he had an interest, but he also quoted Mr. Pappas as insisting that he was Mr. Fotinos’ "business partner" and not his "employee."  The probate petition (prepared by the same attorney) shows "-0-" for the value of Mr. Pappas’ personal property and stocks and bonds.  Neither the questionnaire nor the probate documents mention 583 Baltic.  (Please visit the New York Trusts & Estate Litigation blog, where my partner, Eric Penzer, discusses Pappas in regard to the evidentiary issues surrounding admissions by estate fiduciaries and the possible interplay of the Dead Man’s Statute.) 

The Legal Framework

Justice Battaglia’s analysis sets forth a number of guiding legal principals which can be summarized as follows:

• Petitioners have the burden of establishing by a preponderance of the credible evidence that they hold the requisite shareholder interest to constitute standing to seek judicial dissolution.
• The absence of stock certificates does not preclude a finding that a person has the rights of a stockholder.
• The relationship between a corporation and its stockholders is contractual.  It is the payment, or obligation to pay for shares of stock, accepted by the corporation, that creates the shares and their ownership.
• Consideration for the issue of shares may take many forms besides cash, including payment in services and out of future profits.
• In the first instance a court should look for evidence that consideration has been paid for a stock interest and that proceeds of the enterprise have been distributed to the putative shareholder.
• A court may consider the conduct among the parties reflecting and in furtherance of status as shareholders including the managerial responsibilities borne by the putative shareholder and how non-parties understand the relationship based upon their observation of the conduct among the parties.
• Among the types of documents considered probative of shareholder status are corporate and personal tax returns, bank loan documents and financial statements.  Such documents, however, even when filed with government agencies, are not in and of themselves determinative.
• Estate tax returns and certifications can constitute admissions of the deceased shareholder.
• A party’s failure to offer documentary support for his oral testimony may permit an adverse inference where it can be shown that the document exists, that it is under the party’s control, and that there is no reasonable explanation for failing to produce it.

The Decision

Corfian.  Justice Battaglia concluded that, despite the absence of clear and substantial documentary evidence, "it is more likely than not that Messrs. Pappas, Kalogiannis, and Fotinos were equal shareholders of the corporations formed to conduct business from 577 Baltic."  The court found "particularly significant" that the three men had been shareholders in corporations conducting similar business before working at 577 Baltic which property they owned jointly and equally; that Mr. Pappas and Fotinos told non-party witnesses about joining the others in partnership; that Mr. Pappas’ cash position relative to the others was consistent with the claim that he made capital contributions out of profits; that the three were similarly paid out of a non-payroll account; that all three "exercised significant executive and operational responsibility for the business at 577 Baltic"; that Mr. Pappas and Kalogiannis received no revenue from their ownership of the 577 Baltic property; that the pass-through rental terms of the lease suggested "an identity of ownership of landlord and tenant"; and that Mr. Pappas and Kalogiannis "considered the property at 577 Baltic and the business conducted there essentially as one and the same" so that the court "gives no great import" to the failure to ascribe separate value to the "stock" or business interests in Corfian in the asset questionnaire and estate documents. 

Epiros.  Justice Battaglia reached the opposite conclusion concerning Epiros and 583 Baltic.  He noted the failure of Mrs. Pappas and Kalogiannis to produce any documentary evidence of contributions to the purchase price or other funding of 583 Baltic.  He also ascribed greater significance to the omissions of any reference to Epiros and 583 Baltic in the Pappas asset questionnaire and estate documents.  Justice Battaglia’s careful analysis of the disparate import of these documents to the claims of stock ownership in the two corporations is worth the read:

The reasons that have been articulated for minimizing the significance of these "admissions" in the context of Corfian and 577 Baltic are not present as to Epiros and 583 Baltic.  Mr. and Ms. Pappas could not have thought of the separate and substantial property at 583 to be one and the same as the property and business at 577. 

Petitioners’ claims as to Epiros Realty, Inc. do not benefit from the context out of which Corfian Enterprises, Ltd. grew. When in late 1982 Messrs. Pappas, Kalogiannis, and Fotinos came together to work at 577 Baltic, a property they equally owned, it was for the purpose of continuing the type of business in which they had previously been successful. There is no evidence of an agreement at that time to engage jointly in real estate investment. Indeed, the Court’s conclusion as to Petitioners’ shareholder status in Corfian is based in great measure on the purchase of 577 Baltic as primarily a place to conduct business, rather than an investment.

If more is needed to justify different conclusions as to Corfian Enterprises, Ltd. and Epiros Realty, Ltd., the Court notes that 583 Baltic is apparently the sole "tangible" asset of Epiros, and that for centuries the law has demanded with the Statute of Frauds (see General Obligations Law § 5-703) that there be particular proof before an interest in real property will be recognized. That stricter scrutiny has been applied to alleged oral agreements to transfer stock in a corporation whose sole asset was an interest in realty. (See Yenom Corp. v 155 Wooster Street Inc., 33 AD3d 67, 70-71 [1st Dept 2006]; Bergman v Krausz, 19 AD3d 186, 186-87 [1st Dept 2005].) Although the Statute of Frauds is not at issue here, the underlying policies demand caution in considering a claim that, at the end of the day, seeks recognition of an interest in real property.

My Two Cents.   You really do have to read Justice Battaglia’s entire decision to appreciate fully the complexity and ambiguity of the parties’ business relationships.  Also, Justice Battaglia’s split decision necessarily casts doubt to some extent on the testimony given by both sides or, as Justice Battaglia put it, "challenge[s] the credibility of all the parties, because Ms. Pappas and Mr. Kalogiannis testified that Messrs. Pappas and Kalogiannis were shareholders of both corporations, and Mr. Fotinos testified that they were shareholders of neither."

At bottom, this case is all about the burden of proof.  No one piece of the circumstantial evidence presented by Mrs. Pappas and Kalogiannis was dispositive but, at least as to Corfian, the totality permitted a finding of stock ownership that Fotinos could not overcome in large part because of his own documentary lapses including his failure to produce corporate records in his possession. 

Update August 25, 2010:  In an order handed down this date, the Appellate Division, Second Department, affirmed Justice Battaglia’s rulings upholding Mrs. Pappas’ standing to seek dissolution of Corfian and denying standing to seek dissolution of Epiros.  Read it here.  Read here my post on Justice Battaglia’s July 23, 2010 decision granting Mrs. Pappas’ petition to dissolve Corfian.