01 Oct “Buy Before Boarding” – Plaintiffs Allowed to Ride the Ownership Train Without a Stock Certificate Ticket, But at an Increased Fare
By Michael A.H. Schoenberg, Esq.
Each year, budding and established entrepreneurs form thousands, if not tens of thousands, of new corporations in New York. With the excitement of starting a new business, many owners often overlook the seemingly humdrum formalities of corporate formation, such as issuing stock certificates to the owners.
The consequences of not following through on these formalities can range from the annoying (having to redo the documents) to the drastic (being precluded from claiming an ownership interest), but they all have one common theme: they cost more time and money to address later on than if the issue was addressed at the outset of the relationship, especially if the relationship sours and litigation ensues.
Take, for example, the feuding Lentini brothers in the September 5, 2018 decision of Justice Bransten of the New York County Commercial Division in Lentini v. 219 W. 20th Str. Corp., 2018 NY Slip Op. 32181(U). As the Court recounts in its decision, William and Joseph Lentini had been business partners in numerous ventures dating back to at least 1973. Although the brothers’ ownership interests in some of the ventures were documented, other were not.
Fast forward to 2016, when the brothers’ business relationship soured leading each side to lob derivative claims against each other on behalf of their respective corporations, including Joseph’s 32 separate counterclaims against William. William responded to Joseph’s counterclaims with a motion to dismiss in which William argued, among other things, that Joseph lacked standing to assert his derivative claims because he did not have an ownership interest in the respective businesses. William’s argument centered on Business Corporation Law § 626, which requires that a plaintiff asserting derivative claims on behalf of a corporation be an owner of that corporation.
Although Justice Bransten dismissed the majority of Joseph’s counterclaims for a variety of reasons, she refused to dismiss his derivative claims asserted on behalf of the businesses for which he did not hold a stock certificate. Justice Bransten found that Joseph did not need to hold share certificates to have the right to assert derivative claims, explaining:
The mere fact that the corporation did not issue any stock certificates does not preclude a finding that a person has the rights of a shareholder. It is the payment, or the obligation to pay for shares of stock, accepted by the corporation, that creates both the shares and their ownership. Labor or services actually received by or performed for the corporation constitutes consideration for the issue of shares. However, a claimants’ failure to allege any basis upon which he might claim an actual, equitable or beneficial interest in any corporate shares will result in dismissal for lack of standing.
Assuming the truth of Joseph Lentini’s allegations, he has standing to pursue derivative claims on WCA’s behalf. The second amended complaint alleges that Joseph Lentini owns 50% of the interest in WCA and that, as consideration for his ownership interest, he contributed his time and experience to WCA at a reduced salary. This constitutes consideration for the alleged issue of shares and, if true, creates both the shares and their ownership. Whether Joseph Lentini has an ownership interest in WCA is not before the court on the instant, pre-answer motion to dismiss. Joseph Lentini need only allege a basis upon which he may claim an actual, equitable or beneficial interest in any WCA shares, which he has done.
Justice Bransten may have held open the closing litigation train doors for Joseph to jump onboard with his derivative claims intact, but he now has to pay the increased fare of proving his actual ownership in the businesses. All of the time and money spent on the legal wrangling in the motion to dismiss, and that will be spent in the discovery process to prove (or disprove) Joseph’s ownership interests, could have been saved had he and his brother simply bought their ticket before boarding by following the corporate formalities from the outset and issuing stock certificates for all of their business ventures.
As the adage goes, “a stitch in time saves nine.” Entrepreneurs forming a business, whether corporations, companies or partnerships, and regardless of the number of owners, should take heed: the cost of having a competent lawyer document the formation at the beginning can save many multiples of that cost later on when a dispute arises.