Synopsis of Rule of Law Edit
Brief Fact Summary Edit
The appellee, Harold Kurtz, and the appellant, Abraham Zion, both shareholders in the corporation, “Group”, executed an agreement that no business would be conducted without the appellant’s consent. The appellee executed two agreements on behalf of the corporation even though the appellant objected to the transactions. The appellant sought to cancel the two agreements.
The appellant held all of the Class A stock in Group and appellee owned all of the Class B stock.
The appellant and the appellee executed a shareholders’ agreement before appellant bought shares in Group. The shareholders' agreement stated that no decisions would be made by Group without the consent of the holders of the Class A stock. The appellee promised in the agreement that he would take all steps necessary to fulfill the purpose of the shareholder agreement. However, the articles of incorporation did not mention the shareholder agreement and the Group was not formally registered as a close corporation.
The appellee approved two agreements without the consent of the appellant. The appellant brought suit to cancel the two agreements on grounds that they violated the shareholders’ agreement.
Shareholder agreements that limit the board’s management power are enforceable even though it may not be included in the articles because such an act is not prohibited in statute if the corporation is a close corporation. Group only had two shareholders and the appellee (who was originally the sole owner of Group before the appellant bought shares in the corporation) promised to take all steps to fulfill the purpose of the agreement. Since Group can elect to become a close corporation, a mere formal act, the agreement should be enforced because appellant may have relied on this arrangement before agreeing to buy shares in the corporation.
50 N.Y.2d 92 (1980)
Abraham Zion et al., Respondents-Appellants,
Harold W. Kurtz et al., Appellants-Respondents.
Court of Appeals of the State of New York.
Argued February 7, 1980.
Decided April 29, 1980.
Edward L. Sadowsky, Stephen A. Ollendorff and Stacy L. Wallach for respondents-appellants.
John J. Walsh, Rodney S. Dayan, J. Michael Schell and Michael M. Gordon for appellants-respondents.
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.
*96 MEYER, J.
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 *97 formation of two subsidiaries, the minority stockholder's consent having been obtained, and that the consent provision continues in existence as provided in the agreement. The order of the Appellate Division should, therefore, be modified, with costs to plaintiffs, as hereafter indicated.
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.[1 ] Section 3.01(a) of the agreement expressly provided that without the consent of the holders of class A stock:
98*98"Anything in its Certificate of Incorporation or By-Laws to the contrary notwithstanding, the Corporation[2 ] shall not:"(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 L-W 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 99*99 the escrow agreement, and no such agreement has ever been executed.
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 100*100 incorporated in the corporation's charter, (2) that plaintiffs are entitled to summary judgment declaring that execution of the interest and escrow agreements violated the shareholders' agreement, (3) that plaintiffs are entitled to judgment dismissing the reformation counterclaim, (4) that defendants are entitled to judgment dismissing the second cause of action, without prejudice, however, to such action as plaintiffs may be advised to take to obtain the deposit in escrow of the shares of the two subsidiaries, and (5) that though plaintiffs are not entitled to injunctive relief on the present complaint, the interest and escrow agreements having terminated, payment of the note did not terminate the restriction on corporate action by Group without consent of the class A stockholders. The Appellate Division order should, therefore, be modified as in (4) and (5) above indicated, and, as so modified, should be affirmed.
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 N.Y.2d 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 101*101 shall be managed by the stockholders of the corporation rather than the board of directors" and that such a provision may be inserted in the certificate by amendment if "all holders of record of all of the outstanding stock" so authorize (§ 351).
