Opinion
No. 53991-8-II
05-11-2021
REAL CARRIAGE DOOR COMPANY, INC., EX. REL. Scott T. REES, Mardie A. R. Broderick and Jeremy E. Broderick, Shareholders Thereof; and Scott T. Rees, Mardie A. R. Broderick and Jeremy E. Broderick, Individually, Appellants, v. Don T. REES, Respondent.
James A. Krueger, Attorney at Law, 1201 Pacific Ave., Ste. 1900, Tacoma, WA, 98402-4315, Daniel C. Montopoli, Attorney at Law, 1201 Pacific Ave. #1900, Po Box 1315, Tacoma, WA, 98401-1315, Lucy R. Clifthorne, Vandeberg Johnson & Gandara, LLP, 1201 Pacific Ave., Ste. 1900, Tacoma, WA, 98402-4315, for Appellant. Michael M.K. Hemphill, Roberts, Johns & Hemphill, PLLC, 7525 Pioneer Way, Ste. 202, Gig Harbor, WA, 98335-1166, for Respondent.
James A. Krueger, Attorney at Law, 1201 Pacific Ave., Ste. 1900, Tacoma, WA, 98402-4315, Daniel C. Montopoli, Attorney at Law, 1201 Pacific Ave. #1900, Po Box 1315, Tacoma, WA, 98401-1315, Lucy R. Clifthorne, Vandeberg Johnson & Gandara, LLP, 1201 Pacific Ave., Ste. 1900, Tacoma, WA, 98402-4315, for Appellant.
Michael M.K. Hemphill, Roberts, Johns & Hemphill, PLLC, 7525 Pioneer Way, Ste. 202, Gig Harbor, WA, 98335-1166, for Respondent.
PART PUBLISHED OPINION
Maxa, J. ¶ 1 Scott Rees, Mardie Broderick, and Jeremy Broderick (collectively, appellants) appeal the trial court's dismissal after a bench trial of their claims against Don Rees for minority shareholder oppression, breach of fiduciary duty, and fraud.
¶ 2 Don Rees is the president, chief executive officer (CEO), and majority shareholder of Real Carriage Door Company, Inc. (RCDC), a family business. Scott and Mardie are Rees's children and Jeremy is his son-in-law. They are minority shareholders of RCDC who at one time worked for the company. When Rees filed for a divorce from his wife, the appellants sided with her and eventually terminated their employment with RCDC. Rees subsequently discontinued making dividend distributions to all shareholders and, to replace the dividends he ordinarily would have received as the majority shareholder, increased his own salary by over $1 million in the first year and over $700,000 in subsequent years.
This opinion will refer to appellants by their first name when referencing them as individuals to distinguish them from family members with the same last name. No disrespect is intended.
¶ 3 We hold that, contrary to the trial court's conclusion, under the facts of this case Rees's conduct constituted minority shareholder oppression as a matter of law and entitles the appellants to relief. In the unpublished portion of this opinion, we affirm the trial court's dismissal of the appellants’ breach of fiduciary duty and fraud claims.
¶ 4 Accordingly, we reverse in part and affirm in part the trial court's judgment dismissing the appellants’ claims, and we remand for the trial court to determine the appropriate relief for the appellants’ minority shareholder oppression claim.
FACTS
Background
¶ 5 Rees was the founder, president, and CEO of RCDC. RCDC was converted to an S corporation organization, which meant that RCDC did not pay federal income tax at the corporate level. Instead, RCDC shareholders were responsible for paying taxes on their pro rata shares of RCDC's profits. At that point, Rees owned 51 percent and his wife Beth Rees owned 49 percent of the company's shares. ¶ 6 In 2006, Beth began working for RCDC and eventually took on a human resources role. Rees later created positions in RCDC for their two adult children, Scott and Mardie, and Mardie's husband, Jeremy. Between 2010 and 2013, Rees and Beth gifted shares of RCDC stock to Scott, Mardie, and Jeremy as incentive for them to continue to work for and contribute to the success of RCDC. Rees and Beth wanted the appellants to eventually take over the business.
This opinion will refer to Beth by her first name to distinguish her from Rees. No disrespect is intended.
¶ 7 Scott owned 6 percent of RCDC's shares. He managed RCDC's website and computer needs. Mardie owned 3.1 percent of RCDC's shares. She worked in sales at RCDC, but she stopped working at RCDC in October 2009 after giving birth to her child. Jeremy owned 2.9 percent of RCDC's shares. Jeremy worked as a door drafter, in pricing, and in sales engineering at RCDC.
