Patrick J. McREDMOND, Jr., et al. v. ESTATE OF Andrew MARIANELLI, et al.
Court of Appeals of Tennessee, Middle Section, at Nashville.
June 16, 2000.
Order Denying Rehearing Aug. 31, 2000.
Permission to Appeal Denied by Supreme Court April 16, 2001.
230 S.W.3d 730
That a bill in chancery may be, as a matter of practice, dismissed upon motion for laches in the prosecution of the suit is distinctly recognized in Cowan, McClung & Co. v. Donaldson, 95 Tenn. 322, 32 S.W. 457, and Collins v. Insurance Co., 91 Tenn. 432, 19 S.W. 525.
State v. Patterson, 290 S.W. at 975.
Moreover, we find that this is a proper case for the application of the laches doctrine. A more classic case cannot be imagined. The lengthy unreasonable delay by Mr. Brown coupled with the prejudice to the Defendants, one of whom died eight years after the instigation of this suit, the loss of documents, and the lack of memory of the parties to pertinent facts relating to their defense, all confirm that the criteria for dismissal based on laches was more than amply met in this case. We find the Chancery Court exercised its discretion appropriately in granting the motion to dismiss for laches in the prosecution of this case. We find no merit in any issues raised by Mr. Brown.
V. CONCLUSION
The trial court is affirmed in all respects. This matter is remanded to the trial court for such further proceedings as may be necessary consistent with this opinion and collection of costs below. Costs on appeal are adjudged against Mr. Brown and his surety.
Cyrus L. Booker and Charlnette A. Richard, Nashville, TN, for appellees, Estate of Andrew Marianelli, Walter Marianelli, David Manning, Edwin S. Pyle and Gordon Ferragina.
John P. Branham and Kathryn E. Barnett, Nashville, TN, for appellee Milano Corporation.
OPINION
CANTRELL, P.J., M.S., delivered the opinion of the court, in which KOCH and CAIN, JJ., joined.
Minority shareholders in a Kentucky apparel manufacturing company brought this
I. THE MARKETING SERVICE AGREEMENT
This case arose from a Marketing Service Agreement between a long-established Kentucky apparel maker named Elk Brand Manufacturing Company, and a new entity called Milano Corporation, expressly formed to provide marketing services for Elk. In 1989, the future of the manufacturer was uncertain because of dramatic changes in the apparel industry, and imminent changes in the management of Elk Brand.
Andrew Marianelli, Patrick McRedmond and Louis McRedmond had purchased Elk Brand in 1966. Mr. Marianelli, the majority shareholder, assumed the operation of the company. The McRedmonds served on the Board, but took no role in the day-to-day management of the company. In 1989, all three men were at or near retirement age. Mr. Marianelli was seeking to reduce his management role at Elk Brand, and to step down as its CEO.
Walter Marianelli, Andrew‘s son, was a member of Elk Brand‘s Board of Directors. He wished to take over the management of the company and to acquire his father‘s shares, but he did not have sufficient capital to purchase them. He proposed a plan to the Board which he claimed would benefit the company, while allowing him to accomplish his own goals.
The plan had two components. The first involved the formation of a new entity, called Milano Corporation, to take over marketing for Elk Brand. Milano was to be owned by certain Elk Brand managers, with Walter Marianelli taking an 80% stake. The new company would enter into a Marketing Services Agreement (MSA) with Elk Brand, whereby Milano would use its best efforts to promote the sale of Elk Brand‘s products, and the apparel company would agree to pay Milano 4% of its total sales up to $30 million, 6% of its sales in excess of $30 million, and 20% of any increases in Elk Brand‘s net profits, based upon a three-year rolling average.
A copy of the proposed M.S.A. was distributed to the directors at a Board meeting on August 17, 1989. The proposal was discussed at the next Board meeting on September 13, 1989, after which the Board unanimously agreed to implement it and to allow the M.S.A. to take effect retroactively to September 1, 1989. The directors present and voting were Andrew Marianelli, Walter Marianelli, Patrick McRedmond, Curtis Brasher, and Edwin Pyle.