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, defendantKurtz, 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 102*102 other and further instruments and documents and take, or cause to be taken, all such other and further action as he may deem necessary, appropriate or desirable to implement and give effect to the Stockholders Agreement and the transactions provided for therein." Since there are no intervening rights of third persons, the agreement requires nothing that is not permitted by statute, and all of the stockholders of the corporation assented to it, the certificate of incorporation may be ordered reformed, by requiring Kurtz to file the appropriate amendments, or more directly he may be held estopped to rely upon the absence of those amendments from the corporate charter (Matter of Farm Inds., 41 Del Ch 379, 392-397; Beresovski v Warszawski, 28 N.Y.2d 419;Elyea v Lehigh Salt Min. Co., 169 N.Y. 29, 33; Lorillard v Clyde, 86 N.Y. 384, 389; Kent v Quick-Silver Min. Co., 78 N.Y. 159, 187; Millspaugh v Cassedy, 191 App Div 221; see Delaney, The Corporate Director: Can His Hands Be Tied In Advance, 50 Col L Rev 52, 66).[3 ]
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,[4 ] which did 103*103 not become effective until September 1, 1963, it is worthy of note that in adopting that provision the Legislature had before it the Revisers' Comment[5 ] that: "Paragraph (b) expands the ruling inClark v. Dodge, 269 N.Y. 410, 199 N. E. 637 (1936), and, to the extent therein provided, overrules Long Park, Inc. v. Trenton-New Brunswick Theatres Co., 297 N.Y. 174, 77 N. E. 2d 633 (1948), Manson v. Curtis, 223 N.Y. 313, 119 N. E. 559 (1919) and McQuade v. Stoneham, 263 N.Y. 323, 189 N. E. 234 (1934)." Thus it is clear that no New York public policy stands in the way of our application of the Delaware statute and decisional law above referred to (cf. Grad v Roberts, 14 N.Y.2d 70; 3 White, New York Corporations [13th ed], par 620.01; Kessler, Shareholder-Managed Close Corporation Under the New York Business Corporation Law, 43 Fordham L Rev 197; Hoffman, New Horizons For The Close Corporation in New York Under Its New Business Corporation Law, 28 Brooklyn L Rev 1, 9-10).
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 N.Y. 73; Black's Law Dictionary [4th ed], p 622),[6 ] its meaning is necessarily governed by the context in which it is used. Defendants' argument ignores the fact that the parties agreed, as indicated by what they wrote, that without Zion's consent Group would not engage in "any business or activities of any kind, directly or indirectly, whether through any Subsidiary or by way of a loan, guaranteeor otherwise" (emphasis supplied). As we have held in Randall v Bailey (288 N.Y. 280, 285; accord Shilbury v Board of Supervisors of County of Sullivan, 54 Misc 2d 979, 982 104*104[COOKE, J.]), the word "any" means "all" or "every" and imports no limitation. It is difficult to imagine (short, as the old chestnut puts it, of adding in the opening clause of section 3.01 after "Corporation" the word "positively") a more comprehensive proscription than one against "any business or activities of any kind, directly or indirectly". The more so is that true of a paragraph which then excepts two specifics — acquisition of Lombard stock and insurance on the lives of key personnel — the first of which was a one-time rather than a multiple transaction.
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 N.Y. 36) throughLevine v Shell Oil Co. (28 N.Y.2d 205) and Margolin v New York Life Ins. Co. (32 N.Y.2d 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'sconsent. 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 105*105 of the California real estate and to require that Group and Lombard pay to Half Moon any sums required by Lombard's independent accountants to be expended for additional documentation, subdivision, zoning change or easement. Having expressly agreed that they would take specific action to support the value of the note should their independent accountants require it, defendants cannot now argue that the accountants' view that the interest and escrow agreements were necessary to support the value of the note authorized them to enter into such agreements without Zion's consent, though not expressly excepted from the proscription of section 3.01(a).
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 N.Y.2d 285, 291).
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 Zionobligated 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.
With respect to the second cause of action, however, the 106*106 shoe is on the other foot. While the consents to formation of the two subsidiaries were granted by indorsement on letters from Lombard reciting Lombard's agreement to appropriate amendment of the escrow with Zion'sattorneys to cover the subsidiaries' shares issued to Lombard, the first suggestion that consent was conditioned upon the actual deposit of stock was not made until more than a month thereafter in a letter from Zion's attorneys. The fact that the shares could not be issued until the corporations were formed indicates that the deposit of the stock was not intended as a condition of consent, and that would be the usual construction of the language of the letters, which are phrased in terms of promise rather than condition (cf. Weisner v 791 Park Ave. Corp., 6 N.Y.2d 426, 434; Borax v Borax, 3 AD2d 404, 405, affd without discussion of the point4 N.Y.2d 113; see Restatement, Contracts 2d, [Tent Draft No. 7], § 253, subd , and Comment d; 3A Corbin, Contracts, § 663; 5 Williston, Contracts [3d ed], §§ 664, 665). Moreover, the corporate resolution authorizing formation of the subsidiaries "subject to" the consents which defendants already had is insufficient to create an issue of fact on that score.
