NOT TO BE PUBLISHED IN OFFICIAL REPORTS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 This opinion has not been certified for publication or ordered published for purposes of rule 8.1115.
(Marin County Super. Ct. No. CIV-045583)
These appeals arise from a lawsuit filed by Karen Neuburger, a minority shareholder in defendants San Francisco Network, Inc. (SFN) and KN Ltd. (KN), against the majority shareholders and others in these garment industry closely-held corporations. Following a court trial, the court entered judgment in the amount of $530,557 plus interest in favor of plaintiff Neuburger and against defendants Leonard S. Eber (Eber), Richard Compton, Jr. (Compton), and Eber International, Inc. (EI) on Neuburger's claims for breach of fiduciary duties to her with respect to off-the-books loans and interest rate calculations, and in the additional sum of $303,456 plus interest against defendants Eber, Compton, Dustin Eber, Paul Ginsburg and Cypress IV Partners (Cypress) on Neuburger's claims for breach of fiduciary duties to her with regard to leases negotiated between Eber and SFN/KN.
Defendants appeal from the judgment, contending the court erred in finding they breached any fiduciary duty to Neuburger. Specifically, they contend the trial court erred (1) in finding Eber was a controlling shareholder; (2) in finding Neuburger's claims were properly brought as a direct shareholder action rather than as a derivative action; and (3) in making no findings on the issues of whether the interest rates for the loans and the lease rental rates were market rates and, consequently, fair to the company as a matter of law.
Neuburger also appeals from the judgment, contending the trial court erred in finding that defendants had sustained their burden of showing the fairness of the management agreements between SFN/SN and EI. We shall affirm the judgment.
The Facts and Procedural Background statement is taken in large part from the court's statement of decision, which contains an accurate summary. Additional facts are contained in the discussion, where relevant.
Karen Neuburger began developing a line of women's sleepwear in the early 1990's. By 1994, she had perhaps eight to twelve people working for her and had developed accounts at various department stores. After receiving a large order from Mervyns, she realized she needed a bigger company in order to expand. She contacted Eber, for whom she had worked in the garment business in the past. She knew Eber had sponsored or provided financial assistance to at least one other small company, Harvey Celler, and she asked Eber if she could obtain his assistance using that same arrangement. Eber agreed and they formed SFN, a closely held corporation that purchased the assets of Neuburger's small company. Neuburger contributed $35,000 for 35 percent of the stock and Eber contributed $65,000 for 65 percent of the stock. At formation, Neuburger became president of SFN. Before forming the company, Neuburger had discussions with her husband and their accountant and reviewed the Harvey Celler agreement with Eber and Richard Compton, the chief financial officer (CFO) of EI, a company owned by Eber and his family. According to Neuburger, their accountant did not like the Harvey Celler agreement and did not like Eber's insistence upon at least a 60 percent management share. However, she had worked with Eber and believed that Eber and Compton had expertise in the clothing business that would be useful. She trusted them.
The parties entered into their first management agreement in 1994. Neuburger signed various notes whereby EI loaned sums of money to SFN to provide working capital for the fledgling company. Soon thereafter, Eber transferred a 43 percent interest in SFN to various irrevocable trusts that held the shares for his children. Ginsburg has been trustee of these trusts since the mid-1990's. At all relevant times, Neuburger held shares of stock in 35 percent of the company, Eber held 22 percent of SFN stock, and the Eber children's trust held the remaining 43 percent of the SFN stock. Neuburger was president of SFN, Eber was the chief executive officer (CEO) and chairman of the board, and Compton was the CFO and vice president.
The parties also agreed to a "management agreement" whereby EI received the greater of 12 percent of SFN's income or $15,000 per month in exchange for performing the company's management functions. Neuburger testified she believed Eber would also receive 0.5 percent as an administrative fee for his serving as a consultant and arranger of financing. According to Neuburger, the management agreement's 12 percent (or $15,000/month) allocation to EI was intended to cover the cost of handling all of the company's "back room functions," including data processing, credit and collections, accounting, production control, shipping and distribution, and piece goods warehousing. The 12 percent was broken down with individual percentages attributable to the six separate functions performed by EI. The agreement did not restrict EI to recovery of its costs.
Neuburger acted as president of SFN for approximately two years, after which Eber essentially took over the business because it had not turned a profit. Over time, the remaining business of EI with other small clothing companies and its own garment lines were reduced. By late 1995, Eber had sold off most of his other businesses and continued only in the business of managing SFN. At some point, Neuburger was moved to a new position as "chief lifestyle officer" and, in late 2002, Eber's son Dustin Eber was installed as president of SFN.
The management agreements continued and the company continued to make various loan payments in accordance with agreements signed by Neuburger and Eber. EI continued to handle management functions with Compton taking care of the accounting for EI and SFN. He was CFO and a board member of EI, SFN and KN. He accounted for loan payments and management fees that were paid in accordance with the original management agreement and the supplemental agreements that the parties entered over time. Neuburger agreed to the continuing management agreements (until the final agreement) and the continuing loans. She testified that she trusted Eber and the other defendants and did not question what was occurring.
In 1996, Neuburger was featured on the Oprah Winfrey show, after which business again improved and the sleepwear sales volume increased. SFN changed the pajamas brand to "Karen Neuburger," and Neuburger became the focus of publicity and appearances promoting the product line. She became less available for business decisions, and Eber became even more of the controlling authority for the company.
Also in 1996, the principals formed a separate company to hold the "trademarks" for the products sold by SFN. In 1999, this company became KN. The parties held stock ownership in KN as they had in SFN: Neuberger at 35 percent, Eber at approximately 22 percent, and the four irrevocable Eber children's trusts at approximately 43 percent. Martin Eber was the original trustee for these trusts. Attorney Paul Ginsburg has been the trustee since approximately 1996.
SFN was formed with a $100,000 capital investment. Neuburger knew that the company was undercapitalized. Since she did not wish to dilute her ownership interest, the company obtained working capital through loans. During 1995, EI loaned SFN $170,000, and Neuburger signed a promissory note to guarantee her 35 percent interest in that initial working capital loan. Beginning in 1996, Eber or EI loaned various amounts of money to SFN, pursuant to various terms describing interest at 15 percent and escalation clauses allowing interest to rise one percent per month to a maximum of 25 percent. Compton testified that he did not think that the interest rate on the loans ever got that high, although he agreed the terms allowed for such amounts and the written payment schedule he prepared shows interest payments at these high rates. Various sums of money were deposited with banks to obtain or secure letters of credit for merchants providing fabric and other goods. Other notes and loan agreements were signed over time by SFN with varying and relatively high interest rates that were to increase if they were not paid off. Defendants contended that either Eber or EI loaned or made funds available in amounts approaching $4,000,000 if the guarantees are considered. According to defendants, this was necessary because the parties' initial working capital was inadequate.
Much of the loan amount was kept "off the books" by Compton. He kept the loan agreements and the interest rate calculations in a separate safe that was inaccessible to Neuburger. Although Compton contended that Neuburger knew about the loans at relatively high rates of interest, he acknowledged that he had not provided anything in writing to her regarding the specifics of the interest rates or the mechanism of the charges. Defendants maintained this was necessary in order to create the appearance of a relatively solvent company in the event that the assets could eventually be sold. Eber and Compton advised Neuburger that "they were going to do something off the books so that the factors would not be aware of the debt of [SFN]." She left it to their expertise. However, she never knew about any loans being kept off the books with terms that could allow the charged interest rate to reach 25 percent. Eber testified he thought the interest charged on these loans was 1-1/2 percent per month, or 18 percent per year. However, he left the calculations to Compton. Compton never advised Neuburger of the high interest rates. The off-the-books interest payments on the loans were paid to Eber as salary bonuses through EI.
In 1998, SFN and EI executed an Amended and Restated Management Agreement (ARMA), increasing the management fee to 13.5 percent of net sales, and increasing the minimum monthly fee guarantee to $162,000. Neuburger signed this agreement on behalf of SFN, and later signed two additional amendments to the management agreement on behalf of SFN, in February 2000 and February 2001. These amendments increased the management fee to 14.5 percent of net sales, with a minimum monthly guarantee of $294,840. Plaintiff once again signed these agreements. She also signed the "unanimous written consent" of the SFN board of directors that confirmed the election of Dustin Eber as the president of SFN in late 2002.
By late 2002, EI was no longer manufacturing clothing and was operating as a management company with little need for industrial space. SFN and KN had been its only clients since the mid 1990's. Eber and Compton began to shop for an alternative building to house the companies' manufacturing and office operations. Believing that Neuburger would refuse to relocate to space anywhere beyond the San Rafael area, and operating with the assistance of brokers, Eber and Compton located a building at 2505 Kerner Boulevard near their existing operation. They believed the purchase was preferable to continued renting, and also believed that neither KN nor SFN had the available credit or funds to purchase a building. They formed a separate partnership, Cypress, to purchase the building. Eber and his wife own 72 percent of Cypress; the children's trusts and Dustin Eber own the remaining 28 percent.
In March 2003, Eber purchased the building through Cypress with a down payment of approximately $1 million, with a 10-year mortgage, and payments beginning at between $13,000 and $15,000 per month. Immediately after purchase, in March 2003, Cypress leased back the premises to SFN, KN, and EI, for a 10-year lease term, with rent initially set at $26,543 per month from the combined SFN/KN tenants. The companies began payments approximately eight months before they occupied the leasehold premises, and they did not receive a tenant improvement allowance. Eber signed as the managing or general partner for Cypress, and his son, Dustin Eber (a part owner in Cypress), signed on behalf of SFN and KN, because his father told him to do so. There was no evidence of any negotiation between Cypress and any of the tenant companies. In 2004, after Neuburger complained about the allocation of payments among the various companies, the leases were amended, the rents to SFN/KN were increased, and Neuburger voted against ratification.
On December 1, 2003, SFN and EI entered into a Second Amended and Restated Management Agreement (SARMA), which reduced the monthly management fee from 14.5 to 9.5 percent, and the minimum guarantee from $294,840 to $250,000. By this time, Neuburger had hired counsel and voted against the SARMA. On that same date, KN and EI entered into a renegotiated management agreement, providing EI with compensation at 13.5 percent of net sales, and extending the agreement through 2009. Before these 2003 management agreements and the 2004 amendment to the building lease with Cypress, Neuburger had voted to approve all other agreements.
On April 21, 2004, Ginsburg was elected to the board of directors of both SFN and KN. His election added a fourth director to boards that had previously included just Eber, Neuburger, and Compton. Although Neuburger voted against Ginsburg's nomination, she apparently voted to reelect him when the matter came up in April 2005, after she had filed her original complaint.
Neuburger filed her initial complaint against SFN, KN, EI and the various individual defendants on December 27, 2004, including causes of action for breach of fiduciary duties. She contended at trial that defendant Eber, as a controlling shareholder, and defendants Eber, Compton, Dustin Eber and Ginsburg, as corporate officers or directors of SFN and KN, had violated their fiduciary duties to her as the minority shareholder. She further contended that Eber was the controlling shareholder and that the others yielded to him on all SFN/KN matters. She maintained the loans and their interest rates were "unfair," and lacked the earmarks of an arm's length bargain, and that the high interest off-the-books loans were never disclosed to her as a shareholder. With respect to the Cypress leases and the management agreements, she similarly contended they were "unfair" and lacked the earmarks of an arm's length bargain. She also contended she was never given the opportunity to participate in the purchase of the building. Neuburger maintained the loans, leases, and management agreements diverted to Eber and his family funds that should have been hers pursuant to her 35 percent share in SFN and KN.