The second component of Walter Marianelli‘s plan involved Milano borrowing $5 million from Third National Bank for the purpose of purchasing Elk Brand stock from his father and from other stockholders. Each stockholder received a letter from Milano, offering to purchase up to 60% of the stockholder‘s shares at a price of $400 per share. The letter acknowledged that the per share price was determined arbitrarily by Milano, and that it amounted to about 60% of the book value of the shares. It also identified all the present and anticipated shareholders and officers in Milano.
In the first three years of the MSA, the sales of Elk Brand‘s products increased. However, Elk Brand suffered net losses of $1,857,597 during that period. At the same time Milano‘s net income after taxes amounted to $3,130,429. Elk Brand‘s profits rebounded to record levels in 1993, 94, and 95, as did its sales volume. The company again showed losses in 1996 and 97.
On April 15, 1993, attorneys for 32 Elk Brand shareholders (most of them members of the McRedmond family) addressed a demand letter to the corporation and to seven directors of Elk Brand and Milano. The letter asserted that the operation of the M.S.A. was financially detrimental to the minority shareholders, and demanded that the Board terminate the M.S.A. and file suit against Milano for the return of the fees it had collected. It also recited that one of its purposes was to make the necessary demands which are a pre-requisite to be met by minority shareholders prior to filing a shareholder derivative suit under Kentucky law.
II. DISMISSAL AND APPEAL OF THE DERIVATIVE SUIT
The Directors decided not to respond to the demand, and on August 16, 1993, the minority shareholders brought suit for the benefit of Elk Brand against Milano and its officers and directors. Andrew Marianelli was also named. The plaintiffs claimed that the M.S.A. was voidable as a conflict of interest transaction, because of a direct or indirect interest in the transaction possessed by Andrew and Walter Marianelli, Edwin Pyle and Curtis Brasher, and because the material facts of the transaction were not disclosed. See
The defendants responded by filing a motion to dismiss. They argued that the court should defer to the business judgment of the defendants on Elk Brand‘s Board of Directors, who had investigated the plaintiffs’ claims, and determined that it was not in the best interest of Elk Brand to pursue those claims. They also contended that the plaintiffs did not fairly and adequately represent the interests of Elk Brand‘s minority shareholders.
An extensive hearing on the motion was conducted over three days in April 1994, in Part I of the Chancery Court of Davidson County. At the conclusion of the hearing, the chancellor directed both parties to submit proposed findings of fact and conclusions of law to the court. The court adopted the proposed findings and conclusions submitted by the defendants. The court announced that since it had to consider evidence outside the pleadings, it would treat the motion to dismiss as one for summary judgment. See
The plaintiffs appealed to this court. In a per curiam opinion, McRedmond v. Marianelli, No. 01A-01-9412-CH-00594, 1996 WL 697944 (Tenn.Ct.App. Dec. 6, 1996, at Nashville), we reversed the trial court. We found that the chancellor had erred by granting summary judgment to defendants who had failed to meet their burden of producing uncontradicted evidence that
III. FURTHER PROCEEDINGS
On remand, the chancellor recused himself from further participation in this case, and the case was transferred to Part III of the Davidson County Chancery Court. The defendants renewed their motion for summary judgment. On October 2, 1998, the trial court granted partial summary judgment to the defendants, finding that the “safe harbor” provision of Kentucky conflict of interest statute was met, in that the material facts of the M.S.A. and of the directors’ interest were disclosed and known to a majority of disinterested directors.
On February 9, 1999, the trial court granted defendants’ second motion for summary judgment, thereby disposing of plaintiffs’ claims in their entirety. The court found that the defendants were not guilty of any misrepresentation, or of any breach of fiduciary duty to Elk Brand, and stated that the M.S.A. was fair. On April 21, 1999, the trial court denied the plaintiffs’ motion to alter or amend. The present appeal followed.
