Mountain Manor Realty, Inc. v. Buccheri - 55 Md. App. 185, 461 A.2d 45 (1983)

Rule:

A transaction authorized by the directors of a corporation which is otherwise fair and which serves a legitimate corporate purpose is not invalid merely because one of the motives behind it is the manipulation of control of the corporation. If manipulation for control is a primary or principal motivation for board action the transaction may be invalid.

Facts:

Mountain Manor, Inc. (MMI) was incorporated in 1974. The charter authorized 10,000 shares of $ 10 par common stock, but only 56 shares of that stock were initially issued. One of the original stockholders was Charles W. Roby, who acquired 12 shares. Minutes of a special meeting of directors held on August 19, 1974, reveal that an agreement was executed on behalf of the corporation and by the then-current stockholders which, among other things, precluded those stockholders from selling any of their stock without first offering it to the corporation. The corporation was given the option of matching any bona fide offer from a third party or paying book value, whichever was less.

In 1976, efforts of some sort were made to interest appellant, John V. Conway, in investing in MMI. In December of that year, a corporation owned and controlled by Conway, Mountain Manor Realty, Inc. (Realty), purchased the property upon which MMI operated the rehabilitation center, and on June 10, 1977, it entered into a ten-year lease with MMI. At that time, Conway had no financial interest in MMI and was not connected with its management. On July 6, 1977, Conway was elected a director of MMI. In June, 1978, he and one E. Gordon Leatherman assumed control of the company by buying out all of the stockholders except Roby. As a result of those purchases, the MMI stock was owned as follows: Conway, 22 shares; Leatherman, 22 shares; Roby, 12 shares. Leatherman managed the day-to-day affairs of the company until May, 1980, when Conway was elected president and assumed active command. Conway, Leatherman, and Roby constituted the Board of Directors. At some point, Conway became disenchanted with his investment and began to look for someone to buy his stock. In January, 1980, he signed a letter promising Roby a five percent commission if he (Roby) obtained a buyer. Through Roby, Conway was introduced to Jean Buccheri and Joseph Francus. In September, 1980, Conway agreed to sell his stock to them for $ 5,400 a share; but, because of the failure of certain conditions, the sale was not consummated. Buccheri and Conway continued their discussions but never came to terms.

Unknown to Conway, Buccheri was also negotiating with Roby and Leatherman, who previously had declined to sell their stock. On September 15, 1981, Buccheri bought Leatherman's 22 shares and Roby's 12 shares. This bit of news was communicated to Conway in a letter from Buccheri's counsel. The letter was accompanied by the resignations of Leatherman and Roby as directors and included a request that the corporate records be changed to reflect the sale and that a special meeting of stockholders be called. Conway challenged the sale of Roby's 12 shares, contending that it was in contravention of the 1974 stockholders' agreement, to which Roby was a party. He dutifully called a special stockholders meeting for October 23, 1981, however, stating in the notice that the meeting was called "for the purpose of electing directors of the Corporation and such other business as may properly come before the meeting, it being understood that the matter of ownership of the stock of the corporation will be addressed at such special meeting." In an effort to retain control of the corporation, which control he was likely to lose on October 23, Conway, without notice to Buccheri, Leatherman, or Roby, called a special meeting of directors for October 22, 1981, in Easton, Maryland. At the time, of course, by reason of the resignations of Leatherman and Roby, he was the only remaining director. He invited to this meeting his attorney and two acquaintances -- Margaret Faulstich, who had been one of MMI's initial stockholders, and William C. Widman, an insurance agent who had placed some insurance for MMI. During this meeting, Conway, as sole surviving director, elected the two as directors to fill the vacancies created by Leatherman and Roby. Conway also presented the offer made by Realty to purchase 13 shares of MMI stock at $7,000/share, to match the price paid by Buccheri for Roby’s stock. This was accepted by the newly constituted board. At the stockholders meeting the next day, which was attended by Buccheri and Roby, Conway announced first that the company did not recognize the sale of Roby's 12 shares. He then distributed copies of the minutes of the October 22 directors meeting showing the sale of the 13 shares to Realty. Purporting to vote 35 shares (his 22 and Realty's 13), Conway thereupon nominated himself, Faulstich, and Widman as directors. Counsel for Buccheri, who was also in attendance, disputed the validity of Realty's 13 shares; and, on the authority of the 34 shares owned by Buccheri, or by Buccheri and Roby, Buccheri nominated a different slate. The vote was either 35-34 in favor of Conway's slate or 34-22 in favor of the Buccheri slate, depending upon the validity of the 13 shares sold to Realty. Upon the assumption that he had won, Conway declared the meeting adjourned. However, Conway proceeded to file an action for declaratory judgment that the sale of Roby’s 12 shares to Buccheri was invalid for contravening the 1974 stockholders agreement, that the 13 shares of MMI stock were validly issued to Realty, and the corporate directors were Conway, Faulstich, and Widman. The Circuit Court granted the first prayer, but declared that the 13 shares were not legally issued to Realty and that the three were not the directors of MMI.

Issue:

Did the circuit court err in declaring the October 22 transaction to Realty as invalid?

Answer:

Yes.

Conclusion:

Firstly, with regard to the composition of the board at the time of issuance. With the resignations of Roby and Leatherman, Conway, being the only remaining director and thus necessarily "a majority of the remaining directors," had the authority under § 2-407 (a) (2) (i) and art. II, § 9 of the by-laws to fill the two vacancies, notwithstanding that under § 2-408 (b) there was the lack of a quorum. There being no challenge here to the qualifications of Faulstich and Widman, or otherwise to the procedure of their election, there was no legal impropriety in their election on October 22 as successor directors.

Secondly, with regard to the issuance of the stock. In Maryland stock issuances which have the effect of consolidating or perpetuating management control are not necessarily invalid. They are, instead, to be examined under a sort of balancing test; assuming that the transaction is legal in all other respects -- that it complies, for example, with the standards set forth in § 2-419 -- the court must look to see if there was any legitimate business purpose for the transaction other than the self-interest of the directors. If it finds such a purpose, under Cummings it would then have to determine whether that independent purpose was a primary or principal one, or whether, conversely, the primary object was merely to manipulate control. A relative motivation test, as adopted in Cummings and Heit, is, of course, inconsistent with that urged by Buccheri et al. and apparently applied by the court below. The court declared the transaction not to be in the best interest of the corporation "for the reason that the control of the corporation was manipulated by sale of the stock [by Dr. Conway] to himself without regard of [sic] a stockholders meeting to be held in a couple days . . . ." No account was taken of the collateral benefits flowing to MMI from the sale, and no finding was made as to the motivation of the three directors -- not just Conway -- who voted to accept Realty's offer. The court seemed to apply a type of "ipso facto" test -- if the result was manipulation of control, the transaction is invalid; and that is not what the Maryland law requires. The determinations required under Cummings are, to a large extent, factual ones which must be made by the trial court. The most appropriate action, therefore, would be to remand the case to the circuit court for the making of those determinations. If the court finds that the transaction was, on the whole, motivated by a legitimate corporate purpose, it should declare the sale to be valid; if it finds to the contrary -- that the purpose of the transaction was primarily one of management's self-perpetuation and that that purpose outweighed any other legitimate business purpose -- it should declare the sale to be invalid.