Opinion
G056629
03-19-2020
ASLAN ABREGOV et al., Plaintiffs and Appellants, v. KEVIN LAWRENCE et al., Defendants and Respondents.
John L. Dodd & Associates, John L. Dodd; Cadden & Fuller and John B. Taylor for Plaintiffs and Appellants. Theodora Oringher, Jeffrey H. Reeves; Aviso Legal Group, Linda D. Lam and Lori Ginex-Orinion for Defendants and Respondents.
ORDER MODIFYING OPINION AND DENYING REHEARING; NO CHANGE IN JUDGMENT
It is ordered that the opinion filed on March 19, 2020 be modified as follow:
On page 18, at the end of the third line, insert the following as footnote 11:
11After our opinion was filed, Plaintiffs petitioned for rehearing, contending rehearing is compelled because this court cited section 204, subdivision (a)(11) in concluding that section 3.03(a) of the shareholder agreement was not independently enforceable. The Court of Appeal must afford the parties the opportunity to submit supplemental briefs when its decision is "based upon an issue which was not proposed or briefed by any party to the proceeding." (Gov. Code, § 68081.) The issue Plaintiffs raised on appeal is the enforceability—or not—of section 3.03(a) of the shareholder agreement. That issue was vigorously litigated by the parties, "and the fact that a party does not address an issue, mode of analysis, or authority that is raised or fairly included within the issues raised does not implicate the protections of section 68081. (People v. Alice (2007) 41 Cal.4th 668, 679, italics added.)
Original footnotes 11 through 13 are renumbered accordingly.
The modification does not change the judgment.
The petition for rehearing is DENIED.
DUNNING, J.* WE CONCUR: ARONSON, ACTING P. J. IKOLA, J. *Retired judge of the Orange Superior Court, assigned by the Chief Justice pursuant to article VI, section 6 of the California Constitution.
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115. (Super. Ct. No. 30-2013-00638650) OPINION Appeal from a judgment and postjudgment orders of the Superior Court of Orange County, Ronald L. Bauer, Judge. Affirmed. Motion to Augment Record. Granted. John L. Dodd & Associates, John L. Dodd; Cadden & Fuller and John B. Taylor for Plaintiffs and Appellants. Theodora Oringher, Jeffrey H. Reeves; Aviso Legal Group, Linda D. Lam and Lori Ginex-Orinion for Defendants and Respondents.
* * *
INTRODUCTION
This is the first of two appeals in this lawsuit. We also file today our opinion in the appeal from postjudgment orders. (Abregov v. Lawrence (Mar. 19, 2020, G056866) [nonpub. opn.] (Abregov II).)
Bio-Nutritional Research Group, Inc. (BNRG) makes and sells nutritional supplements and snacks using a propriety form of dietary protein called "Proto Whey," developed by Kevin Lawrence, its founder, majority shareholder, and member of the board of directors. The other two board members are Curtis Steinhaus, minority shareholder, chief financial officer, and chief operating officer, and Carlos Prietto, M.D., also a minority shareholder. We refer to Lawrence, Steinhaus, and Prietto collectively as Defendants. Aslan Abregov, Craig Parrino, and Pierre Ngo are three other minority shareholders; we refer to them collectively as Plaintiffs.
Defendants, in their roles as board members, amended the articles of incorporation to increase the number of authorized shares of stock from one million to 15 million; as majority shareholders, they approved the amendment. Defendants then issued more than six million shares of stock to themselves and one other shareholder (not a party to this appeal). Plaintiffs did not agree to amend the articles of incorporation and did not receive any additional shares. Plaintiffs sued, claiming Defendants engaged in a scheme to dilute Plaintiffs' BNRG shares and pay themselves excessive salaries.
A cornerstone of the dispute is the parties' shareholder agreement. As signed by the parties, this document describes BNRG as a "California close corporation" and requires unanimous shareholder approval to amend the articles of incorporation. This agreement suffers from internal inconsistencies and is at odds with the articles of incorporation and bylaws, which do not include a concomitant unanimity provision. Defendants filed a cross-complaint to rescind the shareholder agreement.
After this lawsuit was filed, Defendants voluntarily cancelled all previously issued shares of stock in excess of the one million authorized by BNRG's original articles of incorporation. The cross-complaint was tried to the court first, and Defendants' attempt to rescind the shareholder agreement failed. Instead, the trial court determined BNRG is not a statutory close corporation and reformed the shareholder agreement by deleting all references to BNRG's being a "close corporation."
The professional negligence cause of action against former corporate counsel, a derivative claim only, then settled. Plaintiffs proceeded to a phase two court trial on their individual and derivative causes of action. They did not succeed. The trial court determined Plaintiffs' requests for declaratory and injunctive relief were not ripe and concluded they had failed to prove all their other causes of action.
On appeal, Plaintiffs challenge the trial court's refusal to order Defendants to rescind the amendment to the articles of incorporation authorizing the issuance of 15 million shares of stock and to award damages for breach of contract and breach of fiduciary duty. Plaintiffs further contend reversal is compelled because the trial court's statement of decision was inadequate, and they seek to modify the judgment to provide that no party prevailed in the action.
