Forced Buyout Provisions as a Risk-Reducing Tool for New York Entities

Three partners sat in the IX Legal main conference room with our clients, the two largest interest holders in a New York family-run real estate group with a significant portfolio. Although the two relatives maintained a good rapport and managed to resolve disagreements in a practical manner, they sensed tensions brewing within the rising generation set to replace them. One of the clients recently concluded an acrimonious divorce proceeding in which the client’s spouse claimed a right to interest in the family’s real estate holding company. That experience, combined with horror stories from business partners and acquaintances, understandably left the clients on high alert.

Although the clients’ goals remained straightforward and achievable, they required systemic collaboration between the firm’s litigation, corporate and real estate departments. The clients sought to implement an amendment to the decades-old operating agreement they inherited to provide for a fair and objective buyout mechanism while simultaneously keeping any potential family scuffles out of the public eye and away from the press. Both individuals remained pensive and concerned about the effect of drawn-out litigation on their family’s legacy. This was the firm’s first example in a growing trend of clients seeking to amend agreements for the purpose of including forced buyout provisions.

Litigating forced buyouts

Shareholders of New York corporations with at least 20% interest have statutory tools at their disposal to force the remaining shareholders of the corporation to purchase the interest of the aggrieved shareholders; see NY BCL Section 1104-a. Upon a showing of illegal, fraudulent or oppressive actions towards the petitioning shareholders by those in control, or that the directors, officers or those in control are looting, wasting or diverting the assets of the corporation for improper purposes, the court may order dissolution of the corporation.

Built into the same Article of the Business Corporation Law (BCL) is the right of election available to the remaining shareholders or corporation within 90 days of the petition to purchase the petitioners’ shares at “their fair value” (NY BCL Section 1118). Upon such election and subsequent application of the purchaser, the court stays the petition to determine the value of the petitioners’ shares, effectively converting the nature of the action from one of shareholder oppression or wrongdoing to a valuation hearing. In the context of a shareholder dispute, this shift serves as a stop-gap measure to prevent further damaging details of wrongdoing or dissention from leaking.

While the Section 1118 election effectively gags the public squabbles of most closely held corporations, for many the damage of a detailed pleading of the inner squabbles provides sufficient harm to image and reputation. Outside of Section 1104-a petitions, shareholders cannot force a buyout, nor can a court “convert over a petitioner’s objection, a dissolution petition that does not afford a buyout option for non-petitioning shareholders” (Fedele v Seybert, 250 A.D.2d 519, 523 (1st Dept. 1998)). The Limited Liability Company Law lacks the equivalent mechanism of a BCL Section 1118, and “does not expressly authorize a buyout in a dissolution proceeding”, although a court may permit an equitable buyout of interests to avoid dissolution, in the appropriate circumstance (Mizrahi v Cohen, 104 A.D.3d 917, 920 (2d Dept. 2013) (internal citations omitted); see also Lyons v Salamone, 32 A.D.3d 757 (1st Dept. 2006), noting the lack of LLC law authorising a buyout but noting that the court may find an equitable method of liquidation or the other party is to purchase the interest in lieu of dissolution).

Assuming a court will save their business from dissolution is a desperate if not foolhardy strategy for an entity’s controlling interest holders. A more prudent course of conduct is to prevent the risk of dissolution altogether by creating a forced buyout provision in the context of a shareholder agreement or operating agreement, or by amending the existing agreement to guarantee its compliance with the framework of relevant court analyses.

Buyouts in agreements

Courts must enforce agreements when they are set down in “a clear, complete document” (W.W.W. Assocs. v Gianconteri, 77 N.Y.2d 157, 162 (1990). In the context of a buyout provision, the same guidelines prevail (Rosiny v Schmidt, 185 A.D.2d 727 (1st Dept. 1992)). Indeed, in Rosiny, the First Department reversed a trial decision preventing a forced sale of defendants’ shares pursuant to the terms of the shareholders’ agreement. The Rosiny shareholder agreement contained a post-mortem buyout for the defendant shareholders at a value of the greater of the book value as of the month preceding the operative date or USD200 per share, and the Rosiny court rejected defendants’ contentions of unconscionability in plaintiff’s interpretation of the buyout provision.

