Montgomery v. Hughes Developers, Inc.

• Decision Date: 06 June 2003
• Citation: 873 So.2d 1109
• Parties: Mays E. MONTGOMERY v. HUGHES DEVELOPERS, INC.
• Court: Alabama Supreme Court

873 So.2d 1109

Mays E. MONTGOMERY v. HUGHES DEVELOPERS, INC.

1002059.

Supreme Court of Alabama.

June 6, 2003.

Rehearing Denied August 29, 2003.

J. Robert Miller, Huntsville, for appellant.

Robert V. Rodgers of Wilmer & Lee, P.A., Huntsville, for appellee.

HOUSTON, Justice.¹

The plaintiff, Mays E. Montgomery, appeals from the judgment of the trial court finding that Montgomery could not recover from the defendant corporation, Hughes Developers, Inc. ("Hughes"), for its issuance of a spurious stock certificate, which Montgomery took as collateral to secure a personal loan he made to the president of Hughes Developers. We affirm in part, reverse in part, and remand.

I. Facts

On May 20, 1991, Mays E. Montgomery lent Morris W. Frank $100,000; to secure that loan Frank executed a promissory note, which contained a notation stating that "(5%) 50 shares of Hughes Developers, Inc. to be assigned as additional collateral." In accordance with this notation, Montgomery received as collateral from Frank "Stock Certificate No. 8" of Hughes representing 50 shares of stock ("the certificate"), together with an "Irrevocable Stock or Bond Power" signed by Frank. The certificate had been issued to Morris Frank on May 1, 1991. The certificate bore the corporate seal and was signed twice by Morris Frank in his corporate capacities as president and secretary of Hughes. In 1994, Montgomery lent Frank an additional $50,000, which was secured by the same 50 shares of stock. Frank paid interest on the note and executed a renewal note each year until 1997.²

Hughes was incorporated in Madison County, Alabama, in 1989. The articles of incorporation list Frank as one of two original incorporators and as one of the initial directors of the corporation. The articles limited the number of authorized shares to 1,000.

It is undisputed that, at the time of the original loan, Frank served as president, secretary, and operating officer of Hughes. All stock certificates issued by Hughes that could be located had been signed by Frank, as issuing agent, on behalf of the corporation, including stock Hughes had issued to him. No other authorized issuing agent was identified by Hughes at trial; indeed, no other signature, besides Frank's, appears on any of the admittedly valid stock certificates issued by Hughes. While there were at least three other shareholders in Hughes, the operation of Hughes, with few exceptions, appears to have been controlled solely by Frank.

In 1997, Frank ceased making any payments on the note. After Frank's death in 1998, Montgomery requested that Hughes transfer into his name the certificate Montgomery had received as collateral for his loan to Frank. Gregory D. Gray, a shareholder of Hughes, who became president and a director of the corporation following Frank's death, denied Montgomery's request to transfer the certificate representing 50 shares of stock to Montgomery because the 50 shares of stock represented by the certificate were in excess of the total number of shares authorized by the articles of incorporation and the certificate representing the 50 shares was therefore void.

Montgomery sued Hughes and Gray, seeking the following relief:

"COUNT I

". . . .

"9. That [Montgomery] be granted a Judgment against Hughes for the sum of $150,000.00, interest and attorney fees, which will extinguish the debt owed Montgomery, and upon payment of the same that Montgomery be ordered to deliver unto Hughes the stock assigned by Frank to Montgomery.

"COUNT II

". . . .

"10. [Montgomery] moves that the Court order and direct the stock certificate of Hughes which is in the possession of Montgomery, being 50 shares of Hughes, be transferred and reissued by Hughes to Montgomery, and the stock of Hughes be structured to allow Montgomery to own 5% of the total number of shares of common stock of Hughes Developers, Inc. which will have the effect of having Montgomery being the owner of 5% of Hughes Developers, Inc.

"COUNT III

". . . .

"11. That in the event [Montgomery] is mistaken for the relief moved for, [Montgomery] moves for such further and different relief as may be meet and proper."

Before trial, Gray was dismissed from the action. Montgomery has not appealed that dismissal.

At trial, Hughes alleged that the 50 shares of stock held by Montgomery were spurious; that those shares exceeded the authorized capital stock of the corporation; that the excess stock was unauthorized by the corporation; and that the corporation had received no consideration for the pledge of stock to Frank.

