JMF Consulting Group II, Inc. v Beverage Mktg. USA, Inc.

[*1] JMF Consulting Group II, Inc. v Beverage Mktg. USA, Inc. 2009 NY Slip Op 50185(U) [22 Misc 3d 1119(A)] Decided on February 4, 2009 Supreme Court, Nassau County Austin, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on February 4, 2009
Supreme Court, Nassau County

JMF Consulting Group II, Inc., Plaintiff,

against

Beverage Marketing USA, Inc., Defendant.



11005/08



COUNSEL FOR PLAINTIFF

DLA Piper US LLP

1251 Avenue Of the Americas

New York, New York 10036

COUNSEL FOR DEFENDANT

Kramer, Levin, Naftalis & Frankel, LLP

1177 Avenue of the Americas

New York, New York 10036

Leonard B. Austin, J.

ORDER

Plaintiff moves for summary judgment and, by separate motion, for a protective order.

BACKGROUND

This is an action for breach of a promissory note. Defendant, Beverage Marketing USA, Inc. ("Beverage Marketing"), is a closely held corporation which [*2]produces Arizona Iced Tea. The company is equally owned by the Ferolito family and the Vultaggio family. John Ferolito ("Ferolito") owns 26% of the stock, and 24% is owned by his son, John Ferolito, Jr. ("John Jr."). Don Vultaggio ("Vultaggio") owns 26% of the stock, and his sons, Spencer and Wesley, each own 12% shares.

During 2005 and 2006, Ferolito and Vultaggio loaned over $100 million to the corporation. According to Vultaggio, the purpose of the loans was to meet working capital needs and to allow for capital expenditures. The loans were evidenced by a series of promissory notes which were payable on demand. The borrowing was in equal amounts from entities controlled by the two groups of shareholders. Vultaggio asserts that the parties agreed that "no owner group would make a demand on any of its notes, unless both of the owner groups made such a demand together." (Vultaggio Aff. ¶8).

Among these loans was a loan made on January 1, 2006, by Plaintiff, JMF Consulting Group II, Inc., ("JMF II"), one of Ferolito's corporations, in the amount of $20 million. Beverage Marketing's obligation to repay the loan was evidenced by a non-negotiable promissory note which provided for annual interest at the rate of 6%. Also in 2006, John Ferolito borrowed $15 million from Hornell Brewing Co., a wholly-owned subsidiary of Beverage Marketing, in order to purchase a personal residence. Ferolito did not issue a promissory note to evidence this indebtedness.

On December 20, 2007, Ferolito and Vultaggio entered into a written agreement, providing that each owner group would receive a payment from Beverage Marketing in the minimum amount of $40,625,000 by the following day. The payment was to be reflected as a "fee" on the books and records of the corporation. Ferolito agreed to indemnify the Vultaggios for any claim made by his son, John Jr., based upon the

payment. Vultaggio agreed to indemnify the Ferolitos for any claim made by his sons, Spencer or Wesley.

In May 2008, the Ferolito family was negotiating to sell their interest in Beverage Marketing to a third party. On May 20, 2008, David Buss, counsel to Ferolito, emailed Thomas Constance, counsel to Vultaggio, updating him on the status of the negotiations. Buss stated that the Ferolitos' interest was being valued on a "debt-free basis," and that the Ferolitos were requesting that Beverage Marketing repay its debt, less the debt which John Ferolito owed to the company.

On May 21, 2008, Constance wrote to Buss, responding to his email, concerning the sale of the Ferolitos' interest and the repayment of loans from the shareholders. In his letter, Constance referred to an "owners' agreement," entered into by Ferolito and Vultaggio ten years before, as well as a more recent agreement of the principal shareholders. Constance asserted that it was never contemplated that one "partner's" loans would be paid while the other would continue to hold substantial debt of the company. Constance stated that Vultaggio was unwilling for Beverage Marketing to repay Ferolito's demand notes and insisted that a potential purchaser acquire Ferolito's notes as well as his shares. Constance also made reference to "potentially catastrophic tax consequences," if the notes were to be repaid.

In a followup letter on May 22, 2008, Buss reiterated his proposal that Beverage [*3]Marketing pay the "net amount" due after deducting the loan owed by Ferolito. Buss asserted that since Beverage Marketing's financial statements stated that the company had the ability to pay all of the loans, Vultaggio's notes could also be repaid. Buss

asserted that he did not anticipate any tax consequences and that repayment of the loans should be a "neutral tax event."

