John’s of 12th Street in the East Village is one of Manhattan’s oldest and most storied red-sauce Italian restaurants. Founded in 1908, John’s hosted a speakeasy and was favored by gangsters during Prohibition. In 1922, it was the scene of the infamous rub-out of bootlegger and “snappy dresser” Umberto Valenti as he left the restaurant, gunned down by future Mafia kingpins Vito Genovese and “Lucky” Luciano. Die-hard fans of The Sopranos might recognize John’s as the scene of Tony’s beat-down of “Coco” Cogliano for harassing Tony’s daughter Meadow (Season 6, Episode 19).
Less violent but of greater interest to business divorce practitioners and corporate counsel, in its current incarnation John’s is the subject of a recent, noteworthy court ruling in a dispute between its majority and minority shareholders. The decision’s outcome — relegating the estate of the deceased majority shareholder to an economic interest holder with no voting rights — required the court to reconcile two “interacting” (the court’s word) provisions in the governing shareholders’ agreement. The court’s resolution ultimately turned on six anodyne, easily overlooked words found in the provision subordinated by the court, what I call a wolf in sheep’s clothing: “Except as otherwise set forth herein.”
The Shareholders. Since 2016, John’s is operated by a corporation named P.J. Restaurant Inc. At the time of its formation P.J. had four shareholders including 55% owner Paul Dauber who also managed the restaurant. The other shareholders included 34% owner Lowell Fein and two other investors holding the remaining 11%.
The Shareholders’ Agreement. In 2017, the shareholders entered into a 39-page First Amended and Restated Shareholders’ Agreement. The Shareholders’ Agreement named Dauber as sole Director, President and Treasurer and Fein as Vice President and Secretary.
The Dispute’s Origin. The limited online court record doesn’t reveal when the rumblings began. The earliest filed record is an early 2022 letter from Fein’s lawyer to Dauber accusing him of failing to provide financial information, failing to timely issue K-1s, failing to make profit distributions, embezzling cash, and reducing Fein’s salary. The letter demanded that Dauber purchase Fein’s shares by returning his initial investment, pay him his pro rata share of distributions that should have been made, and issue his K-1s going back to 2018. Dauber’s lawyer replied in kind, accusing Fein of “shirking” his duties and rejecting his buy-out demand.
Paul’s Death. The dispute was still percolating when Paul died in May 2023. The following month, Fein and the two other minority shareholders signed a “Written Consent of Board and Shareholders” (i) appointing Fein as sole Director and President, (ii) appointing the other two minority shareholders to the remaining offices, and (iii) admitting Dauber’s widow, Judith Dauber, “as a non-voting shareholder of the Company, in accordance with applicable law and the terms of the First A&R Shareholders’ Agreement.” Ms. Dauber did not sign the Written Consent, nor is it clear that her late husband’s shares had passed out of his estate.
P.J. Files Suit Against Ms. Dauber. After further legal jousting, in May 2024 Fein acting as sole Director and President authorized counsel to file suit in P.J.’s name against Ms. Dauber as administrator of her late husband’s estate. The complaint alleged “large-scale fraud, breach of fiduciary duties and unjust enrichment perpetrated over several years” by Mr. Dauber. Specifically, the suit accused him of misappropriating around $1.6 million and other failures of record-keeping, profit sharing, and tax compliance.
Ms. Dauber Moves to Dismiss the Complaint. Ms. Dauber countered with a motion to dismiss the complaint, primarily on the ground that Fein had no authority to institute suit in the name of P.J., she asserted, because he was incapable of assuming the Director and President roles without the Estate’s consent as majority shareholder. Ms. Dauber argued that the claims alleging financial and other malfeasance by her late husband were defective derivative claims masquerading as direct claims by the company.
Ms. Dauber Relies on Section 5.1 (b). Ms. Dauber’s position rested on Section 5.1 (b) of the Shareholders’ Agreement providing for the election of a Director to fill a vacancy by majority shareholder vote. The section states in pertinent part:
Except as otherwise set forth herein, vacancies on the Board of Directors, for whatever reason, shall be filled by the affirmative vote of all of the remaining Directors, provided, however, that if there are no remaining Directors at the time of such vacancy, a replacement Director shall be elected to fill each vacancy pursuant to the affirmative vote of the holders of the majority of the Shares issued by the Company at a special meeting organized in accordance herewith for such purpose [italics added].
Based on this provision, Ms. Dauber argued that Fein could not be elected to the Board without the Estate’s consent as majority shareholder and therefore could not authorize suit in the company’s name.
