Lerner v. Lerner

RODOWSKY, Judge. This appeal is from an order enjoining, pending decision on the merits, a reverse stock split by which the holder of 73.68% of the outstanding stock in a Maryland ordinary business corporation proposes to cash out the 26.32% interest of the other stockholder. We shall affirm for reasons having more to do with the law of preliminary injunctions than with the law of minority freezeouts. Lerner Corporation (the Company) is owned by two brothers, the antagonists Theodore N. Lerner (Theodore) and Lawrence E. Lerner (Lawrence).

Over the years and through a number of entities Theodore and Lawrence have successfully invested in, developed, and managed real estate in the metropolitan Washington, D.C. area. The Company manages real estate, including acting as rental agent. Most of the properties managed by the Company are owned to the extent of 50% or more by Theodore and Lawrence and their families. For the fiscal year ending May 31,1984, ⁷⁷³ the Company had operating revenues of $2,074,900 consisting of fees from two shopping malls, two mixed-use retail strip and office centers, nine apartment complexes, and three office buildings.

As of that date one or more projects were in progress which the Company was also to manage. The Company was organized in 1965. It is a Subchapter S corporation. Its authorized and outstanding capital is 95 shares of no par common stock.

Theodore owns 70 shares and Lawrence owns 25. Theodore is and always has been president and one of the three directors. Prior to September 1983, Lawrence was the Company’s secretary and a director. Theodore has been active in almost all phases of the Company’s business other than actual construction, while Lawrence’s area of prime responsibility has been construction management.

Both brothers took salaries from the Company before the distribution of profits. Theodore says that Lawrence in 1977 began spending six months each year in Florida. Lawrence says that this is on doctor’s orders because Lawrence sacrificed his health in the service of the Company. We can present the picture of this case in broad strokes.

The brothers had a falling out. In September 1983 Theodore caused Lawrence to be removed as an officer and director. In April 1985, Lawrence sued Theodore. Then Theodore had Lawrence removed from the payroll and undertook to freeze Lawrence out as a stockholder.

Lawrence countered by bringing the instant action to enjoin the freezeout. In this injunction case Lawrence alleges that the Company’s business included locating and developing real estate investment opportunities in addition to property management. Lawrence claims that in April 1983 he learned that he had been excluded from the benefit of investment opportunities which had been developed through his efforts and through the expenditure of resources of the Company. Lawrence began questioning Theodore and this led to Theodore’s removing Lawrence in September from the board and ⁷⁷⁴ corporate office.

Thereafter Theodore, his wife Annette, and his son Mark, have been the Company’s directors. In November 1983 the Company engaged a New York consultant to value Lawrence’s shares. The initial report valued his 25 shares at $241,000 as of March 16, 1984. On April 9, 1985, Lawrence sued Theodore, the Company, Annette, and Maurice M. Myers, the chief financial officer of the Company (the April Suit).

Of its nine counts only the first and last deal with the brothers’ relationship in the Company. Count I is a shareholder’s derivative action claiming Theodore diverted real estate opportunities from the Company. Count IX asserts that Theodore utilized his control “in an illegal, oppressive and fraudulent manner” and that corporate assets will be further wasted. That count seeks appointment of a receiver for the Company and its complete dissolution.

Two days after the April Suit was filed Theodore took Lawrence off the Company’s payroll. The April Suit attracted newspaper publicity, particularly an article in the Washington Post of May 14, following which Theodore put in motion the mechanics of the freezeout of Lawrence. Theodore testified that the purpose of the freezeout was to protect the business of the Company from the consequences of a dissonant shareholder. Based on the history of the brothers' relationship, into which the trial court would not delve at the hearing on a preliminary injunction, Theodore said he foresaw Lawrence challenging basic business decisions, e.g., salary increases.

Theodore said he foresaw the morale and productivity of key employees and the Company’s ability to retain key employees adversely affected by turmoil generated by the minority shareholder as illustrated by the April Suit, particularly with its claim for dissolution of the Company. Theodore and two experienced real estate investors (one Mark’s father-in-law and the other a prospective joint venturer with Theodore in two shopping center projects) each opined that the word of mouth and newspaper notoriety about dissension in the Company would cause prospective customers to prefer other managers in the ⁷⁷⁵ highly competitive metropolitan Washington market. Theodore in substance said that he concluded that all connection between the Company and Lawrence had to be severed in order to counter those effects and to allow the Company to prosper. The mechanics of the freezeout are a reverse stock split.

