Toner v. Baltimore Envelope Co.

RODOWSKY, Judge. Appellant, Mary P. Toner (Toner), is a nonvoting shareholder with a minority ownership in a closely held corporation. She complains of the corporation’s having bought the nonvoting stock of some of the other shareholders without having bought her nonvoting stock. Appellant asserts that, solely because the corporation made those purchases, it became obliged to purchase all of her nonvoting stock at the same price.

We shall decline, for reasons hereinafter set forth, to adopt that per se rule as Maryland law. This case comes to us from the United States District Court for the District of Maryland under the Uniform Certification of Questions of Law Act, Md.Code (1974, 1984 ²⁵⁹ Repl.Vol.), §§ 12-601 to -609 of the Courts and Judicial Proceedings Article (Courts Article). The facts are set forth in the certification order. In light of the narrow legal argument made by Toner, the federal court’s statement of facts is limited to an outline of the stock purchase transaction.

The Baltimore Envelope Company (Envelope Co.), a Maryland corporation, was founded in 1930 by two brothers, Charles H. Peters, Sr. (Charles Sr.) and Arthur H. Peters (Arthur). We are next told of the situation prevailing in 1979. Charles H. Peters, Jr. (Charles Jr.), son of Charles Sr., is president of the company. Appellant Toner is a daughter of Charles Sr. Arthur has died and is survived by his widow, Elma.

Arthur and Elma had three daughters, Janet P. Heaphy, Betty P. Van Horn, and Shirley P. Hall. We shall call Elma and her three daughters the Elma Branch. The capital stock of Envelope Co. is divided into two classes of common stock, Class A, which has voting rights, and Class B, which is nonvoting. There are 8,000 shares of Class A outstanding, 50% of which Charles Jr. owns and 50% of which Elma owns.

Each of the above-named surviving members of the Peters family owns some of the nonvoting stock. The Board of Directors in 1979 consists of four persons, Charles Jr., Clarke E. Murphy, Jr. (Murphy), and two representatives of the Elma Branch, Griffith Hall (Hall) and Lowell Bowen (Bowen). * In discussions during 1979 among the stockholders concerning the future of the company, the Elma Branch expressed a strong desire either to sell the company or to sell their stockholdings as a unit. Also in 1979 Tri-State Envelope Corp., a business located in Pennsylvania, offered to purchase the fixed assets of Envelope Co. for $575,000. At that time both Charles Jr. and Toner expressed an interest in purchasing the shares held within the Elma Branch, but neither was financially able to do so.

At a meeting on August 9, 1979, the directors of Envelope Co. considered a motion presented by Hall that the ²⁶⁰ company accept the Tri-State offer and then liquidate. Hall and Bowen voted in favor of the motion while Charles Jr. and Murphy voted against it. Murphy then proposed that Envelope Co. purchase 15,432 shares of the nonvoting stock owned by the Elma Branch at an aggregate price of $300,-000. Charles Jr. stated that this offer was made in conjunction with an offer “made by an individual” to purchase the 4,000 shares of voting stock and the remaining 1,141 shares of nonvoting stock owned by Elma.

Under the proposal all of the stock to be acquired would be purchased at $19.44 per share, whether it was voting or nonvoting. On the advice of Bowen, Hall left the directors’ meeting. In his absence the resolution for corporate purchase of shares carried, based on the votes of Charles Jr. and Murphy, with Bowen abstaining. Thereafter Charles Jr. and Murphy caused Envelope Co. on September 17, 1979, to borrow from a bank $325,000 secured by corporate assets.

Using approximately $300,000 of these borrowed funds Envelope Co. acquired 15,432 shares of its nonvoting stock from the Elma Branch. On September 19, 1979, Murphy acquired for approximately $100,000 the 4,000 shares of voting stock and remaining 1,141 shares of nonvoting stock owned by Elma. He transferred one of the voting shares to Charles Jr. “without consideration.” Based on the stockholdings before and after the-transaction, as the statement of facts presents them, we set forth the following composite: ²⁶¹ Prior to Purchases After Purchases Issued and outstanding Class A Voting Stock (in shares)_ Charles Jr. 4.000 4,001 Elma 4.000 Murphy 3,999 5,000 8,000 Issued and outstanding Class B Nonvoting Stock (in shares)_ Charles Jr. 8,663 8,663 Toner 6,654 6,654 Elma 10,903 Janet P. Heaphy 1.890 Betty P. Van Horn 1.890 Shirley P. Hall 1.890 Murphy 1,141 31,890 16,458 Toner brought suit in the United States District Court against Envelope Co., Charles Jr., and Murphy. That litigation includes a derivative claim with which we are not concerned.

