Bontempo v. Lare (Md. Ct. of Appeals)

Filed: August 6, 2015

Opinion by: Robert N. McDonald

Holdings:

(1) The standard for determining whether a minority shareholder has been “oppressed” by the majority is the shareholder’s “reasonable expectations” upon obtaining an ownership interest in the company. This standard does not, however, dictate the type of equitable relief a trial court must provide, unless it is to be dissolution of the company.

(2) A breach of fiduciary duty to a corporation does not constitute fraud, absent a finding of fraud by the court. In this case, the majority shareholder’s self-dealing was a breach of his fiduciary duty, but because it did not involve deception, it did not rise to the level of fraud. The requested remedies of dissolution of the company and an award of punitive damages were therefore denied.  

Facts: See prior summary of Bontempo v. Lare (Md. Ct. Spec. App.).

Analysis:

The Court agreed with the opinions of the Circuit Court and the Court of Special Appeals on the standard for determining whether a minority shareholder has been “oppressed”: The court should look to the shareholder’s “reasonable expectations” at the time of acquiring an ownership interest in the company. If oppression has occurred, then dissolution of the company can be a remedy.

The Court of Appeals found, however, that even upon a finding of oppression, other, less punishing remedies can also be considered. In choosing a possible remedy, the court should take into account other stakeholders who may be affected, including other shareholders, managers, employees, and customers.

In this instance, Plaintiff argued that he had a reasonable expectation of future employment when he acquired a stake in the company. He said his investment, in the form of sweat equity, should trump his status as an at-will employee. The Court said a “reasonable expectation” can be used to determine whether oppression has occurred but does not dictate what form of equitable relief a court should grant. In addition, reinstating Plaintiff as an employee would not have been a viable option because he and Defendant could not reasonably have been expected to run a business together.

A provision in the shareholder agreement requires an employee to sell his stock upon termination “for cause.” Plaintiff argued that this provision effectively created an employment agreement, overriding his status as an employee at will. The Court was unpersuaded by this argument as well, noting that a buy-out requirement when a shareholder-employee is terminated for cause does not imply that the individual may be terminated only for cause.

On another mater, Plaintiff asked the Court to reconsider his allegations of fraud, which the Circuit Court had denied. He argued that Defendant’s breach of his fiduciary duty to the company constituted fraud as to the company itself and to Plaintiff as an oppressed shareholder.

The Court affirmed the lower court’s finding, noting that although Defendant’s self-dealing did constitute a breach of his fiduciary duty to the company, he made no attempt to conceal the activity. The illicit personal expenditures from the corporation’s accounts were entered into the company’s books, to which Plaintiff had full access.

Plaintiff made his allegations of fraud in connection with seeking dissolution of the company and an award of punitive damages for his benefit. As to the request for punitive damages, the Court said that they are not available as an equitable remedy and that, in any event, a finding of fraud would not support an award of punitive damages.

The full opinion is available in PDF.

Bontempo v. Lare (Md. Ct. Spec. App.)

Filed: April 30, 2014

Opinion by: Douglas R. M. Zanarian

Holding:

(1) When a minority stockholder petitions a court for dissolution pursuant to Md. Code Ann., Corps. & Ass’ns § 3-413 (the “dissolution statute”), such stockholder’s rights will be informed by any existing stockholder agreement and, where there is no evidence of a deadlock of the board of directors or that the company is likely to become insolvent, the court has discretion under the statute to order alternatives to the extraordinary remedy of dissolution.

(2) The dissolution statute does not provide for personal liability, even if fraud is proven.

(3) The proper remedy when a court finds an officer or director has breached his or her fiduciary duties to the company by diverting money from the company for personal use is an order directing such officer or director to repay such money to the company, not an order requiring the company to declare equivalent distributions for all stockholders.

(4) An award of attorneys’ fees and expenses is only appropriate if the injured company has recovered a common fund.

(5) It is the trial court’s role to determine a party’s credibility and whether evidence is sufficient to support the existence of an oral contract.

