Fulton v. Callahan

• Decision Date: 16 April 1993
• Parties: Thomas W. FULTON, et al. v. H.L. CALLAHAN. 1910611.
• Court: Alabama Supreme Court

Page 1235

621 So.2d 1235

Thomas W. FULTON, et al. v. H.L. CALLAHAN.

1910611.

Supreme Court of Alabama.

April 16, 1993.

Rehearing Denied June 4, 1993.

Brock B. Gordon, E. Watson Smith and Alan C. Christian of Johnstone, Adams, Bailey, Gordon and Harris, Mobile, for appellants.

Jerry A. McDowell and David R. Quittmeyer of Hand, Arendall, Bedsole, Greaves & Johnston, Mobile, for appellee.

ALMON, Justice.

The individual defendants, majority shareholders and directors of The Finch Companies, Inc. ("the corporation"), appeal from a judgment awarding the plaintiff, H.L. "Sonny" Callahan, a minority shareholder and director, $3,927,500 in compensatory and punitive damages and appointing a receiver and a new board of directors. The defendants were the corporation and the appellants Thomas W. Fulton, Daniel R. Fulton, Samuel C. Fulton, and Elizabeth J. ("Betty Jo") Fulton. Betty Jo is the daughter of Thomas W. Finch, founder of the warehousing and transfer business that became The Finch Companies, Inc., in 1985. She is the wife of Samuel C. Fulton; Thomas W. Fulton and Daniel R. Fulton are their two sons. Sonny Callahan and Betty Jo Fulton are first cousins.

All of the Fultons are members of the board of directors of the corporation. Together they own 51% of the outstanding shares. Sonny Callahan and his son Scott Callahan are both directors; together they own 49% of the shares. ¹

Callahan brought an action for compensatory and punitive damages, alleging negligent and wanton breach of fiduciary duty and conspiracy to commit these alleged wrongs. Callahan also sought compensatory and punitive damages for intentional depreciation of the company's stock in violation of § 10-2A-71, Alabama Code 1975. In addition, Callahan sought an injunction, a declaratory judgment, an accounting concerning Callahan's "advance account," and the appointment of a receiver pursuant to § 10-2A-195, Alabama Code 1975. The corporation counterclaimed, alleging that Callahan was liable to the corporation for the unpaid amount of $399,650.50 on an advance account. ²

The jury returned a verdict in favor of Callahan, awarding him $2,927,500 in compensatory damages and $1,000,000 in punitive damages. After entering a judgment on the verdict, the trial court considered Callahan's equitable claims. After adopting the jury's advisory findings that the Fultons' conduct had been oppressive and that the Fultons had misapplied and wasted the corporate assets and after making its own finding of a breakdown of the corporate "entente cordiale," ³ the trial court held that Callahan was entitled to equitable relief. The trial court removed the existing board of directors, appointed a receiver and a new board of directors to manage the corporation, and ordered the new board to submit a plan of liquidation.

ISSUES

The Fultons raise a number of issues on appeal, including whether the evidence was sufficient to support a claim of intentional stock depreciation as defined in § 10-2A-71, whether the court erred in denying the motion for new trial on the ground of juror misconduct, and whether the court properly awarded equitable relief.

FACTS

This litigation stems from a dispute between majority and minority shareholders of a closely held family corporation. Because sufficiency of the evidence is at issue, a detailed factual statement is necessary.

The Mobile warehousing and moving business that became The Finch Companies, Inc., was founded as a proprietorship in 1933 by Thomas W. Finch. Thomas W. Finch was Betty Jo's father and Callahan's uncle. In 1957 Mr. Finch incorporated his business, forming two corporations: Finch Realty Company and Finch Warehouse and Transfer Company, Inc. The former owned the real estate; the latter operated the business. When Callahan was 13 years old, he came to live with Thomas W. Finch and his wife, who reared him as a son. Thus, although they were cousins, the relationship of Callahan and Betty Jo was more like that of brother and sister. As they were growing up, both Betty Jo and Callahan worked in the family business. After graduating from high school and spending two years in the United States Navy, Callahan returned and began working in the business as a dispatcher.

In 1964 Mr. Finch died. Callahan, who at the time of Mr. Finch's death was assistant vice president, became president and chief executive officer of both corporations. During Callahan's presidency the business was successful and grew. Operations expanded to Montgomery and Birmingham. Between 1964 and 1985, five new warehouses were built or acquired, increasing the amount of warehousing space used in the business from 50,000 square feet to 650,000 square feet. Callahan also formed two new corporations: Great Southern Corporation and Furniture Leasing Concepts, Inc.

