Independent Distributors, Inc. v. Katz

BISHOP, Judge. Appellees, Joseph J. Katz (“Katz”) and Ernestine K. Feldman Wiesenfeld (“Wiesenfeld”), and other minority shareholders of Independent Distributors, Inc., formerly known as The Zamoiski Co. (the “Company”), filed a complaint in the Circuit Court for Baltimore City against appellants—the Company, the Waterview Land Co. Limited Partnership (the “Partnership”), and nine individuals who were shareholders, directors, or officers of the Company and partners in the Partnership. The trial court dismissed all of the plaintiffs from the case except Katz and Wiesenfeld. The court then held a bench trial on Katz and Wiesenfeld’s shareholder derivative claim, which challenged certain transactions undertaken in 1984 and 1985.

The trial court found that appellants, other than the Company, usurped a corporate opportunity of the Company and ordered “the appointment of a master/auditor to prepare an account to be stated on the aforesaid determination of right and to advise the Court on other appropriate remedies.” Appellants filed a timely notice of appeal to this Court pursuant to Md.Cts. & Jud.Proc.Code Ann. § 12-303(3)(vi) (1989). Issue Appellants present the following question: “When the only evidence shows that a transaction between a Maryland corporation and its directors was fair to the corporation, may the minority stockholders set aside the transaction even when ⁴⁴⁴ they have made no effort and offered no evidence to show the transaction to be unfair?” Facts In its memorandum opinion and order, the trial court provided a concise and cogent statement of the facts of this, and a related, action. That statement of facts, which the parties do not challenge, shall serve as the basis for ours, but at times, we shall add additional facts from the record, particularly with respect to the expert testimony of Ronald Lipman. Joseph M. Zamoiski founded the Company.

After the deaths of Mr. Zamoiski and his wife, ownership of the Company’s stock was divided equally between Calman J. Zamoiski, Sr. and Irene Zamoiski Katz, the founder’s children. Over the years, disputes arose between the Zamoiski family and the Katz family as to the proper management of the Company. At the same time, the Zamoiski family acquired a greater percentage of the Company stock than the Katz family. Years of disagreement and distrust have fueled a family feud, the battles of which have been waged in the court system for over a quarter of a century.

Despite the ongoing feud, the Company remains a family-owned business. Presently, the Zamoiski family owns approximately seventy-one percent of outstanding shares of the Company’s common and preferred stock; the Katz family owns the remaining outstanding shares. A. The 1967 Suit The Katz family shareholders initiated an action in 1967 against the Company and some of the Zamoiski family shareholders pursuant to the Company’s April 1967 recapitalization plan, which called for an exchange of one class of stock for several new classes of stock, with different options allowed to various shareholder groups. The Katz family invoked their statutory appraisal rights in order to determine the fair market value of their holdings so that payment for the stock could be sought from the Company.

Following some initial pleadings, the suit lay dormant for many years, neither side requesting a trial or a dismissal of the action. Prompted by ⁴⁴⁵ the 1985 filing of the case sub judice, the Company and Calman J. Zamoiski, Jr. (“Caiman, Jr”), two of the defendants in the 1967 action, filed a motion to stay the proceedings and a counterclaim for declaratory judgment in the 1967 case. The circuit court dismissed the 1967 complaint, but retained the counterclaim. B. The Present Action In the instant case, the appellees alleged a breach of fiduciary duty by the Zamoiski family shareholders, who control the management of the Company by virtue of their majority stock ownership.

Specifically, the appellees objected to a 1984-85 transaction under which the Company leased the land on which it built its office/warehouse complex from the Partnership, a limited partnership the Zamoiski family formed in order to purchase the real property on which the complex was developed. The parties disputed whether members of the Company’s board of directors and Company officers, who participated individually in the limited partnership, usurped a business opportunity that properly belonged to the Company. The appellants defended by arguing that the transaction did not give rise to a corporate opportunity, that their actions were protected from judicial review by statute, and that the transaction was fair and reasonable to the Company. C. Ths Waterview Transaction Prior to 1984, the Company operated out of facilities in West Baltimore and in Landover, Maryland; however, by 1984, the Landover facility had been condemned by the Washington Area Metropolitan Transit Authority as a part of the District of Columbia Metro project.

