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In Case You Hadn’t Heard… New Case on Officers’ Excessive Compensation

May 9th, 2016 by mmohler

This case was initially brought by Lynn Edelman (“Mr. Edelman”), individually as a minority shareholder and on behalf of EDCO Tool and Supply, Inc. (“EDCO”), as a minority shareholder in EDCO. Mr. Edelman brought this proceeding against the majority shareholders and officers of EDCO alleging that the defendants did not allow minority shareholders access to EDCO’s corporate and financial records and that it was a breach of defendants fiduciary duties to amend the articles of incorporation to allow preferred shareholders absolute discretion to determine the amount and timing of preferred share dividend distributions (Mr. Edelman voted against this amendment). The amendment to the articles allowed the defendants to pay themselves, in addition to their salaries, preferred share dividends.

Rebekah testified on behalf of Mr. Edelman regarding the reasonableness of the compensation paid to the majority shareholders. Rebekah’s analysis showed a significant decline in revenues and a significant increase in compensation as a percentage of revenues. In fact, in multiple years, the total compensation paid to defendants exceeded 100% of EDCO’s net profits. In addition, Rebekah’s analysis revealed a significant decrease in EDCO’s investment portfolio because substantially all of the preferred dividend payments to the defendants were funded by the proceeds from sales of stocks held for investment. Ultimately, Rebekah opined that defendants overpaid themselves beginning May 3, 2008 and that the investment portfolio was not a sustainable source of funding for payments to the defendants.

Judge Richard A. Frye, the trial court judge, held that defendants breached their heightened fiduciary duty to Mr. Edelman as a minority shareholder by “taking excessive preferred dividends for themselves” from EDCO’s long-term cash reserves accumulated mostly while Mr. Edelman was still employed that “really belonged to all the shareholders.” The trial court awarded Mr. Edelman, individually, $468,000 based on the breach of fiduciary duty. Defendants appealed, arguing it was improper for the trial court to place the burden of proof on defendants regarding the reasonableness of compensation and that the finding that defendants were paid excessive compensation was against the manifest weight of the evidence.

The Tenth District Court of Appeals found that, “[w]hen a minority shareholder of a close corporation brings suit against a controlling shareholder for breach of his or her fiduciary duties, a presumption arises that the fiduciary, by virtue of his or her superior position, bears the burden of proof with respect to the fairness of his or her actions.” In addition to confirming the shift of the burden of proof, the Appellate Court also confirmed that no information was presented by the defendants at the trial court level to support the reasonableness of their compensation.

The Tenth District Court of Appeals also overruled defendants’ assignment of error as it relates to excessive compensation citing Rebekah’s testimony and stating that she is “a very well-qualified, objective, and credible witness.” Specifically, the Court of Appeals found that Judge Frye’s decision was not against the manifest weight of the evidence because there was sufficient evidence to prove that the preferred share dividend distributions were made during a time EDCO was not profitable and that these dividend distributions had to be paid from long-term cash reserves that had largely accumulated while Mr. Edelman was still employed at EDCO.

Click here to read the full opinion.

2 thoughts on “In Case You Hadn’t Heard… New Case on Officers’ Excessive Compensation

  1. Ted Dunn

    Did your expert analysis differentiate between the direct claims of the minority shareholders and the derivative claims in favor of the corporation, and, if so, what methodology did you employ to assess damages to each these claims?

    Reply
    1. Rebekah Smith

      Thanks for your inquiry. Our testimony did not delineate between the claims of the minority shareholders and the derivative claims in favor of the corporation. The focus of our testimony was primarily on the compensation paid to the majority , the preferred share divide distributions and how the distributions were funded (i.e. from existing assets versus current profits). While we weren’t asked to delineate between the claims, I’d be interested to hear how one might accomplish that? Thanks! – Rebekah Smith

      Reply

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