Business Divorce in the Surrogate’s Court

Farrell Fritz, P.C.

Like business divorce, New York trusts and estates litigation (“T&E”) is a highly specialized niche of the law. T&E litigators have their own universe of substantive law, their own set of procedural rules – the Surrogate’s Court Procedure Act, and their own courts – the Surrogate’s Court. Each and every one of the 62 counties in the State of New York has a Surrogate’s Court.

The point of all this is to set the stage for this week’s post, emanating from a recent decision by Manhattan Surrogate Nora S. Anderson addressing an important recurring issue: the jurisdictional power of Surrogate’s Court to resolve seemingly-quintessential business divorce disputes typically resolved in Supreme Court.

Business Interest Ownership Claims in Surrogate’s Court 

Business divorce cases most often find their way into Surrogate’s Court because the owner of a business – be it a general or limited partner, corporate shareholder, or LLC member – has died, and his or her former ownership interest must be litigated as part of the settlement of his or her affairs after death. Occasionally the outcome of a business divorce case will depend heavily, or even exclusively, upon the outcome of litigation in Surrogate’s Court.

For example, in Surrogate’s Court, beneficiaries of an estate may litigate their entitlement to receive the decedent’s shares of stock in a corporation under a will or trust. The Surrogate’s Court’s decision about who wins will impact many rights in a business divorce case, including the power to vote shares, to appoint or remove directors or officers, standing to seek judicial dissolution, the right to access books and records, to bring derivative claims, or to enforce any other rights arising from ownership.

Director or Officer Removal Claims in Surrogate’s Court

The decision at the heart of today’s post, Matter of Radio Drama, Opinion and Order [Sur Ct, NY County July 15, 2019], addresses a narrow question – whether the Surrogate’s Court can order judicial removal of a corporate director – but its discussion of applicable law is a useful springboard for considering some other business divorce-related jurisdictional questions. Radio Drama involved a not-for-profit corporation, but its holdings are equally applicable to business corporations.

In the 1980s, Himan Brown, a successful producer of radio programs, formed Radio Drama Network, Inc. (the “Corporation”). Before his death in 2010, Brown transferred millions of dollars to a trust. The trust instrument provided for distribution of the lion’s share of the trust remainder to the Corporation for charitable purposes. In a re-stated trust instrument, however, Brown eliminated the Corporation as his remainder beneficiary and named in its place a separate trust Brown created, thereby eliminating the Corporation’s receipt of all but a small portion of Brown’s estate.

Brown’s long-time lawyer (“Respondent”) drafted Brown’s will and trusts, and served in a variety of fiduciary capacities: i) sole executor of Brown’s estate, ii) sole trustee of both trusts, and iii) one of the four directors of the Corporation. Under the documents Respondent drafted, he was also entitled to lucrative commissions for serving in his various fiduciary capacities. Potential conflicts abound.

The Corporation sued Respondent alleging a variety of fiduciary duty breaches as a director of the Corporation, including that he participated in a “fraudulent scheme” to “divert” virtually all of Brown’s assets from Radio Drama to Respondent personally through the payment to him of exorbitant commissions.  As a remedy, the Corporation asked the Surrogate’s Court to judicially remove Respondent as director of the Corporation. Respondent moved to dismiss the Corporation’s claims insofar as they sought his removal from the board on the ground that the Surrogate’s Court “lacks subject matter jurisdiction over such a claim for relief.”

Surrogate Anderson began her jurisdictional analysis by discussing two intermediate appellate decisions. In Matter of Lainez, 79 AD2d 78 [2d Dept], affd 55 NY2d 657 [1981], the court held that “the power of the Surrogate’s Court relates to matters affecting estates of decedents and not to independent matters involving controversies between living persons.” And in Matter of Corning, 108 AD2d 96 [3d Dept 1985], the court held that “alleged violations of the Business Corporation Law” by non-deceased corporate officers and directors “concern matters between living persons” over which Surrogate’s Court lacks jurisdiction.

