Flip Mortg. Corp. v. McElhone

• Citation: 841 F.2d 531
• Decision Date: 14 April 1988
• Docket Number: 87-1543,Nos. 87-1529,s. 87-1529
• Parties: , RICO Bus.Disp.Guide 6884 FLIP MORTGAGE CORPORATION, Plaintiff-Appellee, v. Donald H. McELHONE; C. Warren Crandall, Defendants-Appellants and Josephine McElhone; Ruth W. Crandall; James Schaffer, Defendants. FLIP MORTGAGE CORPORATION, Plaintiff-Appellant, v. Donald H. McELHONE; Josephine McElhone; C. Warren Crandall; Ruth W. Crandall; James Schaffer, Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (4th Circuit)

Page 531

841 F.2d 531

56 USLW 2538, RICO Bus.Disp.Guide 6884

FLIP MORTGAGE CORPORATION, Plaintiff-Appellee, v. Donald H. McELHONE; C. Warren Crandall, Defendants-Appellants and Josephine McElhone; Ruth W. Crandall; James Schaffer, Defendants.

FLIP MORTGAGE CORPORATION, Plaintiff-Appellant, v. Donald H. McELHONE; Josephine McElhone; C. Warren

Crandall; Ruth W. Crandall; James Schaffer,

Defendants-Appellees.

Nos. 87-1529, 87-1543.

United States Court of Appeals,

Fourth Circuit.

Argued Nov. 5, 1987.

Decided March 4, 1988.

Rehearing Denied April 14, 1988.

Thomas J. Curcio, Robert Dunn (James M. DeSimone, Cohen, Dunn & Sinclair, Alexandria, Va., on brief), for defendants-appellants.

Craig Smith (Smith & McMaster, P.C., Newtown, Pa., on brief), for plaintiff-appellee.

Before WINTER, Chief Judge, MURNAGHAN, Circuit Judge, and BUTZNER, Senior Circuit Judge.

BUTZNER, Senior Circuit Judge:

Donald B. McElhone and C. Warren Crandall, directors and officers of Shamrock Computer Services, Inc. (SCS), appeal a summary judgment entered in favor of Flip Mortgage Corporation (FMC). The principal issue raised by the appeal is whether directors of a dissolved corporation who continue to operate the corporate business in violation of Virginia law are personally liable for debts incurred by the corporation before dissolution. The district court held that Virginia law imposed such liability even though the corporation was subsequently reinstated. We agree with the district court that Virginia law imposes liability on directors who breach their fiduciary duty to creditors to whom the corporation became indebted before dissolution. Nevertheless, we vacate the judgment and remand for determination of the directors' personal liability in accordance with the directions contained in Part II of this opinion.

FMC cross-appeals, assigning as error the district court's dismissal of several other claims that it asserted. We affirm the district court's judgment with respect to these issues except for its dismissal of FMC's claim of fraud.

I

FMC and SCS contracted in 1977 to develop and market a family of computerized mortgage related services. FMC supplied financial expertise, concepts for new products, and marketing efforts, while SCS provided computer expertise, hardware, and computer services to customers. The "Flexible Loan Insurance Program" (FLIP) computer services were distributed primarily through a time-sharing network organized and managed by SCS. ¹ SCS billed the users and was obligated under the terms of the contract to remit to FMC 70% of the revenue from customers' usage of the FLIP system. Some income was also derived from licensing the system for use on a separate computer system, and FMC was entitled to 70% of this revenue.

In 1982, SCS declared that the 70%-30% formula had become inequitable and unilaterally reduced the sums paid FMC. As a result, FMC filed an action based on diversity of citizenship in the district court for the Eastern District of Pennsylvania. Discovery disclosed that for years SCS had not accounted for all receipts each month, and by this means it had deprived FMC of substantial income. As a result, FMC recovered a judgment of $136,714.11 plus interest. The court also ordered an accounting to determine damages for periods not covered by its monetary judgment and directed that SCS pay FMC its full share of all future revenue.

SCS has not satisfied the judgment FMC obtained in the Eastern District of Pennsylvania. According to FMC, it has not furnished the accounting the court ordered nor has it made the required payments on continuing revenues. FMC charges that the directors violated or obstructed the fulfillment of the order by dissipating the assets of the corporation. On April 25, 1985, the day before a hearing was scheduled before the federal court in Pennsylvania on a motion to hold the corporation in contempt for its noncompliance with the judgment, SCS filed a petition for bankruptcy. FMC then commenced this action against the directors, which the district court for the Eastern District of Pennsylvania transferred to the Eastern District of Virginia.