Defendants disputed that Eber was the controlling shareholder and further argued that, in any event, the various management agreements with SFN and KN were "inherently fair" and in the best interest of SFN and KN, as were the loan agreements and their interest rates in the context of the risk involved. They further argued the Cypress lease to SFN and KN was at market rates and, therefore, fair.
A bench trial began on November 16, 2007, and continued during 37 court days over an extended period. The court filed its tentative decision on March 23, 2009. After additional briefing, the court issued its statement of decision on May 4, 2009.
In 2008, there was a sale of the assets of SFN, KN and EI to a third party. The parties filed posttrial briefs on the circumstances and effects of the sale of assets. The court determined it would not consider any of the material or the declarations or briefing regarding damages or predicted collateral consequences of the sale of assets that occurred after the close of evidence.
The court found Eber was the controlling shareholder of SFN and KN and that his stock and the stock from his children's trusts should be considered in the aggregate on the control issue. It further found Eber and the other individual defendants had breached fiduciary duties of good faith and inherent fairness they owed to Neuburger as a minority shareholder in connection with the undisclosed off-the-books loans and high interest rates and the Cypress lease. It found Neuburger's damages were not incidental to those suffered by SFN and KN, but were separate and apart from damages suffered by those entities. Therefore, the action was properly maintained by Neuburger as a direct action, rather as a derivative action on behalf of the corporations. The court also found defendants met their burden of showing the "inherent fairness" of the management agreements, and that Eber and other defendants were not obliged to offer the opportunity to purchase the building at 2505 Kerner Boulevard to Neuburger or to SFN/KN before proceeding with the purchase by Cypress. The court awarded damages for defendants' breaches of their fiduciary duties in the amounts of $530,557 against Eber, Compton and EI in connection with the off-the-books loans and their interest rates, and $303,456 in connection with the Cypress lease against Eber, Compton, Dustin Eber, Ginsburg and Cypress. The court denied Neuburger's claim for punitive damages. It found Neuburger to be the prevailing party and awarded her costs.
Judgment was entered in accordance with the statement of decision on May 29, 2009. Following a hearing on August 7, 2009, the trial court denied Neuburger's new trial motion. These timely appeals by defendants and Neuburger followed.
"[C]orporate officers and directors have fiduciary duties of due care and loyalty to the corporation and its shareholders collectively [citation]. And controlling shareholders have fiduciary duties to exercise their corporate influence fairly for the benefit of the corporation and the other shareholders [citation.]" (Friedman, Cal. Practice Guide: Corporations (The Rutter Group 2010) ¶ 2:19.1, p. 2-5, italics omitted.) "As stated in Jones v. H.F. Ahmanson & Co. (1969) 1 Cal.3d 93, 108 [(Jones)], California Courts 'have often recognized that majority shareholders, either singly or acting in concert to accomplish a joint purpose, have a fiduciary responsibility to the minority and to the corporation to use their ability to control the corporation in a fair, just, and equitable manner. Majority shareholders may not use their power to control corporate activities to benefit themselves alone or in a manner detrimental to the minority.' " (Jara v. Suprema Meats, Inc. (2004) 121 Cal.App.4th 1238, 1252-1253 (Jara).) The breadth of the fiduciary duties of controlling shareholders and directors to the corporation and its other shareholders has been described by our Supreme Court as "extensive." (Jones, at p. 108.) " ' "Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein. . . . The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm's length bargain. If it does not, equity will set it aside." ' " (Ibid., quoting Remillard Brick Co. v. Remillard-Dandini Co. (1952) 109 Cal.App.2d 405, 420-421 (Remillard),in turn quoting Pepper v. Litton (1939) 308 U.S. 295, 306.)
Defendants do not challenge the basic principles of the fiduciary duty owed by controlling or majority shareholders to minority shareholders. Rather, they assert that the court erred in finding Eber to be the "controlling" shareholder.
A shareholder who owns less than a majority of a corporation's outstanding stocks does not, without more, become a controlling shareholder of that corporation, with a concomitant fiduciary status. The burden is upon plaintiff to show domination and control of the board and/or control of the corporation's affairs by the alleged controlling shareholder. (E.g., Odyssey Partners, L.P. v. Fleming Companies, Inc. (Del.Ch. 1999) 735 A.2d 386, 407; Kaplan v. Centex Corp. (Del.Ch. 1971) 284 A.2d 119, 122-123; see O'Reilly v. Transworld Healthcare, Inc. (Del.Ch. 1999) 745 A.2d 902, 912.) Numerous decisions recognize that the question of whether a shareholder is controlling so as to trigger fiduciary duties to other shareholders is an intensely factual one. " 'Whether [the defendant] is a controlling person is an intensely factual question, involving scrutiny of the defendant's participation in the day-to-day affairs of the corporation and the defendant's power to control corporate actions.' [Citation.]" (Howard v. Everex Systems, Inc. (9th Cir. 2000) 228 F.3d 1057, 1065; quoting Kaplan v. Rose (9th Cir. 1994) 49 F.3d 1363, 1382.) (See e.g., Kahn v. Lynch Communication Systems, Inc. (Del. 1994) 638 A.2d 1110, 1114 [the standard of appellate review to chancery court's factual finding that defendant was a controlling shareholder is deferential]; In re Cysive, Inc. Shareholders Litigation (Del. Ch. 2003) 836 A.2d 531, 551 (Cysive)[question whether large block holder is controlling stockholder is "intensely factual"]; Heckmann v. Ahmanson (1985) 168 Cal.App.3d 119, 133, fn. 7 [That the defendant never owned more than 12 percent of outstanding stock was not determinative of control. "The question, a factual one, is what amount of influence it could exert on the corporation by reason of its holdings. [Citations.]"].)
Experts for both plaintiff and defendants below agreed that the question of control was a fact intensive inquiry. Defense expert Hugh Friedman confirmed that the issue of aggregating stock for purposes of evaluating control was intensely factual. Frederick Lambert testified for plaintiff as to the factors that go into determining whether someone is a controlling stockholder. He characterized the inquiry as "a very factually intense analysis of what is the ability of a person . . . through contract, stock ownership, or otherwise, to influence the policy or policies of a certain corporation." Because the question of control is primarily one of fact, we employ the usual deferential substantial evidence standard of review to the court's determination that Eber was a controlling shareholder.
The court found: "Leonard Eber is clearly the 'controlling' shareholder. Although Eber transferred 43 percent of his 65 percent share to his children['s] trusts, plaintiff's corporate expert, Hasting Law School Professor Frederick Lambert, has described control as the ability to influence the business and policy of the corporation. In that regard, he testified that one of the prime areas to consider in control is stock ownership. [Citation.] He found the 65 percent interest to be clearly controlling. Testifying regarding custom and practice, he conceded that trusts are often created but suggested that most practitioners and agencies consider trusts to be 'aggregated' for consideration of any controlling interest. [Citation.] Separately, Lambert also considered Eber's influence over the board of directors and Richard Compton's position as a longtime friend of Eber to be equally suggestive of a controlling shareholder circumstance. The defense expert, Professor Hugh Friedman, was 'not at all familiar' with the concept of aggregating trust shares along with the trustor's percentage in this 'controlling' shareholder analysis. He considered the trusts as separate entities. However, in the context of the factual presentation of Neuburger as the only 'non-Eber' shareholder or director, it seems clear that Eber was the controlling shareholder. The court finds that Leonard Eber was the controlling shareholder and that his stock and the stock from his children's trusts should be considered in the aggregate."
Defendants contend the trial court erred in determining that Eber was the controlling shareholder on the basis of Lambert's testimony that "[p]ractitioners consider, government agencies consider, everyone that I know considers, friendly family trusts to be aggregated with the ownership of the stock of the individual who transferred them to the trust. The SEC [Securities and Exchange Commission] does, everybody does." They argue that Lambert's opinion as to aggregation is wrong as applied to irrevocable trusts that Eber could not modify or terminate without the express permission of his children. They also contend that plaintiff failed to show that Ginsburg, as the trustee of the children's trusts and as a director of KN and SFN, was not independent of Eber's influence. Defendants rely upon Ginsburg's testimony that he did not vote the way he did on any transaction based on any personal or business relationship he had with Eber or EI. Defendants point to evidence supporting their view of Ginsburg as independent of Eber's influence. However, the substantial evidence standard requires that we view the evidence of control in the light most favorable to the court's decision. (Bower v. Bernards (1984) 150 Cal.App.3d 870, 872-873.)
Lambert opined that whether one is a controlling stockholder is typically determined by "whether the person, by stock ownership, contract, or otherwise, has the capability of influencing the business affairs of the corporation." This definition reflects that adopted by the SEC, which defines control as follows: "The term 'control' (including the terms 'controlling,' 'controlled by' and 'under common control with') means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise." (SEC rule 405, 17 C.F.R. § 230.405; SEC rule 12b-2, 17 C.F.R. § 240.12b-2.)
Lambert further testified that majority stock ownership is one of the most obvious ways in which a corporation is controlled and that stock ownership by friendly family trusts may be aggregated with the stock of the individual who transferred them to the trust. Using this standard, Eber had control of 65 percent of the stock of SFN and KN. Lambert also stated that another situation in which control may be found is where "people control a corporation by virtue of their influence over the board of directors, that is the directors are affiliates of theirs . . . ." He opined that Compton was an "affiliate" of Eber. Another factor supporting control was that Eber was the general partner and other Eber family members were partners in the Cypress partnership that owned the building leased by SFN and SN.
Defendants maintain that the SEC definition of "control" is inapplicable to closely held corporations such as SFN and KN. However, they do not provide an alternative and Lambert's use of the SEC definition appears to provide reasonable guidance for the determination of control. As recognized in In re Primedia Inc. Derivative Litigation (Del.Ch. 2006) 910 A. 248, a stockholder derivative suit alleging breach of fiduciary duties by the controlling stockholder and board of directors: "[O]nly a 'controlling stockholder' owes fiduciary duties to other stockholders. [Citation.] A stockholder can meet this 'control' test in one of two ways. First, ownership of more than 50% of the voting power of a corporation satisfies the 'control' test. [Citation.] Alternatively, a stockholder stands as a fiduciary if it 'exercises control over the business and affairs of the corporation.' [Citation.]" (Id. at p. 257.) The Ninth Circuit has recognized that the question of control involves "scrutiny of the defendant's participation in the day-to-day affairs of the corporation and the defendant's power to control corporate actions." (Kaplan v. Rose, supra, 49 F.3d at p. 1382; accord, Howard v. Everex Systems, Inc., supra, 228 F.3d at p. 1065.)
Defendant's expert Friedman had no opinion on the issue of who exercised day-today operational control of SFN or KN.
In Cysive, supra, 836 A2d 531, the court concluded that Carbonell controlled the corporation, even though he owned only 35 percent of the corporation's stock. He was the largest shareholder and exercised control through involvement in management and his status as Cysive's founder and "inspirational force." (Id. at p. 552.) The Cysive court concluded that although it did not need to find that "Lund [a subordinate of Carbonell's] or Carbonell's relatives are merely servile tools of Carbonell, the natural inference from the record is that they are close allies of his who have benefited in material ways from his managerial control of Cysive. At this stage of their relationship, Lund and Carbonell's familial subordinates can safely be considered part of a unified voting coalition." (Id. at p. 552.) Similarly, except in a very few instances when Eber abstained, Eber, Compton and Ginsburg have always voted the same way. Neuburger is the only board member or shareholder of KN or SFN that voted against Eber.