So on one end of the spectrum are disputes involving “living persons,” which do not belong in Surrogate’s Court. What lies on the other end of the spectrum? Surrogate Anderson looked to Matter of Piccione, 57 NY2d 278 [1982], in which the Court of Appeals somewhat cryptically remarked that the Surrogate’s Court jurisdiction extends broadly to matters “affecting estates.”

Where lies director or officer removal on the continuum between matters involving “living person” and those “affecting estates”? Surrogate Anderson held:

Petitioner’s breach of fiduciary duty claim – to the extent that it is offered as the ground for respondent’s removal as a director on petitioner’s Board – is clearly an issue between ‘living persons,’ specifically between petitioner (a corporation) and respondent individually. Respondent’s removal would affect only the corporation’s internal governance, a matter in which neither the estate nor the Revocable Trust has an interest. That an estate and trust both figure in the narrative giving rise to the dispute between petitioner and respondent is not a per se basis for the court’s exercise of jurisdiction. The fact that this court has jurisdiction over some of the claims asserted by petitioner against respondent cannot bootstrap the removal issue into one within the court’s purview. (citations omitted).

Dissolution Claims in Surrogate’s Court

What if Radio Drama involved a claim for judicial dissolution?

Business dissolution claims sometimes find their way into Surrogate’s Court, though they are rare. One such case involved Surrogate Anderson herself, whose decision in Matter of Mui, Opinion and Order [Sur Ct, NY County Nov. 8, 2017], we addressed in an earlier post. In that case, the fiduciary of an estate that owned a minority stake in a corporation operating a fashion business asked the court to dissolve the business. Without addressing jurisdiction, Surrogate Anderson denied dissolution, holding that the majority raised issues of fact whether dissolution was appropriate.

In Sealy v Clifton, LLC, 106 AD3d 981 [2d Dept 2013], the court affirmed the Kings County Surrogate’s ruling which we wrote about here, declaring that a New York LLC had been dissolved by operation of law upon the death of a 50% member based on the express language of the LLC’s operating agreement.

And in Matter of Verdeschi, 63 AD3d 1084 [2d Dept 2009], which we wrote about here, the same court affirmed a Surrogate’s Court decision granting an estate administrator’s petition for judicial dissolution under Section 1104-a of the Business Corporation Law (the “BCL”).

It is interesting to note that the corporation and LLC judicial dissolution statutes, including BCL 1112 and Section 702 of the Limited Liability Company Law, require a party seeking judicial dissolution to sue in Supreme Court. The New York Constitution explicitly states that the Surrogate’s Court has jurisdiction over matters involving decedents only insofar as they are “not within the exclusive jurisdiction of supreme court” (NY Const Art VI, 12 [d]). Nonetheless, it now seems well settled that Surrogate’s Court does indeed have the jurisdictional power to declare or order judicial dissolution, whether by contract or by statute.

Derivative Claims in Surrogate’s Court

What if Radio Drama involved a derivative claim?

Held one court: “Generally, shareholder derivative actions do not invoke the jurisdiction of the Surrogate’s Court” (Matter of Baum, 7 Misc 3d 1027 [A] [Sur Ct, Nassau County 2005]). The most commonly cited reason? In Lincoln First Bank, N.A. v Sanford, 173 AD2d 65 [4th Dept 1991], the court explained that Surrogate’s Court generally lacks jurisdiction over a shareholder derivative action because it is “the corporation, not the estate, which is entitled to the award of damages” in a derivative suit.

But in that same case, the court also held, “We do not suggest that all stockholder derivative actions are outside the subject matter jurisdiction of Surrogate’s Court. Where it is alleged that the decedent misappropriated corporate funds and a stockholder derivative action is commenced against the estate, the matter clearly would involve the affairs of the decedent and would be within the jurisdiction of Surrogate’s Court.”

In sum, Surrogate’s Courts have broad – though not unlimited – powers to resolve business divorce disputes, including battles over stock and other ownership interests, dissolution claims, and under the right set of facts, derivative claims, so long as the dispute is more than just one between “living persons” and “affects estates.” We look forward to future cases like Radio Drama testing the outer boundaries of jurisdiction over business divorce affairs in Surrogate’s Court.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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