Can shares of a closely held private corporation be left to a beneficiary of a deceased shareholder in the shareholder’s will if the certificate of incorporation or by-laws contain restrictions on transfer?

As a broad general principle, it may be stated that provisions which restrict a stockholder's right to sell or transfer his stock are regarded with disfavor and are strictly construed (Sands Point Land Co. v. Rossmoor, 43 Misc 2d 368, 372). Such restrictions generally apply only to voluntary sales and do not apply to judicial sales or other transfers by operation of law (Id.). The draftsman of such a restriction must be very careful if it is the intention of the incorporators to bind the estate of a stockholder (Matter of Estate of Spaziani, 125 Misc 2d 901, 903). In order to bind the estate, the restriction must not only be reasonable, it must also be clearly expressed as intended to bind the estate (Id.). A restriction concerning a "transfer" of stock has generally been held not to include the passing of title by operation of law through a personal representative to the distributees or beneficiaries of a deceased stockholder (Id.). If the certificate of incorporation specifically excludes stock passing by will or intestacy, the restrictive clause will not be applicable to such passage by will or intestacy (Id.). If silent as to the contingency of death, a restrictive clause is not valid and enforceable against the estate (Id.).

The question for decision in this diversity case is whether under the laws of New York the by-laws of Globe Slicing Machine Company prohibiting the "sale or disposition" of shares of its capital stock without first giving the corporation or its other stockholders an opportunity to purchase are applicable to transfers consequent on the death of a stockholder and effected pursuant to the stockholder's will.

[...]

The plaintiffs claim they have a first option to purchase the decedent's shares of Globe stock. Under New York law first option provisions restricting alienation of stock through testamentary as well as inter vivos transfers are valid. Allen v. Biltmore Tissue Corp., 2 N.Y. 2d 534, 161 N.Y.S.2d 418, 141 N.E.2d 812, 61 A.L.R.2d 1309 (1957). However, as Justice Coleman stated in Storer v. Ripley, 12 Misc.2d 662, 178 N.Y.S.2d 7 (N.Y.Co.1958), if a restriction on the alienability of stock is to be effective in the case of a transfer consequent on death "that consequence must be clearly expressed."

Upon Sivertsen's death title to his stock was transferred by operation of law to his personal representative, Hasner. "The corporation is bound to register upon its books the transfer of the certificate of stock to the executor in his representative capacity." Matter of Starbuck, 251 N.Y. 439, 167 N.E. 580, 65 A.L.R. 216 (1929). The question thus centers on whether the executor can transfer the stock to the decedent's beneficiary, Astrid Sivertsen, notwithstanding the wording of the 1930 by-law. In light of the New York policy to construe first option restraints narrowly, we affirm the district court's holding that Article IX of Globe's by-laws does not apply to testamentary dispositions. Storer v. Ripley, supra; Lane v. Albertson, 78 App.Div. 607, 79 N.Y.S. 947 (2d Dept., 1903). In the Lane case the court had before it the articles of a joint stock association which provided that:

"No member of the association, nor his executors, administrators, or other legal representatives, shall sell or transfer any of the capital stock of the association held by him or them, without first offering the same for sale to the association * * *".

The Appellate Division held as a matter of law that the quoted words did not apply either to the transfer of the shares from the decedent to his executor or to the subsequent transfer from the executor to the residuary legatee. The fact that the critical words in the Lane case are "sell or transfer" while in the instant case the limitation is upon "sale or disposition" does not alter the application of a narrow construction of the by-law. First option provisions in order effectively to restrain dispositions by will must specifically so provide. This was not done here.

Following the invalidating of the defendants' attempt to circumvent the effect of Mr. Justice Eager's judgment, the differences among the several stockholders became more and more exacerbated. Matters reached an impasse, the affairs of the corporation are in the hands of a receiver appointed by this court, and Colwell resigned as director. Storer thereupon brought this action to have his rights determined with respect to a successor to Colwell and for other relief and also for money damages. Pending the action Ripley died, and his widow, his executrix, has been brought in as a defendant. The present posture is this: There is only one director, Storer, where three are authorized. Storer asserts that 'it is now plaintiff's principal contention that he is entitled to buy in the Ripley stock from his widow and his executrix.' If this is decided against him, he says that the question before me is 'whether or not Storer and Ripley agreed as stockholders in February, 1951 that Storer was to have practical working control of Believe It Or Not, Inc. through the perpetual election, so long as Storer held stock in the corporation, of a 3-man board of directors, each of whom had to meet with his approval.'

There are expressions here and there in the opinion of Mr. Justice Eager, and in the opinion of the Court of Appeals which tend to support Storer's present contention that in effect he was to be the corporation and that the rights of other stockholders were subject to his domination. But the courts did not so decide. Mr. Justice Eager decided that there was an agreement whereby Storer and Colwell were to be directors (out of three) so long as Storer or one Millar owned stock and that the other stockholders were to do nothing to interfere with that arrangement. And the Court of Appeals held that the attempt on the part of the other stockholders who held a majority of the stock to increase the number of directors from three to five and so dislodge Storer from his position of dominance violated the decree of Mr. Justice Eager and would not be countenanced. Nothing more was decided. The question whether the death of either Storer or Ripley gave the survivor the option to purchase the stock of the one dying was not discussed in any way; that question is open.

