By Bill Sinclair, Esq.

Opinion By: Gould, J.

HOLDING

In 2022, the Appellate Court reversed the Circuit Court of Howard County’s judgement in dismissing the plaintiff’s complaint against their former employer and its attendant Board of Directors. The Appellate Court found that the plaintiff alleged sufficient facts to support a cause of action for all three counts in the initial complaint. Mekhaya v. Eastland Food Corp., 256 Md. App. 497 (2022). 

Recently, the Maryland Supreme Court affirmed in part and reversed in part the judgment of the Appellate Court, holding that plaintiff’s proposed amended complaint adequately alleged: (1) that as a minority stockholder, he reasonably expected his stockholder status would give him ongoing employment and managerial involvement in the corporation; (2) that he had a reasonable expectation of receiving a share of distributable profits based on his ownership percentage, and (3) facts to overcome the presumption that directors complied with the statutory standard of care.  The Supreme Court further held plaintiff’s claim for breach of fiduciary duty based on the failure to make distributions should have been brought against the corporation and that his claim for breach of fiduciary duty and unjust enrichment based on misuse of corporate funds should have been brought as a derivative claim.

FACTS

Eastland is a family-owned and operated corporation in Maryland that imports and distributes food from international and domestic suppliers. The corporation was founded and managed by Pricha, the father of the plaintiff Mekhaya. In 2008, Mekhaya became the Vice President of Operations and received a 28% ownership interest in Eastland. Mekhaya’s mother (Vipa) received 38% of the company’s shares, his brother (Oscar) received 28% of the shares, and Oscar’s children received the remaining 9%. The same year, Mekhaya was elected to the corporation’s board of directors with Oscar, Vipa, and Thaitham. 

In 2017, the Board removed Pricha as president and elected Oscar to take his place as the company’s new president. The following year, the board increased Eastland’s credit line despite Mekhaya’s concerns about the company’s inventory growing at an alarming rate. Stockholders were paid on a salary basis which allegedly included dividends from Eastland’s profits. 

In October 2018, Eastland held a shareholder meeting to elect the board of directors and discuss various matters, including a proposed study to consider the benefits of moving from a salary basis to a shareholder dividend compensation package. Mekhaya was not re-elected to the board of directors and his efforts to re-join were rejected at subsequent meetings. Three days after the stockholder meeting, Mekhaya was terminated from his position with Eastland. Moreover, Eastland refused to pay Mekhaya any share of its profits. Instead, Vipa, who allegedly had done nothing substantial for the corporation, and Oscar, who allegedly had caused a high employee turnover and low morale due to his inadequate management skills, were both taking excessive compensation and diverting company funds for personal use. 

In 2021, Mekhaya filed a complaint alleging three causes of action: oppression of a minority stockholder against Oscar, Vipa, Tisnai, and Eastland (Count I); breach of fiduciary duty against Oscar, Vipa, and Tisnai (Count II); and unjust enrichment against Oscar and Vipa (Count III). In Count I, Mekhaya alleged stockholder oppression on the basis that Appellees frustrated his reasonable expectation as a stockholder by terminating his employment with Eastland, removing him from the board, refusing to pay dividends, paying extremely high salaries, and diverting company funds for personal use. In Count II Mekhaya alleged that the Appellees breached their fiduciary duty through their authorization excessive salaries paid by Eastland and their diversion of Eastland funds for personal use and gain. Lastly, Mekhaya alleged in Count III that Vipa and Oscar were unjustly enriched since they were receiving excessive salaries and diverting company funds for personal use. 

Appellees filed a motion to dismiss, arguing that Mekhaya did not state claims for which relief could be granted and that in the absence of an established shareholder agreement, the decision to remove Mekhaya from the board and terminate his employment was not oppressive. They further argued that the breach of fiduciary duty and unjust enrichment claims failed because the harm suffered was not shown to be direct by Mekhaya. The trial court found that Mekhaya failed to adequately state a claim and dismissed all counts with prejudice. Mekhaya alleged additional facts and filed a motion amend the judgment, but the motion was denied by the court. The Appellate Court reviewed this decision and held that the Circuit Court erred in dismissing the complaint against Eastland and its Board of Directors for shareholder oppression, breach of fiduciary duty, and unjust enrichment. 