¶ 8 After gifting Scott, Mardie, and Jeremy their respective shares, Rees retained 51 percent and Beth retained 37 percent of RCDC's shares.
Rees Separation and Divorce
¶ 9 In March 2013, Rees and Beth separated. The appellants blamed Rees for the couple's marital problems, and the appellants’ relationships with Rees deteriorated. Rees filed for divorce in April 2014. The divorce was finalized in January 2015. As part of the divorce settlement, Rees agreed to purchase Beth's ownership interest in RCDC. After this purchase, Rees now owned 88 percent of the company's shares.
¶ 10 Scott terminated his employment at RCDC in December 2014. Jeremy terminated his employment at RCDC in January 2015. None of the appellants had any further involvement with the company after January 2015. Discontinuance of Dividends
¶ 11 Rees's and Beth's combined annual salary in the two years before 2015 was $190,000. They also received dividend distributions of $976,987 in 2013 and $1,116,257 in 2014. Before 2015, all shareholders, including the appellants, received pro rata dividend distributions on a quarterly basis. As RCDC's profits increased, the shareholders’ dividend distributions increased pro rata.
¶ 12 In 2015, RCDC – at Rees's direction – stopped distributing dividends to shareholders and began paying Rees a dramatically increased salary instead. Rees's salary was $1,213,618 in 2015, $834,562 in 2016, $973,926 in 2017, and $954,500 in 2018. In other words, instead of distributing profits to all shareholders, RCDC essentially paid those profits to Rees in the form of a salary.
¶ 13 Rees explained that the reason RCDC changed its profit distribution was because the appellants no longer worked for the company:
They had abandoned, and they had all completely left, and I was alone carrying everything; and so it didn't make sense to me to continue to pay dividends to those who were contributing nothing to the welfare and ongoing future of Real Carriage Door.
Report of Proceedings (RP) (June 19, 2019) at 52.
It was my decision that I was alone, and the minority shareholders were no longer part of the corporation in the sense that they were no longer working and contributing and making any contribution whatsoever to the corporation; and so it came to me in my business decision to not declare any dividends from the year 2015 forward and for those reasons and those reasons alone.
RP (June 19, 2019) at 68.
Complaint and Bench Trial
¶ 14 In 2018, the appellants – individually and as shareholders of RCDC – filed a lawsuit against Rees in which they asserted claims for minority shareholder oppression, breach of fiduciary duty regarding RCDC and the shareholders, and fraud. They also sought declaratory and injunctive relief. The case proceeded to a bench trial. Scott, Mardie, and Rees all testified to the facts described above.
¶ 15 The trial court issued detailed findings of fact and conclusions of law, including the following conclusions of law (which also included some factual findings):
3. Defendant Rees did not breach his fiduciary duty to the corporation and the minority shareholders. The evidence showed that the corporation's practice was to distribute profits to the Plaintiffs as salary and gifts of dividends. Not distributing gifts of dividends was a reasonable and honest exercise of the directors’ judgment and was not a breach of his fiduciary duty.
4. There was an implied agreement to pay the minority stockholders a salary and gifts of dividends only during the period of their employment and was terminated when they left the corporation.
....
6. Defendant Rees’ decision to not distribute dividends was within the power of RCDC and his authority of management. This decision was made in good faith and was reasonable.
....
8. Defendant Rees actions were business judgments. He provided reasonable explanations for his conduct which were not oppressive. The minority shareholders failed to show oppressive conduct.
....
11. The reasonable expectations for the minority shareholders were that they would receive a salary and gift distributions of shares while employed at RCDC.
Clerk's Papers (CP) at 264-65.
¶ 16 The trial court also entered conclusions of law that the appellants did not prove their minority shareholder oppression, breach of fiduciary duty, and fraud claims. Therefore, the court entered a judgment that dismissed all of the appellants’ claims with prejudice.
¶ 17 The appellants appeal the trial court's judgment.
ANALYSIS
A. STANDARD OF REVIEW
¶ 18 When reviewing a trial court's decision following a bench trial, we ask whether substantial evidence supports the trial court's findings of fact and whether those findings support the conclusions of law. Columbia State Bank v. Invicta Law Group PLLC , 199 Wash. App. 306, 319, 402 P.3d 330 (2017). Evidence is substantial if it is sufficient to persuade a rational, fair-minded person that the declared premise is true. Viking Bank v. Firgrove Commons 3, LLC , 183 Wash. App. 706, 712, 334 P.3d 116 (2014). We view the evidence and all reasonable inferences in the light most favorable to the prevailing party. Columbia State Bank , 199 Wash. App. at 319, 402 P.3d 330. On appeal, we do not review the trial court's credibility determinations. Id. Unchallenged findings of fact are treated as verities on appeal. Id.
