Nicholson v. Evans

• Decision Date: 23 February 1982
• Docket Number: Nos. 16559,16621,s. 16559
• Citation: 642 P.2d 727
• Parties: Larry NICHOLSON, Glen Bingham, Alicia Lewis, and Sorority Industries, a Nevada corporation, Plaintiffs and Appellants, v. George W. EVANS, Stanley B. Nelson, Terry E. Kay, Sorority, Inc., a Utah corporation, Aenco, Inc., a Utah corporation, and John B. Anderson, Defendants and Respondents.
• Court: Utah Supreme Court

Page 727

642 P.2d 727

Larry NICHOLSON, Glen Bingham, Alicia Lewis, and Sorority

Industries, a Nevada corporation, Plaintiffs and Appellants, v. George W. EVANS, Stanley B. Nelson, Terry E. Kay, Sorority,

Inc., a Utah corporation, Aenco, Inc., a Utah

corporation, and John B. Anderson,

Defendants and Respondents.

Nos. 16559, 16621.

Supreme Court of Utah.

Feb. 23, 1982.

Bryce E. Roe and David E. Leta, Salt Lake City, for plaintiffs and appellants.

Richard J. Leedy, R. Brent Stevens, Harold G. Christiansen, Salt Lake City, for defendants and respondents.

OAKS, Justice:

This is an action by a parent corporation and its directors against their former directors and attorney and a subsidiary corporation for damages for breach of fiduciary duty or to establish the parent corporation's continued ownership of the stock of the subsidiary, for an accounting, and for other relief. The issue on these consolidated appeals is whether the directors of a parent corporation can acquire control of its subsidiary from a pledgee of the subsidiary's stock without offering the acquisition opportunity to the parent corporation through a disinterested majority of its directors. Answering that question, in effect, in the affirmative, the district court entered judgment on a jury verdict for the defendants. We reverse.

Because some of the requested relief was equitable, this case was not entirely "triable of right by a jury," Utah R.Civ.P. 38(b). However, plaintiffs demanded a jury trial, with defendants' apparent acquiescence, and the proceedings went forward as if the entire case were being tried by jury as a matter of right. Consequently, it is appropriate for this Court to review the decisions of the judge and jury on that same basis. Utah R.Civ.P. 39(c); Willard M. Milne Investment Co. v. Cox, Utah, 580 P.2d 607 (1978); Houston Real Estate Investment Co. v. Hechler, 47 Utah 215, 152 P. 726 (1915). ¹

Even viewing the evidence in the light most favorable to the defendants, as is appropriate in reviewing the jury's verdict in this case, Mel Hardman Productions, Inc. v. Robinson, Utah, 604 P.2d 913, 917 (1979), there is no substantial basis to support the jury's special verdict that defendants did not "breach their fiduciary duty" to the parent corporation. On the basis of evidence that was essentially uncontested, plaintiffs' motions for a directed verdict or judgment notwithstanding the verdict on the issue of the parent's right to the subsidiary's stock should have been granted as a matter of law.

Viewed most favorably to the defendants, the essential facts are as follows: Sorority Industries (parent), a corporation whose stock was publicly held, was the beneficial owner of all of the stock of Sorority, Inc. (subsidiary), which was in the pie manufacturing business. This subsidiary was the parent's only valuable asset. Some of the parent's stockholders had received their stock in payment of debts owed to them by the subsidiary. Several years before the other events recited in this opinion, all of the subsidiary's stock had been pledged to a bank to secure repayment of a note whose original balance was $171,000. Both the parent and the subsidiary corporations were liable for this debt. Defendant Evans was chairman of the board of directors and chief executive officer of the parent and a member of the board and manager of the subsidiary. Defendants Nelson and Kay were members of the boards of directors and officers of the parent and the subsidiary.

In 1974 and 1975, the bank's successor in interest (creditor) brought various legal actions in the district courts in Utah seeking to collect the balance due on the note and to obtain control of the subsidiary through ownership of the stock pledged for its payment. In March, 1975, the directors of the parent advised its shareholders of the litigation and explained that the creditor would probably prevail. Financial statements of the subsidiary enclosed with this communication showed a deficit in earned surplus of $526,000 and a net stockholders' equity deficit of $35,000, as of December 28, 1974. In March, 1976, the creditor offered to settle the litigation for $70,000, payable $10,000 down and $60,000 in installments. The parent board of directors rejected the offer.

