Oliveira v. Sugarman (Ct. of Special Appeals)

Filed:  January 28, 2016

Opinion by:  Stuart R. Berger

Holdings:  (1) A majority-disinterested and majority-independent board of directors’ unanimous decision to refuse a shareholder demand is not subject to the “special litigation committee” (“SLC”) exception but enjoys the protection of the business judgment rule.  (2) Absent a particularized rebuttal, statements made by a majority-disinterested and majority-independent board of directors within a letter refusing demand are presumed true and may properly be considered by the court. (3) In a derivative action, a shareholder’s right of discovery as to the issue of whether a board of directors acted appropriately in refusing demand is denied unless shareholder has met her burden of proof under the business judgment rule of showing bad faith, bad judgment, or lack of independence.

Facts:  Defendant-Appellees (“Appellees”) include a registered Maryland corporation and its current and former Board of Directors (“Board”) and members of senior management.  Appellants are two shareholders (“Shareholders”).

In 2009, Appellees sought and obtained shareholder approval of an executive compensation plan which issued additional shares of common stock to (1) ensure the ability to settle existing performance-based awards in shares instead of cash, and (2) thereby reduce Appellee’s tax burden.  Following a near-miss of share price performance targets in late 2010, Appellees became concerned that certain key employees might leave for better-paying opportunities with competitors.  After a 6-month review, the Board converted the performance-based awards to service-based awards.  The modification reduced the award amount by 25% and apportioned it into three installments over the years 2012 to 2014, so long as the employee remained employed.

In 2013, Shareholders issued a demand letter requesting Appellees to investigate and institute claims against responsible persons relating to the award modifications.  Shareholders demanded rescission of all shares issued under the 2009 plan, forbearance from issuing any additional shares-as-compensation, and any other appropriate relief due to damages sustained from the Board’s misconduct.

In response, the Board formed an investigative committee of a single, outside, non-management director.  The Board also retained outside counsel which was not then otherwise representing Appellee or its Board members.  After thorough review, the committee recommended refusal of Shareholders’ demand.  The Board unanimously voted to refuse the demand and informed Shareholders that the proposed litigation was not in the corporation’s best interest because Appellee would likely lose, suffer substantial harm, pay both sides’ legal fees, and incur substantial costs even in the event it won due to the millions of dollars required to generate new executive compensation awards.

In 2014, Shareholders began the instant litigation, alleging three derivative claims (breach of fiduciary duty, waste, and unjust enrichment) and two direct claims (breach of contract and promissory estoppel).  Appellees moved to dismiss, contending that because all five counts were essentially derivative claims and because Shareholders had failed to plead sufficient facts to overcome the presumption that the Board had acted in the best interest of the company, the Board was entitled to the protections of the business judgment rule.  Appellees further asserted that were the court to reach the merits, Shareholders had failed to state a claim on any of the five counts.  The circuit court agreed and dismissed Shareholders’ complaint in its entirety.  Shareholders timely appealed.

Analysis:  On appeal, Shareholders sought to establish that the circuit court had erred in two areas: first, by granting motion to dismiss the derivative claims, and secondly by dismissing those claims styled as direct claims. 

A derivative action requires the corporation’s board of directors to conduct an investigation into the shareholders’ allegations to determine whether pursuing the demanded litigation is in the best interests of the corporation.  Should the corporation fail to so litigate and the shareholder bring a “demand refused” action, the court is typically tasked with reviewing whether the board acted independently, in good faith, and with sound business judgment.  

On this point, Appellees sought the protections afforded by the presumption of business judgment rule.  Meanwhile, Shareholders argued that the court should apply an exception to the rule developed by the Court of Appeals in Boland v. Boland.  The Shareholders maintained that because the Boland court had established that a demand refusal was not entitled to business judgment rule protection, then Shareholders were entitled to discovery as to the process by which the Board had made its decision not to litigate leaving the burden to fall on Appellees to provide evidence of acting in good faith and reasonableness.  However, the court distinguished the instant case from Boland, noting that the demand refusal there was made by a special litigation committee (“SLC”) appointed in light of a minority of disinterested directors.  In this case, the decision to refuse demand was made unanimously by a board consisting of a majority of disinterested and independent directors.  As a result, the court found the business judgment rule to apply, and not the Boland exception.