I do not think plaintiff's principal contention is sound.

Of course agreements may provide for their continuance after the death of one of the parties; and of course restrictive agreements on the alienability of property after death will be upheld (cf. Allen v. Biltmore Tissue Corp., 2 N.Y.2d 534, 161 N.Y.S.2d 418; Scruggs v. Cotterill, 67 App.Div. 583, 73 N.Y.S. 882). But there must be such an agreement and if it is to operate as such a restriction, that consequence must be clearly expressed (Stern v. Stern, 79 U.S.App.D.C. 340, 146 F.2d 870; Lane v. Albertson, 78 App.Div. 607, 79 N.Y.S. 947; Taylor's Administrator v. Taylor, Ky., 301 S.W.2d 579; see 65 Harvard Law Review, 773, 791). I cannot find that there was such an agreement. The parties did not mention it in any of their writings; and the oral testimony, whether on the trial before Mr. Justice Eager or before me is too meager to justify any conclusion as to the consequences of death. Storer and Ripley may have thought about it; but they said nothing about it, either in writing or orally. And there are no reasons calling upon me to say that from the nature of things they must have intended it. Storer says that must have been so, else he would not have made the agreement he did; to which Ripley's widow replies that it is just as unthinkable that Ripley would have considered having his shares of stock leave his family--his widow and his two sons--and go to a stranger.

Therefore, there has evolved in the law a general principle that the courts will uphold and enforce restrictions on a stockholder's right of disposition of his stock, or his right of alienability, if reasonable and for a valid business purpose. Hassel v. Pohle, 214 App.Div. 654, 212 N.Y.S. 561 (1925); Cicero Ind. Dev. Corp. v. Roberts, 63 Misc 2d 565, 312 N.Y.S.2d 893 (1970); Stockton v. Lucas, 482 F.2d 979 (1973). A first option restricting, or right of first refusal, on behalf of the corporation or other stockholders has been determined to be a reasonable and valid business purpose. American Broadcasting Companies, Inc. v. Wolf, 76 A.D.2d 162, 430 N.Y.S.2d 275 (1980), affd. 52 N.Y.2d 394, 438 N.Y.S.2d 482, 420 N.E.2d 363 (1981); Rowlee v. Dietrich, 88 A.D.2d 751, 451 N.Y.S.2d 467 (1982).

Consequently, such a clause, as has been adopted by the incorporators of Spaziani Bakeries, Inc. herein, is valid and enforceable. Allen v. Biltmore Tissue Corp., 2 N.Y.2d 534, 161 N.Y.S.2d 418, 141 N.E.2d 812 (1957); Levey v. Saphier, 54 A.D.2d 959, 388 N.Y.S.2d 644 (1976), mot. for lv. to app. den. 41 N.Y.2d 805, 395 N.Y.S.2d 1025, 363 N.E.2d 1186 (1977).

The draftsman of such a clause, however, must be very careful if it is the intention of the incorporators to bind the estate of a stockholder with such a clause. In order to bind the estate the restriction must not only be reasonable but must also be clearly expressed as intended to bind the

Page 857

estate. Storer v. Ripley, 12 Misc.2d 662, 178 N.Y.S.2d 7 (1958); Globe Slicing Machine Co. v. Hasner, 223 F.Supp. 589 (1963), affd. 333 F.2d 413 (1964). The restriction concerning a "transfer" of stock has generally been held not to include the passing of title by operation of law through a personal representative to the distributees or beneficiaries of a deceased stockholder. Lane v. Albertson, 78 App.Div. 607, 79 N.Y.S. 947 (1903); Matter of Starbuck, 251 N.Y. 439, 167 N.E. 580 (1929). The application of such restrictions is limited by the principle "that death would not be presumed to trigger the operation of a repurchase option which did not mention death as a specified contingency." St. Louis Union Trust Company v. Merrill, Lynch, Pierce, Fenner & Smith Incorporated, 562 F.2d 1040, 1047 (1977). If the certificate of incorporation specifically excludes stock passing by will or intestacy, the restrictive clause will not be applicable to such passage by will or intestacy. Cowles v. Cowles Realty Company, 201 App.Div. 460, 194 N.Y.S.2d 546 (1922). If silent as to the contingency of death such a restrictive clause is not valid and enforceable against the estate. Application of Blakeman, 518 F.Supp. 1095 (1981); "Restrictions on Transfers of Stock in Closely Held Corporations: Planning and Drafting", 65 Harvard Law Review, No. 5 (March 1952) 773, at page 791).