Eber is the chairman and CEO of SFN and KN. Compton identified him as the strategic visionary and founder of SFN. (See Cysive, supra, 836 A.2d 531, 552 [Carbonell's position as creator, chairman and CEO of Cysive; his involvement in all aspects of the company's business; and the presence of two close family members in executive positions at the company evidence Carbonell's "practical control" of the company].) According to Eber's friend Martin Kornfeld, Eber "let it be very clear that he was the boss of [SFN]." Eber also told Kornfeld that he was the majority shareholder, and that he controlled the distribution of profits, of salaries and of capital out of KN and SFN. Eber told Kornfeld that he controlled SFN.
Another factor pointing to Eber's control of the companies is Eber's arranging for his son Dustin to become president of SFN and KN in 2002. At the time, Dustin was living in Dallas. It does not appear Dustin had any particular qualifications for the job as president of either SFN or KN. Dustin Eber testified that Eber had negotiated the Cypress lease on behalf of SFN and that he, Dustin Eber, had signed the lease on behalf of SFN. He did not read the lease thoroughly before signing it, did not review it for fairness, and did not ask anyone to make changes to it. No one gave him a summary of the terms of the lease before he signed it. He deferred to Eber and to Compton and the only reason he signed the lease on behalf of SFN was because Eber asked him to do so. The same was true for the lease between Cypress and KN that was negotiated by either Compton or Eber. Dustin Eber signed the Cypress lease on behalf of KN because either Eber or Richard Compton asked him to do so. He did not read the lease. At the time of signing the leases, Dustin Eber understood that Cypress was owned and controlled by his father.
Compton is the CFO, secretary, and a board member of EI, KN and SFN. He also works for Cypress, providing financial services and advice. He helped Cypress secure the mortgage for the Kerner Boulevard property. Eber is his boss at all four companies. KN and SFN do not pay him a salary. He is compensated solely through EI, and Eber determines his salary. Compton has been a close friend of Eber for a long time. He assists Eber with his personal financial affairs. He was the architect behind each of the challenged transactions. (See Odyssey Partners, L.P. v. Fleming Co., Inc., supra, 735 A.2d at p. 408 [board member serving as senior officer for the controlling shareholder was not independent]. Eber could identify no instance where he and Compton voted differently on any KN or SFN board issue.
Defendants contend plaintiff has failed to prove that Ginsburg was not independent either as a director or as trustee for the children's trusts. However, the trial court was not required to credit Ginsburg's testimony that he was independent (Goehring v. Chapman University (2004) 121 Cal.App.4th 353, 368; Eisenberg et al., Civil Appeals and Writs (The Rutter Group 2010) ¶8:54, pp. 8-24 to 8-25) and the record contains substantial evidence that would allow the trial court to determine that Ginsburg was not independent from Eber's influence.
From 1975 to 1996, Ginsburg was a partner with the law firm of Shartsis Friese & Ginsburg. Ginsburg testified he had known Eber since the 1980's and considered him a close friend. At the firm, he was the "relationship partner" with Eber. He had traveled to Hawaii with Eber and the Ebers had come to Ginsburg's Idaho home on two occasions. From time to time Ginsburg and his wife had dinner together with Eber and his wife. Ginsburg advised Eber to establish a family partnership (Cypress), to which he could contribute assets and in which his children would be partners for estate planning purposes. The trusts that Ginsburg established were to own parts of the partnership. Ginsburg became a trustee for the various Eber family trusts, a specific trust for each child that held interests in SFN, KN, and EI. Ginsburg was not paid anything by the trust for serving as trustee. He is paid by KN and SFN for his service as a board member. Before 2004, when the board meetings began, Ginsburg relied almost exclusively on Eber to learn what was happening at KN, SFN and EI for purposes of signing the unanimous written consents. In signing the consents, Ginsburg did not recall whether he was given any information about payroll bonuses SFN was making to Eber relating to accrued off-the-books interest or information regarding amendments to the management agreement with EI. Although at one shareholder meeting, Ginsburg agreed with Neuburger that someone should gather information on how much it actually would cost KN to provide management services to itself, the information provided by Compton in response did not answer that question.
That Eber arranged for Ginsburg's appointment to the Board "is certainly an important factor that provides a court with insight in evaluating whether actual control is pleaded adequately." (Primedia, supra, 910 A.2d at p. 258; see also Cysive, supra, 836 A.2d at p. 552 [ability to reconstitute the board is relevant to control].) Although the nomination of an associate or close friend does not alone establish control or domination (Primedia, at p. 258), the evidence of Eber's control does not stand alone on his nomination of Ginsburg. Because the Eber family trusts held stock in EI and interests in Cypress, Ginsburg had incentives to vote in favor of increasing the lease rates and the management agreement charges. His votes confirmed his allegiance to Eber. He voted to increase the management fee to KN, notwithstanding that he was not given information he requested. He voted to increase the rent for KN and SFN, rather than requiring Cypress to honor the existing 10-year leases. He voted to approve the SARMA without having been provided all of the information about the various changes to that agreement. He voted that KN should pay the same rate as SFN for management services, even though he was unsure of KN's needs and knew there were differences between KN and SFN.
Even defendants' expert Friedman recognized that, as a trustee for the Eber family trusts that held stock in both EI and SFN/KN, Ginsburg had a conflict of interest as he had to "vote both sides." Friedman also admitted that factors such as Ginsburg's longstanding relationship with Eber, that they vacationed at each other's homes, that Ginsburg's daughter had worked for Eber, that Ginsburg's law firm had represented Eber International for over 20 years on 10 or 15 different matters, and that they had virtually identical voting histories, never voting against one another, were not "wholly irrelevant" and that "anybody trying to make a factual determination would want to consider them," and "they may give rise to a structural bias [and] may suggest a lack of complete independence . . . ." Nevertheless, Friedman opined that, "none of [these facts] . . . without more, would rise to the level of domination and control to the point of [allowing] aggregation."
Although it is true that personal friendships, without more, outside business relationships, without more, and approving or acquiescing in the challenged transactions, without more, may each be insufficient to raise a reasonable doubt as to a director's ability to exercise his or her independent business judgment, none of these factors stands alone in this case. (See California Public Employees' Retirement System v. Coulter et al. (Del Ch. 2002) 2002 Del.Ch. LEXIS 144, *29.)
EI's control over SFN and KN's debt is also relevant to the controlling shareholder determination. (See O'Reilly v. Transworld Healthcare, Inc., supra, 745 A.2d at 913.) Eber and his wife own 52 percent of creditor EI's stock and the Eber Family Trust owns the remaining 48 percent.
Taken together, the foregoing evidence provides more than substantial evidence supporting the trial court's determination that Eber was a controlling shareholder, whether based upon the aggregation of his interests with those of his children's trusts or his domination and control of the board and his control of day-to-day operations of the two corporations, SFN and KN.
II. Derivative Suit Not Required
Defendants maintain that the trial court erred in finding Neuburger's claims were properly brought as a direct shareholder action, rather than as a derivative action. They argue any harm to her was suffered equally by all shareholders in KN and SFN, and assert that Neuburger's expert witnesses couched their testimony in terms of harm to the companies, rather than to Neuburger individually.
As recognized in Jara, supra, 121 Cal.App.4th at pages 1253-1254, "Jones[, supra,]1 Cal.3d 93, offers an authoritative analysis for distinguishing claims that must be asserted in a derivative action and those that may be asserted in an individual action. . . . [¶] . . . 'A shareholder's derivative suit seeks to recover for the benefit of the corporation and its whole body of shareholders when injury is caused to the corporation that may not otherwise be redressed because of failure of the corporation to act. Thus, "the action is derivative, i.e., in the corporate right, if the gravamen of the complaint is injury to the corporation, or to the whole body of its stock and property without any severance or distribution among individual holders, or it seeks to recover assets for the corporation or to prevent the dissipation of its assets." [Citations.]' (Id. at pp. 106-107.) In contrast, a stockholder's individual suit is ' "a suit to enforce a right against the corporation which the stockholder possesses as an individual." [Citation.]' (Id. at p. 107.) Applying this distinction to the facts, the [Jones]court concluded '[i]t is clear from the stipulated facts and plaintiff's allegations that she does not seek to recover on behalf of the corporation for injury done to the corporation by defendants. Although she does allege that the value of her stock has been diminished by defendants' actions, she does not contend that the diminished value reflects an injury to the corporation and resultant depreciation in the value of the stock. Thus the gravamen of her cause of action is injury to herself and the other minority stockholders.' (Jones v. H.F. Ahmanson & Co., supra, 1 Cal.3d 93, 107.) The court therefore allowed the plaintiff to seek damages based on the appraised value of her shares. (Id. at p. 118.)" (Jara, at pp. 1253-1254.)
In the instant case, the trial court had previously denied defendants' motion for summary adjudication, wherein they had argued that Neuburger had no individual right of action, but only a derivative right. It ruled, "[p]laintiff has presented evidence that, if believed, may show that her right to receive dividends as a shareholder in [SFN] and in KN, Ltd. has been injured through a scheme or device by the controlling shareholders to distribute 'disguised dividends' to defendant Eber, that excludes plaintiff from participation in such payments. (See Jara [, supra,]121 Cal.App.4th 1238, -1259 [Directors' excessive compensation was merely a device to distribute 'disguised dividends' to the two officer/shareholders that injured minority shareholder]; O'Hare v. Marine Electronics Co. (1964) 229 Cal.App.2d 33, 37-38.)"
As did the trial court, we believe that Jara provides guidance for our analysis of the question.
In Jara, supra, 121 Cal.App.4th 1238, Jara Sr., the minority shareholder in a closely held corporation, sued the corporation and the other two shareholders, alleging that the other shareholders breached an oral contract requiring agreement of all three to any compensation increase and also alleging that they breached their fiduciary duty to the minority shareholder by paying themselves excessive compensation. The trial court dismissed the action on the ground that such a claim could not be asserted individually, but only in a derivative action. The Court of Appeal reversed, after an extensive review of the case law, concluding that the case came within the scope of allowable individual actions under its interpretation of Jones, supra, 1 Cal.3d 93. (Jara, at p. 1258.) The "gravamen" of Jara Sr.'s complaint was "that he was deprived of a fair share of the corporation's profits as a result of defendants' generous payment of executive compensation to themselves." (Ibid.)The payment of bonuses to defendants with the objective of reducing the amount of profit in the corporation that had to be shared with plaintiff Jara Sr. gave rise to an injury to the plaintiff as an individual. (Ibid.)The appellate court recognized that, unlike Jones, where "the manipulation of stock values by the defendants had no effect whatever on the underlying business" (Jara, at p. 1258), in Jara, "the alleged payment of excessive compensation did have the potential of damaging the business." (Ibid.)However, the record showed that during this time the company thrived and Jara Sr. did not claim "the company would have experienced still greater prosperity and growth if the salaries had been smaller but rather maintain[ed] that the payment of generous executive compensation was a device to distribute a disproportionate share of the profits to the two officer shareholders during a period of business success." (Ibid.) In addition, the court reasoned that the policy reasons underlying the derivative action requirement did not support the imposition of the derivative action procedure to a compensation dispute between the three shareholders of a closely held corporation. (Id. at pp. 1258-1259.)