So finding, the court placed the burden on Shareholders to establish sufficient facts that the directors had failed to act on an informed basis, in good faith, and with honest belief that actions taken were in the best interests of the corporation.  In each instance, the court found Shareholders’ arguments unpersuasive.  Shareholders’ allegation that the demand rejection was tainted by one director having received benefits under the contested executive compensation plan was insufficient because the other 5 directors remained disinterested.  Shareholders’ bald allegations of impropriety in the demand investigation were also insufficient in light of the committee’s 40 years of business experience and use of highly respected and experienced outside counsel.  Further, allegations of a mere personal friendship, outside business relationship, or compensation for services – standing alone – were insufficient to raise an inference of lack of independence.

The court was similarly unpersuaded by Shareholders’ next contention that the Board had acted in contravention of authority granted by shareholders in the 2009 plan.  Finding express discretionary language in the text of the 2009 plan, Appellees were clearly entitled to modify the 2008 executive compensation awards.  The court then doubled down: assuming arguendo that the compensation plan modification was improper, the Board acted properly because any remedy would have been detrimental to the best interests of the corporation by incurring considerable additional compensation or tax liabilities.

Shareholders next maintained the lower court had erred by considering facts contained within the Board’s letter refusing demand, arguing that the court should have permitted discovery or, at minimum, made independent factual determinations.  Finding no Maryland precedent, the court looked to Delaware law; pursuant to the business judgment rule, statements contained within a letter refusing demand are presumed true absent a particularized rebuttal.  Here again, the SLC exception did not apply because the demand refusal was approved by Appellee’s majority-disinterested and majority-independent Board.  Because a court’s decision to grant discovery in a demand-refused derivative action would undermine the business judgment rule by obviating the Board’s authority to decide whether litigation was pursuant to the corporation’s best interest, the lower court did not err by denying discovery.  Accordingly, Shareholders failed to meet their burden of establishing sufficient facts and the court held that the lower court did not err by granting motion to dismiss the derivative claims.

Finally, the court turned to the “direct” claims.  Here, the court noted that to maintain direct claims, shareholders must allege sufferance of an injury separate and distinct from that suffered directly by the corporation or derivatively by the shareholder due to injury to the corporation.  Because the injuries allegedly suffered would have been sustained by the corporation (by incurring compensation or tax liability), any claims would have properly been derivative.  The court further found no merit to either claim because the 2009 proxy statement did not constitute a contract, and because no detriment could have been avoided by its enforcement (nullifying a claim of promissory estoppel).  The remaining “direct” claims were therefore derivative and properly subject to dismissal.

The full opinion is available in PDF.

Malinowski v. The Lichter Group, LLC (Maryland U.S.D.C.)

Filed: January 28, 2016

Opinion by: James K. Bredar

Holding:  The U.S. District Court for the District of Maryland, declining to import the doctrine of presumed reliance from federal securities-fraud cases, held that to succeed on a negligent misrepresentation theory involving audit reports made in connection with a 401(k) Plan, employees must prove, among other matters, justifiable action was taken in reliance on the alleged misrepresentation.

Facts:  Plaintiffs were former employees of a transportation contractor.  The company established a 401(k) Plan as an employee benefit plan governed by ERISA.  Defendant-auditor was retained to perform an audit of the Plan’s financial statements for 2009, 2010 and 2011, as required by ERISA’s detailed reporting requirements.

By year-end 2011, the company’s contributions to the Plan were several quarters behind, such that the company owed over $700,000 to the Plan.  Plaintiffs alleged that the Defendant’s audit reports for 2010 and 2011 contained material omissions regarding the Plan.

Analysis:  A plaintiff asserting a claim for negligent misrepresentation must prove that, among other factors, the plaintiff took justifiable action in reliance on the statement.  The Court stated that for purposes of the Plaintiff’s negligent misrepresentation theory, it was not enough that the audit reports may have contained omissions or even misinformation.  The Plaintiffs must demonstrate that they relied on the reports to their detriment.  The Court highlighted that four of the five Plaintiffs admitted that they had no independent recollection of reading or reviewing the audit reports. 