The remedy which Toner seeks is an order directing Envelope Co. to purchase her nonvoting stock under the same terms and conditions offered by the company to members of the Elma Branch for their nonvoting stock. To reach this result Toner makes two arguments. One involves what she calls the “rule of non-discrimination.” In this argument Toner dissects the transaction into separate steps. Step one concerns the decision to undertake the transaction and, for purposes of this argument, Toner concedes that the propriety of that decision is properly analyzed under the business judgment rule.

The second step concerns the manner in which the transaction is carried out. At that step, Toner contends, “the corporation has no discretion to prefer one group of shareholders over another and accordingly its conduct in this stage is controlled by the rule of non-discrimination, rather than the business judgment rule.” (Emphasis in original.) ²⁶² Toner’s second, and principal, argument asks us to apply, as a matter of law, the following proposition which is the first certified question stated in declarative form: Where the directors and majority of voting shareholders of a closely held corporation caused the corporation to repurchase the nonvoting shares from some, but not all, of the corporation’s nonvoting shareholders, [the corporation must] accord a minority holder of nonvoting stock who [is] excluded from the repurchase arrangement, an equal opportunity to sell her shares to the corporation under the same terms and conditions offered to other holders of nonvoting stock[.] (1) Toner’s first argument presses the concept of nondiscrimination between holders of shares of the same class to a literal extreme. We have said that a corporation “in making a dividend, has no power to discriminate between its stockholders [of the same class].” State v. Baltimore & O.R.R. Co., 6 Gill 363, 373 (1847). 1 And see 11 Fletcher Cyclopedia of the Law of Private Corporations § 5352 (M. Wolf rev. ed. 1971 & Supp.1984) (Fletcher). Nondiscrimination between shareholders was also the basis for denying a motion to dismiss one of the claims for relief pleaded in Twenty Seven Trust v. Realty Growth Investors, 533 F.Supp. 1028 (D.Md.1982).

That case arose out of a tender offer directed to the shareholders of a Maryland real estate investment trust. Following through on their earlier announcement, the trustees made a distribution in partial liquidation to all pre-tender shareholders. Those owning ²⁶³ 1,000 shares or less received $17.19 in cash while those, including the plaintiff, owning more than 1,000 shares received $15.29 in distribution certificates and secured notes. The district court concluded that the distributions were sufficiently analogous to dividends to warrant the application of a strict nondiscrimination rule.

Toner says such a rule likewise applied when Envelope Co. purchased the Elma Branch’s nonvoting stock. Envelope Co. is an ordinary business corporation governed by Md.Code (1975, 1985 RepLVol.), Titles 1, 2, and 3 of the Corporations and Associations Article. 2 Subject to certain limitations not relevant here, a Maryland corporation has the general power to “acquire any of its own stock____” § 2-103(10). Power to acquire “any” of its stock does not restrain a corporation from selectively acquiring some of the stock of a given class. A strict nondiscrimination rule would oblige Envelope Co. to offer to buy all of the nonvoting stock of Charles Jr., in addition to Toner’s, because of the corporate purchase from the Elma Branch.

The mere fact that a Maryland corporation seeks to purchase some of its own stock does not automatically create a duty to extend the offer to all other holders of shares of the same class. Sections 2-310 and 2-311 demonstrate this conclusion. In relevant part they provide: § 2-310. Power to acquire own stock.

