Kaplan v. First Hartford Corp., --- F.Supp.2d ----, 2007 WL 973941 (D.Me. Apr 02, 2007)
"This lawsuit is an effort by a 19% shareholder to realize fair value from his ownership of a publicly held, but thinly traded, Maine corporation. In his view, fair value is higher than the price the market will pay for his shares."
FHC has about 820 shareholders. The controlling shareholder held approximately 43%. The corporation was public, but was not registered on any exchange. It failed to observe corporate formalities but did make its SEC filings. After a long period of financial problems and a bankruptcy, the controlling shareholder nursed the company back to financial health, using his own money and credit.
In advance of the company's first shareholders' meeting in 18 years, the controlling shareholder refused to provide the plaintiff with a shareholders' list. The Plaintiff sued to enforce inspection rights and was awarded attorneys' fees because the list was withheld in bad faith.
Over the next two years, the plaintiff questioned apparently self-dealing transactions reflected in the 10K, but was denied access to the records. Plaintiff filed three different lawsuits alleging inadequate disclosures in the SEC filings, and obtained findings that the disclosures were inadequate but was awarded no damages.
The court found that the controlling shareholder treated the corporation as a common enterprise with other companies that he owned and caused the corporation to engage in numerous inter-company transactions that were poorly documented. The court also found that the defendant had caused the corporation to enter into a series of self-dealing transactions that benefited the defendant and members of his family at the expense of the corporation.
The plaintiff initially sought dissolution under the Maine corporation statute that on the grounds that the "directors or those in control of the corporation have acted, are acting or will act in a manner that is illegal, oppressive or fraudulent; [or t]he corporate assets are being misapplied or waste." 13-C M.R.S.A. § 1430(2)(B) & (E). At trial, the plaintiff changed the relief sought from dissolution to appointment of a receiver to pursue alternative remedies. The court rejected the grounds of waste and misapplication of assets, interpreting the statute to apply only to on-going conduct, not to misconduct that occurred in the past. The parties all agreed that the defendant would have the burden of proving the fairness of the challenged transactions, but the court held that the defendant's failure to carry his burden--i.e., evidence justifying a finding of a breach of fiduciary duties--would not, by itself, establish illegal, fraudulent or oppressive conduct under the statute.
The court held that the facts did not justify a finding of fraud or illegality. While the prior lawsuits did establish conduct that was illegal in the sense that securities and corporate laws had been violated, the court held that those statutes had their own penalties and that there was no basis for going beyond those penalties under the dissolution statute. "There is not yet a pattern here that would support going beyond the individual statutory penalties and putting the corporate existence in jeopardy based upon illegal behavior."
The plaintiff argued that the payment of the defendant's attorney's was a waste of corporate assets. Regarding separately the underlying conduct of the defendant, the court rejected the idea that the hiring of counsel could qualify as waste. "Hiring lawyers to defend a corporation against litigation initiated by others will seldom be misapplication or waste of corporate assets that invokes the dissolution statute. Directors and officers usually have a duty to engage lawyers to defend the corporation even if they individually have failed to perform in some way that caused the litigation."
Maine defines a closely held corporation as a corporation with not more than 20 shareholders. 13-C M.R.S.A. § 102(2-A). But its statutory remedies for oppression apply to all corporations. 13-C M.R.S.A. § 1430, providing for judicial dissolution of a corporation if the "directors or those in control of the corporation have acted, are acting or will act in a manner that is illegal, oppressive or fraudulent." The court notes that the Maine corporation statute applies equally to public and private corporations, although the court does acknowledge academic writings and the commentary to the Model Business Corporations Act the dissolution on the grounds of oppressive conduct should be limited to closely held corporations. The court also noted that the corporation did resemble a private company in many ways--its stock was not listed and was only thinly traded; although it had 820 shareholders, the ownership was concentrated in four families, and one stockholder had a near majority and was able to control the corporation.
