By James (Jase) B. Tilley III, Esq.
The Circuit Court of Howard County erred in dismissing Appellant’s complaint against his former employer Eastland and its Board of Directors for shareholder oppression, breach of fiduciary duty and unjust enrichment. Appellant alleged that as a minority shareholder and employee of Eastland he was entitled to receive “de facto” dividends from Eastland’s profits as part of his salary. Appellant asserted that upon termination of his employment, Eastland deprived Appellant of the de-facto dividend portion of his salary and defeated Appellant’s reasonable expectation as shareholder. The lower court incorrectly held that Appellants allegations were insufficient to state a claim for shareholder oppression. Furthermore, Appellant’s claim for breach of fiduciary duty and unjust enrichment were direct not derivative, because if proved, the deprivation of Appellant’s de-facto dividend could cause direct harm to Appellant. Finally, the lower court erred in relying on the “business judgment rule.”
Opinion By: J. Harrell
Eastland is a closely-held Maryland Corporation that imports and distributes food from international and domestic suppliers. In 2000, Eastland hired Mekhaya (Appellant) who became the Vice President of Operations. In 2008, Mekhaya received a 28% ownership interest in Eastland. Mekhaya’s brother (Oscar) owned 28% of the shares, Mekhaya’s mother (Vipa) owned 38% of the shares, and Oscar’s children owned the remaining 9% of the shares. Mekhaya served on the Board of Directors with Oscar, Vipa, and Thaitham.
Eastland was managed by Mekhaya’s father, Pricha. In 2017, the Board removed Pricha as president and elected Oscar as president despite Mekhaya’s objections. In August 2018, Eastland’s Board of Directors agreed to increase Eastland’s credit line. Mekhaya contested the increased credit line because management was growing inventory at an alarming rate. Stockholders were compensated on a salary basis and the salary allegedly included dividends from company profits. In October 2018, Eastland held a shareholder meeting and the agenda included a proposed study to consider the advantages of moving to a shareholder dividend compensation package in lieu of salaries. In October 2018 Mekhaya was not re-elected as a board member and he was subsequently terminated. At the time of his termination, Mekhaya was earning $400,000 annually.
In 2021 Mekhaya filed a complaint against Eastland and Oscar, Vipa, and Thaitham (Appellees) pleading three causes of action. First, Mekhaya alleged oppression of minority shareholder on the basis that Appellees frustrated his reasonable expectation as a stockholder by terminating his employment, removing him from the board of directors, failing to pay dividends, paying excessively high salaries, and diverting Eastland’s funds for personal use.
Second, Mekhaya alleged that Oscar, Vipa, and Thaitham breached their fiduciary duty to act in good faith by authorizing Eastland to pay excessive salaries and diverting Eastland’s funds for personal use and gain. Finally, Mekhaya claimed that Vipa and Oscar were unjustly enriched when they diverted Eastland funds for personal use and received excessive salaries.
Appellees filed a motion to dismiss arguing that Mekhaya failed to state claims for which relief could be granted. Appellees argue that Mekhaya did not establish the existence of a shareholder or employment agreement, and thus, the decision to remove Mekhaya from the board and terminate his employment could not be oppressive. Appellees asserted that Mekhaya failed to rebut the business judgment rule which assumes that business decisions made by a board of directors are reasonable and made in good faith. Furthermore, Mekhaya’s breach of fiduciary duty and unjust enrichment claim fails because Mekhaya did not show that the harm suffered was direct.
At the motion to dismiss, the trial court dismissed all counts with prejudice, finding that Mekhaya failed to adequately state a claim and erred in bringing count two and three as direct suits instead of a derivative suit. Mekhaya filed a motion to alter or amend the judgment alleging additional facts. The court denied the motion to amend or alter judgment.
The appellate court reviewed the circuit court’s decision to deny the motion to amend or alter judgment as correct as a matter of law. The court assumed the truth of the factual allegations in the complaint in favor of the plaintiff.
- The circuit court erred in finding that Mekhaya failed to state a claim for oppression of minority shareholder.
Under Maryland law an oppressive act is “a term commonly used to describe adverse treatment of minority shareholders in a closely-held corporation by those who wield power within the company.” Bontempo v. Lare, 444 Md. 344, 365 (2015). Oppression should be found only when the majority’s conduct seeks to defeat the reasonable expectations held by the minority shareholder in committing capital to the enterprise, and the minority’s expectation was reasonable under the circumstances and central to the shareholder’s decision to join the company. Edenbaum v. Schwarcz-Osztreicherne, 165 Md. App. 233, 258 (2005)
Mekhaya properly stated a claim for shareholder oppression by alleging that the Appellees’ decision to fire him, and refuse to pay the de-facto dividend, defeated his expectation as a shareholder. The circuit court erred by basing its decision upon the finding that there was no confirmed basis for an expectation of a de-facto dividend. The question was not whether Eastland ever expressly declared the distribution of de-facto dividends. The question is whether Mekhaya sufficiently pled that he had a reasonable expectation to receive company profits through his shareholder salary.