(a) Redemption or exchange. — Subject to the provisions of its charter and § 2-311 of this subtitle, a corporation may: (1) Redeem shares of its own stock that the charter provides are redeemable; or (2) Exchange convertible shares. (b) Additional acquisitions. — Subject to the provisions of its charter and § 2-311 of this subtitle, if authorized by ²⁶⁴ its board of directors, a corporation may acquire shares of its own stock in all other cases, including: (1) Purchase of stock that the charter provides is . redeemable; or (2) Gift or legacy. (c) Specific purposes for acquisition. — Subject to the provisions of its charter and § 2-311 of this subtitle, if authorized by its board of directors, a corporation may acquire shares of its own stock to: (1) Eliminate fractional shares; (2) Collect or compromise a corporate debt or claim, if done in good faith; or (3) Satisfy or compromise a claim of an objecting stockholder under Title 3, Subtitle 2 of this article. § 2-311. Limitations on acquisition of own stock.

(a) Limit on consideration. — (1) A corporation may not purchase or redeem shares of its stock that the charter provides are redeemable at the time of the redemption or purchase. for a consideration greater than either: (i) The redemption price at the time of the acquisition; or (ii) Unless a sinking fund or similar provision of the charter requires otherwise, the net asset value per share. (2) In determining net asset value per share under this subsection, assets are attributable to the classes of stock in the order of their respective seniority. However, in the case of redeemable stock the amount may not exceed the current redemption price. (c) Insolvency. — 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.

(d) How acquisition charged. — Except for an acquisition under § 2-310(c) of this subtitle or subsection (a) or ²⁶⁵ (b) of this section, a corporation may purchase or redeem its stock only out of surplus. By referring to a corporation’s acquiring shares of its own stock to eliminate fractional shares, to collect or compromise a debt or claim, or to satisfy or compromise a claim of an objecting stockholder, § 2-310(c) specifically contemplates that acquisitions may be made on an individualized basis. For an acquisition to be valid does not require a like offer to all holders of the same class of stock. Toner suggests that § 2-310(c) supports her argument because “[t]hat provision specifically limits the purposes for which a corporation may acquire its own stock....” This is a misinterpretation of § 2-310(c).

The three purposes enumerated in subsection (c) are set forth separately in § 2-310 because they are treated separately in § 2-311. Those three situations are excepted by § 2 — 311(d) from the general requirement that a corporation may purchase its stock only out of surplus. See H. Brune, Maryland Corporation Law and Practice § 49, at 52-53 (rev. ed. 1953) (Bruñe), commenting on the predecessor statute, Md.Code (1951), Art. 23, § 28, a part of the general revision of the corporation laws enacted by Ch. 135 of the Acts of 1951. Sections 2-310(c) and 2-311(d) are derived from the 1951 enactment.

The reference in § 2-310(b) to acquisition of its shares by a corporation “in all other cases” also undermines Toner’s position. Immediately prior to the recodification of the corporation statutes into the Corporations and Associations Article, the provisions dealing with when a corporation could acquire its own stock were codified as Md.Code (1957, 1973 Repl.Vol.), Art. 23, § 32(a). It provided in relevant part: (a) How and when acquisition, retention or disposition effected. — Any corporation of this State may, from time to time, subject to the limitations contained in this section: ²⁶⁶ (3) Acquire shares of its own stock upon authorization of the board of directors (i) to eliminate fractional shares, (ii) to collect or compromise in good faith a debt due to or a claim of or against the corporation, or (iii) to satisfy or compromise claims of objecting stockholders entitled to payment for their stock pursuant to this article; (4) Acquire shares of its own stock in all other cases, including gift or bequest, upon authorization by the board of directors and, if required by the charter, upon further authorization by stockholders of any class or classes. [Emphasis added in (4).] The three situations specified in former § 32(a)(3) were then excepted by former § 32(b)(3) from the requirement that a corporation acquire its own stock only out of surplus. When part of former § 32 was recodified into § 2-310 of the Corporations and Associations Article by Ch. 311, § 2 of the Acts of 1975, the reference to “all other cases” was omitted.

The omission was cured at the next session of the General Assembly when Ch. 567 of the Acts of 1976 inserted “in all other cases” in subsection (b) of § 2-310. Consequently, the three situations set forth in § 2-310(c) are exceptions to a general rule that acquisitions of stock shall be made out of surplus. Section 2-310(c) does not list the exceptions to an otherwise absolute rule of nondiscrimination. (2) Toner next argues for a judicial overlay on the general corporation statutes, an overlay which she would apply only to closely held corporations.