According to the Court of Appeal: "We find further support for this conclusion in the absence of any policy considerations favoring derivative actions in the procedural context of the present case. As explained in a leading treatise, the traditional justification for requiring a derivative action is that 'it is designed to prevent a multiplicity of actions by each individual shareholder and a preference of some more diligent shareholders over others, and to protect the creditors who have first call on the corporate assets . . . .' (2 Marsh's Cal. Corporation Law (4th ed. 2004 Supp.) Shareholders' Rights, § 15.11[A], p. 15-61; [citations].)
"The rule requiring a derivative action may also be justified as serving the policies of Corporations Code section 800 (formerly section 834), which imposed a series of procedural prerequisites for bringing a derivative action when enacted in 1949. Subdivisions (b)(1) and (c) have the purpose of shielding the corporation from meritless lawsuits by requiring the plaintiffs to have contemporaneous stockownership and by giving the defendants the right to move the court for an order requiring a bond. [Citation.] Subdivision (b)(2), which requires the plaintiffs to submit a demand to the board of directors before filing suit, reflects the legislative intent of encouraging the 'intracorporate resolution of disputes' and protecting 'managerial freedom.' [Citation.]
"These policies find little or no application in the present case. The objective of preventing a multiplicity of lawsuits and assuring equal treatment for all aggrieved shareholders does not arise at all when there is only one minority shareholder. The objective of encouraging intracorporate resolution of disputes and protecting managerial freedom is entirely meaningless where the defendants constitute the entire complement of the board of directors and all the corporate officers. And the policy of preserving corporate assets for the benefit of creditors has, at best, a very weak application where the corporation remains a viable business.
"In the absence of policy considerations favoring a derivative action, we have no reason to look beyond the strict application of precedent in determining whether a derivative action must be brought to assert a shareholder grievance. We see nothing in Jones that bars Jara, Sr., from bringing an individual action claiming damages for the breach of fiduciary duty of majority shareholders as alleged in the second cause of action." (Jara, supra, 121 Cal.App.4th at pp. 12581259.)
Canvassing the numerous and often inconsistent decisions on the issue, Jara, supra, 121 Cal.App.4th 1238, either distinguished or refused to follow several cases relied upon by defendants here, that refused to recognized minority shareholders' standing as individuals, but required derivative actions to redress harm to the corporation. (Id. at pp. 1254-1258.) Jara distinguished Avikian v. WTC Financial Corp. (2002) 98 Cal.App.4th 1108, 1115 ["plaintiffs' core claim' was that the defendants mismanaged the corporation and entered into 'self-serving deals' to sell its assets to third parties"], Nelson v. Anderson (1999) 72 Cal.App.4th 111 [in a two-shareholder corporation, minority shareholder had no standing to sue the majority shareholder for mismanagement], and Pareto v. F.D.I.C. (9th Cir. 1998) 139 F.3d 696 [claim that bank directors breached their duty of care in arranging the liquidation and merger of bank with another financial institution], as cases "dealing with mismanagement . . . ." (Jara at pp. 1254-1255, 1258, italics added.) It distinguished Sutter v. General Petroleum Corp. (1946) 28 Cal.2d 525, 530 and PacLink Communications Internal, Inc. v. Superior Court (2001) 90 Cal.App.4th 958, 966 (PacLink),as opinions dealing with "fraud" and not breach of fiduciary duty by majority or controlling shareholder. (Jara, at p. 1258.)
In PacLink, supra, 90 Cal.App.4th 958, the plaintiffs claimed defendants transferred the assets of the corporation to a second and third corporation, in which the plaintiffs had no involvement, without payment of consideration. In a mandate proceeding, the court sustained a demurrer to causes of action against the transferee for fraudulent transfer, conspiracy and constructive trust. (Jara, supra, 121 Cal.App.4th at p. 1256.) As observed in Jara, PacLink itself provided a reasoned basis for distinguishing the suit against the transferee corporation for fraudulent transfer, conspiracy and constructive trust, from cases such as Smith v. Tele-Communication, Inc. (1982) 134 Cal.App.3d 338 (Smith)and Crain v. Electronic Memories & Magnetics Corp. (1975) 50 Cal.App.3d 509 (Crain),on the ground that the latter two involved personal causes of action by the minority shareholders against majority shareholders for breaches of fiduciary duty, whereas PacLink did not. (Jara, at pp. 1255-1256.)
In Smith, supra, 134 Cal.App.3d 338, a parent corporation's filing of a consolidated tax return with its subsidiary while engaging in liquidating the subsidiary had the effect of appropriating tax benefits to the parent corporation and reducing the distribution to the single minority shareholder in the subsidiary. "The [appellate] court held that the gravamen of the complaint was injury to the plaintiff as the only minority shareholder arising from an alleged beach of fiduciary duty by the majority shareholder." (Jara, supra, 121 Cal.App.4th at p. 1255, citing Smith, at p. 345.) In Crain, supra, 50 Cal.App.3d 509, the majority shareholder exercised control over the company to sell the entire business to a third party for cash and to loan the cash back to itself in return for an unsecured promissory note payable to the company. Minority shareholders in Crain sued the majority, alleging that the effect of the transaction was to leave the company as a shell corporation with an unsecured note as its principal asset. The appellate court held that the complaint alleged a breach of fiduciary duty, entitling the plaintiffs to individual relief and not solely to derivative relief, against the majority shareholder. (Crain, at p. 524; Jara, at p. 1255.)
Jara, supra, 121 Cal.App.4th 1238, refused to follow Rankin v. Frebank Co. (1975) 47 Cal.App.3d 75, 80 (Rankin),concluding it had been rejected by Jones, supra, 1 Cal.3d at pp. 107-108. Rankin held minority shareholders could not recover for the diversion of corporate assets because the gravamen of their case was injury to the corporation, where the majority shareholders transferred the manufacturing aspects of a business being conducted by the corporation to a newly formed corporation in which the minority shareholders held no interest. Jara characterized Rankin as "questionable authority [on several bases, including that] it relied on Shaw v. Empire Sav. & Loan Assn. [(1960)] 186 Cal.App.2d 401, which was expressly disapproved in Jones on a closely related point . . . ." (Jara, at p. 1256; see also Everest Investors 8 v. McNeil Partners (2003) 114 Cal.App.4th 411, 427-428 [declining to follow Rankin].
Jara also found support in the pre-Jones case of De Martini v. Scavenger's Protec. Assn. (1935) 3 Cal.App.2d 691 (DeMartini),in which a corporation began a practice of making monthly distributions, described as wages, to shareholder-employees only. Four plaintiff shareholders, who were not employed by the company, secured a judgment against the corporation in the amount of these distributions. The Court of Appeal affirmed, holding the corporation could not deprive shareholders of their share of the profits in a business by denominating distributions as wages. (Jara, supra, 121 Cal.App.4th at pp. 1256-1257.) "DeMartini cited a Washington opinion holding that a corporation ' "cannot, by paying excessive or extravagant wages to the working stockholders, deprive the appellant of her share of the profits of the business." ' ([DeMartini,]at p. 698.)" (Jara, at p. 1257.)
In its statement of decision, the court below carefully analyzed the derivative versus individual action issue, finding with respect to Neuburger's claim that the defendants "have breached their fiduciary duty to her as a minority shareholder by the diversion of monies through the management agreements and the excessive loan fees, particularly those for off-the-book transactions," that Neuburger "is the one person who is particularly harmed by any actions that prove advantageous for Eber." Although she entered into the transactions willingly in 1994, "when the arrangement is analyzed over time, it becomes apparent that Eber and his trusts as the majority shareholders were obtaining personal benefits from the arrangement that were separate and apart from those flowing to the minority shareholder." The court analogized the case to Jara, supra, 121 Cal.App.4th 1238, in that Neuburger "describe[ed] Eber's actions as enriching himself through 'disguised dividends' causing a particular injury to her by depriving her of any distribution of dividends while permitting him to recover the various management fees and loans proceeds in the form of 'disguised dividends.' "
The court observed that "[b]oth SFN and KN, Ltd. are Sub-Chapter S corporations with the majority of the shares controlled by either Eber or the Eber Family Trusts. In fact, plaintiff is the only shareholder who is not a member of the Eber family and who also does not enjoy any financial interest in EI or the company later formed to purchase the building, Cypress Partners IV. . . . Both Eber and his children also have interests in EI and Cypress and will share in any of the profits from those entities." The court recognized that "[a]lthough it is probably true that excessive management fees, loan charges, and lease payments would also injure KN, Ltd. and SFN, it ignores the obvious to suggest that all of the shareholders of these entities suffer equally from the companies'] lost profits."
The trial court concluded that, as in Jara, supra, 121 Cal.App.4th 1238, the complaint and evidence in this case demonstrated that the objectives underlying the derivative action requirement did not apply in the context of these closely held corporations. " 'The objective of preventing a multiplicity of lawsuits and assuring equal treatment for all agreed shareholders does not arise at all when there is only one minority shareholder. The objective of encouraging intra-corporate resolution of disputes and protecting managerial freedom is entirely meaningless where the defendants constitute the entire compliment of the board of directors and all the corporate officers. And the policy of preserving corporate assets for the benefit of creditors has, at best, a very weak application where the corporation remains a viable business.' (Jara, supra, at p.1259.)"
The court concluded that "[i]t is plaintiff's individual rights as a minority shareholder that are threatened by defendants' actions. This is not at odds with the reasoning of the Supreme Court in Jones:[¶] 'The individual wrong necessary to support a suit by a shareholder need not be unique to that plaintiff. The same injury may affect a substantial number of shareholders. If the injury is not incidental to the corporation, an individual cause of action exists.' (Jones, supra, 1Cal.3d at p. 107.)" The court concluded that Neuburger's injury was not merely "incidental" to injury to the corporation.
We conclude the trial court properly analyzed the issue and its findings are amply supported in the record.
Defendants also seek to support their argument that Neuburger's injuries were no different from those of other shareholders by asserting that "Neuburger's experts couched their testimony in terms of harm to the companies." Defendants cite testimony of plaintiff's expert, William Scott Mowrey, that through the management agreements and the off-the-books interest, defendants diverted profits from KN and SFN, entities where Neuburger had a 35 percent interest, to entities in which she had no interest (EI). They also cite the opinion of Neuburger's real estate expert, Greg Moss, that the Cypress leases were unfair as there was no arm's-length transaction between the owner and KN and SFN, the great majority of provisions favored the landlord to the exclusion of the two tenants, and the lease was very unfair to KN and SFN. However, this testimony serves to support the court's conclusion that Neuburger suffered an injury not shared by other shareholders, as, unlike all the other shareholders, she had no interest in EI or in Cypress. As in Jara, supra, 121 Cal.App.4th at page 1258, where the court recognized that "the alleged payment of excessive compensation did have the potential of damaging the business," the diversion of money from SFN and KN to entities from which Neuburger was excluded and in which all other shareholders held interests, had the potential of damaging these two closely held corporations. Nevertheless, the gravamen of Neuburger's claim was not that the businesses had been damaged, but that Eber, as the controlling shareholder, had violated his fiduciary duties to her (as the sole minority shareholder) by diverting moneys to himself, EI and Cypress.