IV. CONFLICT OF INTEREST
Since Elk Brand is a corporation organized under the laws of Kentucky, its internal corporate affairs are governed by Kentucky law. Director conflict of interest transactions are regulated by
(1) A conflict of interest transaction shall be a transaction with the corporation in which a director of the corporation has a direct or indirect interest. A conflict of interest transaction shall not be voidable by the corporation solely because of the director‘s interest in the transaction if any one of the following is true:
(a) The material facts of the transaction and the director‘s interest were disclosed or known to the board of directors or a committee of the board of directors and the board of directors or committee authorized, approved, or ratified the transaction;
(b) The material facts of the transaction and the director‘s interest were disclosed or known to the shareholders entitled to vote and they authorized, approved, or ratified the transaction; or
(c) The transaction was fair to the corporation.
(2) For purposes of this section, a director of the corporation shall have an indirect interest in a transaction if:
(a) Another entity in which he has a material financial interest or in which he is a general partner is a party to the transaction; or
(b) Another entity of which he is a director, officer, or trustee is a party to the transaction and the transaction is or should be considered by the board of directors of the corporation.
(3) For purposes of subsection (1)(a) of this section, a conflict of interest transaction shall be considered authorized, approved, or ratified if it receives the affirmative vote of a majority of the directors on the board of directors (or
on the committee) who have no direct or indirect interest in the transaction, but a transaction shall not be authorized, approved, or ratified under this section by a single director. If a majority of the directors who have no direct or indirect interest in the transaction vote to authorize, approve, or ratify the transaction, a quorum shall be present for the purpose of taking action under this section. The presence of or a vote cast by, a director with a direct or indirect interest in the transaction shall not affect the validity of any action taken under subsection (1)(a) of this section if the transaction is otherwise authorized, approved, or ratified as provided in that subsection.
...
Walter Marianelli‘s interest in the transaction before us clearly meets the definition of an indirect conflict of interest under section (2) of the statute. However, the transaction is not voidable if at least two directors did not have an interest in the transaction, and were fully informed of the material facts of the transaction and of Walter Marianelli‘s interest in it, before voting for it.
The minority shareholders concede that Patrick McRedmond Sr. was a disinterested director. However, they argue that all the other directors had an indirect interest in the MSA. They contend that in the above statute, the word “if,” found in the phrase “[f]or purposes of this section, a director of the corporation shall have an indirect interest in a transaction if ...” should be read as describing only one type of indirect interest, and not to mean “if and only if.”
The plaintiffs argue that Andrew Marianelli had an indirect interest in the transaction because of his relationship with his son and because he would benefit from the purchase of his own shares; that Edwin Pyle‘s conflict of interest arose from his role as personal attorney to the Marianelli family; and that Curtis Brasher‘s indirect interest could be deduced from his long-term relationship to Andrew Marianelli, and the presence of Elk Brand profit-sharing funds in the bank where Mr. Brasher was employed.
We do not believe that we need resolve the question of whether Andrew Marianelli or Edwin Pyle possessed an indirect interest that should be recognized under the statute, because it appears to us that Curtis Brasher did not. The plaintiffs alleged (1) that Mr. Brasher was a close personal friend of Andrew Marianelli‘s, (2) that in their thirty years on the Board together Mr. Brasher never voted against Mr. Marianelli, and (3) Elk Brand profit-sharing funds were held in the bank where Mr. Brasher was employed.
Curtis Brasher did state that he considered Andrew Marianelli to be his friend. He also stated that as Chairman of the Board of Elk Brand from 1966 on, Mr. Brasher‘s practice was to thresh issues out with the other members of the Board before taking a formal vote on any proposal, in order to achieve unanimity of purpose.