II

Count VI, which is the subject of the appeal taken by McElhone and Crandall (directors), alleged that they became personally liable for debts the corporation incurred before and during dissolution. The statutory basis for this count is Va.Code Secs. 13.1-91 and -92, which provide in part as follows: ²[I]f the corporation fails before the first day of June after the second such annual date to file the annual report or to pay the annual registration fees or franchise taxes ... such corporation shall be thereupon automatically dissolved as of the first day of June and its properties and affairs shall pass automatically to its directors as trustees in dissolution. Thereupon, the trustees shall proceed to collect the assets of the corporations, sell, convey and dispose of such of its properties as are not to be distributed in kind to its stockholders, pay, satisfy and discharge its liabilities and obligations and do all other acts required to liquidate its business and affairs....

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Upon the entry by the Commission of an order of reinstatement, the corporate existence shall be deemed to have continued from the date of dissolution except that reinstatement shall have no effect on any question of personal liability of the directors, officers or agents in respect of the period between dissolution and reinstatement.

The evidence established that for two consecutive years SCS failed to file the annual reports and to pay the annual registration fee and franchise tax. As a result, it was dissolved on June 1, 1983. In violation of the statute, the directors continued to operate the business instead of marshalling corporate assets and paying its creditors. The corporation was reinstated on January 5, 1984. Finding no genuine issue of material fact, the district court entered summary judgment against the directors in the amount of the unpaid judgment, which had been entered by the district court for the Eastern District of Pennsylvania against SCS, plus interest.

The directors argue that their liability, if any, is limited to debts incurred by SCS to FMC in the period of dissolution--June 1, 1983, to January 5, 1984. FMC contends that the directors are liable for debts incurred both before and during dissolution. The district court, perceiving the opportunity for abuse if the directors were permitted to avoid liability for pre-existing debts while they operated without a corporate charter, held that the directors were liable to FMC for debts SCS incurred before and during dissolution.

There can be no doubt that the directors are liable to FMC for debts incurred during the period of dissolution. Two recent cases have applied the statute to impose liability under these circumstances. See McLean Bank v. Nelson, 232 Va. 420, 350 S.E.2d 651 (1986); Moore v. Occupational Safety and Health Review Comm'n, 591 F.2d 991 (4th Cir.1979). These cases, however, dealt only with debts incurred during dissolution, and the courts had no occasion to consider whether directors were liable for debts incurred before dissolution.

People dealing with a corporation are obliged to look to the corporation for satisfaction of their claims. Only in extraordinary circumstances are directors liable for corporate debts. Virginia Code sections 13.1-91 and -92 must be construed in a manner consistent with the strong public policy of shielding directors from individual liability for corporate debt. The statute does not impose any liability for corporate debt on the directors simply because the corporation has been automatically dissolved. Even after dissolution, the directors are shielded from individual liability if they discharge the duties the statute places on them to marshal assets, pay pre-existing debts, and distribute the remaining funds, if any, to the shareholders. Moreover, the directors may temporarily continue the corporate business as an incident to its liquidation without incurring individual liability. See Moore, 591 F.2d at 994 n. 5. If the assets are insufficient to discharge pre-existing debts and the expenses of liquidation, the directors are not liable for the deficiency. Creditors who opted to deal with the corporation when it was a going concern have no cause to complain if they are not paid in full. It is fair to assume that they looked to the corporation's ability to pay, not the directors', when they dealt with the corporation.

The directors' difficulty arises when they violate the law and carry on the business instead of liquidating it. They then become personally liable. McLean Bank, 232 Va. 420, 350 S.E.2d 651, and Moore, 591 F.2d 991. This is not inconsistent with the public policy shielding directors, for it cannot be assumed that creditors elected to deal with corporations whose directors have breached the express trust the law imposes on them to pay the creditors.

The nature and extent of the directors' liability depend on provisions of the Code that describe the effect of dissolution on the corporation, the function of the directors of a dissolved corporation, the injury caused by the directors' wrongdoing, and the effect of reinstatement. ³ The Supreme Court of Virginia has explained the effect of dissolution on the corporation. "A dissolved domestic corporation is no corporation at all." McLean Bank, 232 Va. at 426, 350 S.E.2d at 656; accord Moore, 591 F.2d at 995.

Also, the Supreme Court of Virginia has admonished that where possible every word of the statutes must be given meaning. McLean Bank, 232 Va. at 427, 350 S.E.2d at 656. This principle requires, in the context of this case, a court to give meaning to the word "trustees" in Sec. 13.1-91. Upon dissolution, the directors no longer function as directors of a corporation. Section 13.1-91 provides that they become "trustees" in dissolution. The assets of the corporation...