As the United States Bankruptcy Court for the Central District of California recognized in In re Bangerter (1989) 106 B.R. 649, in which the plaintiff had asserted that the withdrawal of funds by the debtor damaged the plaintiff because it removed assets from the corporation (Data Load) that could have been used to pay Data Load's obligation on a Wells Fargo credit line that plaintiff had guaranteed, "[b]y reducing Data Load's capacity to pay the Wells Fargo Bank, plaintiff had to pay more on his guarantee. An unauthorized removal of corporate assets certainly injures Data Load. It also simultaneously causes injury to the plaintiff. The [Jones, supra, 1 Cal.3d 93 ] court recognized dual injuries to shareholders and the corporation from a majority shareholder's breach offiduciary duties. It, therefore, allowed a minority shareholder to assert an individual claim even though the corporation suffered harm from the same acts. The Smith [supra, 134 Cal.App.3d 338] and Crain[, supra, 50 Cal.App.3d 509] decisions support this interpretation of [Jones]. Accordingly, plaintiff has standing under California law to assert individually his claims against debtor in this proceeding." (Id. at p. 653, italics added.)
Defendants also argue that the harm of which Neuburger complains occurred to the companies, and not to her individually, citing to testimony that if one shareholder did not receive a dividend, none of the shareholders did. However, the testimony to which defendants cite appears to refer mainly to Eber's decision to discontinue the payment of modest dividends intended to provide the shareholders with sufficient funds to pay their income taxes on the retained income of KN and SFN, not to the asserted scheme by which Eber diverted the companies' profits to himself and his family trusts, that is at the core of Neuburger's claims of breach of fiduciary duties.
The trial court did not err in determining Neuburger had standing to bring this action as an individual, rather than requiring it be pursued as a derivative action.
III. Failure to Find That Loan and Rental Rates Were Market Rates
Defendants argue the trial court erred in finding defendants breached any duty owned to Neuburger as it failed to find on the issues of whether the interests rates for the off-the-books loans were market rates or whether the lease rental rates were market rates. Defendants maintain that if the rates were market rates, they could not have been unfair. They also assert that, as a matter of law, the interest and loan rates charged were market rates at the time of the loans. A. Statement of decision
Code of Civil Procedure section 632 requires the court to explain the factual and legal basis for its decision. "The trial court's statement of decision need not discuss each point listed in a party's request; it need only set forth 'ultimate facts' (as opposed to 'evidentiary facts') on the principal controverted issues requested. Thus, if the appealed judgment is otherwise supported by the findings made, the trial court's failure to make findings on 'immaterial issues' is not reversible error. [(] Marriage of Garrity & Bishton (1986) 181 [Cal.App.]3d 675, 687; see Marriage of Burkle (2006) 139 [Cal.App.]4th 712, 736, fn. 15—statement of decision sufficient if it fairly discloses judge's determination re ultimate facts and material issues ('the trial court is not required to respond point by point to issues posed in a request for a statement of decision'); Central Valley Gen. Hosp. v. Smith (2008) 162 [Cal.App.]4th 501, 513[.)]" (Eisenberg et al., Civil Appeals and Writs, supra, [¶]8:25.1, p. 8-15; see also Hellman v. La Cumbre Golf & Country Club (1992) 6 Cal.App.4th 1224, 1230.)
Code of Civil Procedure section 632 provides, in part: "In superior courts, upon the trial of a question of fact by the court, written findings of fact and conclusions of law shall not be required. The court shall issue a statement of decision explaining the factual and legal basis for its decision as to each of the principal controverted issues at trial upon the request of any party appearing at the trial. The request must be made within 10 days after the court announces a tentative decision unless the trial is concluded within one calendar day or in less than eight hours over more than one day in which event the request must be made prior to the submission of the matter for decision. The request for a statement of decision shall specify those controverted issues as to which the party is requesting a statement of decision. After a party has requested the statement, any party may make proposals as to the content of the statement of decision."
We shall conclude the trial court's statement of decision adequately set forth its findings on the ultimate issues of the fairness of the off-the-books loans and interest rates and the lease rents and defendants' concomitant breaches of fiduciary duties. Further findings on the evidentiary issues of whether the rates were market rates were not required. B. Unfairness of off-the-books loans and interest rates
The court found that Neuburger did not know of the details or amounts of the off-the-books loans and high interest rates and that defendants failed to meet their burden of showing the inherent fairness of the off-the-books loan transactions. The court concluded that "keeping the loan amounts and interest rates paid to a majority shareholder off of the company records and in a private safe may be a textbook example of unfairness to a minority shareholder." The court awarded plaintiff "undisclosed loan interest damages" of $530,557, including prejudgment interest through May 2009, based upon testimony of expert Mowrey showing the payments made to Eber from 1998 through 2002, substantially above the disclosed rates, and calculating the monies owed to plaintiff by reason of her 35 percent minority shareholder share with prejudgment interest at 10 percent per year.
The trial court properly determined that defendants bore the burden of demonstrating that the loans and interest rates were "fair" to minority shareholder Neuburger. As stated more than 50 years ago in Tevis v. Beigel (1957) 156 Cal.App.2d 8, 15: " 'A director is a fiduciary. [Citation.] So is a dominant or controlling stockholder or group of stockholders. [Citation.] Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein. [Citation.] The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm's length bargain.' [Emphasis omitted.] (Pepper v. Litton, 308 U.S. 295, 306-307 [60 S.Ct. 238, 84 L.Ed. 281]; Kennerson v. Burbank Amusement Co., 120 Cal.App.2d 157, 172; Remillard Brick Co. v. Remillard-Dandini Co., 109 Cal.App.2d 405, 420 [(Remillard)], italics added by this court.)" (See also Efron v. Kalmanovitz (1964) 226 Cal.App.2d 546, 556-557 (Efron I)["The burden of proof was upon the dominant shareholder . . . to prove that the transaction was undertaken in good faith and that it was inherently fair from the viewpoint of the corporation and it shareholders. [Citation.]"].) " 'The price to be paid, the manner of payment, the terms of credit, if any, and such like questions, must all meet the test of the corporation's best interest.' " (Efron I, at p. 557, quoting Allied Chemical & Dye Corp. v. Steel & Tube Co. (1923) 14 Del.Ch. 1, [120 A.486, 491].)
It has long been recognized that " '[t]he question of fairness is ordinarily one of fact for the trial court and its decision will not be disturbed unless it appears from the record that such decision cannot be supported upon any reasonable view of the evidence and the inferences to be drawn therefrom.' [Citation.]" (Efron I, supra, 226 Cal.App.2d at p. 559.)
The court's findings were supported by expert witness Mowrey, who opined "[t]hat the off-books interest that was paid was unfair as to the minority shareholder Karen Neuburger because it was not disclosed to her. The interest was not disclosed on the financial statements of San Francisco Network and KN, Ltd, and as a result, the payment of off-books interest served to divert profits from those entities where Karen Neuburger had a 35 percent interest to the entities or individuals where she had no interest." Mowrey also testified that, although the disclosed on-the-books interest rate seemed "generally reasonable" in the area of 10 percent or the prime rate plus one, the off-the-books interest that was not disclosed, "tended to go into the higher figures in terms of . . . 15 to 25 percent types of interest rates, were very, very high." But most important to Mowrey's opinion was that the parties had not agreed as to how high the rate would go. That lack of agreement appeared to Mowrey to be substantiated in part by the fact that off-the-books interest stopped being calculated after September 30, 2002.
The findings were also supported by the expert testimony of Lambert, who opined that when a loan was made by someone in Eber's position as lender and controlling shareholder, the minority shareholder "would need disclosure about the principal, interest, the manner in which the loan would be repaid, what a comparable loan would require in terms of interest from a third party, neutral party, and . . . the entire environment of why the loan was being made and what the consequences to the corporation, and in this case to Miss Neuburger as a minority shareholder, would be." Lambert further testified that, in analyzing the off-the-book loans from the standpoint of whether they were fair, one would need to know why repayments were made to Eber, why the interest rates were so high, whether that was a comparable rate, what the term of the loan was, and what the covenants were. He did not see any such disclosures in the record. The court found Neuburger did not receive the disclosures described by Mowrey and Lambert.
Defendants argue that the evidence was not controverted on whether the interest rates were "fair." Clearly, that is not the case, with plaintiff's expert Mowrey testifying that they were "unfair" and the evidence showed that the information Lambert opined was required for the fairness analysis was not provided to Neuburger.
Defendants scaffold their market rate argument as follows: it was undisputed that loans were needed in order for SFN and KN to survive. Mowrey acknowledged that certain factors applicable to SFN and KN generally warranted higher interest rates, including lower creditworthiness, higher risk, lack of security, and other debts being senior in priority to those of the lenders Eber and/or EI. Defendants assert that whether or not the loans and interest rates were disclosed does not determine their fairness, but rather that fairness is based upon whether the off-the-books loans were at market rates.
Both Mowrey's expert testimony and case authority (e.g., Tevis v. Beigel, supra, 156 Cal.App.2d at p. 15) support the court's conclusion that the loan interest rates were "unfair" where they were off-the-book loans at rates higher than those that were disclosed and that they were neither known by Neuburger nor reasonably discoverable by her.
The trial court found "the interest rates charged were not the product of any arm's length bargaining, nor was there any showing of an attempt to perform a market-rate analysis at the time of the high interest rate borrowing. Rather, the numbers involved and the circumstances of the high-rate loans were separately kept in Compton's safe and out of the view of the minority shareholder . . . ." Further, the court was not persuaded by the "internal rate of return" analysis of defense expert Matthew Lynde and observed that Lynde had not testified to the "fairness" of the loans. Ample evidence supports the trial court's finding that the off-the-books loans and their rates did not " ' "carr[y] the earmarks of an arm's length bargain." ' " (Jones, supra, 1 Cal.3d at p. 108.)
Although Neuburger did not contest the need for the loans, and agreed that Eber and Compton had advised her that they were going to do "something off-the-books" so that factors would not be aware of the entirety of the SFN debt, substantial evidence support's the trial court's finding that she never knew the loans being kept off-the-books had terms that could allow the charged interest rate to escalate to 25 percent and that she learned for the first time after retaining counsel and exchanging documents that Eber had received $742,454 in off-the-books interest payments in late 2002. Neuburger was not aware of Compton's memo describing the circumstances for the loan, showing the off-the-books interest due to Eber, or the 18-page spread sheet showing the calculations for the off-the-books loans and apparently showing the payments to Eber. This evidence, when considered together with evidence that the documents memorializing the numbers involved and the circumstances of the high-rate loans were separately kept in Compton's safe, unavailable to Neuburger and out of her view, provides substantial evidence that Neuburger neither knew nor agreed to the off-the-books loan interest rates.
We reject defendants' contention that the court must find the rates to have been above market rates in order to find the off-the-books loans and their rates to be unfair. It was defendants' burden to show the loans and their rates were inherently fair. (Jones, supra, 1 Cal.3d at p. 108; Tevis v. Beigel, supra, 156 Cal.App.2d at p. 15.) Ample evidence supported the court's determination that defendants failed to carry that burden.
