New Oppression Case--Whitehorne v. Whitehorne Farms, Inc.

Whitehorne v. Whitehorne Farms, Inc., --- P.3d ---, 2008 WL 4717985
(Mont. Oct. 28, 2008).
The Montana Supreme Court issued a new shareholder oppression case which comes close to the classic definition of the word "chutzpah." The case involved a family farm corporation. One of the owners did a consistently poor job, lied to his fellow shareholders, and ultimately stole a substantial amount of grain which he sold. At last, the remaining shareholders called a meeting and voted to remove the malefactor as an employee, officer and director. The shareholder received notice, but did not attend. Later, the shareholder did attend the annual meeting, where he had sufficient votes to assure himself a seat on the board of directors, but did not nominate himself. The shareholder sued for oppression. The case was tried to the bench, and the trial court held that the shareholder had not been oppressed and further entered a judgment for damages against the shareholder for conversion. The Supreme Court affirmed. 

The shareholder initially argued that he was oppressed by his termination of employment. On appeal, he conceded that the termination was justified, but argued that his reasonable expectations of accessing the value of his shares were frustrated. In other words, the shareholder argued that the he was oppressed by his inability to sell or cash out his shares. The Supreme Court held that the inability to sell shares in a closely-held corporation was the nature of the beast, and the shareholder was complaining of a situation that every other shareholder experienced. The corporation had never paid dividends but had made employment and salaries available to all shareholders and had paid money only to shareholders who contributed to making the corporation successful. The shareholder had received the same deal as every other shareholder, and had lost the ability to participate only because of his own wrongful conduct. 

The shareholder's lawsuit had very poor timing, and the position was poorly stated, but he did raise an important and difficult issue. This case shows the limits of the reasonable expectation of continued employment. The court implicitly held that this expectation cannot possibly overcome good cause for termination. However, while a corporation should not be required to keep an employee in the face of dishonesty and theft, the fired shareholder remains a shareholder and cannot be forever denied all possibility of an economic return on share ownership. To hold otherwise would permit a corporation to effectively cancel share ownership as a punishment for misconduct as an employee, when the appropriate consequences are loss of employment and payment of damages--both of which happened in this case. When shareholders of a closely held corporation elect to employ all the shareholders and to allow shareholders to receive an economic return by means of salary and bonuses, and then the situation changes so that not all of the shareholders continue to participate through employment, then the corporation has a fiduciary duty to reconsider the policy on how shareholders participate. If some shareholders cannot participate economically through employment, then the corporation must set salaries solely on the value of the services and pay any excess profit through dividends or some other arrangement in which all shareholders can participate. At the point in time when the Whitehorne plaintiff brought his lawsuit, the corporation and other shareholders had done nothing oppressive, and the shareholder would certainly have been barred from seeking equitable relief because of unclean hands (the court did not address this issue). At some point, however, the corporation's conduct could very well become oppressive if the corporation were consistently profitable and yet the corporation continued to pay out all profits through high salaries to shareholder-employees and to exclude the non-employees shareholder from any participation. The Montana Supreme Court indirectly acknowledged this situation in noting that there was no evidence of oppressive intent and no reason to assume that the other shareholders might not offer to buy out the plaintiff in the future.

Eric Fryar
Fryar Law Firm P.C.

www.fryarlawfirm.com

www.shareholderoppression.com

New Article on Enforcing Shareholder Inspection Rights.

There's a new article on www.shareholderoppression.com. "Enforcing Shareholder Inspection Rights—Procedural Guide" [Click here to read it] This article analyzes the mandamus remedy to enforce shareholder inspection rights.

 

 

Eric Fryar

www.fryarlawfirm.com www.shareholderoppression.com

 

New Article on Shareholder Inspection Rights

A new article is up on www.shareholderoppression.com analyzing the rights of Texas shareholders to inspect corporate records. [Click here to read it.]

 

 

Eric Fryar

www.fryarlawfirm.com www.shareholderoppression.com

 

New Article on Choice of Business Structures

Today Eric Fryar posted a new article on www.shareholderoppression.com providing a basic guide to choosing a business form in Texas. The article provides a basic description of the five forms, the federal and state tax implications, and relative advantages and disadvantages of each. Click here to read the article.