On May 29, 2008, Arthur Aufses, another partner in Constance's firm, wrote to Buss in response to his proposal. In his letter, Aufses asserted that the parties had agreed that loans from shareholders could be repaid only if both shareholders agreed to the repayment. Noting that loans from shareholders exceeded $100 million, Aufses asserted that Beverage Marketing did not have the funds to repay that amount of debt. Aufses also stated that, in order to pay the notes, Beverage Marketing would have to suspend shareholder distributions and that John Jr., Spencer and Wesley would not have the funds to pay taxes on income allocated to them by the company. JMF II served a notice of default and demand for payment the following day.

This action on the January 6, 2006 note was commenced on June 13, 2008. In its answer, Beverage Marketing asserts, among other defenses, the purported agreement that loans from shareholders would be repaid only upon the agreement of both groups of shareholders. Following the commencement of the action, Beverage Marketing made principal payments on the note in the amount of $7.25 million, allegedly the difference between the face amount of the note and the balance outstanding on the Hornell loan. Beverage Marketing also made an interest payment in the amount of $554,014. It claims that, offsetting the amount of the Hornell loan, the note is paid. In moving for summary judgment, JMF II asserts that Beverage Marketing is not entitled to offset the Hornell loan because it was made to Ferolito in his individual capacity.

On August 11, 2008, Beverage Marketing attempted to serve deposition subpoenas upon Ferolito's wife, Carolyn, and John Jr. at the Ferolitos' home in New Jersey. The subpoenas also directed that JMF produce various documents, including: (1) documents concerning the various notes; (2) communications between the parties concerning the notes; (3) documents and communications concerning other loans between the parties; (4) documents and communications concerning shareholder distributions by Beverage Marketing from 2005 to 2007; and (5) documents and communications concerning the incorporation of JMF Consulting Group II, Inc. JMF now moves for a protective order, prohibiting Beverage Marketing from taking the depositions of these individuals and denying production of the requested documents.

DISCUSSION

A.Plaintiff's Motion for Summary Judgment

General rules pertaining to the interpretation and enforcement of contracts apply to agreements between shareholders. See, In re Matco-Norca, Inc., 22 AD3d 495 (2nd Dept. 2005); and Highland Sand & Gravel, Inc. v. Squicciarimi, 272 AD2d 375 (2nd Dept. 2000). Thus, unless the shareholder agreement is within the statute of frauds, there is no requirement that the agreement be in writing. Business Corporation Law ("BCL") § 620 provides that an agreement between shareholders must be in writing if it pertains to the exercise of voting rights. While it is clearly advisable to memorialize

a shareholder agreement, the BCL does not require a writing unless voting rights are [*4]affected.

As a general rule, courts must enforce shareholder agreements according to their terms. Matter of Penepent Corp., 96 NY2d 186, 192 (2001). Shareholder agreements avoid costly, lengthy litigation and promote "reliance, predictability and definitiveness in relationships among shareholders in close corporations." Id. The shareholders are free to agree to provisions affecting the management of a close corporation, provided the agreement does not violate the certificate of incorporation, a statute, or public policy. Fletcher, Cyclopedia of Corporations § 5743. See, e.g., Russack v. Weinstein, 291 AD2d 439 (2nd Dept. 2002). Additionally, a shareholder agreement may not infringe the rights of creditors by impairing the capital stock of the corporation. Id.

An agreement in which the shareholders agree that loans to the corporation will not be called without the approval of their shareholders may promote the liquidity of the company and protect the interests of creditors of the corporation. In order to treat all shareholders fairly, pari passu provisions, requiring proportional repayment of all shareholder loans, are frequently included in shareholder agreements. See, Herman v. Feinsmith, 39 AD3d 327 (1st Dept. 2007). However, advances to the capital stock of a corporation may be disguised as shareholder loans to claim an interest deduction or for other tax considerations. Tyler v. Tomlinson, 414 F.2d 844 (5th Cir. 1969). A shareholder agreement with respect to loans may be void for illegality if it furthers a tax fraud scheme. See, Passero v. Siciliano, 37 AD3d 1048, 1050 (4th Dept. 2007). Thus, an agreement with respect to the repayment of shareholder loans may not be enforceable if it is intended to advance tax fraud, impair the capital of the corporation or for some other improper purpose.