Facts: Plaintiff became a minority stockholder of Quotient, Inc. (“Quotient”), a close corporation organized under Maryland law, in 2001. Plaintiff executed a shareholder agreement with the other stockholders of Quotient – the defendants, the Lares (a husband and wife collectively owning 55% of the stock in Quotient). In addition to being a director and officer of Quotient, Plaintiff was also an employee pursuant to an oral agreement with Mr. Lare, which Plaintiff alleged included that he would receive a salary equal to that of the Lares combined. In addition to certain “perks” (e.g., company credit cards for gas, meals and entertainment and a corporate fitness trainer), paid for by Quotient and received by Plaintiff and the Lares, the Lares began paying household employees from Quotient’s payroll account in 2006, advanced interest-free loans from Quotient to two companies in which the Lares had an interest and took a loan from Quotient for renovations to the Lares’ personal home. The relationship between Plaintiff and the Lares began to sour and in 2010 Mr. Lare terminated Plaintiff’s employment with Quotient after Plaintiff refused to voluntarily resign and sell his shares in Quotient. Plaintiff remained an officer and director of Quotient for six months after termination, however, and continued to receive distributions as a stockholder. Plaintiff filed suit against the Lares seeking relief pursuant to Maryland’s dissolution statute and asserted derivate claims on behalf of Quotient for imposition of a constructive trust, breach of fiduciary duty, and constructive fraud and a direct claim for breach of contract.

The trial court ruled in favor of Plaintiff as to his petition for dissolution; however, the trial court refused to dissolve Quotient and instead ordered Quotient to pay Plaintiff $167,638 in damages. The trial court also ruled in favor of Plaintiff as to his claim for breach of fiduciary duty and ordered that the misappropriated funds be treated as a distribution from Quotient and ordered Quotient to pay Plaintiff a proportionate amount, including attorney’s fees, but ruled in favor of the Lares as to Plaintiff’s claim for constructive fraud. The trial court ruled in favor of Plaintiff as to his claim for breach of contract and ordered Quotient to pay Plaintiff $81,818.18 in unpaid distributions, but refused to find an oral equal-compensation contract existed. Both parties appealed.

Analysis: The Court affirmed the holding of the trial court, including the trial court’s refusal to dissolve Quotient; however, it found that the trial court erred in how it allocated the damages.

Although the Court upheld the trial court’s finding, not contested on appeal, that Mr. Lare’s behavior met the standard for oppressive conduct, particularly his threat and ultimate firing of Plaintiff for refusing to voluntarily resign and sell his shares in Quotient, the Court also upheld the trial court’s conclusion that dissolution was not the only available remedy. The Court noted that it was Plaintiff’s status as a stockholder of Quotient, as defined by the shareholder agreement, that defined and bound the rights he was entitled to vindicate under the dissolution statute and the appropriate remedies. Unlike in Edenbaum v. Shcwarcz-Osztreicherne, 165 Md. App. 233 (2005), the Court noted that the shareholder agreement did not mention Plaintiff’s employment rights, thus the shareholder agreement did not give Plaintiff a reasonable expectation of employment or provide an enforceable to such. Instead, the Court found that Plaintiff was entitled to participate in distributions and the affairs and decisions of Quotient consistent with his status as a stockholder. Although Mr. Lare’s actions frustrated such rights, Plaintiff had resigned from Quotient’s board of directors and thus there was no evidence of a deadlock justifying dissolution, nor was there any evidence to suggest that, despite the use by the Lares of Quotient’s funds for personal expenses, Quotient was likely to become insolvent. Therefore, the extreme remedy of dissolution was inappropriate.

The Court also held that the Lares could not be personally liable under the dissolution statute, even if their actions constituted fraud, because the purpose of that statute is to vindicate the reasonable expectations of minority stockholders, in such capacity, against oppression by majority stockholders. Plaintiff’s injury as a minority stockholder was lost distributions, and thus, Plaintiff was made whole by accounting to determine how much money the Lares diverted from Quotient and an order to pay distributions to Quotient stockholders based on the amounts diverted.

The Court also agreed that the Lares had breached their fiduciary duties as directors and officers of Quotient by diverting money from Quotient for personal use; however, the Court held that the trial court erred in ordering a distribution to all stockholders as a remedy. The Court noted that it was Quotient, not Plaintiff, who was harmed because it was Quotient’s money that was taken by the Lares and, thus, distributions would not make Quotient whole but would instead take more money from Quotient. The Court held that the appropriate remedy would have been ordering the Lares to repay Quotient for the money taken. Because such payment would result in a recovery by Quotient of a common fund, the Court noted that an award by the trial court on remand of attorneys’ fees and expenses would be appropriate under the common fund doctrine.

Despite holding that the Lares had breached their fiduciary duties to Quotient, the Court affirmed the trial court’s ruling in favor of the Lares as to Plaintiff’s claim for constructive fraud. Although constructive fraud usually arises from a breach of fiduciary duty, the Court noted that they are not equivalent and that “a director can breach fiduciary duties without committing fraud.” The Court found that, although the Lares had used bad judgment in using funds from Quotient for their personal expenses, they had not engaged in a long course of illegal or fraudulent conduct, especially since all of the transactions were recorded on the books of Quotient and Plaintiff had access to such books. For the same reason, the Court found that the Lares did not act with malice.