P.J. Relies on Section 8.2. P.J.’s argument opposing Ms. Dauber’s lack-of-capacity position relied on Section 8.2 of the Shareholders’ Agreement captioned “Death, Dissolution, or Incapacitation of a Shareholder.” The section authorizes the transfer of shares of a deceased shareholder to the decedent’s estate, but strips the shares of voting and management rights and thereby converts the estate to a mere economic interest holder. Here’s the pertinent language depriving the shares of those rights:
No voting right or management authority in the Company shall pass with the deceased, dissolved, or Incapacitated Shareholder’s Interest, and such right and control shall instead be redeemed in full by the Company, while the voting rights of the remaining Shareholders and/or Directors shall be adjusted pro rata in accordance with this Agreement.
P.J. argued that Section 8.2 trumps Section 5.1 (b) based on the latter’s opening proviso, “[e]xcept as otherwise set forth herein.”
Ms. Dauber’s Response. In response, Ms. Dauber emphasized the use of the word “Shares” as opposed to “Shareholder” in Section 5.1 (b) — both defined terms in the Shareholders’ Agreement — calling for a Board vacancy to be filled “pursuant to the affirmative vote of the holders of the majority of the Shares issued by the Company at a special meeting organized in accordance herewith for such purpose.” In other words, she argued, the “except” proviso in Section 5.1 (b) did not bring Section 8.2 into the picture since the right to vote at a special meeting is expressly delegated to the holder of the majority “Shares.”
The Court’s Decision. The court’s Decision and Order in P.J. Restaurant Inc. v Dauber, authored by Manhattan Commercial Division Justice Margaret A. Chan, summed up the issue before her thusly:
The parties’ dispute primarily comes down to contract interpretation, and in particular, the interaction between §§ 5.1 (b) and 8.2 of the Shareholders’ Agreement. On one hand, § 5.1 (b) requires “the affirmative vote of the holders of the majority of the Shares issued by the Company” to appoint a new director “[e]xcept as otherwise set forth” in the Agreement (Agreement § 5.1 [b]). On the other hand, § 8.2 states that “[n]o voting right or management authority in the Company shall pass with the deceased … Shareholder’s Interest” (id). Defendant posits that § 5.1 (b) means she who has the most shares controls, while plaintiff argues that § 8.2 overrides § 5.1 (b) by removing the right to vote upon death.
Justice Chan does not exactly call it a slam dunk for P.J. Instead, she concludes that, “while there is some ambiguity in the language of the Shareholders’ Agreement, [P.J.] ultimately has the better reading of the two provisions” based on the “Except” proviso in Section 5.1 (b) absent from Section 8.2. “Thus,” she writes, “§ 8.2 controls and defendant’s shares do not allow Judith to vote for director.”
Justice Chan poked some additional holes in Ms. Dauber’s position. First, she pointed to Section 8.2’s statement that “neither ‘voting right or management authority‘ passes upon a shareholder’s death” (italics in original). Ms. Dauber’s claim that “the Estate alone must choose the next director and that no business can be done until she makes that choice,” she critiques, “is essentially claiming a kind of management authority over the Company that did not pass upon Paul’s death.”
Second, she looks to the Shareholders’ Agreement’s definition of “Interest” as inclusive of voting rights and as used in Section 8.2 (voting rights “shall not pass with the deceased . . . Shareholder’s Interest”) to conclude that “the plain meaning of § 8.2 is to remove any voting rights from that Interest.”
“In short,” Justice Chan sums up, “§ 8.2 removes any voting right defendant may have received from Paul, and § 5.1 (b) does not restore that right. Plaintiff therefore validly chose a new director and has the capacity to bring this action.”
Intended or Not, an Unusual Agreement. Section 8.2 does not distinguish between Dauber the majority shareholder and the minority shareholders, all of whose estates could suffer the same fate upon their death or disability. Also, other than a right of first refusal triggered by a third-party offer, I didn’t notice any put right or other buy-sell triggers in the Shareholders’ Agreement. You have to ask yourself, why would any of the P.J. shareholders want to leave their estates and heirs at risk of inheriting non-voting, non-managing interests in a single-location restaurant business which, by the way, would also eliminate the statutory right to seek judicial dissolution reserved for voting shareholders. It’s even more unusual for a controlling majority shareholder to agree to such terms. Yet, Justice Chan decided that’s what the parties intended as expressed in their written agreement.
Trumper vs. Trumped. Some months ago I wrote about a case involving a limited partnership dispute which required the court to decide which of two dueling sections of the partnership agreement prevailed over the other. Each had a “notwithstanding anything herein to the contrary” proviso. The post quoted an expert on contract drafting who advised it best “to determine whether the provision in question in fact needs to trump another provision and, if it does, to specify which provision.”
I found at least 15 provisions in the P.J. Shareholders’ Agreement that use “except as otherwise set forth herein” or some minor variation. Not one of them, including Section 5.1 (b), specified a section intended to trump the one with the proviso. Drafters of shareholder and operating agreements, take note.
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