Plaintiffs urged the Court to import the doctrine of presumed reliance from federal securities-fraud cases into this state law claim.  The Court noted precedent indicating that the “most prominent distinction between common law fraud and a [10b-5] violation is that the latter permits recovery based on a … theory which presumes reliance, while the former requires proof of actual reliance.”  The Court, noting that it was a federal court sitting in diversity, declined to expand tort liability under Maryland law and granted summary judgment on the negligent misrepresentation claim. 

Plaintiffs also alleged breach of professional negligence.  The Court stated that a professional negligence claim, similar to any negligence claim, requires the plaintiff to establish: (i) a duty was owed to Plaintiff; (ii) a breach of that duty; (iii) causation between the breach and the harm; and (iv) damages.  Maryland courts recognize the “but for” test and the substantial factor test when analyzing whether causation exists.  The Court noted that the Defendants, as auditors, were not directly responsible for the over $700,000 deficiency in the Plan.  The Court also noted that the Plaintiffs cannot contend they would have taken action to remedy the deficiencies in the Plan because four of five of the Plaintiffs never saw the reports. 

Plaintiffs argued that the audit reports serve a dual purpose of alerting the Plan participants and the Department of Labor of irregularities and that “but for” the inaccurate audit reports the DOL would have been on notice of the deficiencies and able to correct the arrearage.  The Court stated that the DOL was already conducting an investigation at the time of the 2011 report and that “a careful study of the documents [from the 2010 report] shows the numbers reconcile.”  The Court granted summary judgment on the professional negligence claim.

The opinion is available in PDF.

Dante Askew v. HRFC (U.S. Ct. Appeals 4th Cir.)

Opinion by Diaz, Circuit Judge.

Holding: The Maryland Credit Grantor Closed End Provisions (CLEC) are not violated when a creditor discovers and cures an interest rate on debt that is being charged in excess of the legal limit within sixty days of discovery.

Facts:  Appellant was a party to a retail installment sales contract with a car dealership to finance purchase of a used car. The dealership assigned the contract to creditor.  The contract, subject to CLEC, charged an interest rate of 26.99% in excess of the allowable rate of 24%. In August of 2010, creditor discovered the discrepancy and sent appellant a letter noting that the interest rate listed in his contract was not correct. It then credited his account $845. It also noted that an interest rate of 23.99% until the contract terms were due to completed.

Appellant defaulted and creditor took steps to collect on the account. Appellant alleged that creditor made false statements in their attempts to collect on his account which included: 1) a claim that he would be reported to state authorities; 2) a replevin warrant had been prepared; and 3) his complaint in the case he filed against them in the lower court had been dismissed.

Analysis:

“If a creditor knowingly violates the CLEC, it shall forfeit to the borrower 3 times the amount of interest, fee’s and charges collected in excess of that authorized by CLEC.” Sec. 12-1018(b). CLEC includes two safe-harbor provisions. Section 12-1020 provides:

A credit grantor is not liable for any failure to comply with CLEC, if, within 60 days after discovering an error and prior to institution of an action under CLEC, or receipt of written notice from the borrower, the credit grantor notifies the borrower of the error and makes whatever adjustments are necessary to correct the error.

Appellant argued that creditor violated the CLEC by failing to expressly disclose in the contract an interest rate below the statutory maximum. He also argued that the “discovery rule” should apply to the section 12-1020 safe harbor, which would mean that creditor failed to cure an error within sixty days of discovery. Appellant asserted that creditor failed to properly notify him of the interest rate error and failed to make the adjustments to correct the error.

The Court rejected the argument that the actual interest rate of 24% had to be expressly disclosed in the contract. The only disclosure requirement in section 12-1003(a) is “one mandating that the interest rate charged be expressed as a simple interest rate.” The Court cited that appellant’s interpretation would “subject credit grantors to a rather meaningless technical requirement while doing little to help consumers.” The purpose of the statute is to prevent creditor grantors from charging usurious rates while protecting consumers by eliminating confusing interest rate computations in contracts.