Finally, the Court found that the trial court committed no error in refusing to find that an oral equal-compensation contract existed between Plaintiff and Quotient. Although Plaintiff and his wife testified to the oral equal-compensation agreement and evidence showed that Plaintiff was paid a salary equal to the Lares for four years, there was also evidence that, for multiple years in the beginning and towards the end of his employment, the salaries of Plaintiff and the Lares differed significantly. The Court noted that it was the trial court that heard the evidence and it was not for the Court to determine on appeal whether the trial court gave appropriate weight to the parties’ credibility.

The full opinion is available in PDF.

Consortium Atlantic Realty Trust, Inc. v. Plumbers & Pipefitters National Pension Fund, et al. (Cir. Ct. Mont. Co.)

Filed:  February 5, 2013
Opinion by Judge Ronald B. Rubin

Held:  A board of directors is not subject to Revlon duties when shareholders choose to exercise their put rights under a shareholders agreement.

Facts:  Plaintiff, a Maryland corporation, sued Defendants, union pension funds who owned approximately 93% of the stock in Plaintiff, for breach of a shareholders’ agreement entered into between Plaintiff and Defendants.  Under the shareholders’ agreement, each Defendant was granted the unilateral right to withdraw as a shareholder six years after the effective date of the agreement. Defendants gave proper notice of the exercise of their withdrawal right under the shareholders’ agreement, but the parties disputed the valuation of Defendants’ shares under the withdrawal right. The pertinent section of the shareholders’ agreement required Plaintiff to redeem all of the shares held by a withdrawing shareholder at fair market value. Plaintiff set the fair market value of Defendants' shares at $7.93 per share, the price set forth in an appraisal of one share of stock done two years earlier.  Defendants refused to accept any “discounted” value for their shares, insisting on redemption at $10.00 per share, the price initially paid by Defendants for each share.

Plaintiff filed suit for breach of the shareholders’ agreement. Defendants filed a counterclaim raising a number of claims regarding the shareholders’ agreement and its interpretation, the most pertinent of which was Plaintiff’s failure to maximize shareholder value. Plaintiff moved to dismiss the counterclaim.

Analysis:  Defendants alleged a breach of fiduciary by Plaintiff and certain of its directors by failing to sell the company before Defendants exercised their withdrawal rights so that the directors could obtain a “windfall” when Defendants redeemed their shares for a discounted value. Defendants also contended that the exercise of their withdrawal rights, which collectively amounted to 93% of Plaintiff’s shares, constituted a change-in-control transaction under Maryland law. In short, the court stated that Defendants were attempting to impose Revlon duties, as applied to Maryland law in Shenker v. Laureate Education, on Plaintiff and its directors.

The court agreed that Shenker is limited, until the Court of Appeals says otherwise, to a cash-out merger when the decision to sell the corporation is already made, and dismissed Defendants’ claims. Here, it was the shareholders, not the board of directors, who made the decision to “sell”, i.e., to exercise their put rights under the shareholders’ agreement. Much like a tender offer situation, the decision to be made, withdraw as, or remain a shareholder does not implicate the duties or functions of the board of directors. Revlon duties were inapplicable because the board had nothing to do with the decision to “sell.”

The court also rejected Defendants’ change of control argument, stating that shareholders cannot unilaterally “create” a change of control implicating Revlon solely by virture of their own decisions. Revlon duties are premised upon action taken by the board, which results in a change from managing the company to selling the company. Plaintiff’s board made no decision to sell, merge or otherwise re-organize the business of the company.  Shareholders cannot impose additional duties on a board solely by reason of their own economic decisions to involve provisions of a shareholders’ agreement.


The full opinion is available in pdf.

Ebenezer United Methodist Church v. Riverwalk Development Phase II, LLC, et al.

Filed: June 6, 2012
Opinion by Judge Albert J. Matricciani, Jr.

Held: Managing Member of an LLC did not usurp a corporate opportunity by failing to disclose a potential real estate investment because, under the interest or reasonable expectancy test, something more than mere proximity of geography and joint management or joint financial risk is required.

Facts: A church purchased a 50% interest in an LLC from a development company. The development company managed the LLC. The LLC owned and developed certain properties in Harford County, MD. Later, the development company formed and managed a second LLC to purchase additional land in Harford County. Subsequently, the two LLC's and a third entity controlled by the development company obtained a collective line of credite secured by deeds of trust to their respective properties.

Two years later, the development company repurchased the church's interest at a profit to the church of $30-35,000. When the church learned that the development company had formed the second LLC to buy property, it sued on the grounds of usurpation of a business opportunity. The church claimed that part of the initial attraction in investing in the first LLC was the potential for the company to purchase and develop the land acquired by the second LLC.

After a bench trial, the trial court entered judgment in favor of the defendants, and the church appealed.

