## Facts

- Three men, including Isador Katzowitz, formed and controlled a closely held corporation authorized to issue 1,000 no-par shares at an incorporator-set price of $100 per share; each initially invested $500 for five shares.
- The participants had long operated multiple ventures as equal owners with identical compensation and benefits.
- After a dispute, the parties entered a 1959 stipulation under which Katzowitz withdrew from day-to-day management but remained on corporate boards, continued to receive the same compensation and fringe benefits as the others, and was recognized as an equal stockholder owning the same number of shares in the controlled corporations.
- In December 1961 the corporation owed each of the three shareholders $2,500.
- After Katzowitz rejected a proposal to convert the debt into additional shares, the corporation repaid the $2,500 to each shareholder in cash.
- Shortly thereafter, the other two shareholders-directors convened a special board meeting that Katzowitz did not attend and approved issuance of 75 additional shares at $100 per share, a price stated to be 1/18 of book value and equal in total to the corporation’s prior $7,500 debt to the shareholders.
- Notice offered each shareholder the right to buy 25 of the new shares at $100 per share by a stated deadline; Katzowitz did not subscribe, while the other two did.
- The corporation later voted to dissolve; in liquidation the two subscribing shareholders received substantially larger distributions than Katzowitz, consistent with their increased ownership from the new issuance.

## Issues

1. In a close corporation, whether an issuance of additional shares at a price markedly below book value that benefits shareholder-directors may be upheld based solely on formal notice and an opportunity for the minority shareholder to exercise preemptive rights.
2. Whether the minority shareholder’s failure to purchase the newly issued shares at the stated price constitutes a waiver barring relief, given a prior agreement recognizing equal ownership and the issuance’s dilutive effect.

## Decision

- The Court of Appeals of New York reversed the lower courts and granted relief to Katzowitz.
- The court held that proof of a markedly below-book-value issuance in a close corporation, coupled with insider benefit, establishes a case for judicial relief.
- The burden shifted to the shareholder-directors to justify the issuance price within a defensible range based on valid business reasons.
- Because the insider directors failed to show a valid business justification and were the principal beneficiaries of the dilution, the issuance was improper.
- The court directed judgment recognizing Katzowitz’s right to an equal proprietary interest in the corporation’s assets, subject to an adjustment reflecting the actual capital paid by the other shareholders for the additional shares.

## Legal Principles

- In a close corporation, controlling shareholders who are also directors owe fiduciary obligations comparable to those owed among partners, and transactions affecting ownership are reviewed for substantive fairness rather than mere formal compliance.
- An issuance of shares at a price markedly below book value is not automatically unlawful, but when coupled with insider benefit and minority dilution, it supports an inference of self-dealing sufficient to require judicial scrutiny.
- When a markedly underpriced issuance benefits shareholder-directors, the burden shifts to them to demonstrate that the price is supported by valid business reasons and falls within a justifiable range.
- Formal preemptive-right notice and a minority shareholder’s nonpurchase do not bar relief when the issuance is structured to dilute an equal owner’s interest without legitimate corporate justification, particularly in light of a prior agreement establishing equality.
- An equitable remedy may restore the minority shareholder’s proportional interest while accounting for genuine additional capital contributions made by the insiders.

## Conclusion

The court set aside the practical effect of an insider-favorable, sharply underpriced stock issuance in a close corporation, holding that formal subscription rights and nonexercise do not validate dilutive self-dealing absent a valid business justification, and it ordered relief restoring equal ownership subject to credit for actual new investment.


Katzowitz v. Sidler, 24 N.Y.2d 512 (N.Y. 1969)