By a notice dated May 17, 1985, the Company called a special meeting of the stockholders for May 28, 1985, to consider amending the articles of incorporation. Among the exhibits attached to that notice was a report dated April 15, 1985, in which the same consultant valued Lawrence’s 25 shares as of March 31, 1985, at $438,000. At the shareholders’ meeting Theodore would vote his 73.68% of the outstanding stock to amend the charter (1) to reduce the authorized capital from 95 shares to 2 shares, and (2) to reclassify each existing share of the Company’s stock into Vssth of a share of common stock. A reverse split at that ratio would result in Theodore’s owning two shares, the total authorized stock, while Lawrence would hold five-sevenths of a share.

The proposed articles of amendment further would have prohibited fractional shares and would have provided for cash payment by the Company in lieu of fractional shares. The notice of shareholders’ meeting further advised Lawrence of the existence of appraisal rights and of the procedure for invoking appraisal. By the above procedures Theodore would have cashed out Lawrence’s stockholding in the Company. There is no contention before us that the contemplated procedures outlined above violate any express provision of the corporation statutes, Md.Code (1975, 1985 Repl.Vol.), Corporations and Associations Article. 1 ⁷⁷⁶ On the day before the stockholders’ meeting was to be held Lawrence filed the instant injunction action in the Circuit Court for Montgomery County (the May Suit).

By agreement of counsel the stockholders’ meeting was postponed until the court could rule on Lawrence’s application for an interlocutory injunction. Defendants in the injunction action are the Company, Theodore, and the other two directors, Annette and Mark. After a two day hearing at which some testimony was elicited between the arguments of counsel, the court enjoined the stockholders’ meeting until decision on the merits. The defendants appealed and petitioned this Court for certiorari.

We issued the writ prior to consideration of the matter by the Court of Special Appeals. In speaking of preliminary injunctions we said in State Department of Health and Mental Hygiene v. Baltimore County, 281 Md. 548, 554 , 383 A.2d 51, 55 (1977): While there is “[n]o principle ... better established, than that the granting or refusing of a writ of injunction, is a matter resting in the sound discretion of the court,” ... it is also true that this discretion must be exercised by the chancellor upon a consideration of all the circumstances of the case____ It is frequently said that a proper exercise of discretion requires the court to consider four factors: likelihood of success on the merits; the “balance of convenience”; irreparable injury, which can include the necessity to maintain the status quo; and, where appropriate, the public interest. The defendants’ argument, that Lawrence was required to prove each of these factors, would seemingly have us analogize to the requirement that a plaintiff in a tort action ⁷⁷⁷ prove each of the elements of the tort. In particular the defendants assert that there is no likelihood of success and no irreparable injury.

They submit that Lawrence’s effort to dissolve the Company and the ongoing acrimony and dissension between the two shareholders justify a minority freezeout whether Theodore’s decision is measured by a business purpose or a fairness test, or both. Nor can there be irreparable injury, say the defendants, because Lawrence is assured payment of the fair value of his stock through statutory appraisal or, if it is ultimately judicially determined that Lawrence is entitled to his stock, because a court can effectively reverse the freezeout in this closely held corporation. The defendants argue that the trial judge based the preliminary injunction on an incorrect rule of law, by holding that the desire to eliminate internal dissension could not be a sufficient business reason to oust the minority. Defendants’ ultimate point is that, as a matter of law, no business purpose is required so long as the transaction is “fair.” In contrast, the appellee, Lawrence, strives to place the trial court’s decision principally on factual grounds and urges that there is no abuse of discretion.

He sees the trial judge as unimpressed by predictions of corporate doom if Lawrence continues to be a stockholder and thus there is no business purpose or no fairness to the freezeout. Because the Company manages properties of which he and his immediate family are part owners, and because the April Suit is pending, Lawrence says there will be irreparable injury. Ultimately he urges that Maryland law is or should be that the majority cannot terminate the interest of the minority, without the latter’s consent or without a corporate business purpose, simply by paying a fair price for the minority stock. Certain portions of the trial court’s opinion tend to support the defendants’ position that the preliminary injunction was based largely on the premise that eliminating dissension cannot be a business purpose.