Analysis: Managing members of LLCs owe common law fiduciary duties to the LLC and to the other members, including the duty not to exclude principals from corporate opportunities. Maryland courts examine alleged corporate opportunities under the "interest or reasonable expectancy test" which focuses on whether the corporation could realistically expect to seize and develop the opportunity. If so, the director or officer may not appropriate the opportunity and thereby frustrate the corporate purpose. Instead, the director or officer must first present the opportunity to the corporation and may only exploit it for his own benefit if the corporation rejects it.

The Court rejected the church's argument that the collective security agreement established a corporate opportunity, ipso facto. The church failed to cite or discuss the interest or reasonable expectancy test, claiming instead that the financing arrangement was illegal because the developer had used the proceeds of the transaction to pay for personal vacations, issue a dividend, repurchase stock, and finance other construction projects. This argument failed, the Court stated, because it conflated financial self-dealing with usurpation of a corporate opportunity, with only the latter having been plead and argued on appeal.

The Court then examined the church's claim under the standard set forth in Dixon v. Trinity Joint Venture, 49 Md. App. 379 (1981). In Dixon, the court held that a corporate "interest or expectancy" requires something more than the mere opportunity to develop a neighboring parcel of land. There is no general duty to disclose or to offer participation in other real estate development opportunities. The general partner in Dixon violated his fiduciary duty because the disputed property was more than simply adjoining property under the same management. First, the disputed property presented a direct benefit to the original investment because ownership would have saved the partnership significant development expenses. The church, however, failed to present evidence that the second LLC's property had - or would have had - any effect on the value of the first LLC's property.

Second, in Dixon, restrictions for the disputed property's benefit were imposed on the partnership property at the time of purchase. The Court recognized that while the encumbrance on the first LLC property created by the security agreement was analogous to the restrictions imposed on the partnership property in Dixon, the restrictions in Dixon were imposed for the direct and exclusive benefit of the disputed property. Conversely, the collective security agreement benefited the first LLC and was merely an efficient financial consolidation. Joint financial risk is analogous to consolidated management and therefore is too common to give rise to any particularized interest or expectancy. A reasonable expectation or interest in a corporate opportunity requires something more than mere "proximity" of geography and management, as in Dixon, or of finance, as in this case.

The full opinion is available in pdf.

Boland v. Boland; Boland v. Boland Trane Associates, Inc. (Ct. of Appeals)

Filed: October 25, 2011
Opinion by Judge Sally D. Adkins.

Held:

Holding 1: After a motion to dismiss or for summary judgment against a derivative plaintiff, Maryland courts must review a special litigation committee's ("SLC") independence, and whether it made a reasonable investigation and principled, factually-based conclusions. In this inquiry, the SLC is not entitled to a presumption that it was sufficiently independent from a corporation's directors.

Holding 2: When a court grants summary judgment in a derivative suit based on an SLC's determination that continuing the lawsuit is not in the corporation’s best interest, that court decision is not a final adjudication on the merits so as to preclude a direct suit under the doctrine of res judicata. The court makes no determination of the merits of the allegations when reviewing an SLC's decision. Moreover, a direct action, which asserts individual rights, is an entirely different cause of action than a derivative action, which is brought on behalf of the corporation.

Facts: Two lawsuits arose when a family business, consisting of two corporations and owned primarily by eight siblings (collectively, the "Corporation"), attempted to repurchase the stock of one sister upon her death pursuant to a Stock Purchase Agreement. When the sister's estate refused to sell the stock, the Corporation filed a declaratory judgment action seeking enforcement of the Stock Purchase Agreement. Meanwhile, non-director siblings who had learned of earlier stock transactions that resulted in director siblings acquiring additional corporate stock for themselves, sent a demand for litigation to the Corporation and filed a derivative action in the Circuit Court alleging self-dealing and a breach of fiduciary duty. They also filed "direct" claims, as cross-claims in the declaratory judgment action.

In response, the corporations appointed an SLC consisting of two newly hired "independent directors" to examine the claims. The SLC determined that the stock transactions were legitimate and the Stock Purchase Agreement was enforceable.

The Circuit Court, applying the business judgment rule, deferred to the judgment of the SLC and granted summary judgment to the Corporation on the derivative action. The Circuit Court also dismissed the cross-claims relying on res judicata.

Analysis: On appeal in the Court of Appeals, the Court upheld the application of the business judgment rule by the Circuit Court and held that after a motion to dismiss or for summary judgment against a derivative plaintiff, Maryland courts must review the SLC’s independence, and whether it made a reasonable investigation and principled, factually-based conclusions. However, in this inquiry, the SLC is not entitled to a presumption that it was sufficiently independent from the directors. Because the Circuit Court presumed the independence and good faith of the SLC without requiring that the Corporation prove the SLC's independence, the Court of Appeals vacated the Circuit Court's judgment and remanded for further proceedings.