Because it wanted to centralize its operations, the Company decided to dispose of its existing West Baltimore facility and consolidate its operations into a new, larger facility in the Baltimore area. Officials of Baltimore City (the “City”) became aware of the Company’s situation and suggested that the Company consider relocating to the Waterview area of the City because it is part of an enterprise zone in an urban renewal area. The ⁴⁴⁶ Company agreed to relocate to the Waterview area after the City agreed to provide favorable financing terms in the form of industrial revenue bonds (“IKB’s”) and an urban development grant (“UDAG”). 1. Advice of counsel and accountants After reviewing the proposed transaction with accountants, the Company outlined several important objectives to be met, including: (1) a tax-free exchange of property under § 1031 of the Internal Revenue Code; (2) minimization of financing costs; (3) minimal impact on the Company’s financial statements; and, (4) maximization of financial and tax benefits to the Company’s shareholders.

The remaining issue was how to structure the deal in order to achieve, the Company’s objectives. ■ In a memorandum written in the early stages of the project, Tom Byers, an accountant for the Company, outlined the highlights and objectives of the transaction and pointed out potential exposures. One of these objectives was to have the CEO of the Company, “Buddy Zamoiski [Caiman, Jr.] (via a partnership vehicle) own a ‘part’ of the new facility and lease it to [the Company] in order to personally benefit from the tax advantages of real estate ownership.” On August 2, 1984, Bennett Goldstein, the Company’s outside accountant, and William Kitchel, the Company’s financial officer, prepared a joint memorandum discussing the proposed transaction. One of the objectives stressed in the memorandum was maximization of the financial benefits that would pass through or accrue to the Company’s shareholders. A handwritten note appended to this objective indicated that this was “not to [the] detriment of [the] Company.” The authors of the memorandum expressed a preference that the transactions take place at the corporate level.

They pointed out that appreciation of the real estate over an extended period of time may be one of three conceivable benefits to the shareholders. The memorandum concluded by outlining open questions, including: (a) “[h]ow much of the transaction should be struc ⁴⁴⁷ tured at a partnership level” and (b) “[w]hat considerations shall be given to dissenting shareholders.” The Company referred those and other questions to Mr. Goldstein and Jack Merriman of Weinberg and Green, counsel to the Company. At a conference on August 18, 1984, the suggestion was made that a joint venture be formed with the Company, and a discussion followed as to what portion of the joint venture should be owned by the Company and what portion should be owned by individuals. In that context, the problem of minority shareholders’ rights was. raised and the conferees noted that the problem was “that minority [shareholders] all will want at least their proportion of [the joint venture].” Mr. Merriman noted that if there was a partnership formed without the Katz family participating and “they successfully attack it, what impact?” The answer noted was “Just back to place we started if [the Company] held it.” On August 22, Messrs.

Goldstein and Merriman conferred. At that time, a suggestion was made that, although the City was to convey the land to the Company, the Company should swap that land to the Partnership as a capital item. Then the Partnership would either lease the land from the Company or purchase the land in an installment purchase. The notes from that meeting also indicate that Caiman, Jr. was planning to place into the Partnership key management officials from the Company.

It was also contemplated that the percentage ownership of each partner would be limited by the amount of tax shelter that was usable by the partners. On August 27, 1984, Mr. Merriman advised Company officials that the building should be kept in the Company until the “turn over period or debt/equity ratio benefit” was really needed, then to “do [a] sale [and] leaseback (not necessarily with family [partnership] being buyer).” In September 1984, the plan proposed to maximize benefits to individual shareholders was to allow the Zamoiski family, but not the Katz family, to acquire a direct interest in the project. The Company was to transfer ownership of the land to a joint venture made up thirty percent by a subsidiary of ⁴⁴⁸ the Company and seventy percent by the Zamoiski family shareholders. On September 6, however, Mr. Goldstein wrote a letter bringing to the attention of Company management that the Company would be foregoing substantial tax benefits if it permitted a partnership (that included individuals who could not make use of the tax benefits) to own the property.

He concluded by stating his opinion that “this transaction best be carried out by the [Company].” Similarly, on September 7, Mr. Merriman -wrote Caiman, Jr., indicating that, at least initially, “financing should be taken in the name of the [Company] which would build and own the facility.” Mr. Merriman explained: One of the chief reasons for my conclusion is, of course, the possibility of litigation by minority shareholders if the facility should be built and owned by a partnership comprised chiefly of stockholders other than the Katz family. The investment opportunity in such a partnership would be very attractive because it requires only a nominal capital contribution and affords the partners valuable tax advantages for at least the first five years and the long range probability of having purchased an appreciating type asset. Further, on September 14, Coopers and Lybrand, special accountants for the Company, wrote the Company, suggesting that “the Company should consider development and use of the Waterview Project within [the Company].” Dissatisfied with these opinions, Caiman Jr. sought the advice of Jacques Schlenger, Esquire. On October 10, Mr. Schlenger sent an outline of a proposed structure for the transaction.