There are limits to what courts tolerate, however, and the First Department has rejected a draconian USD1 buyback clause in an operating agreement for any breach of the agreement (Atlantis Mgt. Group II v Nabe, 216 A.D.3d 526 (1st Dept. 2023)). Similarly, the Second Department has rejected a buyout provision with a blank space for purchase price and no mechanism for valuation (Stein v McDowell, 74 A.D.3d 1323 (2d Dept. 2010)). The Stein court found that “[t]he omission of the price from the buyout provision meant that the shareholders’ agreement contained no buyout provision”.

Moreover, a court will nullify a buyout provision when it is not timely exercised; see Urban Archeology Ltd. v Dencorp Invs. Inc., 12 A.D.3d 96 (1st Dept. 2004) (finding that the failure to exercise the buyback within 90 days as contemplated expressly in the parties’ agreement constituted a fatal waiver that the trial court lacked authority to reinstate). To the extent parties modify buyout provisions, courts review the modifications under the same rubric as the original terms (Milgrim v Backroads, Inc., 91 Fed.Appx. 702 (2d Cir. 2002)). Parties negotiating and drafting buyouts must give thought to their application, and to how courts will weigh the fairness of the methodology therein. The opportunity to craft a buyout provision presents a chance to also determine the venue of any challenge and thus the ability to shift disputes from the courts to arbitration.

Arbitration with clauses in the context of a buyout

Article 75 of the Civil Practice Law and Rules (CPLR) establishes the enforceability of a “written agreement to submit any controversy … to arbitration” (CPLR Section 7501; see also 9 U.S.C. Section 1 et seq for the Federal Arbitration Act). Indeed, a “party will not be compelled to arbitrate … absent evidence which affirmatively establishes that the parties expressly agreed to arbitrate their disputes” (Waldron v Goddess, 61 N.Y.2d 181, 183 (1984)). In the context of a dispute among interest holders, the same analysis applies and the court is bound to review the agreement arbitration and ensure that it is “clear, explicit and unequivocal and must not depend upon implication or subtlety” (Sutphin Retail One, LLC v Sutphin Airtrain Realty, LLC, 143 A.D.3d 972, 973 (2d Dept. 2016), citing Waldron at 183–84).

Assuming the applicability of an arbitration provision, a party “aggrieved by the failure of another to arbitrate may apply for an order” under CPLR Article 75 (CPLR Section 7503). Although a motion to compel arbitration succeeds in the appropriate circumstances, it stays rather than dismisses any underlying pending action; see In re Princeton Info, Ltd., 235 A.D.2d 234 (1st Dept. 1997), reversing the dismissal with prejudice of a BCL Section 1104 action to reinstate the proceeding but stay the action pending arbitration since judicial action may be required after the arbitration). Critically, the Princeton matter concerned the applicability of a buyout provision in a shareholders’ agreement. The right to arbitrate is not absolute, however, and may be “modified, waived, or abandoned” (Stark v Molod Spitz DeSantis & Stark, P.C., 9 N.Y.3d 59, 66 (2007)).

The courts will examine the totality of a party’s conduct to determine whether it waived its rights to arbitrate when that party’s “use of the courts is clearly inconsistent with [its] later claim that the parties were obligated to settle their differences by arbitration” (Cusimano v Schnurr, 26 N.Y.3d 391, 400 (2015), internal citations omitted). A party that chooses to “fully participate in litigation for more than 16 months” before moving to compel arbitration clearly waived its rights to arbitrate the underlying claims (Flores v Lower E. Side Serv. Ctr., 4 N.Y.3d 363 (2005)). In deciding on how much time constitutes waiver, the First Department and Second Department held that four months of active litigation suffice (Hyde v Jewish Home Lifecare, 149 A.D.3d 674 (1st Dept. 2017); Byrnes v Castaldi, 72 A.D.3d 718 (2d Dept. 2010)).