The Court referred to its holding as an "Auerbach enhanced" standard, in reference to Auerbach v. Bennett, 393 N.E.2d 994 (N.Y. 1979). In so holding, the Court rejected the so-called Zapata standard under which Delaware courts review a SLC’s recommendation on the merits, applying their “independent business judgment.”

The Court reasoned that "a procedural review under the business judgment rule, although clearly the more deferential standard [toward the Corporation], nonetheless provides for a thorough review of an SLC’s independence, good faith, and methodology, and such inquiry gives trial courts the ability to scrutinize SLC decisions and protect shareholders against collusive practices or inadequate investigations."

On the issue of whether the non-director siblings' "direct" claims, brought as cross-claims in the declaratory judgment action were precluded by res judicata, the Court held that the Circuit Court's grant of summary judgment in the derivative action, based on a recommendation of the SLC, does not form a basis for res judicata because it is not a determination on the merits. Accordingly, the Court held that a trial court's resolution of a derivative complaint, when based on the recommendation of an SLC, cannot be said to be a final judicial resolution on the merits of the claims.

The full opinion is available in PDF.

In re Nationwide Health Properties, Inc. S'holder Litig. (Cir. Ct. Balt. City)

Filed: May 25, 2011

Opinion by: Judge Stuart R. Berger

Held: When stating a claim for breach of fiduciary duty by the board of directors in a stock-for-stock merger, the duty of profit maximization under Shenker v. Laureate Education, Inc. does not apply.

Facts: The Board of Directors (the Board) of Nationwide, a publicly traded Maryland corporation and REIT with investments primarily in healthcare property in the United States, sought the advice of financial advisers on potential merger opportunities. Over a period of three months Nationwide actively pursued a deal with two of these opportunities. After some back-and-forth with the two potential acquiring companies the Board went with the company that offered them a firm, but slightly lower, price than the other.

Analysis: Plaintiffs attempted to use Shenker v. Laureate Education, Inc. to impose a duty of maximizing shareholder value on the Board. The Court distinguished the "cash-out" merger in Shenker as a different transaction from that of a "stock-for-stock" merger. In Shenker the duty of profit maximization was placed upon that board since the transaction was a "cash out" merger, where shareholders are given cash for their stocks, potentially forcing minority shareholders to accept a cash payment, effectively eliminating their interest in the target company and leaving them with no interest in the acquiring company. In a "stock-for-stock" merger, as is the case here, the current shareholder's equity is exchanged at a fixed conversion rate for shares in the acquiring company. The profit maximization standard may only be applied in a "cash-out" merger situation due to the finality of the decision by the board in such a merger as opposed to the current situation where shareholders will maintain an interest in the merged company. The Court noted that if it were to adopt the plaintiffs' reasoning, then there would be a duty of profit maximization in every merger, in direct opposition to existing case law.

The plaintiffs also argued the "stock-for-stock" purchase is effectively a change in control. The Court disagreed and cited the Delaware Supreme Court, which held where "control of both [companies] remains in a large, fluid, changeable and changing market, "directors do not have to obtain the highest possible value for shareholders since the asset remains liquid and easily sold or transferred in the broader market. A "stock-for-stock" merger is essentially a managerial function and there is no duty to maximize shareholder value, as opposed to a cash-out merger where this duty may be imposed. Further, Maryland corporation law reflects the same principle, "[A] stock-for-stock merger will not be a change of control..." (Hanks, Maryland Corporation Law § 6.6(b)). As the plaintiffs did not sufficiently plead facts supporting their change of control argument, the Court did not impose a duty of profit maximization on the Board.

The Court stated the proper analysis of the merger is under the Maryland Business Judgment Rule. To rebut the presumption, the plaintiffs needed to introduce evidence of director self-interest or self-dealing, or that the directors lacked good faith or failed to exercise due care. The allegations in the complaint did not allege a fraud, but rather self-dealing and negligence leading to substantially lower consideration for their shares. The plaintiffs did not show that interests such as early vesting of stock options influenced a majority of the Board in approving the transaction. The allegations of a breach of acting in the interest of the corporation must establish a link between the material benefit and the Board's decision to approve the merger transaction - absent this, allegations of self dealing are conclusory.

A breach of good faith is not met when the Board is presented with two rational options and chooses one that turns out to be less advantageous than the other. To succeed in showing a lack of care, the plaintiffs must show gross negligence was committed by the Board. Courts have held that boards are justified in accepting a lower but more firm offer over one that is higher but more speculative and that a board may act decisively to preserve an offer. The Court did not find such gross negligence was committed by the Board and the claim was dismissed with prejudice.