Nor are we persuaded by Marciano v. Nakash (Del. 1987) 535 A.2d 400 (Marciano),a case upon which defendants rely. In Marciano, during the process of liquidating the company, the chancery court validated a claim for loans made by the Nakashes, one faction of deadlocked board and shareholder ownership of the company, as valid and enforceable debts of the corporation. The Delaware Supreme Court held that the findings of the court of chancery that the challenged loan transactions were reasonable and fair to the corporation were supported by the record. (Id. at p. 401.) The loans were made by the Nakashes without consulting the Marciano faction. (Id. at p. 402.) At the time of a court-ordered sale of assets, the Nakashes and their entities were general creditors of the company being liquidated. (Ibid.) The plaintiffs sought to void the loans and the Nakashes' right to recover as general creditors in the liquidation. (Id. at pp. 403, 405.) The chancery court found that the loans compared favorably with terms available from unrelated lenders and that the need for external financing had been clearly demonstrated. (Id. at p. 405.) The Delaware Supreme Court observed that it was not free to reject the vice chancellor's factual findings, made after an evidentiary hearing, unless the findings were without support in the record or were not the product of a logical deductive process. (Id. at p. 405.) The court took pains to differentiate the test applicable in the corporate liquidation proceeding before it, where the purpose was to test the validity of the challenged loans, from the test applicable to the trial of claims based on allegations of unfair dealing by the interested directors. (Id. at pp. 406-407.) Hence Marciano is readily distinguishable. Not only did the reviewing court expressly state it was not considering allegations of unfair dealing (or in our case, breach of fiduciary duties) by interested directors, but it also applied the substantial evidence test, deferring to the findings of the chancery court, which were supported on the record.
We have concluded that whether or not the off-the-books interest rates were above market, on the evidence presented, the court properly could find they were unfair. We note, however, that substantial evidence on the record indicates that the rates were above market. That evidence includes that the rates were kept off-the-books; that the documents and calculations prepared to memorialize the loan terms and track the accruing interest were hidden and not disclosed to Neuburger; that defendants refused to produce these documents when requested by Neuburger's counsel; that despite having actual knowledge of the off-book interest accounting practices, EI comptroller David Cass conceded he prepared documents for SFN's accountants that falsely stated he was unaware of any information not reflected on SFN's financial statement. It also includes Mowrey's testimony that the off-the-books portion of the interest was "very, very high" and that the interest charges ceased in 2002, notwithstanding that some of the underlying loans remained in place.
We are not persuaded by defendants attempt to use Mowrey's decision to use a 25-percent capitalization rate calculation to reduce to a present value future damages from the alleged excess management fees paid to Eber under the management agreements as evidence that a 25-percent interest rate would have been a market rate. As Mowrey explained, "the capitalization rate is just another way of looking at a discount rate and a present value factor to try and take a dollar earned in the future and reflect it in terms of present value. [¶] An interest rate on the loan—which, you know, may well be a similar number, depending upon how you look at the risk of the income stream, but it's not the same calculation. A loan interest rate is a number that is applied against an amount outstanding in terms of a periodic payment for the use of those funds."
Defendants assert for the first time on appeal in their appellants' reply brief that the four-year statute of limitations or, alternatively, the doctrine of laches barred any claim for breach of fiduciary duty based on these off-the-books loans. They further argue for the first time in their reply brief that Neuburger failed to establish damages arising from any breach of fiduciary duty, because it remained undetermined whether the off-the-books interest rates were market rates. Defendants have waived any such contention by failing to raise them in their opening brief. (Eisenberg et al., Civil Appeals and Writs, supra, ¶9:78.2 at pp. 9-25 to 9-26 ["issues not properly addressed in the opening brief will be disregarded on appeal (especially if it appears the delay in raising those issues was simply a 'gamesplaying' maneuver)"], citing among others, Julian v. Hartford Underwriters Ins. Co. (2005) 35 Cal.4th 747, 761, fn. 4; Tilton v. Reclamation Dist. No. 800 (2006) 142 Cal.App.4th 848, 864, fn. 12.) C. Unfairness of lease
The court founded its damage award on the nondisclosure of the loans and awarded damages of $530,557 (including prejudgment interest through May of 2009) as "undisclosed loan interest damages." The amount was based upon Mowrey's chart, showing the undisclosed interest payments made to Eber from 1998 through 2002, apportioning to Neuburger her 35 percent minority shareholder share.
Defendants contend that the court erred in finding that the leasehold agreements were unfair to the tenants and so constituted a breach of defendants' fiduciary duty to Neuburger. As they argued with respect to the off-the-book loans and interest rates, defendants again argue that the trial court failed to find on the "critical issue" of whether the lease rental rates were market rates. They further contend that the court erred as a matter of law in not finding the rental rate of $2.10 per square foot was the market rate at the time.
Defendants assert in conclusory fashion that, "[w]hile the trial court reached this decision without considering the evidence presented that actual comparable rents were reviewed before the lease was ratified by the shareholders, the differing expert testimony as to the fair market value of rent over time, and the financial circumstances of the companies during the relevant time, the court erred in not finding that, as a matter of law, the rental rate of $2.10 per square foot was a market rate at the time." (Italics added.) We observe that failure to find evidence persuasive is different from a failure to consider the evidence, and we presume the court did consider all relevant evidence. Moreover, as defendants do not cite to the record to support their claims that the court failed to consider the evidence they list and do not provide further argument in their opening brief as to how that evidence would prove determinative, we do not consider defendants to be raising the court's asserted failure to consider this evidence as an issue on this appeal. (Eisenberg et al., Civil Appeals and Writs, supra, ¶9:21 at p. 9-6.)
"The question as to whether the terms of payment fixed by the contract rendered the contract unfair was one of fact to be determined by the trial court and that court having determined that the contract was unfair this court cannot substitute its judgment for that of the trial court. [Citations.]" (Efron v. Kalmanovitz (1967) 249 Cal.App.2d 187, 191 (Efron II.)
In order to avoid application of the substantial evidence standard of review, defendants once again couch their contentions as questions of law. Once again, we reject defendants' premise that the leasehold agreements could only be "unfair," and a breach of defendants' fiduciary duties to the minority shareholder, if the rent, considered in isolation, was below market rates. Rather, the "burden of proof was upon the dominant shareholder . . . to prove that the transaction was undertaken in good faith and that it was inherently fair from the viewpoint of the corporation and its shareholders. (See Tevis v. Beigel, [supra],156 Cal.App.2d 8, 15.)" (Efron I, supra, 226 Cal.App.2d at p. 557.)
The court was not required to expressly state what it found to be the market rental rate in order to find that the lease agreements were unfair. Rather, the court did find upon the ultimate issues of material fact that the lease agreement as a whole was unfair to Neuburger and consequently a breach of defendants' fiduciary duties to her. (See Efron II, supra, 249 Cal.App.2d 187 [The issue of whether the contract was fair to the corporation and its stockholders was "the ultimate fact." "The court was not required to find the probative facts upon which it based its finding of that ultimate fact. [Citations.]"].) " ' "It is axiomatic that a finding of ultimate fact embraces the necessary probative facts to sustain it. Inclusion of evidentiary facts would add nothing of value and would needlessly embellish the structure of the findings with rococo details." ' " (Efron II, at p. 193.)
In its detailed statement of decision, the trial court here found that "for the time period in question, given the lack of any semblance of independent negotiation or evaluation of the lease and the failure of the majority shareholders to take any steps to protect the interest of the minority shareholder, Leonard Eber has failed in his duty to provide inherent fairness and good faith to plaintiff as the minority shareholder. The circumstances surrounding the purchase and subsequent lease of the premises at 2505 Kerner Blvd. do not carry the 'earmarks of an arm's length bargain.' (Jones, supra, [1 Cal.3d] at p. 108[.]) In particular, the court must conclude that the primary objective of the Eber defendants was to lease up the 2505 Kerner premises as fast as possible to ensure a cash flow to cover the mortgage and provide a steady cash flow to the Eber defendants. The court finds that the circumstances of the lease to SFN/KN constituted a breach of defendants' fiduciary duty to plaintiff and will award damages based upon the breach." (Italics added.) These findings were well supported by the evidence. The court properly could determine on the evidence before it that the lease agreements were unfair to Neuburger, whether or not the actual rental rate per square foot, considered in isolation, was a market rate. The court did not err in considering the entirety of the lease agreements and whether other provisions of the agreements were fair to the tenants. In Efron I, supra, 226 Cal.App.2d 546 and Efron II, supra, 249 Cal.App.2d 187, minority stockholders challenged the sale of certain assets of Maier Brewing Company to a new corporation wholly owned by Maier's controlling shareholder. Although the defendants had shown that the price to be paid for the assets was adequate and was fair to Maier and to its minority shareholders, the evidence failed to show that terms of payment of the contract price were fair, judged at the time the offer was accepted. (Efron I, at p. 557; Efron II, at p. 191.) Consequently, the consideration in isolation of a single provision of an agreement, whether it be the sale price in a sales agreement as in the Efron cases, or the rent per square foot in a lease agreement, does not necessarily render the agreement fair. The trial court must consider the agreement as a whole to determine whether it is inherently fair to the corporation and minority shareholders. The court did so here.
The court acknowledged that "calculating what a 'fair' rent should have been in the 2003-2004 time period proved difficult for the experts. They had differing opinions as to the fair market value of rent over time, based to some extent upon the classification of the building as including 'office,' 'light-industrial,' or 'flex' space." The court relied upon the testimony of Neuburger's expert witness, real estate broker Moss, who opined that the building at 2505 Kerner Blvd. should primarily be considered an office building, although it included some "flex" or light-industrial use space as well. Moreover, the court found, based on the evidence that the market at the time was "essentially a tenants' market," although it was harder for tenants to lease "flex" or warehouse space.
The court also relied upon Moss's testimony that many aspects of the lease were very unfair to the tenants. Recognizing that Moss's concern was not the initial rental rate per square foot, but with the " 'whole bundle of rights of a lease,' " the court relied upon Moss's testimony that the other unfavorable terms and conditions of the lease and the lack of any negotiations to arrive at fair lease terms, rendered it unfair. Among those unfair provisions identified by Moss and specified by the court were that monthly rental payments began almost immediately after the leases were signed, even though the tenants did not officially occupy the building until eight months thereafter. Although Cypress spent money on improvements, so did SFN and KN, spending approximately $400,000. Moss testified that in that market it would be very rare that the rental payments began before occupancy and that there was no allowance for tenant improvements. He doubted that this combination of rental payments for eight months before occupancy and payment by the tenants of substantial sums for tenant improvements had ever "happened more than this once." The court also cited Moss's testimony that a 10-year lease term was very uncommon in the San Rafael commercial real estate market. Moss found only two leases for 10-year terms among the 150 properties he had surveyed. The majority of lease terms were far shorter and Moss would have expected to see a five-year term or shorter with a tenant's option to extend, in order to provide the tenants flexibility. Moss saw no evidence of arm's-length bargaining that one would expect in any real estate leasehold contract negotiation. He opined that the agreement was one of the most one-sided he had seen in his 20 years experience as a commercial real estate broker and very unfair to the tenants.
Defendants suggest that provisions found unfair were never invoked by Cypress, citing testimony of defense expert witness Gerald Suyderhoud. The cited pages do not contain evidence that the provisions were never invoked. Moss agreed on cross-examination that the owner had not invoked the insurance pass-through provision, but maintained the agreement provided that the owner did not waive its right to do so by not enforcing the provision. Moreover, that the tenants may never have sought to sublease or assign their leasehold does not mean those provisions were "fair." Rather, the draconian provisions of the lease may have deterred the tenants from considering doing so. Finally, the provisions expressly referenced by the court to support its determination that defendants had failed to demonstrate the inherent fairness of the lease—the eight-month delay between beginning rental payments and occupancy and the lack of a tenant improvement allowance—did occur.