We affirm. Although the trial court erred in declining to address Plaintiffs' individual and derivative declaratory relief causes of action based on the amendment to the BNRG articles of incorporation, the error was harmless. On the merits and as a matter of law, Plaintiffs cannot prevail on those theories. The statement of decision was similarly flawed; but again, that error was harmless and does not compel reversal. Plaintiffs did not prove Defendants breached the shareholder agreement or any fiduciary duties; their damages arguments are therefore moot. In light of our decision in Abregov II, the judgment correctly recites that Defendants are the prevailing parties in the action.
We also grant Defendants' request to augment the record with the reporter's transcript from the September 24, 2018 postjudgment hearing.
GOVERNING PRINCIPLES:
STATUTORY CLOSE CORPORATIONS V.
CLOSELY HELD CORPORATIONS
It is doubtful this action would have been filed but for an imprecision in the drafting of the shareholder agreement. As we discuss below, the shareholder agreement described BNRG as "a California close corporation" and included a provision requiring unanimous shareholder approval in order to amend the articles of incorporation. The articles of incorporation do not include a unanimity provision.
To understand the magnitude of the drafting error and provide perspective for the discussion that follows, we briefly explain why the description of BNRG as "a California close corporation" created such chaos.
California has always recognized "closely held corporations." Although there is no statutory definition for closely held corporations, they are governed by California's General Corporation Law (Corp. Code, § 100 et seq.; all future undesignated statutory citations are to the Corporations Code). The hallmark of a closely held corporation is that its stock is not publicly traded. (In re Marriage of Hewitson (1983) 142 Cal.App.3d 874, 882.) Typically, closely held corporations have relatively few shareholders, but there are no statutory requirements one way or the other concerning the number of authorized shareholders.
California first recognized the separate "statutory close corporation" in 1977, with the enactment of section 158. (Berger, Statutory Close or Closely Held Corporations? (1980) 11 Pac. L.J. 699, 701.) A statutory close corporation is defined in section 158 as a corporation "whose articles contain, in addition to the provisions required by Section 202, a provision that all of the corporation's issued shares of all classes shall be held of record by not more than a specified number of persons, not exceeding 35, and a statement, 'This corporation is a close corporation.'" (Id., subd. (a).) Close corporations are able to conduct their affairs in the manner of partnerships while maintaining advantages of the corporate form. (9 Witkin, Summary of Cal. Law (11th ed. 2017) Corporations, § 35, p. 837.)
BNRG, whose shares of stock are not publicly traded, bears all the characteristics of a closely held corporation. Other than the fact BNRG has fewer than 35 shareholders, it has none of the requisites of a statutory close corporation. (§ 158.)
By statute, articles of incorporation for all corporations, including a statutory close corporation, must set forth the number of shares of stock the corporation is authorized to issue. (§ 202, subd. (f).) A change in the number of authorized shares of stock requires an amendment to the articles of incorporation. (§ 902.) The default rule for amending articles of incorporation for all corporations, including statutory close corporations, is codified in sections 152 and 902, subdivision (a): Amendments to the articles of incorporation may be adopted if approved by the board and a simple majority of the outstanding shares entitled to vote.
Corporations may adopt different requirements for amending their articles of incorporation (e.g., they may require a supermajority or unanimous vote of the shareholders to amend the articles of incorporation). In the case of a statutory close corporation, such departures from the default rule are valid if included in a shareholder agreement. (§ 204, subd. (a)(11).) For all other corporations, the rule is to the contrary: A unanimity provision in a shareholder agreement is not legally effective unless expressly provided in the articles of incorporation. (§ 204, subd. (a)(5).)
The second paragraph of section 204, subdivision (a)(11) provides in part, "[n]otwithstanding this subdivision, in the case of a close corporation any of the provisions referred to above may be validly included in a shareholders' agreement."
Section 204, subdivision (a) lists the "provisions, which shall not be effective unless expressly provided in the articles." Subdivision (a)(5) reads in pertinent part: "A provision requiring, for any or all corporate actions . . . the vote of . . . all of the [shareholders] or the vote . . . of all of the directors, than is otherwise required by this division."
The trial court determined BNRG is not a statutory close corporation. No one has challenged this ruling.
FACTUAL BACKGROUND
BNRG was incorporated in 1996. As the trial court found, "BNRG is the product of the creative skills of its Chief Executive Officer, defendant Kevin Lawrence."
The original articles of incorporation authorized the issuance of one million shares of one class of stock. For a number of years, Lawrence was the only shareholder and held 400,000 shares of stock.
Steinhaus, Parrino, Abregov (all certified public accountants), and Ngo (a certified financial planner) were partners in a firm that provided accounting and tax services to Lawrence. In 2001, when Lawrence sought to raise capital for BNRG, the firm agreed to invest a total of $200,000—approximately $150,000 in cash and $50,000 in services. Initially, the four partners/investors each received 25,000 shares of BNRG stock and a 5 percent ownership interest in the company. As credit for a loan to the company, the investors' shares were soon increased to 26,889 BNRG shares each.
A written agreement between Lawrence and the investors' firm (not the investors individually) signed in 2002 memorialized the infusion of capital and included a provision confirming "[t]he investment in BNRG above assumes that Mr. Kevin Lawrence will contribute and or assign [to BNRG] any and all rights to the intellectual property that is Proto Whey, Power Crunch, and products currently in existence and future products that will be manufactured by BNRG not limited to the product formulas, and the manufacturing process."