The court cited the Daniels v. Thomas, Dean & Hoskins, Inc., 246 Mont. 125, 804 P.2d 359, 368 (Mont.1990), in which the Montana Supreme Court noted that oppression was much less likely in a public company, but was not legally impossible. "In other words, oppression depends on the context."
The court then reviewed the three tests usually recognized for oppression: (1) the "general test" which focuses on "burdensome, harsh or wrongful conduct," (2) the duty of good faith and fair dealing on controlling shareholders, and (3) the "reasonable expectations" test. Noting that neither statutory nor case law in Maine provides any direction as to the choice of the approach, the court held that none of the tests were particularly helpful or predictive in any individual case. Therefore, the court declined to choose among the approaches and instead focused on the particular facts.
The court held that the following factors established oppressive conduct:
1. The plaintiff had proved that the defendant had "treated FHC as his own property," moving money and assets among the corporation and other entities he controlled, exercising peremptory control over the corporation and ignoring the rules of corporate governance.
2. Bad faith withholding of the shareholder's list from the plaintiff in an effort to thwart his attempt to elect outside directors.
3. Making misleading and incomplete statements in proxy materials in an effort to conceal the extent of self-dealing transactions.
4. Payments from the corporation to the defendant's daughters.
5. The provision of management services by the corporation on a property owned by the defendant without a written agreement and in which the fees paid had decreased even though the revenues generated by the property had not.
6. The transfer of funds from the corporation to entities owned by the defendant and payment of expenses for the benefit of these entities, justified as the repayment of various undocumented loans. It is important to note that the court does not hold that the repayment of the loans is improper but focusers on the disregard of corporate formalities.
7. Payment of large bonuses to defendant during the pendency of the litigation. The court held that the business judgment rule did not apply and that the defendant had the burden of proof on the reasonableness of his compensation. The court rejected expert testimony from a consultant that the bonuses paid were reasonable because "there is no indication that the consultant took into account that Ellis is also a 43% shareholder, without the need for the conventional incentives that are used to motivate management."
The court holds: "No one of these actions alone would meet the oppression standard for a shareholder dissolution suit--each has its own remedy, ranging from the remedies that Kaplan has pursued successfully in Maine state court and in federal court in Massachusetts, to other remedies such as a derivative lawsuit, which Kaplan has not pursued. Instead, it is the pattern of abusive conduct that establishes oppression. Kaplan has successfully sued FHC four times, yet the pattern of oppressive conduct continues. The Maine oppression statute should relieve minority shareholders, facing a pattern of abusive conduct, from having to file a new lawsuit for each individual instance."
The court does credit the defendant with having saved the company and with having volunteered the use of his funds and credit to do so. However, the defendant chose to continue to do "business under FHC's auspices, a corporate form where there were other shareholders to whom the directors had corresponding obligations. He therefore was obliged to operate FHC accordingly, not treating the company as part of his general family assets, but as an independent entity of which he was a director (and controlling shareholder) with statutory and fiduciary obligations to others. Whatever good intentions he had originally, his actions cumulatively demonstrate a pattern of peremptory and oppressive treatment of minority shareholders."
The court also acknowledged that the defendant had reinstated audited financial statements, shareholders' meetings and the payment of dividends, but the payment of unreasonable bonuses during the litigation' coupled with the diversion of corporate funds and the extreme hostility to the exercise of legitimate rights by minority shareholders, "demonstrat[ed] that Ellis will not end his peremptory and oppressive behavior without intervention."
"When the statutory grounds for dissolution are met, dissolution is not mandatory but lies within the sound discretion of the court." the Maine corporation statute provides a number of alternative remedies in addition to dissolution. 13-C M.R.S.A. § 1434(2). The court did not believe that the record was adequate to award a remedy and was particularly troubled by the need to deal with some 800 other minority shareholders, and therefore ordered the parties to submit additional briefing on the proper remedy and procedure for implementing a remedy in light of the court's findings on liability.