Lastly, the plaintiffs alleged a breach of the duty of candor. The Court found the complaint failed to state how any of the alleged omissions were material because the plaintiffs made no attempt to explain how the additional information they sought would alter the "total mix" of information made available in the lengthy report provided to shareholders. Accordingly, the plaintiff's disclosure claims were dismissed with prejudice.

The full opinion is available in pdf.

Oliver v. Crump (Maryland U.S.D.C.)

Filed: September 15, 2011

Opinion by: Judge Ellen Lipton Hollander

Held: In a suit alleging breach of fiduciary obligations of directors of a corporation, a Maryland court may exercise personal jurisdiction over out-of-state directors of a Maryland corporation that conducts its business operations in Maryland.

Facts: Defendants were directors, officers and employees of a Maryland corporation. Plaintiff alleged defendants acted in a course of misconduct. All of the defendants reside in Delaware.

Analysis: A court exercising personal jurisdiction over non-resident defendants does not violate the due process clause of the U.S. Constitution when the defendants have "minimum contacts" in the state and "the exercise of jurisdiction based on those contacts is constitutionally reasonable." The Court applied the logic of Pittsburgh Terminal Corp. v. Mid Allegheny Corp., 831 F.2d 522 (4th Cir. 1987), which involved a West Virginia corporation and directors who lived in the State of Virginia.

In Pittsburgh Terminal, the Fourth Circuit held "the acceptance of a directorship constitutes minimum contacts in a derivative suit." The Court also found minimum contacts because, among other reasons, (a) Maryland law, like West Virginia law, provides the business and affairs of the corporation shall be managed under the direction of a board of directors, (b) directors participate in business decisions that have a primary effect in the forum state and (c) by becoming directors, the defendants purposefully availed themselves of the privilege of doing business in that state.

Turning to the constitutional reasonableness portion of the due process test, the Court cited Pittsburgh Terminal, which noted the factors of the case made the "assertion of jurisdiction more reasonable." The Court agreed. As in Pittsburgh Terminal, the defendants live in a neighboring state. Maryland has a strong interest in providing a forum to hear a claim alleging wrongful acts by the directors of one of its domestic corporations. And, according to the Court, while defendants receive many benefits of the legal fiction of a corporation, requiring "them in turn to shoulder one of the few burdens of such fiction" did not seem unfair.

The opinion is available in pdf.

The George Wasserman and Janice Wasserman Goldsten Family Limited Liability Company v. Kay (Ct. of Special Appeals)

Filed: February 9, 2011

Opinion by Judge James R. Eyler

Held: A claim brought by partners in a general partnership or members of an LLC against a managing partner or managing member will survive a motion to dismiss if they sufficiently allege they suffered harm directly and the managing partner or managing member violated duties owed to the partners or members.

Facts: Plaintiffs are partners in five real estate investment general partnerships and two real estate investment LLCs. Defendants are Mr. Kay, an individual that is the managing member or de facto managing member or partner of the partnerships and LLCs, and Kay Management Company, Inc. and Kay Investment Group, LLC, two entities controlled by Kay. Plaintiffs alleged Defendant took money from the partnerships and LLCs and invested the money with Kay Investment through Kay Management. In turn, Kay Investment invested the money with the Bernard Madoff entities. Plaintiffs brought suit following the Madoff ponzi scheme collapse.

The complaint set forth thirteen counts, including, among others, fraud, breach of fiduciary duties, conversion, civil conspiracy and negligence. The Circuit Court granted Defendant's motion to dismiss because none of the claims were individual, the derivative claims involving the partnerships were not agreed to by a majority of the partnership, and the failure to make demand on behalf of the LLCs was unexcused.

Analysis:

After a lengthy discussion of corporations, general partnerships and LLCs, the Court framed the principal issues on appeal as (1) whether Plaintiffs may assert individual claims against Kay and (2) whether Plaintiffs may bring derivative claims on behalf of the partnerships and LLCs against Kay.

(1) Individual Claims

Applying logic from Shenker v. Laureate Education, Inc., which permitted a shareholder to bring a direct action when the shareholder suffers the harm directly or duties owed to the shareholder have been violated, the Court extended the rationale to the law of partnerships and LLCs. The Court then concluded Plaintiffs sufficiently alleged (a) they suffered harm directly and (b) Kay violated duties owed directly to the Plaintiffs.

Plaintiffs alleged Kay took funds that were required to have been distributed. He also took funds required to be held in reserve, further injuring Plaintiffs by forcing them to replace the removed reserves.