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.
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 107*107 IV of the agreement expressly states that, with stated exceptions, the provisions of section 3.01 are applicable even after the "loan period" has expired.
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.
GABRIELLI, J. (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.[7 [*]] Plaintiff agreed unconditionally to the creation of these subsidiaries and therefore has no basis for complaining that this corporate activity was undertaken without his consent. Because I conclude that the agreement requiring plaintiff's consent was invalid under well-established public policies, however, I deem it unnecessary to consider whether plaintiff's unconditional consent was actually obtained. Instead, I would hold that plaintiff's consent was not required as a condition precedent to the creation of the subsidiaries, since the agreement from which his right to consent is derived is an illegal attempt by shareholders to deprive the board of directors of its inherent authority to exercise its discretion in managing the affairs of the corporation. But, for the same reason, and contrary to the majority's holding, I would reverse the determination 108*108 of the Appellate Division with respect to plaintiff's first cause of action and hold that plaintiff cannot maintain a suit based upon defendants' failure to obtain his consent prior to executing the disputed interest and escrow agreements.
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 N.Y. 174, 178-179; McQuade v Stoneham, 263 N.Y. 323; Manson v Curtis, 223 N.Y. 313, 323; Matter of Abbey [Meyerson, 274 App Div 389,] affd 299 N.Y. 557; cf. Matter of Farm Inds., 41 Del Ch 379, 390; Triggs v Triggs, 46 N.Y.2d 305; Matter of Glekel [Gluck, 30 N.Y.2d 93]; see, also,University Computing Co. v Lykes-Youngstown Corp., 504 F.2d 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 109*109 in a very substantial way their duty to use their own best judgment on management matters".
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 N.Y. 410) or where the illegal provisions were severable from the otherwise legal provisions which the shareholder sought to enforce (Triggs v Triggs, 46 N.Y.2d 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, 110*110 contemplate that such variations from the corporate norm will be recorded on the face of the certificate of incorporation (Del General Corporation Law, § 351; Business Corporation Law, § 620, subd [b]). New York additionally requires that the existence of a substantial restriction on the powers of the board "shall be noted conspicuously on the face or back of every certificate for shares issued by [the] corporation" (Business Corporation Law, § 620, subd [g]). Significantly, in both Delaware and New York, a provision in the certificate of incorporation restricting the discretion of the board has the effect of shifting liability for any mismanagement from the directors to the managing shareholders (Del General Corporation Law, § 351, subds -; Business Corporation Law, § 620, subd [f]).
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 111*111 to the private shareholder agreement, will not be drawn into an investment that he might otherwise choose to avoid.
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 N.Y. 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 112*112 shareholder agreements to "sterilize" a corporate board of directors (Del General Corporation Law, § 351; Business Corporation Law, § 620, subd [b], pars -; subd [g]). But the laws of both jurisdictions go further, requiring in each case that the "close corporation" give notice of its unorthodox management structure through its filed certificate of incorporation. The obvious purpose of such a requirement is to prevent harm to the publicbefore it occurs. If, as the majority's holding suggests, this requirement of notice to the public through the certificate of incorporation is without legal effect unless and until a third party's interests have actually been impaired, then the prophylactic purposes of the statutes governing "close corporations" would effectively be defeated. It is this aspect of the majority's ruling that I find most difficult to accept.
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.
Order modified, with costs to plaintiffs, in accordance with the opinion herein and, as so modified, affirmed.
[1 ] 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 Zionany 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.
[2 ] In the agreement "Corporation" refers to Group and "L-W" to Lombard.
[3 ] 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.
[4 ] 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."
[5 ] (1961 Legis Doc No. 12, at p 40.)
[6 ] 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".
[7 [*]] 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.