On a motion for summary judgment, it is the proponent's burden to make a prima facie showing of entitlement to judgment as a matter of law, by tendering sufficient evidence to demonstrate the absence of any material issues of fact. JMD Holding Corp. v. Congress Financial Corp., 4 NY3d 373, 384 (2005); and Andre v. Pomeroy, 35 NY2d 361 (1974). Failure to make such a prima facie showing requires denial of the motion, regardless of the sufficiency of the opposing papers. Liberty Taxi Mgt. Inc. v. Gincherman, 32 AD3d 276 (1st Dept. 2006). However, if this showing is made, the burden shifts to the party opposing the summary judgment motion to produce evidentiary proof in admissible form sufficient to establish the existence of material issues of fact which require a trial. Alvarez v. Prospect Hospital, 68 NY2d 320, 324 (1986).

By establishing the making of the promissory note and the default in payment, JMF II has made a prima facie showing of entitlement to judgment in its favor. Two Lincoln Advisory Servs., Inc. v. Shields, 293 AD2d 740, 741 (2nd Dept. 2002); and Mangiatordi v. Mahner, 293 AD2d 454 (2nd Dept. 2002). The burden thus shifts to Beverage Marketing to show that it is not obligated to pay the instrument according to its tenor. In this case, Beverage Marketing argues that its partial payments on the note constituted an accord and satisfaction.

The theory underlying the common law rule of accord and satisfaction is that the parties have entered into a new contract displacing all or part of their original one. Denberg v. Parker Chapin Flatau & Klimpl, 82 NY2d 375, 383 (1993); and Horn Waterproofing Corp. v. Bushwick Iron & Steel Co., 66 NY2d 321, 325 (1985). The rule [*5]has generally been accepted as "a legitimate and expeditious means of settling contract disputes." Id. Nevertheless, a creditor may have "good cause to believe that he is fully entitled to retain the partial payment which is rightfully his and presently in his possession, without having to forfeit entitlement to whatever else is due." Id. See also, Shuttunger v. Woodruff, 259 NY 212, 216-217 (1932). To promote settlement, but protect the legitimate expectations of the creditor, a creditor is permitted to accept a partial payment and explicitly reserve his rights to collect the balance of the debt. Horn Waterproofing Corp. v. Bushwick Iron & Steel Co., supra.

Where a plaintiff, who has commenced an action on his claim, accepts a partial payment, the failure to discontinue or formally settle the action negates any intent to enter a new agreement. See, e.g., UMLIC VP, LLC v. Mellace, 19 AD3d 684 (2nd Dept. 2005). Thus, a plaintiff need not expressly state that he is reserving his right to pursue the balance of the claim. Where a plaintiff is suing upon an instrument for the payment of money, his acceptance of a principal or interest payment is similarly without prejudice to his right to collect the balance owed. The Court concludes, as a matter of law, that Defendant's payments of principal and interest did not give rise to an accord and satisfaction.

However, the holder of a non-negotiable instrument takes it subject to any defenses which were good against the transferor. UCC § 3-201; and County Trust Co. v. Berish, 4 AD2d 777 (2nd Dept. 1957). Since JMF II acquired the non-negotiable note from JMF Consulting Group, it is subject to viable defenses against its assignor, including a shareholder agreement not to call loans to the corporation without the approval of the shareholders.

Constance's reference to "potentially catastrophic" tax consequences, the extraordinary $80 million distribution, and the indemnity agreement against claims by other family members suggest that the tax ramifications of the shareholder loans have not been fully disclosed. The Court's concerns are not dispelled by Buss's conclusory assurance that repayment of the loans would be a "tax neutral event." Nevertheless, the Court must assume, on this summary judgment motion, that the shareholder agreement with respect to loan repayment had a proper purpose.

Since the agreement by the shareholders was antecedent to the issuance of the promissory note, it does not constitute an oral amendment in violation of the note's provisions. General Obligations Law § 15-301. Thus, the agreement is enforceable despite the failure to memorialize it in a writing. The Court concludes that Beverage Marketing has demonstrated a triable issue as to whether a shareholder agreement bars enforcement of the note without the joint approval of the two groups of shareholders. Plaintiff's motion for summary judgment must be denied.