¶ 19 Here, several of the trial court's key factual findings are included in the court's conclusions of law. If findings of fact are mischaracterized as conclusions of law, we analyze them as findings of fact. Allen v. Dan & Bill's RV Park , 6 Wash. App. 2d 349, 365, 428 P.3d 376 (2018). ¶ 20 We review the trial court's application of facts to law and the court's legal conclusions de novo. Viking Bank , 183 Wash. App. at 712, 334 P.3d 116.
B. MINORITY SHAREHOLDER OPPRESSION CLAIM
¶ 21 The appellants argue that Rees engaged in minority shareholder oppression by paying RCDC's profits to himself as a salary rather than making regular dividend distributions that would benefit all the shareholders. We agree. 1. Legal Principles
a. Duty to Minority Shareholders
¶ 22 It is a recognized principle that majority shareholders "must, at all times, exercise good faith toward the minority stockholders." Hay v. Big Bend Land Co. , 32 Wash.2d 887, 897, 204 P.2d 488 (1949).
¶ 23 The foundation of a minority shareholder oppression claim is RCW 23B.14.300(2)(b). See Scott v. Trans-System, Inc. , 148 Wash.2d 701, 708-09, 64 P.3d 1 (2003). Under that statute, trial courts have discretion to dissolve a corporation in a proceeding by a shareholder if there is proof that "[t]he directors or those in control of the corporation have acted ... in a manner that is illegal, oppressive, or fraudulent." RCW 23B.14.300(2)(b). Judicial dissolution is such an extreme remedy that it should be applied with caution. Scott , 148 Wash.2d at 708-09, 64 P.3d 1. But courts also may consider alternative remedies that are less severe than dissolution, including an award of damages to minority shareholders. Id. at 717-18, 64 P.3d 1.
¶ 24 Courts have adopted two tests for determining oppressive conduct toward minority shareholders under RCW 23B.14.300(2)(b). See Scott , 148 Wash.2d at 710-11, 64 P.3d 1. The first test, the "reasonable expectations" test, defines oppressive conduct as an act taken by the majority in violation of the minority's reasonable expectations – " ‘those spoken and unspoken understandings on which the founders of a venture rely when commencing the venture.’ " Id. at 711, 64 P.3d 1 (quoting Robblee v. Robblee , 68 Wash. App. 69, 76, 841 P.2d 1289 (1992) ). This test is most appropriate when the minority shareholder was one of the original participants in forming the corporation. Scott , 148 Wash.2d at 711, 64 P.3d 1 .
¶ 25 The second test defines oppressive conduct as " ‘burdensome, harsh and wrongful conduct; a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members; or a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.’ " Id. (quoting Gimpel v. Bolstein , 125 Misc. 2d 45, 50-51, 477 N.Y.S.2d 1014 (Sup. Ct. 1984) ). The court in Scott approved a statement that oppressive conduct also includes " ‘the plundering of a ‘close’ corporation by the siphoning off of profits by excessive salaries or bonus payments and the operation of the business for the sole benefit of the majority of the stockholders, to the detriment of the minority stockholders.’ " Scott , 148 Wash.2d at 713, 64 P.3d 1 (quoting Baker v. Commercial Body Builders, Inc. , 264 Or. 614, 629, 507 P.2d 387 (1973) ).
¶ 26 The minority shareholder bears the burden to prove oppressive conduct by a preponderance of the evidence. Scott , 148 Wash.2d at 712, 64 P.3d 1. Once the minority shareholder shows oppressive conduct, "the burden shifts to the majority shareholder ... to show there were legitimate business justifications for the conduct." Id. at 709, 64 P.3d 1. "[A]cts are not oppressive where there is a reasonable explanation for them." McCormick v. Dunn & Black, P.S. , 140 Wash. App. 873, 889, 167 P.3d 610 (2007).
b. Business Judgment Rule
¶ 27 The business judgment rule provides immunity to corporate management for a transaction that is within the corporation's power and management's authority if "there is a reasonable basis to indicate that the transaction was made in good faith." Scott , 148 Wash.2d at 709, 64 P.3d 1 ; see also RCW 23B.08.300(4). Absent "evidence of fraud, dishonesty, or incompetence," courts generally will not interfere with the judgment of corporate management. In re Spokane Concrete Prods., Inc. , 126 Wash.2d 269, 279, 892 P.2d 98 (1995). However, immunity does not apply when a corporate director or officer acts "in bad faith and with a corrupt motive." Interlake Porsche & Audi, Inc. v. Bucholz , 45 Wash. App. 502, 509, 728 P.2d 597 (1986). 2. Rees's Increased Salary in Lieu of Dividends
¶ 28 To prevail on their minority shareholder oppression claim, the appellants were required to prove the (1) Rees engaged in oppressive conduct, and (2) there was no legitimate business justification for the conduct. Scott , 148 Wash.2d at 712-13, 64 P.3d 1.