Under the Revised Uniform Partnership Act, general partners owe each other, not just the partnership, fiduciary duties. Section 9A-405(b) of the RUPA "clearly provides a mechanism through which partners can sue other partners directly for breach of those obligations and others." However, there is no statute in Maryland expressly addressing LLC members' fiduciary duties. The Court, after finding managing members to be "agents for the LLC and each of the members, which is a fiduciary position under common law," again applied rationale from Shenker, to state where no statute precludes or limits fiduciary duties under common law, the underlying duties apply. Accordingly, the Court found Kay's fiduciary duties as the managing partner/member to run to the partnerships, the LLCs, the partners and the members.

(2) Derivative Claims

The Court found the term "derivative" inappropriate in a general partnership context. Derivative actions are necessary in a corporate and limited partnership context because shareholders and limited partners have no management rights. "Unlike shareholders and limited partners, however, general partners all have the ability to act on behalf of the partnership, and all have management rights." Accordingly, no need for a derivative action exists. The Court turned to whether minority general partners can bring claims against other partners. The Court cited many sections of RUPA to conclude all partners have equal ability to enforce rights involving partnership property. While section 9A-405(j) of RUPA requires unanimous consent of all the partners, the Court felt it should be tempered "when non-plaintiff partners have conflicts of interest." Instead, "the unanimity requirement should not apply to defendant partners and other interested partners."

However, based on the facts, the Court found a suit on behalf of the partnerships unnecessary because Plaintiffs adequately alleged an individual direct injury. If Plaintiff's prove the allegations, complete relief will be afforded. The derivative claims on behalf of the LLC were rejected for the same reason.

Note: In discussing fiduciary duties in the LLC context, the Court, citing section 4A-402(a) of the Maryland Limited Liability Company Act, notes that "one Maryland statute governing LLC operating agreements does suggest that provisions within operating agreements could alter existing duties or create other duties..." However, no such provisions were alleged in the case.

The full opinion is available in pdf.

In re Terra Industries, Inc. (Balt. City Cir. Ct.)

Filed: July 14, 2010
Opinion by Judge Evelyn Omega Cannon

Held: An exculpatory clause in a corporation's charter holding directors harmless from personal liability to the corporation or shareholders to the fullest extent of the law is enforceable, and it justified entry of summary judgment in favor of defendant directors. Section 1-102 of the Corporations and Associations Article is expansive and applies to every Maryland corporation and to all their corporate acts.

Facts: CF, a competitor of Terra, made numerous attempts to acquire Terra through unsolicited bids. Terra rejected those offers. CF bought Terra stock on the open market, which allowed it three seats on Terra's Board of Directors. Terra later told CF that it was not for sale and CF withdrew its offer to acquire Terra and announced it was no longer pursuing the acquisition. Unbeknownst to CF, Terra was entertaining other potential interests in its acquisition. CF later made another offer to acquire Terra which was accepted by the Board and the two companies merged.

Before the Terra/CF merger, four actions were filed, two of which were Maryland cases and consolidated into this action, alleging, among other things, that the individual defendants breached fiduciary duties by approving the Terra/CF merger. Terra's charter contained a provision which provides: "To the fullest extent permitted by statutory or decisional law . . . no director or officer of the Corporation shall be personally liable to the Corporation or its stockholders for money damages."

Analysis: The court found that the exculpatory clause was applicable, Plaintiffs had not pled facts of active and deliberate dishonesty, and the exculpatory clause may form the basis for granting a motion for summary judgment. Both section 2-405.2 of the Corporations and Associations Article and section 5-418 of the Courts and Judicial Proceedings Article of the Maryland Code allow the charter of a corporation to include any provision expanding or limiting the liability of its directors and officers. The court also found that actions taken in the sale or merger of a corporation are "corporate acts" as contemplated by section 1-102 of the Corporations and Associations Article and discussed in Shenker v. Laureate Education, Inc., 411 Md. 317 (2009).

The full opinion is available in pdf.

Shenker v. Laureate Education, Inc. (Ct. of Appeals)

Filed November 12, 2009
Opinion by Judge Glenn T. Harrell, Jr.

Held: Where corporate directors exercise non-managerial duties outside the scope of §2-405.1(a) of the Maryland Corporations and Associations Article, such as negotiating the price that shareholders will receive for their shares in a cash-merger after the decision to sell the corporation has already been made, they owe their shareholders common law duties of candor and good faith efforts to maximize shareholder value and shareholders may bring direct claims for breach of those fiduciary duties.

Facts: In 2006 and 2007, Laureate Education, Inc., a publicly-held Maryland corporation, underwent a private acquisition process whereby several directors ("Board Respondents") and private equity investors ("Investor Respondents") purchased Laureate through a cash-out merger transaction.