Because the market for sale of minority shares in a closely held corporation is limited or nonexistent, Toner asks us to mandate that an equal opportunity to sell to the corporation be extended to all holders of a class of shares when the corporation purchases any of its shares of that class. Inasmuch as it is the particular relief which this argument emphasizes, the cases on which Toner principally relies base their holdings variously on the duty ²⁶⁷ of the majority to the minority and on the duty of directors to the corporation and its shareholders as such. There are Maryland cases which have recognized the fiduciary obligation of majority shareholders, in certain matters, to minority shareholders. See Baker v. Standard Lime & Stone Co., 203 Md. 270 , 100 A.2d 822 (1953); Cooperative Milk Service, Inc. v. Hepner, 198 Md. 104 , 81 A.2d 219 (1951); Levine v. Imperial Pkg.

Corp., No. 1967/A203 (Cir.Ct.Balt.City Jan. 25, 1968); United Funds, Inc. v. Carter Products, Inc., Daily Record, Sept. 23, 1963, at 2, col. 1 (Cir.Ct.Balt.City No. 102A/450). And see Bruñe, supra, § 252 (Supp.1974). The duty has been accepted, in a variety of contexts, by many other jurisdictions. See, e.g., Southern Pacific Co. v. Bogert, 250 U.S. 483 , 39 S.Ct. 533 , 63 L.Ed. 1099 (1919); McDaniel v. Painter, 418 F.2d 545 (10th Cir.1969); Perlman v. Feldmann, 219 F.2d 173 (2d Cir.), cert. denied, 349 U.S. 952 , 75 S.Ct. 880 , 99 L.Ed. 1277 (1955); Burt v. Burt Boiler Works, Inc., 360 So.2d 327 (Ala.1978); Alaska Plastics, Inc. v. Coppock, 621 P.2d 270 (Alaska 1980); Jones v. H.F. Ahmanson & Co., 1 Cal.3d 93 , 460 P.2d 464 , 81 Cal.Rptr. 592 (1969); Singer v. Magnavox Co., 380 A.2d 969 (Del.1977); Cressy v. Shannon Continental Corp., 177 Ind.App. 224 , 378 N.E.2d 941 (1978).

And see 12B Fletcher, supra, § 5811 (C. Swearingen rev. ed. 1984) and cases cited therein; Johnson, Strict Fiduciary Duty in Close Corporations: A Concept in Search of Adoption, 18 Cal.W.L.Rev. 1 (1981); Comment, The Strict Good Faith Standard — Fiduciary Duties to Minority Shareholders in Close Corporations, 33 Mercer L.Rev. 595 (1982); 30 Drake L.Rev. 679 (1981). See also the Commentary to § 6 of the ABA’s Model Business Corporation Act (the corporate share acquisition provision) found in 1 Model Business Corporation Act Annotated 254 (W. Scott 2d ed. 1971) (“[minority shareholders are protected from abuse [where the shares of particular shareholders only are purchased] by traditional common law principles of fraud and the fiduciary obligation ²⁶⁸ of management and controlling stockholders to the minority”). 3 From the standpoint of Charles Jr. and Murphy as directors, it is well settled in Maryland that they owe a fiduciary duty to Envelope Co. and its shareholders. For general statements see, e.g., Merchants Mortgage Co. v. Lubow, 275 Md. 208 , 339 A.2d 664 (1975); Parish v. Maryland & Virginia Milk Producers Ass’n, 261 Md. 618 , 277 A.2d 19 , cert. denied, 404 U.S. 940 , 92 S.Ct. 280 , 30 L.Ed.2d 253 (1971); Pritchard v. Myers, 174 Md. 66 , 197 A. 620 (1938); Coffman v. Maryland Publishing Co., 167 Md. 275 , 173 A. 248 (1934); Booth v. Robinson, 55 Md. 419 (1881); Cumberland Coal & Iron Co. v. Parish, 42 Md. 598 (1875); Levin v. Levin, 43 Md.App. 380 , 405 A.2d 770 (1979); Martin Marietta Corp. v. Bendix Corp., 549 F.Supp. 623 (D.Md.1982); Lawson v. Baltimore Paint & Chemical Corp., 347 F.Supp. 967 (D.Md.1972); Miller, The Fiduciary Duties of A Corporate Director, 4 U.Balt.L.Rev. 259 (1975). See also § 2-405.1.