Defendants seize upon Moss's statement that, "taken in isolation I don't have a huge issue with the rental number," to support their claim that the rental rate was fair. (Italics added.) However, Moss explained that "[t]o take rental rate in isolation from the whole bundle of rights of a lease is of relatively little value." In response to the question whether he could quantify what he meant by a better rental rate, Moss testified, "[w]e run a risk, in my opinion, of focusing exclusively on rental rate without talking about the bundle of rights in a lease provision. But if we were to only focus on rental rate, at the risk of not talking about other provisions, portions of Novato, so 5 miles up highway 101 at the time were probably ten, 15 percent less per rent. Across the bridge in Richmond are also approximately ten, 15 percent less in rent. And the City of Petaluma has many alternatives that might be as much as 25 to 30 percent less in rent." Moss further opined that he would counsel a tenant not to enter such a one-sided lease, but that if tenants were going to enter such a lease, that it should be at a "steep, steep discount," that he quantified at perhaps "half rate," arriving at a rate of $.80 or $.90 per square foot to be enough of a discount to compensate the tenants for renting in accordance with the burdensome conditions of the lease document.
Moss further testified that there were many other choices available for SFN and KN in this market, especially if the tenants were open to alternatives in Marin County or Richmond or Petaluma. At time of occupancy, there were more than 40 alternatives of equal or greater square footage that could have accommodated these tenants in Marin County, Corte Madera, Larkspur, San Rafael, Novato, East Bay Richmond or Petaluma. Moss would have encouraged the tenants to look elsewhere as they likely could get much more favorable terms both in rental rates and in lease provisions, including tenant improvements and so forth.
Defendants further argue that the court failed to determine what the market rate was for the space at the time the leases were entered and what damage occurred to Neuburger that was proximately caused by the fiduciary duty breach resulting from the disparity between the market rates and the actual rates charged. They maintain if the rental rates were at market, they were "fair" and there was no harm to plaintiff and no damages. We disagree. The court's damage assessment was founded on the evidence presented.
The court determined that Mowrey's damage calculation based upon Moss's "half rate" suggestion, was not a fair assessment of Neuburger's damages, given Moss's concerns regarding the lease "in toto" and the uncertainty as to whether Mowrey's calculations were based on a "triple net" or other rental rate. Rather, the court selected the $1.58-per-square-foot base rent per month for the lease with all tenants, as the basis for its damage calculation. The court explained: "Defendants initially selected $1.58 per square foot as the base rent per month for the leases with all tenants. [Citation.] However, they raised that rental rate in early 2004 to $2.10 while reducing the actual space allocated to SFN and KN. [Citation.] There was very little explanation for this change, no real negotiation, and the document was signed again by the same individuals, Dustin Eber for the tenants and his father for the landlord. [Citation.]" The court "accep[ted] the unexplained rate increase as a reasonable source for a damages calculation, recognizing that nonmonetary factors make any analysis difficult. That calculation, . . . reduced by plaintiff's 35 [percent] interest share, yields damages to plaintiff of $209,057, when calculated from the lease onset through the February of 2008 end of lease period. That figure becomes $17,500 higher, or $226,557 when the period is extended to the July of 2008 sale date.[ ] Plaintiff has added a prejudgment interest component of $76,899, yielding suggested damages of $303,456. The court recognizes the difficulties inherent in any lease damages assessment and will accept this as a reasonable figure for plaintiff's leasehold interest damages. It is the complete lack of bargaining and defendants' insistence upon an income flow before occupancy that are problematic here. When liability is clear, although damages are not precisely shown, the amount may be accepted even with some element of uncertainty. [Citation.]" The court here recognized the difficulty of calculating damages with certainty. Its use of the initial rental rate of $1.58 per square foot as a base was reasonable in the circumstances, particularly as it was defendants' wrongful conduct in providing lease agreements that were so one-sided in favor of Cypress that made calculation of an appropriate market rate extremely difficult. (See GHK Associates v. Mayer Group, Inc. (1990) 224 Cal.App.3d 856, 873-875 [where fact of damages is certain, law requires only that some reasonable basis of damages computation be used, and the damages may be computed even if the result reached is an approximation]; Tomlinson v. Wander Seed & Bulb Co. (1960) 177 Cal.App.2d 462, 474 [Once certainty as to the fact of damage is established, less certainty is required as to the amount of damage"].)
"A net lease ' "presumes the landlord will receive a fixed rent, without deduction for repairs, taxes, insurance, or any other charges, other than landlords' income taxes. . . . A lease is not 'net,' as this term is used in long-term leases, if the tenant's repair obligations are less than these." [Citation.]' (Brown v. Green (1994) 8 Cal.4th 812, 827.) Thus, the arrangement involves 'the virtually complete transfer of the incidents of ownership from landlord to tenant.' [Citation.] 'In practice, under a "net lease," the tenant may have certain minimal obligations regarding operating costs. Under a "triple net lease," all operating costs are the tenant's obligation.' (Cal. Practice Guide: Real Property Transactions [(The Rutter Group 2010]) § 7:35.)" (Tin Tin Corp. v. Pacific Rim Park, LLC (2009) 170 Cal.App.4th 1220, 1226 fn. 3.)
In the summer of 2008, there was a sale of SFN and KN assets to a third party.
Defendants argue that the court's finding that the circumstances surrounding the purchase and lease of the building did "not carry the 'earmarks of an arm's length bargain' " was insufficient to show unfairness in lease transactions between closely-held corporations with common ownership and management.
The court stated that it would examine plaintiff's contention that the lease was one-sided and unfair and that it violated defendants' duty of good faith and inherent fairness, using the standards set forth in Jones, supra, 1 Cal.3d at page 108, and particularly the admonition to examine the transaction to see if it " 'carries the earmarks of an arm's length bargain.' " (Ibid.)
Citing Efron II, supra, 249 Cal.App.2d at page192, defendants contend that the "arms length bargain" test of Jones, supra, 1 Cal.3d at page 108, cannot be the test for fairness for transactions between closely-held corporations with common ownership and management, such as EI, SFN and KN. The appellate court in Efron II, upheld the trial court's ultimate finding of fact that the contract of sale of corporate assets to a corporation wholly owned by the selling corporation's dominant shareholder was unfair. Because the finding that the contract was unfair was supported by the evidence, the appellate court concluded it was "immaterial" whether the additional finding that the transaction did not have the "earmarks of an arm's length transaction" was supported by the evidence. (Id. at pp. 191-192.) The court concluded "[t]he finding that the transaction did not carry the 'earmarks of an arm's length transaction' [was] a finding beyond the issues before the court." (Id. at p. 192.) In dictum, the court then observed: "[The defendant] controlled both corporations and was, in effect, dealing with himself. It is self evident that 'arm's length' cannot be the test of the validity of such a transaction for one cannot deal at arm's length with himself. Such contracts if fair are valid. (Corp. Code, § 820.)" (Efron II, at p. 192.)
Although superficially appealing, this logic taken to the extreme would gut the well-established law dealing with the fiduciary duties of majority shareholders to minority shareholders when close corporations are involved. Such duties are particularly pertinent to transactions between closely held corporations where a controlling shareholder of one corporation attempts, as here, to funnel profits away from the minority shareholder to a corporation or corporations controlled by the majority shareholder and in which the minority shareholder has no interest. (See Remillard, supra, 109 Cal.App.2d 405; Jones, supra, 1 Cal.3d 93; Jara, supra, 121 Cal.App.4th 1238 [all involving closely held corporations].). The courts have repeatedly articulated the standard by which fairness may be assessed as whether the challenged transactions possess the "earmarks of an arm's length bargain." (Pepper v. Litton, supra, 308 U.S. at p. 306; Jones, at p. 108; Remillard, at pp. 420-421; Efron I, supra, 226 Cal.App.2 at pp. 556-557.) These courts never hinted that there might be an "exception" for transactions between close corporations controlled by the same majority shareholders. Indeed, in Fisher v. Pennsylvania Life Co. (1977) 69 Cal.App.3d 506 (Fisher),the court rejected the argument that directors and controlling shareholders owed duties to minority shareholders only in the case of a closely held corporation. According to the Fisher court, "In the Jones case the Supreme Court did reason that traditional theories of fiduciary duty have failed to offer protection to minority shareholders and 'particularly to those in closely held corporations whose disadvantageous and often precarious position renders them particularly vulnerable to the vagaries of the majority.' ([Jones, supra,]1 Cal.3d at pp. 100, 111.) Although the Supreme Court dicta in Jones does reflect a particular concern for minority shareholders in closely held corporations, nothing in that dicta also suggests that the Supreme Court would limit the rule of 'inherent fairness to the minority' only to those cases involving closely held corporations. We do not read any language in the Jones case as granting a license either to majority shareholders or to corporate directors to exercise bad faith with minority shareholders in corporations that are not closely held." (Fisher, at pp. 512- 513.)
Moreover, we do not read the language "earmarks of an arm's length transaction" as mandating an actual arm's length negotiation between those in control of the two corporations and themselves. Rather, we understand the test for inherent fairness in transactions between closely held corporations under common control where a minority shareholder alleges that the controlling majority has breached their fiduciary duties to the corporation and/or the minority requires the controlling majority to demonstrate they took steps in fashioning the terms of the deal to protect the interest of minority shareholders and/or to demonstrate that the transaction or agreement was one that reasonably could have been reached following an arm's length negotiation—i.e., that the transaction bears the "earmarks of an arm's length bargain."
Furthermore, even were we to agree that the court should not have relied upon the "arm's length bargain" test in evaluating the inherent fairness of the lease, the ultimate finding that the circumstances of the lease constituted a breach of defendants' fiduciary duty to Neuburger as a minority shareholder was independently supported by the court's findings that the majority shareholders completely failed to take any steps to protect her interests with regard to the lease agreements; that the lease provisions were one-sided and unfair; that the primary objective of the Eber defendants was to lease up the premises as fast as possible to ensure a cash flow to cover the mortgage and provide a steady cash flow to the Eber defendants; and that Eber had failed to provide inherent fairness and good faith to plaintiff as the minority shareholder.
Neuburger contends the trial court erred in finding the management agreements inherently fair. In an interesting about-face from her position in response to defendants' appeal, she argues that defendants could not meet their burden of proving the management agreements were fair, absent evidence that the management agreement charges were at "market rates." She further asserts there was no substantial evidence that the charges for services EI provided to SFN/KN under the management agreements were fair.
As described by the court, "[t]he original agreement provided for a management fee of 12 percent or $15,000 per month, whichever was greater, and the parties initially operated on that basis. Thereafter at varying intervals, the agreement changed via amendment. On September 29, 1998, the parties entered into the ARMA, at which time the monthly guarantee had risen to $162,000. On or about May 23, 2000, the agreement was amended again raising the minimum monthly guaranteed payment to $294,840. . . .
The parties entered into a final management agreement, this being the SARMA, dated December 1, 2003. By that point, plaintiff had been raising questions about the management agreements and loan fees. The SARMA reduced the management fee from 14.15 percent to 9.5 percent and also dropped the guaranteed monthly sum from $294,890 to 250,000, in part because of efficiencies in the new combined location of the companies."