Therefore, the administratrix herein is not required to offer the stock back to the corporation. She may distribute it in kind to the distributees of Vincent Spaziani, since the contingency of death was not specifically referred to in the certificate of incorporation. Benkard v. Leonard, 231 App.Div. 625, 248 N.Y.S. 497 (1931); Scruggs v. Cotterill, 67 App.Div. 583, 73 N.Y.S. 882 (1902). We are not faced with or considering the issue, however, of the binding effect of this restrictive clause upon these lineal descendants once the stock has been transferred into their respective names.

Since the 1966 agreement is not in force the court must consider Article VI, Section 7 of the corporation's by-laws, which provides:

No stock shall be transferred to any person not a stockholder of the corporation unless such stock shall first be offered to the other stockholders of the corporation for purchase within sixty days of such offer at a price representing the book value of such stock as shown on report of the financial status of the corporation compiled as of the first day of the month during which said offer shall have been made.

Gruner contends that this provision applies to Lauck's bequest in his will of the shares to his three daughters and that he has a right to buy those shares at book value. The argument is that Lauck's gifts to his three daughters in 1976 were made without Gruner's consent, that he may now require the recission of those gifts, that upon recission none of the daughters will be "a stockholder" and that thus the shares bequeathed to them are subject to Gruner's option before they are "transferred" by the executrix into their names.

While the parties agree that there is no Connecticut decision in point, in most other jurisdictions where the question has been raised the courts have held that similar provisions do not apply to dispositions as a result of death. In Globe Slicing Machine v. Hasner, 333 F.2d 413 (2d Cir.1964), cert. denied, 379 U.S. 969, 85 S.Ct. 666, 13 L.Ed.2d 562 (1965), the court held that under New York law a by-law restriction against a "sale or disposition" of shares without giving an option did not apply to a transfer by an executor to the decedent's beneficiary. The court held that such first option provisions "in order effectively to restrain dispositions by will must specifically so provide." Id. at 415. See also Storer v. Ripley, 12 Misc.2d 662, 664, 178 N.Y.S.2d 7, 10 (Sup.Ct.N.Y.Cty.1958) (if such a restriction is to be effective as to a transfer consequent on death "that consequence must be clearly expressed"); Lane v. Albertson, 78 App.Div. 607, 79 N.Y.S. 947 (2d Dep't 1903) (articles of joint stock association restricting a sale or "transfer" do not apply to transfer to executor or subsequent transfer to residuary legatee).

Cases in six other jurisdictions have taken a similar view. See In Re Estate of Martin, 15 Ariz.App. 569, 490 P.2d 14 (1971), pet. denied, 108 Ariz. 536, 502 P.2d 1355 (1972); Matter of Estate of Riggs, 36 Colo. App. 302, 540 P.2d 361 (1975); Stern v. Stern, 146 F.2d 870 (D.C.Cir.1945); Vogel v. Melish, 31 Ill.2d 620, 203 N.E.2d 411 (1964); Elson v. Security State Bank of Allerton, 246 Iowa 601, 67 N.W.2d 525 (1954); Taylor's Admr. v. Taylor, 301 S.W.2d 579 (Ky. 1957). Only Massachusetts has reached a different conclusion. Colbert v. Hennessey, 351 Mass. 131, 217 N.E.2d 914 (1966); Boston Safe Deposit and Trust Co. v. North Attleborough Chapter of the American Red Cross, 330 Mass. 114, 111 N.E.2d 447 (1953).

Plaintiffs have stated claims for breach of contract based on Joseph's transfer of A Shares to Christina and the 2020 Trust, and his transfer of B Shares to the 2020 Trust and the 2012 Joseph Trust in violation of the ROFRs in the Stock Redemption Agreement and the Cross-Purchase Agreement. The clear and unambiguous terms of those Agreements make clear that the intent behind the parties' entry into the Agreements was to have an arrangement governing lifetime transfers of A Shares and B Shares as well as transfers upon a shareholder's death (i.e., the parties agreed that they would obtain insurance on their lives to have ready access to funds needed to acquire the A and/or B Shares from a deceased shareholder's estate). The language further makes clear that they were entering into the Agreements to ensure that upon the death of a shareholder, the estate would be obligated to sell the A or B Shares to the surviving shareholders and/or Paraco, as the case may be. Thus, contrary to the cases cited by Defendants where the agreements failed to specify that a transfer by will would constitute a transfer subject to an ROFR (Globe Slicing Machine Co. v Hasner , 333 F2d 413 [2d Cir 1964]; Lane , 78 AD 607; Storer v Ripley, 12 Misc 2d 662 [Sup Ct, NY County 1958]; Matter of Blakeman, 518 F Supp 1095 [ED NY 1981]; Matthews v United States , 226 F Supp 1003, 1006 [ED NY 1964] ["in the absence of an explicit provision giving the other stockholders a right to call for the stock of a decedent by the reason his death the courts of New York are slow to read the word ‘transfer’ broadly in a first refusal agreement and are slow to treat transmission by will as requiring a sale to the other stockholders"]), here the Agreements were drafted to: (1) prevent a shareholder's ability to alienate the shares during his lifetime without triggering the ROFR; (2) require a deceased shareholder's estate to sell the B Shares to the surviving shareholders or Paraco and the A Shares to Paraco.