In June 2006, Laureate's Chairman and CEO Douglas L. Becker informed the Board of Directors that he intended to make an offer to purchase Laureate, at which time the Board created a Special Committee composed of three independent directors, who retained a law firm and financial advisors. The Special Committee approved Becker's second offer to purchase Laureate for $60.50 per share and unanimously recommended that the Board approve the proposed transaction on January 28, 2007.

On January 30, 2007, various Laureate shareholders ("Petitioners") challenged the proposed merger on the grounds that the Board Respondents breached their fiduciary duty, that they conspired to breach those duties, and that they and the Investor Respondents aided and abetted that breach.

The Circuit Court granted Respondents' motions to dismiss, dismissing the action as an impermissible direct shareholder suit where the Petitioners had "failed to allege a cognizable duty owed them" by Investor Respondents.

In June 2007, Laureate announced that it had accepted an increased offer from Investor Respondents to acquire Laureate at $62 per share by way of a tender offer and second-step merger. The Special Committee's financial advisors again concluded the offer as financially fair, although several of Laureate's institutional shareholders disagreed, and the Board approved the transaction. Petitioners filed a second complaint in the Circuit Court alleging that the Board Respondents breached their fiduciary duties owed to Petitioners and the Circuit Court again dismissed the claims.

The Circuit Court held that a direct action against corporate directors for alleged violations of fiduciary duties is unavailable in Maryland because §2-405.1(g) forecloses exactly these types of claims. Petitioners appealed to the Court of Special Appeals, which affirmed the Circuit Court's dismissal, holding that §2-405.1(g) bars all direct shareholder claims and that any claims by shareholders against directors for breach of fiduciary duties must be brought derivatively on behalf of the corporation.

Analysis: The Court of Appeals disagreed with the Circuit Court and the Court of Special Appeals that §2-405.1(a) provides the only source of duties owed by corporate directors and that §2-405.1(g) bars all direct shareholder claims against those corporate directors for breach of their fiduciary duties. The Court held that such conclusions are erroneous and shareholders may indeed bring direct suits against corporate directors for breach of common law duties of candor and good faith efforts in particular circumstances, such as in the context of a cash-out merger transaction.

The Court stated that directors and officers owe a duty of care to the corporation and its shareholders under §2-405.1(a). Petitioners conceded that §2-405.1(a) governed the sole source of directorial duties in instances that involve the management of the business and affairs of the corporation. However, Petitioners argued, additional common law duties are triggered once a "threshold decision to sell the corporation has been made and which concern only matters personal to the shareholders." The Court agreed, holding that directors of Maryland corporations owe fiduciary duties of candor and maximization of shareholder value to their shareholders beyond those enumerated in §2-405.1(a) made outside the purely managerial context, such as when faced with an inevitable or highly likely change-of-control situation, and at least in the context of negotiating the amount shareholders will receive in a cash-out merger.

In the context of a cash-out merger, the Court stated, directors assume a different role than solely "managing the business and affairs of the corporation." The Court cited the pivotal Delaware case Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986) numerous times in support of its holding that duties concerning the management of the corporation's affairs change after the decision is made to sell the corporation. Directors act as fiduciaries on behalf of the shareholders in negotiating a share price that shareholders will receive. The Court also stated that a 1997 opinion by the Maryland Attorney General suggests that the General Assembly did not seek to occupy the entire field of directorial duties owed by corporate directors in enacting §2-405.1(a), but instead intended to codify the duty of care owed by directors in exercising their managerial duties.

In addition to its holding regarding directors' fiduciary duties to shareholders in particular situations, the Court also held that the Court of Special Appeals erred in holding that §2-405.1(g) bars all shareholder direct claims. Claims for breach of common law fiduciary duties of candor and maximization of shareholder value may be brought directly by shareholders despite the language of §2-405.1(g). The Court held that Petitioners in this case were not restricted to derivative claims and could pursue direct claims for breach of fiduciary duty because the shareholders were owed direct fiduciary duties from the Board Respondents. In support of this holding, the Court noted that the injury alleged here, that shareholders received too low a value for their shares in a cash-out merger, was an injury suffered solely by the shareholders and not Laureate as a corporation. Laureate's interests would not be implicated by the price received by shareholders, nor would it suffer harm as a result of the price.

The Court agreed with the Court of Special Appeals and rejected the civil conspiracy claims, holding that "a defendant may not be adjudged liable for civil conspiracy unless that defendant was legally capable of committing the underlying tort alleged."

The Court also affirmed the Court of Special Appeals in rejecting the aiding and abetting claims, holding that the actions of the Investor Respondents were not out of the normal course of business practices.

The full opinion is available in PDF.