We believe that if the ties of friendship or a long history of voting the same way were sufficient to constitute a conflict of interest, the actions of a great many corporate directors would likely fall under attack. Such a holding would tend to undermine the general principle that the business and affairs of a corporation are to be managed by its directors, Aronson v. Lewis, 473 A.2d 805, 812 (Del.Supr.1984). It would also be inconsistent with the non-interventionist policies that Tennessee‘s courts have consistently followed in regard to internal corporate matters. Lewis v. Boyd, 838 S.W.2d 215, 220 (Tenn.Ct.App. 1992). Finally, it is clear from the record
Since we have found that Mr. Brasher did not have an interest in the transaction, we must determine whether he and Patrick McRedmond Sr. were aware of the material facts of the transaction and of Walter Marianelli‘s interest in Milano Corporation. The affidavit of Curtis Brasher states that the issues the M.S.A. was designed to address, and the structure of the agreement, were discussed by the Board of Directors for about a year before they voted to approve the agreement; that all directors participated in the discussions; and that all questions asked by each director were answered. Mr. Brasher states that he knew who the owners of Milano Corporation would be, and he knew that Walter Marianelli would own the majority of its shares, but that he did not know, or did not remember, exactly what percentage of the new corporation each shareholder would own.
Mr. Brasher‘s testimony at the 1994 hearing before Part I of the Chancery Court supports the statements in his affidavits, as do the minutes of the Board for the years 1988 and 1989. Plaintiffs attempt to raise doubts as to the truthfulness of the affidavit by pouncing on some seeming inconsistencies between testimony and affidavit, but after reading both, it does not appear to us that they have raised questions of material fact such as would preclude summary judgment for the defendants on the question of conflict of interest.
The M.S.A. had a term of five years, with a provision for automatic annual renewals, subject to the right of either of the parties to terminate the agreement by giving timely written notice to the other. In 1994, the Board considered a resolution to renew the M.S.A. for five years. By that time, the Board members were all familiar with the operation of the agreement, and with its effect on Elk Brand, as well with the allegations of the present suit.
The members of the Board in 1994 were Curtis Brasher, Patrick McRedmond Sr., Edwin Pyle, Andrew Marianelli, Louis McRedmond, David Manning and Walter Marianelli. Five of the seven directors voted in favor of renewal, with Louis McRedmond and Walter Marianelli abstaining. Of course both of them had an interest in the outcome, as did David Manning, who held 1% of the stock in Milano. Once again, Patrick McRedmond Sr. and Curtis Brasher1 voted for the resolution, thus negating any possibility that the transaction could be found voidable under the Kentucky Conflict of Interest Statute, supra.
The defendants argued that once the question of conflict of interest was resolved in their favor, no further inquiry was required, and they were automatically entitled to dismissal of the remaining claims. The chancellor correctly found that the complaint contained causes of action that could be distinguished from the conflict of interest claim. After examining the record, however, she concluded that the defendants were entitled to summary judgment on those claims also.
The appellants claim that the chancellor erred by concluding that the M.S.A. was fair, and in ruling that the appellees had met their fiduciary duties. The appellees
V. BREACH OF FIDUCIARY DUTY
The question of fiduciary duty stands on a different footing. It is axiomatic that the officers and directors of a corporation owe a fiduciary duty to the corporation and to its shareholders. Johns v. Caldwell, 601 S.W.2d 37 (Tenn.Ct. App.1980); Acree v. E.I.F.C., Inc., 502 S.W.2d 43 (Ky.1973). Controlling shareholders likewise owe a fiduciary duty to minority shareholders. Nelms v. Weaver, 681 S.W.2d 547, 549 (Tenn.1984). The reason for that duty was described by this court in Intertherm, Inc., v. Olympic Homes Systems, 569 S.W.2d 467 (Tenn.Ct. App.1978):
“As a fiduciary, the officer or director [or majority shareholder] has a strong influence on how the corporation conducts its affairs, and a correspondingly strong duty not to conduct those affairs to the unfair detriment of others, such as minority shareholders or creditors, who also have legitimate interests in the corporation but lack the power of the fiduciary.”
