Cavalier Oil Corp. v. Harnett

• Decision Date: 05 September 1989
• Citation: 564 A.2d 1137
• Parties: CAVALIER OIL CORPORATION, a corporation of the State of Delaware, Plaintiff Below, Appellant, Cross-Appellee, v. William J. HARNETT, an individual, Defendant Below, Appellee, Cross-Appellant.
• Court: Supreme Court of Delaware

Page 1137

564 A.2d 1137

58 USLW 2187

CAVALIER OIL CORPORATION, a corporation of the State of

Delaware, Plaintiff Below, Appellant, Cross-Appellee, v. William J. HARNETT, an individual, Defendant Below,

Appellee, Cross-Appellant.

Supreme Court of Delaware.

Submitted March 28, 1989.

Decided Sept. 5, 1989.

James F. Harker, Herlihy & Wier, Wilmington, John R. Fornaciari, P.C. (argued) and Robert M. Disch, Eckert, Seamans, Cherin and Mellott, Washington, D.C., for appellant, cross-appellee.

James M. Mulligan, Jr. and Collins J. Seitz, Jr., Connolly, Bove, Lodge & Hutz, Wilmington, Thomas Earl Patton (argued), Brett L. Antonides, and Mitchell R. Kreindler, Schnader, Harrison, Segal & Lewis, Washington, D.C., for appellee, cross-appellant.

Before HORSEY, WALSH and HOLLAND, JJ.

WALSH, Justice:

This is an appeal by Cavalier Oil Corporation ("Cavalier") and a cross-appeal by William J. Harnett ("Harnett") from a final judgment of the Court of Chancery determining the fair value of 1,250 shares of stock owned by Harnett in EPIC Mortgage Servicing, Inc. ("EMSI"), a closely-held Delaware corporation. The appraisal action followed a short form merger, pursuant to 8 Del.C. § 253, of EMSI into Cavalier on November 20, 1984.

Harnett rejected Cavalier's offer of $93,950 for his EMSI shares, electing instead to assert his appraisal rights under 8 Del.C. § 262. Consolidated appraisal proceedings were tried in the Court of Chancery which, after extensive post-trial briefing, entered judgment fixing the value of Harnett's EMSI stock at $347,000. ¹ This appeal and cross-appeal resulted.

Cavalier's principal contention on appeal is that the Court of Chancery erred in valuing a corporate opportunity claim asserted by Harnett because the assertion of this claim was barred by res judicata and not otherwise assertable in a statutory appraisal proceeding. Cavalier also appeals from the refusal of the Vice Chancellor to apply a minority discount in valuing Harnett's interest in EMSI. Harnett cross appeals from rulings which rejected certain cash flow projections offered by Harnett's financial expert and which refused to consider Harnett's claim that his EMSI shares had been diluted by shares improperly issued to other shareholders.

We conclude that the Court of Chancery, in both its findings and methodology, correctly applied the standards which govern an appraisal proceeding under Delaware law. Accordingly, we affirm the judgment in all respects.

I

The Court of Chancery appraisal action was the culmination of a complex and litigious business relationship between Harnett and the two majority shareholders of Cavalier, Tom J. Billman ("Billman") and Clayton C. McCuistion ("McCuistion"). All three individuals were original investors in Equity Programs Investment Corporation ("EPIC"), a Virginia corporation established in 1975. ² EPIC's principal business activity was the purchasing of model homes from builders for lease-back purposes. Directly and through subsidiaries, EPIC later expanded into other types of real estate management and mortgage servicing. By 1983, Billman and McCuistion together owned over ninety percent of EPIC's shares while Harnett held the balance of shares.

From its original form, the corporate structure of EPIC changed as various specialized entities were spun off. In 1982, ERSI, which was the companion corporation in the appraisal proceeding, was established as an affiliate of EPIC, with stock ownership reflecting that of the parent. In 1977, EPIC created Epic Mortgage, Inc. ("EMI"), a Delaware corporation, as a subsidiary for servicing mortgages on properties owned by EPIC. In February, 1983, another new subsidiary, also a Delaware corporation, EPIC Mortgage Servicing, Inc. (EMSI), was spun off from EMI and its shares were distributed proportionately. As part of this transaction, EMSI was given the right to service all mortgages in EMI's portfolio. The following month, Community Savings and Loan, Inc. ("CSL"), a Maryland chartered savings and loan association controlled by Billman and McCuistion, effected a merger of EPIC, along with its subsidiary EMI, into CSL. The negotiations between Harnett and the majority shareholders which led to the EPIC-CSL merger were extended and acrimonious.