 

Eric Fryar

www.fryarlawfirm.com

www.shareholderoppression.com

 

New article on Statute of Limitatons

Today Eric Fryar posted an article on www.shareholderoppression.com analyzing the issues relating to statute of limitations in Shareholder Derivative Actions and Shareholder Oppression lawsuits, including the application of the discovery rule and the doctrine of adverse domination in Texas law. Click here to read the article.

The full article is available for download in .pdf format in the Files section of the Shareholder Oppression Discussion Group.

Eric Fryar

www.shareholderoppression.com www.fryarlawfirm.com

Recent Texas Shareholder Oppression Case‹Gibney v. Culver, 2008 WL 1822767 (Tex. App.--Corpus Christi 2008, no pet) (unreported).

Recent Texas Shareholder Oppression Case—Gibney v. Culver, 2008 WL 1822767 (Tex. App.--Corpus Christi 2008, no pet) (unreported).

 

Michael Gibney brought a shareholder derivative suit for fraud and breach of fiduciary duty against Roy Culver, Jr., Micro-Blend, Inc., Culver Interests, and Ana-Tech, Inc and an individual claim for shareholder oppression against Roy himself. Gibney secured a judgment of $250,000 from the trial court for shareholder oppression against Roy, but the trial court, through a directed verdict dismissed Gibney's derivative claims. Micro-Blend, Inc. was founded by Gibney to manufacture patented blending systems for soft drinks and was financed by Roy, who was also the majority shareholder and Chief Executive Officer.

 

This case provides a good illustration for how to submit a shareholder oppression claim. The difficulty in crafting a jury charge for shareholder oppression is that the cause of action itself is an equitable remedy and the finding that a pattern of oppression exists is a conclusion of law for the court. However, the factual issues from which the conclusion of oppression is based are must be submitted to the jury. Where there is no factual dispute, the court is permitted to consider evidence of instances of oppressive conduct, but where there is a factual dispute, the issue must go to the jury. Therefore, to be safe, the plaintiff's lawyer will want to submit as many highly particularized jury questions as possible to obtain finding of a large number of acts of oppression. This practice flies in the face of recent developments in Texas law favoring fewer questions and broad-form submission; however, there does not seem to be any alternative.

 

The Jury Charge reproduced in the Gibney opinion illustrates the practice:

 

Jury Charge

Question No. 1.

Do you find from a preponderance of the evidence that Roy Culver, Jr., since November 27, 1998, maliciously or wrongfully refused to allow Michael Gibney to examine the books and records of Micro-Blend, Inc.?

 

Answer: Yes or No: NO

 

Question No. 2.

 

Do you find from a preponderance of the evidence that Roy Culver, Jr., since November 27, 1998, maliciously or wrongfully used his position as the Chief Executive Officer of Micro-Blend, Inc., to award excessive salaries and compensation to himself to the detriment of Michael Gibney?

 

Answer: Yes or No: YES

 

Question No. 3.

 

Do you find from a preponderance of the evidence that Roy Culver, Jr., since November 27, 1998, maliciously or wrongfully used his position as the Chief Executive Officer of Micro-Blend, Inc., to award excessive salaries and compensation to members of his family to the detriment of Michael Gibney?

 

Answer: Yes or No: YES

 

Question No. 4.

 

Do you find from a preponderance of the evidence that Roy Culver, Jr., used his position as the Chief Executive Officer of Micro-Blend, Inc., to maliciously or wrongfully direct the withholding of payment of dividends from Micro-Blend, Inc., to Michael Gibney in 1998, 1999, and 2000?

 

Answer: Yes or No: NO

 

If you have answered any one of the preceding questions "YES," answer the next question. If you have answered each of the preceding questions "NO," do not answer the next question.

 

Question No. 5.

 

What is the value of Michael Gibney's shares in Micro-Blend, Inc .?

 

*4 Answer in dollars and cents, if any.