With the addition of the investors, more than 400,000 shares of BNRG stock still remained unissued. BNRG bylaws authorized three directors. In June 2002, BNRG had two directors—Lawrence and Steinhaus.
In 2003, Lawrence invited Prietto, his brother-in-law, to invest in BNRG. Prietto was concerned about his ability "to get out of the deal" and a "cram-down," that is, dilution of ownership through issuance of additional shares of stock. Prietto also sought appointment to the third director position.
Lawrence instructed his attorney, Alan Novodor, to prepare a shareholder agreement to address Prietto's concerns. Novodor's paralegal drafted the document using a Matthew Bender form for statutory close corporations as a template. No one advised the paralegal that BNRG was, or intended to become, a statutory close corporation. The paralegal did not examine the BNRG articles of incorporation to confirm its status as a statutory close corporation. In addition to describing BNRG as a statutory close corporation, section 3.03(a) of the draft shareholder agreement required the written consent of all shareholders to approve any amendments to the articles of incorporation.
Several iterations later—and with the statutory close corporation and unanimity language intact—the shareholder agreement was signed in January 2004 by Plaintiffs, Defendants, and two other shareholders (Michael Quigley, who owned 2,500 shares, and Narendra L. Parson, M.D., whose family trust received 5,397 shares in exchange for a $50,000 investment). Within three years, BNRG's value increased from $1 million to $5 million, based on the per-share price Prietto paid.
These individuals are not parties to either appeal.
When the shareholder agreement was signed, it reflected the following ownership of BNRG shares:
| Name | Shares Owned | Percent Owned(Based on Shares Issued) |
|---|---|---|
| Kevin Lawrence | 400,000 | 74.110% |
| Michael Quigley | 2,500 | 0.463% |
| Curtis Steinhaus | 26,889 | 4.982% |
| Aslan Abregov | 26,889 | 4.982% |
| Pierre Ngo | 26,889 | 4.982% |
| Craig Parrino | 26,889 | 4.982% |
| Carlos A. Prietto, M.D. | 24,288 | 4.500% |
| Narendra L. Parson and Rita ParsonFamily Trust | 5,397 | 1.000% |
| Total Shares Issued | 539,741 | 100% |
| Unissued Shares | 460,259 | |
| Total Authorized Shares | 1,000,000 |
By the year 2009, however, BNRG was in a four-year sales slump and had just endured two years of net losses. Steinhaus left his accounting firm with Plaintiffs and became BNRG's acting chief financial officer. BNRG hired Chris Riley to revitalize its sales strategies, "bring some consumer goods expertise to the group," and take BNRG "to the next level." Riley's compensation package included a 5 percent interest in BNRG, with an opportunity to gain additional shares if certain sales milestones were met, to a maximum of 20 percent of BNRG's stock. Abregov understood his ownership in BNRG might be diluted, but did not object to hiring Riley on those terms "if he could perform" and because all shareholders would be diluted proportionately.
Riley was terminated within the year, and BNRG repurchased his stock. In December 2009, Steinhaus officially became BNRG's chief financial and chief operating officer and for compensation was given essentially "the same deal" Riley had received.
The first of several attempts to amend BNRG's articles of incorporation occurred in 2009. Majority shareholder Lawrence unilaterally signed an amendment to the BNRG articles of incorporation authorizing BNRG to increase the authorized shares of stock from one million to three million. Novodor never filed the amendment with the California Secretary of State because it did not have the consent of all shareholders. Lawrence never told Plaintiffs about the attempt to amend the articles of incorporation because the document was never filed.
Several significant events occurred in 2010. The board approved and signed Steinhaus's formal employment agreement. Steinhaus's compensation included an initial signing bonus of 88,889 BNRG shares of stock and incentive compensation of additional shares if certain revenue goals were met. The board also approved the formation of a medical board consisting of physicians Prietto and Parson, who were to receive additional shares of stock for their service in this capacity. Defendants discussed increasing the number of authorized shares to 15 million, but made no decision at that time.
As a result of these decisions, Steinhaus's ownership interest in BNRG rose from 4.982 percent to 14.258 percent. Lawrence was issued 168,431 additional BNRG shares in exchange for "contributions to BNRG of such items as services and intellectual property." Prietto and Parson were given additional shares that kept their ownership interests at 4.5 percent and 1 percent, respectively. At this point, BNRG still had not issued all of the one million authorized shares of stock. That soon changed.
On January 1, 2011, a unanimous BNRG board approved increasing the number of authorized shares to 15 million. The board members, who owned more than 75 percent of BNRG's stock, did not hold a shareholder meeting or immediately advise Plaintiffs of the amendment. Lawrence was of the opinion, based on Novodor's advice, that he alone, as the majority shareholder, could amend the articles of incorporation.
Although the conforming certificate of amendment to the BNRG articles of incorporation was not filed with the California Secretary of State until July 2012, BNRG's board immediately began issuing additional shares of stock; more than six million shares were issued to Defendants and Parson. By the time the dust settled, Lawrence's ownership interest in BNRG was reduced to 64.505 percent, Steinhaus's was increased to 29.982 percent, and Prietto's and Parson's dropped to 3.6 percent and .8 percent, respectively. Plaintiffs' interests decreased to .36 percent each. Lawrence agreed all this "doesn't look very good."
