Willis v. Donnelly

Decision Date19 June 2003
Docket NumberNo. 14-00-00569-CV.,14-00-00569-CV.
Citation118 S.W.3d 10
PartiesMichael T. WILLIS, Francie Willis, Willis Hite Enterprises, Inc., and Urban Retreat of Houston, Inc., Appellants, v. Dan DONNELLY, Appellee and Cross-Appellant, v. Michael T. Willis, Cross-Appellee.
CourtTexas Court of Appeals

Billy Shepherd, Houston, for appellants.

Jeff Nobles, Michael H. Norman, Houston, for appellees.

Panel consists of Justices YATES, SEYMORE, and GUZMAN.



This is a double appeal involving shareholders' ownership of two closely held corporations, breach of fiduciary duty, breach of contract, and attorney's fees.

In the first appeal, consisting of 37 issues (some overlapping and some containing numerous subparts), Michael T. Willis, Francie Willis, Urban Retreat of Houston, Inc., and Willis Hite Enterprises, Inc. seek reversal of a judgment awarding Dan Donnelly $1.7 million for breach of contract, $1.7 million for breach of fiduciary duty, and a constructive trust on Urban Retreat stock and realty. First, we reverse and remand the breach of contract claim as more specifically delineated in this opinion because the trial court submitted an improper measure of damages. Because liability was contested, we may not reverse solely for a new trial on damages. Second, we affirm the judgment for breach of fiduciary duty. However, because the constructive trust partially provides a double recovery for breach of fiduciary duty and partially secures damages for breach of contract, which we are reversing and remanding, we remand for an election of remedies pertaining to breach of fiduciary duty and reverse that portion of the constructive trust relating to breach of contract.

In the second appeal, Dan Donnelly contends that the trial court erroneously awarded $400,000 in attorney's fees in connection with his $26,982.58 default on a loan made to him by Mike Willis. We reverse and remand for a determination of properly segregated and reasonable attorney's fees incurred in prosecuting the defaulted loan.

A. Urban Retreat

Urban Retreat, a Houston day spa, had its genesis in 1989 through the planning of its visionary, Mike Willis, a Houston businessman. He and a hired consultant, Richard Hite, located a site for the spa adjacent to an exclusive neighborhood, negotiated a lease for the property, and obtained a loan to renovate the facility. Willis also formed two corporations, Urban Retreat of Houston, Inc. (the day spa, hereinafter "URB") and Willis Hite Enterprises, Inc. (envisioned as a management business for a chain of spas, hereinafter "WHE").1

Having created the shell of Urban Retreat, Willis needed only to find staff and clientele. To this end, Hite approached Dan Donnelly, a popular hairstylist and president of an established local salon. Willis and Hite suggested that Donnelly could transfer his clientele and staff to the soon-to-open day spa. Donnelly would manage the spa, continue his hairstyling business, and strive to increase business. In exchange, if certain longevity or gross revenue goals were met, Donnelly would gain ownership in URB and WHE, an increase in salary, and a seat on WHE's board of directors. Willis personally assured Donnelly that he would provide the financial backing for the business.

Donnelly executed a Letter Agreement on July 10, 1989, which set forth the levels of URB and WHE stock ownership and salary he would attain over the years: (1) 25% URB stock and 10% of WHE stock after 12 months' employment or when the spa's gross revenues equaled those made in Donnelly's salon the prior year; (2) annual increases of URB stock, up to 50%, contingent on yearly half-million-dollar gains in gross revenues; (3) $110,000 salary for two years; and (4) five percent of gross revenues as salary in year three and beyond. The Letter Agreement also provided each shareholder the right of first refusal to purchase another shareholder's stock. Further, it set forth the value of Donnelly's shares should his employment terminate: the greater of two times earnings in the prior year or assets minus liabilities.

Donnelly transferred his profitable business to URB, bringing several hairstylists, manicurists, and other salon personnel with him. URB held its grand opening in mid-December 1989. The gross revenues soon surpassed those of Donnelly's previous salon.

However, Urban Retreat's costs were great, and the construction expense had exceeded projections. Further, Willis and one other minimal shareholder had provided only $1,000 as capital contribution. The $800,000 construction loan was in URB's name, although Willis provided a $600,000 certificate of deposit as collateral. Additionally, although Willis personally transferred almost $297,000 to URB, he listed it as a loan instead of capital contribution.2 Thus, just six weeks after its grand opening, URB was over $1,000,000 in debt.