Also at trial, Montgomery's counsel attempted to clarify his claim for relief against Hughes as stated in count I of his complaint, stating that the claim was based on the certificate, and not on the personal note signed by Frank:

"THE COURT: You have got another action in which you're essentially attempting to have the corporation made responsible for the loan and I noted that the notes—none of the notes were signed in the capacity as president of the corporation and, I guess, I am sitting here while you go through all wondering if you are trying to perform the note or establish some kind of apparent authority to execute a note on behalf of the corporation, to make the corporation—

"[Montgomery's counsel]: No, sir, not in any way whatsoever. What I am trying to show is that—is that there has been a defense asserted that this stock is not valid, that it is not proper stock, that, number one, that it is fraudulent—his answer says it is a fraud, his answer states all of these things. We contend that we will show by the evidence and by the actions of Morris Frank that he had total, complete, unqualified control of this corporation and could do anything he wanted to and I contend that that is the evidence and that is what the totality of all of this is.

"THE COURT: So you are not maintaining your claim then that the corporation is responsible for the 100—

"[Montgomery's counsel]: No, sir, there are some cases, though, that seem to indicate that if a person who has been given apparent authority goes out and he does issue some type of fraudulent stock, let us say that, but yet the corporation clothed him with the authority to do things of that nature, then the corporation might be liable for a judgment, but as far as executing a note and saying the corporation is responsible, no, I am not doing that.

"THE COURT: So then if I understand you then, you are not still maintaining a claim against the corporation for $150,000 plus interest judgement on the grounds that when Mr. Frank signed, he signed on behalf of the corporation?

"[Montgomery's counsel]: I am not saying he signed on behalf of the corporation, but if the corporation gave him the authority to go out and issue stock and sell land and do anything he wanted to as a—just a personal corporation, and he goes out and he issues stock, then, in my opinion, they would be barred from that and even though they might not honor the stock, there are some cases which hold they are required to pay off."

Following the hearing, Montgomery also presented written arguments to the trial court in which he argued that even if the trial court found that the 50 shares represented an overissue of Hughes's stock, the overissue provision of Article 8 of Alabama's Uniform Commercial Code justified the recovery requested in count I of his complaint.

After an ore tenus hearing the trial court found as follows: "The stock Certificate Number 8 purportedly issued by the defendant corporation to Morris W. Frank, in which the plaintiff claims a security interest, was an overissue of stock unauthorized by the corporation." The trial court concluded:

"Therefore, the Certificate Number 8, and the shares it purports to represent, are void. As the plaintiff cannot hold a valid security interest in a void instrument, plaintiff's claim for relief in Count II for an order directing the defendant corporation to issue him a stock certificate declaring his ownership of 50 shares of stock in, or 5% ownership of, the defendant corporation is denied."

The trial court also found:

"The debt owed the plaintiff was incurred by Morris W. Frank personally. It was not the debt of, and was not guaranteed by, the defendant corporation. Therefore, plaintiff's claim for relief in Count I is denied."

The trial court further summarily denied "all other claims." Montgomery appealed.

II. Analysis

Accepting the trial court's findings of fact as true, as we must, we agree that because the stock was an overissue, the 50 shares of stock represented by the certificate are void.³ "It is a well-established principle that any issue of stock by a corporation in excess of the amount prescribed or limited by its charter is ultra vires, and the stock so issued is void, even in the hands of a bona fide purchaser for value." Crawford v. Twin City Oil Co., 216 Ala. 216, 218, 113 So. 61, 63 (1927). The adoption of Article 8 of Alabama's Uniform Commercial Code codified this established principle of corporation law that an overissue of stock is illegal, and the provisions in Article 8 for validating a security or requiring its issue or reissue are drafted so as to avoid an overissue. Consequently, the person who claims to be the holder of a security that is defective because it is an overissue, is left without a valid security. Therefore, the trial court, in the present action, correctly determined that Montgomery was not entitled to an order compelling Hughes to transfer the stock to Montgomery, and that portion of the judgment is due to be affirmed.

However, despite the well-established rule that stock that represents an overissue is void, even in the hands of a bona fide purchaser for value, it is equally well established that the bona fide purchaser has a right to recover damages from an issuer who has permitted an overissue to occur. This right of recovery was traced by the Court of Appeals of New York, writing in 1865, to an eighteenth century ...