The court found with respect to the management agreements, "that [Neuburger] has not shown the necessary breach and consequent damages and that defendants have sustained their burden of justifying their conduct over the period of the fiduciary relationship as contemplated by Jones, [supra, 1 Cal.3d 93,] et al." Specifically, the court found defendants "sustained their burden of showing the fairness of the management agreements even though those agreements resulted in a larger profit percentage to the management company, EI, than was achieved by the manufacturing companies, SFN/KN." The court found that Neuburger had agreed to the management structure, had accepted the benefit of it and the growth that was provided over the decade of the relationship. She did not challenge it until the end of the relationship in 2004. With an investment of only $33,000, Neuburger accepted salaries over the 10-year period that yielded over $1 million, even though Eber made much more. Meanwhile, defendants bore the major share of the financial risk in what all conceded was a risky enterprise. The court found that defendants "established that the cost structure changed over time and that the changes necessitated changes in the management agreements and the minimum monthly payments that were required by them." The court refused to conclude, "solely on the basis of profits over time, that defendants have taken undue advantage of plaintiff's requested agreement for management of her sleepwear manufacturing company."
Substantial evidence supports the court's finding that defendants met their burden of showing the management agreements were fair, and that Neuberger had not shown the necessary breach and consequent damages. As we have recognized with respect to the trial court's assessment of the loan and lease agreements, the single factor of "market rate" is not the only measurement of fairness of the agreements in these circumstances. Rather, the court was required to look to the fairness of the entire management agreement, in context of the relationship of the parties, in determining whether defendants had sustained their burden. The trial court's determination of inherent fairness is entitled to substantial deference. (Efron II, supra, 249 Cal.App.2d at p. 191; Efron I, supra, 226 Cal.App.2d at p. 556.) We will not substitute our judgment for that of the trial court, "unless it appears from the record that such decision cannot be supported upon any reasonable view of the evidence and the inferences to be drawn therefrom.' [Citation.]" (Efron I, at p. 559.)
Neuburger contends the evidence demonstrated that Eber used the management agreements to take the profits from SFN and KN for himself and his family. She cites the evidence favorable to this view of the facts, including the following: El's only clients were SFN and KN; EI began "sloughing" employees to SFN and KN, requiring them to take on functions previously provided by EI, and there was nothing unique about the services provided by EI that SFN and KN could not have provided themselves; SFN was financially capable of managing itself; under the management agreements, EI was assured a profit and SFN/KN were not; and there was a "gross disparity of profits" between SFN/KN and EI. However, that is not the substantial evidence standard of review.
Under the substantial evidence standard of review, we are required to defer to the trial court's findings of fact, unless unsupported by any reasonable view of the evidence and inferences to be drawn therefrom. At most, Neuburger's factual recitation points to conflicts in the evidence.
Defendants produced evidence that Neuburger acquiesced in the management structure over nine years of the relationship and that the general and administrative expenses of SFN were "within a reasonable and expected range" of other comparable apparel companies. The court found persuasive the testimony of CPA Allan Whitman, who had many years' experience in the garment industry, and who compared SFN/KN's overhead and overall expense structure to that of the garment industry made up of companies doing similar sales volume and who concluded that the EI charges to SFN and KN under the management agreement during the years 2000 through 2004 were reasonable. The amounts incurred during those years were within industry standards and "almost right on." Whitman opined that it appeared that the minimum charges in the management agreements during the years 2001 through 2005 were reasonably based on El's expenses in providing the services during those years. It appeared to him that the minimums were derived from El's determination what its average monthly cost was to provide the services.
Whitman also testified generally to the efforts of EI to obtain approval of the SARMA after Neuburger raised questions about it, by having it reviewed by Moss Adams, a regional CPA firm specializing in the apparel industry. Moss Adams issued its March 28, 2005 report, comparing general and administrative expenses of similarly situated apparel manufacturers, and concluding that the general and administrative expenses paid by SFN (where the EI fees were primarily accounted for) were "within a reasonable and expected range" of the other comparable apparel companies. Whitman opined that the Moss Adams report was reasonable. The approach taken in the Moss Adams report was similar to Whitman's approach, but more complex. The report's results were consistent with his that the EI charges being made under the SARMA to SFN were reasonable.
The court recognized that neither Whitman nor Moss Adams could find comparable written agreements within the garment industry. However, it is not necessarily the case that there were no such agreements in the industry. Rather, it may be that management agreements for closely-held corporations were not publicly available. The Moss Adams report stated that "the information was not readily, if at all, available, as they were not able to find comps or information on other closely held management companies that pay management fees for services. They did find a few public companies with management fees, but we concluded that those were not comparable."
The court expressly rejected plaintiff's expert Mowrey's testimony that even the smallest amount of profit would be "unfair" to SFN/KN. It found that Mowrey's testimony, that it was his "understanding" that the management services should be brought "in-house," did not recognize the history of the parties' transactions and provided "no assistance when the 'fairness' of the transactions are concerned." The court was not required to credit Mowrey's assumption that management services could be brought in-house for a lower price. Nor was it required to agree with his view that El's profit from the management agreements was sufficient to make the agreement unfair, particularly where the evidence showed that EI had suffered losses for years before profiting from the arrangement. Mowrey did not perform an analysis to determine whether SFN would have been capable of taking the management services in-house. He did not render an opinion that any particular percentage or minimum guarantee in any of the management agreements were unfair, except for the SARMA, and that was because it resulted in profits for EI. He acknowledged that he was not testifying that any of the costs that EI spent performing services for SFN or KN were fair or unfair. His profit chart did not take into account EI's losses from 1994 through 1999, and he acknowledged that an offset of those losses would be fair.
The trial court also found that Mowrey did not analyze "the costs to perform" the services that were performed by EI and "the additional costs that would have been required if the personnel necessary for the management services were incorporated into the SFN/KN, Ltd. operation." In her cross-appellant's reply brief, Neuburger argues for the fist time that the court erred in concluding Mowrey had not analyzed the costs to SFN/KN to provide such services, as he was "provided detailed information about the costs EI incurred to provide these very services, and he used the data to evaluate whether KN/SFN could and should be managed in-house, as opposed to paying someone else for those services." Neuburger fails to cite to the record for this assertion. In fact, Mowrey testified he had the cost data available, but that he had not analyzed the fairness of those costs. Rather he accepted EI's costs and compared EI profits to those of SFN/KN to support his opinion that because EI made a profit under the management agreements, those agreements were unfair. The record supports the court finding on this point. Were that specific finding erroneous, the record as a whole would still support the court's determination that the management agreements were fair.
Eber testified that EI lost money from 1995 through 2000, and Compton estimated that EI averaged approximately $100,000 per year profit on the management agreements. ~(RT 4457-4458)~ Eber testified that SFN/KN was "highly leveraged" at the point of entering the SARMA, and that they were relying upon Eber's unlimited guarantee, that the companies as a practical matter did not have the staff to bring the many services in house, that they did not have the expertise to manage the internal or external process, and that they did not have the space. Defendants produced evidence that, without the agreements, should Neuburger try to bring the management functions in-house, EI's unlimited corporate guarantee and credit rating with the factor would cease, causing the corporation to fold. Compton also testified that he had concluded after his examination of the question that it was "impractical and improbable and not possible" for SFN and KN to bring the management services in-house.
Further, the evidence supported the court's finding that the success of the Karen Neuburger clothing line was "due in great part to the expert management efforts of EI and its personnel," and that the principals would not willingly agree to perform those services in house for SFN/KN. Eber and Compton had knowledge about and relationships with factors and other outsourced service providers, and Neuburger herself had testified she would probably hire Cass, Eber or Compton to be in charge of the factoring and banking relationships. The court recognized Cass had testified explicitly that he would not work for SFN.
The court's finding that there was no persuasive evidence that SFN and KN had the financial ability to bring the management function in-house was amply supported by the evidence.
Nor are we persuaded by Neuburger's argument that defendants' showing that SFN/KN would have been unable to perform management services for themselves, and that the amounts spent by SFN/KN for general and administrative expenses were reasonable when compared to similar companies, did not prove the management agreements were "fair." First, the finding that SFN/KN would have been unable to perform the management service for themselves, completely undermines Neuburger's contention and Mowrey's opinion that "any profit" on the management agreements by EI was a breach of fiduciary duty, as his conclusion was premised on this assumption that SFN and KN could bring the services performed by EI in-house and so retain any profit for themselves. Second, as the parties were unable to produce evidence of comparable management agreements in the industry, it was reasonable for the court to look to the Moss Adams survey of general and administrative expenses for comparable companies, as relevant to the court's determination whether the SARMA entered into in December 2003 was fair. That the Moss Adams survey was completed more than a year after the SARMA was executed, was a factor for the court to consider in weighing its relevance, but does not render the study irrelevant to the issue of fairness.
The court stated it had "received no evidence suggesting that the management contracts with their percentages apportioned to services provided were not a reasonable attempt to quantify the cost structure of the companies." It further found defendants had shown "steps were taken to analyze the costs, that amendments and new agreements were made as the relationship continued, and that a request for confirmation of the fairness of the agreement was made after it was challenged." These findings are amply supported by the evidence.
In addition to Whitman's testimony that it appeared to him the minimums were derived from an estimate of EI's average monthly cost to provide the services and that the minimums charged were reasonably based on EI's expenses in providing those services, Compton testified to the basis for the various changes in the management agreements and their amendments. He testified that, as to the 1998 Amended and Restated Management Agreement (ARMA), he calculated the minimum guarantee formula based on Eber's estimate or forecast of the gross sales, reduced to net sales, divided by 12 and multiplied by the management fee. Compton further testified that he believed the $162,000 minimum in the 1998 ARMA allowed EI to maintain a cash flow that allowed them to provide the services to SFN that it required and that he believed it was reasonable. He also explained the reasons for various increases in some charges in amendments to the ARMA. The same formula was used to arrive at the $250,000 minimum in the 2003 SARMA, and that monthly minimum was also to give EI the necessary cash flow, month-to-month, to be able to provide the services SFN required. The court found his "testimony describe[d] the logic behind the increased gross sales to the company and the need for increasing the guaranteed monthly sums in the various agreements and amendments." Moreover, Cass testified that as sales grew, the sales volumes resulted in increased payments from EI to the outsourced warehouse that served as a "third-party logistics provider." Cass also testified that toward the end of 2003, SFN transitioned from a manufacturing to a distribution model. Therefore, there was a reduction in the cost of goods sold expense. This also resulted in changes in the employee structure between EI and SFN. Defendants produced evidence that EI's reduction in staff from around 500 employees to 14 or 15 employees reflected EI's transformation from a production-based business to a service-oriented business. When SFN moved from manufacturing to a production model, and the companies were being housed together, one of the results was that certain positions were eliminated at EI and many of the persons working in those positions were hired at SFN/KN for other types of positions.
The final management agreement, dated December 1, 2003 (the SARMA), reduced the management fee from 14.15 percent to 9.5 percent and dropped the guaranteed monthly minimum from $294,890 to $250,000, in part because of new efficiencies in the new combined location of the companies. Eber and Compton testified that one reason for the changes to the SARMA in 2003 was that SFN's needs were changing. Everybody was coming together in one building. The nature of the relationship between the companies were changing. Some of the production costs were no longer being incurred by EI.
We conclude that substantial evidence supports the court's finding that defendants had sustained their burden of showing that the management agreements were fair.
The judgment is affirmed. The parties shall bear their own costs in connection with the appeals.