McGinley v. Massey

KARWACKI, Judge. The Circuit Court for Washington County entered summary judgment for the appellees, J. Alvin Massey and Margaret K. Massey, in their action against the appellant, Howard M. McGinley, to enforce his guaranty of payments due under a stock redemption agreement. Upon McGinley’s appeal of that judgment to this Court, the parties elected to proceed on an expedited basis pursuant to Rule 1029. They have agreed to the following statement of the case: Prior to April 18, 1985, J. Alvin Massey and Margaret K. Massey (“Appellees”) were joint owners of three hundred (300) shares of common stock of Specialty Carburetion & Equipment, Inc. (“the Corporation”), a close corpo ³⁵⁴ ration organized under the laws of the State of Delaware.

At all times relevant to the subsequent dispute between the parties to this appeal, Howard M. McGinley (“Appellant”), a resident of Washington County, Maryland, was president and a stockholder of the Corporation. On April 18, 1985, Appellees, Appellant, and the Corporation entered into a Stock Purchase Agreement (“the Redemption Agreement”), whereby the Corporation agreed to purchase or redeem all of Appellees’ shares of common stock of the Corporation for the purchase price of $20,000.00. The redemption purchase price was to be paid in installments as follows: (1) $528.70 upon execution of the Redemption Agreement; (2) thirty-six consecutive monthly payments in the amount of $264.35 commencing on May 1, 1985; and (3) $15,206.25 as a balloon payment on May 1, 1988. The Redemption Agreement provides that it shall be construed according to the laws of the State of Maryland.

The Redemption Agreement provides that Appellant shall pay any balance due from the Corporation in the event that the Corporation defaults in payment, ceases doing business, becomes insolvent, or declares bankruptcy. The guarantee provides that should the Corporation fail to cure any default within ten (10) days, the entire balance then outstanding would become due and payable by Appellant, as guarantor, within thirty days from his receipt of written demand for payment by Appellees. At the time of the execution of the Redemption Agreement, the liabilities of the Corporation exceeded its assets and it was insolvent. On the date of the execution of the Redemption Agreement, the law of the State of Maryland and the law of the State of Delaware prohibited redemption of stock by a corporation when it was either insolvent or would become insolvent as a result of the redemption.

Shortly after the execution of the Redemption Agreement, the Corporation defaulted. Appellant began making payments but thereafter stopped paying. ³⁵⁵ Appellees jointly filed a Complaint and Motion for Summary Judgment in the Circuit Court for Washington County against Appellant, as guarantor, for the balance of payments due under the Redemption Agreement. In a hearing on Appellees’ Motion, the trial court granted the Motion on the issue of liability, but reserved its ruling on the proper amount of damages to be awarded Appellees. The parties subsequently stipulated to the amount in controversy, and the trial court entered judgment in favor of Appellees in that amount on December 29, 1986.

The appellant presents a two-pronged argument attacking the judgment of the circuit court: A. The Redemption Agreement was illegal and unenforceable as against public policy because it was executed in violation of a statutory prohibition. B. Since the Redemption Agreement itself was illegal and unenforceable, Appellant’s guarantee of payments owing thereunder is null, void, and unenforceable. We agree with the appellant that the Redemption Agreement was executed in violation of a statutory prohibition, whether we apply the law of Maryland, as provided for in the agreement, or the law of Delaware, the state under whose laws Specialty Carburetion & Equipment, Inc., was organized. At the time the Redemption Agreement was executed, “the liabilities of the Corporation exceeded its assets and it was insolvent.” Under Md.Code (1985 Repl.

Vol.), § 2-311(c) of the Corporations and Associations Article, “A corporation may not purchase or redeem any of its stock if the corporation is insolvent or the transaction would cause the corporation to become insolvent.” Similarly, Del. Code Ann. (1983 Repl.Vol.), title 8, § 160(a)(1) provides: (a) Every corporation may purchase, redeem, receive, take or otherwise acquire, own and hold, sell, lend, exchange, transfer or otherwise dispose of, pledge, use and otherwise deal in and with its own shares; provided, however, that no corporation shall: ³⁵⁶ (1) Purchase or redeem its own shares of capital stock for cash or other property when the capital of the corporation is impaired or when such purchase or redemption would cause any impairment of the capital of the corporation, except that a corporation may purchase or redeem out of capital any of its own shares which are entitled upon any distribution of its assets, whether by dividend or in liquidation, to a preference over another class or series of its stock if such shares will be retired upon their acquisition and the capital of the corporation reduced in accordance with §§ 243 and 244 of this title. Nothing in this subsection shall invalidate or otherwise affect a note, debenture or other obligation of a corporation given by it as consideration for its acquisition by purchase, redemption or exchange of its shares of stock if at the time such note, debenture or obligation was delivered by the corporation its capital was not then impaired or did not thereby become impaired; ... (Emphasis supplied.) In light of the corporation’s insolvency at the time, its agreement to purchase or redeem the appellees’ shares of common stock violated both of the statutes just quoted. 1 As a general rule, contracts that violate statutes will not be enforced.

Queen v. Agger, 287 Md. 342, 346 , 412 A.2d 733 (1980). Such contracts when executed by a corporation are illegal and not merely ultra vires. Downing Dev. Corp. v. Brazelton, 253 Md. 390, 398-400 , 252 A.2d 847 (1969); 7A Fletcher Cyclopedia of the Law of Private Corporations §§ 3400, 3580-83 (1978).

Satisfied that the first prong of the appellant’s argument is correct, we now consider whether the second prong follows therefrom. The appellees, while conceding that the corporation’s execution of the Redemption Agreement was ³⁵⁷ illegal, argue that it does not necessarily follow that the appellant’s guaranty of payment under the agreement is unenforceable. They cite three reasons relied upon by the circuit court as to why the guaranty portion of the agreement should be enforced: A. Even if the Redemption Agreement was contrary to the statute, it would be a misapplication of the statute to use it to deny the appellees relief under the facts of this case. B. The guaranty and the Redemption Agreement were two distinct and separable contracts, and the guaranty was separately enforceable.

C. The appellant should be estopped from denying the validity of the guaranty agreement. In Schaun v. Brandt, 116 Md. 560 , 82 A. 551 (1911), the Court of Appeals addressed essentially the same issue that we are presented with in the instant case. There, the United States Land Company (U.S. Land), a corporation organized under the laws of Delaware, had entered into an agreement to purchase 100 shares of its own capital stock from Schaun for $900. Brandt, as surety, gave his bond to secure payment of the purchase price in the event that U.S. Land defaulted on its obligation.

U.S. Land defaulted, and Brandt refused to pay the purchase price. Schaun then brought suit against Brandt seeking to recover on the bond. On appeal from a judgment in favor of Brandt, the issue presented was whether Schaun’s pleading (to which Brandt had successfully demurred) stated an action against Brandt on his bond. Specifically, the Court considered whether the declaration demonstrated that U.S. Land was authorized to purchase its own capital stock at the time of its agreement with Schaun.

In affirming the trial court’s ruling, the Court observed that under the statutes then regulating Maryland corporations, “a Maryland corporation, in the absence of express authority, has no power to contract for the purchase of its own stock, and that a promise to pay money knowingly ³⁵⁸ loaned or advanced for that purpose can not be enforced.” 116 Md. at 563 , 82 A. 551 . Not only was such a contract unauthorized by statute, but it would be unenforceable “because both the creditors and other stockholders of the corporation may be injured by the unauthorized reduction of its capital, and such a contract is contrary to