a. Oppressive Conduct
¶ 29 The appellants had the initial burden to prove oppressive conduct by a preponderance of the evidence. Scott , 148 Wash.2d at 712, 64 P.3d 1. We hold that the trial court erred in concluding that the appellants did not satisfy this burden.
¶ 30 The evidence is undisputed that in 2015, RCDC at Rees's direction (1) stopped distributing dividends to shareholders, thereby depriving them of their share of company profits; and (2) converted the dividends the shareholders would have received into a dramatically increased salary for Rees. In other words, instead of distributing profits to the shareholders as RCDC historically had done, Rees paid those profits to himself.
¶ 31 As a matter of law, this conduct was wrongful and oppressive. The Supreme Court adopted the statement that oppressive conduct includes " ‘the plundering of a ‘close’ corporation by the siphoning off of profits by excessive salaries or bonus payments and the operation of the business for the sole benefit of the majority of the stockholders, to the detriment of the minority stockholders.’ " Scott , 148 Wash.2d at 713, 64 P.3d 1 (quoting Baker , 264 Or. at 629, 507 P.2d 387 ). That is exactly what happened here. Rees's decision to increase his salary in lieu of paying dividends benefitted him by preserving his pre-2015 total compensation to the detriment of the appellants, who no longer shared in company profits.
¶ 32 Rees argues that the trial court's findings of fact support the conclusion that paying Rees a large salary in lieu of paying dividends was justified. First, the trial court found in finding of fact 20 that RCDC took this action because Rees "now either performed or oversaw the previous duties" of the appellants after they no longer were employed at RCDC. CP at 264. Rees's additional responsibilities certainly justified some increase in his salary. But nothing in the record supports a finding that because the appellants no longer were working at RCDC, Rees was justified in discontinuing the distribution of dividends and increasing his annual salary by $700,000 to $1 million.
¶ 33 Second, the trial court found in conclusion of law 3 that "[t]he evidence showed that the corporation's practice was to distribute profits to the [appellants] as salary and gifts of dividends ." CP at 264 (emphasis added). The court found in conclusion of law 4 that "[t]here was an implied agreement to pay the minority stockholders a salary and gifts of dividends only during the period of their employment and was terminated when they left the corporation." CP at 264 (emphasis added). These conclusions are factual findings, which we analyze as findings of fact. Allen , 6 Wash. App. 2d at 365, 428 P.3d 376.
¶ 34 Based on these findings of fact, the trial court concluded that "[t]he minority shareholders failed to show oppressive conduct." CP at 265. And the court concluded that the appellants failed to prove their minority shareholder oppression claim.
¶ 35 Substantial evidence does not support the factual findings supporting the trial court's dismissal of the appellants’ claims. Conclusions of law 3 and 4 refer to "gifts of dividends." CP at 264. Although Rees and Beth gifted stock, there was no evidence that the dividends paid were "gifts." In other words, the trial court failed to recognize the distinction between stock and dividends. The court correctly found that that the appellants’ "reasonable expectations" were that they would receive "gift distributions of shares while employed at RCDC." CP at 265. But as the owners of the gifted stock, the dividends the appellants received were not "gifts"; they were the appellants’ share of the company profits.
¶ 36 Regarding the implied agreement to pay dividends to the appellants during their period of employment that the trial court found in conclusion of law 4, Rees, Scott, and Mardie all testified that the appellants were gifted RCDC shares to incentivize them to continue working for RCDC. But the gift of shares is a different issue than distribution of dividends. The appellants are not claiming that Rees should have continued to gift them shares after they left the company. They are claiming that they were entitled to dividends on the gifted shares that they already owned. Further, there was no evidence that supported the finding that there was an implied agreement to distribute dividends to appellants only while they were working for RCDC. Again, the appellants certainly expected that they no longer would receive gifts of stock if RCDC did not employ them. But entitlement to dividends is a different issue.