The Court finds that Mekhaya’s expectation of receiving de-facto dividends was reasonable. Although Maryland statutes do not expressly address de-facto dividends, the concept of a constructive dividend is a nationally recognized concept. The Court notes that closely held corporations are incentivized to characterize payments to shareholders as a salary so that the payment can qualify for federal tax deductions. See 26 C.F.R. § 1.162-7(a). Other courts have found that regardless of how the corporation characterizes the payment, the transaction “should be examined to determine whether they are in fact a distribution of dividends, and if so the excluded shareholder must participate equally in payment received by other shareholders.” Alaska Plastics, Inc. v. Coppock, 621 P.2d 270 (Alaska 1980). The Court states that other circuits have found minority shareholders have a “reasonable expectation to receive some benefit from their minority share.” Ford v. Ford, 878 A.2d 894 (Pa. Super. Ct. 2005).
The Court holds that Mekhaya properly advanced a showing that his expectation of receiving de-facto dividends was reasonable. Thus, Mekhaya’s complaint demonstrated that the Appellees defeated Mekhaya’s reasonable expectation as a minority shareholder when Appellees terminated Mekhaya’s employment and stopped paying his salary.
- The circuit court erred in dismissing Mekhaya’s claim for breach of fiduciary duty. The circuit court incorrectly concluded that Mekhaya could not bring a direct suit or overcome the presumption afforded by the business judgment rule.
Mekhaya sufficiently demonstrated that Appellees’ failure to pay de-facto dividends breached their fiduciary duties and caused direct harm to Mekhaya. To establish a breach of fiduciary duty, the plaintiff must show “(i) the existence of a fiduciary relationship; (ii) breach of the duty owed by the fiduciary to the beneficiary; and (iii) harm to the beneficiary.” Plank v. Cherneski, 469 Md. 548, 599 (2020) (quotation marks and citations omitted); Shenker v. Laureate Educ., Inc., 411 Md. 317, 346 (2009). In closely held corporations the “majority shareholder owes a fiduciary duty to the minority shareholder not to exercise control to the disadvantage of the minority stockholders.” Mona v. Mona Elec. Grp., Inc., 176 Md. App. 672, 697 (2007). A minority shareholder may brig direct suit when “the shareholder suffers harm directly or a duty is owed directly to the shareholders, though such harm may also be a violation of a duty owing to the corporation.” Shenker v. Laureate Educ., Inc., 411 Md. 317, 345 (2009).
The Court found that Mekhaya properly pled that Appellees owed Mekhaya a fiduciary duty as a minority shareholder. Appellees owed Mekhaya the duty of a de-facto dividend and the Court stated that “a declared but unpaid dividend is an asset of the shareholders to who it is owed.” In re Classic Coach Interiors, Inc., 290 B.R. 631, 636 (2002). Thus, taking the pleadings as true, the Court found that the Appellees had a fiduciary duty to continue to pay the de-facto dividends to Mekhaya. The Court further held that the breach of fiduciary duty claim may be brought as a direct suit because recovery of the unpaid dividends would go directly to Mekhaya.
- The circuit court incorrectly dismissed Mekhaya’s claim for unjust enrichment.
To establish a claim of unjust enrichment a plaintiff must prove “(1) that a benefit was conferred upon the defendant; (2) that the defendant knew about or appreciated the benefit; and (3) that it would be inequitable to allow the defendant to retain the benefit.” Mona, 176 Md. App. at 712-13. Mekhaya identified that the “benefit” conferred to Appellees was the unpaid de-facto dividend. To sustain the claim, Mekhaya will need to show that he was owed the dividend, that Oscar and Vipa understood that the company used a de-facto dividend as a compensation structure, and that it would be unjust for Appellees to retain the dividend. In this case, the court found that Mekhaya adequately pled facts to support each of those requirements, and that as a result, the circuit court erred in dismissing the claim for unjust enrichment.
Jase Tilley is with Lerch Early & Brewer, where he works on a variety cases ranging from probate matters, disputes over business relations, corporate transactions, and insurance disputes.