BNRG's sales revenues and profits increased substantially after Steinhaus became chief financial officer and chief operating officer. Net income in 2010 was $27,260.85 while in 2016 net income had jumped to $4,844,072.19. According to Defendants, by 2017 BNRG was worth 200 times more than its value when Plaintiffs first invested it.
PROCEDURAL BACKGROUND
Plaintiffs initiated this lawsuit in March 2013. Plaintiffs never sought to amend the complaint to conform to proof, and the original complaint remained the operative pleading.
Plaintiffs brought individual and derivative causes of action for declaratory relief based on Defendants having amended the BNRG articles of incorporation without unanimous shareholder approval. Plaintiffs alleged, in essence, that BNRG was a statutory close corporation, the unanimity provision in the shareholder agreement controlled, and the 2012 amendment to the BNRG articles of incorporation purporting to increase the number of authorized shares of stock to 15 million was "void as ultra vires and in violation of the [s]hareholder agreement." In the prayer for relief for these causes of action, Plaintiffs sought a mandatory injunction to compel BNRG to take "all necessary steps" to make itself a statutory close corporation "including amending the Company's articles of incorporation" to reflect that status.
Derivative causes of action seek to remedy injuries to the corporation or to the whole body of its stock when the board of directors fails or refuses to do so. (Grosset v. Wenaas (2008) 42 Cal.4th 1100, 1108.) "Shareholders may bring a derivative suit to, for example, enjoin or recover damages for breaches of fiduciary duty directors and officers owe the corporation. [Citation.] An individual cause of action exists only if damages to the shareholder were not incidental to damages to the corporation." (Schuster v. Gardner (2005) 127 Cal.App.4th 305, 313.)
The individual and derivative causes of action for breaches of contract and fiduciary duties were based on allegations Defendants issued themselves and Parson more than six million shares of stock, thereby diluting Plaintiffs' percentage of ownership, paid themselves excessive salaries, and failed to make certain disclosures.
Defendants maintained BNRG was not a statutory close corporation and the 2012 amendment to the BNRG articles of incorporation increasing the number of authorized shares of stock to 15 million was valid. (§ 204, subd. (a)(5).) Nevertheless, in May 2014, Defendants voluntarily and formally cancelled the issuance to themselves and Parson of all shares of stock in excess of one million "in the interests of avoiding additional disharmony among [BNRG]'s shareholders, mollifying certain of [Plaintiffs'] concerns, and avoiding certain and additional legal costs and uncertainties." As a consequence, as of May 2014, and at the time of trial, one million shares of BNRG stock remained issued. The ownership interests in BNRG held by each shareholder were as follows:
The recitals to the share cancellation agreement state: (1) BNRG is authorized to issue 15 million shares of stock; (2) Plaintiffs challenge the validity of the authorization and issuance of BNRG shares in excess of one million; (3) the parties to the share cancellation agreement believe that challenge is unfounded; and (4) the agreements are made "in the interests of avoiding additional disharmony among BNRG's shareholders, mollifying certain of [Plaintiffs]'s concerns, and avoiding certain and additional legal costs and uncertainties."
| Name | Shares Owned | Percent Owned |
|---|---|---|
| Kevin Lawrence | 610,004 | 61.00% |
| Michael Quigley | 2,500 | 0.25% |
| Curtis Steinhaus | 277,144 | 27.714% |
| Aslan Abregov | 26,889 | 2.689% |
| Pierre Ngo | 26,889 | 2.689% |
| Craig Parrino | 26,889 | 2.689% |
| Carlos A. Prietto, M.D. | 24,288 | 2.429% |
| Narendra L. Parson and Rita Parson Family Trust | 5,397 | 0.540% |
| Total | 1,000,000 | 100% |
| Total Shares Issued | 1,000,000 |
Defendants also served each Plaintiff with a Code of Civil Procedure section 998 settlement offer in the amount of $500,000, for a total of $1.5 million. Plaintiffs did not accept them. Plaintiffs entered into a nonmonetary settlement with several other defendants, who are not involved in this appeal.
The matter was tried in two phases. The court trial on Defendant's cross-complaint began in May 2016. The trial court found "BNRG is not a close corporation," but did not rescind the shareholder agreement because Defendants presented no evidence of fraud, duress, or undue influence, ruling instead that "those occasional references to a close corporation" should be stricken, but "[t]he substantive operative provisions [of the shareholder agreement] should all survive."
After the phase one trial, Novodor, BNRG's erstwhile counsel, settled Plaintiffs' derivative legal malpractice claim. Over opposition by BNRG and Defendants, the trial court determined the attorney's settlement was in good faith. All the settlement proceeds, only described as a sum not less than $350,000, were paid to BNRG. Plaintiffs also voluntarily dismissed their causes of action for promissory estoppel, negligent misrepresentation, and fraud against Defendants.
The phase two court trial on Plaintiffs' remaining causes of action (individual claims for breach of fiduciary duty, breach of contract, declaratory relief, and unjust enrichment; derivative claims for breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, declaratory relief, and accounting) began in October 2017. The trial court granted Parson's motion for judgment at the close of Plaintiffs' case-in-chief. After the parties presented evidence, the trial court took the matter under submission and issued a written ruling, intended to be the statement of decision.