 

Answer: $4,000,000

 

From a legal standpoint, these issues somewhat misstate the elements. There is no requirement of malice for any of the recognized oppressive conduct, except suppression of dividends. The determination of the award of dividends is protected by the business judgment rule unless there is proof of malicious intent in the making of dividend decisions. However, this level of culpability is not required to prove denial of the right to inspect and excessive compensation. In fact, the burden on these issues should probably be on the defendant, not the plaintiff. The limitation of the jury questions to a period of time after November 27, 1998 was done to exclude conduct outside the four-year statute of limitations. This also was an error. The facts evidencing the pattern of oppressive conduct are not a cause of action in themselves, but the basis for the formation of an equitable remedy. The statute of limitations does not apply. If the plaintiff delayed unreasonably in seeking equitable relief from the court, the defendant might be entitled to assert the equitable defense of laches; however, that was not submitted in this case. Also a strong argument could be made that the valuation question should not be predicated on particular findings regarding oppression. The valuation does not represent damages flowing from one or more of the oppressive acts; rather it is a factual finding on which the court has discretion to base the formation of an equitable remedy. If the jury answered "No" to one or even all of the questions, it is theoretically possible for the trial court or the appellate court to still order a buy-out or impose another remedy based on acts of oppression which were not controverted in the record.

 

Both parties appealed in Gibney, the court of appeals upheld the trial court's directed verdicts on the derivative claims but reversed the judgment for shareholder oppression. The court's reasoning in the appellate opinion is erroneous in the extreme, and it is fortunate that it is an unpublished opinion. The trial court granted a directed verdict on derivative claims against the controlling shareholder and related entities for excessive compensation on the basis of statute of limitations. The court of appeals upheld that ruling, holding that the cause of action accrued more than four years before the claim was filed and holding that the plaintiff had not sufficiently proved the elements of fraudulent concealment. Both courts and apparently the plaintiff completely overlooked the doctrine of tolling limitations as a result of adverse domination of the board of directors.

 

Second, the court of appeals upheld the trial court's directed verdict on the fraud claim against third parties related to the controlling shareholder that money was fraudulently paid to these entities as salary and payroll but was in fact merely siphoning away profits. Both courts held (apparently because services were in fact rendered) that there was no demonstration of harm or damages. In all probability the plaintiff incorrectly pleaded the cause of action. This was not a fraud claim. The fact that the payments were fraudulently mislabeled is really of little import. The question was whether there was a breach of fiduciary duties because the payments were excessive or otherwise unfair to the corporation. The third parties would not be sued for fraud but for knowingly participating (aiding and abetting) a breach of fiduciary duties. Because these were self-interested transactions, the burden of proof would have been on the defendants. Damages are irrelevant in the traditional sense. The remedy for a transaction made in violation of fiduciary duties is to rescind the transaction completely—to forfeit the compensation, subject to a claim for quantum meruit that would have to be proved by the defendants.

 

The court of appeals also overturned the judgment for oppression on the grounds that there was insufficient evidence of excessive salaries—the only oppressive act for which Plaintiff obtained an affirmative finding. It must be conceded that this sole kind of oppressive conduct is problematic because excessive compensation is a violation of duties owed to the corporation, not to the shareholder, and there is an adequate remedy at law in the recovery of damages for breach of fiduciary duties in favor of the corporation. Excessive compensation for the controlling shareholder and members of his family or close associates certainly can be oppressive, independent of the claim of the corporation, where the excessive compensation is a form of financial manipulation either designed or with the obvious effect of denying the minority shareholder an economic return on his share ownership. The jury finding in this case does incorporate this latter concept in stating that excessive compensation was done "maliciously or wrongfully" and "to the detriment of Michael Gibney." The court of appeals ignores this aspect of the finding and instead holds the evidence insufficient to show excessive compensation in the first place. The court of appeals cites a Fifth Circuit tax decision for authority on the factors governing excessive compensation, places the burden of proof on the plaintiff, and holds that deference should be given to the decision by the board of directors decision setting salaries (apparently utilizing the business judgment rule, although not citing it). All of this is wrong. The opinion clearly demonstrates that the controlling shareholder and his family had control of the board. Therefore, the salary decisions were self-dealing transactions and are entitled to no deference whatsoever. On the contrary, such transactions are presumed to be fraudulent unless the interested parties sustain their burden of proving the fairness of the transactions to the corporation. The proper question before the court of appeals was not whether the plaintiff introduced sufficient evidence to demonstrate the excessiveness of the compensation but whether the defendants introduced sufficient evidence to demonstrate the fairness of the compensation. On the face of the opinion, the answer would seem to be "no" if the proper burden of proof had been used.

See also the www.shareholderoppression.com and www.fryarlawfirm.com.