Harnett was initially offered only nonconvertible, nonvoting preferred shares in CSL in exchange for his EPIC holdings. He rejected this proposal, intent on retaining his proportionate equity interest in EPIC and its progeny. While negotiations ensued, Billman and McCuistion, apparently without Harnett's knowledge, arranged for EMSI to enter into an agreement with EMI under which EMI undertook to perform EMSI's mortgage servicing business, thereby gaining significant revenues which were originally intended to accrue to the spun-off EMSI. Harnett received his certificate for 1,250 shares of EMSI, dated March 2, 1983. Harnett claims that he did not learn of the diversion of EMSI's corporate opportunity until he was notified in November, 1984, of the merger of EMSI into Cavalier and was tendered a check for $93,950 for his stock.

During his ongoing dispute with Billman and McCuistion, Harnett instituted two actions which form the basis for the res judicata claim. In October, 1983, Harnett filed suit in the United States District Court for the Eastern District of Virginia, to recover damages for his minority interest in EPIC. Harnett v. Billman, C.A. No. 83-1029-A, (E.D.Va., Oct. 13, 1983) ("Harnett I "). The amended complaint in Harnett I contained five counts: (1) common law fraud, (2) federal securities fraud, (3) RICO violations, (4) state securities fraud, and (5) a shareholder derivative claim. The focus of this action was the alleged misrepresentations and nondisclosures made by EPIC's majority shareholders in connection with the CSL merger.

The factual allegations in Harnett I included, inter alia, a claim that as a result of the misappropriation of 29,000 shares of EPIC stock by Billman and McCuistion in June, 1982, Harnett's stock in EPIC was improperly diluted, and later, when EMSI was spun off from EPIC on March 1, 1983, his proportionate interest in EMSI was reduced. Harnett sought only damages on his dilution claim.

In October, 1983, Harnett was unaware of the dealings which led to the corporate opportunity claim that he later asserted in the appraisal action. Thus, in Harnett I, these facts were not alleged, nor was a claim based upon them. Harnett I was dismissed, with prejudice, in February, 1984, pursuant to a settlement agreement executed by the parties. This settlement agreement and the subsequent order of dismissal expressly reserved to Harnett the right "to assert the facts underlying the derivative action of Count V [of the Amended Complaint] as those facts may affect the value of [Harnett's] stock." The Court of Chancery construed this provision, in accordance with the intent of the parties, to include the corporate opportunity claim in Harnett's appraisal action even though those facts were not known to Harnett at the time that Harnett I was dismissed.

Harnett II was filed in Federal District Court in February, 1985. The complaint in Harnett II contained four counts: (1) federal securities law violations, (2) state securities law violations, (3) common-law fraud and (4) breaches of fiduciary duty by Billman and McCuistion, as majority shareholders of EMI, EMSI and Cavalier. The District Court eventually awarded damages on Harnett's common-law fraud claim, but granted summary judgment as to Harnett's other three claims finding, alternatively, that they were barred by the doctrine of res judicata and that they were subsumed within the previous order of dismissal. On appeal, the Fourth Circuit Court of Appeals, while not disturbing the findings of the District Court, reversed the award of damages on the common-law fraud claim on res judicata grounds. The Fourth Circuit concluded as a matter of law that the common-law fraud claim could have been known to Harnett and thus should have been asserted by Harnett in Harnett I. Harnett v. Billman, 4th Cir., 800 F.2d 1308, 1314-16 (1986), cert. denied, 480 U.S. 932, 107 S.Ct. 1571, 94 L.Ed.2d 763 (1987).

In the Court of Chancery, Cavalier argued that Harnett's corporate opportunity claim in the appraisal action was precluded by the doctrine of res judicata. This assertion was based on the Fourth Circuit's finding, in Harnett II, that Harnett's common-law fraud claim was barred by res judicata. Harnett, relying on the savings language in the order of dismissal in Harnett I, contended that the corporate opportunity claim was viable.

The Vice Chancellor first ruled that Cavalier had the burden of proving the availability of the affirmative defense of res judicata. Without disagreeing with the Fourth Circuit's analysis of the common-law fraud claim raised in Harnett II, he addressed the question of whether the facts supporting the corporate opportunity claim were encompassed in the savings provision in the order of dismissal of Harnett I. Based on the evidence presented, the Court of Chancery concluded that the parties intended to preserve all facts as they may relate to an appraisal action, and that had the corporate opportunity aspect of an appraisal proceeding been raised in Harnett I, those facts also would have been saved. In sum, he determined that Cavalier had failed to show why the facts underlying the corporate opportunity aspect of Harnett's appraisal action would have been treated differently from the other facts alleged in count five of the amended complaint in Harnett I, had the facts been known to Harnett and raised in Harnett I. The Vice Chancellor thus concluded that Cavalier failed to establish a sufficient factual basis for the assertion of its res judicata defense.

II

The resolution of the res judicata claim presents, preliminarily, a choice of law issue. The Court of Chancery did not specifically rule on this point but cited both...