Appellant’s argument regarding the discovery rule of CLEC was predicated on an interpretation of the rule that would have required creditor to discovery the interest rate error at the time it assumed the contract. The Court rejected this argument stating that creditor took the proper steps to correct the error, when it actually discovered it. It stated that the goal of the discovery rule is to encourage creditors to “cure any CLEC violation upon learning of it and notify the debtor, who is otherwise unaware of any problem with the loan.”

The Court concluded that creditor complied with section 12-1020’s notice requirement in that it notified appellant in the cure letter by identifying the of the substance of the mistake at issue in the case, charging too much interest.

Appellant believed that he was entitled to a refund of all interest collected in excess of 6%, under Maryland usury law. The Court deemed this argument moot because it raised too late but also noted that the default rate of 6% is only applied in the absence of statute providing otherwise. Here, the CLEC governs and simply required creditor to make a timely refund of the interest collected above CLEC’s statutory maximum. The summary judgment on the breach of contract claim was upheld because “liability under CLEC begets a breach of the contract, and a defense under CLEC precludes contract liability.”

The Court however did determine that a reasonable jury could find creditor’s collection activities to be in violation of the Maryland Consumer Debt Collection Act (MCDCA). Creditor was alleged to have told appellant that it had taken legal action against him on three separate occasions. The Court reversed the lower court’s order granting summary judgment to creditor on appellant’s MCDCA claim. 

The full opinion is available in PDF.

Wagner v. State of Maryland (Ct. of Appeals)

Filed:  December 17, 2015

Opinion by Watts, J.

Holding:  A party to a joint or multiple-party account may commit theft from that account.

Facts:  As of 2005, Father owned an IRA containing nearly $200,000 and a bank account containing a few thousand dollars.  Father added Daughter to the bank account after his wife died.  Between 2005 and 2009, $181,670 was transferred from the IRA to the bank account.  During that same time, $251,645 was taken from the bank account via withdrawals and wire transfers to Daughter’s accounts.  Father did not authorize such withdrawals and transfers. 

The trial court made the following additional factual findings:  (1) Daughter was added to the account to allow her to access the funds in the account if something happened to Father; (2) Daughter understood that the money in the account belonged to Father; and (3) Daughter withdrew funds from the account and used them for her own purposes. 

Section 1-204(f) of the Fin. Inst. Article provides: “unless the account agreement expressly provides otherwise, the funds in a multiple-party account may be withdrawn by any party or by a convenience person for any party or parties, whether or not any other party to the account is incapacitated or deceased.” 

Analysis:  Daughter argued that a person cannot be guilty of theft from a joint or multiple-party bank account if the person is a party to the bank account, because such person is an owner of the funds in the account.  The State argued that Daughter withdrew funds from the account without Father’s authorization and used them for her benefit.  The State asserted that FI §1-204(f) does not confer ownership of an account but instead provides authorization to withdraw funds from an account absent some other agreement between the bank and the parties to the account. 

The Court stated that having the ability to withdraw funds pursuant to FI §1-204(f) does not create an interest in or give ownership of the property to a party to the account.  While there is a rebuttable presumption of equal ownership of funds among parties to a multiple party account (see our summary of Morgan Stanley & Co. Inc. v. Andrews), the Court held that the evidence adduced at trial rebutted that presumption because the funds in the account were Father’s funds, Daughter was added for the sole purpose of accessing the funds if necessary and Daughter agreed to the arrangement.  A signature card that identifies Daughter as a “joint owner” is not dispositive of an ownership interest in the account.  The Court found nothing in FI §1-204(f) to prevent a conviction of theft and found the evidence sufficient to demonstrate the Daughter committed theft.

The Court also found the evidence supported a conviction for embezzlement (fraudulent misappropriation by fiduciary), which merged with the conviction for theft.  Because Father and Daughter knew the funds in the account were Father’s and Daughter was permitted to access funds in the account at Father’s direction and on his behalf, a fiduciary relationship “implying and necessitating great confidence and trust on the one part and a high degree of good faith on the other part” was created.  The Court noted that simply being a party to a joint or multiple-party account does not necessarily make that party a fiduciary.