The trial court concluded judgment must be entered in favor of Defendants and against Plaintiffs on all causes of action. The trial court issued a ruling by minute order, which ultimately became the statement of decision, in which the court found:
1. "One million shares [of corporate stock] are authorized, one million shares are presently issued and held." The dilution of Plaintiffs' interest from their original 5 percent to the current 2.689 percent "was lawful because the BNRG articles of incorporation authorized the issuance of one million shares and [Plaintiffs] did not negotiate a nondilution pact."
2. Although Plaintiffs' respective interests had been diluted at one point to .36 percent, there was no need to decide whether the dilution was unlawful because BNRG canceled all shares above the one million authorized by the original articles of incorporation.
3. Compensation to Lawrence and Steinhaus, in the form of salary and additional stock, was fair. Lawrence created BNRG's products and first delivered them to market, committed substantial personal assets to BNRG, and worked "long and hard." Steinhaus brought "needed entrepreneurial and management skills." The substantial number of shares Lawrence and Steinhaus received were not disproportionate to the success they achieved for BNRG. In contrast, Plaintiffs were passive investors whose contributions, though not to be viewed lightly because they invested in the early years, did not contribute in the same degree to BNRG's success.
Plaintiffs do not challenge the salary portion of the Lawrence and Steinhaus compensation packages.
4. Plaintiffs' individual $50,000 investments were worth $5.378 million. "In view of their limited (non?) participation in the business, it is very difficult to see how these plaintiffs have been mistreated."
The trial court did not make a specific ruling as to the validity or enforceability of section 3.03(a) of the shareholder agreement, but found Plaintiffs did not prove any damages. After the trial court issued the intended statement of decision, Plaintiffs asked that it be amended to address whether the 2012 amendment to the articles of incorporation constituted a breach of the shareholder agreement and a breach of Defendants' fiduciary duties. Plaintiffs proposed the specific language they sought. The trial court declined to expressly rule on section 3.03(a); however, the intended statement of decision became the trial court's final ruling.
Defendants' counsel prepared a proposed judgment. The trial court signed the proposed judgment as presented. Judgment was in favor of Defendants on the complaint. On the cross-complaint, the judgment decreed, "the Shareholder Agreement . . . shall, as sought by the Cross-complainants, be reformed to remove any and all references to [BNRG] being a 'close corporation,' or being designated 'close.'" The judgment stated Defendants were the prevailing parties.
After entry of judgment, Plaintiffs sought to reopen the case to admit several exhibits (Parrino's Form K-1's for tax years 2013 through 2016) that were identified at trial, but not offered into evidence. Plaintiffs contended these exhibits established the damages they incurred as a result of Defendants' breaches of the shareholder agreement and their fiduciary duties. The trial court denied the motion to reopen evidence.
Plaintiffs also moved for a new trial and to vacate the judgment. In those motions, Plaintiffs argued: (1) the trial court should issue a mandatory injunction requiring Defendants to amend the BNRG articles of incorporation to reduce the number of authorized shares from 15 million back to the original to one million; (2) Plaintiffs were entitled, as damages for breach of contract and/or breach of fiduciary duty, to the difference between the corporate distributions they received in 2012 and 2013 and what they would have received if the six million shares of stock had not been issued to other shareholders; and (3) the judgment should designate Plaintiffs as the prevailing parties for both phases of trial.
The trial court denied the motion for a new trial and the motion to vacate the judgment, finding (1) Plaintiffs' request for damages had been "a moving target" in that they had presented at least four different damages calculations, and Plaintiffs did not offer adequate proof of damages; (2) the validity of the amendment to the articles of incorporation was not before the court because there was no evidence Defendants planned to issue more than one million shares; and (3) no party prevailed.
Plaintiffs' notice of appeal encompasses the judgment, the order denying the motion to reopen evidence, the order denying the motion for a new trial, and the order denying the motion to vacate the judgment.
Abregov II is a separate appeal by Defendants from the trial court's order denying their motion for attorney fees and determination that no party prevailed under Code of Civil Procedure section 1032.
DISCUSSION
I.
DEFENDANTS' 2012 AMENDMENT
TO THE ARTICLES OF INCORPORATION WAS VALID.
Plaintiffs' complaint sought a declaration that the 2012 amendment to the articles of incorporation was a void and ultra vires act and asked for a mandatory injunction "to require the directors to file a correcting amendment, reflecting only the authorized 1,000,000 shares." The trial court declined to grant the requested relief on the basis Defendants' cancellation of all issued shares of stock in excess of one million mooted Plaintiffs' causes of action for declaratory and injunctive relief.
Whether a justiciable controversy exists presents a question of law this court reviews de novo. (Wilson & Wilson v. City Council of Redwood City (2011) 191 Cal.App.4th 1559, 1582.) In a case like this one—where undisputed facts demonstrate the existence of an actual controversy—the litigants' respective rights should be declared even though the party seeking relief is not the one entitled to a "favorable declaration." (Wellenkamp v. Bank of America (1978) 21 Cal.3d 943, 948.)
Defendants' cancellation of millions of shares of stock did not moot the issue, as the amendment to the BNRG articles of incorporation remains on file with the California Secretary of State. The trial court should have ruled on the validity of the 2012 amendment to the articles of incorporation. Its failure to do so, however, was harmless as Plaintiffs are not entitled to relief on these theories.