A fiduciary is person or entity holding the character of a trustee. Svanoe v. Jurgens, 144 Ill. 507, 33 N.E. 955 (1893). A fiduciary duty is the duty to act primarily for another‘s benefit. Haluka v. Baker, 66 Ohio App. 308, 34 N.E.2d 68 (1941). With respect to directors in a close corporation, “They are required to act in the utmost good faith, and ... they impliedly undertake to give to the enterprise the benefit of their care and best judgment and to exercise the powers conferred solely in the interest of the corporation and not for their own personal interests.” 18B Am.Jur. Corporations § 1689. A fiduciary is not an insurer, Young v. Phillips, 170 Tenn. 169, 93 S.W.2d 634 (1936), but is bound to exercise good faith and due diligence. Lee v. First National Bank, 150 Tenn. 275, 263 S.W. 89 (1924); Wallace v. Lincoln Savings Bank, 89 Tenn. 630, 15 S.W. 448 (1891).
The trial judge disposed of the issue of the fiduciary duty by concluding that the M.S.A. was “fair.” Her conclusion was based on a factual finding that Elk Brand survived and profited from the MSA.
We think the facts are in dispute on that issue. Although Elk Brand faced an uncertain future in 1989, we think a finder of fact could conclude that it could have survived even without the benefit of the M.S.A. with Milano, and that the profits transferred to Milano, with little investment on its part, could have accrued to Elk Brand.
The record shows that only two individuals were critical to Milano‘s success: Walter Marianelli and Gordon Ferragina. One was a director of Elk Brand and the other a former employee. In the first
We do not conclude that all the conflicting evidence shows a breach of duty, but we do think that the evidence could support that conclusion. Therefore, summary judgment on the fiduciary duty issue was improper. Byrd v. Hall, 847 S.W.2d 208 (Tenn.1993).
A. THE PARTIES
The transactions in question in this action are the 1989 M.S.A. between Elk Brand and Milano and its renewal in 1994. Therefore, only the officers, directors, or majority shareholders at the time of the transactions had a fiduciary duty to Elk Brand or the minority shareholders. As a matter of law some of the following defendants did not have that duty and the liability of others should be restricted to the relevant time periods.
1. Milano
a. The 1989 MSA
Milano did not own any stock in Elk Brand at the time the M.S.A. was approved in 1989. In fact, Milano‘s offer to purchase Elk Brand shares was contingent on approval of the MSA. At the critical point in time, therefore, Milano was simply a potential purchaser of an interest in Elk Brand.
The plaintiffs argue that this case is not just about approval of the MSA, but it is also about Milano receiving the excessive payments under the MSA. But we cannot find any support for the argument that a party having a contract with a corporation violates a fiduciary duty to the corporation or to the minority shareholders by continuing to receive the benefits of the contract after acquiring control of the corporation. It may have been a bad contract for Elk Brand, but Milano did not violate a duty to Elk Brand by accepting its benefits.
b. The M.S.A. Renewal
Milano was the majority shareholder when the Elk Brand Board renewed the MSA. It is generally held that transactions between a corporation and its majority, dominant, or controlling shareholder will be closely scrutinized by the courts with the burden of proof placed upon the shareholder when the good faith and fairness of such a transaction is challenged. Intertherm, Inc. v. Olympic Homes Systems, 569 S.W.2d 467, 471-2 (Tenn.Ct.App.1978). Thus, Milano‘s transactions with Elk Brand are subject to close scrutiny, and under normal circumstances, it would have the burden of showing the good faith and fairness of such transactions.2
2. Gordon Ferragina
Mr. Ferragina was not an Elk Brand director in 1989 or when the M.S.A. was renewed in 1994. Therefore, he took no action that could be classified as a breach of his fiduciary duty to Elk Brand.