From the court’s perspective, such behaviour of active engagement in litigation followed by a reversal and application to compel arbitration contains indications of “blatant forum-shopping” (Cuisamano at 401). Critically, waiver is fact-specific, and a party that merely moves to dismiss prior to compelling arbitration does not waive its right to arbitrate unless the opposing party demonstrates prejudice (Stark at 67).

While a party may still file an action in court, a valid arbitration cause ensures that the action is promptly stayed and then moved to the appropriate private forum. This prevents the public from further engaging in review of the latest filings on the docket and speculating as to the nature of the parties’ spat. However, there is nothing preventing a vindictive aggrieved interest holder from filing in the first instance in the courts, even with a valid arbitration provision. Parties must consider that even a brief attempt to litigate rather than promptly move to compel may jeopardise the ability to compel arbitration.

Learning from prior buyout litigation

We recently settled a matter involving a dispute between members of a limited liability company that owned valuable real estate in Astoria, Queens (Imian P.V. Member LLC v Vlacich LLC, No. 654719/2024 (Sup. Ct. N.Y. Co.); Vlacich LLC v Imian P.V. Member LLC et. al., No. 721125/2024 (Sup. Ct. Queens Co.)). In that situation, the operating agreement contained a buyout provision providing a mechanism for dispute resolution that permitted the aggrieved party to value the company and, in his valuation, simultaneously submit his interest for sale within a period of time after serving notice on the other member. The caveat remained that the other member possessed the right, within the same period, to elect to purchase the initiating member’s interest at the same valuation. If the non-triggering member did not elect to purchase within the timeframe, the triggering member’s notice served as his purchase price for the other member. The concept gave the triggering member a dilemma with balance: select a price too low and the receiving member turns the tables to purchase your interest at a discount. Alternatively, the triggering party risked paying a premium for overvaluing the company, as the agreement forced the triggering party to purchase at the same rate where the other member did not elect to purchase under his valuation. A conceptually straightforward summary judgment motion became muddied when the other member disputed our client’s standing as a member after the court dismissed its counterclaim. However, the parties came to terms before the dust settled following a motion to reargue the summary judgment motion.

Conversely, in a shareholder dispute highlighted by a breakdown of trust between the two 50% interest holding principals with only a voluntary (rather than a forced) buyout or mechanism in place to address potential misappropriation of corporate assets, the sole logical remedy remained a BCL Section 1104 dissolution (Matter of Markopoulos, No. 718319/2025 (Sup. Ct. Queens Co.)). As the election remedy of BCL Section 1118 remains unavailable in a dissolution under Section 1104, the petitioner filed without the fear that his shareholder partner could use his petition to purchase his interest in the business. Here, cooler heads prevailed and the respondent’s selection of competent counsel led to a swift settlement of the action. The outcome in this matter, while optimal under the circumstances, stood to benefit from an enforceable forced buyout provision. If the shareholder agreement presented the client with the opportunity to buy out his partner upon certain conditions outlined in the petition for dissolution, with a binding arbitration provision, the company could avoid the risk that its clients would learn of the upheaval at the top.

Executing an enforceable buyout

Working hand in hand across the relevant departments, the firm finalised the family’s amendment to ensure the group and its portfolio’s continued survival in the face of any anticipated adversity. Our team crafted a fair vehicle, with objective valuations and a triggering mechanism to avoid the pitfalls learned from experience and through research. The amended operating agreement contained express binding arbitration language, ensuring the parties’ option to keep their issues outside of the courts. After explaining the new system in detail, the clients expressed relief that their vigilance guaranteed the survival of their grandparents’ efforts. The potential issues of the next generation must take place within a new framework designed to continue the legacy of the original generation, give fair value to any aggrieved members, ensure leadership remains with the most capable, and keep drama out of the public eye. While predicting the cost savings for these particular clients requires omniscience, we can confidently report that the cost to prepare and execute the amendment to the operating agreement remained less than 1% of a hotly contested litigation and from that time forward all parties to the agreement and their successors maintain a better understanding of their rights and responsibilities vis-à-vis the buyout clause.