On February 3, 1977, the creditor again offered to settle for $70,000, this time payable in cash by February 14, 1977. On February 7, the parent and subsidiary boards of directors, meeting jointly, authorized Evans to attempt to procure a bank loan to settle the creditor's claim. In this same meeting, the corporation treasurer was authorized to reimburse Evans and Nelson out of corporate funds "if it becomes necessary that they have to use their personal means to protect the integrity of the company." Evans immediately approached the corporations' bank, but the bank declined to make the loan secured by the corporate properties (which had already been mortgaged to the bank). However, the bank offered to advance $50,000 to Evans and Nelson personally (secured by mortgages on their homes) if they could find another acceptable guarantor. Defendant Anderson, an attorney who had been retained to defend the parent and the subsidiary in the creditor's litigation to collect this note, agreed to serve as guarantor. The bank looked to the earnings of the subsidiary as the primary source for repayment of this loan.

On or about February 11, 1977, defendants Anderson, Evans, and Nelson formed a corporation, AENCO, Inc., of which they were the sole stockholders, each owning one-third of its outstanding stock. This corporation was admittedly formed solely for the purpose of facilitating loans and payments relating to the settlement of the creditor's claim on the note and the acquisition of the subsidiary's stock.

No further meeting was held to report to the corporations' directors on the bank's willingness to advance $50,000 to Evans and Nelson upon the receipt of security and a personal guarantee, even though the February 3d resolution of reimbursement seemed to contemplate just such an arrangement. No other bank or potential financing agency was approached to attempt to raise the $70,000 to settle the litigation. At no time during this critical period was any communication sent to advise the parent's stockholders of the imminent loss of the parent's principal asset, the pie making subsidiary, or the conditions under which it could be saved.

Since 1972, the financial condition of the subsidiary had improved steadily, until the net stockholder's equity in February, 1977, was a positive $200,000 according to Evans and $305,000 according to another defense witness. The parent corporation's stockholders were not advised of this improvement. So far as the record shows, their last information of the financial condition of the subsidiary was the March 1975 report of (1) a December 28, 1974, net equity deficit of $35,000, and (2) the fact that the creditor would probably succeed in obtaining control of the subsidiary.

Before February 14, defendants Evans, Nelson, and Anderson, acting through their corporation, AENCO, Inc., and making personal guarantees, obtained the $50,000 loan from the bank. They also removed $20,000 from the funds of the subsidiary, for the stated purpose of repaying themselves for amounts the corporation owed them individually. On February 14, 1977, AENCO gave the creditor a check for $70,000 in settlement of the litigation on the note. Defendant Evans testified that his intent at that time was to give the parent corporation the benefit of this acquisition.

On March 24, 1977, the district court, in a proceeding in which defendant Anderson appeared in behalf of the various defendants, entered an uncontested summary judgment declaring the creditor the legal and beneficial owner of the outstanding shares of the subsidiary. On March 31, 1977, AENCO, Inc., advised the subsidiary corporation that the stock that had previously been held by the creditor should be reissued in the name of AENCO, Inc.

On April 1, 1977, Evans, Nelson, and Kay resigned from the parent's board of directors. On or immediately after that date, they notified the shareholders of their resignations and of the fact that a judgment had been entered declaring the creditor the owner of all of the common stock of the subsidiary. Plaintiff Bingham, a director of the parent corporation, thereupon appointed plaintiffs Lewis and Nicholson, who were stockholders, to serve with him as interim directors. All were subsequently elected by the parent's stockholders. After failing in their efforts to regain the stock and control of the subsidiary from defendants, the plaintiff directors and the parent corporation instituted this action.

By the time of the trial of this case, in January and February, 1979, the $50,000 bank loan defendants had used to acquire the subsidiary's stock had been reduced to $15,000. All payments had been made from the earnings of the subsidiary. At trial, Evans testified that he and Nelson initially purchased the subsidiary's stock from the creditor to protect the subsidiary and its employees, and to hold the stock as security for the subsidiary's payment of the more than $100,000 it owed to Evans and Nelson, thereby securing their claims in preference to the other creditors. However, he admitted, they later assumed ownership and control of the subsidiary and declined to recognize the parent's beneficial interest in the stock and subsidiary.

The fiduciary duties of defendant Anderson, the corporations' attorney, are not before us on this appeal because Anderson settled with the plaintiffs while the trial was in progress, and by stipulation of all parties the claims against him and his counterclaims were dismissed with prejudice.

Directors and officers have a fiduciary duty of loyalty to their corporation and its stockholders. Branch v. Western Factors, Inc., 28 Utah 2d 361, 502 P.2d 570 (1972); Elggren v. Woolley, 64 Utah 183, ...