The Appellate Court’s decision to reverse the circuit court judgement was based solely on its analysis of the original complaint. The Supreme Court instead analyzed the legal sufficiency of the amended complaint since leave to file should have been granted if it stated a cause of action. After review, the court found that the proposed amended complaint alleged sufficient facts to support one of the three causes of action asserted by Mekhaya.

ANALYSIS 

Count I – Stockholder Oppression 

• The circuit court erred in dismissing Count I with prejudice and denying the plaintiff leave to amend the count pursuant to his proposed complaint as the amended complaint set forth sufficient facts to state a claim for stockholder oppression. 

The first count is a statutory claim alleging that the defendants have frustrated the plaintiff’s reasonable expectations as a stockholder by engaging in oppressive conduct involving: (1) the termination of his employment (2) removal from the board of directors (3) diverting Eastland’s profits from him to Oscar and Vipa; (4) refusing to declare and pay his dividends; and (5) refusing to pay the profits to Mekhaya as a bonus instead of a declared dividend, thereby causing him damages. This court has described oppression as “adverse treatment of minority stockholders in a closely held corporation by those who wield power within the company.” Bontempo v. Lare, 444 Md. 344, 365 (2015). Furthermore, the court in Edenbaum held that oppression is found only when the majority’s conduct seeks to defeat the reasonable expectations of the minority shareholder in committing capital to the enterprise, and the minority’s expectation was reasonable under the circumstances and central to the shareholders decision to join the company Edenbaum v. Schwarcz-Osztreicherne, 165 Md. App. 233, 257 (2005). 

Mekhaya properly stated a claim for shareholder oppression by alleging that when he accepted employment with Eastland, the expectation of continuous employment, participation in management, and the receipt of profits as an eventual owner were central to his decision to join. Eastland was founded by Mekhaya’s father and has only ever been managed and operated by family members. This court finds it reasonable for a son who leaves a profession at the request of his father to expect continued employment by the family-owned business, particularly since the period of employment predating the issuance of shares can be seen as Mekhaya’s father testing his son’s commitment and dedication to Eastland. 

Mekhaya also pleaded sufficient facts to support the reasonable expectation that he would receive his share of distributable profits in accordance with his ownership percentage. Generally, a reason for owning stock is to enjoy the benefits of economic success, which alone adds a measure of reasonableness to the expectation James J. Hank, Jr., Maryland Corporation Law § 7.1, at 223 (1994, 2019 Supp). Following Mekhaya’s termination, defendants Vipa and Oscar drew excessive compensation and diverted corporate funds for personal use to reduce the company’s profits. The court finds that these allegations do in fact state a viable cause of action for minority stockholder oppression under the standard articulated in Edenbaum and adopted in Bontempo. 

This court holds that since the proposed amendment to Count I would have been effective in stating a cause of action for stockholder oppression, the circuit court erred by dismissing Count I with prejudice and denying Mekhaya leave to amend that count pursuant to his proposed amended complaint. Additionally, this Court concluded that Mekhaya sufficiently pleaded facts that would constitute “oppressive conduct” under CA § 3-413(b)(2), and at trial a court would be permitted to fashion equitable relief in the same manner that this court and the Appellate court upheld in Bontempo and Edenbaum. 

Count II – Breach of Fiduciary Duty 

• The circuit court correctly dismissed count II of the complaint with prejudice and without leave to amend due to the plaintiff not having a viable direct claim for compensatory damages and not pursuing count II as a derivative claim on Eastland’s behalf. 