That proposal called for a partnership (comprised of the Company’s shareholders) to purchase the property and lease it, or some portion thereof, back to the Company. As Mr. Schlenger contemplated the transaction, all shareholders of the Company would be entitled to become partners in the Partnership, as both general and limited partners, in proportion to their interests as shareholders in the Company. The dominant factor in Mr. Schlenger’s recommendation was estate planning. He sought to achieve significant estate tax savings for the Zamoiski family through the use of a “capital ⁴⁴⁹ freeze” partnership.

Specifically, the Zamoiskis would “control the operation of the Partnership and have the opportunity to shift the future income and appreciation attributable to the Land to other persons (probably younger generation members of the Zamoiski family).” 2. The Debt-to-Equity Ratio Maintaining a favorable debt-to-equity ratio (the ratio of the debt shown on the Company’s balance sheet to the stockholders’ equity) was asserted to be of particular concern to the Company. The Company is a high-volume wholesaler and distributor of consumer goods; from 1984 to the end of the 1980s, it regularly dealt "with 600 to 800 manufacturers and suppliers per year. John Mulkey, the Company’s Treasurer, testified that the Company relies on open lines of credit from its suppliers to give it an interest-free period after receipt of merchandise before it must pay the supplier’s invoice.

According to Mr. Mulkey, being forced into a C.O.D. arrangement with its suppliers would be detrimental to the Company. Because the Company’s suppliers weigh the Company’s debt-to-equity ratio as a primary factor in approving open lines of credit, the Company was concerned that it maintain a favorable ratio at all times. The record further discloses, however, that, although suppliers generally investigate a company’s financial stability and request financial information before approving credit lines, the Company is privately-held, and, with few exceptions, does not release its full audited financial statements (which would reveal the true nature of the transaction and the Company’s obligation as guarantor) to its suppliers. During the period in question, the Company’s full financial statements, with auditors’ notes, were given to only three of its suppliers, which collectively represent less than twenty percent of the Company’s outstanding obligations. 3.

Tke Agreement In December 1984, the Partnership executed a Land Disposition Agreement (the “Agreement”) with the City for the ⁴⁵⁰ acquisition of several parcels of land (hereinafter referred to as “the Waterview Property”). At the same time, through IRB and UDAG financing and its own outlay of money, the Company began construction of its office/warehouse complex on the Waterview Property at a cost of approximately $14,-000,000. The Waterview Property was transferred by deeds to the Partnership in March and September, 1985. The consideration for the property was $2,400,000, all of which was financed by three purchase money mortgages taken back by the City.

The executed mortgages were signed by both the Partnership as owner and the Company as developer. Guarantees signed in connection with promissory notes were.also signed by the Company. As the deal was structured, none of the individual partners was liable for the debts of the Partnership; instead, the Company undertook ultimate responsibility for both the construction of the warehouse and the servicing of the debt on the Waterview Property. In return for its obligations, the Company received a thirty year lease with a five year option on the Waterview Property.

The term of the lease exceeds the span of the mortgage. The lease agreement sets forth rental payments to the Partnership that correspond to payments owed to cover the mortgage debt. At the end of the lease term, the Partnership will own the warehouse and fixtures the Company constructed. According to testimony at trial, the Partnership benefits from the transaction because it acquires any appreciation in the real estate that occurs during the term of the leasehold (upon the expiration of the lease, the property, and the improvements thereon, are expected to be worth an estimated $33 million).

The Company benefits because it does not have the debt liability of the land purchase on its financial statements and can walk away in thirty years if the deal turns out to be a “white elephant.” Although the purchase price of the Water-view Property was $2,400,000, which was the total face amount of the promissory notes to the City, all payments of principal and interest under the notes were deferred for five years, and the interest that accrued during the five-year period was added to the principal balance due at the beginning of the ⁴⁵¹ sixth year. Because of the interest accrual, the liability that would have been reflected on the balance sheet if the Company had purchased the land would have been approximately $3,000,000. At the time of the Agreement, the Partnership was comprised of one general partner and two classes of limited partners. Class A limited partners held an aggregate eighty-one and one-half percent interest in the Partnership.