The full opinion is available in PDF.

Md. Comm’r of Fin. Regulation v. Cashcall (Ct. of Special Appeals)

Filed: October 27, 2015

Opinion by: Krauser, C.J.

Holding:

A company qualifies as a “credit services business” under the Maryland Credit Services Business Act only if the sole business activity is loan arrangement services and the business must directly receive compensation from a Maryland consumer.

Facts:

Defendant is a California company that marketed consumer loans through online services. Defendant referred consumers to two federally insured out-of-state banks and assisted the clients complete the loan application. If a customer met the lending requirements, one bank would process the loan, less an origination fee paid to the Defendant. Under the contract between the bank, Defendant must repurchase the loan amount – including all servicing and processing fees – owed by the consumer after the loan was disbursed. Additionally, the interest rates of these loans exceeded the permissible rates under Maryland law.

The Maryland Commissioner of Financial Regulation received numerous consumer complaints from 2007 to 2009. The Commissioner initiated an action in 2009, charging that Defendant operated as a credit services business without a license in violation of the Maryland Credit Services Business Act (“MCSBA”).

Analysis:

The court observed that, pursuant to the MCSBA’s legislative history, any company that receives payment directly from a consumer for loan repayment is subject to regulation under the MCSBA.  Any attempt by a company that provides consumer lending services and receives payment would undercut the law in opposition to the legislative intent of the law. Thus, the state would apply a broad view to regulate companies that operate primarily to provide consumer loans.

To define the term, “credit services business,” the Court reviewed Gomez v. Jackson Hewitt, Inc., 427 Md. 128 (2012). In Gomez, the Court of Appeals determined that Jackson Hewitt, Inc. had not violated the MCSBA. Jackson Hewitt offered tax preparation services and provided refund assistance lending (“RAL”) to qualifying customers, but did not directly receive any compensation from the customer for the RAL services. The Gomez Court ruled that Jackson Hewitt did not fit the legal requirements for a credit services business.

The Court distinguished Defendant’s services from Gomez on two key issues. First, Defendant received compensation directly from the consumers. Each loan processed by either bank was subject to the same “origination fee” which was then rolled into the repacked loan bought by Defendant. Consumers paid Defendant for the borrowed amount plus this origination amount. The Court concluded that Defendant “by collecting the origination fee paid by the borrowing consumer, received ‘direct payment’ from the consumers and therefore was . . .  a ‘credit services business’ under the MCSBA.” In contrast, Jackson Hewitt did not have a set origination fee which consumers never directly paid to the company for the loan services.

Second, Defendant fell under MCSBA regulation because it operated primarily and wholly as a consumer lending service. Defendant assisted consumers to complete the loan application, referred the loan to a bank, and repurchased the debt. The Court explicitly stated Defendant’s “loan arrangement service was . . . the only service [Defendant] provided.” Jackson Hewitt, on the other hand, primarily provided tax preparation services and only a small fraction of the consumers received RAL.

The full opinion is available in PDF.  

Sutton v. FedFirst Financial Corporation (Ct. of Special Appeals)

Filed:  October 29, 2015

Opinion by:  Graeff, J.

Holdings:  (1) The common-law fiduciary duties of candor and maximization of shareholder value articulated in Shenker v. Laureate Education, Inc. did not apply to a merger where shareholders received a mix of cash and stock consideration because the merger did not result in a sale or change of control of the target company.  (2)  Shareholder’s appeal is not moot even though rescission of merger would be impracticable, because shareholder could obtain rescissory damages in lieu of actual rescission if he were to prevail on his claims.

Facts:  Plaintiff, a shareholder of FedFirst Financial Corporation, sought to enjoin a merger between FedFirst and CB Financial Services, Inc., alleging that FedFirst’s directors breached fiduciary duties owed to FedFirst’s shareholders and that CB Financial aided and abetted the alleged breaches.

FedFirst began to explore a possible business combination with CB Financial in January 2013.  During the course of negotiations with CB Financial, FedFirst’s financial advisors were unsuccessful in soliciting other offers.  On April 14, 2014, after receiving a fairness opinion from its financial advisors, the FedFirst board unanimously approved the merger agreement with CB Financial, which was executed and announced that day.