In Count II (breach of fiduciary duty), Mekhaya alleged that, as directors of Eastland, Oscar, Vipa, and Tisnair owe fiduciary duties to Eastland and its stockholders. Additionally, Mekhaya alleged that, as majority stockholders, Oscar, and Vipa owe him fiduciary duties as well. The factual basis for the breach of fiduciary duty claim is essentially the same as his oppression claim, specifically, Oscar and Vipa’s excessive compensation, diversion of corporate funds for personal use, and taking profits without paying Mekhaya his rightful share. Mekhaya argued that he is entitled to pursue a direct claim because the court in Shenker v. Laureate Education, Inc., held that CA § 2-405.1 acknowledged that directors owe duties to the stockholders. He further argued that he has a direct claim under the common law rule that majority stockholders owe fiduciary duties to minority stockholders Lerner v, Lerner Corp., 132 Md. App. 32, 53 (2000). 

The court finds that Mekhaya did not state direct claims regarding Count II, breach of fiduciary duty, for compensatory damages for the alleged excessive payments made to Vipa and Oscar. First, the cases addressing the fiduciary duties of majority stockholders to minority stockholders do not hold that such duties give rise to direct actions for compensatory damages Lerner, 132 Md. App. at 53. The court relied on Maryland law’s recognition of the majority stockholders’ duties to minority stockholder duties in establishing the breach gives rise to claims for equitable belief by minority stockholders Twenty-Seven Trust v. Realty Growth Investors, 533 F. Supp. 1028, 1029 (Md. U.S.D.C. 1982). Therefore, under the alleged circumstances, compensation for the breach of duty claim would lie in the oppression count. Second, Mekhaya alleged that he did not receive his rightful share of profits when the directors authorized Eastland to distribute profits to its stockholders. Therefore, his claim for compensatory damages would be against Eastland rather than the directors, but Eastland was not named a defendant for Count II. Third, Mekhaya’s claim regarding the misuse of corporate funds by Oscar and Vipa is flawed in that the damage was sustained by the overall corporation, not Mekhaya Mona v. Mona Elec. Grp., Inc., 176 Md. App. 672, 695 (2007). As a minority stockholder, Mekhaya did not suffer any damages distinct from Eastland’s that would sustain the compensatory damage claim, which is the sole remedy sought in this count. Lastly, Mekhaya did not sue derivatively on behalf of Eastland, but rather individually and as a result, this court holds that the breach of fiduciary duty count was properly dismissed by the circuit court. 

Count III – Unjust Enrichment 

• The plaintiff’s unjust enrichment claim is based on the same facts as those alleged in the breach of fiduciary duty claim. Therefore, the result and reasoning are the same: the benefits of excessive compensation and funds for personal use came at the company’s expense, not the plaintiffs’ expense. Accordingly, since Count III was asserted in the individual capacity instead of derivatively on Eastland’s behalf, the circuit court correctly dismissed Count III with prejudice and without leave to amend. 

The three elements a plaintiff must prove to establish a claim for unjust enrichment are “(1) a benefit was conferred upon the defendant; (2) the defendant was aware or the appreciated the benefit; and (3) it would be unfair to allow the defendant to retain the benefit.” Mona, 176 Md. App. At 713-13. Damages regarding unjust enrichment are measured by the defendant’s gain, not by the plaintiff’s loss Mogavero v. Silverstein, 142 Md. App. 259, 276 (2002). A claim for unjust enrichment “is not aimed at compensating the plaintiff, but at forcing the defendant to disgorge benefits that would be unjust for him to keep.” Hill, 402 Md. At 296.

Since Mekhaya’s unjust enrichment claim was based on the same facts supporting his breach of duty fiduciary claim, this court holds that the result is therefore same. The benefits of excessive compensation and misuse of company funds for personal use resulted in damages to Eastland, not Mekhaya directly. Therefore, the court finds that the circuit court did not error by dismissing Count III with prejudice, which contained claims Mekhaya asserted in his individual capacity rather than derivatively on behalf of Eastland. 

In conclusion, this court finds that under Maryland law, the proposed amended complaint set forth sufficient facts to state a claim for stockholder oppression, however, the amended complaint did not allege sufficient facts to support the plaintiff’s direct claims for breach of fiduciary duty and unjust enrichment.

Full Opinion available HERE | Appellate Court Opinion available HERE | MSBA Business Law Section Blog HERE

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Bill Sinclair is the chair of Silverman Thompson’s (https://www.silvermanthompson.com/) business litigation practice.