Willis quickly recognized the need to "stop the bleeding." There is evidence that he proposed suspending Hite's $7,000 a month salary even before the grand opening. He also considered transferring Hite's employment to WHE instead of URB. In early 1990, Hite left Urban Retreat.3 On January 1, 1990, just two weeks after the spa opening, the minimal shareholder transferred his 100 shares to Willis, leaving Willis the sole shareholder of URB's 1,000 issued shares.4 In April 1990, Willis hired a second consultant as URB's "non-operating chief financial officer." Willis promised to sell this man 25% of URB stock for $1 after Willis's "capital investment" had been repaid.

Nonetheless, URB continued to lose money. Willis was thus faced with a financial quandary: he had personally guaranteed URB's $14,000 a month lease, pledged his $600,000 CD as collateral for the construction loan, and invested $540,500 of cash by December 31, 1990. If URB did not meet its outside financial obligations, Willis would personally lose a large amount of money. The Letter Agreement with Donnelly added to the financial quagmire. It prevented Willis from firing Donnelly within the first 12 months of business, except for gross misconduct. It also guaranteed Donnelly's stock ownership at the 12-month mark because gross revenues were on track. After 12 months, Willis could fire Donnelly and his shares would be worthless under the Termination provision of the Letter Agreement. However, Donnelly was by far the greatest revenue producer in the spa.

In March 1991 (after Donnelly met revenue goals ensuring him 25% URB stock and 10% WHE stock), Willis sought to change Donnelly's status. Willis was no longer willing to provide 100% of the financing unless he was still "100% owner." He wanted Donnelly to "step up" and "act like an owner." Legal documents were prepared, but never signed, capping Donnelly's ownership at 25% of URB stock and rescinding the Letter Agreement. Willis also wanted Donnelly to assume some of the debt, but Donnelly declined to do so.

Certainly, it made good business sense for Willis to minimize his potential losses and work towards profitability. However, Willis then continued to control Urban Retreat in disregard of Donnelly throughout the years. He rationalized that Donnelly had relinquished ownership when he refused to "act like an owner." When Donnelly asked about stock issuance, Willis would assure him that he intended to live up to the Letter Agreement, but asked to delay until the business "turned the corner." At the same time, Willis continued to use URB as a wholly-owned, sub-chapter S-corporation for tax benefits. Willis also unilaterally cut Donnelly's salary5 in March 1992, supposedly temporarily, and diminished his management responsibilities. Willis continued to make "loans" to URB although there is no evidence such loans were approved by the board of directors.6

Additionally, Willis controlled Urban Retreat through his wife, Francie. He supposedly transferred all of his URB stock to her. A "unanimous consent of the board" was prepared in March 1991, but never signed, reflecting URB's permission for Francie to convey to Willis a beneficial interest in URB's option to buy its realty. Then, on July 30, 1992, Willis and Francie personally purchased the URB realty for $1.6 million. On that day, Francie, acting as president, signed a waiver of URB's option. Included in the waiver was the statement that a "third party" wished to buy the realty and that "said third party has required a release" of URB's option. One week after closing, the Willises amended URB's lease, increasing its total rent over the lease term by $280,000. URB's monthly rent of $14,000 remained the same, though the Willises' monthly note was then only $10,800. Further, in the new lease, the Willises obligated URB to pay the property taxes. Finally, in March 1993, Francie signed a promissory note on behalf of URB, documenting that it owed her husband $1,897,896 in loans.7

Over these years, Donnelly's personal hairstyling revenues had increased, as did the overall gross revenues of the spa. In fact, every revenue goal in the Letter Agreement was met. Each time he asked about his stock, Willis would assure Donnelly that he would live up to the agreement. Finally, in late November 1994, Francie learned that Donnelly was helping a friend plan a new day spa. When she learned of this, she asked Donnelly to leave Urban Retreat.

B. Loans to Donnelly

In January 1992, Donnelly asked Willis to borrow $18,000. He signed a promissory note for that amount at eight percent annual interest, to be repaid $500 a month from Donnelly's paychecks. On July 1, 1993, Willis loaned Donnelly an additional $20,000. He rolled the previous note into the second, for a total principal of $31,183.70, at eight percent annual interest, to be repaid from Donnelly's paychecks. The entire amount would become due if Donnelly's employment at URB terminated. After November 1994, Donnelly stopped...

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