The merger agreement provided that FedFirst shareholders would receive either  cash or shares of CB Financial common stock in exchange for each FedFirst share, at their election, subject to the requirement that 65% of the total shares of FedFirst would be exchanged for CB Financial stock and 35% would be exchanged for cash.  The agreement prohibited FedFirst from soliciting other acquisition proposals, but did not preclude it from considering unsolicited offers, as long as they were “superior proposals.”  If FedFirst terminated the agreement before consummating the merger it would pay CB Financial a termination fee.

On April 21, 2014, Plaintiff filed a class action lawsuit in the Circuit Court for Baltimore City against FedFirst, its seven individual directors and CB Financial, asserting both direct and derivative claims.  He later voluntarily dismissed the derivative claims, and on September 19, 2014, the Circuit Court dismissed the remainder of his claims with prejudice.  Plaintiff promptly noted his appeal, but did not move to stay the merger pending appeal, and on October 31, 2014, FedFirst and CB Financial completed the merger.

Analysis:  Plaintiff argued that FedFirst’s directors had breached common-law fiduciary duties of candor and maximization of shareholder value, as articulated in Shenker,, which held that directors owed such duties to shareholders in “cash out” mergers that effectively eliminated their interest in the target company without providing any interest in the acquiring company.  Shenker also established an exception to the general rule that a shareholder may only challenge a merger transaction in a derivative action (i.e., on behalf of the corporation), holding that a shareholder may bring direct claims when “the occurrence of appropriate events” triggers the aforementioned common-law duties to shareholder individually.  Plaintiff argued that  Shenker’s holding was not limited to “cash out” transactions, but that other “appropriate events” could give rise to fiduciary duties of candor and maximization of value to shareholders.

The Court conducted a detailed analysis of Shenker and agreed that its holding was not limited to “cash out” transactions, but that fiduciary duties of candor and maximization value are owed to shareholders when “the decision is made to sell the corporation,” the “sale of the corporation is a foregone conclusion,” or the sale involves “an inevitable or highly likely change-of-control situation.”  While the Court of Appeals declined to explain what factual scenarios may satisfy these triggering events, the Court looked to Delaware case law, which recognizes duties to shareholders only in the following scenarios:

(1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (3) when approval of a transaction results in a sale or change of control (internal quotations and citations omitted).

The Court found none of these scenarios present with respect to the FedFirst/CB Financial merger.  Plaintiff did not allege that FedFirst initiated an active bidding process or abandoned a long-term strategy to seek to break up the company. Rather, the FedFirst directors merely explored options for a potential merger, which they would then present to the stockholders for approval.  The facts did not indicate that the sale of the company was a foregone conclusion. And, perhaps most importantly, the Court found that the mixed cash and stock consideration did not result in a sale or change of control of the company, noting that, “Unlike the scenario involved in the cash-out merger transaction in  Shenker, FedFirst’s shareholders in this case, by virtue of the stock portion of the merger agreement, have a continuing interest, including voting power, in the combined company, and they can participate in the future successes of CB Financial.”

For these reasons, the Court found that the duties articulated in Shenker did not apply, , that FedFirst’s directors were subject only to the ordinary managerial duties set forth in C.A. § 2-405.1 and were protected by the business judgment rule, and that Plaintiff had no basis for his direct claims against FedFirst and its directors.  The Court also dismissed Plaintiff’s aiding and abetting claims against CB Financial because it had found no underlying breach of fiduciary duties.

While the Court ultimately affirmed dismissal of Plaintiff’s claims on the merits, it rejected Defendants’ threshold argument that Plaintiff’s claims were moot because he sought to prevent a merger that had been completed while the appeal was pending.  The Court recognized that unwinding a long-completed merger involving more than two million publicly traded shares and an integration of corporate management would not be practicable, but found that the possibility of rescissory damages (i.e., the fair value of Plaintiff’s shares) had Plaintiff prevailed on the merits of his claims precluded a finding of mootness.

The full opinion is available in PDF.