B.Defendant's Request for Summary Judgment

CPLR 3212(b) provides that, if it appears that any party other than the moving party is entitled to a summary judgment, the court may grant such judgment without the necessity of a cross-motion. The power to search the record and grant summary relief to a non-moving party is not, however, boundless. Since a motion for summary judgment must be addressed to one or more specific causes of action or defenses, a court may search the record and grant summary judgment to a non-moving party only with respect to a cause of action or issue that is the subject of the motion before the court. Dunham v. Hilco Construction Co., 89 NY2d 425, 429-430 (1996). [*6]

Although Beverage Marketing has not cross-moved for summary judgment, it argues that the note has been paid, after offsetting the loan made to Ferolito by Hornell Brewing. JMF II argues that a setoff is not permissible because a corporation may not setoff a debt owed by its principal shareholder. Ordinarily, a court must respect the corporate form, and a shareholder is not personally liable for the debts of the corporation. However, a claim against the shareholder may be enforced against the shareholder's interest in the corporation. CPLR 5201(c)(1). Moreover, where an affirmative recovery is not sought, setoff is an equitable remedy. Hammerstein v. Henry Mountain Corp., 11 AD3d 836 (3rd Dept. 2004). Equity "does not exalt form over substance." American Broadcasting Co. v. Wolf, 76 AD2d 162, 171 (1st Dept. 1980). Thus, where a corporation is owned by a single shareholder, or a small family group, it may be permissible for a debtor of the corporation to setoff a claim against the principal shareholder. See, Kristensen v. Charleston Square, Inc., 273 AD2d 312 (2nd Dept. 2000). Since JMF II recognized Beverage Marketing's right to such an offset, Beverage Marketing may setoff the Hornell loan, provided that Hornell assigns the loan to its parent corporation. Nevertheless, since the balance outstanding on the Hornell loan was not a subject of the motion before the Court, the Court declines to search the record with regard to the issues of setoff and payment.

C.Protective Order

CPLR 3103 provides that the court may, on motion of any party or of any person from whom discovery is sought, make a protective order denying, limiting, conditioning, or regulating discovery. Protective orders are designed to prevent unreasonable annoyance, expense, embarrassment, disadvantage, or other prejudice to any person or the courts. A cause of action based upon an instrument for the payment of money only is "presumptively meritorious." Banco Popular v. Victory Taxi Management, Inc., 1 NY3d 381, 383 (2004). Nevertheless, Defendant is entitled to discovery concerning "defenses based on facts extrinsic to [the] instrument." Alard v. Weiss, 1 AD3d 131 (1st Dept. 2003).

In view of the Court's rulings with respect to JMF II's standing and Defendant's right of setoff, there is no need for discovery as to the reorganization of JMF Consulting Group or the relationship between Ferolito and his corporation. Nevertheless, because an improper tax motive may affect the enforceability of the note, Defendant is entitled to discovery concerning the circumstances surrounding the "shareholder loan program." Thus, Plaintiff's motion for a protective order denying discovery of documents shall be granted, except as to documents relating to the making of loans between Beverage Marketing and its shareholders.

A party desiring to take the deposition of a particular officer, director, member or employee shall include in the notice or subpoena served upon such entity the identity, description, or title of such individual. CPLR 3106(d). Such person shall produce the individual so designated unless he/she shall have, no later than ten days prior to the scheduled deposition, notified the requesting party that another individual would instead be produced and the identity, description or title of such individual is specified. Id. Thus, a corporate party may, in the first instance, choose whom to produce as its witness at a deposition. However, an adverse party, subject to the discretionary regulation of the trial court, is entitled to conduct further depositions of any corporate employee who is shown to have knowledge of the facts in issue. Niesig v. Team I, 149 AD2d 94, 104-105 (2nd Dept. 1989).

From the submissions of the parties, it is clear that the shareholder loan program was conceived and implemented by the principal shareholders, John Ferolito and Don Vultaggio. [*7]Defendant has made no showing that Carolyn Ferolito or John Ferolito, Jr. has any knowledge concerning the purpose of the shareholder loans to the corporation. Accordingly, Plaintiff's motion for a protective order, prohibiting the taking of the depositions of those persons should be granted without prejudice to a later showing that

either or both of the proposed witnesses has information relevant to this case beyond that of the principal shareholders.

Accordingly, it is,

ORDERED, that Plaintiff's motion for summary judgment is denied; and it is further,

ORDERED, that Plaintiff's motion for a protective order is granted without prejudice as indicated herein; and it is further,

ORDERED, that counsel for the parties shall appear for a preliminary conference on February 27, 2009 at 9:30 a.m.

This constitute the decision and Order of the Court.

Dated: Mineola, NY_____________________________

February 4, 2009Hon. LEONARD B. AUSTIN, J.S.C.