Ellzey v. Fyr-Pruf, Inc.

• Court: Mississippi Supreme Court
• Writing for the Court: Before PATTERSON; PATTERSON; COFER
• Citation: Ellzey v. Fyr-Pruf, Inc., 376 So.2d 1328 (Miss. 1979)
• Decision Date: 31 October 1979
• Docket Number: FYR-PRU,No. 51289,INC,51289
• Parties: Ben ELLZEY, George E. Bass and J. L. Johnson, Complainants/Appellants, v., et al., Defendants/Appellees.

Page 1328

376 So.2d 1328

Ben ELLZEY, George E. Bass and J. L. Johnson Complainants/Appellants, v. FYR-PRUF, INC., et al., Defendants/Appellees.

No. 51289.

Supreme Court of Mississippi.

Oct. 31, 1979.

Rehearing Denied Dec. 12, 1979.

Corr, Carlson & Fleming, George C. Carlson, Jr., Sardis, Freeland & Gafford, T. H. Freeland, III, Oxford, E. Clifton Hodge, Jr., University, for complainants-appellants.

McClure, May & Mitchell, Cinclair May, Sardis, for defendants-appellees.

Before PATTERSON, C. J., and SUGG and WALKER, JJ.

PATTERSON, Chief Justice, for the Court:

In the Chancery Court of the Second Judicial District of Panola County Ben Ellzey, George E. Bass, and J. L. Johnson filed what became, following amendment, a stockholders' derivative action alleging that Marlyn Yarborough, John P. Fox, James B. Lollar, and Sterling Allen, all officers and directors of Fyr-Pruf, Inc., a Mississippi corporation, had usurped business opportunities belonging to Fyr-Pruf. The court placed the burden of proving all issues by clear and convincing evidence upon the complainants and dismissed the bill with prejudice following a hearing. Because we are of the opinion the court erroneously placed the burden of proof upon complainants, we reverse and remand.

Fyr-Pruf, Inc. was incorporated on August 17, 1970, to produce padding material. The initial investors, among them Dr. George Bass, a chemist, thought a patent might be obtained on "the Bass formula," a process through which it was believed flame-retardant padding could be mass-produced. However, the "formula" proved to be unsuited to manufacturing processes, and a patent never issued. Despite this setback, the officers of Fyr-Pruf, among them appellees Yarborough, Fox, Lollar, and Allen, persisted in maintaining Fyr-Pruf as a going concern in the carpet padding trade. A lease had been obtained on a manufacturing facility in Batesville, and production began in October 1970, with output increasing until April 1971, when Fyr-Pruf lost its facility following a change in the ownership of the leased premises occurring after Fyr-Pruf unsuccessfully tendered its own bid to the Small Business Administration, lessor.

Thereafter, Fyr-Pruf officers and directors sought a new manufacturing facility and additional equipment to expand production of padding. A site located in Water Valley came to their attention as Fyr-Pruf officials sought an SBA loan to secure a lease. With the aim of obtaining the necessary equipment for Fyr-Pruf, appellant Ellzey contacted Sam Lerman, a St. Louis, Missouri businessman who owned machinery for mass-producing carpet padding.

Officers of Fyr-Pruf made several trips to discuss the purchase of this equipment from Lerman and ultimately tendered a check for $5,000 to hold it for ten days, agreeing that Fyr-Pruf would try to locate financing for the purchase of the equipment and a facility in which to continue production. Unfortunately, on June 23, 1971, Fyr-Pruf received notice from SBA of the denial of its application for a loan to acquire the Water Valley facility.

By this time, the formation of a rival corporation for the production of carpet padding, Bondafoam, Inc., had become a reality. Its charter issued on June 24, the day following the SBA's rejection notice. Sustained by the investments and managerial talents of appellees, who had not resigned from their positions as officers and directors of Fyr-Pruf, the incipient Bondafoam leased the Water Valley facility and began what proved to be a profitable padding manufactory, using equipment which appellees Yarborough, Allen, and Lollar had purchased in June 1971 from Lerman. Significantly, Yarborough, Allen and Lollar had learned of the availability of the machinery due to their representation of Fyr-Pruf in negotiations with Lerman. At the time of the purchase for Bondafoam, the equipment was essential to Fyr-Pruf's expectation of tooling up a new plant. The evidence suggests the appellees who organized Bondafoam and purchased the equipment in St. Louis did so surreptitiously, with the purpose of excluding appellants from the new venture. Appellants insist that it was not until June 1971, long after the appellees had become interested in forming Bondafoam, that they acknowledged Fyr-Pruf had become unprofitable.