During these years, Callahan and the Fultons established two practices. First was the annual distribution of substantially all the earnings and profits of the business. Because the shareholders were also employees, these distributions took the form of salaries and bonuses. The purpose of this arrangement was to avoid the disadvantageous tax consequences of distributing the earnings and profits of the business to the shareholders in the form of dividends. Second was the practice of maintaining "advance accounts" for directors and officers. Before 1985, Callahan, Betty Jo, Mrs. Finch, and Samuel Fulton (Betty Jo's husband) each maintained draw or advance accounts. These accounts allowed them to withdraw money during the year. At the end of the year, the accounts would be credited with whatever bonuses were declared. If such bonuses were insufficient to cover the advance account, then the negative balance was carried over to the next year.

In 1984 Callahan was elected to the United States House of Representatives. Because of strict limits on outside earned income imposed by ethics rules of the House of Representatives, Callahan proposed that the business reorganize and become a Subchapter S Corporation. The Fultons agreed, and four corporations (Finch Realty Corporation, Finch Warehousing and Transfer Company, Inc., Great Southern Corporation, and Furniture Leasing Concepts, Inc.) were consolidated into one corporation called The Finch Companies, Inc. The Callahans and the Fultons elected to make the new corporation a Subchapter S corporation. Unlike a Subchapter C corporation, corporate earnings in an S-corporation pass through and are taxed directly to the shareholders at individual rates. Shareholders of an S-Corporation are taxed on their proportionate shares of the corporation's earnings, regardless of whether the directors declare any dividends. Thus, under this new arrangement Callahan would receive unearned income from the business in the form of dividends taxed to him but not to the corporation.

As part of an agreement between the Callahans and the Fultons, Callahan stepped down, and Betty Jo's son Thomas W. Fulton ("Thomas") became president of the newly consolidated corporation. The parties agreed that the Fultons would hold a 51% majority of all the shares of the corporation and that the Callahans would hold 49%. The Fultons and the Callahans also agreed to require Callahan's approval for any capital expenditure in excess of $5,000. Other aspects of the agreement, however, were disputed at trial. Callahan testified that he and Betty Jo orally agreed that each year all the earnings and profits of the corporation would be distributed as dividends to the shareholders. Betty Jo denied any such agreement. Undisputed, however, was testimony showing that all of the corporation's profits for 1985, 1986, and 1987 were distributed automatically without formal action on the part of the board of directors.

During the first three years that followed the consolidation, relations between Callahan and the Fultons were generally amicable. These were the most profitable years the business had ever known. In a January 1988 board meeting, Thomas proposed that the business expand from warehousing and local drayage into long-haul freight. After reviewing earnings projections prepared and presented by Thomas at the February 1988 meeting, the board unanimously approved the plan. Based on his own investigation and consultation with others in the long-haul freight business, Thomas estimated that with five tractors and eight trailers, the trucking division would generate first-year earnings of $37,599. Although initially opposed to the idea Callahan voted in favor of the proposal after receiving assurances from Thomas that losses would not exceed $50,000. Thomas also agreed in January 1988 that if the venture did not succeed, he would shut it down.

After the decision in 1988 to enter the long-haul freight business, relations between Callahan and the Fultons began to deteriorate, along with the financial strength of the business. Losses from the trucking division mounted. Callahan continued his practice of taking large withdrawals on his advance account, and Callahan and the Fultons initiated difficult negotiations for the buy-out of Callahan's shares.

Contrary to Thomas's projections, the plan to enter the long-haul freight business turned out disastrously. From the beginning, the trucking division suffered heavy losses. By April 1989, after 10 months of operation, the trucking division had lost $77,449. Notwithstanding such losses, in 1989 Thomas leased 20 more trucks and additional trailers.

By the end of 1989 the trucking division had lost $300,000. In a business plan prepared by Thomas and presented to the board in February 1990, Thomas projected, based on 1989 information, that the trucking division would have net profits of $88,612 in 1990, $148,000 in 1991, and $213,000 in 1992. The division, however, lost approximately $300,000 in 1990. At trial, Thomas testified that he expected the division to lose around the same amount in 1991. By September 1991, after roughly three years of operation,...