Directors must demonstrate the fairness of a transaction between themselves and the corporation. See, e.g., Chesapeake Constr. Corp. v. Rodman, 256 Md. 531 , 261 A.2d 156 (1970); Ross Transport, Inc. v. Crothers, 185 Md. 573 , 45 A.2d 267 (1946). Directors may not waste corporate assets.

Devereux v. Berger, 264 Md. 20 , 284 A.2d 605 (1971); Parish v. Maryland & Virginia Milk Producers Ass’n, supra; Waller v. Waller, 187 Md. 185 , 49 A.2d 449 (1946); Levin v. Levin, supra. See also § 2-315. Directors must prove a proper corporate purpose for, and the fairness of, exchanges and issuances of stock affecting corporate funds and control. Cummings v. United Artists Theatre Circuit, Inc., 237 Md. 1 , 204 A.2d 795 (1964); Ross Transport, Inc. v. Crothers, supra; First Mortgage Bond Homestead Ass’n v. Baker, 157 Md. 309 , 145 A. 876 (1929); Mountain Manor Realty v. Buccheri, 55 ²⁶⁹ Md.App. 185, 461 A.2d 45 (1983).

The remedy common to these cases for breach of the directors’ obligations is voiding the transaction. See, e.g., Chesapeake Constr. Corp. v. Rodman; Ross Transport, Inc. v. Crothers, both supra. Toner’s “equal opportunity” argument lies beyond our prior decisions.

To appellant “equal opportunity” means a duty on the majority/directors to cause Envelope Co. to offer to purchase her nonvoting shares based solely on the fact that the corporation purchased the nonvoting shares of another. The argument rests heavily on three cases, with the principal analysis to be found in Donahue v. Rodd Electrotype Co. of New England, Inc., 367 Mass. 578 , 328 N.E.2d 505 (1975), a case involving a closely held corporation. The corporation had been purchased as a going business by Harry C. Rodd (Rodd) and Joseph Donahue (Donahue). They had worked for the corporation when it was owned by a parent corporation.

Rodd was general manager, and Donahue had been promoted from a laborer’s job eventually to plant superintendent, and corporate vice president by 1955. Over the years Rodd had purchased 200 shares of the corporation’s stock from the parent and Donahue had purchased 50 shares, in all instances at $20 per share. In 1955 the corporation bought the shares owned by its parent for $135,000, of which $75,000 was cash, obtained in large part from a loan to the company by Rodd who had mortgaged his home. Rodd was the dominant influence in the company.

Eventually his two sons entered the business. One became corporate vice president and in 1964 the other replaced Donahue as plant superintendent. By 1970 Rodd was 77 years old and Donahue was dead. Rodd, through a program of gifts to his three children, had reduced his holdings to 81 shares.

His sons wanted him to retire. Rodd and his children agreed upon a plan under which each child purchased two shares of stock, Rodd gave ten shares to each child, and the corporation purchased Rodd’s remaining 45 shares for $800 a share, a figure which one son testified reflected book and liquidating value. At this time ²⁷⁰ 45 of the Donahue shares were owned by Donahue’s widow and five by his son. They sued the corporation and Rodd’s children and lost in the trial court.

The Supreme Judicial Court of Massachusetts, however, directed entry of a decree ordering Rodd Electrotype to purchase the Donahue stock or Rodd to remit the purchase price paid for his shares, plus interest. 4 The Court classified the company as a close corporation, but there was no Massachusetts statute defining what a close corporation was or treating specially the legal problems of the closely held corporation. The Court “deem[ed] a close corporation to be typified by: (1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation.” Id. at 586 , 328 N.E.2d at 511 . The opinion then reviewed the various ways in which the minority in a close corporation may be oppressed by the majority without having any ready market for minority shares. “Because of the fundamental resemblance of the close corporation to the partnership, the trust and confidence which are essential to [that] scale and manner of enterprise, and the inherent danger to minority interests in the close corporation,” the Court said “that stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another.” Id. at 592-93 , 328 N.E.2d at 515 (footnotes