In analyzing likelihood of success, the trial judge stated that “the bottom line is ⁷⁷⁸ that majority shareholders simply may not freeze out minority shareholders because of dissension, bitterness or acrimony between the shareholders, even in a closely held company as the Lerner Corporation.” After observing that “[t]he right to continue as a shareholder in a corporation is a valuable personal right to the individual,” the trial court said that “[a] shareholder, therefore, may not be ousted from the corporation because of strong differences between the individual shareholders as freely as the relationship might be severed if they were partners.” In response to the defendants’ argument that there could be no irreparable harm, the trial judge said that the argument totally ignores the fact that [Lawrence] would no longer be a shareholder, which is not necessarily dependent upon the monetary value of the shares but involves his personal right to remain a shareholder unless it would prevent the majority shareholders from carrying out a legitimate business transaction such as a beneficial merger. The defendants in the case before us say the trial judge applied a per se rule against the freezeout of a minority stockholder in a closely held corporation. For a number of reasons we do not believe that the court ruled so extremely. First, such a rule would decide the ultimate merits, on which the circuit court clearly reserved until trial on the merits.

Second, the trial judge described himself as persuaded that the “appropriate rational evaluation” was represented by Clark v. Pattern Analysis & Recognition Corp., 87 Misc.2d 385 , 384 N.Y.S.2d 660 (1976), a decision of the Supreme Court, Oneida County. That case did not apply any per se rule, but it did involve a preliminary injunction against a freezeout through a one to 4000 reverse stock split in a somewhat closely held corporation. The court said that a minority stockholder would be protected against threatened acts by the majority which violated fiduciary obligations, even if the corporation were to follow statutory mandates to the letter and that “[w]here there is an allega ⁷⁷⁹ tion of fraud, illegality or bad faith, coupled with a tenuous showing of legitimate corporate business purpose, fairness requires that a minority shareholder be afforded an opportunity to fully contest the actions of the majority before he is deprived of his property.” Id. at 390 , 384 N.Y.S.2d at 664-65 . The corporation in Clark claimed that its purposes in removing the plaintiffs as shareholders were to leave as shareholders only employees or close relatives of employees and to maintain the confidentiality of its financial statements. 2 The Clark court concluded that the majority had not made out a strong and compelling, legitimate business purpose supportive of the action taken against the minority who demonstrated a strong probability of ultimate success.

Clark simply illustrates in the area of freezeouts one approach to whether a preliminary injunction should issue. Third, the statutes give Theodore the power to freeze out Lawrence. The question to be decided on the merits in this case is whether equity will intervene permanently to enjoin the freezeout. In a case bearing some analogy to that issue this Court refused injunctive relief.

See Homer v. Crown Cork & Seal Co., 155 Md. 66 , 141 A. 425 (1928). There the plaintiff owned 3.3% of the stock of A Co., the target company, in an early form of takeover. Of A Co.’s 9,500 outstanding shares the owners of B Co., one of A Co.’s competitors, had acquired 6,500 at an average price of $277 and had later acquired an additional 1,246 shares at higher prices. A Co. then proposed selling all of its assets to C Co., which was also controlled by A Co.’s majority.

After the sale A Co. was to liquidate and would distribute $277 per share. C Co. alternatively offered to purchase the ⁷⁸⁰ shares of A Co.’s minority at $277 per share or to exchange C Co.’s stock for minority shares in A Co. Following the purchase B and C planned to consolidate. The complaint seeking to enjoin the sale of assets was dismissed on demurrer and affirmed on appeal. This Court explained that if the allegations had set forth a proposal by a board of directors, and its certain adoption by the requisite vote of shareholders, that all the assets of one corporation be sold to another corporation at a price so greatly below the alleged value of these assets as to be indicative of a breach of duty to the selling corporation, the chancellor should not hesitate to intervene by injunction in order that the contemplated action be probed and prevented, if fraudulent, in view of the pregnant circumstance that the board of directors and the necessary majority of stockholders in each corporation were either identical or acting pursuant to a common scheme and in obedience to the same central control.