Because BNRG is not a statutory close corporation and the articles of incorporation do not require unanimous shareholder approval for amendments, section 3.03(a) of the shareholder agreement never became effective. (§ 204, subd. (a)(5).) Accordingly, the amendment to the articles of incorporation to increase the number of authorized shares of stock, which was approved by the board and holders of a majority shares of stock, was valid. (§§ 152, 902, subd. (a).) The amendment was not a void or an ultra vires act, and BNRG is legally authorized to issue 15 million shares of stock.
II.
SECTION 3.03(a) OF THE SHAREHOLDER AGREEMENT
IS NOT INDEPENDENTLY ENFORCEABLE.
Because section 3.03(a) of the shareholder agreement was never effective, it is not a legal impediment to Defendants' ability to amend the BNRG articles of incorporation without Plaintiffs' consent. Is section 3.03(a) nonetheless separately enforceable as either a breach of the shareholder agreement or a breach of Defendants' fiduciary duties to Plaintiffs? Under the circumstances here, where BNRG is not a statutory close corporation, the answer must be no. As a matter of law, section 3.03(a) is contrary to public policy and not enforceable. (Kallen v. Delug (1984) 157 Cal.App.3d 940, 951 [whether a contract provision is "contrary to public policy is a question of law to be determined from the circumstances of each particular case"].)
Section 15.01 of the shareholder agreement suggests, too, that section 3.03(a) was never effective. Section 15.01 provides: "This Agreement will remain in effect until the Corporation ceases to be a close corporation as defined in California Corporations Code Section 158 . . . . Notwithstanding any such termination, the provisions in [the] Articles [of Incorporation] concerning restrictions on transfer, mandatory buy-sell provisions, non-competition[,] trade secrets, and arbitration will remain in effect until all Shareholders agree in writing to a termination, or until they expire by their terms." From the get-go, BNRG was never a statutory close corporation.
Section 204, subdivision (a)(11) is dispositive on this point. That provision provides in pertinent part, "Nothing [in subdivision (a) of section 204] shall affect the enforceability, as between the parties thereto, of any lawful agreement not otherwise contrary to public policy." To permit the board of directors and majority shareholders of a corporation organized under General Corporation Law (i.e., any corporation other than a statutory close corporation) to validly amend the articles of incorporation, but still be liable to minority shareholders for breach of contract or fiduciary duty based on the unanimity provision in the shareholder agreement, flies in the face of the straightforward requisites in section 204, subdivision (a)(5). Section 204, subdivision (a)(5) is a codified expression of this state's public policy concerning certain types of amendments to articles of incorporation for General Corporation Law entities. (Civ. Code, § 1667; see Jennings v. Marralle (1994) 8 Cal.4th 121, 135 [statutes reflect this state's public policies].) Section 3.03(a) of the shareholder agreement is not consistent with Corporations Code section 204, subdivision (a)(5) and is, accordingly, contrary to public policy. It is not enforceable.
Civil Code section 1667 defines "unlawfulness" in part as that which is "1. Contrary to an express provision of law; [¶] [or] 2. Contrary to the policy of express law, though not expressly prohibited . . . ."
III.
PLAINTIFFS' DAMAGES CLAIMS BASED ON INADEQUATE
CORPORATE DISTRIBUTIONS ARE MOOT.
Based on the premise that Defendants' amendment to the articles of incorporation and issuance of more than one million shares of stock to themselves were void acts, Plaintiffs contend their percentage interests in BNRG were unlawfully diluted for several years, until May 2014, when Defendants cancelled all shares in excess of one million. Alleging breach of section 3.03(a) of the shareholder agreement and breach of fiduciary duty, Plaintiffs sought to prove as damages the difference between the corporate distributions they should have received before the dilution of their interests and what they actually received. Plaintiffs attempted to rely on form K-1's, but most of those were never received into evidence and no one testified as to their significance. The trial court found Plaintiffs failed to prove damages.
BNRG operates as an S (sometime referred to as a Subchapter S) corporation. As an S corporation, BNRG itself pays no taxes on corporate income. Instead, its tax liability is "passed through" to each shareholder on a pro rata basis. Shareholders individually report and pay taxes "on their share of the S corporation's income regardless of whether the corporation makes any distributions." (Heller v. Franchise Tax Bd. (1994) 21 Cal.App.4th 1730, 1734; see Friedman et al., Cal. Practice Guide: Corporations (The Rutter Group 2019) ¶ 2:119, p. 2-96.) S corporations provide shareholders with an IRS form K-1, which indicates the individual shareholder's pro rata share of corporate income. Lawrence testified BNRG's policy was to "pay[] out distributions to all shareholders to cover their tax burden." There was no evidence that BNRG paid distributions to shareholders in excess of their estimated individual tax liability.
On appeal, in addition to the claim of damages pegged to inadequate corporate distributions, Plaintiffs argue they suffered: (1) Loss of voting power due to share dilution; (2) decrease in the shareholder value when their percentage ownership decreased from 4.982 percent to .36 percent each; and (3) attorney fees in filing and prosecuting this lawsuit to force Defendants to cancel their shares in excess of one million.
Plaintiffs failed to raise any of these categories of damages at trial and therefore forfeited any claim of error on appeal. Plaintiffs never quantified in the trial court any damages based on an alleged loss of voting power or temporary decrease in the economic value of their investment. (Adams v. Murakami (1991) 54 Cal.3d 105, 122 ["A plaintiff must prove the amount of compensatory damages to which he or she is entitled"].)
