HONORABLE Justice

INDEXNo. 11005/08

SUPREME COURT - STATE OF NEW YORKIAS TERM PART 12 NASSAU COUNTY

PRESENT:HONORABLE LEONARD B. AUSTIN

JusticeMotion R/D:9-15-Submission Date: 10-16-Motion Sequence No. : 001, 002/MOT D

JMF CONSULTING GROUP II , INC.,

Plaintiff,COUNSEL FOR PLAINTIFFDLA Piper US LLP1251 Avenue Of the AmericasNew York, New York 10036- against -

Defendant.

COUNSEL FOR DEFENDANTKramer, Levin, Naftalis & Frankel, LLP1177 Avenue of the AmericasNew York, New York 10036

BEVERAGE MARKETING USA, INC.,

ORDER

The following papers were read on Plaintiff' s motion for summary judgment andPlaintiff' s motion for a protective order:

Motion Sequence NO.

Notice of Motion dated August 18 , 2008;Affidavit of John M. Ferolio sworn to on August 15 , 2008;Plaintiff' s Memorandum of Law

JMF CONSULTING GROUP II , INC. v. BEVERAGE MARKETING , INC.Index No. 11005/08

Motion Sequence No.

Notice of Motion dated August 18 , 2008;Affirmation of Robert F. Fink , Esq. dated August 18 , 2008;Plaintiff' s Memorandum of Law;

In Opposition to Both Motions

Affidavit of Don Vultaggio sworn to on September 15 , 2008;Affirmation of Arthur H. Aufses III , Esq. dated September 15 , 2008;Defendant's Memorandum of Law in Opposition to Plaintiff' s Motion for Summary

Judgment;Defendant's Memorandum of Law in Opposition to Plaintiffs Motion for a Stay of

Discovery and Protective Order;Affidavit of John Ferolito , Jr. , sworn to on October 7 , 2008;Affirmation of David B. Buss , Esq. dated October 8; 2008;

In Further Support of the MotionPlaintiff' s Reply Memorandum of Law in Support of Motion for Stay of Discovery and

Protective Order.

Plaintiff moves for summflry 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

produces Arizona Iced Tea. The company is equally owned by the Ferolito family and

the Vultaggio family. John Ferolio ("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.

JMF CONSULTING GROUP II , INC. v. BEVERAGE MARKETING , INC.

Index No. 11005/08

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

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 Ferolio 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

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. Ferolio agreed to

indemnify the Vultaggios for any claim made by his son, John Jr. , based upon the


Index No. 11005/08

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 Ferolios 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 Qf 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

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

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

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


Index No. 11005/08

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

Hornellioan. Beverage Marketing also made an interest payment in the amount of

$554 014. It claims that , offsetting the amount of the Horneliloan , the note is paid. In

moving for summary judgment , JMF II asserts that Beverage Marketing is not entitled to


Index No. 11005/08

offset the Horneliloan 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, pr hibiting Beverage Marketing from taking the

depositions of these individuals and denying production of the requested documents.

DISCUSSION

EJntiff'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 A.D. 3d 495 (2

Dept. 2005); and .tand Sand & Gravel. Inc. v. Sauicciarimi , 272 A.D.2d 375 (2

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

JMFCONSUL TING GROUP II , INC. v. BEVERAGE MARKETING , INC.

Index No. 11005/08

a shareholder agreement , the BCL does not require a writing unless voting rights are

affected.

As a general rule , courts must enforce shareholder agreements according to their

terms. Matter of Penepent Corp , 96 NY.2d 186, 192 (2001). Shareholder agreements

avoid costly, lengthy litigation and promote "reliance , predictability and definitiveness in

relationships among sharehold rs 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. Russack v. Weinstein , 291

AD.2d 439 (2 Dept. 2002). Additionally, a shareholder agreement may not infr.inge 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 wil

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 AD. 3d 327 (1 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 (5 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 AD.3d 1048 , 1050 (4 Dept. 2007). Thus

JMF CONSULTING GROUP II, INC. v. BEVERAGE MARKETING , INC.

Index No. 11005/08

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 N. 3d 373, 384 (2005); and Andre v. Pomeroy , 35

2d 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 A.D.. 3d 276 (1 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 N. 2d 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 A.D. 2d 740 741 (2 Dept. 2002); and

Mangiatordi v. Mahner , 293 A.D. 2d 454 (2 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.


Index No. 11005/08

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.

Q!berg v. Parker Chapin Flatau & Klimpl , 82 N. 2d 375 , 383 (1993); and Horn

Waterproofing Corp. v. Bushwick lron & Steel Co. , 66 N.Y.2d 321 325 (1985). The rule

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 N.y. 212 , 216-217 (1932). To promote settlement, but

protect the legitimate expectations of the creditor , a creditor is p rmitted 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. UMLIC VP. LLC v. Mellace , 19 A.D. 3d 684 (2

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.


Index No. 11005/08

However, the holder of a non-negotiable instrument takes it subject to any

defenses which were good against the transferor. UCC 9 3-201; and County Trust Co.

v. Berish , 4 A.D.2d 777 (2 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

provisions. General Obligations Law 9 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.


Index No. 11005/08

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 N.Y.2d 425 , 429-430 (1996).

Although Beverage Marketing has not cross-moved for summary judgment , it

argues that the note has been paid , after offsetting the loan made to Ferolio 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 A.D. 3d 836 (3 Dept. 2004). Equity "does not exalt form over

substance. American Broadcasting Co. v. Wolf, 76 A.D.2d 162 , 171 (1 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


Index No. 11005/08

shareholder. See Kristensen v. Charleston Square. Inc. 273 AD.2d 312 (2 Dept.

2000). Since JMF II recognized Beverage Marketing s right to such an offset, Beverage

Marketing may setoff the Hornellioan , provided that Hornell assigns the loan to its

parent corporation. Neverthele$s , since the balance outstanding on the Hornellioan

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.

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

NY.3d 381 , 383 (2004). Nevertheless, Defendant is entitled to discovery concerning

defenses based on facts extrinsic to (the) instrument." Alard v. Weiss , 1 A. 3d 131 (1

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.

JMF CONSULTING GROUP 1I tNC. v. BEVERAGE MARKETING , INC.

Index No. 11005/08

Thus, Plaintiffs 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 31 06(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 149 A.D.2d 94 104-

105 (2 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. Defendant has made no showing that Carolyn Ferolito or John Fe ro lio , Jr.

has any knowledge concerning the purpose of the shareholder loans to the corporation.

Accordingly, Plaintiffs motion for a protective order, prohibiting the taking of the

depositions of those persons should be granted without prejudice to a later showing that

JMF CONSULTING GROUP II , INC. v. BEVERAGE MARKETING , INC.Index No. 11005/08

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,

This constitute the decision and Order of the C

Dated: Mineola , NYFebruary 4 , 2009 Hon. LEONARD B.

ENTEREDFEB 0 9 2009

NASSAU COUNTYCOUNTY CLERK'

S OFFICE

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