Court Considers Constructive Dividends in Calculating Parties' Entitlement to Share of Company's Assets

On July 9, 2020, Justice Livote of the Queens County Commercial Division issued a decision in Chun You Cheng v. Yang, 2020 NY Slip Op. 50801(U), considering constructive dividends in calculating the parties' share of a corporation's assets, explaining:

Having determined the ownership, the payments made to the parties must be accounted for. Defendants believed that the payments made to plaintiffs were part of a buyout and that the various payments and benefits that defendants received were made in lieu of formal distributions to avoid taxes. However, there was no meeting of the minds on a buyout or dissolution. Accordingly, as a matter of equity, these payments shall be treated as constructive dividends to the parties.

A constructive dividend arises where a corporation confers an economic benefit on a shareholder without the expectation of repayment, even though neither the corporation nor the shareholder intended a dividend. The crucial concept in a finding that there is a constructive dividend is that the corporation has conferred a benefit on the shareholder in order to distribute available earnings and profits without expectation of repayment. Although the subject usually arises when the recipient fails to pay tax on the constructive dividend, the concepts also apply when one shareholder reaps a benefit to the detriment of the others.

Constructive dividends may consist of compensation paid to a shareholder in excess of what is considered reasonable; the use of corporate-owned property if the value of such usage is not repaid or is not included in a shareholder-employee's salary or wages; or, the bargain purchases of corporate property by a shareholder. Benefits paid or given to a family member may also constitute constructive dividends.

Thus, the payments made to the parties must be treated as constructive dividends. Accordingly, plaintiffs have received dividends and constructive dividends in the amount of $5,246,001, representing $3,954,121 in payments from GVL; $713,000 directly from defendants; and $578,880, in imputed rent for the apartment held off the market for plaintiffs' use.

Defendants have received dividends and constructive dividends in the amount of $6,689,534, representing $1,959,382 in payments from GVL; $1,693,960 in pension and life insurance premiums; $208,415 in donations made by GVL on defendants' behalf; $434,062 in non-business expenses reimbursed by GVL; $281,176 in lost profits from the below market sale of units to family members; $204,539 in excess commissions to Dahlia; and $1,908,000 in imputed rent for the units used by defendants. Accordingly, the defendants have received distributions and imputed distributions in the amount of $6,689,534.

Thus, plaintiffs have received dividends and constructive dividends in the amount of $5,246,001. Defendants have received dividends and constructive dividends, less a credit for monies paid to plaintiff, in the amount of $6,689,534. Because the defendants Roger Yang, as Administrator of the Estate of Mu-Chiao Yang, Hsiu-Lan Yang, and, A.J. Chan own twice the plaintiffs share, defendants are entitled to an additional dividend of $3,802,486 ($5,246,001 x 2 = $10,492,002 - $6,689,534 = $3,802,486).

Defendants argue that the classification of some of these payments as constructive dividends is barred by the statute of limitations. However, plaintiffs acquiesced to these payments because the parties agreed that they would be made in lieu of dividends to avoid taxes. Accordingly, the classification is not barred by the statute of limitations.

(Internal quotations and citations omitted).

This decision relates to a significant part of our practice: business divorce (a break-up between the owners of a closely-held business). Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding a business divorce.