That leaves only Plaintiffs' claimed damages based on alleged insufficient corporate distributions in 2012 and 2013. However, as we have just concluded the 2012 amendment to the BNRG articles of incorporation was a valid corporate act and section 3.03(a) of the shareholder agreement is not independently enforceable, Plaintiffs' damages arguments on this score are moot.
Based on our holding, there is no reason to remand the matter to the trial court for a new statement of decision. That request is also moot.
Even if we were to consider the argument on the merits, Plaintiffs cannot prevail. Most of the K-1 forms were not offered into evidence. Regardless, there was no testimony to explain how the K-1 forms themselves, even if they had been received into evidence, would establish damages. Plaintiffs do not support their appellate arguments on the damages issue with "cogent legal argument or citation to [apt] authority." (Cahill v. San Diego Gas & Electric Co. (2011) 194 Cal.App.4th 939, 956.)
IV.
PLAINTIFFS FAILED TO PROVE A BREACH OF FIDUCIARY
DUTY IN ISSUING ADDITIONAL SHARES OF STOCK
TO LAWRENCE AND STEINHAUS.
Defendants, as corporate officers and directors, owe a fiduciary duty to all BNRG shareholders. (Singhania v. Uttarwar (2006) 136 Cal.App.4th 416, 426.) As majority shareholders, Defendants owe fiduciary duties to Plaintiffs as minority shareholders. (Ibid.)
In the trial court, Plaintiffs contended Defendants breached their fiduciary duties in both capacities by issuing to Lawrence and Steinhaus additional shares of BNRG stock to Plaintiffs' detriment and without any business purpose. On appeal, Plaintiffs contend Defendants' actions in this regard ran afoul of the holding in Jones v. H.F. Ahmanson & Co. (1969) 1 Cal.3d 93 (Jones) and violated section 310. Substantial evidence supports the trial court's findings that Defendants did not breach any fiduciary or statutory duties.
A.
Jones
Majority shareholders and directors may not "control corporate activities to benefit themselves alone or in a manner detrimental to the minority. . . . [They] must benefit all shareholders proportionately." (Jones, supra, 1 Cal.3d at p. 108.) Jones adopted a "comprehensive rule" that officers, directors, and controlling shareholders must act in "good faith" and with "inherent fairness" to minority shareholders "in any transaction where control of the corporation is material." (Id. at pp. 110, 112.)
Schemes that diminish a minority shareholder's interest in the corporation may constitute a breach of fiduciary duty. (Skarbrevik v. Cohen, England & Whitfield (1991) 231 Cal.App.3d 692, 707.) Then again, they may not. Jones is not an anti-dilution case. The question under Jones is not whether Plaintiffs wound up with a lesser interest in a company worth far more than when they made their initial investments, but whether actions undertaken by majority shareholders "benefit[ted] themselves alone or in a manner detrimental to the minority" or whether they "benefit[ted] all shareholders proportionately." (Jones, supra, 1 Cal.3d at p. 108.)
Steinhaus's compensation was roughly equivalent to Riley's, and no shareholder opposed Riley's compensation package. Moreover, Steinhaus took on greater corporate responsibilities than those assumed by Riley. Steinhaus achieved greater success; his efforts increased the value of the company, thereby increasing the value of every shareholder's interest.
Defendants' decisions to offer executive positions to Steinhaus and compensate him with additional shares of BNRG stock satisfied Jones's "good faith" and "inherent fairness" rule. (Jones, supra, 1 Cal.3d at p. 108.) The 161,366 shares of BNRG stock Steinhaus kept after the share cancellation meant every other shareholder's interest was diluted, but the dilution was proportional as to all the other shareholders: Plaintiffs went from 4.982 percent to 2.68 percent, each, and Lawrence's interest dipped to 61 percent. In other words, Steinhaus's position and compensation affected all shareholders proportionately.
We also find no Jones violation as a result of issuing additional shares of stock to Lawrence. After the May 2014 share cancellation, Lawrence owned more shares than when the 2004 shareholder agreement was executed, but his overall percentage interest in BNRG was reduced. In seeking cancellation of those additional shares, Plaintiffs rely heavily on language in Lawrence's 2002 written agreement with their former accounting firm, which stated Lawrence would "contribute and or assign any and all rights to the intellectual property" for current and future products. Plaintiffs argue that when Lawrence agreed in 2002 to contribute his future intellectual property rights to BNRG, he necessarily waived future compensation. Defendants argue the provision is silent as to compensation to be paid to Lawrence for future intellectual property rights.
This skirmish over the wording of the 2002 agreement is beside the point, and one we need not resolve. Lawrence testified he was given additional BNRG shares as compensation for services. Before he received the additional shares, he assumed additional responsibilities in order to save BNRG from bankruptcy, including the critical and strategic role of becoming "basically the marketing department" for BNRG. BNRG did not have the cash to pay him, and he was compensated instead with shares of stock, which was a "[r]eally common thing for companies in that position to do." The trial court found Lawrence "worked long and hard" for BNRG, and Lawrence's testimony alone constituted substantial evidence to support that finding. (Casella v. SouthWest Dealer Services, Inc. (2007) 157 Cal.App.4th 1127, 1143-1144 [testimony of single witness may constitute substantial evidence].) We conclude the 2010 issuance of 168,431 BNRG shares to Lawrence had a legitimate business purpose and was not undertaken to benefit Defendants alone or to cause disproportionate detriment to Plaintiffs.
