No Breach of Fiduciary Duty in Fraudulent Stock Transfer Agreement, But There Was a Breach of Contract and a Violation of the Implied Covenant of Good Faith and Fair Dealing

No Breach of Fiduciary Duty in Fraudulent Stock Transfer Agreement, But There Was a Breach of Contract and a Violation of the Implied Covenant of Good Faith and Fair Dealing

      In a recent decision by a US District Court in Arkansas, it was held that, where a shareholder engaged in a fraudulent share transfer agreement, there was no breach of fiduciary duty. However, on the same facts, there was a breach of the implied covenant of good faith and fair dealing. Morrison v MC Express LLC, Case No. 3:17-CV-00144 BSM (E.D. Ark. Jan. 9, 2018).

      Mitchell started a trucking business, MC Express, Inc. He enlisted Morrison for assistance in obtaining customers. Morrison agreed to do so in return for both commissions and stock in the MC Express. In 2002, Morrison and Mitchell executed an agreement providing that there would be transferred to Morrison 10% of Mitchell’s stock in the MC Express upon “the removal of Chuck Mitchell’s personal liability by the holders of the debts owed by MC Express, Inc.” Morrison, with Mitchell’s knowledge and consent, held himself out as a “minority member” in the corporation.

      For over 10 years, no stock was transferred to Morrison pursuant to the March 29, 2002 agreement. In November, 2012, Mitchell, without Morrison’s knowledge, changed the name of the company to “MC Express Leasing” and formed a new LLC under the name “MC Express.” He then began to transfer many of the assets of the corporation to the LLC with the effect that the corporation was left undercapitalized. Then, December 2016, Mitchell told Morrison, inter alia, that Mitchell had never been personally liable on the debts of MC Express and for that reason Morrison would never be entitled to the 10% of the stock.

       Initially, the court found that there had been a breach of contract. Mitchell never guaranteed any of the bank debt or other obligations of MC Express, so the condition precedent to the transfer of the shares to Morrison had always been satisfied. In addition, by having transferred assets from MC Express to the newly organized LLC, in which Morrison had no and would have no ownership interest, Mitchell violated the implied covenant of good faith and fair dealing. “Morrison, however, presumably did not enter into an agreement to receive stock in an undercapitalized and pilfered corporation.”

       With respect to the claim for fiduciary duty, it was rejected on what may be a somewhat questionable basis. The court found that, while fiduciary obligations are owed to shareholders, Morrison never became a shareholder, and therefore cannot claim the benefit of those obligations. Understandable, but there exist a lingering question as to whether Mitchell, by having violated the stock transfer agreement and in so doing deprived Morrison of the rights to formally acquire the shares and thereby become a shareholder, should be able to hide behind his improper actions to deprive Morrison of the breach of fiduciary claim.