The evidence concerning the financial ability of Fyr-Pruf to secure the Water Valley lease and the equipment conflicted. Assuming the March 31, 1971, audited financial statement was prepared in accord with accepted accounting principles, we must conclude that as late as that date Fyr-Pruf's assets exceeded its liabilities, making it then solvent by balance sheet standards. Appellees dispute the accuracy of the statement, however, contending that the asset carried as "RECEIVABLE FROM STOCKHOLDERS $40,000," the debit corresponding to the $40,000 credit to the common stock account, was a sham, because Fyr-Pruf had in fact "given" the stock to appellees Fox and Yarborough. They also argue various pieces of equipment carried as assets were not in fact "owned" by Fyr-Pruf, but were possessed conditionally subject to outstanding liens.

In our opinion, the burden of showing the $40,000 accounts receivable was improperly carried as an asset rests upon the appellees. As corporate officers, they occupied fiduciary positions with Fyr-Pruf. Smith v. Mississippi Livestock Producers Ass'n, 188 So.2d 758 (Miss.1966). As fiduciaries, they must prove by clear and convincing evidence the inherent fairness of their receiving a thing of value (40,000 shares of stock) from the corporation for anything less than full and adequate consideration, measured at the time received.

Whether legal title to the equipment controlled the extent to which it could be carried as an "asset" on Fyr-Pruf's balance sheet also presents an issue. We conclude legal title, if not immaterial, is certainly not decisive, Mississippi Code Annotated section 75-9-202 (1972), even when the transaction is cast in terms of a lease-purchase option agreement. Continental Leasing Corp. v. Lebo, 217 Pa.Super. 356, 272 A.2d 193 (1970); Nickell v. Lambrecht, 29 Mich.App. 191, 185 N.W.2d 155 (1970); and United Rental Equipment Co. v. Potts & Callahan Contracting Co., 231 Md. 552, 191 A.2d 570 (Md.App.1963). In our opinion, the equipment represented a net asset of Fyr-Pruf to the extent its value exceeded any indebtedness secured by it. See Miss.Code Ann. § 75-9-504(2) (1972). From the abbreviated March 31 statement, we observe items, such as "N/P EQUIPMENT," ¹ suggesting that encumbrances upon the equipment were properly reflected on the face of the balance sheet.

The court below, however, after placing the burden of proving all issues by "clear and convincing" evidence upon the complainants, stated, "That Fyr-Pruf had become insolvent by May of 1971, seems to (be) a logical conclusion of fact." This determination rested upon an erroneous application of the burden of proof as well as unsound conceptions that title to the equipment was conclusive in determining whether it was an asset and that the $40,000 in stockholder receivables should have been deleted because "(t)he stock was never paid for." For these reasons the trial court's finding concerning Fyr-Pruf's financial status must be reexamined on remand.

The questions of this appeal require us to decide what a complainant alleging usurpation by a fiduciary of a "corporate opportunity" must prove to establish a prima facie case. We must also decide the character of the required proof, the precise role of financial inability of the corporation to take advantage of the opportunity, and how the fiduciary may absolve himself of liability once the complainant has established a prima facie case.

Axiomatic in our law is the proposition that corporate officers and directors, as fiduciaries, owe to their corporation the duty to exercise the utmost good faith and loyalty. American Empire Life Ins. Co. v. McAdory,319 So.2d 237 (Miss.1975); Cooper v. Mississippi Land Co., 220 So.2d 302 (Miss.1969). Fiduciaries, as Justice Cardozo put it, must be "held to something stricter than the morals of the market place," Meinhard v. Salmon,249 N.Y. 458, 164 N.E. 545, 62 A.L.R. 1 (1928).

In its sweep, Knox Glass Bottle Co. v. Underwood, 228 Miss. 699, 89 So.2d 799 (1956), holds that once a conflict of interest has been shown to exist between the pursuits of a corporation and its fiduciary the burden rests upon the fiduciary to establish ratification upon full and continuing disclosure of material facts, inherent fairness, or other circumstances tending to show discharge by the fiduciary of his duty to the corporation. Specifically, Knox holds that "self-dealing," i. e., a situation in which the corporation and its fiduciary bargain on opposite sides (lessor/lessee, seller/ buyer, etc.) of the transaction forming the basis of the suit, automatically raises a presumptive conflict of interest, thus shifting the burden to the fiduciary to justify his conduct.

Presently, we reaffirm Knox. Nevertheless, our inquiry cannot stop, because the appellants' case did not rest solely upon an allegation of self-dealing, but included an essential allegation of seizure by appellees of a business opportunity. ² We think under these circumstances a prima facie case of conflict of interest with a consequent shifting of the burden of proof to the fiduciary does not arise automatically, as it does in a case of self-dealing; but it does arise when the complainant shows by a preponderance of the evidence that the business opportunity is also a corporate opportunity in view of all the facts and circumstances surrounding the transaction.

In Miller v. Miller, 301 Minn. 207, 222 N.W.2d 71 (1974), the Court established an eclectic test for determining whether a business opportunity is a corporate one. It follows, in part:

The threshold question to be answered is whether a business opportunity presented is also a "corporate"...