The theory of the appellants is that a gross inadequacy of price is accompanied by collusion between two boards of directors, who represent but a single dominant will, in order that the assets of one corporation may become the property of the other at less than half its value through the approval of each corporation by the requisite majority vote of stockholders, who, in both corporations, are under the absolute control of the same dominant will or ownership. If this were the effect of all the allegations of the bill of complaint, the question would not be one of controversy between the majority and minority stockholders over value, in respect to which wide variance in opinion may honestly subsist, but would be one of fraud, which would be peculiarly the province of equity and so take the question out of the [appraisal] statute, since [the appraisal statute] contemplates proceedings begun and consummated in good faith and not those infected with fraud. [ 155 Md. at 79-80 , 141 A. at 432 .] The particular complaint in Homer did not adequately plead “fraud” but revealed only a dispute over the value of the ⁷⁸¹ minority stock which could have been fairly resolved in a statutory appraisal proceeding. Homer teaches that while an injunction can lie where there is “fraud,” despite the availability of an appraisal remedy, an injunction will not issue simply because the majority use the letter of the corporation statutes to acquire the shares of the minority who are unwilling to sell and who claim the price is inadequate. Fourth, the majority of courts that have considered challenges to freezeouts seem to agree, at least at the conceptual level of legal principle, that the majority may freeze out the minority if there is a business purpose for the action.

In this context “business purpose” usually refers to the business of the corporation, viewed as an entity distinct from the majority. The difficulty at the level of application lies in the fact that corporations come in various sizes and that the facts of the decided cases, including the freezeout technique employed, come in various shapes. For cases allowing a freezeout after finding a business purpose see, e.g., Dower v. Mosser Industries, 648 F.2d 183 (3d Cir.1981) (to enable subsidiary corporation to obtain loan for expansion of business); Grimes v. Donaldson, Lufkin and Jenrette, Inc., 392 F.Supp. 1393 (N.D.Fla.1974), aff'd, 521 F.2d 812 (5th Cir.1975) (to permit business dealings between related corporations which would otherwise be inhibited by potential claims of conflict of interest); Tanzer v. International General Industries, 379 A.2d 1121 (Del.1977) (to facilitate long term debt financing of the parent corporation where plaintiff was frozen out of subsidiary); Teschner v. Chicago Title & Trust Co., 59 Ill.2d 452 , 322 N.E.2d 54 (1974), appeal dismissed, 422 U.S. 1002 , 95 S.Ct. 2623 , 45 L.Ed.2d 666 (1975) (to reduce corporate expenses and simplify and facilitate procedures); Alpert v. 28 Williams Street Corp., 63 N.Y.2d 557 , 473 N.E.2d 19 , 483 N.Y.S.2d 667 (1984) (to obtain additional capital for modernizing apartment house, an investment which tax shelter syndicate would not have made without freezing out minority of prior ownership); Leader v. Hycor, Inc., 395 Mass. 215 , 479 ⁷⁸² N.E.2d 173 (1985) (to “go private” where cost of maintaining public company was not justified by poor market in stock). On the other hand it is not a proper corporate business purpose for the majority stockholder to take the corporation private in order to have it assume the debt on personal loans to the majority stockholder.

See Coggins v. New England Patriots Football Club, 397 Mass. 525 , 492 N.E.2d 1112 (1986). If the rule applied by the trial court here was that dissension between the owners of a business cannot, under any circumstances, justify a freezeout, then we do not agree. Discord within a closely held, general business corporation can conceivably reach the point where eliminating a dissonant minority’s interest would not violate the majority’s duty to the minority, particularly where matters of business judgment are the subject of controversy and the discord is impairing the corporation’s ability to conduct business. Horizon House-Microwave, Inc. v. Bazzy, 21 Mass.App. 190 , 486 N.E.2d 70 (1985) involved a corporation having three shareholders, two of whom were brothers, whose relationship was characterized by hostility and deadlock.

One brother, who held the majority of stock, diluted the stockholdings of the other brother, in order to alleviate complaints about compensation by the third shareholder, a key employee in their highly technical enterprise. The court would not intervene in the corporate transactions by which those objectives were accomplished because they enabled the corporation to operate effectively in the best interest of all concerned. To say that there is no per se rule against a minority freezeout in a closely held corporation does not, however, answer the issue before us. The issue here is whether the chancellor abused his discretion in preliminarily enjoining the freezeout, pending the ultimate decision on the merits.

The answer to that question, in the context of the arguments advanced here, requires a brief review of the law relating to preliminary injunctions. ⁷⁸³ An excellent exposition is found in the leading case in the United States Court of Appeals for the Fourth Circuit on preliminary injunctions, Blackwelder Furniture Co. v. Seilig Manufacturing Co., 550 F.2d 189 (4th Cir.1977). On the merits the plaintiff claimed anti-trust violations, including retail price maintenance enforced by terminating the plaintiff as a dealer. In order to keep its business going while the suit for a permanent injunction was pending, the plaintiff sought a preliminary