Class A limited partnership interests were offered to all of the Company’s shareholders, including the Katz family shareholders, in proportion to what would have been their stock interests in the Company as of the time the 1967 suit was initiated. Class B limited partners were to hold an aggregate seventeen and one-half percent interest of the Partnership. Class B limited partnership interests were offered to key upper-level management employees who were not family members and who did not hold stock in the Company. Each employee who participated in the plan received a two and one-half percent interest in the Partnership.

Caiman, Jr. became the general partner and received a one percent interest in the Partnership. 4. Offer to Katz Family Shareholders In October 1984, prior to the formation of the Partnership, the Katz family shareholders were contacted through counsel and notified of the proposed transaction and its structure. The Katz family shareholders were offered the opportunity to participate as limited partners in the Partnership on a pro rata basis with the other shareholders of the Company; however, the structure of the proposed transaction was essentially presented to them as a fait accompli. The Katz family shareholders did not respond to the proposal at that time.

In April 1985, counsel for the Zamoiskis and the Katzes met again to discuss whether the Katz family shareholders planned to participate as limited partners in the Partnership. At that time, the Katzes were supplied with copies of the key transaction documents. A few weeks later, the Katz family shareholders informed counsel that they would be declining the ⁴⁵² offer to participate in the Partnership and raised their objection to the overall transaction. D. Testimony of Ronald Lipman Appellants called Mr. Lipman, an expert in the field of real estate appraisal, to render his opinion regarding the “fairness” of the lease to the Company.

Mr. Lipman’s testimony, which was uncontradicted, focused on a comparison of the fair market value of the land in fee simple as of December 1984, with the present value as of the same date of the Partnership’s “leased fee position” in the property, i.e., the present value of (1) the Partnership’s right to receive a thirty-five year stream of rental payments for the Waterview Property, plus (2) the reversion of the improved property at the end of the lease term (taking into account appreciation and depreciation). Mr. Lipman valued the land in fee simple at $2,260,000 as of the valuation date, but testified that the present value of the Partnership’s leased fee position was between $1,840,000 and $2,175,000. Based on that comparison, Mr. Lipman concluded that the Company’s lease obligation was below fair market value. The following colloquy ensued: Q: And in this hypothetical exercise I have you doing here, in December of 1984, if you were advising the [Partnership] about the investment value of the Waterview lease, what would your advice be?

A: To try to negotiate an increased rent, either an increased rent in one of the two segments in which rent is being paid, or to negotiate some rent during the first five-year period when no rent had been paid. In order to balance the fee simple value against the leased fee value, more rent had to be paid under the contract. THE COURT: But in a sense that would [sic] an asset to the [Company]—I mean the ... Company basically is paying less than it should pay, is, what you’re saying, to the partnership.

THE WITNESS: When everything is compared on an apples-to-apples basis, that’s correct. ⁴⁵³ THE COURT: And you said [the Company] has a, quote, sweetheart kind of lease? THE WITNESS: It’s called a leasehold advantage. THE COURT: But the advantage is the shareholders are Zamoiskis [sic], the detriment being the partnership of Waterview. That’s the bottom line.

I just want to make sure I— THE WITNESS: Yes. THE COURT: Okay. E. The Trial Court’s Opinion In its memorandum opinion and order, the trial court concluded that (1) Md.Corps. & Ass’ns Code Ann. (hereinafter “CA”) § 2-405.1, Maryland’s codification of the business judgment rule, was inapplicable because the facts in this case implicated the directors’ duty of loyalty, rather than their duty of care; (2) CA § 2-419, Maryland’s interested director statute, was inapplicable because the lease transaction between the Company and the interested directors and officers, ie., the Partnership, was “merely collateral to and a necessary byproduct of the disputed land transaction”; (3) the “overarching concern in all corporate opportunity cases is whether the taking of the opportunity was fair to the corporation”; (4) the opportunity to purchase the Waterview Property belonged to the Company and “the placing of all financial liability on the Company, without the benefit of ultimate ownership ... [was] generally unfair to the Company and its shareholders”; (5) a waiver of the corporate opportunity was impossible because “[a]ll of the voting shareholders at the time of the events were members of the Zamoiski family, as a result of the still pending 1967 suit filed by all Katz family stockholders and the charter provision establishing no voting rights for preferred stockholders,” see Md.Corps. & Ass’ns Code Ann. § 3-204 (1993) (stockholder who demands payment for stock under the appraisal statute “[c]eases to have any rights of a stockholder with respect to that stock, except the right to receive payment of its fair value”); and, (6) the defendants’ offer to the ⁴⁵⁴ plaintiffs of an interest in the Partnership was not a legally sufficient substitute for waiver of the