3. David Manning
Mr. Manning became a member of the Elk Brand Board in 1992. He did not
B. THE BURDEN OF PROOF
One thing remains to be said about the burden of proof on this issue. We have cited the cases placing a high burden on fiduciaries that engage in transactions with the corporation they represent. For those directors that had no interest in the transactions, the burden may not be as great. The defendants, however, cite a Kentucky statute,
Since the issue of the burden of proof was not decided by the court below we will not decide it here. The trial court on remand will decide who bears the burden of proof and the quantum of proof necessary to carry it.
We affirm the trial court‘s refusal to set aside the M.S.A. on the ground of a conflict of interest. We affirm the dismissal of Mr. Ferragina on the claim of a breach of fiduciary duties. We reverse the trial court‘s dismissal of the claims based on a breach of a fiduciary duty, but we restrict the liability of the individual defendants to the time period after they became fiduciaries. We remand the case to the Chancery Court of Davidson County for further proceedings and tax the costs on appeal equally to the appellants and the appellees with the exception of Mr. Ferragina.
ORDER DENYING PETITION FOR REHEARING
CANTRELL, Presiding Judge, M.S.
The defendants have filed a thoughtful and respectful Petition to Rehear in this case, arguing that we erred by reversing the summary judgment in their favor on the plaintiffs’ claims that the defendants breached their fiduciary duty. We have considered their arguments, and we have concluded that our opinion was not in error.
I. MILANO‘S ARGUMENT
The first argument, presented on behalf of defendant Milano Corporation, is that as the majority shareholder in Elk Manufacturing Company, it may have owed a fiduciary duty to the minority shareholders of that corporation, but it did not owe such a duty to the corporation itself. They contend that since the minority shareholders brought a derivative action on behalf of the corporation, and not on their own behalf, if we accept Milano‘s argument, we are obligated to affirm the summary judgment for Milano.
Milano notes that we cited the case of Intertherm, Inc. v. Olympic Homes Systems, 569 S.W.2d 467 (Tenn.Ct.App.1978) several times in our opinion, and contends that the Intertherm case is not on point, because it involved a suit against the defendant corporation brought by some of its creditors, rather than a derivative suit brought on behalf of the corporation by its minority shareholders.
Despite the factual differences between the Intertherm case and the one before us, however, we believe that the principle of fiduciary duty stated in both cases is the
“... courts will closely scrutinize the transactions of a majority, dominant, or controlling shareholder with his corporation, and will place the burden of proof upon the shareholder when the good faith and fairness of such a transaction is challenged .... [i]t is obvious that the reason for applying the rule to a [dominant, majority or controlling] shareholder is the same as the reason for applying it to an officer or director, that is, that he occupies a fiduciary position with regard to the corporation, and those interested in it.”
Milano‘s argument is without merit.
II. THE ARGUMENTS OF THE INDIVIDUAL DEFENDANTS
The individual defendants in this case, Walter Marianelli, David Manning, Edwin S. Pyle and the estate of Andrew Marianelli argue that our resolution of the conflict of interest question should also conclusively resolve the question of breach of fiduciary duty in their favor.
Their argument relies entirely upon the provisions of Kentucky‘s conflict of interest law,
Another section of the same statute says that a vote cast by a director with an interest in a proposed transaction which was authorized, approved, or ratified as described above will not affect the validity of the action taken.
Such an argument shifts the focus away from the question of whether they were guilty of breach of their fiduciary duty to the corporation they served, and towards the question of causation. In other words, they are saying that even if the M.S.A. damaged Elk Brand‘s bottom line and the value of its stock, the Board‘s decision to ratify the agreement cannot be held against them because their votes were of no legal consequence.
It appears to us, however, that the purpose of
The standard of conduct required of corporate directors is described in
(1) A director shall discharge his duties as a director, including his duties as a member of a committee:
(a) In good faith;
(b) On an informed basis; and
(c) In a manner he honestly believes to be in the best interests of the corporation.
It appears to us that the plaintiffs have raised genuine questions of fact as to whether in formulating, investigating and acting upon the MSA, the individual defendants have conducted themselves in accor-
The Petition to Rehear is denied.
CANTRELL, Presiding Judge, M.S.