As a corollary to Jones, a corporate "director cannot, at the expense of the corporation, make an unfair profit from his position [and] is precluded from receiving any personal advantage without fullest disclosure to and consent of all those affected." (Remillard Brick Co. v. Remillard-Dandini Co. (1952) 109 Cal.App.2d 405, 419.) Plaintiffs contend Defendants had a duty to disclose (1) Lawrence's singlehanded 2009 effort to amend the articles of incorporation; (2) unspecified corporate financial information in advance of the July 2010 shareholder meeting; and (3) the board's intent to issue additional shares of stock to Lawrence, Steinhaus, Prietto, and Parson.
To the extent these contentions are based on the notion that Defendants obtained unfair advantages at Plaintiffs' expense, they fail: Substantial evidence supports the trial court's findings that Defendants' conduct vis-à-vis Lawrence and Steinhaus benefited all shareholders proportionately. To the extent the contentions are based on a general duty to disclose operational discussions and decisions, they miss the mark: Defendants had sole responsibility for BNRG's operations.
B.
Corporations Code Section 310Independent of the challenge based on Jones, supra, 1 Cal.3d 93, Plaintiffs argue the board's actions that increased the number of shares issued to Lawrence and Steinhaus should be voided pursuant to section 310, subdivision (a). That statute provides a contract or transaction between a corporation and one or more of its directors is void or voidable unless one of three statutory conditions is met: (1) the material facts concerning the transaction and the director's interest are fully disclosed to or known by the shareholders and the contract or transaction is approved by the shareholders in good faith without counting the shares of the interested director; or (2) the material facts as to the transaction and the director's interest are fully disclosed to or known by the board and (i) the board authorizes, approves, or ratifies the transaction without counting the vote of the interested director and (ii) the contract or transaction is just or reasonable as to the corporation at the time it is authorized, approved, or ratified; or (3) if the conditions in (1) or (2) are not met, "the person asserting the validity of the contract or transaction sustains the burden of proving the contract or transaction was just or reasonable as to the corporation at the time it is authorized, approved, or ratified." (§ 310, subd. (a)(1)-(3).)
Defendants counter that section 310 is inapplicable because the shareholder agreement gives the board sole discretion in employment matters. We do not agree. By giving the board control over employment matters, Plaintiffs did not waive the protections of section 310, subdivision (a) or give Defendants carte blanche to breach their fiduciary duties to minority shareholders.
However, the board's votes, insofar as stock issuance and compensation for Lawrence and Steinhaus are concerned, fell within the provisions of section 310, subdivision (a)(2). As to each challenged board action, the interests of each director/Defendant were disclosed to or known by the other directors/Defendants and, since the votes were unanimous, each action was approved by two disinterested directors, thereby satisfying section 310, subdivision (a)(2)(i). As discussed above, the decisions were "just and reasonable as to" BNRG when they were made, satisfying section 310, subdivision (a)(2)(ii) as well.
V.
PLAINTIFFS DID NOT PROVE THEIR DERIVATIVE CAUSES OF ACTION
Plaintiffs contend the trial court erred in finding they did not prove their derivative causes of action for breach of fiduciary duty, professional negligence against Novodor, declaratory relief, and accounting. We disagree.
The derivative claims for breach of fiduciary duty and declaratory relief were based on the same facts and arguments as Plaintiffs' individual causes of action. Defendants legally amended the articles of incorporation and then legally issued more than one million shares of BNRG stock. Plaintiffs proved no breach of fiduciary duty to themselves or the corporation as a result of those actions. Plaintiffs presented no evidence that the additional shares of stock issued to Lawrence and Steinhaus injured "the corporation . . . or . . . the whole body of its stock." (Grosset v. Wenaas, supra, 42 Cal.4th at p. 1108.)
The derivative cause of action for professional negligence was resolved by settlement before the phase two court trial. Plaintiffs never asked the trial court to determine if Novodor was liable to the corporation for professional negligence. The trial court's statement of decision, fairly read, refers only to Plaintiffs' derivative causes of action that were brought to trial and does mean to say Plaintiffs failed to prove or recover on the professional negligence cause of action. Plaintiffs did not brief any issue concerning the accounting cause of action.
VII.
THE JUDGMENT CORRECTLY STATES DEFENDANTS ARE
THE PREVAILING PARTIES.
The judgment states BNRG, Defendants, and Parson "are deemed to be the prevailing parties in this action." As we hold in Abregov II, Defendants are the prevailing parties in this action under Code of Civil Procedure section 1032. The judgment therefore correctly recites that Defendants are the prevailing parties.
Parson was dismissed from the complaint. He is by definition a prevailing party. (Code Civ. Proc., § 1032, subd. (a)(4).) --------
DISPOSITION
The judgment, the order denying the motion to reopen evidence, and the order denying the motion to vacate the judgment are affirmed. Respondents shall recover costs on appeal.
DUNNING, J.* WE CONCUR: ARONSON, ACTING P. J. IKOLA, J. *Retired judge of the Orange Superior Court, assigned by the Chief Justice pursuant to article VI, section 6 of the California Constitution.