¶ 37 We hold that the undisputed evidence that Rees paid RCDC's profits to himself instead of paying dividends establishes that the appellants proved that Rees engaged in oppressive conduct against them as minority shareholders. Substantial evidence does not support the trial court's findings that lead the court to conclude otherwise.
b. Reasonableness of Decision/Business Judgment
¶ 38 Because the appellants demonstrated oppressive conduct, the burden shifted to Rees to show "legitimate business justifications for the conduct." Scott , 148 Wash.2d at 709, 64 P.3d 1. In addition, Rees could avoid liability under the business judgment rule by showing that the dividend decision was reasonable and made in good faith. Id. We hold that the trial court erred in concluding that Rees established a reasonable, good faith reason for dramatically increasing his salary in lieu of payment of dividends.
¶ 39 The trial court concluded that Rees's decision to increase his salary in lieu of distributing dividends was reasonable and made in good faith. Specifically, the court made the following conclusions of law: (1) "[n]ot distributing gifts of dividends was a reasonable and honest exercise of the directors’ judgment," CP at 264; (2) the decision not to distribute dividends "was made in good faith and was reasonable," CP at 264; and (3) "Defendant Rees’ actions were business judgments. He provided reasonable explanations for his conduct which were not oppressive," CP at 265.
¶ 40 The only findings of fact that provided support for these conclusions were the three discussed above: finding of fact 20 and the findings of fact incorporated in conclusions of law 3 and 4. The trial court concluded that Rees's decision to pay himself a dramatically increased salary in lieu of paying dividends was reasonable because he had taken on extra responsibilities and that dividends were gifts to the minority shareholders to which they were entitled only while they worked for RCDC. However, as discussed above, finding of fact 20 does not justify increasing Rees's salary by $700,000 to $1 million. The court concluded that the decision not to distribute dividends was reasonable because dividends were merely gifts that would be paid only while the appellants were working for RCDC. However, as discussed above, substantial evidence does not support the findings in conclusions of law 3 and 4.
¶ 41 Significantly, Rees did not explain why there was a business reason for not paying dividends and how his dividend decision benefitted RCDC. Instead, he admitted that the only reason he discontinued paying dividends was because the appellants no longer worked for RCDC. He was using the payment of dividends to reward the appellants while they worked for RCDC and to not reward them when they did not. But that is not a legitimate, good faith business reason for discontinuing the distribution of dividends while simultaneously increasing his own salary. Dividends are not "bonuses" to be distributed for good performance. They are a way that the existing shareholders share in a company's profits. ¶ 42 Rees also testified that "the majority shareholders of any corporation in the United States can declare dividends or not declare dividends." RP (June 19, 2019) at 67-68. Rees may be correct that no law requires a company to make dividend distributions and that whether to distribute dividends generally is within a corporation's business judgment. See 1 F. HODGE O'NEAL & ROBERT B. THOMPSON, OPPRESSION OF MINORITY SHAREHOLDERS AND LLC MEMBERS § 3:5 (rev. 2d ed. 2011). However, there is a well-established principle that majority shareholders owe a duty of good faith to minority shareholders, Hay , 32 Wash.2d at 897, 204 P.2d 488, and Rees is incorrect that a majority shareholder simply can stop paying dividends without a valid business justification.
The appellants also argue that the testimony of RCDC's bookkeeper demonstrates that Rees acted in bad faith when he stopped making dividend distributions. However, Rees disputed that testimony, and the trial court's findings indicate that the court did not accept the bookkeeper's testimony on this issue.
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¶ 43 We hold that substantial evidence does not support the trial court's findings and therefore that those findings do not support the court's conclusions that Rees's decision to discontinue the distribution of dividends was reasonable. Instead, we hold that the undisputed evidence establishes as a matter of law that Rees's justification for paying RCDC's profits to himself instead of paying dividends – because the appellants no longer worked for RCDC – was not a legitimate business reason.
c. Summary
¶ 44 We hold that substantial evidence does not support the trial court's findings of fact and conclusions of law regarding the appellants’ minority shareholder oppression claim, and therefore that the trial court erred in dismissing that claim. We also hold as a matter of law that the appellants established their minority shareholder oppression claim.
¶ 45 There are a number of possible remedies for minority shareholder oppression, including the award of damages. Scott , 148 Wash.2d at 717-18, 64 P.3d 1. We remand for the trial court to determine the appropriate remedy.
CONCLUSION
¶ 46 We reverse in part and affirm in part the trial court's judgment dismissing the appellants’ claims, and we remand for the trial court to determine the appropriate relief for the appellants’ minority shareholder oppression claim.
¶ 47 A majority of the panel having determined that only the foregoing portion of this opinion will be printed in the Washington Appellate Reports and that the remainder shall be filed for public record in accordance with RCW 2.06.040, it is so ordered.
We concur:
SUTTON, J.
GLASGOW, A.C.J.